Change-of-control clauses


In practically all M&A transactions one of the key issues that require close attention by the acquirer at the due diligence stage and during negotiation of the transaction documents is the ability to transfer the target’s contract rights to the acquirer.

Commercial contracts (e.g. cooperation agreements, licences for key technology, etc.) and agreements with financial institutions (credit for financing operations, leasing agreements and the like) often represent some of the most valuable assets of the target, and thus the issue of effective assumption of rights under such contracts is crucial to the investor.

In the case of a transaction involving acquisition of shares, the issue of the change in the parties to legal relationships (here, contracts) does not arise. Thus contract provisions that prohibit assignment of rights under contracts do not apply to share deals. Nonetheless, even though the identity of the parties to the contract does not change as a result of the transaction, when a capital group sells shares in a subsidiary to another group, in practice this results in a change in control of the target-something which the other party to the contract may care about strongly.

Thus parties will often include change-of-control clauses in contracts, governing issues of the parties’ mutual rights and obligations in the event of a change in the ownership structure of one or both of them. Most often such clauses include provisions under which a change in the ownership structure of a party requires consent of the other party. Clauses of this type are routinely included in agreements with banks and other financial institutions.

Change-of-control clauses are based on the assumption that in commercial practice cooperating entities are often parts of larger capital structures (holding companies, capital groups or the like), and membership in such a structure may also be a condition for maintaining or breaking off commercial relations with a given entity. Membership in a group may give the other party an additional guarantee of reliability or solvency. And if one party to a contract is going to be acquired by a competitor of the other party, that might obviously justify a decision by the other party to end its cooperation with the target.

Regulations under Polish law

Change-of-control clauses have not been specifically regulated under Polish law, but the permissibility of their use may be clearly inferred from the principle of freedom of contract set forth in Civil Code Art. 353 1.

Because the concept of “change of control” is also not defined in Polish law, the definition of this term made by the parties when agreeing on their mutual rights and obligations will be of key significance.

Under Polish law, a change-of-control clause may be interpreted under Civil Code Art. 353 §2 as:

  • an undertaking to act-for example to notify the other party before or after the fact of a change in its ownership structure (involving acquisition of control over it by a third party), or obtain prior consent to such a change from the other party, or
  • an undertaking to refrain from acting-for example not to make changes involving control over the party without notifying or obtaining the consent of the other party.

If the parties did not define the concept of change of control in the agreement, it is necessary to interpret the concept under Civil Code Art. 65 and determine the meaning the parties would have assigned to it. For this purpose, reference may be made to other definitions used in Polish law in relation to concepts of control, particularly under corporate law, competition law and securities law.

Types of change-of-control clauses

In order to avoid ambiguity or the need to interpret a change-of-control clause, the parties usually define precisely what circumstances they regard as change of control. In commercial practice, several types of change-of-control clauses may be distinguished.

First, the clause may apply both to direct changes in control, involving acquisition of shares in the subsidiary, and to indirect changes, where the ownership of the parent company changes.

Second, a change-of-control reservation may apply to both sale of shares in the subsidiary to a third party (not previously a shareholder) and to sale to a current shareholder (i.e. a transaction between shareholders of the subsidiary).

Third, the clause may contain provisions excluding or limiting its use, e.g. providing that sale of shares to specific entities identified in the agreement, or within a specific period, will not be regarded as a change of control.

Finally, the parties may include a provision in the change-of-control clause under which neither party may transfer its shares in a subsidiary without consent of the other party, but consent may not be refused without serious grounds.

A key issue for the parties to contracts with change-of-control clauses is the consequences provided for breach of the clause. Generally parties provide that a change of control in violation of the clause entitles the other party to terminate the agreement without prior notice or on very short notice, or may, for example, expose the breaching party to a contractual penalty.

Given the possible consequences of violating change-of-control clauses, such as loss of valuable contracts, it is in the interests of the parties to a share deal to perform a due diligence review of commercial agreements to which the target is a party, or include appropriate representations and warranties concerning the lack of change-of-control clauses in agreements concluded by the company.