326 9 Exit of Different Classes of Investors
asset, the firm may have a legal obligation to return the asset or cease using it. If
the firm purchases the asset from the investor, the firm will pay a purchase price.
Risks. This gives rise to five important risks. (1) The withdrawal or reposses-
sion of assets that the firm uses in its business operations can cause operational
problems (operational risk). (2) It can be difficult to replace the asset (replacement
risk). (3) Even if the firm were able to replace the asset, it might cost the firm
more (refinancing risk). (4) In some cases, the firm is so dependent on the contin-
ued use of the asset that it becomes exposed to the risk of hold-up. (5) If the owner
of the asset transfers ownership to somebody else, counterparty commercial risk
can change, because the new owner is either more likely or less likely to withdraw
the asset than the original owner was, and either more likely or less likely to abuse
its position than the original owner was.
Management of risk. The firm will typically manage such particular risks in the
following ways (see also sections 3.3.3 and 3.3.4; for assets used as collateral, see
Volume II).
The first is ownership. The firm should own its core assets. This can lead to
vertical integration. For example, if the firm is dependent on a large distributor for
the distribution of its products, the firm may prefer to mitigate risk either by ac-
quiring the distributor or by establishing a subsidiary of its own and transferring
the distributorship to its subsidiary.^1 In addition, the firm can ensure that its core
assets are not owned by the same external party.
The second is through the regulation of the contract period and termination.
The firm can mitigate risk through contract terms that: provide for a long contract
period; limit the investor’s right to terminate the contract prematurely; provide for
a long notice period when the contract is terminated by the investor; permit the
firm to terminate the contract in an easier way; and give the firm an option to buy
the asset on termination.
The third is by limiting both the right of the investor to transfer ownership of
the asset to a third party and the right of the investor to assign the contract to a
third party.
Legal constraints on performances to asset investors. Legal constraints on per-
formances to asset investors depend on the asset and the type of investment. Gen-
(^1) The legal framework of the firm’s distribution channels can be understood as a process.
The firm starts with direct sales to customers in the market. Commercial agency pro-
vides access to established distribution channels. However, commercial agents typically
lack financial resources to invest in sales and marketing. Sooner or later the firm will
terminate the commercial agency relationship. The parties have therefore regulated the
terms of the termination of the commercial agency relationship in detail. As the weaker
party, the commercial agent is protected by mandatory provisions of law based on Di-
rective 86/653/EEC (Directive on commercial agents). A sole distributor typically has
better financial resources compared with a commercial agent. However, both the sole
distributor and the principal know that the principal will want to terminate the sole dis-
tributorship contract if the sole distributor either does not do well or does very well.
Even in this case, the parties have regulated the terms of termination in detail. The terms
of commercial agency contracts and distributorship contracts reflect this process.