What is a most favored nation-clause?

As an investor or as a customer you might feel worried that you are not getting the best deal in your business relationships, and that other current or future customers/investors/buyers/partners etc. will get a better deal (even at your expense!).

There is an age-old way to adress such an issue. That is to insert a most favored nations clause (an "MFN") into the agreement. Such a clause basically means that you are entitled to the best price, and the best other terms, that your counterparty is offering, or in the future will offer, another customer/investor/buyer/partner.

You can also see it as a non-discrimination regulation if imposed on a general level - such as in relation to a venture capital or private equity fund - no party should be treated as lesser than the others in the same type of contractual relationship.

Example of a most favored nations situation

You give a converitble loan to a startup. The loan comes with an interest of 8 % annually.

A year later, the startup takes up a new convertible loan and gives the lender 10 % in annual interest. Based on the fact that the initial loan agreement with you has a most favored nations clause - at the time the startup enters into the new loan agreement, you are also entitled to an interest of 10 %.

Risks with a most favored nations clause

Now then, what are the risks with such a clause? Well, for the obvious, there could be a challenge for the party - the seller, the company etc - that is under the obligation to at the same time be able to evolve and progress its business. If you must always provide the same terms on all (or to those counterparties smart and/or strong enough to demand it) - this would mean less ability to make better and better deals. It would limit your flexibility.

In particular in relation to a seller-buyer situation such clauses should also be used with care as they may be challenged as anti-competitive (making it harder to compete over e.g. price).

Recommendation when entering into a most favored nations clause

Hence, when requested to enter into a most favored nations clause - make sure to have reasonable limits to it. In time, and in the general scope.

When you are the one entitled to have a most favored nations treatment - consider how you can verify that the clause is adhered to. As the contracts with other lenders, investors, customers etc will be without you as a party to them, and most likely with some form of confidentiality, you need to ensure sufficient transparency. You could also impose a liquidated damages clause that should have a deterrent effect in relation to breaching the most favored nations obligation.

Conclusion

A most favored nations clause can be a very important protection for you as buyer, investor, lendor. So do consider if you should, and have the negotiation power to, demand such a clause. As a seller, borrower, a startup or other - offering a most favored nation can be (i) a way to get a deal done at all as it provides more comfort to your counterparty, and (ii) get better terms into the deal, as you can make your counterparty more comfortable with the negotiated terms not being worse that reasonable when comparing with other terms and conditions you offer and accept.

Stockholm, 2024-02-01

Author: Katarina Strandberg