Private Equity

When is a person’s status as an “affiliate” determined—when the contract restricting an affiliate’s activities is entered into, or at the time an alleged violation of the contractual restriction occurs? Stated differently, can a contracting party become responsible for an alleged violation of a contract restricting a party and “its affiliates” by the actions of a person after it becomes an affiliate, even though it was not an affiliate when the contract was entered into? According to a recent Delaware Court of Chancery decision, Symbiont.IO, Inc. v. Ipreo Holdings, LLC, 2021 WL 3575709 (Del. Ch. Aug. 13, 2021), the answer, at least in the context of a non-competition provision contained in a joint venture agreement, is that a person’s status as an affiliate is generally measured at the time of the alleged breach. As a result, a contracting party that agrees to restrict its affiliates’ actions, without qualifying language, becomes responsible for an affiliate’s violation of those restrictions after that affiliate becomes an affiliate, even if the contracting party has no control over that affiliate but is instead controlled by it. And it matters not that the person becoming an affiliate is simply continuing to conduct its business as it has always done and was not itself bound by the non-competition agreement.

Although there is New York authority suggesting that “[a]bsent explicit language demonstrating the parties’ intent to bind future affiliates of the contracting parties, the term ‘affiliate’ includes only those affiliates in existence at the time that the contract was executed[,]”^[1] Vice Chancellor Laster believed that Delaware authority was to the opposite effect, at least in the context of a non-competition provision, citing Universal Studios, Inc. v. Viacom Inc., 705 A.2d 579 (Del. Ch. 1997). Indeed, the Viacom precedent was deemed to clearly articulate that a non-competition provision restricting “its affiliates” included both those which existed at the time the contract was entered into, as well as those that acquired that status at a later date. And, in light of that precedent, contract draftspersons of agreements governed by Delaware law are responsible for knowing that Delaware law requires explicitness in restricting the term affiliates to only those that currently constitute affiliates, if that is what is intended. According to Vice Chancellor Laster:

Lawyers draft in the shadow of existing precedent. A major benefit of precedent is to clarify the meaning of contractual terms so that parties can deploy them with confidence. When Symbiont and Ipreo entered into the JV Agreement in 2016, the Viacom case was settled precedent. It had been on the books for nineteen years. The decision not only illuminates the plain language of the JV Agreement, but it also shows that if the drafters wanted to achieve a different result, such as limiting the coverage of the Affiliate Definition to those Persons that qualified as affiliates on the effective date, then they needed to include additional language to achieve that result.

So while it may be better practice to use terms like “present and future” as a modifier to the term affiliates when your intent is to include future affiliates in the restricted category, it is even more important to specifically modify the term affiliates with a modifier like “current” or “now existing” when your intent is to exclude future affiliates. And it can’t hurt to be a little more careful in throwing around the term “affiliates” in your contracts to begin with.^[2] A portfolio company’s non-compete that restricts affiliates, may well block the sale of that portfolio company to any buyer who had been a competitor of the portfolio company’s non-compete counterparty long before the non-compete was entered into. Moreover, an exception for the sponsor and its other affiliates (which is a common feature of these provisions in the private equity arena and which was present in the JV Agreement at issue in Ipreo Holdings) may not help much.

And please don’t forget that there is a distinction between purporting to bind affiliates to an agreement and simply becoming liable for their actions. In this case, the fact that a new purchaser of the portfolio company, who thereby became the portfolio company’s affiliate, was not actually bound by the non-compete entered into by the portfolio company was irrelevant in the action against the portfolio company for the continued actions of its new parent affiliate. After all, as noted by Vice Chancellor Laster, “a party can accept contractual consequences for events beyond its control, including the actions of entities that are not parties to the contract.”