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Affiliate definition clauses in contracts

[UPDATE 2012-09-12: See the sample language and annotations for this definition.]

Why “affiliate” is often a defined term

Some contracts give “affiliates” of parties some of the same rights and/or obligations as the parties themselves (for example, some license agreements). Other contracts require parties to make representations and warranties not only about themselves but about their affiliates as well (for example, some merger agreements). This sample clause is a fairly typical definition of affiliate, mirroring definitions found in U.S. securities laws such as Rule 501(b) of SEC Regulation D, 17 CFR § 230.501(b).

Heads-up: Could affiliates be competitors?

Conceivably, one of the other side’s existing (or future) affiliates could turn out to be one of your competitors, or some other person or entity you’d just as soon not do business with. Ask yourself whether it would cause you any heartburn if such an affiliate were to have the rights (and/or obligations) of an affiliate under the Agreement.

Heads-up: Less than 50% ownership for “control”

Some contracting parties may ask for a lower percentage than 50% to establish "control": They may have subsidiaries in which they own less than a majority of the stock, but they feel they still have de facto voting control. Counterparties might not be comfortable with less than 50% control, however. For those situations, consider specifying particular non-controlled organizations that are to be deemed affiliates even in the absence of a control relationship.

Heads-up: What happens if affiliate status is lost?

It might be appropriate to provide in the Agreement, in case of loss of affiliate status, for the orderly phase-out of specific rights and obligations. For example, suppose that (1) a software license agreement permitted the licensee’s affiliate to use the software, and (2)  that an affiliate were to lose its status as such because of a corporate divestiture. It could be quite disruptive if the affiliate were required immediately to stop using the licensed software.

Heads-up: Affiliate “control” through power to direct management can be a bad idea

Some contracting parties want their “affiliates” to include companies that they control through, for example, “the power to direct or cause the direction of the management and policies of the organization, directly or indirectly, whether through ownership of voting securities, by contract or credit arrangement, as trustee or executor, or otherwise.” This language is modeled on text found in the U.S. securities laws (for example, in Rule 1-02(g) of SEC Regulation S-X).

For regulatory purposes, the SEC’s language may be all well and good. But if this kind of definition of “control” were to be used in a contract, it’s not hard to imagine how, in later litigation, the parties might have to engage in extensive — and expensive — discovery about who has what management power.

For an example of an expensive legal battle over who did or did not have “control” — in this case, control of a vessel in drydock that was destroyed by fire — see Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., No. 08-40885 (5th Cir. Apr. 20, 2010) (affirming summary judgment in relevant part).

In many circumstances, it may be enough to state that certain specified companies will be deemed “affiliates,” even though the specific legal relationships in question don’t qualify as "control."