The Overlooked Importance of “Assignment” Clauses in Mergers and Acquisitions

In the high-stakes world of mergers and acquisitions (M&A), the assignment clause is often overlooked—until it becomes a deal-breaker. This seemingly mundane provision governs whether a party can transfer its rights and obligations under a contract to another entity. For business executives and legal teams navigating M&A transactions, understanding the nuances of assignment clauses is critical. This article provides a deep dive into the role of assignment clauses in M&A, supported by real-world examples, legal analysis, and actionable advice to help you avoid costly pitfalls.

What is an Assignment Clause?

An assignment clause specifies whether and how a party can transfer its contractual rights and obligations to a third party. A typical assignment clause might look like this:

“Neither party may assign this Agreement, in whole or in part, without the prior written consent of the other party, except that either party may assign this Agreement to an affiliate or in connection with a merger, acquisition, or sale of all or substantially all of its assets.”

In M&A transactions, assignment clauses can determine whether key contracts can be transferred to the acquiring entity, making them a critical component of due diligence.

Why Assignment Clauses Matter in M&A

1. Preserving Contractual Relationships
   Many M&A deals rely on the transfer of key contracts, such as customer agreements, supplier contracts, and intellectual property licenses. If these contracts contain restrictive assignment clauses, the deal may be jeopardized.
2. Avoiding Breach of Contract
   Attempting to assign a contract without complying with its assignment clause can result in a breach, leading to disputes, termination of the contract, or even litigation.
3. Maintaining Business Continuity
   In asset sales, the inability to assign contracts can disrupt operations, leaving the acquiring entity without access to critical resources or revenue streams.

Legal Principles Governing Assignment Clauses

1. Freedom of Contract
   Parties are generally free to include any terms they choose in an assignment clause, including outright prohibitions on assignment or requirements for prior consent.
2. Anti-Assignment Provisions
   Courts typically enforce anti-assignment provisions, meaning that a contract cannot be assigned if the clause prohibits it. However, there are exceptions, such as assignments by operation of law (e.g., in bankruptcy).
3. Delegation of Duties
   Even if a contract prohibits assignment, it may still allow the delegation of duties to a third party. However, the original party remains liable for performance.
4. Change of Control Provisions
   Some contracts include change of control provisions, which treat a merger or acquisition as an assignment. These provisions can trigger consent requirements or even termination rights.

Case Studies: Lessons from the Trenches

1. Case Study 1: The Telecom Deal That Fell Apart
   In a high-profile M&A deal, a telecommunications company attempted to acquire a competitor. During due diligence, it was discovered that several key customer contracts contained strict anti-assignment clauses. The target company had to renegotiate these contracts, delaying the deal and increasing costs.Lesson: Conduct thorough due diligence to identify restrictive assignment clauses early in the process.
2. Case Study 2: The Software License That Couldn’t Be Transferred
   In SQL Solutions, Inc. v. Oracle Corp. (1991), a software license agreement prohibited assignment without consent. When the licensee was acquired, Oracle argued that the license could not be transferred to the new entity. The court agreed, leaving the acquiring company without access to critical software.Lesson: Pay special attention to intellectual property licenses, which often contain restrictive assignment clauses.
3. Case Study 3: The Bankruptcy Exception
   In In re Catapult Entertainment, Inc. (1999), a bankruptcy court ruled that a patent license could be assigned despite an anti-assignment clause because the assignment was part of a bankruptcy proceeding. This case highlights the unique considerations in bankruptcy scenarios.Lesson: Understand the exceptions to anti-assignment provisions, particularly in bankruptcy contexts.

Actionable Advice for Business Executives and Legal Teams

1. Conduct Thorough Due Diligence
   • Identify all key contracts early in the M&A process.
   • Review assignment clauses to determine whether consent is required or assignment is prohibited.
   • Pay special attention to customer contracts, supplier agreements, and intellectual property licenses.
2. Negotiate Assignment-Friendly Clauses
   • When drafting or reviewing contracts, include language that permits assignment in connection with M&A transactions. For example:“Either party may assign this Agreement in connection with a merger, acquisition, or sale of all or substantially all of its assets without the consent of the other party.”
3. Seek Consents in Advance
   • If a contract requires consent for assignment, initiate discussions with the counterparty early in the M&A process.
   • Be prepared to provide assurances or negotiate amendments to secure consent.
4. Consider Change of Control Provisions
   • If a contract includes a change of control provision, determine whether it treats the transaction as an assignment.
   • Negotiate carve-outs for M&A transactions if necessary.
5. Plan for Contingencies
   • If key contracts cannot be assigned, develop a contingency plan. For example:
     • Structure the deal as a stock purchase rather than an asset purchase.
     • Negotiate interim agreements to maintain business continuity.
6. Leverage Legal Expertise
   • Engage legal counsel with experience in M&A and contract law to navigate complex assignment issues.
   • Consider jurisdiction-specific nuances, as the enforceability of assignment clauses can vary.

Conclusion

Assignment clauses may seem like a minor detail, but they can have a major impact on the success of an M&A transaction. By understanding the legal principles, learning from real-world examples, and following actionable advice, business executives and legal teams can avoid costly pitfalls and ensure a smooth transaction. Remember, the key to success lies in early due diligence, strategic negotiation, and expert legal guidance.