Change of Control Clauses

Many agreements may align their definition of control to that of section 2 of the Companies Act, which sets out the definition of control for companies, close corporations and trusts. In respect of companies, a person controls the company or its business if it is (i) a subsidiary of that first person as determined in accordance with section 3(1)(a) of the Companies Act; or (ii) that first person together with any related or inter-related person, is (a) directly or indirectly able to exercise or control the exercise of a majority of the voting rights associated with the company’s securities, whether pursuant to a shareholder agreement or otherwise; or (b) has the right to appoint or elect, or control the appointment or election of directors of that company who control a majority of the votes at a meeting of the board. A similar definition of control exists for close corporations and trusts. In addition, an overarching definition is contained in section 2, which provides that a person controls a juristic person or its business if that first person has the ability to materially influence the policy of the juristic person in a manner comparable to a person who, in ordinary commercial practice, would be able to exercise an element of control referred to above.

 

Including a change of control clause in a material agreement is not uncommon. Typically, change of control clauses are included in agreements where there is an interest in understanding the “controlling mind” of a counterparty, either in light of the long-term duration thereof or the nature of the relationship being established. The concern may be that when the “controlling mind” of such counterparty has changed, the contractual relationship between the parties may not be as viable. Change of control clauses usually include lang-uage requiring the written consent of the counterparty prior to implementing such change of control, or stipulating that the implementation of a change of control would constitute an event of default, triggering termination of such agreement or some other negative consequence.

 

Examples of agreements which could contain change of control clauses, unbeknownst to a shareholder, are agreements concluded by companies with material suppliers, contractors, or even key employees.

 

When conducting a due diligence investigation, it would be important for a purchaser (or a seller in the event of it conducting a vendor due diligence investigation for a bid process) to (i) determine the material agreements concluded by TargetCo; (ii) consider whether these material agreements contain change of control clauses which require prior written consent of the counterparty or may give rise to a termination event; and (iii) determine the likelihood of obtaining such consent and the anticipated time required to do so.

 

Triggering a Change of Control Clause

A change of control clause contained in a material agreement would usually set out the process to be followed if the clause is triggered. A common process would be that, prior to a change of control being implemented, TargetCo would be required to initiate discussions with and obtain the written consent of the counterparty. Failure to obtain this consent may result in TargetCo being in breach of the agreement, which would entitle the counterparty to remedies under the relevant agreement, such as termination or a claim for damages.

 

From a purchaser’s perspective, when acquiring a controlling shareholding in a company, one would prefer that the material agreements remain of force and effect, so that TargetCo may continue its operations on the same basis post-implementation of a transaction. For example, a material supplier ceasing to provide an essential component required for TargetCo’s operations may be detrimental to its revenue.

 

Companies should take caution when entering into agreements with change of control clauses.  Further, to mitigate the potential risks surrounding change of control clauses, the following should be considered:

 

• Shareholders may want to consider including an obligation on the board of a company in the memorandum of incorporation that shareholder consent is required prior to concluding agreements which contain onerous provisions, such as change of control clauses.

 

• In preparing for a sale, a seller may wish to conduct a vendor due diligence investigation to assess whether there are material agreements which include change of control clauses.  Similarly, a purchaser should conduct a due diligence investigation to assess the need to maintain any material agreements which may contain change of control clauses.

 

• Where change of control clauses are contained in material agreements, the parties should determine the likelihood of obtaining consent from a counterparty, and the time period (if any) in the agreement to obtain such consent.

 

Valayathum is a Director and Arends an Associate in Corporate and Commercial | Cliffe Dekker Hofmeyr.