After signing a new contract with a principal, most reps will properly focus on generating sales within the newly assigned territory.  Even in this era of corporations getting gobbled up or “restructured” on a regular basis, little thought is given to what happens if the principal gets bought out.  Yet several important questions are usually presented.

Is the rep’s commission stream adequately protected?  What happens if the acquiring party purchases only some of the principal’s assets?  In the worst case scenario, can the principal and the new purchaser conspire to orchestrate a sale that lets the purchaser off the hook from paying commissions under the terms of their deal?

These issues were front and center in a case recently decided by the federal court in Kentucky involving a rep who found his contractual rights at risk after certain assets of its principal were acquired by a company with whom it had no contractual or other relationship.  The fact pattern, while alarming, is hardly isolated.

Sales rep Telecom Decision Makers, Inc. (TDMI) contracted with Navigator Telecommunications LLC in 2005 to solicit local and long distance accounts for its telecommunications business.  The lucrative rep agreement called for Navigator to pay continuing commissions on accounts TDMI generated until the customers’ contracts with Navigator terminated.

The rep agreement contained a common term providing that it was binding on “the successors and assigns of Navigator in connection with and in contemplation of any reorganization, bankruptcy, merger, consolidation, or sales of all or substantially all of the ownership interest or assets of Navigator.” In the event of such a “Change of Control,” the contract would be “deemed assigned to Navigator’s successor.”

Birch Communications, Inc. entered into an asset purchase agreement to purchase certain business and residential lines from Navigator in 2008.  Before that agreement was signed, Navigator gave notice of termination to TDMI.  Birch also sent TDMI notice that it was purchasing substantially all of the residential and business accounts of Navigator.

After the agreement was executed, Birch informed TDMI that it did not assume responsibility for, and would not pay, the continuing or “residual” commissions due under Navigator’s contract with TDMI.  This led TDMI to sue Birch, asserting that its purchase of Navigator’s residential and business local and long distance accounts comprised a “Change of Control” that assigned the obligation to pay commissions to Birch under its contract with Navigator.

Birch disputed that its purchase amounted to a Change of Control, contending that it did not acquire substantially all of Navigator’s assets, and Navigator retained significant other business.  After the parties took discovery on the “Change of Control issue, Birch moved for summary judgment, raising three central arguments.

1.  Did Birch’s Asset Purchase Change Control of Navigator?

Because TDMI had no contract with Birch that could be enforced, the court quickly determined that “Telecom’s rights rise or fall” on the interpretation of “Change of Control” from its contract with Navigator.

Birch pointed to certain persuasive facts to contend that no “Change of Control” took place: (1) it purchased only a small portion of the Navigator assets; (2) Navigator had 50 employees prior to the asset purchase, and now has 39; (3) Navigator remained an operating company in the same business after the asset purchase; (4) Navigator continued to earn revenue of about $2.35 million per month after the sale, down from $3.4 million before the sale; (5) Navigator sold only 15 to 17percent of its 104,000 telephone lines to Birch, and retained 85percent of its total telephone lines and 78.8percent of its revenue; and (6) Navigator’s EBITDA (calculation of earnings before interest, taxes, depreciation, and amortization) increased by 96.2percent.

Recognizing these facts were compelling, TDMI relied on the summary judgment standard, where it doesn’t have to overcome all of Birch’s facts and win the case; that duty applies later at the trial stage.  Instead, it need only show a dispute as to certain material facts to render summary judgment inappropriate.

To demonstrate disputed facts, TDMI effectively turned to an economic analysis, and submitted an expert opinion that the asset purchases did affect a “Change of Control” based on Birch’s acquisition process, the allocation of value based on gross margin and the allocation of value based on net income.  This “diametrically opposed expert testimony concerning the nature and characteristics of the asset sale and its impact on Navigator” convinced the court that a classic factual dispute existed, precluding summary judgment.

While the raw numbers Birch marshaled from Navigator’s business records were powerful, the court ruled that “these mere numbers, without more, do not evidence whether a sale of all or substantially all of the assets of the company occurred.”  A trial would be necessary to resolve the disputed factual issue of whether there was a “Change of Control” of Navigator.

Before TDMI would live to fight another day, however, it had to withstand Birch’s two other, related contentions.  Fortunately for TDMI, the court considered these and succinctly found “neither argument has legs.”

2. Do the Contractual Payment Obligations Survive Termination?

Navigator provided its 30-day notice of termination on June 20, 2008, enabling Birch to seek summary judgment on the grounds that when it entered into the asset purchase agreement with Navigator in November 2008, no agreement with TDMI was in existence, and no assignment could therefore have been made.

The court deemed the argument that the sales rep agreement was not in effect on the date the asset purchase agreement was signed “a red herring.”  In advancing this argument, Birch ignored other language in the rep agreement expressly providing that the obligation to pay the residual commissions survived its term.  The court also found support in the rep agreement’s language establishing that Navigator would owe the residual commissions even under a “Change of Control.”

Finding that the rep agreement provided for assignment of “the ongoing obligation to pay residual commissions” to Birch, the court concluded that the effectiveness or viability of the rep agreement after July 2008 was irrelevant.  Summary judgment on this theory was easily denied.

3. Does the Absence of Revenue Collection by Navigator Matter?

Birch then cherry-picked other language in the Navigator-TDMI agreement stating: “payment of residual commissions will survive…and will be paid…so long as…Navigator is collecting revenue…under this Agreement.”  Reasoning that it, not Navigator, was collecting revenue for services under the Navigator-TDMI agreement, Birch urged that no residual commissions were owed TDMI.

As with the prior argument, the court found Birch was inappropriately focusing on the viability of the rep agreement on the date the asset purchase agreement was signed.  The proper focus is whether the rep agreement effectively assigned the obligation to pay commission in the event of an asset purchase.  Finding that it did, the court viewed Birch as standing “in the shoes of Navigator for purposes of assessing the collection of revenue,” and denied summary judgment to Birch on this basis as well.

TDMI survived summary judgment chiefly because its rep agreement with Navigator was well drafted, and included several important provisions for its benefit.  A lesser agreement could have yielded significantly different results for the rep.  Particularly where commissions were contractually due to continue even after the agreement’s termination, it was essential for the rep to ensure that the value carefully provided in one contract term is not undermined by another, less thought-out provision.