Boilerplate clauses – usually tucked away at the back of the contract – can seem dry and legalistic. But for high-tech companies, the wrong boilerplate clause in an IP contract can affect the valuation of the company. Two clauses – assignment, and change of control – are of particular significance.
Young, technology-based companies have a habit of running out of money. For financial and strategic reasons, a company may need to be able to react quickly to corporate opportunities, including mergers, acquisition, joint ventures, trade sales and stock market flotations. When doing so, it will need to demonstrate its market value.
The value of such a company may be based largely on the products that it has in development. In turn, this value can depend on two main assets: (1) intellectual property (IP), and (2) contracts affecting the development of the IP, including R&D agreements, consultancies, IP licences, option agreements, and so on.
If the IP contracts do not “survive” a corporate transaction such as an acquisition, they have no value to the acquirer. If the IP contracts are central to the value of the company, this may mean that the company has no value. When the acquirer’s lawyers conduct due diligence on the target company’s important contracts, the assignment and change of control clauses will be scrutinised closely.
There are two main ways in which a business can be sold. Either the shares in the company are sold, or the assets of the company are sold. The practical effect of each of these routes may be similar; which route is chosen may be based partly on an assessment of tax and liability issues.
In the case of an asset sale, the company’s IP contracts may need to be transferred to the buyer. An assignment clause in a contract states whether a party has the right to assign or novate the contract to a third party. Sometimes, the clause will permit transfer of the contract to a purchaser of the business. The acquirer in an asset sale will hope to see such a clause. In the absence of such a clause, and depending on the law of the contract, it may not be possible to transfer the contract to the acquirer.
Some form of assignment clause is often seen in a detailed commercial contract. Less commonly seen, but just as important, are change of control clauses. Typically, a change of control clause will state that a party may terminate the contract if there is a change of control of the other party. “Change of control” is usually defined in such circumstances, and typically will include the situation where a person acquires a majority of the shares of one of the contracting parties.
The presence of a change of control clause in a valuable contract may act as a “poison pill” in the event of an acquisition of the shares of a contracting party. In other words, the contract may have no value to the acquirer, if it can be terminated on a change of control.
At the time of negotiating important IP contracts, it is not always easy to persuade the other party to include a suitable assignment clause and to omit an undesirable change of control clause. In this blogger’s experience, the negotiating discussion is different, depending on the type of counterparty one is dealing with:
- If the other party is a young, high-tech company, it may understand the issue and readily accept the need for appropriate provisions.
- If the other party is a large, multinational company, it may understand the issue but its sympathy for the issue may be unpredictable. Sometimes it will be concerned about the IP contract being acquired by one of its competitors. We have been involved in negotiations where a change of control clause has been included but limited to situations involving another multinational company
- If the other party is a family-owned business, whose ownership has stayed in one family for generations (this type is encountered in some parts of Europe), there may be little understanding of the issue, and a lengthy discussion may be required
- If the other party is a Government body or charity, it may be concerned about transfers to an “undesirable” company. For example, cancer research charities are unwilling to allow transfers to a company that has tobacco interests.
Parties sometimes leave discussion of boilerplate clauses to the final stages of their negotiations, and they are sometimes surprised at the amount of effort that is required to reach agreement on seemingly innocuous boilerplate provisions.
After a posting of this kind, there is inevitably a plug: readers who wish to be well-prepared for such discussions will have read our book, A-Z Guide to Boilerplate and Commercial Clauses (Bloomsbury, 2nd edn, 2006). The book includes discussion of legal, drafting and negotiating issues in respect of a wide range of boilerplate clauses.