Q: I represent a company—let’s call it “ClientCorp”—that has a long-term contract with another company, “TargetCorp.” A provision in the agreement allows ClientCorp to exit the contract in the event of a “change of control” at TargetCorp. We have become aware that TargetCorp is in negotiations to be acquired by a third party, “AcquirerCorp,” a change that would trigger this provision. ClientCorp represents about 20% of TargetCorp’s business. Instead of exercising our right to exit the contract, we would like to negotiate new terms with AcquirerCorp. (Our client’s contract is no longer “market,” and we think we could get better terms in a new deal today.) Should we tell AcquirerCorp now about our intention to renegotiate?
A: Change-of-control provisions are standard in long-term agreements, as they allow a party to avoid being forced to work with someone other than its agreed-upon counterpart. In this situation, the change-of-control provision gives you substantial leverage. You should be cautious about how you use that leverage, and even more cautious about inadvertently giving it away.
AcquirerCorp will almost certainly discover the change-of-control provision as part of its due-diligence process on TargetCorp, but it may be uncertain as to whether you intend to trigger it. If you tell AcquirerCorp about your intention to renegotiate, AcquirerCorp will factor that better deal for you into its valuation of TargetCorp. Consequently, AcquirerCorp will be willing to pay less for TargetCorp, and the ZOPA (zone of possible agreement) with TargetCorp will shrink. Even worse, if AcquirerCorp gets nervous about the risk associated with renegotiating 20% of TargetCorp’s revenues, AcquirerCorp may back away from the deal entirely. Of course, that would leave your change-of-control provision untriggered and your client stuck in a disadvantageous contract.
A better strategy would be to approach TargetCorp and explain your interest in preemptively renegotiating the terms of your contract in exchange for a commitment that you will not exercise your change-of-control provision with respect to AcquirerCorp. TargetCorp should be very interested in this offer, as pinning down 20% of its revenues should allow it to get a higher price from AcquirerCorp, likely more than offsetting the concessions in its contract with you. Even if the acquisition doesn’t go through, you will have improved terms in your ongoing relationship with TargetCorp.
Before you go forward with this strategy, however, have your attorneys ensure that an acquisition of TargetCorp by AcquirerCorp would in fact trigger your change-of-control provision. Not all change-of-control provisions are created equal, and deal lawyers regularly scrutinize these provisions to see if they can be avoided.
For example, when Merck acquired Schering-Plough in 2010, it structured its deal as a “reverse merger,” in which Merck was acquired by Schering-Plough even though Merck was the much larger company. Schering-Plough had contracts with Johnson & Johnson (J&J) to market and distribute two blockbuster drugs, Remicade and Simponi, but these contracts had change-of-control provisions. The deal lawyers believed that the reverse-merger structure would avoid triggering the change-of-control provisions, thereby preserving Remicade and Simponi for Merck. Naturally, J&J sued Merck for its legalistic maneuvering, and the parties settled after lots of wrangling. You’ll want to be sure that your change-of-control provision does not have similar loopholes before implementing this negotiating strategy.
Joseph Flom Professor of Law & Business, Harvard Law School
Douglas Weaver Professor of Business Law, Harvard Business School
Academic Editor, Negotiation Briefings
Author, Dealmaking: The New Strategy
of Negotiauctions (W. W. Norton, 2011)
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