They often say that the only thing that is certain in life is change (well, that and death and taxes, but they are topics for another occasion) and this adage certainly holds true in the corporate world.
Given the fact that acquisitions, divestments and other ownership changes are continually altering the shape of the corporate landscape, it is important for companies to know that their IT and other commercial contracts will be able to respond well to such changes. In this article, we look at some ways in which these contracts can be set up to deal with changes that may take place at a corporate level.
Acquisition of a new group company
Many companies seek to drive growth by acquiring other entities. However, in order to capitalise on any acquisition, it is important for the purchaser to integrate the new entity into its corporate group effectively. A critical aspect of integration is to ensure all group companies use a common IT system, as this will facilitate interaction within the group and also harness economies of scale to reduce the group’s IT overheads.
However, IT contracts are commonly not broad enough to cover an entire corporate group. In many cases, these contracts are made only for the benefit of one company (the contracting entity) and do not extend to cover related companies. However, if this issue is considered in advance, it is possible to prepare these contracts so as to cover the entire group. For example:
- where products or services are provided on a purchase order basis, the contract may provide that related companies are also entitled to place purchase orders. In this case, the service provider is likely to require that the contracting entity accept payment and compliance liability for products or services ordered by its related entities. The contracting entity may wish to manage these risks through intra-group indemnities (so that a group company placing a purchase order under the contract is required to indemnify the contracting entity against default under the purchase order);
- the contract may allow for a related company to enter into a direct agreement with the service provider on the same terms. This allows group companies to adopt the terms of the head contract without the need for negotiation. In this case, each group company can have a separate relationship with, and liability to, the service provider, but there will still be consistency across the group, with each group company gaining the benefit of the same services on the same terms and conditions. An associated issue with this structure is the splitting of group spend across a number of mirror image contractors with the one vendor. Given that the quantum of liability caps and service level rebate “at risk” amounts is normally directly tied to the quantum of contract spend this has the capacity to reduce the company group’s liability recourse against the service provider.
The scope of any mechanism that extends the benefit of a contract to other group entities will depend on the way that the contract defines the group. A common approach is to refer to the Corporations Act definition of “related body corporate”, so that the group covers the contracting entity and each of its related bodies corporate. However, care is needed when adopting this approach, as the Corporations Act definition will not cover all companies that may otherwise be considered to be part of the same group. In particular, it may not capture companies that are not under common “control” (in the sense of there being common control over more than 50% of the board members, voting rights or share capital of the relevant companies). This will mean that companies in which the contracting entity holds a minority shareholding miss out. It will also exclude companies with different ownership but which operate under the same branding (such as franchise companies) and unincorporated joint ventures. Where the intention is to include such entities, the definition of the licensee / customer will need to be broad enough to ensure full “group” coverage.
Divestment of an existing business
From time to time, a company may wish to sell part of its business, either due to a strategic shift in focus, in order to raise funds or other reasons. Whatever the context, the purchaser will want to know that it is acquiring all of the assets necessary to continue operating the business, both in terms of physical assets (such as plant and equipment) and also contractual assets (such as software licences and IT services).
Transferring a contractual asset is not necessarily a straight-forward matter. Often, contracts will expressly prohibit any transfer without the prior consent of the counterparty. In this case, the company will need the permission of the counterparty to transfer the contract as part of the sale. The power to withhold consent may give the counterparty leverage to require contract changes in its favour (for example, a software licensee may seek to charge an additional fee as a condition of giving its permission to a proposed transfer of a licence to a different entity).
Even if the contract is silent on transfer rights, the seller may not necessarily be in any better position. The common law generally allows a party to assign the benefit (but not the burden) of its contractual rights without obtaining the counterparty’s consent. However, this general principle is subject to some limitations. In particular, it is not possible to assign “personal” rights without consent. Copyright licences, such as a software licence, will normally be regarded as a personal right of the licensee which is not assignable without the licensor’s consent. Accordingly, even if an IT contract is silent as to the matter of assignment, this does not necessarily mean that the parties will have complete freedom to deal with their rights without obtaining counterparty consents.
In any case, an assignment by itself can only ever be effective to transfer rights under a contract. To transfer obligations under a contract, such as an obligation to pay licence fees, a novation will be required. A novation requires a three-way agreement between the original parties to the agreement and the new incoming party. Although the original counterparty’s consent will be required to give effect to a novation, recent case law suggests that, as long as it is drafted with sufficient clarity, licensor’s consent may be given in advance, as part of the original contract. If a company is contemplating divestments, it may wish to include in contracts used for that business a provision under which the counterparty agrees in advance to any novation of the agreement to a purchaser of the business.
Where the divested business is receiving services or licensing software under a group-wide contract then a different approach will be needed. The right to create mirror–image contracts for the benefit of the divested business is one approach. The right for the divested business to continue to receive services and use software for a period under the existing contract is another, although this structure will create liability issues for the divesting entity which will need to be covered off in the sale of business contracts.
In the context of an outsourcing the contract will ideally provide for the apportionment of spend baselines, liability caps, etc based on the respective historical spend of the divested entity.
Change of control
In some cases, IT providers may require a right to exit a contract if there is a change in the ownership of a customer (for example, where a new owner buys a controlling share in the company). The justification for this is usually that the provider has entered into the contract on the basis of the customer’s existing ownership structure, including the financial capacity of the existing owners, and should not be held to the contract if that structure changes in a way that could alter the provider’s exposure under the contract.
The clear difficulty with this from the customer’s perspective is that any change of control will then potentially jeopardise the continuity of the IT services on which its current operations are based. The risk that its service contracts will be terminated upon a change of control may have a significant negative impact on the value of the customer’s business and on its ability to attract potential purchasers, particularly if it will not necessarily be straight-forward to find a replacement service provider who can deliver an equivalent service. Accordingly, in order to preserve the value of its business, the customer will want to guard against giving the service provider an unfettered right to terminate for change of control.
Clearly the preferred position for the customer is to not agree to such a termination right at all. However, if the service provider absolutely insists, then there should be some limitations around its ability to exercise that right. For example, the customer may impose a condition that the service provider will only be able to terminate on a change of control if the new owner:
- does not have at least the same financial capacity as the previous owner; and
- is not able to provide security, such as a bank guarantee or financial undertaking, to secure performance of its financial obligations under the contract.