In every sale transaction, among the initial considerations to be addressed is the impact of the potential structure of the transaction on the ongoing conduct of the business being sold. Generally speaking, determining the appropriate transaction structure is a function of tax, continuity of business operations and legal liability. Critical in that determination is understanding whether key customer, vendor or other commercial contracts contain restrictions on transfer or assignment of the contract, and whether those restrictions apply to a sale of assets, a change of control of the entity, or to other transaction structures (e.g. a merger or consolidation). If key commercial contracts contain restrictions that are triggered by the transaction structure and would potentially interrupt or negatively impact the business, then due consideration must be given to mitigating the risk to buyer and seller.
- What is an Anti-Assignment Clause?
An anti-assignment clause is a provision in a contract that prohibits or limits the ability of one contract party to transfer or assign some or all of their rights and obligations under the contract to another person or entity.
- Why are Anti-Assignment Clauses Typically Included in Commercial Contracts?
Anti-assignment clauses protect the original contract parties’ interests by ensuring that only the original parties benefit from (or are obligated by) the contract’s terms. Contracting parties can rely on the performance standards they expect from their counterparty and the ability to develop their business relationship over the contract term. Anti-assignment clauses also protect sensitive or confidential business information shared between the original contract parties from being disclosed to unwanted recipients, including competitors. Finally, anti-assignment clauses help ensure that businesses subject to strict governmental or regulatory requirements don’t run afoul of their obligations if an unanticipated assignment occurs.
- Why Do Contract Parties Negotiate to Limit the Scope of Anti-Assignment Clause in Commercial Contracts?
Many businesses rely on the ability to transfer contracts to meet changing business needs, particularly in connection with a sale transaction. An overly restrictive clause that prohibits any assignment, or a clause that permits assignment with consent, but doesn’t include appropriate limitations on a party’s ability to leverage that consent, ignores business realities. If the contract affects critical elements of business operations, such as financing sources, customer revenue streams or vendor supply chains, potential buyers look for assurance that the contract will remain in place post-sale. Contracts with appropriately tailored assignment clauses are more attractive to potential buyers because they allow these transfers to occur smoothly without unnecessary roadblocks or delays.
- What Are the Common Types of Anti Assignment Clauses
a. Assignment Prohibited:
Example: "Neither party may assign, transfer, or otherwise dispose of any of its rights or obligations under this Agreement. Any purported assignment shall be null and void."
This clause prohibits any direct assignment of all or any part of the contract from the original contract party to another entity. Any attempted assignment without a waiver of the clause by the non-assigning party will constitute a breach of the contract.
b. Assignment Permitted with Consent:
Example: "Neither party may assign, transfer, or otherwise dispose of any of its rights or obligations under this Agreement without the prior written consent of the other party, not to be unreasonably withheld, conditioned or delayed. Any purported assignment made without such consent shall be null and void."
This clause provides some flexibility, permitting assignment but only with the express consent of the other party. Assignment clauses that permit consent often provide that the non-assigning party cannot unreasonably withhold, condition or delay their consent. This prevents the non-assigning party from arbitrarily withholding consent or leveraging their consent to unfairly negotiate new contract terms.
c. Assignment Prohibited in a Change of Control/Sale of Substantially All Assets Transaction:
Example: "Neither party may assign, transfer, or otherwise dispose of any of its rights of obligations under this Agreement, including upon (i) a sale of all or substantially all of its assets or (ii) a direct or indirect change of control of the assigning party."
This clause prohibits both direct assignment in any asset sale (where the contract party itself sells some or all of its assets, including the subject contract, to a third-party buyer) and in an equity “change of control” sale (where the equity owners of the contract party sell their equity to a third-party buyer).
d. Assignment by Operation of Law Prohibited:
Example: “Neither party may assign, transfer, or otherwise dispose of any of its rights of obligations under this Agreement by operation of law in connection with a merger, consolidation or reorganization.”
This clause prohibits assignment in specific M&A transactions, namely mergers and consolidations, if and as dictated by applicable state law. Though state laws vary, in many states the contract, and the merging party’s rights and obligations under it, are automatically assigned to the successor entity in the merger unless the contract explicitly prohibits assignment in the context of a merger. The merger is treated as a continuation of the business of the merging entity by the surviving entity. The surviving entity assumes the assets and liabilities of the merged entity(ies) as part of the legal effects of the merger.
5. What Happens if a Seller Attempts to Assign or Transfer a Contract to a Buyer in Violation of an Anti-Assignment Clause?
Any attempted assignment or transfer without compliance with the clause, or a waiver of the clause by the non-assigning party, will constitute a breach of the contract, giving the non-assigning party the right to exercise remedies against the seller. These remedies typically include the right to immediately terminate the contract, claw back fees and recover damages incurred by the non-assigning party as a result of the assignment. The contract will also become unenforceable by the buyer, negatively impacting business operations post-close. If the closing of the sale is contingent upon successful contract assignment, buyers may use the failure to obtain consent as an opportunity to re-negotiate purchase price.
6. How Does an Anti-Assignment Clause Affect an Asset Sale?
In an asset sale, assets are transferred from the seller to the buyer, giving the buyer ownership of those assets without changing the ownership or business structure of the seller itself. An asset sale may be structured narrowly, where the seller agrees to sell a specified list of assets that are materially meaningful to business operations (e.g., specified IP, material contracts, inventory, real property), or more broadly, as a sale of “all or substantially all” of the seller’s assets.
An asset sale that contemplates transfer of the subject contract from seller to buyer will trigger both an anti-assignment clause that prohibits direct assignment of the contract itself (example (a) above) and a clause that requires consent of the contract counterparty (example (b) above).
7. How Does an Anti-Assignment Clause Affect an Equity Sale?
An equity “change of control” results in a material change in the ownership or decision-making power of an entity, typically through the sale or transfer of a majority stake in its equity or the ability to control the entity’s governing body (i.e., board of directors).
A sale transaction that contemplates an equity change of control of the contract party will not trigger a clause that only prohibits direct assignment of the contract itself (example (a) or example (b) above), because the contract stays with the entity after the sale. But it will trigger an anti-assignment clause if the clause prohibits assignment on any direct or indirect equity change of control (example (c) above). In this case, even a change of control of the parent of the contract party would trigger the anti-assignment clause as an “indirect” transfer.
8. How Does an Anti-Assignment Clause Affect a Merger or Consolidation?
In a merger, two or more entities combine to form a single entity. The interpretation of a merger, and the enforceability of anti-assignment clauses, is governed by the law of the states where the merging entities are organized. When a contract party merges (or combines or consolidates) with a third party, the successor entity automatically inherits the rights and obligations by “operation of law”.
New Jersey courts consistently rule that anti-assignment clauses only prevent the assignment of rights, not their transfer by operation of law, such as in mergers or consolidations. Many states, however, will uphold anti-assignment clauses that explicitly prohibit the assignment of the contract in a merger even if “by operation of law” the contract would otherwise be assumed by the surviving entity (example (d) above). New York courts in particular have emphasized the need for clear, unambiguous language in anti-assignment clauses in order to prevent automatic assignment. In other states the enforceability of the clause turns on the structure of the merger itself. Delaware courts have held that if the contract party subject to the anti-assignment clause is the surviving entity in the merger, the clause will not be triggered, and no consent will be required.
9. What Can Sellers Do to Navigate Anti-Assignment Clauses in Connection with a Sale?
Understanding the impact anti-assignment clauses will have on a proposed transaction structure is essential for businesses navigating the complexities of an M&A transaction. To ensure the continued success of the acquired business, the buyer must inherit all key commercial contracts, as drafted and without change to the agreed contract terms. If these agreements cannot be transferred, the buyer risks losing vital business relationships, which can impact revenue forecasts, operational continuity, and ultimately, the value of the transaction. Sellers also bear this burden if the purchase price includes earnout consideration that is contingent on achieving future revenue targets or other metrics affected by commercial contracts. Even if contracts allow for assignment with consent, obtaining that consent can be time-consuming and costly. Counterparties may leverage their consent as an opportunity to negotiate more favorable terms, or in some cases, refuse to consent altogether, leaving the buyer with no choice but to replace the contracts. Contracts that are material to the seller’s operations (i.e., material customer or vendor contracts) may take longer to finalize, adding complexity and cost to the deal.
Businesses anticipating an eventual sale must plan for the future by negotiating flexible assignment provisions during the contract procurement stage. Ideally the assignment clause will be drafted to expressly permit assignment in connection with a sale transaction, specifically calling out an equity change of control, asset sale and merger/consolidation. If the counterparty will not permit assignment without their consent, then the clause should be drafted to prohibit them from unreasonably withholding, conditioning or delaying their consent. When existing contracts come up for renewal, take the opportunity to re-examine the assignment clause and re-negotiate as needed.
Before engaging with potential buyers, sellers must work with their financial and legal advisors to identify and analyze anti-assignment clauses during their internal due diligence review period. Understanding these provisions facilitates the seller’s ability to negotiate for a deal structure that ensures most (if not all) commercial contracts will remain enforceable after the sale closes and limits the risk of contract termination. When reviewing contracts against LOIs submitted by interested buyers, consider:
- whether the contract’s anti-assignment clause will be impacted by the buyer’s proposed deal structure (e., does the clause apply to an equity change of control transaction, an asset sale or both).
- how the proposed deal structure affects the seller’s contractual rights.
- what rights the contract counterparty may exercise if it refuses to consent to the transaction or the assignment provision is breached.
- how to support the buyer facing a potential termination or renegotiation of a contract during the post-sale integration phase.
Understanding these elements will facilitate a smoother sale process and minimize post-sale business disruption.
For more information, contact Jillian Benda Goldberg at .
