Planning for Challenges in Third-Party Agreements

After transaction agreements are negotiated, drawn up, and executed, a business’s sale may still be contingent on permission from one or more third-parties. “Third-party consents” or “agreements” must be obtained before a business transfer can truly complete. Buyers, particularly in asset sales, mandate third-party consents in the negotiation stage of a deal because they want to put safeguards in place to ensure that the business will continue to run smoothly after the M&A event. For example, a software business that is undergoing an acquisition for its patents and other IP assets may have a long-term contract with a licensee, but a clause in the contract may allow the licensee to cancel if the software company has a change of control. The buyer in this transaction could require third-party consent from the licensee, to alleviate the concern that the ownership change would cause a loss of business or renegotiation of licensing terms.

Procedurally, third-party consent is an affirmative covenant, because it requires that the buyer or seller takes the action to obtain it prior to deal closing. These consents can be key closing conditions, and they are collected during the pendency stage, immediately after transaction documentation is complete and just before closing. Critical parties in third-party consents can be diverse. They include banks, debt holders, landlords, equipment leasers, software licensees, permit providers, key suppliers and customers, and more. While working with each party may have specific challenges for gaining sign off, there are overarching recommendations on how to swiftly navigate the third-party consent terrain:

1. Early Identification

Obtaining third-party consents can take significant time and effort. If a sale requires government approval for example, more time will be needed to accommodate bureaucratic realities. Also, some third parties may see change of ownership as an opportunity to renegotiate the terms of their contracts. Thus, one of the most critical determinants of handling third-party consents effectively is identifying the consents and their relevant counter-parties early on in the deal process so that you can anticipate problems and plan for solutions.

2. Minimize the Number of Consents

Third-party consents not only require time and effort, but they also create risk and lower business value. The contingency of third-party approval makes a transaction more risky for the buyer and seller because it may not be obtained; there have been cases of transactions failing to close due to a third-party consent not being secured. Third-party consents can also decrease a business’s value in an asset sale. Because the sale is incumbent on a third-party’s approval, control over the business moves away from the seller toward the third-party, as the stability of revenues can be questioned. Due to this uncertainty, a third-party consent is always a downward force on valuation.

A best practice is for buyers and sellers to always seek to reduce the number of third-party consents. Business owners can help by anticipating change of ownership and thus avoiding anti-assignment clauses in their contracts. Business owners, if they are required to gain consent in their third party contracts, should include in their contracts that consent cannot be withheld or delayed unreasonably by the third-party.

3. Keep your Books in Order

Not specific to M&A, there is business value in being rigorous on documentation of products and services agreements, IP protections, employment policies, and other paperwork. Law firm Mayer Brown recommends that sellers maintain a database of agreements. New online technologies have been developing in this space that may help. A company called RightSignature for example is making it easy to execute contracts online, and maintain a searchable database. Technology like Axial’s DealMail allows network Members to effortlessly have an accurate and trackable history of contracts they send and receive, all within a private, secure environment.

Having robust records of documents reduces uncertainty and potentially large cost associated with third-party consents. If there is a high degree of reliability in your records, it will require fewer resources to track down and obtain consent. Because there will be more confidence from the buyer that all agreements are accounted for, the downward pressure of third-party consents on price will be minimized as well, as the buyer will have less reason for concern that outstanding liabilities may be in existence.

4. Active Management

In the process of obtaining third-party consents, the best practice is to be disciplined on managing the process and planning specifically how the consents will be obtained. If third-party agreements are identified early, there should be ample time to determine who the decision-maker for the consent is, the timing for contacting him/her, and what his/her concerns may be. Consents should be handled one by one, with someone from your M&A team given responsibility over initiating and monitoring progress on a given consent.

Be careful of transferring any information to a third-party other than what is specifically needed for consent. According to law firm Fasken Martineau, M&A processes have derailed and lawsuits have transpired when privacy is violated in an M&A process because information about the M&A was revealed to a third-party outside the scope of the consent.

Sometimes, it is not possible for the consent to be obtained without renegotiation of a particular counter-party’s contract. In those cases, law firm Mayer Brown encourages to commence negotiations with third-parties as promptly as possible.

Keeping third-party consents top of mind throughout an M&A process is a savvy practice of successful M&A practitioners. Leaving third-party consents to a last-minute task can result in additional slowdown, lower value, higher risk, and potential legal recourse. Conversely, integrating awareness and identification of third-party consents early in the deal process will benefit buyers, sellers, and advisors later on, and can make the difference in how, and if, the deal gets closed.