Most Favoured Nations Clauses: Understanding the Risks and Rewards Across Different Contracts

In the world of contracts, the "Most Favoured Nations" (MFN) clause is a powerful tool that can have far-reaching implications across various legal agreements, including procurement contracts, investment contracts, and fund contribution contracts. While these clauses offer potential benefits, they also come with significant risks. Anyone faced with an MFN should tread carefully, understanding fully well that such clauses can have long-standing and often unforeseen consequences.

What is a Most Favoured Nations (MFN) Clause?

An MFN clause is a contractual provision that ensures the party benefiting from it (the beneficiary) will receive terms at least as favorable as those offered to any other party in the same or similar transactions. Essentially, it guarantees that the beneficiary is not at a disadvantage compared to others.

MFN Clauses in Different Types of Contracts

1. Procurement Contracts

In procurement contracts, an MFN clause can ensure that the buyer receives the best possible terms offered by the supplier to any other customer. For instance, if a supplier offers a discount to another customer, the buyer with an MFN clause is entitled to receive the same discount. This arrangement could be problematic, the discount to the other customer could be an outcome of order size, order specifications, seasonality of the underlying product, cost of inputs/labour, differential pricing across jurisdictions, and so on. In other words, from a seller’s perspective, an MFN should (if conceded) be drafted to be applicable only on a true apples-to-apples situation.

2. Investment Contracts

In investment contracts, an MFN clause ensures that an investor receives terms that are at least as favorable as those provided to any other investor in future funding rounds. This too presents challenges, on one hand the MFN could operate on pricing terms (and pricing may account for various factors unique to the new investor, such as the new investor offering access to an inaccessible market). The MFN could also operate on governance terms (such as the new investor having extensive consent rights because it is coming-in at a significantly higher valuation and is taking a much higher stake). Finally the MFN could also cover exit/ liquidity preference rights available to a new investor (which may be an outcome of their size, scale, profile, brand value, and so on). In other words, for a company to have an MFN may be challenging and companies often look to have a sunset on the MFN.

3. Fund Contribution Contracts

In fund contribution agreements, an MFN clause ensures that a contributor receives terms at least as favorable as those offered to any other contributor. This is often for variations in management fees offered to different investors in the fund (for instance the anchor investor may get a discount on fees), sharing of carried interest, right to be exempt from certain investment, addition rights to information on portfolio companies, rights to co-invest in portfolio companies, and so on. Needless to add, MFNs are not given away easily in this context, since they could meaningfully impact the operations of the fund itself and funds that are in the pipeline.

Balancing the Risks and Rewards

MFN clauses offer significant rewards in terms of fairness, protection, and competitiveness for the holder of the MFN. However, these benefits come with risks, particularly around complexity, enforcement, and the potential to stifle future negotiations or relationships.

Takeaways

Most Favoured Nations clauses can be a double-edged sword. While they offer protection and ensure fairness, they also require careful consideration and management to avoid unintended consequences. To effectively navigate the inclusion of MFN clauses in any contract, parties should:

Understand the Scope: Clearly define what the MFN clause covers—whether it’s pricing, terms, covenants, or fees.

Consider Flexibility: Build in flexibility to allow for exceptions or adjustments in future negotiations, reducing the potential for conflict or operational constraints.

Monitor Compliance: Establish robust mechanisms for monitoring and enforcing MFN clauses, particularly in complex agreements involving multiple parties.

Whether you are a buyer, investor, or contributor, understanding the risks and rewards of MFN clauses will help you make informed decisions that support your strategic objectives and protect your interests over the long term.