Assignment-consent provisions

Under U.S. law, most contract rights are freely assignable, and most contract duties are freely delegable absent some special character of the duty, unless the agreement says otherwise.

(Licenses are among the noteworthy exceptions: in general, a licensee may not assign its license rights nor delegate its license obligations without the licensor’s consent.)

In some situations, however, the parties will not want their opposite numbers to be able to assign the agreement freely; contracts often include language to this effect.

Suppose an agreement says that one party must give its consent before another party can assign the agreement. That can give the non-assigning party quite a bit of leverage if the assigning party finds itself in an M&A- or corporate-reorganization situation. Example: Consider the Dubai port deal:

• In 2006, a Dubai company that operated several U.S. ports agreed to sell those operations. (The agreement came about because of publicity and political pressure about the alleged national-security implications of having Middle-Eastern companies in charge of U.S. port operations.)

• A complication arose in the case of the Port of Newark: The Dubai company’s lease agreement gave the Port Authority of New York and New Jersey the right to consent to any assignment of the agreement – and that agency initially demanded $84 million for its consent.

• After harsh criticism from political leaders, the Port Authority backed down a bit: it gave consent in return for “only” a $10 million consent fee, plus $40 million investment commitment by the buyer. link link

An assignment-consent clause in a contract involving an intellectual-property license (for example, a software license) can also screw up an internal corporate reorganization. Here’s an example: A customer of a software vendor did an internal reorganization. As a result, the vendor’s software ended up being used by a sister company of the original customer. The vendor demanded that the sister company buy a new license. The sister company refused. The vendor sued, successfully, for copyright infringement, and received the price of a new license as its damages. (That strikes me as massively shortsighted behavior on the part of the vendor; I wouldn’t want to be a salesman trying to sell something else to that customer.) See Cincom Sys., Inc. v. Novelis Corp., No. 07-4142 (6th Cir. Sept. 25, 2009) (affirming summary judgment in favor of vendor).

If you’re drafting or negotiating this kind of provision, you’ll need to decide whether its exception should apply to a sale or other disposition of substantially all the assets of –

• the assigning party’s entire business; or
• its business relating specifically to the agreement, for example, in the case of a spin-off of a corporate product line or division.

A prospective assigning party might argue for such a carve-out along the following lines:

We need to keep control of our strategic destiny. If we ever wanted to sell a product line or a division (or even the whole company) in an asset sale, we would need to be able to assign this agreement as part of the deal, without worrying about whether some executive at your company is going to get greedy and try to hold us up for a consent fee.

The other side might respond with something like this:

What if you decided to sell a product line or a division to one of our competitors? We need to retain control over that possibility, and the only way to do that is for us to retain the absolute right to consent to any assignment you might make.

Editorial comment: The prospective assigning party’s concern about being “held up” is a real one: See the discussion above concerning the 2006 Dubai port deal.

Possible alternative: Termination in lieu of veto: It doesn’t have to be all or nothing. Another approach might be to give the non-assigning party, instead of a veto over asset-disposition assignments, the right to terminate the contract for convenience. (Of course, the implications of termination would have to be carefully thought through.)

A prospective assigning party might argue for the right to assign to an affiliate along the following lines:

We sometimes routinely move assets around within our ‘corporate family’; we want to be able to do so with this contract without having to take the trouble to get your approval.

The other party might reasonably object:

We have no idea whether your affiliate would be in a position to fulfill your obligations under the contract, nor whether we’d be able to recover from you if there were a breach.

If you’re willing to unconditionally guarantee your affiliate’s performance, we might be able to go along with this. Otherwise, though, we have a problem with this clause.

Editorial comment: Before approving a blanket affiliate-assignment authorization, consider whether you and your client know enough about the other party’s existing- or future affiliates to be comfortable with where the agreement might end up.

• Even if this provision were absent, applicable law might impose a reasonableness requirement; see the discussion of the Shoney case in the commentary to the Consent at discretion provision.

But a reasonableness requirement might not be of much practical value, whether contractual or implied by law. Such a requirement could not guarantee that the non-assigning party would give its consent when the assigning party wants it. And by the time a court could resolve the matter, the assigning party’s deal could have been blown.

Still, an unreasonable-withholding provision should make the non-assigning party think twice about dragging its feet too much. Here’s a hypothetical: Suppose the assigning party’s deal looked like it was about to fall apart because of the non-assigning party’s delay in giving consent. The assigning party’s lawyers would doubtless start making ugly noises about breach of contract and a lawsuit for damages. That ought to get the other party’s attention, because the damages for a busted deal could conceivably be big – cf. Pennzoil vs. Texaco and its $10.5 billion damage award for tortious interference with an M&A deal.

• Including this provision might conflict with the Materiality of assignment breach provision, for reasons discussed there in the summary of the Hess Energy case.

The non-assigning party might want the absolute right to withhold consent to an assignment in its sole discretion. If so, it would be a good idea to try to include that in the contract language. Otherwise, there’s a risk that a court might hold that any withholding of consent must meet a commercial-reasonableness test.

In 2009, the Alabama Supreme Court rejected a claim that Shoney’s restaurant chain breached a contract when it demanded a $70,000 to $90,000 payment as the price of its consent to a proposed sublease. The supreme court noted that the contract specifically gave Shoney’s the right, in its sole discretion, to consent to any proposed assignment or sublease. Significantly, prior case law from Alabama was to the effect that a refusal to consent would indeed be judged by a commercial-reasonableness standard. But, the supreme court said, “[w]here the parties to a contract use language that is inconsistent with a commercial-reasonableness standard, the terms of such contract will not be altered by an implied covenant of good faith. Therefore, an unqualified express standard such as ‘sole discretion’ is also to be construed as written.” Shoney’s LLC v. MAC East, LLC, No. 1071465 (Ala. Jul. 31, 2009) (on certification by Eleventh Circuit), cited by MAC East, LLC v. Shoney’s [LLC], No. 07-11534 (11th Cir. Aug. 11, 2009), reversing No. 2:05-cv-1038-MEF (WO) (M.D. Ala. Jan. 8, 2007) (granting partial summary judgment that Shoney’s had breached the contract).

Contract drafters sometimes loosely use the term “assignment” as encompassing not only assignment of rights but also as a delegation of obligations. This provision makes it clear that this is the intended meaning.

Such a provision might not be necessary in a contract for the sale of goods governed by the Uniform Commercial Code, because a similar provision is found in UCC § 2-210

In most cases, neither an assignment nor a delegation relieves the assignor of responsibility for past performance or breach unless the non-assigning party or parties agree otherwise.

It’s entirely reasonable for a non-assigning party to want to be notified promptly after an assignment by the other party. But a prospective assigning party should be think carefully before agreeing to give the non-assigning party prior notice of an assignment.

Suppose an assignment were to be made in connection with an M&A deal or asset disposition. If the assigning party gave advance notice to the other party, the other party theoretically could make trouble – for example, by threatening to go public about the deal if the assigning party didn’t agree to X.

Many parties will be exceedingly reluctant to agree to language like this. The language is drafted so as not to (purportedly) void an M&A deal that doesn’t have the other party’s prior consent. But such a transaction (or series of transactions) could still end up a breach of this Agreement.

[ADDED 2011-06-01:] The Delaware Chancery Court refused to rule out the possibility that a reverse triangular merger could act as an assignment of a contract, requiring consent. Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, No. 5589-VCP (Del. Ch. Apr. 8, 2011) (denying motion to dismiss). See also the discussion of this opinion by Katherine Jones of the Sheppard Mullin law firm.

Consider an agreement in which a vendor is to provide ongoing services to a customer. A powerful customer might demand the right to consent to the vendor’s assignment of the agreement, even in strategic transactions. The vendor, on the other hand, might refuse to give any customer that kind of control of its strategic options.

A workable compromise might be to allow the customer to terminate the agreement during a stated window of time after the assignment if it is not happy with the new vendor.

A chief significance of this kind of provision is that failure to obtain consent to assignment, if it were a material breach, would give the non-assigning party the right to terminate the Agreement.

If an assignment-consent provision requires that consent not be unreasonably withheld, then failure to obtain consent to a reasonable assignment would not be a material breach, according to the court in Hess Energy Inc. v. Lightning Oil Co., No. 01-1582 (4th Cir. Jan. 18, 2002) (reversing summary judgment). In that case, the agreement was a natural-gas supply contract. The customer was acquired by a larger company, after which the larger company took over some of the contract administration responsibilities such as payment of the vendor’s invoices. The vendor, seeking to sell its gas to someone else at a higher price, sent a notice of termination, on grounds that the customer had “assigned” the agreement to its new parent company, in violation of the contract’s assignment-consent provision. The appeals court held that, even if the customer had indeed assigned the contract (a point on which it expressed considerable doubt) without consent, the resulting breach of the agreement was not material, and therefore the vendor did not have the right to terminate the contract.