Do you want to know what happens to existing contracts when a business is sold? If YES, here are a few clauses and contract principles you must know.
When a business is sold or bought, a key component is the contracts to which the company is a party to. These contracts can be with customers and the source of a company’s revenue; with service providers or various licensing agreements that allow the company to operate or a lease for a particularly favourable location or on particularly favourable terms.
A company’s contracts are often an important part of a business, adding substantial value. Note that ensuring the transfer of any such contracts can greatly impact the structure and timing of the acquisition of a business.
Clauses That Determine What May Happen to Existing Contracts After a Business is Sold
The general rule with respect to contracts is that they are freely assignable. Like other types of property, agreements and the rights under those agreements can be transferred from one party to another. There are, however, some exceptions to this general rule. Note that legislation can restrict the assignability of certain types of contracts, as can public policy (as is the case with agreements dealing with spousal support).
Contracts that are personal in nature, maybe comprising personal relations or personal skills, are not assignable. An assignment of a contract cannot result in an increase of the burden on the remaining third party to the contract.
Additional, contracts may also include anti – assignment provisions, which expressly prohibit assignment of the contract, or provide that such assignment can only occur under certain conditions. Note that in the context of most purchase and sale transactions, the relevant exception will be the inclusion in the contracts of anti – assignment provisions.
However, if a business has a major change in ownership, (the sale of a business, for instance), part of the terms of the sale may be the assignment of the contract to the new owner. If the business sale documents don’t specify, you might have to look at the contract itself.
As part of the buy/sell process, a new contract may be substituted for a previous contract, with the agreement of both parties. All these factors and options are explicitly explained below.
2 Major Contract Principles That Dictate How a Contract is Transferred
Many business contracts include sections dealing with what happens if there is a change in the business. Two contract principles that might affect the need to make a change in the contract are novation and assignment.
Novation is a substitution, including the substitution of one party or obligation for another in a contract. This is how that works: Party X and Party Y are the main signers of the contract. Party X has been bought by Party Z, Parties X and Yare expected to agree to the novation and sign a novation agreement stating that Party Z has been substituted for Party X. Party X is excused from liability by the novation agreement, and Party X gives up any rights against Party Y.
However, a novation agreement signed by all parties is not always the best way to get started. It can be an expensive way to go about the process especially because the existing company would need to provide agreements to every customer.
Also note there is a risk that a customer will refuse to sign the novation, will want to renegotiate the terms of the novation, or will seek to renegotiate the terms of the original contract. Should the customer refuse to sign the novation, it could still be possible for the establishment of novation to occur if the consent is received from the conduct of the customer.
For instance, the consent can be inferred when a customer deals with a one specific company instead of the existing company over the course of time. Additionally, if the customer will not consent to a novation, the existing company will have the choice to end the contract if they choose to do so. This option is dependent on the terms of the individual contracts that are signed.
Assignment is a transfer of some property or ownership to someone else, including duties and rights. The assignor in the contract will no longer get any benefits of the rights assigned. These will be transferred to the assignee.
Even though the assignor will divest the contract rights, the assignment will not eliminate any performance obligations of the assignor to the non – assigning person. The non – assigning party will keep the right to get the performance from the assignor, the remedies against the assignor if the party does not perform
Nonetheless, it is pertinent that everyone is familiar of what the terms of the contract include. Assignment of obligations and rights is a very simple concept but with very crucial ramifications within the context of the law. There are major restrictions on the effect of assignment in a lot of cases.
Note that all documentation needs to provide a clear explanation of the provisions regarding assignments. It should also outline why this is so necessary for a contract to work properly. A company could choose to assign a contract to one party and assume that it will have rights outlined in the contract. However, an assignment will only transfer the company’s rights, such as getting paid.
Have it in mind that the burden under the contract does not get transferred and will stay with the company. The burden can be dealt with in a couple different ways: The risk for the outgoing party will be financial with regard to non – performing claims.
It can then seek indemnity from an incoming party for breach of failure to perform. Also the company can subcontract the performance to the party, meaning the company will then transfer the obligation to perform while the company is responsible for those obligations.
Note that assignments are typically allowed by law except when it is prohibited against the assignment in a lease. When assignments are allowed, assignors are not required to contact the other parties in the contract. They can just assign rights. But also note that assignments can’t have a negative effect on the duties of the other parties to the contract. It cannot also prevent the other party from getting a complete performance.
Assignment and novation are completely different. They can both be used to make changes in a business but in different ways. With assignments, you will continue to perform while giving some of your rights to another party. Howbeit, if you have a contract with a business and something changes, consult your attorney before you make any decisions, sign a new contract, or make statements that might compromise your status in the contract.