A change of control is where there is a shift in a company's ownership or management resulting in the decision-making capacity of the entity being transferred to a different group of shareholders and/or directors.
Change of control clauses are contractual provisions which are normally included in agreements such as mergers and acquisitions, financing arrangements, or IT vendor contracts. These outline the various circumstances under which the control of a company or its assets can be transferred to a third party. A change of control clause aims to protect the interests of parties involved in the agreement by specifying the events or triggers, such as a change of ownership or management structure of one of the contracting parties, which would qualify as a change of control. Such clauses often set out the rights, obligations, and remedies of the parties in the event of a change of control, potentially including (i) the ability to terminate the agreement; (ii) the right to accelerate payment obligations; or (iii) the right to impose restrictions on the transferee party. Essentially, a change of control clause aims to safeguard the contracting parties' interests and to ensure transparency and accountability in the contractual relationship.
Common transactions which trigger a change of control, include, inter alia:
- disposition of all or the majority of company assets;
- mergers;
- acquisition of a company's issued and outstanding shares in the target company;
- change of the company's board members; and
- change of shareholders.
Legal considerations
Legal considerations regarding change of control clauses in IT contracts are paramount due to the potential implications on both contracting parties.
First, drafting these clauses requires precision to define what constitutes a change of control event. This definition must encompass various scenarios such as mergers, acquisitions, or transfers of a substantial portion of assets, ensuring clarity to avoid ambiguity or disputes in the future. Moreover, parties must consider the implications of such changes on the obligations and rights under the contract. For instance, the non-assigning party might want the right to terminate the contract or renegotiate terms if there's a change of control, safeguarding against potential risks arising from dealing with a new entity with different capabilities, resources, or priorities.
Secondly, enforcement mechanisms and remedies need careful consideration within change of control clauses. Parties should outline specific steps or notifications required in the event of a change of control and establish clear procedures for the affected party to exercise its rights. Additionally, these clauses often include provisions regarding the consent of the non-assigning party for any transfer of rights or obligations resulting from a change of control, ensuring that the original parties maintain control over whom they contract with. Moreover, in the case of termination rights triggered by a change of control, parties must clearly delineate the consequences, such as the payment of termination fees or the transition of services to another provider.
Contracting parties should consider the impact which a change of control may have on their continued business relationship. After a service provider has experienced a change of control, customers should consider their best course of action by taking into account some of the following factors:
- potential changes to the levels of support and service provider compliance with service levels;
- impact on licencing models, such as on-premise versus software-as-a-service;
- pricing and licencing costs; and
- support and maintenance and/or continuation of specific products/service offerings.
The bottom line is that when there is a change of control, the management and organisational structure is likely to be restructured and certain products and/or service offerings may altered or discontinued based on the direction and commercial goals of the new board/management of the vendor. Companies must consider the degree of criticality of the vendor's/service providers service and how any changes to the services being rendered may affect them.
The observed trend among service providers, particularly when there is a change of control, has led to a notable increase in customers terminating their agreements with vendors who recently have undergone such a transition and seeking alternative vendors. However, the possibility of termination is dependent on (i) whether a right to terminate in light of a change of control is contained under your IT agreement; and (ii) the degree of criticality and integration of the vendor's software in existing business operations and enterprise systems. As such, it is crucial for companies to consider vendor/service provider lock-in, migration costs and the degree of change required in migrating vendors.
Furthermore, where a service provider experiences a change of control, they cannot materially degrade the standard of services being rendered under the applicable IT services agreement. Notwithstanding, a change of control provision in IT agreements, customers should ensure that such agreements make provision for the right to terminate in the event that the new acquirer renders services which are materially or substantially deficient in any of the following areas: (i) pricing and licencing; (ii) software functionality and requirements; and (iii) support and maintenance. Therefore, in order to prevent a company from degradation of the standard of IT services being rendered by a vendor/service provider due to a change of control, it should ensure that its IT agreement grants it the right to promptly terminate the agreement, and migrate to a new vendor, renegotiate core service terms that will be no less favourable than the previous agreement prior to the change of control event.
To avoid the risks of vendor lock-in and high migration costs, companies should engage in proper vendor due diligence before committing to a specific IT vendor. It is important to consider factors, including but not limited to:
- standard terms and whether such terms may be amended;
- vendor's attitude towards negotiations;
- vendor's market dominance;
- vendor's longevity and product/service offering roadmaps;
- criticality of vendor's services;
- degree of reliance on the vendor; and
- ease of switching/migrating to a new vendor.
Therefore, it is recommended that any IT agreements that an organisation may conclude with IT vendors contain a change of control clause granting the right to either (i) terminate the agreement; (ii) re-negotiate specific contractual terms; or (iii) revise pricing and licencing models. Accordingly, it is also recommended that companies maintain proper oversight over which of their contracts contain change of control clauses, what the triggering events are, and planned contingencies in the event that the change of control clause is triggered.
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.