The Abc of affiliates

Affiliate, should it be part of the business agreement or should it not be part of the business agreement? This is uppermost question that most corporate lawyers have in their mind while drafting and negotiating the agreements. So we will evaluate in details the impact of having/not having affiliates in the agreements.

Affiliates shall mean any company, existing now or in the future, owning or owned by, either directly or indirectly, or controlling or controlled by or under common control. This is the closest definition that I can come up with for affiliates. An entity controls another when it owns or controls, directly or indirectly, more than 50 per cent of the voting securities or voting interests of the said other entity or when it controls the composition of the board of directors of the said other entity. The affiliate companies can be spread across the globe and there is no geographical constraint to the same.

In agreements we often come across these wordings......

“This agreement is effective from _______________, by and between ABC Limited, a company, incorporated under the Companies Act, 1956, with its registered office located at ______________ (which, together with its affiliated companies, is referred to in this Agreement as the “Company”) of one part, and ......”

During agreement negotiation, it is not uncommon to see the above wordings in many agreements. There are many questions that arise now.

1) Rights and obligations put in here run only to the signatory company and can by mere reference to the affiliate can the signatory company bind the affiliate companies?

2) Is the signatory authorised to sign on behalf of each of the affiliate company?

3) Are all the affiliate companies jointly and severally liable?

4) If one of the affiliate companies ceases to be an affiliate post execution of the agreement, does it cease to be a party of the agreement?

5) If one the affiliate is in breach of the agreement, will the claim arise against that particular affiliate or against other affiliate companies as well ?

If you attempt to answer any of the above queries, you will also understand the complexity of including the word affiliate in the agreement.

Now let us see a different scenario where the parent company is entering into a master agreement for receiving services across the globe either by itself or through its affiliate companies spread across the globe. In such a scenario, it will be better to have a master agreement with the parent company “together along with its affiliate.” Now if the services are received/given with its affiliate in a different geography then a simple work order or a purchase order referring the master agreement is good enough for that particular geography. One need not enter into the complex process of negotiating a separate agreement for each of the geography where the services are received/given. Of course, needless to say, this need not be restricted to services model of business but is applicable for any type of business scenario. 

The practice of using affiliates have been creeping into the agreement templates for several years now. So how do we enforce the obligations? The affiliate could have the obligation, as in “The affiliate shall...” or the parent company could have the obligation, as in “The parent company shall cause the affiliate to comply with the requirement in the agreement.” Since, the parent has executed the agreement on behalf of its affiliates, it will be the obligation of the parent company to cause the affiliate to comply with the requirement in the agreement.

The only reason I see to have the parent company bear the obligation would be to make it liable for affiliate’s failure to perform. By signing the agreement, the parent is assuming obligations that run only to the parent company, not to the affiliate, so the parent is in effect entering into the agreement on its own behalf.

Again, can it be presumed to have a principal agency relationship between the affiliate companies? Can the parent company sign the agreement as agent for and on behalf of affiliate — if not explicit agency relationship at least an implied agency relationship? This makes it clear that the parent company is signing the agreement as agent for the affiliate, which are the principals under the agreement and hence have privity of contract with the counterparty. Now another question arises. Is it required for the counterparty to see the documentation and get convinced of the agency relationship?

Yes the laws are still unclear and the agreements are signed to make the business operations easy with possibly the following explanations and options.

1) Enter into an agreement with the parent company and treat the affiliate as third party beneficiary (they get the benefit, but the obligations doesn’t  directly bind the affiliate because of the lack of privity of contract). Especially in such agreements we have “authorised users” whereby the “authorised users” can be one of the affiliate companies taking benefit from the agreement but they may not be bound by the obligations in the agreement because they may take refuge under the pretext of not having a privity of contract with the counterparty.

2) Enter into an agreement with the parent company and treat the parent as a subcontractors, and require the parent company to enter into a separate subcontracting with its affiliates. This isn’t crazy as it sounds because there are often intercompany agreements between parent company and affiliates.

3) Enter into a separate agreement with each legally independent affiliates. Obviously, this can greatly increase the transaction costs and administrative time.

4) Enter into a master agreement with the parent company and then have the affiliate “join” the master agreement through work orders, statement of work, purchase orders which puts the affiliate into direct contractual privity.

I, as a corporate lawyer, feel that it is best to leave the affiliate out of the agreement and address the requirement of the affiliate joining into the agreement differently. By including in the definition of the company the affiliates you are only exposing the liability of the affiliates. Instead, my suggestion would be to try to include the following or similar wordings in the agreement.

“This is a global framework alliance agreement. Both parties agree to utilise this agreement for mutual engagement worldwide by their respective applicable affiliates. If opportunities for business as given in the agreement exist in a country where either party operates through its local affiliate(s), the parties may cause each of their applicable local affiliates to enter into applicable local agreements/statement of work. Each of the party shall retain full responsibility and liability for the performance of their respective affiliates.”

This way we circumvent the possibility of exposing the liability of the affiliate companies but at the same time also “join” the affiliate in the agreement.

 (The writer is is the global head of legal in a major information technology company)