Canada: Beware The Boilerplate — Part II

In the second part of our series on the "boilerplate" of tech commercial agreements, we focus on the all-important assignment. In the last TLQ, we looked at governing law and dispute resolution provisions.

Easy To Miss

In the supplier standard form contract, the assignment clause (or, rather, non-assignment clause) typically sits quietly at the end of the agreement, seemingly harmless, stating (to the few who bother to read it) that the customer may not assign the agreement without the consent of the supplier.

Many business people fail to understand the implications of this clause. That is, until two or so years later, when the customer decides to reorganize its business and sell half of it to a third-party purchaser. Then the lawyers will be all over the assignment clause, and the big cost of ignoring this key provision at the time the contract was signed finally comes to light, because the non-assignment clause prevents the contract from being moved to another entity, as called for by the reorganization. Of course the customer can always ask the supplier to amend the contract, but this tends to result in additional fees being required by the supplier — whereas these likely would have been avoided had the proper assignment clause been negotiated when the deal was originally entered into.

Reasonable Flexibility is Key

The fundamental lesson from the above example is that in this day and age, where corporate reorganizations and mergers, acquisitions and divestitures occur with great frequency, an assignment clause that simply prohibits the customer from any transfer of the agreement is clearly inappropriate. Some degree of flexibility is critical, from the perspective of the customer.

The important question is "How much flexibility?" Is it reasonable for a customer to demand total discretion, as would be the case if the contract simply provided that the customer could transfer the agreement to any third party without the consent of the supplier? Virtually all suppliers will push back hard on such a proposition, as it would give rise to a secondary market in the software or services that are the subject of the contract. There are, however, certain narrow assignment scenarios that are very important to the customer but are typically not that problematic for the supplier (at least not when negotiated as part of the initial contract; when asked for by the customer later, the same flexibility from the supplier usually comes with a hefty fee to be paid by the customer).

Intragroup Transfers

One of these is the transfer of the agreement to an affiliate of the customer. The reason for such a transfer is typically driven by some form of reorganization of the corporate group to which the customer belongs. It might be, for example, that all IT agreements of a certain kind, worldwide, are being consolidated into a single, centralized entity.

Whatever the reason, most suppliers will not have a big issue approving, in advance (i.e., when the agreement is signed) such a possible future assignment by the customer. So, don't forget to reflect it in your revised version of the contract.

Sale of Business Exception

By far the most important exception to the "no assignment" default position of the supplier that a customer needs to address, however, is the scenario where the customer sells its business. At that point, it is usually critical that the outsourcing or other material commercial arrangement be transferable to the purchaser.

This is usually not a problem if the sale is being effected by a transfer of the shares of the customer. A non-assignment clause in a contract would not typically be triggered by a sale of shares, unless the contract specifically stated that such a change in control would be deemed to be an assignment (but this is done quite rarely).

The issue (for the customer) invariably arises when there is a transfer of the business by a sale of assets. In that case, the tech commercial agreement would be one such asset, and so the modified assignment clause ideally would allow a customer to assign the agreement (without supplier's consent) to a purchaser of the customer's business.

In this regard, the supplier may want to restrict the scope of this permission to those situations where the purchaser is buying "all or substantially all" the customer's assets. Be careful with such a narrowing. It essentially limits the permission to entire sales of your company. But it might be you're splitting your business into several businesses. In that case, a better formulation would be to allow the assignment to anyone who acquires the business unit(s) that uses the technology related to the contract at issue.

In short, it is very important that customers review the boilerplate (non)assignment clause, and then revise it to provide the customer with important flexibility as invariably will be required by the customer in the course of the next few years.

Novation vs. Assignment

As a customer, you need to consider one more important assignment-related issue. In most assignment situations, the assignor is not relieved of liability under the contract; rather, for this to happen, what the customer requires is a full novation (such that the supplier agrees the assignor has no ongoing liabilities under the contract after the transfer of it). While this is preferable to the assignor, it presents some real risks to the supplier, including as to the creditworthiness of the assignee.

It is therefore not unusual to provide, in this part of a beefed-up assignment clause, that the novation is conditional upon the assignee having a certain credit rating (typically somewhat commensurate with that of the assignor). This is not an unreasonable ask from the supplier, as its core concern under the contract is to get paid.

Supplier's Assignment Rights

To this point, we have focused only on the customer's assignment clause requirements. What about the supplier's reasonable needs?

Suppliers typically want full flexibility, and so, in their standard form agreements usually they simply don't say anything to restrict their assignment rights (silence on this point tends to mean the supplier can assign the agreement without the need for customer consent). Or, if addressed in the supplier's standard form contract, the right of supplier assignment will be made subject to obtaining customer consent, but it is also provided that such consent may not be unreasonably withheld by the customer.

Narrowing Supplier Discretion

In many cases (and in most cases involving sophisticated, big-ticket deals), the customer will want to restrain supplier discretion more than what is contemplated by the "not to be unreasonably withheld" standard. Bottom line: the customer has spent long hours in the RFP process, and in subsequent negotiations, determining that this particular supplier is the one that best suits the customer's needs. Therefore, from the customer's perspective, the supplier should not be permitted, as a matter of right, to hand off the work to an entity that the customer does not know (or worse, that the customer refused to do business with as part of the same RFP process).

What this analysis leads most customers to conclude is that the supplier should only be able to assign the agreement to an entity that acquires the supplier's entire business (on the assumption that the core business that had been providing services to the customer previously will then continue to keep so operating, but under new ownership). There is, then, some symmetry between this exception to the general no-assignment rule, and the same sort of exception required by the customer and noted above. In both cases, some flexibility is introduced into the contract, but not so much as to make the parties nervous about the future of their respective counterparties.

Carving Out Revenue Streams

The one exception to the foregoing is where the supplier wants to assign the revenue stream it receives from the customer under the contract. A supplier would do this as part of a fairly typical financing plan of the supplier's business, and for the most part, this arrangement should not present the customer with a problem.

It should be made clear in the contract, however, that notwithstanding such assignment of the payments, the customer will continue to interface only with the supplier, and that if there are any issues arising out of the contract, they will be dealt with only by the supplier (and not the assignee of the revenue stream). Thus, contractual comfort must be given to the customer that such an assignment of the fees paid or payable under the contract will have no adverse impact on the customer. For example, the language should stipulate that if the payments are assigned (or the right to receive the payments are assigned) to an entity resident outside of Canada, then the supplier will indemnify the customer from any related withholding taxes that the customer may now have to pay as a result of the assignment of the payment stream to a company not resident in Canada.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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