1. Affiliate clauses in contracts
2. The loss of affiliate status
3. How affiliates are determined

An affiliated companies clause is applicable to any subsidiary or parent company of an organization. An affiliated company may be an entity that already exists, or one that is started or acquired in the future. In a nutshell, an affiliated company is any company that controls a separate entity (directly or indirectly) or is controlled by another company.

The term "affiliation" refers to a relationship between two companies in which one falls under the other. Or, in a different scenario, Company A is an affiliate of Company B if they both fall under Company C. Affiliation between two companies can also exist if at least half of the voting shares of each company are owned by the same person, legal entity, or corporation.

Under the affiliated companies clause, an affiliate can be:

  • One member of a controlled group of companies
  • An unincorporated business under an employer's common control
  • An entity not classified as an employer, but which is required to be associated with an employer

Affiliate clauses in contracts

In some contracts, a party's affiliate can be given the same obligations and rights as the party themselves. A great example of this is license agreements. In other contracts, companies can be required to provide warranties and representations about their affiliates as well as themselves. This is commonly applicable in merger agreements.

If Company A and Company B enter into a contract, it is possible that a current or future affiliate of Company A could one day become a competitor of Company B. This affiliate (let's call it Company C) could also be an entity that Company B did not want to do business with for some reason. It is important for Company B to consider whether the rights and obligations that Company C could acquire as an affiliate could be detrimental.

In order to establish control, a contracting party may ask for a percentage lower than 50 percent. It is possible that they may have a subsidiary in which they feel they have de facto voting powers without owning a majority of the stock. In these circumstances, one should consider specifying that these non-controlled subsidiaries are also to be affiliates.

The loss of affiliate status

The agreement should specify provisions that come into play if affiliate status is lost. These would cover an orderly process of phasing out specific obligations and rights. Let's suppose that one company had a license to use a particular software, and the affiliate also had the right to use this software. If the termination of the affiliation could cost an affiliate the rights to use this software with immediate effect, it could be extremely problematic.

How affiliates are determined

In most cases, it's enough to specify that certain companies will be considered affiliates even if the relevant legal relationships do not qualify as controlling.

The Small Business Administration (SBA) determines affiliation in a variety of ways:

  • A company is considered to be an affiliate of another company when one has control of another, or if both are controlled by a third party. Whether or not this control is being exercised is irrelevant, as long as the ability to control can be proven.
  • The SBA will take various factors into consideration, including ownership, a previous connection with another entity, management, and contractual relationships. All of these play a part in deciding whether two companies are affiliated.
  • The control that is in place may be either affirmative or negative. Negative control refers to cases in which a minority shareholder can prevent the shareholders or board of directors from taking action.
  • Even if a concern, entity, or individual has control indirectly, by means of a third party, affiliation may be found in some circumstances.

The SBA will decide whether an affiliation exists by taking all the circumstances into account. An affiliation may be found even in a case in which there is not a single factor which, on its own, could constitute affiliation.

It is important to note that businesses largely owned by investment companies that fall under the Small Business Investment Act (1958) as amended are not considered affiliates. This also applies to development companies that qualify under the Act.

If you need help with the affiliated companies clause, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with companies such as Google, Menlo Ventures and Airbnb.