Section: Purchase and Sale
Negotiation Time: Minimal to Moderate
Transaction Costs: Insignificant to Expensive
Major Impact: Deal Value and Risk Management
Third Party Consents
What is This? Many times, businesses (or governmental entities) other than the Buyer and Seller will need to provide consent to some aspect of the transaction. This section lays out the consents that are required, which side is responsible for obtaining them, and addresses what happens if they’re not obtained.
The Middle Ground: In written legal agreements there is often language that either allows or prohibits unilateral assignment of the contract or a change of control with regard to a contracting party (such as the sale of a controlling interest of their business). A contract typically contains one or the other, and each has different legal consequences, but for ease of discussion we’ll refer to them collectively as “assignment” unless an explicit distinction is made between the two. In agreements that explicitly allow assignment or are silent on the issue, the Buyer will assume the place of the Seller. In agreements that explicitly prohibit it, the Buyer still needs to take the place of the Seller. In such cases, the Third Party Consents provision states that the Seller must use its reasonable best efforts to obtain the third party’s consent to an assignment. If the third party refuses to grant an assignment, the Seller is required to remain a party to the contract and act on behalf of the Buyer, to the extent the law and the contract at issue allow such an arrangement. Finally, the provision explicitly states that the Buyer retains its right to abandon the transaction if a third-party consent is not obtained, unless the Buyer waives that right in writing or moves forward with the Closing despite the absence of such consent.
Purpose: The Third Party Consents provision determines, where applicable, how third parties will be handled in transitioning contractual relationships. Some industries function almost entirely on the basis of formal contracts that prohibit assignments, while other industries involve few, if any, written agreements. When the target company operates in the former category, this provision is an important element of the Agreement because of its impact on the value of the deal to the Buyer. If the target company is in an industry involving few written agreements, and leased real estate is not an issue, a formal conversation on the issue of third-party consents is likely unnecessary.
Buyer Preference: For the Buyer, the two most important aspects of this clause are the ability to abandon the transaction if third-party consents are not obtained and the standard of effort the Seller must put forth to obtain them. In certain companies and industries, one contract may contribute a significant amount of value to the Business, and if the Buyer cannot benefit from that contract the Business is not worth the contemplated Purchase Price. In that situation, the Buyer must be able to walk away with impunity. By setting an effort standard for obtaining third-party consents, the Buyer has some assurance that the time and money spent on due diligence is not being wasted and that the Seller will attempt to procure the consents even after the Purchase Price has been paid (if the parties have mutually agreed to allow consents to be obtained after Closing). The Buyer wants to set a high effort standard, but one that is within the Seller’s ability to meet. Furthermore, if obtaining third-party consents is critical to the success of the Business moving forward the Buyer may require the Seller to represent that all such consents have been obtained (with any exceptions listed in the Disclosure Schedules).
Seller Preference: The Seller has numerous options for altering this provision to reduce its level of risk. First, it wants to negotiate an effort standard it is confident of being able to meet, which may be something less than “reasonable best efforts.” In lieu of a general standard, it might prefer to set out specific actions it must take to comply with this clause. Other options for controlling the risk presented by this provision include setting an end date for obtaining consents and setting a cap on expenses incurred as a result of trying to comply with this section.
Differences in a Stock Sale Transaction Structure: In a stock sale, no assignment of contracts is necessary since the Business is the party bound by the contract both before and after the acquisition. However, change of control provisions are specifically intended to prevent the Buyer taking the Seller’s place in a contract without the third party’s consent. Therefore, this provision is still necessary in a stock purchase to address the transfer of the Seller’s contracts that contain change of control language.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.