How to ensure continuity of commercial contracts after the closing of an M&A deal?

There are different objectives and motives for carrying out M&A transactions – one of the reasons may be acquiring a given, existing business (or part of it) in order to develop one's own enterprise or capital group. It is then crucial to guarantee the contractual continuity of the acquired business with existing customers and suppliers, which may sometimes involve the need to introduce appropriate party changes to such contracts. But is this always possible?

Verification of contracts of the acquired business during legal due diligence

Legal due diligence is one of the steps preparing the parties to conduct a transaction.

Its purpose is, among other things, to verify and assess the acquired business from the perspective of potential legal risks that may have a significant impact on the buyer’s pricing strategy in relation to a given company or asset.

As part of the above-mentioned process, not only basic matters related to the target’s activities are analysed, such as permits, licenses and consents based on which the business is conducted, but also all material and long-term contracts to which the acquired entity is a party, including, in particular, contracts with key customers and suppliers.

Regardless of the need to examine contracts in terms of their compliance with the law, review of potential cases of violation of contractual provisions and, as a result, quantification of the identified risk, the analysis focuses primarily on the confirmation of the durability of existing legal relationships or, depending on the type of transaction, the possibility of making changes of a party to contracts. Commercial contracts are often a necessary element to secure the continued, uninterrupted operation of the acquired company or asset – thus the issue of their effective “acquisition” will be of key importance for the future buyer.

Contracts with key customers and suppliers

What should be considered to ensure the durability of existing contracts? In a share deal (concerning shares in a commercial company) or an asset deal (acquisition of an enterprise, an organized part of an enterprise or individual assets), it is crucial from the buyer’s perspective to identify, at an early stage, in the contracts concluded by the target with its contracting parties, contractual provisions regulating the issues of mutual rights and obligations in the event of a possible change in the ownership structure (the so-called change of control clauses). Such action allows for an assessment of whether and which contracts may be at risk due to the update of the condition for applying the change of control clause.

In commercial practice, the “change of control” clause most often involves obliging one party to obtain the prior consent of the other party to the change of control or to provide prior information about such a planned action. Such provisions most often provide that a “change of control” contrary to the provisions of the contract entitles the other party to terminate the contract without notice or results in the party’s liability, e.g. for a contractual penalty. The “change of control” itself is most often defined as the direct or indirect transfer of the management centre of a company or enterprise to a new entity that has not yet had a decisive impact on its activities. The transfer of the mentioned management centre may be made in various ways, i.e. by selling share rights, concluding a contract transferring the management of the company (enterprise) to another entity, selling the enterprise or its organized part, granting personal powers to appoint the majority of members of the governing bodies.

Therefore, examining the existence of the change of control clauses is very crucial. Another argument often determining whether to maintain or break off business relations with a given entity is its capital affiliation. This is because it may constitute an additional guarantee of reliability or solvency for the entrepreneur. At the same time, taking control of a contracting party by a competitor may, for obvious reasons, be a justification for the intent to immediately terminate cooperation.

In the case of asset deals, the transferability of contracts is slightly more complex. This results from the civil law based definition of an enterprise, according to which an enterprise as such does not include obligations related to its running. Consequently, the potential buyer must obtain the consent of the other party to all contracts covered by the transaction to effectively transfer the obligations arising therefrom. Otherwise, the seller and the buyer will remain parties to the contract within the scope of the obligations arising from the contract (as part of the cumulative assumption of debt). This means that these entities will be jointly and severally liable towards the contracting party. Such a situation may not be favourable for both the buyer and the seller of the enterprise or its organized part.

Contracts concluded under the public procurement regime

In asset transactions, special attention should be paid to the transferability of contracts concluded under public procurement law. Unlike share deals, such transfer is only possible in cases strictly specified in Article 455 of the Public Procurement Law (the “PPL”). This is due to the fact that these contracts are the result of a highly formalized procedure in which a specific offer was selected based on the participation or selection criteria specified in the invitation to tender and tender documents. Consequently, the contract may only be awarded to a contractor selected in accordance with the provisions of the Public Procurement Law due to the lack of space for freedom in changing the legal relationship established in this regime.

Following multiple law amendments, in 2016 the PPL allowed for several cases of transferability of tender contracts. A contractor may be changed when such a possibility is provided for in the contractual provisions, or when a new contractor replaces the current contractor as a result of universal succession, assuming the rights and obligations of the current contractor as a result of acquisition, merger, division, transformation, bankruptcy, restructuring inheritance or acquisition of the existing contractor or its enterprise. The last case of possible transfer of this type of contract is when the contracting authority assumes the contractor’s obligations towards its subcontractors. This catalogue is therefore very limited.

Entity-based changes arising from contractual provisions generally do not apply to M&A transactions. The purpose of this provision is to secure possible modifications within a consortium or civil partnership, which usually results from the contract notice or other tender documents.

Both in transactions and at the preparatory stages for the sale of (part of) the business, Article 455 section 1. 2b) of the PPL applies. Under it, it is possible to transfer a contract under the public procurement law if a new contractor replaces the existing one as a result of universal succession. Therefore, if the new contractor meets the conditions for participation in the proceedings, there are no grounds for exclusion and it does not result in other significant changes to the contract, an entity-based change to the contract takes place as part of the entry into all rights and obligations of the seller. Unfortunately, this does not happen automatically – it is necessary to sign an annex to the original contract. Even in view of the formalism of public tenders, this obligation seems too conservative. One may risk saying that in the case of universal succession, the act of notifying the contracting authority of the change of contractor would be sufficient, but in order to implement such a change, another amendment to the PPL would be required, so we will wait a while for such a development.

Summary

Commercial contracts are the foundation of most companies’ businesses. It is therefore worth preparing in advance for the transaction process by appropriately identifying the risks and all activities that need to be performed to ensure the proper functioning of the entity after closing the transaction.

Authors:

Hanna Wiejowska, Associate, Baker McKenzie

Paweł Jaros, Senior Associate, Baker McKenzie

This article comes from magazine:
FOCUS ON Business #16 May-June (3/2024)