Change of control clauses in joint venture agreements

Key Points

Change of control provisions in contracts typically receive little attention in the early stages of M&A deals, but in practice they can play a significant role in the structuring of, and the completion risk associated with, transactions.

The focus of this article is on change of control clauses in joint venture or shareholder agreements. The cases discussed below illustrate the different and often unintended ways change of control clauses can operate in these contexts.

Acquirers need to carefully review change of control clauses as part of any due diligence on a target company or, if access to the contracts is not available (for example, in the case of a hostile takeover bid), consider making the bid conditional on counterparties waiving any rights under material contracts containing change of control clauses.

General operation of change of control clauses

The identification of the existence of a change of control clause in a contract is usually a straightforward exercise. The more difficult question is how the clause actually applies to the transaction under consideration.

The following sorts of issues can arise:

• Does the clause only apply to a change of ownership of the shares in the relevant company, or is it drafted broadly enough to capture up-stream changes of ownership?
  If the wording of the clause focuses on legal or beneficial ownership of the shares of the company, selling the shares in an upstream holding company may not trigger the operation of the clause. On the other hand, if the wording refers to a change in control of the shares in the company, that may cover the sale of shares in a holding company.
• Is there a listed company exception and how does it apply?
  Often a change of control clause will include a carve-out for a change of control resulting from a transaction in relation to listed securities. However, these are occasionally drafted so the exception only applies if the actual contractual party is listed, not if its holding company is listed.
• Does the change of control clause only operate if a new party acquires control of the company (rather than, for example, an existing owner ceasing to control the company)?
  If so, it may be that conducting an IPO or demerger of the company will not attract the operation of the clause if the IPO or demerger does not result in any new party acquiring control of the company.
• Is there an obligation on the counterparty not to unreasonably withhold consent to the change in control?
  A provision of this nature is common, for example, in leases (consistent with the statutory provision in some states that a landlord cannot unreasonably withhold consent to an assignment of the lease). In practice, it can sometimes be difficult to effectively ‘enforce’ such an obligation as the cases have held that there is generally no obligation on the counterparty to provide reasons for refusing to consent to a change of control (unless, of course, there is an explicit provision to this effect in the contract itself).

Rationale for change of control clauses in joint ventures

A typical (but by no means universal) approach in a joint venture agreement is that:

• each joint venture participant has preemptive rights in relation to a disposal of a direct interest in the joint venture (sometimes tag along or drag along rights also apply), and
• a change of control of a joint venture participant gives the other participants a right to buy its joint venture interest for fair value.

The rationale of a change of control clauses like this was summarised in the 2006 case of Pauls Trading Pty Ltd v Norco Co-operative Limited, as follows:

It is to protect a participant in the joint venture against the risk that its partners might change, against its wish, by the acquisition of their shares by a third party, or by a third party acquiring control over the joint venturer by acquiring the shares in its holding company. The continuing participant is not obliged to accept its new partner. It is given the option of acquiring the defaulting participant’s interest in the joint venture.

However, the cases indicate that if these type of clauses are ineffectively drafted, they can be easily circumvented, allowing participants to change the effective ownership of their interests without triggering adverse side effects.

Upstream changes of control – the Norco case

The Pauls case is an example of a how a broadly worded change of control clause can capture upstream changes of control.

The case concerned a joint venture among Norco and Pauls Australia, a subsidiary of Parmalat of Italy. The joint venture included change of control clause and defined a change of control as a situation where a person and its associates (as defined in the Corporations Act 2001 (Cth) (Corporations Act)) became entitled to exercise voting power of more than 50 per cent in respect of a joint venture participant, or acquired the capacity to appoint half the directors of a joint venture participant.

The court found that each company in the Parmalat group of companies was an associate of each other, and the ultimate Parmalat parent company and Pauls were both associates of Parmalat Australia (even though a number of entities were interposed between them).

Accordingly, because of the associate reference in the change of control definition, the appointment of an external administrator to Parmalat Italy (when it filed for bankruptcy) constituted a change in control of Pauls under the joint venture agreement, and triggered a buy-out right for Norco.

Kawasaki – courts will not imply a change in control clause

The 2008 case of Kawasaki (Australia) Pty Ltd v ARC Strang Pty Ltd illustrates that the courts will generally construe pre-emptive clauses in joint venture agreements strictly and will be reluctant to imply provisions that are not expressly included in the joint venture agreement.

An ARC entity, the corporate trustee of a family trust, was a party to a shareholders’ agreement. The shareholders’ agreement had relatively standard pre-emptive provisions that were triggered if a shareholder wished to transfer its shareholding in the joint venture company. The shareholders’ agreement did not contain a change of control clause.

To effect a sale of its shareholding in the joint venture company:

• the ARC trustee entity transferred the beneficial interest in the shares in the joint venture company to itself in its own capacity, then resigned (and was replaced) as trustee of the family trust, and
• the shares in the ARC trustee entity (which then held the beneficial interest in the shareholding in the joint venture company) were sold to the purchaser.

The court held that the sale was effective and did not trigger the pre-emptive rights under the shareholders’ agreement.

The reference in the shareholders’ agreement to a ‘transfer’ of shares meant a transfer of the legal interest in shares. Furthermore, the court held that there was no reason to imply a change of control clause into the shareholders’ agreement and rejected arguments that the ARC had breached any fiduciary duties or duties of good faith to the other joint venture participant.

Aquila – internal restructuring OK

The 2007 case of Aquila Steel Pty Ltd v AMCI (IO) Pty Ltd concerned the interaction of the following clauses in a joint venture agreement:

• The joint venture agreement prohibited transfers of a joint venture interest except in accordance with the agreement. However, a participant could (subject to certain requirements) transfer its joint venture interest ‘as a matter of right’ to any related body corporate.
• The joint venture agreement also provided that, where a change in control occurred in relation to a joint venture participant, the remaining participant had an option to purchase the joint venture interest of that participant at market value.

In summary, AMCI undertook an internal restructure under which AMCI Steel transferred its interest in the joint venture to a related body corporate, then AMCI subsequently sold (indirectly) the shares in AMCI Steel as part of the sale of some of its Australian coal interests.

The court rejected Aquila’s objections to the transaction and found that the transfer by AMCI Steel of its joint venture interest was permitted under the related body corporate provision and the sale of the coal interests did not trigger the change of control clause as, by that stage, AMCI Steel (that was the subject of a change of control) was no longer a joint venture participant.

The theme that emerges from these cases is appropriately drafted change of control provisions can be effective in protecting a joint venture participant’s interests against an unwelcome third party entering the venture, but still flexible enough to allow participants to undergo internal reorganisations that do not change ultimate control.

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