M&A Vocabulary – Understanding the experts: “Change of Control”

The target of a transaction is generally the acquisition of a company as a “going concern”, i.e., with the target company continuing its operations, including all of its business relationships and processes. The buyer is convinced that any planned integration of the target into its own structure will have a positive impact on the financial results of the overall company that emerges.

To achieve these positive effects, it is therefore important to the buyer that the transaction does not impair the target’s key, well-functioning business relationships. In extreme cases, the continued existence of a few selected—or even just a single—contractual relationship can be decisive for the acquisition from the buyer’s perspective.

Therefore, every legal due diligence includes reviewing whether material contracts with the target company’s business partners contain “Change of Control” clauses.

Such “Change of Control” clauses allow the benefiting contractual partner to assert certain rights if the relevant changes occur at the target company. The underlying idea is that, under certain circumstances, a party should be able to withdraw from its contractual obligations—for example, if the other party is acquired by a competitor or if there is another material change in the shareholder base of the contractual partner. Typically, such changes must be reported to the contractual partner; however, even if there is no contractually agreed notification obligation, it can generally be assumed that there is a duty to disclose with regard to the agreed circumstances that constitute a “Change of Control”, because by agreeing such a clause the parties have documented the materiality of these changes for the decision on whether to continue the business relationship.

These changes primarily involve a change in the (shareholder) structure of the target company that grants a third party a controlling influence over decision-making processes within the target. This is inevitably the case when the buyer acquires all shares. In addition, other—sometimes more far-reaching—arrangements are possible, e.g.:

• Extending “Change of Control” to include changes in the shareholder structure not only of the target company, but also of its shareholders (indirect “Change of Control”);
• Including personnel changes in the target company’s management in the definition of a “Change of Control”;
• Defining a percentage threshold for changes in shareholding relationships as a “Change of Control”.

In some jurisdictions, the criteria for a “Change of Control” are defined by law, although differing contractual provisions may be permitted.

While in supply or service agreements—aside from occasional rights to adjust terms—the contractual relationship can generally be terminated by notice without having to observe ordinary notice periods, loan agreements may also include further possible rights and claims of the bank, such as the provision of additional collateral or partial repayment of the loan amounts. However, even in such financing agreements, termination and full repayment of the entire outstanding loan amount is always established as a last resort.

As described above, there are typically information obligations between the contracting parties regarding the existence of circumstances that could give rise to a “Change of Control”. By contrast, the existence of such clauses in the target company’s contractual agreements is generally subject to a seller’s disclosure obligation in an M&A transaction only if either the relevant contractual relationship (i) is objectively material to the target company’s business activities (e.g., exclusive supply agreement, license, etc.) or (ii) the buyer has expressly pointed out the importance of continuing the respective business relationship unchanged.

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