Understanding change of control clauses in Canadian contracts

While price and terms often get the most attention in contracts or investment deals, one aspect that is often overlooked in financing documents is the change of control clause. If not carefully considered, this clause can significantly alter the deal and have major consequences.

In this article, we'll discuss the basics of these types of clauses, how they work, and what investors and target corporations should know. Above all else, consulting a private equity lawyer will also be helpful to learn about change of control clauses.

What is a change of control clause?

A change of control clause is a contract provision that gives a party certain rights or obligations if there is a change in the ownership of the target corporation. Also called a change of control provision, it only takes effect once a specified triggering event occurs.

A change of control clause may be triggered by various events, from changes in a company's management team to the sale of the entire corporation.

Change of control clauses appear in various types of contracts and are often used by private equity firms. They may be included in investment agreements when a firm invests in a target corporation. Such clauses can also affect existing investors and employees if triggered by the firm's investment.

Watch this video to know more about change of control clauses, especially in the context of contracts in general:

To learn how change of control clauses operate in private equity transactions, reach out to the best private equity lawyers in Canada as ranked by Lexpert.

Purpose of change of control clauses

"Change of control provisions serve several purposes that can benefit parties to a contract:

• clarifies the party's rights: the clause gives a party clear rights when ownership or management of the other party changes; it lets the party ask for consent, payment, or even termination of the agreement when control moves to someone new
• protects the parties' relationship: because changes in leadership can affect business relationships, a change of control clause helps protect parties' interests throughout the deal

Where are change of control clauses found?

Change of control provisions are standard in most types of contracts. These include transactions involving investments and financing, as in private equity.

Here are some of the contracts where these change of control clauses can be found:

• private equity agreements: executed between fund managers (the general partners) and the investors (the limited partners) of a private equity fund
• financing agreement: these clauses are also present when the private equity firm invests in a target company, either through equity financing or leveraged buyout
• loan contracts: used when lenders loan to corporations, so that any changes in the corporation's management trigger the clause
• shareholder agreements: when shareholders are shaken up in a corporation, some shareholders can opt to sell their shares by using the clause
• employment contracts: employees can exit a company without violating its labour contract if changes in the organization triggers the clause
• commercial contracts: under the clause, long-time clients can disregard contractual obligations with a company if the top heads are changed

A change of control clause can be used by any party in a contract when the appropriate conditions are met.

However, these clauses are not always labeled "change of control clause. Sometimes, they appear as unnamed or untitled provisions, which can be overlooked. To be sure, it's better to consult a lawyer who can thoroughly read and explain the contract to see if there is a hidden change of control clause.

The video below shows how change of control clauses work in different contracts:

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What triggers a change of control clause?

The triggering event for a change of control clause depends on the contract language. In private equity, the specific events are defined in the financing or investment agreement.

Here are some examples of triggering events for a change of control provision or clause:

• sale of all, or substantially all, of the corporation's assets
• purchase of the corporation's majority shares by a third party
• mergers and acquisitions (M&As) or consolidations
• investment by a private equity fund
• change in the majority shareholders
• change in the membership of the board
• when the corporation goes public

For example, it might be agreed in a shareholder agreement that if a private equity firm invests in the corporation, making it a majority shareholder, the rest of the shareholders have the right to sell their shares to the corporation. This will compel the corporation to buy these shares, which would not be possible without the clause.

What are the consequences of a change of control clause?

Like the triggering event, the effects of a change of control provision depend on what the parties specify in the contract. Below are some of the effects of a change of control provision:

• sending a notice to all investors: at minimum, all parties must be informed of the change once or before the triggering event occurs, regardless of whether they exercise their rights under the clause
• purchase of the investor's shares: this is common when a private equity fund purchases or invests in a corporation and some shareholders want to exit after the change
• lender's prepayment: in a loan agreement, the clause may require the borrower to repay the lender immediately if ownership changes, as the lender may not want to deal with new owners

For instance, in a private equity agreement, a change of control in the firm can result in the following, if stated in the agreement:

• agreement cancellation: investors can terminate the agreement, which may result in debt acceleration and other post-agreement rights
• debt acceleration: much like a prepayment, the investors in the firm must be paid their investments plus interest immediately
• terms renegotiation: an alternative to agreement cancellation and debt acceleration is that parties must renegotiate the agreement's terms or even restructure the private equity fund

How can lawyers help regarding a change of control clause?

A private equity lawyer can review the change of control provisions before the deal closes. Early legal review transforms this clause from a hidden cost into a manageable part of the deal structure, preventing any surprises to all parties.

Interpreting a contract is one of the many roles a lawyer can play. They can understand what the definition of "change" and "control" really is under the contract, instead of guessing after the fact.

Lawyers can also help enforce a change of control clause. Depending on the parties' circumstances, they can check what remedy is available and proper, which will ensure that it is business-as-usual for all parties.

As always, lawyers act as gatekeepers before parties commit any contractual mistakes. They can flag when something is likely to count as a change of control under the agreement. This helps clients understand which transactions are safe and which require further discussions.

Finally, lawyers give practical advice when a change of control is already in motion. They can map out deadlines, notice periods, and repayment dates. They can even assist clients to evaluate whether a waiver, amendment, or full refinancing is the best path.

Change of control clause: Key considerations for contracts and investments

A change of control clause often goes unnoticed until the deal is done. By then, options are limited. Early conversations between parties and legal review can help address potential issues with change of control clauses. These provisions do not always work against either party, but legal advice can help parties understand and manage their impact.

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