Change of Control Clause

A change of control clause protects a party that chose to deal with a particular business and its owners. If those owners sell, the clause lets the other party approve the new owner, walk away, or call in money it is owed.

Most clauses have two parts. The first defines "control". Common definitions catch a transfer of more than 50% of the voting shares, a change in who can elect a majority of the board, or control in fact. Broader versions also catch indirect changes at a parent or holding company, an amalgamation, or a sale of substantially all of the assets. The second part sets the consequence:

• Consent: the change cannot happen without the counterparty's prior written consent.
• Termination: the counterparty may end the contract on notice within a set window after the change.
• Deemed assignment: the change is treated as an assignment, so the contract's assignment rules, including any consent requirement, apply.
• Default: the change is an event of default, letting a lender demand repayment.
• Payment: the change triggers a payment, such as change of control severance.

Well-drafted clauses also carve out transfers that change nothing in substance, such as a transfer to an affiliate, an internal reorganization or a transfer to a family holding company.

The two clauses answer different questions, and which one matters depends on how the deal is structured.

A corporation is a separate legal person. When a buyer purchases its shares, the corporation stays the party to every contract, and no assignment occurs. A plain anti-assignment clause is therefore usually not engaged by a share sale; only a change of control clause, or an anti-assignment clause that deems a change of control to be an assignment, gives the counterparty a say. The tax and liability side of choosing a structure is covered under asset purchase vs. share purchase, and the free asset vs. share sale checker helps frame it.

In an asset purchase, the seller's corporation transfers each contract to the buyer. Contractual benefits can generally be assigned unless the contract restricts it, but obligations cannot be shifted to the buyer, and the seller cannot be released, without the counterparty agreeing. That release is a novation.

An amalgamation is a third case. Under section 179 of the Ontario Business Corporations Act, the amalgamated corporation possesses the property and rights, and is subject to the contracts, of each amalgamating corporation, so no assignment is needed, but a clause that expressly names amalgamation as a trigger will still apply.

Buyers find change of control and consent requirements in predictable places:

• Commercial leases: many leases deem a transfer of shares that changes control of a corporate tenant to be an assignment requiring the landlord's consent. See lease assignment vs. sublease.
• Loan and security agreements: a change of control is usually a default, so the seller's debt is repaid or refinanced at closing.
• Franchise agreements: franchisors control who owns the franchisee corporation, usually by treating a change of control as a transfer, and attach conditions such as training, fees and renovations. See franchise agreement.
• Customer, supply, distribution and licence agreements: key accounts may carry a termination right on a change of control, and intellectual property licences are often limited to the original licensee.
• Shareholder and joint venture agreements: a change of control of a corporate shareholder can trigger buy-sell rights for the other owners.
• Executive employment agreements: change of control severance may be single trigger (paid on the change itself) or double trigger (paid only if the executive is also terminated or demoted).

Third-party consents often set the pace of a closing. A disciplined review during due diligence usually follows these steps:

1. Obtain a complete list of material contracts and the full signed text of each, including amendments, side letters and renewals.
2. Review every contract for assignment, change of control, amalgamation, exclusivity and termination for convenience language, and record the trigger, the consequence, the notice period and the consent standard.
3. Sort the results into consents that must be in hand before closing, notices that can follow closing, and contracts that the buyer can afford to lose.
4. Make the critical consents a closing condition and have the seller represent that its schedule of required consents is complete.
5. Agree who approaches each counterparty, when, and with what information, so confidentiality is preserved and the counterparty is not surprised.
6. Allocate the cost of consents, such as landlord legal fees, transfer fees or price concessions, and decide what happens to the price if a key consent is refused.

The review should start early. A landlord, lender or major customer has no obligation to work to the buyer's timetable.

The best time to manage a change of control clause is when the contract is first signed, long before any sale. An owner who may sell or reorganize should ask for:

• Carve-outs for transfers to affiliates, internal reorganizations, estate planning and holding company transfers.
• A consent standard of "not to be unreasonably withheld, conditioned or delayed", with deemed consent if the other party does not answer within a fixed number of days.
• Notice only, rather than consent, where the counterparty's real concern is information.
• A termination right that must be exercised within a short window after notice, or not at all.
• A permitted sale of the whole business to a buyer of equal or better financial standing.

Where a contract leaves consent to one party's discretion, the common law duty of good faith requires that discretion to be exercised reasonably, meaning in a way connected to the purposes for which it was granted, as the Supreme Court of Canada held in Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7. The duty of good faith in contracts is a narrow safety net, not a substitute for a negotiated consent standard. The guide on when a business contract needs a lawyer's review lists assignment and change of control language among the red-flag clauses.

Teodor Varga owns all the shares of a Mississauga machine shop with annual revenue of $4.2 million, 38% of it from one automotive supply contract. Shirin Karimi's holding company agrees to buy all of the shares for $3.1 million.

Because it is a share purchase, no contract is assigned. Due diligence still finds three triggers. The supply contract lets the customer terminate on 60 days' notice after any transfer of more than 50% of the voting shares. The lease deems a change of control to be an assignment, with consent not to be unreasonably withheld. The bank's credit agreement makes a change of control an event of default.

The share purchase agreement makes the customer's written waiver and the landlord's consent closing conditions, and the bank debt is repaid at closing from Shirin's new financing. The customer waives its termination right in exchange for a three-year extension at prices 3% lower, so the parties cut the purchase price by $120,000 to reflect the lost margin. The landlord consents after Shirin signs a personal guarantee. The deal closes six weeks later than planned, but with its largest customer secured.