Germany: Change-Of-Control Clauses In Joint-Venture Companies: Legal Pitfall In The Context Of Group Restructurings

Last Updated: 14 October 2008
Article by Martin Kock

Whether for tax reasons prior to the end of the fiscal year or to reorganize the corporate group in preparation for acquisitions or divestitures, corporate group restructurings generally take place under time pressure. Presumably they are under control, since the transactions take place "in house." Caution is warranted, however, when—as is often the case—the corporate group holds interests in jointventure companies.

Since the "fit" with the joint-venture partner is particularly important in the joint-venture context—unlike in a purely financial participation—each of the partners has an interest in protecting the ownership structures of the joint venture from unwanted changes. For this reason, change-of-control clauses are often used. In a first step, these clauses provide that the sale of shares in the joint-venture entity must be approved by the joint-venture partner. In addition, the nonselling shareholder is often granted preemptive rights; on the other hand, the nonselling shareholder can also be obligated to purchase the shares to be sold in the event he refuses to consent to the sale to third parties. In a second step, more complex clauses also cover the direct or indirect change in the ownership structure of the group entity holding the joint-venture shares (the "JV parent"). In this case, the corporate group entity can be obligated to sell its shares to its partners. Preemptive rights with respect to the shares of the JV parent are, in contrast, more difficult to implement and are typically not desired by the parties.

Such change-of-control clauses can be a problem in the context of a corporate group restructuring. If the JV parent is transferred within the group, a change in ownership formally occurs on the parent level, so the question arises whether the relevant change-of-control provision is triggered. It is highly advisable to address this question when forming the joint venture by providing for exceptions for transactions within the corporate group at both levels.

If the joint-venture agreement does not include such an exception, an attempt should generally be made to resolve the issue with the other joint-venture partner. Experience shows, however, that joint ventures generally have a sensitive equilibrium of conflicting partner interests. Therefore, every accommodation that goes beyond the contractual obligations typically has to be "paid for" by concessions from the partner requesting such accommodation.

Alternatively, one could also take the position that no change of control within the meaning of the clause has occurred. The whole purpose of change-of-control clauses supports this argument. The clause is intended to prevent third parties from influencing the joint venture; if the shareholding remains within the corporate group, there is no new partner from a corporate perspective. However, maintaining such a position may lead to discussion, even litigation. Therefore, measures should be taken which support the argument that there has been no change in control on a formal level, such as concluding specific control and controlprevention agreements as set out below.

Typically, change-of-control clauses encompass the acquisition or change of control over the JV parent in the corporate group. "Control" may be defined directly by reference to the corporate-law definition of "dependence" in the German Stock Corporation Act, or the definition may be fixed in the joint-venture agreement itself. Such definitions usually make clear that from a corporate group perspective, indirect control of the JV parent is exercised by the "higher level" companies, all the way up to the ultimate corporate parent. Therefore, if the JV parent is transferred within the group, it can by way of precaution conclude a so-called controlprevention agreement with its new parent. Such an agreement suspends corporate control and decisional authority and therefore prevents the new parent from obtaining control over the JV parent. However, the control chain remains interrupted by this type of agreement, as the JV parent is no longer controlled by anyone. Therefore, at the same time, a control agreement must be concluded with the JV parent and one of the companies in the old chain of control; this is most easily accomplished by concluding the agreement directly with the ultimate parent company. Although the entity that was formerly a higher-level company to the JV parent (and, in turn, even higher-level companies) therefore loses its control due to the transaction, a control change does not take place, since a change-of-control clause is typically worded to cover the acquisition of control rather than its loss or change. Through the control agreement, control is still exercised along the old control chain. At that level, direct control is merely substituted for indirect control; however, this change in the control structure is generally not covered by a change-of-control clause.

One must realize that even this construction does not entirely remove the risk of litigation. However, it does enable the joint-venture partner to base its arguments against a change-of-control event on the rationale of the clause, as well as on the wording. This will, in any case, improve the bargaining position. The exact wording of the change-of-control clause is decisive—the more clearly the clause refers to the statutory definition in the German Stock Corporation Act or the control of the ultimate corporate parent, the safer it will be to implement the corporate restructuring without the consent of the joint-venture partner.

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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