Change of Control Clause: What It Does to a Sale

A credit approval is a judgment about a business in particular hands: who sets the strategy, how much debt they will tolerate, whether they reinvest or draw the profits out, and whether they will put money in when a quarter goes wrong. A new owner can change all of that without a dollar of the loan moving. A buyer that borrowed to fund its purchase may need the company's cash to service that debt.

The lender's difficulty is that shareholders can sell without asking it. The company signed the facility agreement and the shareholders, in that capacity, did not, so a sale of shares leaves the contract untouched unless the contract says otherwise. This clause says otherwise. Nothing in New Zealand, Australian or UK law sets where the line falls: it is a term negotiated deal by deal.

The trigger usually has more than one limb. One looks at shares or votes: a named person or family ceases to hold a majority, or someone else acquires one. Another looks at power without ownership, such as the right to appoint most of the board or to direct management. The words matter at the margin. "Ceases to hold more than 50%" is met by a sale that leaves the family on exactly half; "ceases to hold at least 50%" is not. Reach matters too, because a sale of the holding company above the borrower changes control just as surely, and a clause limited to direct shareholders would miss it.

The result varies with the market for the loan. Syndicated agreements on London-market forms have commonly made it a cancel-and-prepay event, and some deals now let each lender choose whether to be repaid. A bilateral bank facility may instead list it as an event of default or a review event, or simply prohibit the change without consent. The label has consequences. An event of default can set off cross-default clauses in the borrower's other contracts, where a prepayment event ordinarily does not.

A family-owned maker of fishing tackle, constructed for this page like every figure in it, agrees in principle to sell 40% of its shares to a trade buyer. The family's adviser reads the facility agreement and sees the first limb: the family must hold more than 50% of the votes. Keeping 60%, the adviser concludes there is nothing to discuss. The second limb says a change of control also occurs if anyone else gains the right to appoint a majority of the directors, and the draft shareholders' agreement gives the buyer three of five board seats.

If the bank held to the clause, the company would owe US$14.0m on the day the family received US$12.0m, and the two sums would sit in different pockets. The figures are the example's, and a swap's close-out can run either way depending on where rates have moved.

The family has two routes. It can cut the buyer to two seats, which takes the deal outside both limbs. Or it can ask for consent. The bank asks who the buyer is, how it funded the purchase and what it expects to take out of the company. It consents on terms: no dividends for two years, the definition rewritten to name the new shareholder, and a fee. Its letter has to be in hand before the sale agreement becomes unconditional, and the family's first draft of the confidentiality agreement, which barred it from telling its bank, has to change.

A change of control usually comes through the shares. A sale of the business and its assets is a different transaction and is caught elsewhere, usually by the undertaking restricting disposals and by mandatory prepayment of the proceeds. The distinction decides who ends up with the debt: a buyer of shares acquires a company that still owes it, while a buyer of assets leaves the debt behind with the seller.

A key-person clause watches a named individual's role rather than who owns the shares, so a founder can sell out and stay on without tripping it, or keep every share, retire and trip it. A material adverse change clause asks for a judgment about effect; a change of control is mostly a matter of fact on the definition's words, though a limb such as the power to direct management can still be argued. And a seller's personal guarantee is a separate contract. It does not fall away because the shares have gone, and a seller who wants out of it needs a release from the bank.

DEFINED IN ONE PARAGRAPH → · READING YOUR FACILITY LETTER → · MANDATORY PREPAYMENT →

The clause gives the lender a seat at the table, and what it does with the seat is a credit decision. A stronger owner with better access to capital may be welcome, and the consent may be easy. A buyer loading debt above the borrower is a different loan from the one approved, and the bank may prefer repayment. Either way the credit desk needs time, so a consent that has to go through credit approval belongs early in the sale timetable, and the lender's answer belongs among the conditions of the sale agreement.

The clause can also be tripped with no sale in view. A new investor's share issue can dilute a family below the line. A trust restructure can move the votes to a holder the definition does not name. A death can pass shares to an estate. A borrower planning succession reads the definition before the lawyers draft, and a lender writing it asks which of those events it would in fact want to hear about.

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