Change-of-control clause

When a company is sold, it gets new owners. For the company’s business partners, this can be a problem. A supplier may have enjoyed working with the old leadership, but not with the new owner. This is exactly what the change-of-control clause is for. The English term literally means: someone else is now in charge. The clause sets out what happens to the contract in this case.

What is at stake when ownership changes

Contracts are concluded between companies, but trust arises between people. A customer gives a provider sensitive data or relies on years of cooperation. If the provider is suddenly bought by a direct competitor, the situation changes completely. Without a clause, the customer would still have to keep fulfilling the contract.

This point is also important for banks. Anyone who lends money to a company checks carefully beforehand who owns it and how solid its finances are. A new owner can load the company with debt or sell off parts of it. That is why loan agreements almost always contain such a clause. The bank can then demand immediate repayment of the loan.

A third case concerns employees, especially executives. For them, the clause is included in the employment contract and guarantees severance pay if they have to leave or want to leave after a takeover. In the business press this is often called a “golden parachute”. The idea behind it is that an executive board should not block a sensible takeover out of fear for their own job.

When the clause is triggered and what happens then

First, the contract must define what actually counts as a change of control. Usually a threshold is set, often 30 or 50 percent of the shares. If someone buys more than this share, the case has occurred. Some contracts additionally name other triggers, such as replacing the majority on the supervisory board. The more precise the definition, the less dispute there is later.

Then comes the actual legal consequence. The mildest variant is a notification obligation: the sold company only has to inform its partner. More common is a special right of termination with a short notice period. The harshest variant lets the contract end automatically or makes all outstanding payments immediately due.

A common misconception is that the clause prevents the sale itself. It does not. The owner may still sell their shares. However, the clause makes the sale more expensive and less attractive, because the buyer must expect to lose important contracts as a result. That is exactly why buyers systematically check all of a target company’s contracts for such clauses before a takeover.

Takeovers, licenses, and cloud contracts

In business news, the term mainly appears in connection with takeovers. When it says that a deal still depends on the approval of key customers, change-of-control clauses are often behind this. The buyer then has to ask each partner individually whether they will continue the contract. These approvals can take months and drive down the purchase price.

In the tech industry, these clauses are especially common. Software is rarely bought outright but licensed, meaning it is made available for use in exchange for a fee. Such license agreements often prohibit transfer to a new owner without permission. Contracts for cloud services, i.e. rented computing power in third-party data centers, also regularly contain them.

Young companies in the AI sector quickly notice this. A start-up working for a large corporation usually has such a clause in its contract. If the start-up is later acquired, the large corporation can withdraw. Anyone building a company with the eventual goal of selling it should therefore keep an eye on these clauses early on.