Contract Drafting (Spring 2019)

By D. C. Toedt III
Attorney & arbitrator — tech contracts & IP
Adjunct professor, University of Houston Law Center

Updated Wednesday January 16, 2019 11:26 Houston time

Important initial notes:

  1. This document is still a work in progress — by student request, I've been consolidating many of the major reading materials into this document and indicating which readings should be studied, read, skimmed, are extra, or are optional. "Black letter" indicates something students should learn well. I'm "freezing" the document for the semester so that people can print it out if they want.
  2. For many students, this document will work just fine if read on the screen. Also by student request, however, I've tried to set up this document for printing to hard copy. Typographically, the setup is less than optimal for printing — for example, there are some page breaks immediately after a heading, instead of keeping the heading together on the same page with the following text. (It's not supposed to do that, but I haven't figured out why it does.)
  3. IMPORTANT: The readings are intentionally not set up in the order in which we cover the topics, but instead in a mostly-alphabetical order (along the general lines of a dictionary or encyclopedia). This arrangement should help you to quickly find specific reference material if you need to look something up during this course, or afterwards.
  4. The chronological list of reading assignments in § 2 includes cross-references to the assigned materials.
  5. Unfortunately I haven't had time to group all of the exercises together; some of them in the later weeks of the course are still in the weekly plan section.

Table of contents:

1 Key dates this semester

Wed. Jan. 30: MIDTERM QUIZ #1

Mon. Feb. 18: Reshuffle the groups

Wed. Feb. 20: MIDTERM QUIZ #2

Mon. Mar. 11: NO CLASS — spring break

Wed. Mar. 13: NO CLASS — spring break

Wed. Mar. 20: MIDTERM QUIZ #3

Mon. Apr. 01: Reshuffle the groups

Wed. Apr. 10: MIDTERM QUIZ #4

Mon. Apr. 22: Last day of class if makeup day is NOT needed

Wed. Apr. 24: Last day of class if makeup day IS needed

Wed. May 01: FINAL EXAM (6:00 to 7:00 p.m. for both sections; room TBD)

2 Reading assignments & weekly plan (subject to change)

2.1 Flashcards as "reading assignments"

In addition to the reading assignments below, be sure to look through the "Flashcards": Review questions, § 6 to find the ones related to the reading assignment — because:

  • the midterm quizzes (§ 4.44.5) and part of the final exam (§ 4.44.6) will be based in part on these flashcards; and
  • by having to scan through the flashcards, in search of the specific flashcards relating to the reading material, you'll get a preview of upcoming concepts and thus help you get yourself up to speed more quickly.

2.2 Week 1 (Mon. Jan. 14)

2.2.1 Course startup

  1. Student introductions:
    • Name
    • 2L? 3L? LLM?
    • Career intentions
    • Undergraduate school & degree
    • Work experience
    • Previous contract experience
  2. Provide email addresses in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section )
  3. First in-class exercise: Where did Professor Toedt go to law school? Reason: It's a good idea to look up the people on the other side of a contract negotiation — or for that matter, anyone else you'll be dealing with. Google and LinkedIn are extremely useful for that purpose.

2.2.2 Review the course info

  1. Toedt contact information; office hours: § 4.42.
  2. General course information, § 4.41.1.
  3. Grading: § 4.44.
  4. PSA requested by the University: Counseling is available (see § 4.43).

2.2.3 Reading for this week

Since this wasn't posted in time for advance reading:

(Study:) Signature blocks, § 4.97 — look this over

(Read:) Contracting mechanics, § 4.39 — know the section headings in this chapter, skim the actual text.

(Study:) Microsoft Word: Crucial things to know, § 4.79 — read somewhat carefully

(Read:) Drafting mechanics, § 4.49 — look this over

(Read:) Title of agreement, § 4.100 — read carefully

(Study:) Preamble of the agreement, § 4.83 — read carefully

(Study:) Background of agreement, a.k.a. "recitals", § 4.23 — read carefully

(Study:) Defined terms, § 4.46 — read carefully

(Read:) Sayings, § 4.93 — we'll be seeing these again

Homework (drafting specific provisions), § 3 — read the fact pattern; we will use this all semester to build a sophisticated contract, piece by piece.

2.2.5 Thumbsucker questions: Goals, etc.

For discussion, in small groups:

  1. In your practice, do you expect you'll be doing more drafting of contracts, or more review of drafts that others have prepared? Explain.
  2. What do you think are the main goals of a contract drafter or reviewer?
  3. In abstract terms, what do you think is the client's overarching goal in negotiating a contract?
  4. What do you think is likely to be the worst bottleneck in getting a contract to signature?
  5. What kind of contract language do you think business lawyers should aspire to write?
  6. TRUE OR FALSE: A contract drafter should strive to anticipate and address all harms to the client that might occur in the course of the parties' relationship.

[NEW:] Ambiguity: "… was clearly executed" vs. "clearly was executed"

From an email I received from the American Arbitration Association: "For unknown reasons, the reports generated that reflected completions of the Standards & Responsibilities form failed to include your entry even though the form was clearly executed." (Emphasis added.)

QUESTION: What are the two possible meanings for the italicized version?

2.2.6 Preview question: Vagueness vs. ambiguituy

QUESTION: What is a "vague" term? What is an "ambiguous" term?

2.2.8 Read-along lecture: Rewriting a wall of words

2.3 Week 2 (Mon. Jan. 21)

NO CLASS MONDAY (MLK holiday).

2.3.1 Reading for this week

(Study:) Ambiguity, the bane of contract drafters, § 4.8 — look over the text

(Read:) Writing rules, § 4.104 — read the section headings, look over the text

(Read:) Walls of words (WOW): Simplifying them, step by step, § 4.103 — look over the section headings; we will go over them in detail in various class sessions.

2.3.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.3.4 Additional "homework" for next Wednesday (not for turning in)

For the Gigunda-MathWhiz engagement, jot down some ideas for a "term sheet," namely:

  • a list of the types of provisions that you think will need to be included to protect your client's interests; and
  • a list of the types of provisions that you are sure the other side will want, and therefore will want to include (so as not to invite the other side to propose something much more favorable to that side).

You might want to consider the list of typical provisions at https://perma.cc/HD4P-RJ4P

Consider also the SNITS acronym: What could happen — good or bad — during:

  • Startup of the relationship
  • Normal operations
  • Infrequent operations
  • Trouble
  • Shutdown of the relationship

If you don't know what your client will want as an outcome in a given situation, consider whether the parties can agree to a process for later determining what the outcome should be.

2.4 Week 3 (Mon. Jan. 28)

2.4.1 Reading for this week

(Study:) Payment terms, § 4.82 — read

(Study:) Interest on past-due amounts, § 4.72 — read

(Skim:) Security interests, liens, etc., § 4.94 — skim; focus mainly on the headings

(Skim:) Guaranties, § 4.67 — skim; focus mainly on the headings

(Black letter:) Key takeaways about reps and warranties, § 4.89.1 about reps and warranties

(Black letter:) Representations vs. warranties, § 4.89.2 between reps and warranties

(Study:) Reps and warranties, § 4.89 — scan through the rest

Article II: Representations and Warranties of Seller, § 7.1 — look this over; there's no need to study it in detail

§ 8.16: Disclosure Schedules, § 7.4 — note how disclosure schedules tie in with reps and warranties

2.15 Real Property, § 7.1.15 — look this over; there's no need to study it in detail

2.4.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.4.3 MONDAY: Dry-run quiz to test Blackboard (zero points)

Wednesday would not be the time to find out that you don't have access to this course on Blackboard ….

2.4.4 WEDNESDAY: Quiz #1

2.4.5 WEDNESDAY: Bring your term-sheet notes

See last week's plan.

2.4.7 News: AAA accused of wage shorting

Source: L.M. Sixel, Tow driver says AAA shorts him and others on wages (HoustonChronicle.com Jan. 29, 2018)

Relevance: Just because a contract says, The parties are independent contractors, that doesn't mean a court will rule that way — especially if one of the parties claims to be an employee of the other.

2.4.8 Collect additional email addresses

If you didn't type your email address into the the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), please email it to me at dc@toedt.com so I can add it to the class Google Group email list. If you're not on that email list, you'll miss important announcements.

2.5 Week 4 (Mon. Feb. 4)

2.5.1 Reading for this week

(Study:) Acknowledgements in a contract, § 4.3 (not the notary-public kind)

(Study:) Acknowledgements in a notary certificate, § 4.2

(Study:) Indemnities, § 4.68

(Read:) Reasonable efforts, § 4.86

(Study:) Commercially reasonable (efforts, etc.), § 4.30

(Study:) Best efforts, § 4.25

In this article, look over just (i) the part with the chart including "35 mph," and (ii) the paragraph immediately preceding the chart. Think about:

  • what might constitute "unreasonable" action such as, say, unreasonable withholding of consent to assignment of the agreement); and
  • how a drafter, representing a party that might seek consent, might try to negotiate a workable arrangement.

Stanford-Tesla lease: Skim through it in the Supplement, especially the annotations.

2.5.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.5.3 Reading review

In your groups, discuss:

  1. What are the two kinds of certificates that notaries public [cf. "attorneys general"] typically sign?
  2. What's a simpler term for "indemnify"?
  3. FACTS: A) Alice acknowledges that she had the opportunity to consult a lawyer before signing a contract with Bob. B) In a lawsuit against Bob under the contract, she claims that she wasn't able to consult a lawyer. QUESTION: What result (normally)?
  4. Suppose that Alice promises to indemnify Bob against third-party claims. Now suppose that Carol sues Bob. QUESTION: Must Alice pay for Bob's defense?
  5. FACTS: A) You represent Alice in negotiating a contract with Bob. B) Alice is unsure that she can actually perform one of her obligations, so Bob asks her to commit to making her "best efforts" to do so. QUESTION: What do you advise Alice, and why?
  6. Is there any significant difference between "reasonable efforts" and "commercially-reasonable efforts"?

2.5.5 "And" — in the gospels (Greek manuscripts), and in contracts

DCT to discuss the use of "Something something something; and something else something else something else."

See the Gospel of Mark 10:33-34, in an almost-literal, word-for-word translation from the Greek "original":

Lo, we go up to Jerusalem and the Son of Man shall be delivered to the chief priests and to the scribes and they shall condemn him to death and shall deliver him to the nations and they shall mock him and scourge him and spit on him and kill him and the third day he shall rise again.

(Emphasis added.) Cf. the original of Verizon-Yahoo stock purchase agreement, section 2.15, which we worked on last time — "my kingdom for a period!"

(a) (i) Each material lease or sublease (a “Lease”) pursuant to which Seller (to the extent related to the Business) or any of the Business Subsidiaries leases or subleases real property (excluding all leases or subleases for data centers) (the “Leased Real Property”) is in full force and effect and Seller or the applicable Business Subsidiary has good and valid leasehold title in each parcel of the Leased Real Property pursuant to such Lease, free and clear of all Encumbrances other than Permitted Encumbrances, except in each case where such failure would not, individually or in the aggregate, reasonably be expected to have a Business Material Adverse Effect and (ii) there are no defaults by Seller or a Business Subsidiary (or any conditions or events that, after notice or the lapse of time or both, would constitute a default by Seller or a Business Subsidiary) and to the Knowledge of Seller, there are no defaults by any other party to such Lease (or any conditions or events that, after notice or the lapse of time or both, would constitute a default by such other party) under such Lease, except where such defaults would not, individually or in the aggregate, reasonably be expected to have a Business Material Adverse Effect.

2.6 Week 5 (Mon. Feb. 11)

2.6.1 Reshuffle the groups

New groups will be announced after adds and drops.

2.6.3 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.6.5 In the news: Indemnity pays off, to the tune of $108.9 million

Jacobs Engineering Group Inc. v. ConAgra Foods,    N.W.2d   , 301 Neb. 28 (Sept. 14, 2018):

This case arises out of an explosion at a ConAgra Foods, Inc. (ConAgra), plant in Garner, North Carolina, which killed 3 ConAgra employees and injured more than 60 others.

When dozens of employees sued Jacobs Engineering Group Inc. (Jacobs) [which had essentially zero involvement], Jacobs sought contractual indemnification from ConAgra, but ConAgra declined, and Jacobs defended against and settled the claims.

Jacobs sued ConAgra for indemnification in the district court for Douglas County. Following a 4-week trial, the jury awarded Jacobs the full amount of the settlement payments, $108.9 million, and the court entered judgment on the verdict.

We affirm.

* * * 

Section 10 of the parties’ engineering agreement contained mutual indemnification provisions which provided that each party indemnify the other for “claims, losses, costs, penalties, damages and/or expenses” to the extent caused by the indemnifying party’s negligence or the negligence of others under that party’s control.

* * * 

The North Carolina Department of Labor conducted an investigation into the explosion and found multiple violations of North Carolina code. The department determined that ConAgra violated its duty to furnish conditions of employment “free from recognized hazards that were causing or likely to cause death or serious physical harm.” The department found multiple life-threatening conditions occurred in the presence of ConAgra management, including ConAgra’s failure to purge the 3-inch natural gasline used to supply gas to the vacuum pumproom and allowing the presence of numerous possible ignition sources while a natural gasline was being purged in an enclosed room.

In contrast, the North Carolina Department of Labor found Jacobs performed no work that could have contributed to the accident, did not have knowledge of the hazardous condition, and did not have a scope of work that would have permitted knowledge of the hazardous condition. ConAgra “accepted what the authorities determined” and did not conduct a separate investigation.

Thereafter, 67 individuals and ConAgra’s property insurers filed several lawsuits against Jacobs and Pottner; the total settlement demands exceeded $507 million. Shortly after the first suit was filed, Jacobs requested contractual indemnity from ConAgra and ConAgra denied that request and did not participate in the settlements.

(Extra paragraphing added.)

QUESTION (for small-group discussion): Why did the 67 ConAgra employees sue Jacobs and not ConAgra?

2.7 Week 6 (Mon. Feb. 18)

2.7.1 Reading for this week

(Black letter:) Amendments in writing, § 4.9: What do you think is the most-important takeaway? What if anything can a drafter do about it?

(Read:) Unilateral amendments, § 4.101

(Study:) Entire agreement, § 4.52

(Study:) Reliance disclaimer, § 4.88 — focus on the black letter

Optional: Scan through Writing, Briefly, by Paul Graham, noted essayist and multi-millionnaire co-founder of famed tech startup accelerator Y Combinator in Silicon Valley. His short essay breaks several rules but is worth reading.

2.7.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.7.3 WEDNESDAY: Quiz #2

You know what to do.

2.7.4 Change of group assignments

2.8 Week 7 (Mon. Feb. 25)

2.8.1 Reading for this week

(Study:) Termination, § 4.99 — focus on black letter

Article VI: Termination, § 7.3 — look this over; there's no need to study it in detail

5.02 Conditions to the Obligations of Purchaser, § 7.2.2 — read subdivision (a); we will use that as a vehicle for discussing some typical issues that can come up in M&A work and how they can create the right for a party to walk away from the deal.

In the Supplement, look over the following in the Stanford-Tesla lease:

Optional: Ross Guberman, Five Ways to Write Like Justice Kagan (LegalWritingPro.com Mar. 20, 2018)

2.8.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.8.3 Ambiguity alert: Kellyanne Conway

From the Washington Post: "Tapper said that Conway’s boss, the president, has been the subject of numerous sexual assault allegations and has said that those women lied about them."

Q: Who, exactly, said "those women lied" — was it Tapper, or Conway's boss? How could this be clarified?

2.8.4 Termination-related questions

  1. What does it actually mean to "terminate" a contract?
  2. Is there any downside to sending a notice of termination for breach?
  3. Under U.S. law, is a termination-for-breach provision even necessary in a contract?
    • If yes: What law gives rise to the need to include a termination-for-breach provision in a contract?
    • If no: Why include a termination-for-breach provision?
  4. Alice sends Bob a notice terminating their contract for breach, but it turns out that she was mistaken: there was no breach. The contract also contains a different provision allowing Alice to terminate at will. QUESTION: What two things could Alice have done (at different points in time) to protect herself from an own-goal problem?
  5. You've been tasked with drafting a contract provision allowing your client to terminate the contract for breach. You draft language that gives the right to terminate to "the non-breaching party." QUESTION: What will (or should) your supervising attorney say about that?
  6. Cure periods: Discuss the pros and cons of having different cure periods for different breaches, versus one, one-size-fits-all cure period.

2.8.5 In-class exercise: Termination

This is a provision from an actual contract form provided by Customer.

x.x Termination. Customer may terminate the Agreement or any Statement of Work, in whole or in part, for convenience (i.e., for any reason or no reason) effective as of any date by giving Provider written notice of the termination. Except as provided in the last sentence of this Section, Customer’s failure to perform in accordance with the Agreement or otherwise comply with the terms of the Agreement will not be deemed to be grounds for termination by Provider, and Provider hereby expressly waives any such termination rights it may have. Provider acknowledges that Customer would not be willing to enter into the Agreement without assurance that the Agreement may not be terminated by Provider and that Provider will not have the right to suspend performance of the Services, in each case except, and only to the extent, expressly provided in the following sentence. If Customer fails to pay Provider when due any amount owed Provider hereunder, Provider will notify Customer of such default in writing, and if Customer has not cured such default within sixty (60) days after Customer’s receipt of such notice, then Provider may terminate the affected Statement of Work in whole upon at least ninety (90) days prior written notice to Customer.

ASSIGNMENT: As the attorney for Provider:

  1. Break up the provision.
  2. Build a list of issues to discuss with Provider and/or with Customer, as follows:
    • substantive issues — both legal- and business-related; and
    • "necessary" stylistic changes, e.g., for enhanced client readability and/or to R.O.O.F.

2.8.6 Survival clauses

DISCUSS: Which type of survival clause is better:

  • one that enumerates (lists) all surviving provisions; or
  • one that states simply, "all provisions that by the nature should survive, do survive …."

DISCUSS: Would a survival clause preserve particular provisions after expiration of the agreement, as opposed to after termination?

2.8.7 Ambiguity alert: The death of democracy in Europe?

From a Paul Krugman column, NY Times, Aug. 27, 2018:

What Freedom House calls illiberalism is on the rise across Eastern Europe. This includes Poland and Hungary, both still members of the European Union, in which democracy as we normally understand it is already dead.

QUESTION: Where is democracy supposedly already dead?

2.8.8 Walk-away rights after termination

FACTS:

  1. Alice and Bob have entered into a contract under which Alice will sell Bob her used MacBook computer.
  2. The contract states in part: "Bob need not buy the Computer if, at the Closing Time, the Grateful Dead decals that are currently affixed to the Computer have not been removed, along with all glue residue."
  3. Alice shows up at the designated time and place for the Closing, but the Dead stickers are still there.

QUESTION: Can Bob pull the plug and walk away from the transaction? Why or why not?

QUESTION: If Bob goes ahead anyway with the purchase, can he sue Alice for damages? Why or why not?

DIFFERENT FACTS:

  1. (alternative) The contract does not include the walkaway provision in the original facts above. Instead, the contract states in part: "Before the Closing, Alice will remove the Grateful Dead stickers and all glue residue."

Now answer the questions above. [Hint: Consider the "perfect tender rule" of UCC article 2.]

QUESTION: What if the contract hadn't said anything at all about the Dead stickers?

MORE FACTS:

  1. This is all taking place in a non-UCC jurisdiction;
  2. The contract includes the alternative "Before the Closing, Alice will remove the [stickers];"
  3. The contract does not include the original "Bob need not buy the Computer" escape clause; and
  4. Bob feels very strongly about not wanting the Dead stickers on the computer.

QUESTION: What could Bob have included in the contract — other than the escape clause — to allow him to walk away?

2.8.9 Lecture: Asset acquisition sequence

DCT to lecture on the time line for typical asset purchases, including:

  1. Preliminary discussions
  2. Letter of intent ("LOI") / memorandum of understanding ("MOU")
  3. Initial due diligence
  4. Contract signature, with obligations and conditions to closing
  5. Additional due diligence + any necessary deal clearances
  6. Closing

2.8.10 Stanford-Tesla termination provision

See the questions in the margin at https://toedtclassnotes.site44.com/Annotated-Contracts.pdf#page=21, lines 152 et seq.

2.8.11 Break-up exercise: Subcontracting (Duke Energy)

The provision below is from a services agreement form used by Duke Energy, at https://goo.gl/imaf3v (archive.org):

B.  Subcontracting. Upon prior written notice to and consent of Duke Energy (not to be unreasonably withheld), Contractor may have any portion of the Services performed by any Subcontractors of, including Persons related to or affiliated. with, Contractor. Contractor and any proposed Subcontractors must meet the specific safety criteria as defined in the Duke Energy Health and Safety Supplemental Requirements. If subcontracting is permitted by Duke Energy, Contractor will still continue to be responsible for the performance and completion of the Services. If requested by Duke Energy, Contractor must provide Duke Energy with copies of any contracts with third parties regarding the assignment of rights or delegation of duties hereunder. Contractor must obtain terms and conditions in its contracts with Subcontractors and suppliers which are consistent with the rights of Duke Energy and the duties of Contractors pursuant to this Agreement. Contractor will deliver to Duke Energy for Duke Energy's review a written list of the Subcontractors that the Contractor proposes to engage or use in the performance of the Services before the Contractor enters any contract with any Subcontractor, and Duke Energy will have the right to approve or reject each proposed Subcontractor. No contractual relationship will exist between Duke Energy and any Subcontractor with respect to the Services. Contractor will be fully responsible to Duke Energy and any applicable third party for all acts, omissions, failures, and faults of all Subcontractors as fully as if they were the acts, omissions, failures, and faults of Contractor.

ASSIGNMENT: As the attorney for Contractor:

  1. Break up the paragraph for easier review.
  2. What if any problems do you anticipate with the "not to be unreasonably withheld" provision in the first sentence — and what would you propose to do about them?
  3. Re-read the penultimate sentence, which begins: "No contractual relationship will exist between Duke Energy and any Subcontractor with respect to the Services." GROUP-DISCUSSION QUESTION: How enforceable do you think that is?
  4. What other issues (if any) do you think might be troublesome for Contractor — and what would you propose to do about them if, before the agreement was signed, you were negotiating it on behalf of the Contractor?

2.9 Week 8 (Mon. Mar. 4)

2.9.1 Reading for this week

(Read:) Independent contractors (disclaimer), § 4.69

(Skim:) Audits, § 4.20

(Skim:) Background checks, § 4.22

Sheryl Sandberg employment agreement: Scan through it in the Supplement, especially the annotations.

2.9.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.9.3 In the news (termination): Heiman v. Bimbo Foods

From Heiman v. Bimbo Foods Bakeries Distrib. Co., 902 F.3d 714 (7th Cir. 2018):

According to JTE's complaint, which we must accept as true for purposes of this appeal, Bimbo Foods began fabricating curable breaches in the spring of 2008 as part of a scheme to force JTE out as its distributor.

• Bimbo Foods employees filed false reports of poor customer service and out-of-stock products at stores in JTE's distribution area.

• Even more egregiously, Bimbo employees would sometimes remove JTE-delivered products from grocery store shelves, photograph the empty shelves as "proof" of a breach, and then return the products to their initial location.

• On one occasion, in 2008, a distributor caught a Bimbo Foods manager in the act of fabricating a photograph and reported him.

Bimbo assured JTE that this misconduct would never happen again. Nevertheless, unbeknownst to JTE, Bimbo Foods continued these scurrilous tactics.

[Bimbo's] goal was to force JTE to forfeit its distribution rights so that Bimbo Foods could install a new distributor that would take a smaller slice of the proceeds: 18 percent as compared to JTE's 22 percent.

When JTE refused to sell its distribution rights in January 2011, Bimbo Foods breached the distribution agreement and unilaterally terminated JTE's agreement, citing the fabricated breaches as cause.

Several months later, in September and October 2011, Bimbo Foods forced JTE to sell its rights to new distributors.

(Emphasis added.) (The Seventh Circuit affirmed the district court's dismissal of JTE's complaint on statute-of-limitation grounds.)

2.9.4 Questions about independent-contractor status

For small-group discussion: What factors might influence a court to (i) honor, or (ii) disregard, a contract's statement that the parties were independent contractors?

2.9.5 Sheryl Sandberg employment agreement questions (1)

These questions relate to the Sheryl Sandberg employment agreement in the Supplement, starting at page 101.

For purposes of the following questions, assume that you represent Facebook in negotiating this agreement (unless stated otherwise below).

1. When might a drafter want to do an amended and restated agreement instead of just amending the agreement? [1]

2. What are some other ways of amending an agreement?

3. Sandberg's lawyer asks that you change all the instances of the second person ("you") to third person ("the Executive"). How do you advise Facebook about the pros and cons of her request? [2]

4. Lines 30-40: The letter goes into great detail about Sandberg's duties. Facebook's HR vice president wants to know if you can eliminate all that, because from the title "Chief Operating Officer" it should be obvious what Sandberg's duties will be. QUESTION: What do you advise the HR VP about the possible concerns here — for Sandberg and FB? (Hint: See lines 174-80 (vesting acceleration) and lines 273-75 (definition of Involuntary Termination — material adverse change in responsibilities).)

5. Lines 72-73 ("your Employment will not infringe the rights of any other person"): From a drafting-technique perspective, what's wrong with this provision? [3]

6. Lines 74-78 (return of prior employers' confidential information): Facebooks' HR VP wants to know why this provision has Sandberg both representing and warranting these things. What do you say? [4]

7. Lines 81-82 (salary): The provision refers to Sandberg's salary as the "gross annual rate" of $300K per year (emphasis added). Sandberg's lawyer wants Facebook to change the provision to "an annual salary of $300,000 per year." What do you advise Facebook, and why? [5]

8. Lines 83-84 (salary per company's standard payroll procedures): If Sandberg wanted to lock in her pay periods at, say, weekly, how would you advise Facebook to respond? [6]

2.9.6 Exercise: Background check clause review & revision

This is a provision from an actual contract form provided by Customer. ASSIGNMENT: As the attorney for Provider, build a list of issues to discuss with Provider and/or with Customer, as follows:

  • substantive issues; and
  • "necessary" stylistic changes, e.g., for enhanced client readability and/or to R.O.O.F.

Provider warrants that it has with respect to all Provider’s Personnel who are expected to perform Services under this Agreement: (i) conducted background checks; (ii) conducted checks against relevant persons-wanted lists published by national or international law enforcement bodies, the Consolidated Screenings List compiled by the United States Departments of Commerce, State, and Treasury, and any comparable lists maintained by non-U.S. authorities that are applicable to the activities engaged in under this Agreement (collectively “Government Sanctions or Watch List”); (iii) verified all qualifications used as a condition of employment (e.g., education, licensing, certifications, references, previous employers, etc.); and (iv) conducted a credit history review if the position pertains to a position of substantial trust such as involving large sums of money or substantial assets of value where theft or similar financial improprieties could reasonably occur. At a minimum, background checks required in (i) above shall include the checking of criminal convictions for any offenses other than minor traffic violations for all geographic areas wherein such individual have resided during the past five (5) years. Should any member of Provider’s Personnel appear on a Government Sanctions or Watch List, or the background checks or verifications disclose inaccurate or false information, a criminal conviction record, credit history or factors that could bear upon the desirability of a particular individual performing Services under this Agreement, Provider will advise Customer of the result of the check.  Customer shall have the right to request that Provider remove from the Services or Customer’s or its Affiliate Companies’ premises, any such individual. Provider shall be responsible for complying with any notice requirements associated with such disqualification as may be established by Applicable Law. Provider warrants that it has, by operation of law or valid agreements with Provider’s Personnel, the right to obtain this information and to disclose it to Customer as required herein, to the extent reasonably practicable. Additionally, Customer shall have the right to conduct additional background checks on Provider’s Personnel who will be performing Services for Customer. Provider shall take all actions and execute all documents and shall cause Provider’s Personnel to take all actions and execute all documents as are necessary to assist Customer in this process.

2.10 Week 9 (Mon. Mar. 18)

2.10.1 Reshuffle the groups

New groups will be announced after adds and drops.

2.10.2 Reading for this week

(Read:) Insurance, § 4.71

Optional:

2.10.3 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.10.4 WEDNESDAY: Quiz #3

You know what to do.

2.10.5 Exercise: Insurance

Facts
  • You represent ChemCo, which owns and operates a chemical refinery in Pasadena.
  • ChemCo has a periodic maintenance shutdown scheduled for some of its equipment scheduled for July. ChemCo is interested in engaging Provider to do some of the maintenance work. Provider's workers would be coming onto ChemCo's site for this purpose.
  • Provider has not only commercial general liability ("CGL") insurance coverage, but also professional-liability coverage, also knownn as errors-and-omissions ("E&O") coverage.
  • The ChemCo manager with whom you are working wants Provider to designate ChemCo as an "additional insured" on Provider's E&O policy. The manager reasons that this will give ChemCo an independent bucket of money against which it can make claims.
Questions
  1. What's the difference between a "named insured" and an "additional insured"?
  2. What is an "additional named insured"? (Careful — it's a trick question.)
  3. What types of insurance coverage should ChemCo ask Provider to carry for this purpose?
  4. Should ChemCo ask for Provider's policy to be an "occurrence" policy or a "claims-made" policy?
  5. Should ChemCo ask to be named as an "additional insured" on Provider's policy? Why?
  6. Would you expect Provider to push back in response to the additional-insured requirement? Why or why not?
  7. Would ChemCo actually be able to make claims against Provider's E&O policy?
  8. How would you advise the ChemCo manager about whether, and how, to proceed with his idea about making ChemCo an additional insured? [Discuss with your partner(s).]
  9. What might be the consequences if Provider agreed to provide insurance but then didn't do so?
Negotiation strategies

If you represent a seller, should your "standard" T&Cs include an insurance provision along the lines of what a customer might request? Why or why not? (Discuss)

Certificate

FACTS:

  • The contract draft requires Provider to maintain certain levels of insurance.
  • Before signing the contract, ChemCo asks Provider for a copy of its insurance certificate.
  • Provider's sales manager, Pat, notices that Provider's CGL and E&O insurance have expired. Pat is fairly sure that the Provider finance people are in the process of negotiating new policies with a new carrier. So Pat electronically changes the expiration date on the old certificate of insurance and emails it to his contact at ChemCo.
  • After the contract is signed, Provider's finance people put in place new CGL and E&O coverage with a new carrier.
  • Subsequently, Provider's workers accidentally injure a visitor to the ChemCo premises.

QUESTION: What are the parties' legal and practical positions?

2.10.6 Quickies: CPI increases in pricing

FACTS:

  1. You represent Buyer in negotiating a long-term master purchase agreement with Seller.
  2. You draft a price-increase clause that limits Seller's permissible price increases to no more than "the increase in CPI" (and no more than one price increase per year as well).
  3. A year later, Seller says it is increasing its price by the percentage stated in a particular CPI published by the U.S. Government for the specific industry in which Seller and Buyer operate. You hadn't known there even was such a thing.
  4. Your client Buyer angrily tells you that Seller's price increase must be limited to the (much-lower) increase in the "regular" CPI, namely CPI-U, US City Average, All Items, 1982–1984=100.

QUESTION: In this fact situation, to what does "CPI" refer?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: The Consumer Price Index.

QUESTION: In the U.S., where does CPI data usually come from ?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: The U.S. Bureau of Labor Statistics — see https://www.bls.gov/cpi/

QUESTION: On these facts, how might a court rule on Buyer's claim that Seller's price increases must be limited to the increase in CPI-U and not to the increase in the special CPI?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: Chances are that the court would rule against your client Buyer, because you drafted the price-increase limitation.

2.10.7 Review

Discuss in your groups:

  1. What should a contract's title look like?
  2. What should a contract's preamble look like?
  3. What should a contract's recitals look like?
  4. How should a contract be dated?
  5. Where are three possible places to put a definitions section?
  6. How can you serve the reader if you have • some definitions in a defined-terms section, and • other definitions "in-line" in the clauses where they're used?
  7. What's an example of D.R.Y.?
  8. Is it appropriate for a contract to say: Alice represents that she will pay Bob [X DOLLARS] on [X DATE]?
  9. What should an organizational signature block look like?

2.10.8 Clarity exercise: Closing obligations left unclear

CLAUSE: From Gingras v. Avery, 90 Conn. App. 585, 591, 878 A.2d 404, 408 (2005):

The closing shall take place on or before sixty (60) days after subdivision approval; but in no event later than March 15, 2003.

QUESTION: The phrase "The closing shall take place" is an example of what?

TRUE | FALSE | MAYBE: This clause properly states the number of days after subdivision approval.

FACTS:

  • To be entitled to close the purchase, the buyer was required to meet certain prerequisites.
  • The buyer failed to do so before the stated date.
  • In court, the buyer claimed that it was still implicitly entitled to close the purchase, in part because in real-estate agreements, time (allegedly) is not of the essence.

EXERCISE: Rewrite the quoted language above to be clear that the buyer's right to purchase turns into a pumpkin "on" (?) the stated date.

(Hat tip: Ken Adams.)

2.10.9 Pro tip: Using insurance to immunize you from liability even for gross negligence

An opinion by the New York Court of Appeals reminds drafters that, under the law of that state, a contract can be structured to absolve a service provider from liability even for its own negligence or gross negligence. The trick, according to the court, is to draft the contract so that:

  1. the customer agrees to buy insurance to cover any damage or other loss that might result from the service provider's negligence; and
  2. the customer also waives the service provider's liability, agrees to look solely to its insurer for recovery, and waives subrogation, so that the customer's insurance company can't come after the service provider for reimbursement of whatever the insurance company has to pay out for the damage.

This drafting approach worked for Diebold, Inc., an alarm-system company. Diebold provided backup alarm service for a bank. The bank was burglarized, allegedly because of Diebold's gross negligence in ignoring problems with the alarm system. Diebold's contract with the bank, though, included provisions like those enumerated above: The contract required the bank to buy insurance, and included a waiver of Diebold's liability. As the court described the provision:

Diebold's contract contained a clause entitled “Property Insurance and Waiver of Subrogation” where Abacus agreed to obtain insurance coverage to cover its losses in the event of a theft. The agreement between Diebold and Abacus provided that Abacus “shall look solely to its insurer for recovery of its loss and hereby waives any and all claims for such loss against Diebold” and that Abacus' insurance policy would contain a clause providing that such waiver would not invalidate the coverage.

Abacus Federal Savings Bank v. ADT Security Services, Inc., 18 N.Y.3d 675, 967 N.E.2d 666, 681, 944 N.Y.S.2d 443 (2012) (affirming most grounds of dismissal of bank's claim against alarm-system companies after burglary, but reversing as to breach-of-contract claim against one defendant) (citations, alteration marks, and internal quotation marks omitted).

The burglarized bank claimed that Diebold's alleged gross negligence in maintaining the alarm system invalidated the limitation of liability. The court, however, held that while the exculpatory provision could not relieve Diebold for liability for gross negligence, the insurance provision and waiver of subrogation would be enforced: “A distinction must be drawn between contractual provisions which seek to exempt a party from liability and contractual provisions which in effect simply require one of the parties to the contract to provide insurance for all of the parties.” Id., 967 N.E.2d at 684 (cleaned up). The court also explained that “gross negligence, when invoked to pierce an agreed-upon limitation of liability in a commercial contract must smack of intentional wrongdoing. It is conduct that evinces a reckless indifference to the rights of others.” Id. at 683 (cleaned up).

Incidentally, Diebold's co-defendant did not have a mandatory insurance requirement in its contract, but merely left it up to the bank to decide whether to purchase insurance, nor did it include a waiver of liability and of subrogation. The court held that the co-defendant's limitation of liability provisions could not withstand a claim (if proved) of gross negligence. Id. at 685.

Comment: A contract drafter wanting to use the Diebold approach might also want to include a choice of law provision specifying New York law as the governing law for the contract. (Of course, other states' law might be to the same effect.)

Comment: The court's reasoning seems to imply that it didn't matter which party buys the insurance — as long as the amount of the insurance wasn't unreasonable, then it was OK to require the customer (or whoever) to look solely to the insurer for recovery of any loss that might occur.

Comment: In the real world of sales negotiations, a happy medium might be for the contract to provide:

  • that the service provider's liability is limited to X dollars, or to some formula such as X times the amount paid by the customer in the previous 12 months; and
  • that the customer must purchase insurance (or self-insure) against losses in excess of the agreed limited amount, with the customer also waiving the service provider's liability in excess of that amount.

2.10.10 Real-world negotiation: Disputes over termination

This afternoon I spent time on the phone with The Other Side in negotiating a software license agreement.

  • I represent Service Provider, which wants to license complex computer software ("Software") from Developer, a small company in Silicon Valley.
  • Service Provider (my client) wants to use the software in providing on-line services ("Services") to Service Provider's customers.
  • Service Provider will pay Developer, as a royalty, a percentage of Service Provider's revenue from providing the Services.
  • Developer wants to be sure (among other things) that it gets paid, so it wants the right to terminate the license if Service Provider materially breaches the agreement (after notice and an opportunity to cure).
  • If Developer did terminate the license, then Service Provider would not be able to continue using the Software to provide services to Service Provider's customers — which might put Service Provider in breach of its contractual obligations to its customers.
  • I added the following (an edited version is below) to Developer's draft license agreement:

(f) Because of the significance of the Software License to the Service(s), a termination of the Software License for default by Service Provider will take effect only upon the entry of a final judgment or (if applicable) arbitration award, from which no further appeal is taken or possible, that termination is proper under subdivision (a).

  • Developer's attorney, from a name-brand law firm in Silicon Valley, said that my proposed addition was "unfair."

QUESTIONS: In your groups, discuss the following, then we'll discuss together:

  1. Why do you think Developer's attorney reacted the way he did?
  2. What do you think my response was?
  3. How do you think we compromised?

2.10.11 Pro tip: Lay readers prefer explanation over brevity

Two international surveys, conducted several years apart, suggest that when lay people must read detailed, technical language, they strongly prefer more explanation, even if it means they have to read somewhat more. For legal text, the two surveys used the identical question; while multiple questions would have been more satisfying, the results were nevertheless striking:

Question 21: Which would you prefer to read?

1.    21% (n=142) If you don’t respond, the court will issue a default judgment.

2.    79% (n=538) If you don’t respond, the court will issue a default judgment. That means you’ll lose, and the court will give the plaintiff what he is asking for.

Christopher R Trudeau and Christine Cawthorne, The Public Speaks, Again: An International Study of Legal Communication, 40 U. Ark. Little Rock L. Rev. 249, 278 (2017) (emphasis added). (Hat tip: 500 Words.)

The same had been true in the earlier survey as well:

In the first study, 78% of responders preferred a longer version that explained what default judgment meant over a shorter version that was very clear, yet did not explain that term.

In fact, that was the only choice-of-language question where the longer version prevailed, so we felt compelled to test this same question again—with more respondents from various English-speaking countries—to see if this result would be consistent. If so, this data would help to dispel a common misconception about plain language: that it means you must always shorten things.

While shortening text is usually a byproduct of plain language, the point is to clearly explain technical information to interested readers in ways they can understand—even if that does lengthen the text, at times.

Id. at 254-55 (cleaned up; emphasis and extra paragraphing added).

The article concludes:

First, and this is worth remembering, people frequently needed to use legal information to do their jobs. This is true no matter what sector they are in: in healthcare, in government, or in business. But what was surprising was how much workplace productivity is impacted by traditional legal language. To recap, not only did the vast majority of responders spend more than fifteen minutes interpreting legal information they had to use, but the ones who could not understand that information wasted even more time trying to find and interpret that information in a different way. What a waste of time.

Second, no matter the English-speaking country, people overwhelmingly prefer clear language to traditional legal language. In fact, the results show that the preference for plain language may be even stronger outside of the U.S. But, even in the U.S., more than 80% preferred plain language, which is a substantial majority by any measure.

Third, the preference for plain language increases with the person’s education level. We were pleasantly surprised to see that the results from this study were consistent with the results in the first study. This additional data helps further “debunk the argument that higher-educated people will not mind traditional legal language as much as other[s] do.”

Finally, if terms cannot be avoided, explain those terms. We were encouraged—and a little surprised—by the results from the two choice-of-language questions that tested preference for explaining technical terms (one medical term and one legal term). Notably, these were the only two choice-of-language questions where the longer version prevailed. These results are a good reminder that using plain language does not always mean shortening something. It means explaining technical concepts to a reader in ways that help them understand—even if that means adding more words.

In the end, the public has spoken, again, and from nearly every major English-speaking country. They know what they want—they want plain language.

Id. at 281-82 (emphasis added, footnote omitted).

2.10.12 A tweet from President Trump

From this tweet by the president:

"Federal Judge throws out Stormy Danials lawsuit versus Trump. Trump is entitled to full legal fees." @FoxNews Great, now I can go after Horseface and her 3rd rate lawyer in the Great State of Texas. She will confirm the letter she signed! She knows nothing about me, a total con!

And this response by a liberal-leaning columnist:

While we’re on the topic, can we talk about the comma in the very last sentence?

2.10.13 Ambiguity and a trademark license termination clause

From General Nutrition Investment Co. v. Holland & Barrett Int'l Ltd (Rev 1) [2017] EWHC 746 (Ch), ¶ 15:

5.2 The Licensor may terminate this Agreement [sic] immediately by notice in writing if:

     (a) The Licensee [i] materially breaches this Agreement or any other member with the H&B Group commits an act which would amount to a material breach of this Agreement or [ii] (without prejudice to the Licensor’s other rights to terminate under this Agreement) otherwise infringes the Licensor’s rights under the Trade Marks [iii] to an extent likely to cause material lost to the Licensor; or …

(Bracketed romanettes added; hat tip: IP Draughts.)

QUESTION 1: Does the materiality qualifier in clause iii apply to both clause i and clause ii or just to clause ii? EXERCISE: Rewrite to clarify.

QUESTION 2: Why does this quotation include "[sic]" after "terminate this Agreement"?

2.10.14 Ambiguity and resistance to President Trump

TEXT: "The temptation for progressives to resist pushing their own concrete policy agenda is compelling, especially since doing so gives the other side ammunition for criticism …." (From Joel Berg, It's Policy, Stupid — Why progressives need real solutions to real problems, Washington Monthly, Apr. 10, 2017.) QUESTION: In the quotation, the bold-faced "doing so" refers to what, exactly — pushing a policy agenda, or resisting pushing an agenda? EXERCISE: Rewrite to clarify.

2.11 Week 10 (Mon. Mar. 25)

2.11.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.11.3 Quickie: You get what you INspect …

See this article: Tokyo 2020 Olympics venues linked to earthquake safety data scandal:

A major Japanese hydraulics company has admitted to doctoring earthquake safety data for buildings across the country, including some venues for the 2020 Tokyo Olympics.

 * * * 

The KYB scandal is only the latest example of corner cutting and data fudging by Japanese firms. Last year, industrial giant Kobe Steel admitted it falsified information on products sold to major brands including Boeing and Toyota, while care maker Nissan had to halt production after problems in its inspection process emerged.

Some experts say Japanese firms are too willing to sacrifice standards in order to grow market share and profits. That's a particular challenge in their domestic economy, which has struggled for decades with sputtering growth and falling prices.

2.11.4 Governing law: Different clauses, different laws?

Consider the UK Supreme Court's Rock Advertising case, which rejected the "Cardozo Rule" that amendments- and waivers-in-writing clauses were effectively unenforceable. (Blog post about it.)

QUESTION: Can you adopt a  choice-of-law provision that governs just the amendments-in-writing clause, and/or the waivers-in-writing clause? EXAMPLE:

The parties expressly agree that this provision [OPTIONAL: but no other] is to be interpreted and applied in accordance with English law as announced in Rock Ad­ver­t. Ltd v MWB Bus. Ex­ch. Ctrs. Ltd, [2018] UKSC 24.

2.11.5 Quickie: Tesla's supply-chain issues

Here are some dangers that a company can encounter: (1) Not getting paid; (2) not being able to build your product because your suppliers won't supply you with parts unless you pay cash on delivery (C.O.D.); (3) having a supplier go out of business because you didn't pay them. From a Bloomberg story:

… [A short-seller of Tesla stock] said her firm sees some suppliers to Tesla filing for bankruptcy, which poses particular risk to the carmaker because many of its components are single-sourced.  * * *

The Wall Street Journal reported in August on an Original Equipment Suppliers Association survey of executives that found most respondents believed Tesla posed a financial risk to their companies. Some small suppliers claimed in the previous several months that they failed to get paid, the newspaper reported, citing public records.

Gabrielle Coppola, Tesla Short Seller Warns of ‘Massive’ Supply-Chain Disruption, Bloomberg.com, Oct. 19, 2018

2.11.6 Governing law (Duke Energy)

The provision below is from a services agreement form used by Duke Energy, at https://goo.gl/imaf3v (archive.org):

L.  Governing Law. This Agreement will be governed by, and construed in accordance with, the laws of the State Contractor and Duke Energy agree to relinquish and waive their rights to a trial by jury in any action brought hereunder.

QUESTION: Any comment about the last portion?

2.11.7 Governing law: Always push for your own state's law?

FACTS: You represent Alpha LLC, in Texas, which is licensing its trade secret chemical-refining process to Bravo Corporation, which will use the process in Bravo's refinery in Oklahoma. ¶ Bravo insists that the license agreement be governed by Oklahoma law.

QUESTION: What would be some of the pros and cons of Alpha's agreeing to Oklahoma law?

2.11.8 Ambiguity: Julia Louis-Dreyfus's early career

From a NY Times piece about Julia Louis-Dreyfus's being awarded the Mark Twain Prize for American Humor:

When she was still in college, Louis-Dreyfus was cast on “Saturday Night Live,” where she played a televangelist with a raunchy retelling of the Nativity. She has said those years were grim — a young woman trying to prove herself in a male-heavy cast — and missing the camaraderie of her work in Chicago. And on Sunday, she said it was not appropriate for her work there to be honored in a celebration of comedy.

(Emphasis added.)

QUESTION: In the italicized portion, which exactly is the "her work there" to which Louis-Dreyfus was supposedly referring — was it her work at SNL, or her work in Chicago?

2.11.9 Governing law: How far does it extend?

FACTS: Your client Alpha LLC, in Houston, and Bravo Corporation, in Oklahoma, enter into a services agreement under which Alpha will perform services partly in Houston and partly on-site at Bravo's refinery near Tulsa. ¶ The agreement includes the following provision: This Agreement is to be interpreted in accordance with New York law. ¶ The services go badly, and Bravo sues Alpha, in federal court in Tulsa, (i) for breach of contract, and (ii) for fraudulent inducement for allegedly "overselling" Alpha's capabilities.

QUESTION: How would the court go about analyzing which state's law is to govern the fraudulent-inducement claim? What conclusion do you think the court would reach?

2.11.10 Governing law: Agree to some neutral state's law?

FACTS: Your client Alpha LLC, in Houston, is entering into an agreement with Bravo GmbH, in Germany. ¶ Neither party wants the other party's law to apply. ¶ Bravo's counsel proposes that the agreement specify that English law will govern. ¶ Neither the parties nor the subject matter of the agreement have any connection to England.

QUESTION: How likely is it that a U.S. court would enforce a choice of English law in the contract?

[This wasn't in the reading — it will be next semester — but is discussed in this Oct. 4 blog post]

2.11.11 Two-way vs. one-way NDAs

FACTS:
(i) Your client Alice has been asked to sign a confidentiality agreement ("NDA") that was prepared by Bob ("The Other Side").
(ii) Neither Alice nor you have any past history with Bob.
(iii) The NDA's terms apply equally to the confidential information of both Alice and Bob, not just to the confidential information of only one party or the other.
(iv) Alice is in a hurry and asks if it's OK to just sign the NDA, given point (iii) above.

QUESTION: What's your answer to Alice — and why?

2.11.12 NDA "sunset" provisions (1)

MORE FACTS for the situation in 2.11.11:
(iv) Alice is the party that would be disclosing her confidential information to Bob.
(v) Bob's draft NDA provides that Bob's confidentiality obligations will expire one year from the effective date of the NDA — EXCEPT THAT for any information that Alice can show is a "trade secret" (as defined in the applicable law), Bob's confidentiality obligations will not expire until the information comes within the scope of one or more of five exclusion categories listed in the NDA, e.g., information that has been published, information that the receiving party gets from another source, etc.

2.11.13 NDA "sunset" provisions (2)

ALTERNATIVE FACTS for the situation in 2.11.12:
(v) Bob's draft states that Bob's confidentiality obligations will expire one year from the effective date of the NDA — period. Alice wants to know if she can agree to that.

QUESTION: Is this likely to be OK?

2.11.14 Exercise: Confidentiality agreement

FACTS: You represent Seller, Inc., which is considering signing a confidentiality agreement ("NDA," or nondisclosure agreement) with a potential customer, Buyer, Inc.

MORE FACTS: The NDA says:

The Receiving Party acknowledges that the Confidential Information is proprietary to the Disclosing Party, has been developed and obtained through great efforts by the Disclosing Party and that Disclosing Party regards all of its Confidential Information as trade secrets.

QUESTION: Are you OK with this?

MORE FACTS: The NDA contains blanks to be filled in for who will be the "Disclosing Party" and who will be the "Recipient."

QUESTION: What should be filled in?

Should the NDA include a time limit for when disclosure can be made in confidence? Why or why not?

MORE FACTS:

The NDA includes a number of exclusions from the definition of Confidential Information. One of those exclusions is that information subject to a third-party subpoena is not considered Confidential Information.

QUESTIONS:

  1. Would you object to this? Why?
  2. What would be a better alternative?

MORE FACTS: The nondisclosure agreement states: "The Receiving Party acknowledges that any breach or threatened breach of this Agreement by the Receiving Party would result in irreparable harm to the Disclosing Party, entitling the Disclosing Party to temporary and permanent injunctive relief against the breach; the Receiving Party waives any requirement that the Disclosing Party post a bond." You remember seeing this sort of clause in a lot of NDAs.

QUESTION: From Seller's perspective, do you see any problem with this clause?

2.11.15 In the news: Jacobs Engineering sells division

From the Houston Chronicle, Oct. 23: "Jacobs sells energy engineering business for $3.3B":

Jacobs Engineering Group is selling its Houston energy and chemicals business to Australian construction and engineering firm WorleyParsons Ltd. in a cash-and-stock deal valued at $3.3 billion.

The unit employs more than 2,000 Houston-area workers.

The deal represents a major shift in the energy engineering and construction sector with Jacobs essentially leaving oil and gas and WorleyParsons becoming a much bigger force in U.S. energy industry. …

As required by SEC regulations, Jacobs filed a Form 8-K that includes the complete Stock and Asset Purchase Agreement. Some of the major sections are:

Article I: Definitions

Article II: Purchase and Sale — note especially Sections 2.09 through 2.12, concerning the Closing, the payment of the preliminary purchase price, and the provision for post-Closing adjustment of the purchase price.

Article III: Representations and Warranties of Seller, which refers to the Seller Disclosure Schedule as carve-outs from the reps and warranties. Then Section 3.26, at the end of Article III, disclaims other reps and warranties by Seller (a "roadblock" clause).

Article IV: Representations and Warranties of Buyer — in particular, Section 4.08 Available Funds warrants that "Buyer has, or at the Closing will have available to it after giving effect to the Financing, all funds necessary to pay the Cash Consideration and all other amounts required to be paid by it in connection with the consummation of the transactions contemplated hereby on the Closing Date." Then Section 4.19, at the end of the article, disclaims other reps and warranties by Buyer (another "roadblock" clause).

2.11.16 Discussion: Letters of intent

QUESTIONS:

  1. What are some reasons business people often like letters of intent?
  2. What could go wrong with signing a letter of intent, and how could a drafter try to put up guard rails?

2.11.17 Lecture / discussion: Master agreements

QUESTIONS:

  1. What are some reasons parties use master agreements?
  2. How can a master purchase agreement be drafted to allow affiliates of the buyer to order "under" the master agreement?

2.11.18 Review: Choice of law (Rick's)

The provision below, at https://goo.gl/DRbLRw (edgar.sec.gov), is from a 2008 real-estate purchase agreement involving the parent company of "gentleman's club" Rick's Cabaret:

Section 10.15. Choice of Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Texas, without regard to principles of conflict of laws. In any action between or among any of the parties, whether arising out of this Agreement or otherwise, each of the parties irrevocably consents to the exclusive jurisdiction and venue of the federal and state courts located in Dallas County, Texas.

HYPOTHETICAL FACTS: Suppose (i) that one of the parties is a New York corporation; (ii) the agreement is negotiated and signed in New York City; and (iii) that party sues one of the other parties for fraud in the inducement but not for breach of contract.

QUESTION: On the hypothetical facts above, what effect, if any, would this provision have on the choice of law?

QUESTION: If you were reviewing this provision, what might your reaction be about the location of the last sentence of this provision?

2.12 Week 11 (Mon. Apr. 1)

2.12.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.12.3 In the news: Business lawyer and his business partner 'stiff' a photographer they'd hired

Thomas Grady Photography, Inc. v. Amazing Vapor, Ltd., No. S-17-818 (Neb. Oct. 26, 2018): A business lawyer and his business partner started a "vaping" wholesale busi­ness. The lawyer orally hired a photographer at $800 per day to take pictures of e-cigarette hardware, supplies, and liquids — but then the vaping company didn't pay the photographer's $2,400 invoice; instead, the partners asked the photographer to reduce his price in return for the promise of more work in the future. (The photographer declined their offer.) The state supreme court upheld a judgment that the lawyer was personally liable for the $2,400, on grounds that the lawyer hadn't disclosed that he was acting as agent for his company. 

Possible drafting lessons:

  • Some parties will try to retrade a deal (that's putting it politely); it's not uncommon for first-time customers or -clients to try the gambit, "I know we agreed to pay you $X, but if you'll reduce the price now, we'll give you more business in the future."
  • The photographer might have helped his case if he'd sent the customer even a bare-bones advance email confirmation that set forth: (i) what the photographer was going to do, and (ii) what the cost would be.
  • It's interesting that the lawyer-vaping partner, faced with personal liability, elected to take the case to trial and then all the way to the state supreme court. The supreme court's opinion doesn't shed any light on why the lawyer didn't just pay the photographer's $2,400 invoice.

2.12.4 Injunctive relief in an NDA (1)

MORE FACTS for the situation in 2.11.11:
(vi) Bob's draft NDA includes a injunctive-relief provision that states that, if Alice breaches the NDA, then Bob will be irreparably harmed and will be entitled to injunctive relief.

QUESTION: Is this a good idea for Alice?

2.12.5 Injunctive relief (2)

MORE FACTS for the situation in 2.12.4:
(vii) The injunctive-relief provision in Bob's draft NDA also states that Alice waives any requirement that Bob post a bond.

QUESTION: Is this a good idea for Alice?

2.12.6 Discussion: Services provisions

In your groups, discuss the following:

  1. In a master services agreement, which should take precedence: a statement of work, or the master agreement? Why?
  2. In a master services agreement, should each new statement of work: (A) be considered an addition to the master agreement, or (B) be a separate contract that incorporates the master agreement by reference? Why?
  3. When might it make sense for a customer to "pull the permits" for services work, instead of the service provider?
  4. What exactly does "workmanlike performance" mean?
  5. What are the "classic three" remedies for defects in services?
  6. Why do customers typically want a services agreement to state that the provider will control the means and manner of the work? Wouldn't customers want to keep that flexibility?
  7. Extra: When drafting a services agreement for a customer, what sorts of things should you plan for if the customer wants to "pull the plug" before the job is done?

2.12.7 In the news: Business buyer tries to walk a deal by claiming that essential terms hadn't been agreed

Mussulam v. Ali, No. 17-0762 (Tex. Oct. 26, 2018):

Musa “Moses” Musallam and Amar Ali entered into a written agreement relating to the sale of Musallam’s business to Ali. Musallam refused to close, maintaining that the agreement lacked essential elements of a binding contract and was thus only an agreement to agree. … The jury found that they had agreed. …

The trial court denied Musallam’s motion and rendered judgment for Ali. Musallam appealed, in part, challenging the jury’s finding that he agreed to sell the business to Ali. …

 * * *

Musallam owns Fanci Candy, Inc., a wholesale distributer of candy and tobacco products. At times relevant to this matter, Fanci Candy had contracts to buy tobacco products directly from Altria Group Distribution Company (the owner of Philip Morris and U.S. Tobacco) and Lorillard Tobacco Company.

In April 2012, Musallam approached Ali, the vice president of convenience store distribution business A to Z Wholesalers, Inc., about purchasing Fanci Candy. A to Z Wholesalers did not have a direct contract with either Altria or Lorillard, thus it bought those companies’ tobacco products through middlemen and paid higher prices for them than did Fanci Candy.

Because Altria and Lorillard ordinarily would not enter into new contracts to sell directly to wholesalers, businesses that wanted to buy directly from them usually sought to do so by buying companies that had direct contracts.

But the Altria and Lorillard direct-purchase contracts would not necessarily transfer if Fanci Candy was sold: both Altria and Lorillard reserved the right to discontinue direct sales to Fanci Candy absent their approval of its purchaser.

 * * *

The Stock Transfer Agreement provided that the sales price for the furniture, fixtures, and equipment such as stamping and packing machines would be their value “as mutually agreed upon by the parties prior to the Closing Date,” and the price of the land and building would be the value set by an appraisal to be accomplished before the closing date.

 * * *

On June 28, 2013, Lorillard notified Ali that it would not approve the change in ownership.

 * * *

… Musallam asserted that when an agreement leaves material terms open for future adjustment it is not binding but constitutes merely an agreement to agree. He argued that whether the price for furniture, fixtures, equipment, and other open issues were material terms was a fact question for the jury that must be determined before the court could decide the legal question of whether the Stock Transfer Agreement was a binding contract or merely an agreement to agree.

Id. at 1, 2, 3, 4 (extra paragraphing added).

2.12.8 Ambiguity exercise and the Red Sox World Series title

From a piece by Ronald Blum, Associated Press October 29, 2018: “[The Red Sox] trailed 4-0 in the seventh inning of Game 4 when ace Chris Sale rose from the dugout bench for a fiery, profane, motivational rant and woke up for a 9-6 win.”

QUESTION: Who "woke up," exactly? How could this be fixed?

(Note: The above version was in the Houston Chronicle, Oct. 29, 2018, but the error was fixed in the online version.)

2.12.9 Exercise: Jury trial waiver

FACTS:

You are a lawyer at a law firm in Houston. A law school classmate, who moved to Atlanta after graduation, has referred one of her Atlanta corporate clients to you. (That's a good reason to get to know, and be on good terms with, the people you meet in school ….)

Your classmate's Atlanta client is hiring a Houston company to perform certain services. The client has agreed to your classmate's advice that a Texas lawyer should be involved in the negotiation. The Houston service provider's contract form says that:

  • both sides waive the right to a jury trial
  • Texas law applies
  • litigation will be Houston
  • any action to enforce the contract must be brought within one year after the cause of action accrues.

Your classmate says that your mutual client would like to:

  • preserve its right to a jury trial; and
  • get a longer limitation period.

QUESTIONS:

  1. Your classmate asks if the jury-trial waiver would be enforceable in a Texas court. What do you tell her?
  2. You ask your classmate whether the jury-trial waiver would be enforceable in a Georgia court. What will her answer be?
  3. Your classmate asks whether the one-year limitation period is enforceable in Texas. What do you tell her?
  4. Would your answer on the limitation period be any different if the contract were for the sale of goods?
  5. You ask your classmate whether the one-year limitation period is enforceable in Georgia. What will her answer be?
  6. As a practical matter, who is more likely to file a breach-of-contract suit in the future — the Houston services company, or the Atlanta customer? What does that suggest about which of the contract provisions in question is, or are, likely to be most important to the Atlanta customer?
  7. Name up to three changes that you could ask for in the contract to preserve the Atlanta company's right to a jury trial. (Hint: See the suggested reading — and consider what trade-offs you might be making. Also, one possible change could be to delete existing language.)
  8. If any new language is necessary to implement your proposed changes, draft it.
  9. Could you use a two-step strategy to try to get at least some of what your client wants? That is, propose Change A, and if you can't get the Houston services company to agree, then propose Change B as a fallback position? What might those two changes be?

SUGGESTED READING:

2.12.10 In the news: $706M judgment for breach of NDA provisions

From Patrick Danner, Judge upholds record $706M Bexar jury verdict, [San Antonio] ExpressNews.com, Oct. 25, 2018:

State District Judge David A. Canales on Thursday entered a final judgment in favor of San Francisco-based HouseCanary Inc., a real estate analytics firm that had accused a Detroit company affiliated with mortgage lender Quicken Loans of stealing trade secrets and breach of contract.

 * * *

Canales’ ruling comes more than seven months after a 12-person jury found Amrock misappropriated HouseCanary’s technology for real estate valuation and appraisal analytics and had breached confidentiality agreements. The trial took seven weeks.

Jurors awarded HouseCanary more than $235 million in actual damages and $470.8 million in punitive damages. Canales affirmed the jury’s award and added almost $29 million in prejudgment interest.

The judge also awarded about $4.5  million in attorneys’ fees to HouseCanary. …

[A defense lawyer] also said, “This is the kind of damage award that annihilates companies. It just destroys them.” [Defendant] Amrock has 1,200 Michigan employees “who are wondering if they’re going to lose their jobs because of this” verdict.

2.12.11 "Sole and exclusive" – what does it mean?

2.12.12 "Sole cost and expense" – what does it mean?

Accountants apparently distinguish between cost and expense:

A cost might be an expense or it might be an asset. An expense is a cost that has expired or was necessary in order to earn revenues. We hope the following three examples will illustrate the difference between a cost and an expense. …

What is the difference between cost and expense?, AccountingCoach.com

And:

#+BEGINQUOTE An expense is a cost that occurs as part of a company's operating activities during a specified accounting period. A retailer will likely incur the following expenses: the cost of goods sold, commissions earned by the sales staff, rent for the retail space, the cost of the electricity used, advertising that took place, wages and salaries that were incurred, etc. #+ENDQUOT

What is an expense?, AccountingCoach.com

2.12.13 Feedback clauses in nondisclosure agreements

One of my blog readers, a paralegal for a USD $13B (revenue) multinational corporation, asked me my thoughts about the following clauses, which she said her customers were increasingly asking her company to agree to in confidentiality agreements.

Clause 1 (extra paragraphing, paragraph numbering, and bullets added):

1.1 Feedback: Vendor may (but is not obligated to) provide feedback or input to Company based on Confidential Information.

1.2 Any and all such feedback (including any and all test results, error data, reports or other information) shall be the exclusive property of Company, and/or are hereby assigned to Company by Vendor at no cost to Company.

1.3 Company may use such feedback in any manner and for any purpose, without limitation, liability or obligation to Company and its successors and assigns.

1.4 Vendor warrants and represents[:]

  • that it owns an intellectual property rights in and to the Feedback and
  • that the Feedback does not infringe upon the intellectual property rights of any other third party.

Clause 2:

2.1 Feedback Clause. Any ideas, suggestions, guidance, or other information disclosed by Vendor regarding the design of Company’s components, including design and design for manufacturability feedback, and all intellectual property rights therein and thereto, shall be collectively deemed “Feedback.”

2.2 Notwithstanding [another section], Company shall own all Feedback and all such Feedback shall be deemed to be the Confidential Information of Company and not Vendor.

2.3 Accordingly, Vendor hereby assigns to Company all of its right, title, and interest in and to such Feedback.

2.4 To the extent that the foregoing assignment is ineffective for whatever reason, Vendor agrees to grant and hereby grants to Company a non-exclusive, perpetual, irrevocable, royalty-free, worldwide license (with the right to grant and authorize sublicenses) to make, have made, use, import, offer for sale, sell, reproduce, distribute, modify, adapt, prepare derivative works of, display, perform, and otherwise exploit such Feedback without restriction.

EXERCISE: As counsel for Vendor, how might you respond to these various proposed provisions?

EST

2.12.14 Ambiguity: Why hyphens can be important

From Stanford law professor Mark Lemley (used with his permission):

Paradise-Time-Travel-Bookstore-Lemley.png

And in the same vein, from a then-student in this course (spring 2016): Mice Breeding Chinese Scientists Say Making Babies in Space Is Possible (Inverse.com). The student's comment: "TL;DR: Hyphens are important, yo."

2.12.15 Poor word choice: "Loanee"

From Katie Stancombe, COA affirms breach, fraud, unjust enrichment claims brought by bank, TheIndianaLawyer.com Oct. 26, 2018:

A bank that brought breach of contract, fraud and unjust enrichment claims against its loanee won each of those claims on appeal, but failed to state a claim that the loanee violated the “usual and customary practices” laid out in its participation agreement, according to a Friday opinion from the Indiana Court of Appeals.

(Emphasis added.)

QUESTION: "Loanee" ?????

2.13 Week 12 (Mon. Apr. 8)

2.13.1 Reshuffle the groups

New groups will be announced after adds and drops.

2.13.3 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.13.4 MONDAY: Open mike about the reading

QUESTION: What aspects of the reading for this week do you think a client would have trouble understanding? And how would you explain it to them?

2.13.5 WEDNESDAY: Quiz #4

You know what to do.

2.13.6 Exercise: Ambiguity and short-term trading

From a Hacker News discussion:

First commenter: "You should only short term trade with your 401k."

Responder: "You're saying, 'if you're going to short-term trade, you should use your 401k to do it in preference to any other funds source', [sic] right? Because there's a way to read this where you're saying 'the only way you should trade with your 401 is short-term'. [sic]"

First commenter: "Lol. The first."

QUESTION: How can the above sentence be clarified by simply moving words around? (As noted above, there are two possible meanings.)

QUESTION: Why did I write "[sic]" where I did?

2.13.7 Exercise: Illusory contract follow-up (reprised)

The following is from Henderson v. A & D Interests, Inc., No. 3:17-CV-096 (S.D. Tex. Mar. 9, 2018) (granting defendant's motion to dismiss in favor of mandatory arbitration):

[Defendant] Heartbreakers operate [sic] an adult entertainment club in Dickinson, Texas. Plaintiffs Frankie Henderson (“Henderson”) and Kaitlyn Jersey (“Jersey”) worked as exotic dancers at Heartbreakers. They signed and executed the Independent Contractor/License Agreement Between A&D Interests, Inc. d/b/a Heartbreakers and Independent Contractor (“License Agreement”). The License Agreement contains an arbitration provision. …

Henderson and Jersey argue the License Agreement is unenforceable because it is illusory. The Court disagrees. The Fifth Circuit has held that an arbitration agreement is illusory “[w]here one party has the unrestrained unilateral authority to terminate its obligation to arbitrate.” Nelson v. Watch House Int’l, L.L.C., 815 F.3d 190, 193 (5th Cir. 2016) (quoting Lizalde v. Vista Quality Markets, 746 F.3d 222, 225 (5th Cir. 2014)).

Here, the License Agreement does not give such unilateral authority to either party. Section 8 of the License Agreement gives both the Licensor and Licensee the power to “terminate the agreement at any time with or without notice.” As both parties were provided termination rights, the Court finds that the License Agreement is not illusory.

Id., slip op. at 1, 3 (emphasis and extra paragraphing added).

QUESTION: If either party had "terminated" the Agreement, would the arbitration provision have died with the Agreement?

[DCT to discuss New England case]

QUESTION: If a drafter didn't want arbitration to die upon termination, what could that drafter do during drafting / negotiation?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: The drafter could state that the arbitration provision would survive any termination or expiration of the Agreement.

QUESTION: Which of these drafting approaches is better In Professor Toedt's view?

A.    Allow for termination of the Agreement but state that specified provisions survive.

B.    Allow for termination of specific rights and obligations but not of the Agreement.

C.    Neither is better; either will work OK.

D.    Do what your supervising partner prefers.

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: D: In Professor Toedt's view, B is the better choice, but when you're starting out, do it the way your supervising partner wants.

2.13.8 Exercise: Warranties – who can sue?

FACTS:

  • You represent ABC Corporation, which is negotiating a master purchase agreement under which ABC and its various affiliates can issue purchase orders to buy widgets from XYZ Inc. You've been asked to review a draft of the master agreement, prepared by XYZ's lawyers.
  • One provision of the draft states that "XYZ warrants to ABC that the widgets, as delivered, will be free from defects in materials and workmanship."

HYPOTHETICAL: Suppose that one of ABC's affiliate corporations were to order widgets under this master agreement, and it turned out that those widgets did have defects.

QUESTION 1: Would the affiliated corporation be able to sue XYZ for breach of warranty? [7]

QUESTION 2: As ABC's lawyer, how could you improve the warranty provision on this point? [8]

2.13.9 Exercise: Indemnities

1. What is the difference between an indemnity and a warranty? [9]

2. IF FALSE, EXPLAIN WHY: IF: Alice agrees to indemnify Bob against damage arising from occurrence of Event X; THEN: This reduces the risk to the parties associated with the (possible) occurrence of Event X. (CAUTION: Read this carefully.) [10]

3. IF FALSE, EXPLAIN WHY: An indemnity obligation allocates at least some of the financial risk of Event X. [11]

4. IF FALSE, EXPLAIN WHY: The following is an acceptable conventional phrasing: Alice hereby indemnifies Bob against any damage Bob might incur if it rains tomorrow. [12]

2.13.10 Exercise: Atari indemnification provision

From section 11 of an Atari consulting contract at https://goo.gl/TvfYKa (onecle.com via archive.org):

Consultant agrees to indemnify and hereby does indemnify, defend and hold harmless Atari, its affiliates, and their respective officers, directors, employees, distributors, agents, customers and licensees from and against any liability, damage or expenses (including without limitation attorneys' fees) based on the untruth or breach of any representation, warranty or covenant contained in this agreement.

QUESTIONS:

  1. Given the meaning of indemnify, what does the phrase, "and hereby does indemnify" literally mean, and does that make business sense?
  2. The end of this provision refers to the "untruth" of any "covenant"; any thoughts about that?
  3. Does Atari gain anything by asking for this indemnity obligation, as opposed to relying on straightforward breach-of-contract remedies?
  4. If you were representing Consultant, what might you say about the list of beneficiaries of this indemnity obligation?
  5. If you were representing Consultant, how might you try to negotiate less-onerous terms for this provision?

2.13.11 Ambiguity exercise: Prime rate plus 2%

TEXT (from a dispute that I arbitrated): A contract states that payments remaining past due more than 30 days after the due date will bear interest at “a rate per annum equal to the prime rate published by the Wall Street Journal on the business day before the date on which such interest begins to accrue, changing with each change in such published rate, plus two percent (2%)."

FACTS: On the relevant date, the Journal's published U.S. prime rate was 4.00%.

QUESTION: On its face, from a drafting style perspective, what's wrong with this interest-rate provision?

QUESTION: What interest rate should be applied to the late payment — 6%, or 4.08%?

QUESTON: How could the interest-rate language be clarified?

2.13.12 Ambiguity: Separate interviews

From an arbitration award I was writing (and caught myself): "Ms. Doe and her coworker Jane Roe were separately interviewed by Human Resources manager John Doe and Becky Bow."

QUESTION: How many people were interviewed by how many people?

2.13.13 Drafting fail: "Each male grandson …."

From this article:

… when I was 13 I was bequeathed a shotgun after my grandfather died. Each male grandson was given one.

QUESTION: What are two ways of improving this passage?

2.13.14 Exercise: Payments based on net revenue

From a contract drafted by The Other Side of a deal (sanitized):

Subject to the terms and conditions of this Agreement, ABC shall pay, on a quarterly basis, to XYZ twenty percent (20%) of Data Revenue (net of all associated costs and expenses) for Licensed Transactions for the Term of this Agreement ….

QUESTION: Should XYZ have any business concerns about the "net of all associated costs and expenses" term?

2.13.15 Rewriting exercise: Termination

From this license agreement:

12. TERMINATION

If the royalties due hereunder have not been paid within the time allowed by this Licence Agreement or if either party shall breach of any of the representations, warranties, covenants, promises or undertakings herein contained and on its part to be performed or observed and shall not have remedied such breach within thirty (30) days after notice is given to the breaching party by the non-breaching party requiring such remedy or if either party shall have an Examiner appointed over the whole or any part of its assets or an order is made or a resolution passed for winding up of such party unless such order is part of a scheme for reconstruction or amalgamation of such party then the other party may forthwith terminate this Licence Agreement without being required to give any or any further notice in advance of such termination but such termination shall be without prejudice to the remedy of such party to sue for and recover any royalties then due and to pursue any remedy in respect of any previous breach of any of the covenants or agreements contained in this Licence Agreement.

EXERCISE: Rewrite to clarify — don't mess with the substance.

2.14 Week 13 (Mon. Apr. 15)

2.14.2 Weekly routine

Monday: Small-group review of reading, note key points in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), then brief class discussion.

Monday: Discuss Gigunda-MathWhiz drafting project with colleagues as needed.

Wednesday: Drafting homework due — see § 3.

2.14.3 Exercise: Relationship of the parties

From a confidentiality agreement that I'm negotiating for a small client, which will be exchanging confidential information with another relatively-small company (that is, each company is likely to disclose some of its confidential information to the other):

7.      Relationship of Parties. The Receiving Party understands that nothing herein: (a) requires the disclosure of any Confidential Information of the Disclosing Party, which information may be disclosed, if at all, solely in the option of the Disclosing Party; (b) requires the Disclosing Party to proceed with any proposed transaction or business relationship in connection with which Confidential Information may be disclosed; or (c) is deemed to create any principal/agent relationship, joint venture[,] or other business relationship between the parties hereto.

EXERCISE: Imagine that you're a very-new lawyer who has been asked by a partner to review this paragraph for the client. The partner has asked that you come up with an exhaustive list of every issue — both substantive and stylistic — that you can think of in this paragraph. (Do this in your groups.)

2.14.4 Exercise: Care of confidential information

From a confidentiality agreement that I'm negotiating for a (different) small client, which will be receiving confidential information from a global company:

4.1       The Receiving Party shall exercise all due care in ensuring the proper and secure storage of the Confidential Information.

 * * *

4.3       As soon as practicable after a demand in writing from the Disclosing Party all original copies of the Confidential Information shall be retrieved and returned by the Receiving Party to the Disclosing Party and the Receiving Party shall, on request, notify the Disclosing Party in writing that it has:

(i)       destroyed all other copies of the Confidential Information in its possession; and

(ii)       taken all reasonably practicable steps to permanently erase all Confidential Information from computer media; and

(iii)       procured that all persons to whom the Receiving Party has disclosed any Confidential Information comply with this Article 4 .

QUESTION: If you're representing the receiving party, do you have any thoughts about this language?

2.14.5 Exercise: The weather

Suppose that today, right now, Alice and Bob are in our classroom and are about to sign a contract. For some reason, the contract states that Alice represents that it's sunny outside at the time and place of signature.

QUESTION: How would you advise Bob?

2.14.6 Ambiguity (or vagueness?): Readiness to die

One Friday night my wife and I were sitting on the couch watching a DVR recording of a Grey's Anatomy episode. In the episode, an on-screen patient dies unexpectedly in surgery.

My wife paused the recording and said she'd heard a piece on the radio that day, something about the desirability of a quick death.

(I'll tell the rest of the story in class.)

2.14.7 Ambiguity: Long hours in BigLaw

From Erin Johnston, Not All at Once, And Not All Alone, ABA Journal, Nov. 2018, at 14:

My success [as a Kirkland & Ellis litigation partner] has not been the result of a perfectly-executed master plan. But I can say that I have unapologetically asked for what I needed and was pleasantly surprised by the responses I received. No one above me assumed they knew what I wanted, or that what I wanted would always be the same.

At times I turned down opportunities to avoid travel or to focus on my family; other times I chose to take that trip or work long hours. …

(Emphasis and extra paragraphing added.)

QUESTIONS:

  1. What are two possible meanings of the italicized portion?
  2. How could the italicized portion be clarified?

2.14.8 Exercise: Shipping cost recovery

FACTS:

1.  Alice and Bob sign a contract for Alice to deliver 100,000 widgets to Bob at a price of $1.00 each plus ground shipping.

2. The contract requires all amendments and waivers to be in writing.

3.  Bob calls up Alice on the phone and says "I need the widgets right away — ship them by overnight air." Alice does so.

4.  Alice bills Bob for $100,000 plus the extra cost of overnight-air shipping. Bob refuses to pay, pointing out that he didn't agree in writing to modify the contract terms.

QUESTION 1: Can Alice recover her extra cost for overnight-air shipping, or must she "eat" that cost? (LOOK-UP: UCC § 2-104; UCC § 2-209; UCC § 2-201(1) & (2).)

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: It depends in part on whether Alice is a "merchant" in widgets, i.e., someone who deals regularly in widgets. If so, then under UCC § 2-209, the amendments-in-writing provision is enforceable against her — UNLESS Bob orally waived the amendments-in-writing requirement with his phone call.

QUESTION 2: What if anything could Alice have done to make sure she could recover the extra cost?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: Alice could have sent Bob a quick confirmation email, or text message, confirming their oral agreement that it was OK for Alice to ship by overnight air and bill Bob for the cost.

MORE FACTS:

5.  The contract states that amendments must be in writing and signed by the party sought to be bound.

QUESTION: What if anything could Alice have done to make sure she could recover the extra cost?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: Alice could have sent Bob a quick confirmation email, or text message, confirming their oral agreement that it was OK for Alice to ship by overnight air and bill Bob for the cost, and asking Bob to confirm his agreement by return email or text message.

MORE FACTS:

6. The contract between Alice and Bob is on Bob's standard purchase-order form. It states that Bob has the right to amend the terms unilaterally whenever he wants.

7.  The contract includes a forum-selection provision requiring any litigation to take place in Bob's home county.

QUESTION: If Alice were to sue Bob for the additional cost of air shipment of the widgets, must she sue in Bob's home county?

Decide on your answer, then click on the gray area below.
Be prepared to explain your answer.

Answer: Very likely not — the unilateral-amendment provision might well make the entire contract illusory.

2.14.9 Ambiguity: Will HRC run again?

From Bradley Honan and Arick Wierson, Please, Hillary, don't do it (CNN.com Nov. 15, 2018):

In 2018, we saw the progressive, Bernie Sanders wing of the Democratic party and the more centrist factions, previously marshaled by Hillary Clinton, temporarily band-aid over their differences that were on full display in 2016 for the common good.

QUESTION: What, exactly, was it that was supposedly "for the common good" —

  • differences on full display; or
  • band-aiding over those differences?

QUESTION: How could the above sentence be rewritten to make it clear which one the writer intended?

2.14.10 In the news: A condition is not a promise

See Allen v. SWEPI, LP, No.  4:18-CV-01179 (M.D. Pa. Nov. 8, 2018): The court held that an agreement between a landowner and an oil-and-gas exploration company did not require the exploration company to drill and produce oil from the property — the contract was only an option agreement that gave the exploration company the right, but not the obligation, to do so.

2.14.11 Ambiguity: Job-hunting in Japan

From this article:

… This is most likely a result of the Japanese university system, whereby your major and your future job often have little correlation. Typically one year before graduation, you apply for jobs and run around the city in a suit trying to convince a company that does virtually anything to hire you. If you’re lucky, you get in, and in the best of cases, you get training before starting whatever job you now find yourself in.

QUESTION 1: What are two possible meanings of the italicized portion?

QUESTION 2: How could the italicized portion be improved?

2.14.12 Exercise: Stanford-Tesla lease: Landlord consent terms

From the Stanford-Tesla lease:

6.1 Permitted Use. Tenant may use and occupy the Premises during the Term solely for the uses specified and permitted in Article 1 and for no other purpose without the prior written consent of Landlord, such consent to be granted or withheld in Landlord’s sole and unfettered discretion. …

6.2 Prohibited Uses. … No loudspeaker or other device, system or apparatus shall be used at the Premises without the prior written consent of Landlord. No explosives or firearms shall be brought onto the Premises without the prior written consent of Landlord, which Landlord may withhold in its sole and absolute discretion.

QUESTION: What difference is there — if any — between the italicized language in the consent in 6.1 and at the end of 6.2, versus in the first of the two consents in 6.2?

QUESTION: How might a court interpret the "No loudspeaker or other device, system or apparatus" language? What did the parties likely intend? EXERCISE: In your groups, discuss how to rewrite this sentence.

2.14.13 Exercise: Tenant audit rights (for in-class exercise)

In your small groups:

  1. Rewrite the following, from this real-estate lease, to make it as user-friendly as possible. (Don't worry about fixing the substance of the provision.) Pay special attention to the last sentence.
  2. Consider what changes you might want to make if you were representing Landlord.

6.5 Tenant’s Audit Rights. Landlord shall keep reasonably detailed records of all Operating Expenses and Real Estate Taxes for a period of at least two (2) years. Not more frequently than once in every 12-month period and after at least twenty (20) days’ prior written notice to Landlord, Tenant together with any representative of Tenant shall be permitted to audit the records of the Operating Expenses and Real Estate Taxes. If Tenant exercises its audit rights as provided above, Tenant shall conduct any inspection at a reasonable time and in a manner so as not to unduly disrupt the conduct of Landlord’s business. Any such inspection by Tenant shall be for the sole purpose of verifying the Operating Expenses and/or Real Estate Taxes. Tenant shall hold any information obtained during any such inspection in confidence, except that Tenant shall be permitted to disclose such information to its attorneys and advisors, provided Tenant informs such parties of the confidential nature of such information and uses good faith and diligent efforts to cause such parties to maintain such information as confidential. Any shortfall or excess revealed and verified by Tenant’s audit shall be paid to the applicable party within thirty (30) days after that party is notified of the shortfall or excess to the extent such overage or shortfall has not previously been adjusted pursuant to this Lease. If Tenant’s inspection of the records for any given year or partial year reveals that Tenant was overcharged for Operating Expenses or Real Estate Taxes by an amount of greater than six percent (6%), Tenant paid such overage and such overage was not otherwise adjusted pursuant to the terms of this Lease, Landlord shall reimburse Tenant for its reasonable, third party costs of the audit, up to an amount not to exceed $5,000.

2.14.14 Rewriting exercise: Confidential information (Atari agreement)

Rewrite the following to make it more readable; it's from an Atari consulting agreement, at https://goo.gl/ukMKTr (onecle.com via archive.org), between an individual and Atari:

7.    Confidentiality and Security.

Consultant recognizes and agrees that in the course of performing services hereunder Consultant will generate or otherwise become privy to written or orally conveyed information that is proprietary or confidential to Atari, its affiliates, or their customers and/or to other parties to whom they may have confidentiality obligations. This information may include, without limitation, plans to introduce new products or services (including in this regard the existence of the Project), methods of doing business, planned transactions, market information, pricing information, supply sources, license and contract terms, information pertaining to customers' businesses, non-public financial data and operating results, system and component designs, specifications, computer software and technical information. Consultant understands that Atari and/or such affiliates, customers and other parties regard such information as trade secrets, and Consultant will employ Consultant's best efforts to assure the continued confidentiality thereof. Consultant will not disclose such information to anyone or use it for any purpose other than the performance of Consultant's services hereunder. Consultant will take all reasonable measures to prevent any unauthorized person from gaining access to such information and to prevent such information from being accessed, disclosed or used in any unauthorized manner, including complying strictly at all times with all applicable physical and computer system security procedures. Consultant will not break or attempt to break any of Atari's (or such affiliates’, customers' or other persons’) security systems, or obtain, or attempt to obtain access to any program or data other than those to which Consultant has been given access in writing. Upon any termination, cancellation or expiration of this agreement or at Atari's request at any other time, Consultant will deliver to Atari all materials in tangible form containing any of the information referred to in this Section 7, shall purge any and all copies thereof from all files and storage media retained by Consultant, and shall retain no archival or other copies thereof whatsoever. Further in such event, Consultant shall return any keys, security passes, equipment or other items or property supplied to Consultant by Atari or by any such affiliate, customer or other person.

QUESTION 1: If you're representing Consultant, why should the phrases "best efforts" and "all reasonable measures" cause you some concern?

QUESTION 2: How is Consultant supposed to know just what Atari information is subject to the confidentiality restriction?

QUESTION 3: Why should the penultimate sentence be of concern to Consultant?

2.15 Week 14 (Mon. Apr. 22)

2.15.2 Makeup day: Wed. Apr. 24 (if necessary)

2.15.3 Pizza for section with highest quiz average

I might be a couple of minutes late, picking up the pizza at Pink's.

2.15.4 Discussion of final week's reading

2.15.5 Collaborative review outline

In the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), collaborate with your groups to outline what you think are some of the key themes and takeaways from the course — what do you think a new associate should keep in mind?.

2.15.6 DCT's survey

Also in the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), let me know (anonymously) what you liked about the course and what you think could use improvement.

Possible areas of interest:

  • Small-group discussion of questions before one student is called on
  • Ambiguity exercises
  • Breaking up walls of words
  • Spaced-retrieval practice, a.k.a. quizzes
  • Drafting & markups in small teams
  • Common Draft contract provisions and commentary

2.15.7 Course evals

We'll take a few minutes to do the school's course evaluation:

  1. The comments are especially important — many students look at those.
  2. If you have negative feedback, for selfish reasons I'd prefer that you wrote it in the the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ); it's up to you whether to include negative feedback in the official course evaluation.

2.15.8 Jeopardy!

3 Homework (drafting specific provisions)

3.1 Facts to start (based on an actual client project)

  1. In each of the three in-class study groups, two of the students in the group will represent "Gigunda Energy," a (hypothetical) global oil-and-gas company headquartered in California but with a significant campus in Houston.
  2. The other two students in each group is to represent (the equally-hypothetical) "MathWhiz LLC" in Houston.

    MathWhiz is headed by Mary, who is an expert in analyzing seismic data to predict where oil or natural gas deposits might be. Mary "came up" in the industry working for major oil companies, then started her own company. Her business has grown; she now employs several junior analysts, and also selectively subcontracts work to others (usually, longtime friends or colleagues of hers) to do specialized tasks.

    (Each group is to decide which students will represent which company. When groups change, the representations might be reassigned.)

  3. Gigunda Energy expects to collect seismic data, over a period of about a year, from a potential oil field in Outer Mongolia. Gigunda wants to hire MathWhiz to analyze the seismic data.
  4. Gigunda and MathWhiz have discussed the likely amount of work that will be involved. They have agreed that Gigunda will pay MathWhiz a flat monthly fee of $20K for up to 200 staff hours of work per month, with additional work being billed at $150 per hour.

A partner in your law firm has asked you to prepare a draft contract and to help the parties negotiate it.

Remember, some of you represent Gigunda Energy, others represent MathWhiz.

3.2 Week-by-week drafting assignments

Each of these drafting assignments is due on a Wednesday at the beginning of class — be sure to read the general instructions at § 4.44.4.

Week Wed. Provision Points
01 Jan. 16 Title and signature blocks for the agreement 5
02 Jan. 23 Preamble and recitals 5
03 Jan. 30 Payment terms; interest clause 10
04 Feb. 06 MathWhiz reps and warranties (a) 10
05 Feb. 13 Rep- and warranty disclaimers 10
06 Feb. 20 Each party's indemnity obligations 20
07 Feb. 27 Assignment consent 20
08 Mar. 06 Amendments, waivers, entire agreement 20
09 Mar. 20 Recordkeeping; audit rights; background checks 20
10 Mar. 27 Termination rights 20
11 Apr. 03 Insurance 20
12 Apr. 10 IP rights; notices 20
13 Apr. 17 Governing law; forum selection 20
    TOTAL: 200

NOTES:

(a) Don't include disclaimers — that'll come later.

4 Readings (including course info)

4.1 (Study:) A.T.A.R.I.

Avoid the Argument: Rewrite It!

4.2 (Study:) Acknowledgements in a notary certificate

4.2.1 (Black letter:) "Notarizing" a document with an acknowledgement certificate can make it self-proving

(This section discusses the certificate of acknowledgement by a notary public or other authorized official; that's a different type of certificate than a "jurat," which is tantamount to an oath sworn by the signer — the notary or other official certifies that the signer of the document appeared personally [or, in some jurisdictions, remotely by live audio and video call] and declared, under penalty of perjury, that the document's contents were true.)

A document such as a deed to real property might include, after the signature blocks, a space for a notary to sign a certificate that the signer appeared before the notary, presented sufficient identification, and acknowledged that the signer indeed signed the document. In many jurisdictions, the notary's signed certificate and official seal serve as legally-acceptable evidence that the document isn't a forgery — that is, that the document is authentic. (This is sometimes referred to as making the document self-authenticating or self-proving.)

The law likely requires a notary's certificate of acknowledgement if the document is to be recorded in the public records so as to put the public on notice of the document's contents. Let's illustrate the process with a hypothetical example.

  • Suppose that "Alice" is selling her house. To do so, she will ordinarily sign a deed and give it to "Bob," the buyer.
  • Bob will normally want to take (or send) the deed to the appropriate government office to have the deed officially recorded. That way, under state law, the world will be on notice that Bob now owns Alice's house.

But how can a later reader know for sure that the signature on the deed is in fact Alice's signature and not a forgery?

The answer is that under the laws of most states, for Alice's deed to Bob even to be eligible for recording in the official records, the deed must include an acknowledgement certificate, signed by a notary public or other authorized official. The notary's certificate must state that Alice:

  • personally appeared before the notary (usually on a stated date);
  • produced sufficient identification to prove that she was indeed Alice; and
  • acknowledged to the notary that she had signed the deed.

If Alice signed the deed in a special capacity (e.g., as trustee of a trust or executor of her father's estate), then the notary's certificate will usually say that, too.

Once Alice has done this, the notary will sign the certificate and imprint a seal on the deed. The notary might do this with a handheld "scruncher" that embosses the paper of the deed, or instead with an ink stamp (this depends on the jurisdiction).

Typically, the notary is also required to make an entry in a journal to serve as a permanent record.

This acknowledgement procedure allows the civil servants who must record Alice's deed to look at the deed and have at least some confidence that the signature on it isn't a forgery.

Incidentally, state law usually determines just what wording must appear in an acknowledgement.

In some jurisdictions, Alice is not required to actually sign the deed in the presence of the notary; she need only acknowledge to the notary that yes, she signed the deed.

See generally Acknowledgements and Jurats (NationalNotary.org).

4.2.2 (Black letter:) Other, non-notary officials might also be authorized to certify signature authenticity

By statute, certain officials other than notaries public (note the plural form, "notaries public" and NOT "notary publics") are authorized to certify the authenticity of signatures in certain circumstances. See, e.g., Tex. Civ. Prac. & Rem. Code § 121.001, which gives the power to certify signature acknowledgements to district-court and county-court clerks and, in certain cases, to commissioned officers of the U.S. armed forces, among others.

4.2.3 (Extra:) A notary public can't certify a signature if s/he has a conflict of interest

See generally, e.g., American Society of Notaries, Conflicts of Interest (2008).

See also Tex. Civ. Prac. & Rem. Code § 121.002: That statute specifically allows a corporate employee (who is a notary public) to certify the acknowledgement of a signature on a document in which the corporation has an interest unless the employee is a shareholder who owns more than a specified percentage of the stock.

4.2.4 (Read:) A flawed signature-acknowledgement certificate can lead to serious problems in court

Parties will want to double-check that the notary "does the needful" (it's an archaic expression, but I like it) to comply with any statutory requirements.

In a New York case, a married couple's prenuptial agreement was voided because the notary certificate for the husband's signature didn't recite that the notary had confirmed his identity. See Galetta v. Galetta, 21 N.Y.3d 186, 191-92, 991 N.E.2d 684, 969 N.Y.S.2d 826 (2013) (affirming summary judgment that prenup was invalid).

  • It was undisputed that the couple's signatures on the agreement were authentic, and there was no accusation of fraud or duress. See id., 21 N.Y.3d at 189-90.
  • Even so, said the state's highest court, the notarization requirement was important because it "necessarily imposes on the signer a measure of deliberation in the act of executing the document." Id. at 191-92.

4.2.5 (Extra:) A lawyer who certifies a client's signature acknowledgement might have to testify about it

In many states it's easy to become a notary public. Some lawyers themselves become notaries so that they can certify the authenticity of clients' signatures on wills, deeds, and the like.

But that might lead to the lawyer's being called someday to testify in a court proceeding about a signed document.

  • For example, the notary might have to explain how he or she confirmed the signer's identity if that information isn't stated in the lawyer's notary records.
  • That in turn might disqualify the lawyer from being able to represent the client whose signature was certified.

See, e.g., Tex. Civ. Prac. & Rem. Code § 121.001; Tex. Discipl. R. Prof. Conduct 3.08 ("Lawyer as Witness").

(As a practical matter, though, that might not be too much of an issue, because the lawyer might already have to testify by virtue of having participated in the events leading up to the signing of the document.)

4.2.6 Review questions

Suggested reading: § 4.2

  1. FACTS: Your client, Landlord, has negotiated a five-year commercial lease agreement for one of its office buildings. The tenant's lawyer wants the signers to have their signatures notarized. Landlord agrees to have the signatures notarized. ASSUME: All events take place in Texas and are subject to Texas law.
  2. QUESTION: Why might the tenant's lawyer want the lease agreement to be notarized? Would that be in your client Landlord's best interest? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: J. Allen Smith & Michael R. Steinmark, Tenants' Rights Under Unrecorded Leases, at http://goo.gl/S2prC (2010); Tex. Prop. Code §§ 12.001, 13.001, 13.002.
  3. QUESTION: If the notary public can't find her notary seal, may she sign the notary certificate and skip applying the seal? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Gov. Code § 406.013; Tex. Civ. Prac. & Rem. Code § 121.004.
  4. QUESTION: What must the notary public do before signing the notary certificate to confirm that the signers are who they claim to be? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.005(a).
  5. QUESTION: Must the notary's certificate say anything in particular about the identity of the signer? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.005(b).
  6. QUESTION: What must the notary do after notarizing the signature(s)? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.012; Tex. Gov. Code § 406.014.
  7. QUESTION: If no notary is around, can you notarize the signatures as an attorney? Should you? Explain, citing relevant statutory- and regulatory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.001; Tex. Discipl. R. Prof. Conduct 3.08 ("Lawyer as Witness").
  8. QUESTION: Surprise! The person who will sign the lease for the tenant has gone on a business trip to Kuwait and will FAX her signed signature page to you. Can your secretary, who is here in Houston and is a notary public, notarize that signature page? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.004(a).
  9. QUESTION: Another document in the transaction must be signed and notarized by an individual who's in California. Is anything special required for the notary certificate? What downside risk does the notary have if the notary is asked to sign the certificate in the absence of the individual who's going to sign the document? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Cal. Civ. Code § 1189(a).
  10. QUESTION: Who in Kuwait could "notarize" the signature? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.001.

4.3 (Study:) Acknowledgements in a contract

A contract reviewer should be extremely careful about statements in a draft agreement in which the parties “acknowledge” something or another. Such language might preclude the reviewer's client from later disputing what was acknowleged in the contract.

Consider the case of Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG: The contract was a license agreement between a manufacturer of cell-phone docking stations and a patent owner. The license agreement required the manufacturer to pay royalties on the manufacturer's products that were covered by the patent. The license agreement included a statement in which the manufacturer "acknowledged" that certain specific docking stations were indeed covered by the patent. The manufacturer, however, later denied that some of those specific docking stations were covered by the patent — to no avail: The court held that the acknowledgement language in the contract precluded the manufacturer from denying the patent's coverage. Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016 (10th Cir. 2014) (affirming trial-court judgment in part).

But contract drafters should still give some thought to judiciously including one or more factual acknowledgements in a draft. Doing so could help to reduce the cost and burden of any future disputes, as well as make it easier for the client's future trial counsel to do their jobs.

On the other hand, nobody likes a drafter who asks the other side to “acknowledge” something that clearly is or would be in dispute.

  • EXAMPLE: Suppose that a customer's purchase-order form includes printed boilerplate language stating that "Supplier acknowledges that any failure by Supplier to deliver the goods or services required by this purchase order at the stated delivery date will cause Customer significant long-term harm." In a particular case that might be true, but in a standard contract form it's just obnoxious.
  • EXAMPLE: Suppose that a supplier's standard terms of sale recite that "Customer acknowledges that Supplier's products have a reputation for exceptionally-high quality and value for the money." Come on, now; few if any customers would willingly agree to such a statement in a lawsuit, so it's bad form for the supplier to ask the customer to agree to it in the contract.

4.4 (Read:) Affiliate status

4.4.1 (Black letter:) Affiliate status hinges on a "control" relationship (including common control).

Many and even most contractual definitions of affiliate are derived from the regulatory definition promulgaged by the U.S. Securities and Exchange Commission ("SEC") in Rule 405, 17 C.F.R. § 230.405:

Affiliate. An affiliate of, or person affiliated with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.

 * * *

Control. The term control (including the terms controlling, controlled by and under common control with) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

[Emphasis added.]

 * * *

Voting securities. The term voting securities means securities the holders of which are presently entitled to vote for the election of directors.

4.4.2 (Skim:) Business context: Why "affiliates" might be relevant in contracts

Affiliate status can be important in a contract because the contract might give rights to — and/or (purport to) impose obligations on — the "affiliates" of one or both of the parties.

For example, a software license agreement might grant the right to use the software not only to the named licensee company, but also to affiliates of the licensee company. Such an agreement will almost certainly impose corresponding obligations on any affiliate that exercises the right to use the software.

Or, a customer will sometimes want its non-owned "affiliated" companies to be allowed to take advantage of the contract terms that the customer negotiates with a supplier.

A supplier, though, might not be enthused about an expansive definition of affiliate. The supplier will often not want to limit its own freedom to negotiate more-favorable terms with the customer's affiliates.

4.4.3 (Black letter:) Include affiliates as "parties" to the contract? (Probably not.)

Some agreements, in identifying the parties to the agreement on the front page, state that the parties are, say, ABC Corporation and its Affiliates. That's generally a bad idea unless each such affiliate actually signs the agreement as a party and therefore commits on its own to the contractual obligations.

The much-better practice is to state clearly the specific rights and obligations that (some or all) affiliates have under the contract. This is sometimes done in "master" agreements negotiated by a party on behalf of itself and its affiliates. For example, consider a negotiated master purchase agreement between a customer and a provider. The master agreement might require the provider to accept purchase orders under the master agreement from the customer's affiliates as well as from the customer itself, so that the customer's affiliates can take advantage of the pre-negotiated pricing and terms.

CAUTION: An affiliate of a contracting party might be bound by the contract if (i) the contracting party — or the individual signing the contract on behalf of that party — happens to control the affiliate, and (ii) the contract states that the contract is to benefit the affiliate. That was the result in Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10948-CB, slip op. at 3, 52-53 (Del. Ch. Aug. 18, 2016). In that case, (i) the contract stated that a strategic alliance was being created for the contracting party and its affiliates, and (ii) the contract was signed by the president of the contracting party, who was also the sole managing member of the affiliate. The court held that the affiliate was bound by (and had violated) certain restrictions in the contract.

4.4.4 (Read:) The danger of affiliate status via "management control"

The vagueness of the "management power" language could lead to expensive litigation. Drafters should therefore be cautious in taking such an approach, even though it's often seen in existing contracts and templates.

It might be the case that the definition of affiliate would be relevant only to determine, say, which affiliates of a customer are entitled to the negotiated pricing, or are entitled to use licensed software. In that situation, the downside risk of a management-power definition of affiliate might be manageable. But it's not hard to imagine how, in later litigation, the parties might have to engage in extensive – and expensive – discovery for trial of a fact-intensive dispute about who had what management power at the relevant time(s). If a contract really needs to define Affiliate without being limited by a certain percentage of voting control, one better approach is for the contract to designate specific affiliates.

Consider the Offshore Drilling Co. case: the parties in the lawsuit hotly disputed who had had "control" of a vessel destroyed by fire, and thus which party or parties should be liable for damages. The specific facts and outcome of the case aren't important here — what matters is that the parties almost-certainly had to spend a lot of time and money fact-intensive litigation over the control issue. See Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., 604 F.3d 221 (5th Cir. 2010) (affirming summary judgment in relevant part). That's the last thing parties to a contract should want.

And in the UBS v. Red Zone case, the UBS investment bank and Red Zone LLC, a private equity firm (whose managing member was Dan Snyder, owner of the Washington Redskins) entered into a contract which stated, in part, that Red Zone would pay UBS a $10 million fee if Red Zone succeeded in acquiring — or in acquiring "control" of — the amusement-park company Six Flags. Apparently Red Zone never did acquire more than 50% of Six Flags's stock, but because of other circumstances the appellate court held that:

… Red Zone clearly controlled Six Flags once its insiders and nominees constituted the majority of the board and took over the company's management.

It cannot be disputed that Red Zone had seized the power to direct Six Flags' management and policies.

We reject Red Zone's argument that it did not control Six Flags simply because it did not obtain ownership of the majority of its voting shares. The argument is at odds with the inclusive definition of "control" ….

4.4.5 (Skim:) Affiliate status through voting control: Language origins

Most definitions of affiliate include references to control of the right to vote for an organization's board of directors (or equivalent). Such language generally tracks terminology found in U.S. securities laws such as SEC Rule 405, 17 C.F.R. § 230.405, as well as in other sources. See, e.g., UBS Securities LLC v. Red Zone LLC, 77 A.D.3d 575, 578 (N.Y. App. Div. 1st Dept. 2010) (quoting Black's Law Dictionary and citing New York and Delaware statutes).

4.4.6 (Extra:) Deciding on the minimum voting percentage for control

A minimum voting percentage for control of 50% seems to be pretty typical. Drafters, though, should think about why they're defining the term affiliate (see § 4.4.2), because the answer might warrant changing the percentage.

4.4.7 (Extra:) Other definitions of voting control

Some drafters might want voting control also to arise from one or more of the following:

  1. a legally-enforceable right to select a majority of the members of the organization's board of directors or other body having comparable authority — note that this alternative does not say that control exists merely because a person has a veto over the selection of a majority of the members of the organization's board;
  2. a legally-enforceable right, held by a specific class of shares or of comparable voting interests in the organization, to approve a particular type of decision by the organization; or
  3. a legally-enforceable requirement that a relevant type of transaction or decision, by the organization, must be approved by a vote of a supermajority of the organization's board of directors, shareholders, outstanding shares, members, etc. (The required supermajority might be two-thirds, or three-fourths, or 80%, etc.)

4.4.8 (Black letter:) Designating named affiliate groups can add flexibility

By designating specific affiliate groups, drafters can expand the definition of affiliate on a case-by-case basis as needed. This can be useful because voting control might not capture all of the individuals and/or orgainzations that a party wants to name as affiliates.

If it's not possible to determine in advance who all the named affiliate groups will be, the parties could consider:

  • letting one party unilaterally name additional affiliates with the other party's consent, not to be unreasonably withheld; and/or
  • designating specific "open enrollment" periods in which affiliates can be named.

4.4.9 (Read:) Pro tip: Plan for changes in affiliate status

Contract drafters and reviewers should plan for changes in affiliate status, in case one or more of the following things happens:

  • A party acquires a new affiliate, e.g., because its parent company makes an acquisition;
  • Two companies cease to be affiliates of one another, e.g., because one of them is sold off or taken private;
  • A third party – perhaps an unwanted competitor – becomes an affiliate of "the other side."

4.4.10 (Extra:) The timing of affiliate status can be important

In some circumstances, affiliate status might exist at some times and not exist at others. That could be material to a dispute. Compare, for example:

• "Absent explicit language demonstrating the parties' intent to bind future affiliates of the contracting parties, the term 'affiliate' includes only those affiliates in existence at the time that the contract was executed." Ellington v. EMI Music Inc., 24 N.Y.3d 239, 246, 21 N.E.3d 1000, 997 N.Y.S.2d 339, 2014 NY Slip Op 07197 (affirming dismissal of complaint).

• In GTE Wireless, Inc. v. Cellexis Intern., Inc., 341 F.3d 1 (1st Cir. 2003), the appeals court held that Cellexis breached a settlement agreement not to sue GTE or its affiliates when it sued a company that, at the time of the settlement agreement, had not been a GTE affiliate, but that later became an affiliate. Reversing a summary judgment, the appeals court reasoned that the contract language as a whole clearly contemplated that future affiliates would be shielded by the covenant not to sue. See id. at 5.

4.5 (Study:) Agreement date

It's always a good idea for a contract to be dated. The date can be:

  • in the title: Agreement and Plan of Merger dated December 25, 20xx between A and B ….
  • in the preamble with blank lines: This Agreement is made the     day of                between A and B ….
  • in the preamble with a filled-in date: This Agreement is made December 25, 20xx between A and B ….
  • in the signature line with a blank date line: Dated:             
  • in the signature line with a filled-in date: Dated: December 25, 20xx

The author's strong preference is: None of the above, and instead as follows:

  1. In the preamble: This Agreement is made, effective the last date written in the signature blocks below ….; and
  2. In the signature blocks, include a "Date signed:                      " line for each signer to hand-write the actual date — note how it says "Date signed" to remind the signer to write in the actual date.

Why? See Don't backdate a contract for deceptive purposes, § 4.97.8; see also (Study:) Effective date, § 4.51.

4.6 (Study:) Agreements to agree

It can be tempting In U.S. jurisdictions, an agreement to agree is generally unenforceable. That will be true not just of contracts as a whole, but of specific provisions.

Optional reading: See generally, e.g., Daniel P. Graham and Tyler E. Robinson, Enforceable Contract or Unenforceable Agreement to Agree? The Importance of Specificity in Teaming Agreements (WileyRein.com 2013).

4.7 (Black letter:) Agreements to negotiate in good faith are enforceable

Sometimes when parties can't agree about a specific point, they might be tempted to agree that they'll negotiate that point later in good faith. That, though, could really complicate the parties' lives if they can't reach agreement. Unlike an agreement to agree, an agreement to negotiate in good faith is likely to be enforceable, and breaching that agreement could end up being expensive for the breacher.

Consider, for example, SIGA Technologies, Inc. v. PharmaThene, Inc., 67 A.3d 330 (Del. 2015): Breach of an agreement to negotiate in good faith resulted in a $113 million damage award. It bears noting that the parties certainly had to spend a ton of money to litigate the dispute, because good faith isn't the kind of claim that can be readily disposed of in a summary-judgment proceeding.

4.8 (Study:) Ambiguity, the bane of contract drafters

4.8.1 Introduction

Ambiguity is one of the worst sins a contract drafter can commit. A contract term is ambiguous if it is susceptible to two or more plausible interpretations — and such a term can cause major difficulties for the parties. Many lawyers would agree that ambiguous language is one of the top sources of trouble for contracting parties.

In litigation, creative trial counsel, exercising 20-20 hindsight, can be quite skilled at proposing alternative meanings to language that the drafters probably thought was crystal clear.

4.8.2 Two examples of ambiguous contract provisions

Here's a simple example of ambiguity from a hypothetical lease agreement: Tenant will completely vacate the Premises no later than 12 midnight on December 15; Tenant's failure to do so will be a material breach of this Agreement.

Now suppose that, at 10:00 a.m. on December 15, Tenant is still occupying the Premises.

QUESTION: Does Tenant still have 14 hours left in which to finish moving out? Or is Tenant already in material breach?

* * * 

And then: What if Landlord had re-leased the premises to a new tenant with December 15 as the agreed move-in date?

Now for a real-world example: In the Offshore Drilling v. Gulf Copper case, the owner of an off-shore drilling rig and a maintenance contractor disputed whether the contractor had had “control” of the rig at the time that the rig was damaged by fire and thus whether the contractor was contractually obligated to indemnify the owner. The term control is vague — vagueness can be thought of as a type of ambiguity, as discussed below — and so the parties had to litigate the meaning of the term. See Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., 604 F.3d 221 (5th Cir. 2010) (affirming summary judgment in relevant part).

4.8.3 Benefits of unambiguous contract terms

Spotting and fixing ambiguities in a contract before signature should be a prime goal of all contract drafters and reviewers. Unambiguous provisions are generally a Good Thing because:

  • Unambiguous language tends not to lead to disputes between the parties in the first place — although that certainly isn't a universal rule.
  • If a dispute does arise over an unambiguous provision, the judge will often decide the case quickly, e.g., on a motion to dismiss on the pleadings or a motion for summary judgment. That's because (in the U.S.) interpretation of an unambiguous contract term is generally a question of law for the court.

Ambiguities aren't necessarily fatal, because the law has rules for resolving them, as discussed below. But when a contract term is ambiguous, an expensive- and time-consuming trial is likely to be needed to determine just what the parties had in mind. To borrow a phrase from a former student (in a different context): "That's a conversation I don't want to have."

4.8.4 A brief review of contract interpretation

Here's a quick recap of some basic principles of contract interpretation:

  1. A contract provision is unambiguous if it can be given a certain or definite meaning. (A contract provision isn't necessarily ambiguous just because the parties disagree on how to interpret it.)
  2. In a lawsuit, the judge normally makes the first pass at determining the meaning of a disputed provision; if the provision is unambiguous, then the judge will declare the provision's meaning.
  3. The judge will try to figure out what the parties had in mind, as expressed in the contract language.
  4. Context matters: The judge will try to read contract provisions in a way that "harmonizes" them; at a minimum, the judge will try not to read Provision A in a way that would make Provision B meaningless.
  5. The judge will give contract terms their plain, common, or generally accepted meaning — unless, that is, the contract shows that the parties used particular terms in a technical or different sense.
  6. If all else fails — if the usual contract-interpretation principles don't produce a definitive answer for what a contract provision means — then the judge will rule that provision is ambiguous; in that situation, the case will have to be tried, and the trier of fact (usually, the jury) will decide what the parties seem to have had in mind — often by looking to extrinsic evidence under the parol evidence rule.

See, e.g., Plains Explor. & Prod. Co. v. Torch Energy Advisors Inc., 473 S.W.3d 296, 305 (Tex. 2015); Coker v. Coker, 650 S.W.2d 391, 393 (Tex. 1983).

Courts often look to specific rules of interpretation such as:

  • Specific terms normally take precedence over the general.
  • A term stated earlier in a contract is given priority over later terms.
  • Under the principle of ejusdem generis, "if a law refers to automobiles, trucks, tractors, motorcycles, and other motor-powered vehicles, a court might use ejusdem generis to hold that such vehicles would not include airplanes, because the list included only land-based transportation." Nolo’s Plain-English Law Dictionary (law.cornell.edu).
  • The rule of the last antecedent: A federal criminal statute included a mandatory ten-year minimum sentence in cases where the defendant had previously been convicted of "aggravated sexual abuse, sexual abuse, or abusive sexual conduct involving a minor or ward.” The Supreme Court held that the minor-or-ward qualifier applied only to abusive sexual conduct, not to sexual abuse — as a result, a defendant was subject to the ten-year mandatory minimum sentence for sexual abuse against an adult. Lockhart v. United States, 577 U.S. xxx, No. 14–8358, slip op. at part II-A (U.S. March 1, 2016).
  • But see the series-qualifier principle: Dissenting in Lockhart, Justice Kagan argued: "Imagine a friend told you that she hoped to meet 'an actor, director, or producer involved with the new Star Wars movie.' You would know immediately that she wanted to meet an actor from the Star Wars cast—not an actor in, for example, the latest Zoolander." Id. (Kagan, J., dissenting).
  • Other things being equal, under the (Read:) Contra proferentem, § 4.38 principle, ambiguous provisions will often be construed against the drafting party.

See generally, e.g., Vincent R. Martorana, A Guide to Contract Interpretation (ACC.com 2014); James J. Sienicki and Mike Yates, Contract interpretation: how courts resolve ambiguities in contract documents (Lexology.com 2012: https://goo.gl/ZGkwJu).

4.8.5 Vagueness is a type of ambiguity

As one type of ambiguity, a term is vague if its precise meaning is uncertain. As a silly example, consider this provision in a contract for a home caregiver: Nurse will visit Patient's house each day, check her vital signs, and give her cat food.

The italicized sentence above is ambiguous, in that conceivably it might take on any of three meanings:

  1. Nurse is to put a bowl of food down for Patient's cat each day.
  2. Nurse is to bring cat food with her when s/he visits Patient.
  3. Nurse is to feed cat food to Patient. (OK, this one is might not be plausible.)

The italicized sentence above might also be vague if it turned out that Patient had more than one cat.

And the first two meanings listed above are vague in another sense as well: The term cat food encompasses wet food, dry food, etc.

4.8.6 What should you do about ambiguity?

What do you do if you spot an ambiguity in a draft contract draft? The answer might depend on the circumstances:

  • If your side drafted the ambiguous language, then you'll definitely want to fix the ambiguity: under the doctrine of (Read:) Contra proferentem, § 4.38, a court might resolve the ambiguity in favor of the other side.
  • On the other hand, if the other side drafted the ambiguous language, then you might not want to say anything about it, in the hope that contra proferentem will result in an interpretation favorable to your client.
  • BUT: If you notice but fail to point out an ambiguity created by the other side's drafter, the other side might argue that you waived application of contra proferentem by "laying behind the log."

The safest approach might be some combination of:

  • Ask the partner or the client — and document that you did so; and/or
  • A.T.A.R.I. - Avoid the Argument: Rewrite It.

4.8.7 Optional further reading about ambiguity

Some amusing examples of ambiguity can be read at the Wikipedia article on Syntactic ambiguity, at https://goo.gl/6zmrH5

See also numerous categorized case citations by KPMG in-house attorney Vince Martorana, at https://goo.gl/kQax4T.

4.8.8 Mnemonic

  • A.T.A.R.I. - Avoid the Argument: Rewrite It (where "it" is a potentially-ambiguous term)

4.8.9 Possible quiz and exam questions

Contra proferentem rule

FACTS:

  • You represent Buyer in negotiating a long-term master purchase agreement with Seller.
  • You draft a price-increase clause that limits Seller's permissible price increases to no more than the increase in CPI (and no more than once a year as well).
  • A year later, Seller says it is increasing its price by the percentage stated in a particular CPI published by the U.S. Government for the specific industry in which Seller and Buyer operate. You hadn't known there even was such a thing.
  • Your client Buyer angrily tells you that Seller's price increase must be limited to the (much-lower) increase in the "regular" CPI, namely CPI-U, US City Average, All Items, 1982–1984=100.

QUESTION: On these facts, how might a court rule on Buyer's claim that Seller's price increases must be limited to the increase in CPI-U and not to the increase in the special CPI?

A: Chances are that the court would rule in favor of Seller, because you (on behalf of Buyer) drafted the price-increase provision.

4.9 (Black letter:) Amendments in writing

4.9.1 (BL) The "Cardozo Rule": Writing requirements are ineffective

A U.S. court might decline to enforce an amendments- or waivers-in-writing provision — although the issue isn't free from doubt. The rationale for non-enforcement would typically be that parties are always free to orally agree to amend or waive the writing requirement itself. As then-Judge (later Justice) Cardozo said in a 1919 New York case:

Those who make a contract, may unmake it. The clause which forbids a change may be changed like any other. The prohibition of oral waiver may itself be waived. Every such agreement is ended by the new one which contradicts it … What is excluded by one act, is restored by another. You may put it out by the door, it is back through the window. Whenever two men contract, no limitation self-imposed can destroy their power to contract again.

Beatty v Gug­gen­heim Ex­plor­a­tion Co., 225 N.Y. 380, 387-88 (1919) (Cardozo, J.), quoted in Israel v. Chabra, 12 N.Y.3d 158, 163-64 (2009) (emphasis added, internal citations and quotation marks omitted).

On the other hand, see DeValk Lincoln Mercury, Inc. v. Ford Motor Co., 811 F.2d 326, 334 & n.2 (7th Cir. 1987): The Seventh Circuit, looking to Michigan precedents, upheld a summary judgment giving effect to an "antiwaiver" clause in Ford's dealership agreement.

For a dated-but-useful survey of relevant case law in several jurisdictions, see Wisconsin Knife Works v. Nat'l Metal Crafters, 781 F. 2d 1280, 1288 (7th Cir. 1986) (Posner, J., on a panel with Easterbrook, J.) (reversing and remanding judgment on jury verdict that contract had been orally modified).

4.9.2 (BL) But an amendments-in-writing requirement might be validated by statute

A statute might validate a contract's statement that the contract can be amended only in writing. For example:

• In contracts for the sales of goods, Uniform Commercial Code § 2-209(2) provides that "[a] signed agreement which [sic] excludes modification or rescission except by a signed writing cannot be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party." (Emphasis added.)

• On the other hand, under subdivision (4) of the same UCC section, a contract provision can be waived without a writing, which is why many contracts also state that waivers likewise must be in writing.

• In New York, General Obligations Law § 15-301(1) provides that '[a] written agreement or other written instrument which contains a provision to the effect that it cannot be changed orally, cannot be changed by an executory agreement unless such executory agreement is in writing and signed by the party against whom enforcement of the change is sought or by his agent.' For a discussion of the history of that statute, see the opinion in of the Court of Appeals of New York (that state's highest court) in Israel v. Chabra, 12 N.Y.3d at 163-67 (2009) (on certification to the Second Circuit).

In a 2014 opinion, though, the Second Circuit explained two judge-made exceptions to that New York statute:

First, under the principle of equitable estoppel, if a party to a written agreement has induced another's significant and substantial reliance upon an oral modification, then the party may be estopped from invoking the bar on oral modification.

Second, where there is partial performance of the oral modification sought to be enforced, the requirement of a writing may be avoided.

To invoke equitable estoppel, the parties' conduct must not otherwise be compatible with the agreement as written

and, for partial performance, the parties' conduct must be unequivocally referable to the oral modification.

Aircraft Services Resales LLC v. Oceanic Capital Co., No. 13-3738-cv, slip op. at 3-4 (2d Cir. Oct. 9, 2014) (summary order affirming district court ruling that both listed exceptions applied) (extra paragraphing added), citing Rose v. Spa Realty Assocs., 42 N.Y.2d 338, 343-44 (1977).

4.9.3 (Extra:) The UK Supreme Court has rejected the Cardozo Rule

In May 2018, the UK Supreme Court expressly rejected the Cardozo Rule, concluding that “the law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation.” Rock Advert. Ltd v MWB Bus. Exch. Ctrs. Ltd, [2018] UKSC 24 ¶ 10. The judgment's author, Lord Sumpton, branded as “a fallacy” the notion that the importance of party autonomy precludes parties from “validly bind[ing] themselves as to the man­ner in which future chan­ges in their legal relations are to be achieved”; he noted that:

  • by entering into a contract in the first place, the parties are already voluntarily limiting their future autonomy to a certain extent; and
  • “There are many cases in which a particular form of agreement is prescribed by statute …. There is no principled reason why the parties should not adopt the same principle by agreement.”

Id. at ¶ 11.

The judge explained why no-oral-variation clauses can make business sense:

There are at least three reasons for including such clauses.

The first is that it prevents attempts to undermine written agreements by informal means, a possibility which is open to abuse, for example in raising defences to summary judgment.

Secondly, in circumstances where oral discussions can easily give rise to misunderstandings and crossed purposes, it avoids disputes not just about whe­ther a variation was intended but also about its exact terms.

Thirdly, a measure of formality in recording variations makes it easier for corporations to police internal rules restricting the authority to agree them.

These are all legitimate commercial reasons ….  I make these points be­cause the law of contract does not normally obstruct the legitimate intentions of businessmen [sic], except for overriding reasons of public policy. Yet there is no mischief in No Oral Modification clauses, nor do they frustrate or contravene any policy of the law.

Id. at ¶ 12 (emphasis and extra paragraphing added).

For additional commentary on the Rock Advertising case, see Glenn D. West, Cognitive Dissonance in the Common Law of Contracts: Oral Mod­i­fi­ca­tions to Written Agreements that Purport to Invalidate Oral Modi­fi­ca­tions  (May 29, 2018).

4.9.4 (Extra:) So: Choose English law to govern no-oral-variations clauses?

A bold American contract drafter therefore might want to try to take advantage of the Rock Advertising holding by using a targeted, single-clause choice of law. After all: Choice-of-law clauses are widely used and readily enforced in the United States (unless the choice of law offends some public policy of the forum state), as discussed in § 4.64.

It might seem strange for a contract to specify different choices of law to gov­ern dif­fer­ent clauses of the contract.  But conceptually this isn't unheard of:

• In the 1988 update to the Restatement (Second) of Conflicts of Laws, comment i to § 187 states in part that “the parties may choose to have different issues involving their con­tract governed by the local law of dif­fer­ent states.”  The comment cites Kronovet v. Lipchin, 288 Md. 30, 415 A.2d 1096 (1980), in which loan docu­ments for a real-estate project ad­opt­ed local Maryland law for interest- and usury issues but New York law for others.

• In its 2018 Akorn decision, the Delaware chancery court ob­served: “At­ten­t­ive readers will have noted that none of the parties to the Mer­ger Agree­ment is a Delaware entity. … The parties nevertheless chose Delaware law to gov­ern the Mer­ger Agreement (excluding internal affairs matters gov­erned by Lou­i­si­a­na law) and selected the courts of this state as their ex­clu­sive forum for litigation.” Akorn, Inc. v. Fresenius Kabi AG, No. 2018–0300–JTL, slip op. at 11 n.14 (Del. Ch. Oct. 1), aff'd, No. 53,2018 (Del. Dec. 7, 2018).

• The EU's Rome I Regulation on contractual obligations states in Article 3.1 that “… By their choice the parties can select the law applicable to the whole or to part only of the contract.”

• An international contract might specify that it is to be governed by the laws of, say, Brazil, but that any arbitration is to be “seated” in England, which might well mean that the arbitration pro­ceed­ings would be gov­erned by Eng­lish law.  That was precisely the holding of an English court in Sul­america CIA Nacional De Seg­ur­os SA & Ors v Enesa Engenharia SA & Ors, [2012] EWCA Civ 638, dis­cussed in Sherina Petit and Marion Edge, The gov­ern­ing law of the arb­i­tra­tion agree­ment Q&A, in Norton Rose Ful­bright, Int'l Arbitr. Rpt. 2014 – issue 2.  I also seem to re­member seeing (but can't lay my hands on) at least one contract that ex­press­ly speci­fied one country's law to govern the contract but another country's law to govern arbitration proceedings.

• Domestic contracts often specify that the substantive law of a particular jur­is­dic­tion will apply — which implicitly leaves in place the procedural law of the for­um state — or they might specify a jurisdiction to provide both sub­stantive and procedural law, although a court might not honor a choice of procedural law.  See generally (the extremely-useful) John F. Coyle, The Canons of Con­struc­tion for Choice of Law Clauses, 92 Wash. L. Rev. 631, 648-55 (2017). When a contract requires that amendments and waivers be in wri­ting, it like­wise amounts to a choice of procedural rules.

4.9.5 (Extra:) Could a clause-specific choice of UK law be disregarded?

A clause-specific choice of law is unlikely to work when the clause in question offends a public policy of the forum state.  See the examples in the com­ment­ary to (Read:) Governing law, § 4.64. As the Rock Advertising court notes, however, it's not as though a no-oral-variation clause would offend public policy.

One more possible concern:  What if neither the parties, nor the subject of the contract, had anything to do with England — would that dissuade a U.S. court from applying English law?  Probably not: The parties' desire for a neutral, well-established law such as that of New York, Delaware, or England would likely be honored as an “other reasonable basis for the parties' choice.” Restatement (Second) of Con­flicts of Laws, § 187(2)(a) (1971).

Compare the related subject of choice of forum, where the Supreme Court said:

Not surprisingly, foreign businessmen prefer, as do we, to have disputes resolved in their own courts, but if that choice is not available, then in a neutral forum with expertise in the subject matter. Plainly, the courts of Eng­land meet the standards of neutrality and long experience in admiralty litiga­tion. The choice of that forum was made in an arm's-length negotiation by ex­perienced and sophisticated businessmen, and absent some com­pel­ling and countervailing reason it should be honored by the parties and en­forced by the courts.”

The Bremen v. Zapata Off-Shore Co., 407 US 1, 11-12 (1972).  Similar considerations would seem to favor allowing parties to choose a neutral, established law to govern their contract, even when they have no other connection to the jurisdiction of that law.

4.9.6 (Extra:) Proving oral waiver of the choice of English law could be tricky

Suppose that a contract chose English law for the amendments- and waivers-in-writing clauses. Even so, a contracting party in the U.S., following Beatty, might still try to claim that the parties had orally agreed to amend or waive, not just the particular pro­vision in dispute, and not just the writing requirement, but also the English choice of law.

But now try to imagine the opening statement at trial: Ladies and gen­tle­men of the jury, the landlord and my client, the tenant, orally agreed to three things: (1) That the landlord would reduce the monthly rent; (2) to waive the lease's no-oral-modifications clause; and (3) to waive the lease's choice of English law for that requirement.” Many judges and jurors might be understandably skeptical of such an argument.

4.10 (Optional:) And/Or Definition

4.10.1 Why use "and/or"?

And/or helps remedy a deficiency in the English language, namely the lack of an inclusive-or term. (Mathematicians and computer programmers use XOR for that purpose.)

4.10.2 Alternatives

Ken Adams, author of A Manual of Style for Contract Drafting, helpfully suggests that, when dealing with a list of three or more items, use "one or more of A, B, and C." That might well work in many cases. See Kenneth A. Adams, "A, B, and/or C", Dec. 2, 2012, at http://goo.gl/m9U3p (adamsdrafting.com).

4.10.3 Is "and/or" even proper English?

Opinions vary (to put it mildly) as to whether and/or is "proper" English. For example, one appellate judge excoriated the use of and/or as "indolent." That judge — evidently not a slave to brevity — proclaimed that instead a drafter "could express a series of items as, A, B, C, and D together, or any combination together, or any one of them alone." See Carley Foundry, Inc. v. CBIZ BVKT, LLC, No. 62-CV-08-9791, final paragraph (Minn. Ct. App., Apr. 6, 2010) (italics added). Um, sure, your honor. See also Ted Tjaden, Do Not Use "and/or" in Legal Writing, Jul. 27, 2011, at http://goo.gl/7d74L (slaw.ca). Granted, it's possible to use and/or inappropriately. See, e.g., the examples collected by Wayne Scheiss, director of the legal-writing program at the University of Texas School of Law, in In the Land of Andorians (Jan. 2013). But let's face it: Trying to ban and/or might be an exercise in frustration, because many drafters will use the term anyway. And properly used, the term and/or can be a serviceable shorthand expression. So the better practice might well be just to define the term and be done with it.

4.11 (Read:) "Any of A, B, and C"

The term "any of A, B, and C" arguably means exactly one of the listed items. If that's in fact what's meant, consider saying instead, "any one of A, B, or C."

Contrast that with "one or more of A, B, and C."

4.12 (Read:) "Any transaction or relationship resulting from this Agreement"

A contract provision — for example, a forum-selection provision, arbitration provision, or governing-law provision — might state that the provision applies, not only to the contract itself, but also to "any transaction or relationship resulting from this Agreement." The quoted phrase is informed in part by an arbitration provision seen in cases decided by the Fifth and Eleventh Circuits respectively. The provision in question stated that "[a]ll disputes, claims, or controversies arising from or relating to this Agreement or the relationships which result from this Agreement … shall be resolved by binding arbitration." See Sherer v. Green Tree Servicing LLC, 548 F.3d 379, 382-83 (5th Cir. 2008) (reversing denial of motion to compel arbitration), citing Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1310 (11th Cir. 2005) (same).

4.13 (Read:) Approval of requests automatically

Some contracts include automatic-approval language, along the general lines of, "If we send you a request to approve something, and we don't hear from you to the contrary within X days, then you'll be deemed to have agreed to the request." Many parties, though, are uncomfortable with that concept.

4.14 (Read:) Arbitration

Arbitration of disputes is required in some commercial contracts and many consumer- or employee-facing contracts. Arbitration can be both faster and less expensive than litigation — if, that is, the arbitral tribunal manages the case well. An arbitration can also remain confidential, which won't necessarily be the case for litigation in court.

(BL) Below are some key things to know about arbitration. (For more information, see the Common Draft Arbitration provisions and commentary.)

  • Arbitration is binding; mediation generally is nonbinding.
  • A three-arbitrator panel is often more than three times as costly as using a single arbitrator.
  • Arbitration proceedings can be kept confidential if the parties so agree.
  • The American Arbitration Association's Commercial Arbitration Rules are quite workable, although there are other arbitration providers with their own rules. (Disclosure: The author serves as an arbitrator on AAA's commercial panel.)
  • An arbitrator might have the power to decide a case as she sees fit, in accordance with her own notions of fairness, without staying within the strict bounds of the contract or the law, unless the contract or the arbitration rules say otherwise.
  • Arbitration is especially popular in international contracts, because, by treaty, enforcement of foreign arbitration awards is very often easier than enforcement of foreign court judgments.
  • In international contracts, the language of the arbitration should be specified, including the language for any notices. Otherwise, a party might receive a notice of an arbitration claim in, say, Chinese — precisely that happened in CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, 829 F.3d 1201 (10th Cir. 2016).

4.15 (Read:) Arising out of

In a 2014 insurance-coverage case, the Tenth Circuit observed that:

The language arising out of has been construed broadly. Couch on Insurance explains:

The phrase[] ["arising out of" is] generally considered to mean "flowing from" or "having its origin in." Accordingly, use of these phrases does not require a direct proximate causal connection but instead merely requires some causal relation or connection.

Courts have split on where "arising out of" falls on the causation scheme with some courts finding it equivalent to "but for" causation and others finding it somewhere between "but for" causation and proximate causation.

Higby Crane Service, LLC v. National Helium, LLC, 751 F.3d 1157, 1164 (10th Cir. 2014) (reversing and remanding summary judgment for plaintiffs) (extra paragraphing added, alteration marks by the court), quoting 7 Steven Plitt et al., Couch on Insurance § 101:52 (3d ed. 2005).

4.16 (Study:) Assignment-consent requirements

4.16.1 Legal background

Ordinarily, in U.S. law, most contracts (but not all) can be assigned freely, and their duties delegated, without the consent of the other party, if the contract doesn't specify otherwise, in the interest of promoting economic efficiency. See, e.g., Tina L. Stark, Negotiating and Drafting Contract Boilerplate ch. 3 (2003).

On the other hand, “personal services contracts” are generally not assignable. One commentator has noted that “[w]hat constitutes a ‘personal service contract' is relatively ill-defined in the case law; courts' specifications of this general standard include identification of trust or confidence in the other party; reliance upon special skill, knowledge, expertise, unique talent, or qualifications; and, sometimes, credit.” Jared G. Kramer, When Should Contracts be Assignable? An Economic Analysis, at 6-7 (Harvard.edu 2004) (reviewing case law and statutory provisions; footnotes and internal quotation marks omitted). As an example, it's probably safe to predict that if country-music legend Willie Nelson were to sign a contract to play a concert at the Houston Livestock Show and Rodeo, a court would not countenance Nelson's assigning the contract and delegating his performance obligation to rapper Kanye West.

4.16.2 The non-assignability of IP licenses

Under U.S. law, licenses of intellectual property are an exception to the general rule of assignability — an IP licensee may not assign its license rights, nor delegate its license obligations, without the licensor's consent, even when the license agreement is silent on the subject. See, e.g.:

For further discussion of the assignability of IP licenses, see this article, posted on the Web site of the Licensing Executives Society, by Finnegan Henderson attorneys John Paul, Brian Kacedon, and Douglas W. Meier.

The non-assignability of IP licenses is a good deal for IP owners and can put IP licensees in something of a bind. EXAMPLE: Imagine that you're a customer that will be taking a license to intellectual property, for example computer software, from a supplier. In the U.S., you can't assign the license without the supplier's consent — and the supplier might want to be the sole source of licenses, so that no one else can make money selling licenses.

For real-world examples of a software vendor controlling the supply of its software licenses in this way, see, for example:

  • Vernor v. Autodesk, Inc., 621 F.3d 1102 (9th Cir. 2010) (vacating summary judgment granting declaratory judgment). In that case, Vernor bought used copies of Autodesk's AutoCad software from Autodesk's direct customers and then resold those copies on eBay. The appeals court held that Autodesk did not sell copies of its software, but licensed them, and therefore Vernor's actions were prohibited by copyright law, because the first-sale doctrine did not apply;
  • The Sixth Circuit's Cincom case, discussed above, in which a software supplier successfully sued a customer and, in effect, forced the customer to re-buy the customer's software license after the customer did a corporate reorganization;
  • Adobe Systems Inc. v. Hoops Enterprise LLC, No. C 10 2769 (N.D. Cal. Feb. 1, 2012), in which the court granted partial summary judgment dismissing the defendants' counterclaim of copyright misuse.

4.16.3 Motives for assignment-consent requirements

In some situations, even though the law would normally allow assignment of a contract, one party to the contract might want its opposite number not to be free to assign it. Contracts often include language to this effect. Such language can be great for a party that has the right to consent to another party's assignment — and very not-great for a party that must obtain consent to such an assignment.

For example: You're a supplier. You're talking to a potential customer about a contract to sell them your stuff. The customer will often want you to agree not to assign the contract to anyone without their consent. The customer's rationale is basically this: We don't care if assignability is good for commerce in general: We want to decide who we do business with. (Yes, grammatically this gets the who-whom bit wrong.)

And customers sometime demand assignment-consent restrictions "Just Because." They're especially likely to do so if they went to some trouble picking out a supplier, for example by going through a request for proposal (RFP) process.

4.16.4 Problem 1: Strategic veto power

In a long-term contractual relationship, a customer's desire to restrict assignment can be dangerous for a provider. Suppose that a provider were required to get a customer's consent before the provider assigned a contract between them. That could give the customer a de facto veto over the provider's future strategic decisions, such as spinning off an unincorporated division, selling off a product line, or reshuffling its assets among different affiliates in its corporate "family."

EXAMPLE: In one high-profile, politically-sensitive case involving a Dubai company, the Port of New York and New Jersey was able to extract a $10 million consent fee, plus a commitment to invest $40 million in improvements to terminal operations, in return for its consent to an assignment of a lease agreement, as reported in the New York Times.

EXAMPLE: A woman dying of cancer arranged to leave her ownership interest in a real-estate investment to a trust for the benefit of her long-time companion. A court held that this was ineffective because of an anti-assignment clause in the investment contract documents. See Lee Graham Shopping Center, LLC v. Estate of Diane Z. Kirsch, 777 F.3d 678 (4th Cir. 2015) (affirming summary judgment).

4.16.5 Problem 2: Burden

Obtaining assignment consents could be burdensome: In one case involving assignment consents, the assigning party wanted to sell a product line but had to seek consent from some 25 different companies. At a minimum, this would be time-consuming and could easily delay closing the deal; at worst, 25 different companies could each try to extract a price for their consent — possibly with each successive company demanding more than the previous one. See MDS (Canada) Inc. v. Rad Source Tech., Inc., 720 F.3d 833, 850 (11th Cir. 2013) (affirming district court's judgment in part and certifying question of sublicense-as-assignment to Florida supreme court), certified question answered in part, No. SC13-1215 (Fla. July 10, 2014).

4.16.6 Government contracts

Some government contracts, by law, cannot be assigned by the contractor. For example, a New York statute provides that, whenever a company enters into a contract with a state agency, the company cannot assign the contract without the agency's consent; if the contractor fails to obtain the consent, the agency "shall revoke and annul such contract," and the contractor forfeits all payments except that needed to pay its employees. See N.Y. State Fin. L. art. 9, § 138. That, of course, would give the state agency considerable leverage — which New York state agencies apparently can be unabashed about wielding, as seen in the Dubai deal discussed above.

4.16.7 Pledges

Even without an explicit carve-out, courts have distinguished between assigning an agreement in its entirety and assigning certain rights and benefits under the agreement. See, e.g,. Bioscience West, Inc. v. Gulfstream Prop. & Cas. Ins. Co., 185 So.3d 638 (Fla. App. 2016): In that case, the appeals court held that an insurance policyowner had not assigned the insurance policy per se (which would have violated an assignment-consent requirement in the policy), but instead had merely assigned the right to payment for a particular loss that had occurred. See id. at 640-42. (I haven't researched whether a court would apply the same reasoning in a case that didn't involve an insurance policy; in many jurisdictions, insurance policies are construed strictly in favor of the policyholder and against the insurance carrier.)

4.16.8 Asset-transfer exceptions

A party might balk at an assignment-consent provision if that party might later spin off a division or a product line (or even sell the entire company) in a sale of business assets. That party might insist on an exception to the consent requirement for such transactions, so as not to give the other party a de facto veto over the assigning party's strategic destiny. A non-assigning party, though, might object to such an exception because it wants to control who it must do business with. The negotiation of that point might come down to a question of bargaining power and skill.

For example: Suppose that Alice and Bob are negotiating a contract between them. It'd be fairly standard for Bob to want to be able to assign the contract without Alice's consent if Bob were to do an asset disposition such as the sale of an unincorporated division or a specific product line. This could be crucial to Bob's company if the company wanted to retain control over its own strategic destiny. It also could keep Bob's assignee ("Betty") from having to re-buy and pay again for an IP license that the assigning party already paid for once.

In their contract negotiation, Bob might argue for one or more consent carve-outs along the following lines: We need to keep control of our strategic destiny. If we ever wanted to sell a product line or a division (or even the whole company) in an asset sale, we'd need to be able to assign this agreement as part of the deal. We don't want to have to worry about whether somebody at your company was going to get greedy and try to hold us up for a consent fee.

Alice, though, might respond in the negotiation with something like this: What if you decided to sell a product line or a division to one of our competitors? We need to retain control over that possibility. The only way for us to do that is to retain the absolute right to consent to any assignment you might make.

(It might not be necessary to give a party an absolute veto over an asset-transaction assignment; instead, the prospective assigning party might consider agreeing not to assign its assets without first consulting with the non-assigning party.)

4.16.9 Prohibit unreasonable withholding of consent?

Goal: Give the non-assigning party some skin in the game

Suppose that Alice and Bob have entered into a contract, and that the contract requires Bob to obtain Alice's consent before assigning the agreement to anyone else. Bob might try to negotiate a requirement that Alice must not unreasonably withhold, delay, or condition her consent. This would give Alice some "skin in the game": If the contract language didn't expressly require Alice to be reasonable in granting or withholding consent, then Alice might be tempted to drag her feet; that could cause delays, which in turn could scuttle Bob's proposed transaction, causing damage to Bob for which Alice might be held liable.

Of course, even an express reasonableness requirement might not be enough to keep Alice from dragging her feet, in the hope of extracting concessions from Bob or his assignee (see the discussion of the New York port lease agreement assignment). Still, a prohibition against unreasonably withholding consent should make Alice at least think twice about doing so, because of the potential threat that Bob might sue for damages for killing his deal.

How does the law treat "unreasonable" withholding of assignment consent?

Even if the agreement is silent as to unreasonable withholding of assignment consent, the law might have something to say about it:

• In the context of tenant assignment of leases, section 1995.260 of the California Civil Code provides that:

If a restriction on transfer of the tenant’s interest in a lease requires the landlord’s consent for transfer but provides no standard for giving or withholding consent, the restriction on transfer shall be construed to include an implied standard that the landlord’s consent may not be unreasonably withheld. …

Apropos of that statutory provision, a California appeals court held in 2008 that a contract provision allowing the landlord to withhold consent “for any reason or no reason” was not to be construed as including an unreasonably-withheld standard, saying that “the parties’ express agreement to a ‘sole discretion’ standard is permitted under legal standards existing before and after enactment of section 1995.260, as long as the provision is freely negotiated and not illegal.” Nevada Atlantic Corp. v. Wrec Lido Venture, LLC, No. G039825 (Cal. App. Dec. 8, 2008) (unpublished; reversing trial-court judgment that withholding of consent was unreasonable).

• In the Pacific First Bank case, in a lease agreement prohibited the tenant from assigning the agreement, including by operation of law, without the landlord's consent. The lease agreement also stated that the landlord would not unreasonably withhold its consent to an assignment of the lease to a subtenant that met certain qualifications. Notably, though, the lease agreement did not include a similar statement for other assignments. The Oregon supreme court held that ordinarily, the state's law would have required the landlord to act in good faith in deciding whether or not to consent to an assignment. But, the court said, the parties had implicitly agreed otherwise; therefore, the landlord did not have such a duty of good faith. See Pacific First Bank v. New Morgan Park Corp., 876 P.2d 761 (Or. 1994) (affirming court of appeals decision on different grounds, and reversing trial-court declaration that bank-tenant had not materially breached lease agreement).

• In a factually-messy Eleventh Circuit case, the court upheld a trial court's finding that the owner of a patent, which had exclusively licensed the patent to another party, had not acted unreasonably when it refused consent to an assignment by the licensee to a party that wanted to acquire the licensee's relevant product line. MDS (Canada) Inc. v. Rad Source Tech., Inc., 720 F.3d 833, 850 (11th Cir. July 1, 2013) (affirming district court's judgment in part and certifying question of sublicense-as-assignment to Florida supreme court).

• The Tennessee supreme court held that "where the parties have contracted to allow assignment of an agreement with the consent of the non-assigning party, and the agreement is silent regarding the anticipated standard of conduct in withholding consent, an implied covenant of good faith and fair dealing applies and requires the nonassigning party to act with good faith and in a commercially reasonable manner in deciding whether to consent to the assignment." Dick Broadcasting Co. v. Oak Ridge FM, Inc., 395 S.W.3d 653, 656-57 (Tenn. 2013) (affirming vacation of summary judgment and remand to district court).

• Likewise, the Alabama supreme court alluded to such a possibility in the Shoney's case. The contract in suit specifically gave Shoney's the right, in its sole discretion, to consent to any proposed assignment or sublease. The supreme court held that this express language trumped a rule that had been laid down in prior case law, namely that a refusal to consent is to be judged by a reasonableness standard under an implied covenant of good faith. "Succinctly stated, under Alabama law 'sole discretion' means an absolute reservation of a right. It is not mitigated by an implied covenant of good faith and fair dealing in contracts because an unqualified reservation of a right in the sole discretion of one of the parties to a contract expresses the intent of the parties to be subject to terms that are inconsistent with any such implied covenant." Shoney's LLC v. MAC East, LLC, 27 So.3d 1216, 1220-21 (Ala. 2009) (on certification by Eleventh Circuit).

• State law also might impose a reasonableness requirement if a commercial- or residential lease agreement requires the landlord's consent before the tenant can assign the lease. I haven't researched this in any depth, but I did run across an unpublished California opinion and an old law review article, each collecting cases (the citations for which I seem to have misplaced).

4.16.10 Assignment without consent: Material breach?

Legal effect of a material-breach provision

If an assignment of an agreement without a required consent did constitute a material breach of the agreement, then the non-assigning party might have the right under the law to suspend its own performance; it might also have the contractual right to terminate the agreement for material breach. Some assignment-consent provisions therefore state explicitly that assignment without consent constitutes a material breach.

Business motivation 1: Leverage

To put the material-breach option into context, suppose that:

  • Alice and Bob are negotiating a contract.
  • Alice wants the contract to say that Bob must obtain Alice's prior written consent if he wants to assign the contract to someone else.
  • Alice also wants the contract to state that if Bob fails to obtain Alice's consent to assignment, then that will constitute a material breach of the contract.

In this situation, Alice probably wants the right not merely to seek damages, but also the right to terminate the agreement — or even rescind it, that is, unwind it — if Bob were to make an unauthorized assignment of the agreement. That prospect might give Alice a lot of leverage to demand money or other concessions from Bob or his would-be assignee.

Alice could get that right if the contract stated that Bob's assignment of the agreement without Alice's consent constitute a material breach.

(But giving the non-assigning party the right to terminate could help break an impasse about the assignment-consent issue.)

Business motivation 2: Greener pastures

A material-breach clause would also give Alice an excuse to scrap her contractual relationship with Bob and take up with another, more-lucrative party.

The desire to ditch an existing contractual relationship seems to have been at work in Hess Energy Inc. v. Lightning Oil Co., 276 F.3d 646, 649-51 (4th Cir. 2002) (reversing summary judgment). In that case:

  • The contract in suit was a natural-gas supply contract.
  • The customer buying the natural gas was acquired by a larger company, which became the customer's new parent company.
  • The new parent company took over some of the customer's contract-administration responsibilities, such as payment of the natural-gas vendor's invoices.
  • The vendor decided it wanted to sell its natural gas to someone else – at a higher price than it was getting under the contract with its existing customer.
  • The vendor therefore sent a notice of termination to the customer's new parent company; the alleged grounds for termination were that the customer had supposedly "assigned" the agreement to its new parent company, in violation of the contract's assignment-consent provision.

The Hess appeals court expressed considerable doubt that the customer had indeed assigned the contract. The court went on to say that, even if the customer had in fact assigned the contract, the resulting breach of the agreement would not have been a material breach, and therefore the vendor did not have the right to terminate the contract.

But what if it's later adjudged not to have been a material breach?

Suppose further that Alice doesn't include a material-breach clause in the assignment-consent provision of her contract with Bob. In that case, Alice might not be able to terminate the contract merely because Bob assigned the agreement without her consent. That in turn could mean that Alice would be stuck with a new contract partner. Alice's only remedy against Bob for assigning without his consent would presumably be money damages — and it might be difficult and expensive for Alice to establish, with evidence, the fact and amount of her damages.

Moreover, if Alice did give notice of termination for material breach, Alice's action might itself constitute an “own goal” breach of the contract. See, e.g., Hess Energy, 276 F.3d at 651; Automated Solutions Corp. v. Paragon Data Sys., Inc., 2006 Ohio 3492, 167 Ohio App.3d 685 (2006) (hardware company's wrongful termination of contract with software company caused hardware company to lose its contract right to distribute software company's product); cf. Southland Metals, Inc. v. American Castings, LLC, 800 F.3d 452 (8th Cir. 2015) (terminating party held liable for $3.8 million in damages for terminating for breach without allowing contractually-required cure period).

4.16.11 Assignment without consent: Void?

Suppose that Bob purports to assign his contract with Alice without her consent, in violation of a requirement in the contract. Is the assignment a nullity? Or instead is the assignment technically valid, but a breach of the agreement, for which Alice can recover her proved damages – if any? The law varies on this point.

• A court applying the so-called 'classical approach' might hold that an assignment was void if made without a required consent. See, e.g., Condo v. Connors, 266 P.3d 1110, 1117-18 (Colo. 2011).

• In contrast, a court applying the so-called “modern approach” (or one of its variations) might hold that such an unconsented assignment was a breach of the contract, for which damages might be available, but that the assignment per se was not void unless the contract said so, perhaps with requisite “magic words.” See id. at 1119 (following modern approach but declining to apply magic-words test on the facts of the case); cf. David Caron Chrysler Motors, LLC v. Goodhall's, Inc., 43 A.3d 164, 170-72 (Conn. 2012) (reviewing case law from numerous jurisdictions).

4.16.12 Assignment by operation of law?

Under applicable law, a merger might or might not constitute an "assignment"

The law seems to vary as to whether a merger or similar transaction effects an assignment of contracts by operation of law.

• In one case, the Delaware chancery court ruled, on summary judgment, that "mergers do not result in an assignment by operation of law of assets that began as property of the surviving entity and continued to be such after the merger." Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH 62 A.3d 62 (Del. Ch. 2013) (partially granting motion for summary judgment) (emphasis added).

• A California federal court, reviewing case law, noted the existence of variations in different states' laws on this point. The court held that the law governing the license agreement would control. See Netbula, Llc v. BindView Development Corp., 516 F. Supp.2d 1137, 1148-50 (N.D. Cal. 2007), where the court granted the defendants' motion for summary judgment dismissing the plaintiff's claim of copyright infringement. (Disclosure: I was vice president and general counsel of the defendant BindView during most of the relevant events and was a deposition witness in the lawsuit.)

• See generally a state-by-state survey by Jolisa Dobbs of the Thompson Knight law firm at https://www.tklaw.com/files/Publication/8d36e11d-b8c2-4eca-936c-dcf47edcec91/Presentation/PublicationAttachment/555e994e-8462-4b40-8e01-4bc60843de92/Keeping it Fast by Merging Around Consent to Assign.doc

Danger: Loss of valuable rights

If a merger or reorganization did constitute an unauthorized assignment, then the affected party might lose valuable rights. For example:

• A company that had licensed the use of an expensive computer program found itself liable to the vendor for $459,000 — i.e., the original price of the license — because the customer did an internal reorganization that resulted in a different corporate affiliate's using the software, without the vendor's consent. See Cincom Sys., Inc. v. Novelis Corp., 581 F.3d 431 (6th Cir. 2009). (DCT comment: That software vendor likely shot itself in the foot: it probably will never, ever make another sale to that customer.)

A bank lost roughly half of 50-year real-estate lease after it merged into its own wholly-owned subsidiary without the landlord's consent. See Pacific First Bank v. New Morgan Park Corp., 876 P.2d 761 (Ore. 1994).

Cf. ClubCorp, Inc. v. Pinehurst, LLC, C.A. No. 5120-VCP, slip op. at 6 (Del. Ch. Nov. 15, 2011) (denying motion for summary judgment; contract language was ambiguous as to whether party's right to indemnification had survived party's merger).

A stock sale alone would not effect an assignment

A Seventh Circuit opinion followed what seems to be the general (U.S.) rule that a mere change of control of a licensee corporation, through a transfer of the corporation's stock to a new owner, does not constitute an "assignment" of the license that would require consent of the licensor (assuming, that is, that the licensee remains a separately-functioning corporation):

… [T]he sale of all the stock in a closely held corporation whose principal asset is a contract does not violate a nonassignment clause even when the stock is sold to a person to whom, previously, the counterparty had explicitly refused that the contract be assigned.

If the counterparty to a contract with a corporation wishes to limit the persons to whom ownership or control of the corporation can be sold, it must do this through specific language to that effect in the contract (a "change of control" clause); a nonassignment clause will not suffice.

[T]he mere change of stock ownership would not nullify a non-assignable license, absent a change in control provision.

VDF Futureceuticals, Inc. v. Stiefel Labs., Inc., 792 F.3d 842, 846 (7th Cir. 2015) (Posner, J.) (extra paragraphing added, alteration marks by the court, internal quotation marks revised), quoting Kenneth Ayotte & Henry Hansmann, Legal Entities as Transferable Bundles of Contracts, 111 Mich. L. Rev. 715, 724 (2013), and Elaine D. Ziff, The Effect of Corporate Acquisitions on the Target Company’s License Rights, 57 Bus. Lawyer 767, 789 (2002).

4.17 (Skim:) Association membership rules

An association's rules might not count as a binding contract. From a Fifth Circuit case:

Dr. Barrash claims that because he was a member of the AANS, the association's bylaws formed a contract between them. The bylaws include the disciplinary procedures to be followed by the PCC. Dr. Barrash argues that the AANS breached the bylaws when it censured him because the PCC did not strictly comply with its own procedures. He claims that this breach caused damages because he lost income opportunities as an expert witness following publication of the censure.

To date, no Texas court has allowed a plaintiff to challenge a professional organization’s internal disciplinary procedures under a breach of contract theory.

Based on Texas precedent and the doctrine of judicial non-intervention, we find that Dr. Barrash has failed to state a plausible breach of contract claim.

Barrash v. American Association of Neurological Surgeons, Inc., 812 F.3d 416, (5th Cir. 2016) (affirming dismissal for failure to state a claim upon which relief can be granted) (citations omitted).

4.18 (Optional:) Assumption of the risk

From a Utah supreme court case:

It is a basic principle of contract law that parties are generally free to contract according to their desires in whatever terms they can agree upon. This includes assuming risks that third parties or external environmental circumstances will fail to conform to the parties‘ expectations.

And absent language in the contract to the contrary, a party who contracts knowing that governmental permission or license will be required ordinarily assumes the obligation of assuring that permission will be granted.

Mind & Motion Utah Investments, LLC, v. Celtic Bank Corp., 2016 UT 6, para. 35 (affirming summary judgment) (footnotes omitted) (citing, among other things, 14 James P. Nehf, Corbin on Contracts § 76.5 (2001)) (extra paragraphing added)

4.19 (Study:) Attorney fees

4.19.1 Legal background: The "American rule" vs. "loser pays"

In the United States, "[o]ur basic point of reference when considering the award of attorney's fees is the bedrock principle known as the American Rule: Each litigant pays his own attorney's fees, win or lose, unless a statute or contract provides otherwise." Baker Botts L.L.P. v. ASARCO LLC, 576 U.S. _, 135 S.Ct. 2158, 2164 (2015) (reversing award of attorney fees in bankruptcy-related case) (cleaned up; emphasis added).

Some view a prevailing-party allocation of attorney fees as fundamentally more fair: If you lose a case, presumably you were responsible for the case having to be litigated, so you should pay the attorney fees and expenses that you forced the prevailing party to spend. (The prevailing-party rule is sometimes called the "loser pays" rule, or the "everywhere but America" rule.)

Complicating the picture: Big companies sometimes regard litigation expenses as a cost of doing business, and once in a while, a big company might try to use its superior financial strength to bully a weaker counterparty. Smaller companies can try to offset that advantage by negotiating a prevailing-party clause.

Of course, a prevailing-party clause raises the stakes for a smaller litigant as well: If the smaller litigant were to lose the case, then the smaller litigant would be liable for the bigger litigant's attorney fees; those fees will often have been billed by a big, expensive law firm.

4.19.2 What constitutes a prevailing party?

Some courts have held that, if the putatively-winning side is not the "prevailing party" if it did not receive any monetary damages or equitable relief. See, e.g., Intercontinental Group Partnership v. KB Home Lone Star LP, 295 S.W.3d 650 (Tex. 2009) (5-4 reversal of $66,000 attorney fees award to plaintiff that had received a zero-dollar damages award and no declaratory or other equitable relief).

Some commentators have suggested that drafters should specify what they mean by "prevailing party," but my guess is that most will not want to do so.

4.19.3 The "Texas rule": Only a successful contract enforcer can recover fees …

If a party negotiating a contract under Texas law thinks it might be more likely to be the defendant in a dispute than the plaintiff, then that party might want to affirmatively include a "pay your own lawyer" provision in the contract. That's because in Texas, absent an agreement otherwise, a party that successfully enforces a claim against an individual or corporation on an oral or written contract — but not a party that successfully defends against an enforcement action — is entitled to recover attorney fees. See Tex. Civ. Prac. & Rem. Code § 38.001.

Courts have held that under section 38.001, attorney fees are recoverable only from an individual or corporation — and not from an LLC. See Hoffman v. L&M Arts, No. 3:10-CV-0953-D, slip op. at part III-C (N.D. Tex. Mar. 6, 2015) (citing cases).

In 2015, a bill to change that died in committee in the Texas Legislature. See Tate Hemingson, Recovery of attorney fees under Civil Practice & Remedies Code Section 38.001 (Strasburger.com 2015).

4.19.4 The California rule: It's all "prevailing party"

California Civil Code § 1717 provides, in essence, that any one-way attorney fees provision (as is sometimes seen in consumer-facing contract forms) is to be treated as a prevailing-party provision, and states that attorney fees under the section cannot be waived.

To like effect are Fla. Stat. § 57.105(7) and Mont. Code Ann. 28-3-704.

4.19.5 Other possible attorney-fee provisions

Drafters could consider limiting eligibility for attorney-fee awards to:

  • any party that succeeds in enforcing one or more rights under the Agreement;
  • a specified party if it is the prevailing party (but not the other party even if it prevails);
  • neither party — that is, each party will bear its own attorney fees and expenses.

4.19.6 (Extra:) Even one-sided attorney-fee clauses might well be enforced

Some contracts contain unilateral attorneys' fee clauses; for example, a real-estate lease agreement might state that the landlord can recover its attorney fees if it has to sue the tenant, while remaining silent as to whether the tenant can ever recover its attorney fees. (Under the 'American rule,' that would normally mean that the tenant could not recover, even if it were the prevailing party in a suit brought by the landlord — except in California, as noted above.)

Such unilateral clauses might well be enforceable. See, e.g., Allied Indus. Scrap, Inc., v. OmniSource Corp., 776 F.3d 452 (6th Cir. 2015) (reversing district court's denial of attorney fees), discussing Wilborn v. Bank One Corp., 906 N.E.2d 396 (Ohio 2009) (affirming dismissal of borrowers' lawsuit against lenders claiming that unilateral attorneys' fee clause in residential mortgage loan agreement form was void as contrary to public policy).

4.20 (Skim:) Audits

4.20.1 Why audit clauses can be useful: A real-world example

The nuclear Navy, in which the author served, has a saying: You get what you inspect, not what you expect. This saying can be equally true in the world of contract relationships: Mistakes can happen — and sometimes, so can creative accounting, stonewalling, and even outright fraud.

Here's a real-world situation in which an audit provision in a contract came in handy for the would-be auditing party:

  • A Saudi company signed a consignment agreement with a Florida company. Under that agreement, the Florida company would sell what was expected to be around $500 million worth of aircraft parts.
  • The parties apparently didn't have any procedure in place for confirming just what parts the Saudi company had shipped to the Florida company to be sold off. (The court's opinion suggests that the Florida company might have used "creative" accounting techniques in that regard.)
  • The Saudi company tried to get discovery to find out just how much the Florida company had really sold.
  • The Florida company evidently stonewalled on producing its records.
  • The district court refused to order an accounting — this, even though the parties' contract included an audit provision.
  • The appellate court reversed and remanded, stating that the district court abused its discretion by refusing to order an accounting.

See Zaki Kulaibee Establishment v. McFliker, 771 F.3d 1301 (11th Cir. 2014).

4.20.2 Some things an audit might uncover

One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships." Craig L. Greene, Audit Those Vendors (2003). Greene lists a number of things that fraud examiners watch for, including, for example:

  • fictitious "shell entities" that submit faked invoices for payment;
  • cheating on:
    • shipments of goods (e.g., by short-shipping goods or sending the wrong ones) or
    • performance of services (e.g., by performing unnecessary services or by invoicing for services not performed);
  • billing at higher-than-agreed prices;
  • kickbacks and other forms of corruption;

and others. See id.

4.20.3 Who should be allowed to be an auditing party?

In some cases involving multiple parties to a contract, a recordkeeping party might want to defined Auditing Party to include only selected other parties.

A recordkeeping party might want the absolute right to veto the auditing party's choice of auditors, instead of having the right to give reasonable consent.

On the other hand, the auditing party might not trust the recordkeeping party to be reasonable in exercising that veto, and could be concerned that a dispute over that issue would be time-consuming and expensive.

An auditing party might want to add that consent is deemed given if the recordkeeping party doesn't object in writing within X days after receiving or refusing the auditing party's written proposal of an auditor.

Contract-negotiation consultant and author John Tracy suggests (in a LinkedIn discussion thread) that an auditing party should consider agreeing in advance that, if it wishes to audit the recordkeeping parties books and records, the auditing party will engage the outside CPA firm that regularly audits the recordkeeping party's books anyway. John says that this should reduce the cost of the audit and assauge the recordkeeping party's concerns about audit confidentiality; he also says that "the independent CPA will act independently rather than risk the loss of their license and accreditation and get sued for maipractice."

4.20.4 Audit times, locations, frequency, deadline

An audit might end up being at least somewhat burdensome and disruptive to the recordkeeping party; most recordkeeping parties will want to limit the auditing party's ability to initiate audits.

An audit request should be timely; otherwise, a creative counsel might try to argue that the party had the right to conduct an audit even when, for example, the underlying agreement had expired or been terminated. A would-be auditing party's counsel tried unsuccessfully to make such an argument in New England Carpenters Central Collection Agency v. Labonte Drywall Co., 795 F.3d 271 (1st Cir. 2015) (affirming district court's judgment after bench trial).

At some point, the recordkeeping party might want to be able to get rid of its records; also, it won't want to have to support an audit of (say) 20 years of past records.

4.21 (Read:) "Avoid" versus "reduce the chance"

It's probably not a bad idea to try to avoid using the word avoid (yes, I get the self-contradiction), because it could later be branded as a representation of some kind. Instead, consider reduce the chances of as a softer, less-committal alternative.

BEFORE: "… to avoid a significant risk of the Partnership or the Operating Partnership becoming taxable as a corporation …." (From the Enterprise Products Partners limited-partnership agreement, section 4.7(b).)

AFTER: "… to reduce the risk of the Partnership or the Operating Partnership becoming taxable as a corporation …."

4.22 (Skim:) Background checks

4.22.1 Business purpose of background checks

It's not uncommon for customers to want service providers to do background checks on the providers' key personnel. The goal is normally to identify people with criminal records or other indicia of potential trouble. As discussed below, this can be a sensitive topic, possibly with legal complications.

A customer might especially want (or need) for a supplier to have background checks run on the supplier's personnel, for example:

  • if the customer is a government contractor;
  • if the supplier will have access to the customer's confidential- or sensitive information;
  • if the supplier's personnel will "face" the customer's own customers or clients, that is, be seen or heard by them.

NOTE: It's entirely possible that, due to the nature of the industry (e.g., technology consulting services), the contractor might have already had background checks performed on its relevant people.

4.22.2 Caution: Obtaining consent of checked individuals might be advisable even if not legally mandatory

Parties conducting or commissioning background checks should be sure to check applicable law to see if any particular form of consent is required.

It might well be prudent to obtain consent to a background check even if the law doesn't require it. If the individual were to learn of an unconsented background check, his displeasure might go viral on social media, especially given today's heightened sensitivity to privacy concerns.

4.22.3 Caution: Credit-check issues under the Fair Credit Reporting Act

Credit checks can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act. One particular procedural requirement seems to come up in class-action lawsuits: Section 1681b(b)(2)(A) of the Act, which states that, with certain very-limited exceptions:

… a person may not procure a consumer report, or cause a consumer report to be procured, for employment purposes with respect to any consumer, unless–

  1. a clear and conspicuous disclosure has been made in writing to the consumer at any time before the report is procured or caused to be procured, in a document that consists solely of the disclosure, that a consumer report may be obtained for employment purposes; and

ii) the consumer has authorized in writing … the procurement of the report by that person.

(Emphasis and paragraphing added.) Hat tip: Ken Remson, Employers Hit With Background Check Lawsuits, May 20, 2014; see also Todd Lebowitz, Publix to Pay $6.8 Million Settlement over Noncompliant Background Check Forms (EmploymentClassActionReport.com Nov. 3, 2014).

In July 2015, the Chuck E. Cheese restaurant company settled a class-action lawsuit by employees who asserted that the company's background-check consent form did not comply with the FCRA's strict requirements. See, e.g., David M. Gettings, Timothy St. George and David N. Anthony, Chuck E. Cheese Settles Background Check Lawsuit For $1.75 Million (Mondaq.com).

4.22.4 Caution: Disclosure of medical test results might well require consent

"Physicians and other providers are often paid by employers to conduct drug tests, fitness-for-duty or return-to-work exams, or employment physicals for employees. In such circumstances, the physician may mistakenly assume that they may disclose the test and exam results to the employer without the patient’s authorization, but that is not correct." Kim C. Stanger, HIPAA: disclosing exam results to employers (Lexology.com 2015).

4.22.5 Caution: Restricting personnel assignments might be attacked as discriminatory

A blanket prohibition against using personnel with criminal records could be problematic: It might be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the U.S. See generally the EEOC general counsel's enforcement guidance published in April 2012.

The EEOC has filed lawsuits against employers who allegedly "violated Title VII of the Civil Rights Act by implementing and utilizing a criminal background policy that resulted in employees being fired and others being screened out for employment …." EEOC press release, June 11, 2013.

Companies should also be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use, as opposed to making accommodations of some sort.

4.22.6 Caution: State- or federal law might restrict employers' personnel decisions

In addition, some states might likewise restrict an employer's ability to rely on criminal background information in making employment-related decisions. Drafters should pay particular attention to the law in New York, Massachusetts, Illinois, and Pennsylvania (not necessarily an exhaustive list).

On a related note: "Bills pending in both houses of Congress would make it unlawful for most federal contractors to request a job applicant, whether orally or in writing, to disclose criminal history record information before the applicant has received a conditional offer of employment." Garen E. Dodge, Richard I. Greenberg, and Susan M. Corcoran, Proposed ‘Ban the Box’ Legislation Would Limit Criminal History Inquiries by Federal Contractors (JacksonLewis.com 2015).

For a list of states and cities with ban-the-box laws, see Michelle Natividad Rodriguez and Nayantara Mehta, Ban the Box: U.S. Cities, Counties, and States Adopt Fair Hiring Policies (NELP.com 2015).

4.22.7 Legal-compliance indemnity option

Suppose that Customer requires Provider to have background checks done on all Provider personnel who will be accessing Customer's premises. Then suppose that a Provider employee complains that the background check violated his rights under applicable law. The Provider employee might be tempted to sue Customer, not just Provider. In that situation, this provision would require Provider to protect Customer from the cost of defending and/or paying damages for such claims.

As with any indemnity obligation, drafters should consider whether the indemnifying party might be liable for unforeseeable damages as well as foreseeable damages; see § 4.68.4 for additional details.

4.22.8 Optional further reading

Consider checking the Wikipedia entry on background checks to get ideas for further research on this subject.

4.23 (Study:) Background of agreement, a.k.a. "recitals"

4.23.1 Style tip: Avoid "Witnesseth" and "Whereas" clauses

(Like all purely-style tips: (1) this one isn't worth making a big deal about if you're reviewing a draft prepared by The Other Side; and (2) if your supervising partner has a preference, then do it /that way.)/

Modern drafters avoid archaic "Witnesseth" and "Whereas" clauses, such as those seen in this real-estate purchase agreement. (Don't bother reading the text, just get a sense of how it looks.)

W I T N E S S E T H:

WHEREAS, Seller is the owner of a certain real property consisting of approximately 4.637± acres of land, together with all rights, (excepting for mineral rights as set forth below) , title and interests of Seller in and to any and all improvements and appurtenances exclusively belonging or pertaining thereto (the "Property") located at 10557 Wire Way, Dallas (the "City"), Dallas County, Texas, which Property is more particularly described on Exhibit A attached hereto and incorporated herein by reference; and

WHEREAS, contemporaneously with the execution of this Agreement, North by East Entertainment, Ltd., a Texas limited partnership ("North by East"), is entering into an agreement with RCI Entertainment (Northwest Highway), Inc., a Texas corporation ("RCI Entertainment"), a wholly owned subsidiary of Rick's Cabaret International, Inc., a Texas corporation ("Rick's") for the sale and purchase of the assets of the business more commonly known as "Platinum Club II" that operates from and at the Property ("Asset Purchase Agreement"); and

WHEREAS, subject to and simultaneously with the closing of the Asset Purchase Agreement, Seller will enter into a lease with RCI Entertainment, as Tenant, for the Property, dated to be effective as of the closing date, as defined in the Asset Purchase Agreement (the "Lease") attached hereto as Exhibit B and incorporated herein by reference; and

WHEREAS, subject to the closing of the Asset Purchase Agreement, the execution and acceptance by Seller of the Lease, and pursuant to the terms and provisions contained herein, Seller desires to sell and convey to Purchaser and Purchaser desires to purchase the Property.

NOW, THEREFORE, for and in consideration of the premises and mutual covenants and conditions contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

Instead, draft background recitals … in simple, plain English. As Warren Buffett says, in his preface to the SEC's Plain English Handbook:

When writing Berkshire Hathaway’s annual report, I pretend that I’m talking to my sisters. I have no trouble picturing them: Though highly intelligent, they are not experts in accounting or finance.

They will understand plain English, but jargon may puzzle them. My goal is simply to give them the in­form­a­tion I would wish them to supply me if our positions were reversed.

To succeed, I don’t need to be Shakespeare; I must, though, have a sincere desire to inform.

No siblings to write to? Borrow mine: Just begin with “Dear Doris and Bertie.”

U.S. Securities and Exchange Commission, Plain English Handbook at 2 (Aug. 1998) available at https://goo.gl/DZaFyT (sec.gov) (emphasis and extra paragraphing added).

4.23.2 Keep the background simple

The "Background" section of the contract should briefly explain to a future reader why the parties are entering into the contract, preferably in short, numbered paragraphs.

As a general proposition, the drafter should just tell the story: explain in simple terms — with short sentences and paragraphs — what the parties are doing, so as to help future readers get up to speed more quickly.

4.23.3 Example: The Verizon-Yahoo stock purchase agreement

The original "Recitals"

The following is from a highly-publicized stock purchase agreement in the tech industry:

RECITALS
1.0 Background
WHEREAS, concurrently with the execution and delivery of this Agreement, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement substantially in the form attached hereto as Exhibit A (the “Reorganization Agreement”), pursuant to which Seller and the Company will complete the Reorganization Transactions at or prior to the Closing; 1.1 Concurrently with the execution and delivery of this Agreement, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement, in substantially the form attached to this Agreement as Exhibit A (the “Re­org­an­i­za­tion Agreement”).

1.2 Under the Reorganization Agreement, Seller and the Company are to complete certain "Re­org­an­i­za­tion Transactions" at or prior to the Closing.
WHEREAS, concurrently with the execution and delivery of this Agreement, Excalibur IP, LLC, a Delaware limited liability company (“Excalibur”), and Seller are entering into an Amended and Restated Patent License Agreement substantially in the form attached hereto as Exhibit D (the “License Agreement”); 1.3 Also concurrently with the execution and delivery of this Agreement, Excalibur IP, LLC, a Delaware limited liability company (“Excalibur”), and Seller are entering into an Amended and Restated Patent License Agreement in substantially the form attached to this Agreement as Exhibit D (the “License Agreement”).

[The remainder of the text has been omitted.]

The recitals, rewritten as a "Background" section

The above original example is far from the worst you'll ever see. As shown above, though, it can be rewritten in a more-modern style, with:

  • the recitals retitled as a (numbered) "Background" section;
  • the "WHEREAS" terms deleted;
  • some of the sentences shortened; and
  • some of the "legalese" rephrased.

Take a look at the "redlined" version below to see the details. Strikethroughs indicate deletions; underlining indicates insertions. (Not all revisions are so marked.)

1.00 RECITALS BACKGROUND

1.01 WHEREAS, concurrently Concurrently with the execution and delivery of this Agreement, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement in substantially in the form attached hereto as Exhibit A (the “Reorganization Agreement”). pursuant to which Under the Reorganization Agreement, Seller and the Company will are to complete the Reorganization Transactions at or prior to the Closing.

1.02 WHEREAS, concurrently Also concurrently with the execution and delivery of this Agreement, Excalibur IP, LLC, a Delaware limited liability company (“Excalibur”), and Seller are entering into an Amended and Restated Patent License Agreement, in substantially in the form attached hereto as Exhibit D (the “License Agreement”).

1.03 WHEREAS Seller now owns, and immediately prior to the Closing it will own, all of the Shares (defined below).

1.04 WHEREAS, upon the terms and subject to the conditions set forth in this Agreement, Seller desires to sell the Shares to Purchaser, and Purchaser which likewise desires to purchase the Shares from Seller, the Shares on the terms and subject to the conditions set forth in this Agreement (the “Sale”);

1.05 WHEREAS, the The board of directors of Purchaser has approved this Agreement and the transactions that it contemplates. contemplated hereby; and

1.06 WHEREAS, the The board of directors of Seller has (i) approved this Agreement and the Transactions (defined below), (ii) determined that this Agreement and Sale and the Reorganization Transactions are expedient and for the best interests of Seller and its stockholders and (iii) resolved, subject to the terms of this Agreement, to recommend that the stockholders of Seller authorize the Sale and the Reorganization Transactions.

1.07 NOW, THEREFORE The parties enter into this Agreement in consideration of the mutual representations, warranties, covenants and agreements set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged. the parties hereto agree as follows [This section 1.07 arguably could be deleted.]

4.23.4 Caution: Recitals might be binding

A court might give special or even binding weight to recitals in a contract. For example, California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added; hat tip: Commenter "Kazu" at the Adams Drafting blog.)

See also the notes to (Study:) Acknowledgements in a contract, § 4.3.

4.23.5 Special topic: Background section for settlement agreements

When an agreement is made to settle a dispute, it can be really advantageous for the background ssection of the signed agreement to document that fact. This advantage is illustrated in Pappas v. Tzolis, 20 N.Y.3d 228 (2012). In that case:

  • Tzolis, a businessman, owned part of a limited liability company ("LLC") along with two colleagues, Pappas and Tziolis invested $50,000 in the company, while Ifantopoulos invested $25,000. The LLC acquired a long-term lease on a building in Lower Manhattan.
  • About a year later, after repeated disputes had arisen, Tzolis bought out Pappas and Ifantopoulos for 20 times (!) their respective investments.
  • A few months later, Tzolis sold the building lease for $17.5 million.
  • Pappas and Ifantopoulos sued Tzolis for (among other things) fraud and breach of fiduciary duty, claiming that Tzolis had arranged the sale before he bought them out, without telling them he was doing so.

New York's highest court ruled that Pappas's and Ifantopoulos's complaint should have been summarily dismissed:

Here, plaintiffs were sophisticated businessmen represented by counsel. Moreover, plaintiffs' own allegations make it clear that at the time of the buyout, the relationship between the parties was not one of trust, and reliance on Tzolis's representations as a fiduciary would not have been reasonable.

According to plaintiffs, there had been numerous business disputes, between Tzolis and them, concerning the sublease. Both the complaint and Pappas's affidavit opposing the motion to dismiss portray Tzolis as uncooperative and intransigent in the face of plaintiffs' preferences concerning the sublease. The relationship between plaintiffs and Tzolis had become antagonistic, to the extent that plaintiffs could no longer reasonably regard Tzolis as trustworthy.

Therefore, crediting plaintiffs' allegations, the release contained in the Certificate is valid, and plaintiffs cannot prevail on their cause of action alleging breach of fiduciary duty.

Id. at 233 (emphasis and extra paragraphing added).

In similar fashion, in a settlement agreement, the Background section can recite facts about the dispute between the parties. The court likely will accept those facts as true. See the commentary to (Study:) Acknowledgements in a contract, § 4.3. That can help counter what one commentator says will be the plaintiffs' lawyers' response to the Pappas decision, namely not to stipulate in their complaints that the parties had a dispute. See Peter Mahler, Pappas Saga Ends … (2012).

4.23.6 Drafting exercise: Background of Agreement

The following is from a real-estate purchase agreement:

THIS REAL ESTATE PURCHASE AND SALE AGREEMENT (this "Agreement") is made and entered into by and between WIRE WAY, LLC, a Texas limited liability company ("Seller"), and RCI HOLDINGS, INC., a Texas corporation ("Purchaser"), pursuant to the terms and conditions set forth herein.

W I T N E S S E T H:

WHEREAS, Seller is the owner of a certain real property consisting of approximately 4.637± acres of land, together with all rights, (excepting for mineral rights as set forth below) , title and interests of Seller in and to any and all improvements and appurtenances exclusively belonging or pertaining thereto (the "Property") located at 10557 Wire Way, Dallas (the "City"), Dallas County, Texas, which Property is more particularly described on Exhibit A attached hereto and incorporated herein by reference; and

WHEREAS, contemporaneously with the execution of this Agreement, North by East Entertainment, Ltd., a Texas limited partnership ("North by East"), is entering into an agreement with RCI Entertainment (Northwest Highway), Inc., a Texas corporation ("RCI Entertainment"), a wholly owned subsidiary of Rick's Cabaret International, Inc., a Texas corporation ("Rick's") for the sale and purchase of the assets of the business more commonly known as "Platinum Club II" that operates from and at the Property ("Asset Purchase Agreement"); and

WHEREAS, subject to and simultaneously with the closing of the Asset Purchase Agreement, Seller will enter into a lease with RCI Entertainment, as Tenant, for the Property, dated to be effective as of the closing date, as defined in the Asset Purchase Agreement (the "Lease") attached hereto as Exhibit B and incorporated herein by reference; and

WHEREAS, subject to the closing of the Asset Purchase Agreement, the execution and acceptance by Seller of the Lease, and pursuant to the terms and provisions contained herein, Seller desires to sell and convey to Purchaser and Purchaser desires to purchase the Property.

NOW, THEREFORE, for and in consideration of the premises and mutual covenants and conditions contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

EXERCISE: Redraft this into a "Background of the Agreement" section.

  • Use short, simple sentences and short paragraphs.
  • Eliminate as much legalese as you can.

4.24 (Study:) Battle of the Forms

4.24.1 Business background: D[**]kish documents

When a corporate buyer makes a significant purchase, it's quite common for the buyer's procurement people to send the seller a purchase order. Typically, if the seller wants to get paid, it must quote the purchase-order number on the invoice, otherwise the buyer's accounts-payable department simply won't pay the bill. This is a routine internal-controls measure implemented by buyers to help prevent fraud.

Many buyers, however, try to use their purchase-order forms, not just for fraud prevention, but to impose legal terms and conditions on the seller. These buyers put a lot of fine print on the backs of their purchase-order forms; the terms of the fine print typically include 1) detailed — and often onerous — terms for the purchase, including for example expansive indemnity requirements; and 2) language to the effect of, our terms and conditions are the only ones that will apply; yours don't count, no matter what you do.

Sellers aren't always innocent parties in this little mating ritual, either: It's not uncommon for a seller's quotation to state that all customer orders are subject to acceptance in writing by the seller. Then, the seller's written acceptance takes the form of an "order confirmation" that itself contains detailed terms and conditions — some of which might directly conflict with the buyer's purchase order.

This is known as the "Battle of the Forms," of the kind contemplated by UCC § 2-207 and sometimes experienced in common-law situations as well.

In a sense, such purchase-order and sales-confirmation forms are "d[**]kish," in that they try to displace rival terms and conditions, in much the same way that natural selection supposedly has favored human male genitalia that are sized and shaped to displace rival semen from a female. See, e.g., Gordon G. Gallup and Rebecca L. Burch, Semen Displacement as a Sperm Competition Strategy in Humans, 2 Evol. Psych. 12 (2004). (My wife, a lawyer herself, raised her eyebrows disapprovingly about this paragraph, but the metaphor strikes me as quite apt.)

4.24.2 How the UCC handles the Battle of the Forms

The (U.S.) Uniform Commercial Code expressly provides ground rules for the Battle of the Forms. To illustrate, let's consider a hypothetical example in which 1) Customer sends Supplier a purchase order for widgets; 2) Customer's purchase order states that Customer's payment is due net 120 days from the date of Customer's receipt of a correct invoice; it also states that Customer rejects any additional or different terms that Supplier might propose; and 3) After receiving the purchase order, Supplier ships the requested widgets together with a written order confirmation that objects to Customer's purchase order terms and states that Customer's payment is due net 10 days from the date of the invoice.

Under UCC § 2-207(3), the two conflicting net-days payment terms would drop out — you can think of them as killing each other off — and unless the parties agreed otherwise, the payment terms would be set by the UCC's relevant gap-filling provision, if any. (On the subject of payment terms, UCC § 2-310 requires payment at the time and place at which Customer receives the goods, which might be the place of shipment, unless the parties agree otherwise.)

As an example, see Northrop Corp. v. Litronic Industries, 29 F.3d 1173 (7th Cir. 1994) (Posner, J.): This was a case where:

  • the buyer's purchase order stated that the seller's warranty provision was of unlimited duration;
  • the seller's acknowledgement form stated that the seller's warranty lasted only 90 days;
  • the trial court held, the appellate court agreed, that both of those provisions dropped out of the contract, and therefore the buyer was left with an implied warranty of "reasonable" duration.

4.24.3 Pro tip for sellers

Sellers should never sign a buyer's purchase-order form — nor fill an order in response to a purchase order — without carefully reading its terms and sending an order confirmation with suitably-worded terms of sale.

4.24.4 Caution: The UN CISG relies on the "mirror image" (or "last shot") rule

CAUTION: Analysis of the Battle of the Forms is different under the UN Convention on Contracts for the International Sale of Goods. See generally, e.g., VLM Food Trading Int'l, Inc. v. Illinois Trading Co., No. 14-2776 (7th Cir. Jan. 21, 2016), where the appeals court affirmed a judgment below that, "because Illinois Trading never expressly assented to the attorney's fees provision in VLM's trailing invoices, under the Convention that term did not become a part of the parties' contracts." Id., slip op. at 2. The appeals court explained:

[T]he Convention departs dramatically from the UCC by using the common-law “mirror image” rule (sometimes called the “last shot” rule) to resolve “battles of the forms.” With respect to the battle of the forms, the determinative factor under the Convention is when the contract was formed. The terms of the contract are those embodied in the last offer (or counteroffer) made prior to a contract being formed. Under the mirror-image rule, as expressed in Article 19(1) of the Convention, “[a] reply to an offer which purports to be an acceptance but contains additions, limitations or other modifications is a rejection of the offer and constitutes a counter-offer.”

Id., slip op. at 5-6 (citations, internal quotation marks, and some alteration marks omitted; emphasis added).

4.24.5 CAUTION: Filling a purchase order might well mean that the buyer's T&Cs apply

Remember that in U.S. jurisdictions, a customer's sending of a purchase order might count as an offer to enter into a contract, which could be accepted by performance, i.e., by filling the purchase order. Consider the following actual examples:

  • From a Honeywell purchase-order form archived at http://perma.cc/CUV6-NKTY, § 1 "This Purchase Order is deemed accepted when Supplier returns the acknowledgment copy of this Purchase Order or begins performing, whichever is earlier." (Emphasis added.)
  • From a General Electric purchase-order form § 1: "This Order shall be irrevocably accepted by Supplier upon the earlier of: (a) Supplier's issuing any acceptance or acknowledgement of this Order; or (b) Supplier's commencement of the work called for by this Order in any manner." (Emphasis added.)
  • From a Cisco purchase-order form § 1: "Supplier's electronic acceptance, acknowledgement of this Purchase Order, or commencement of performance constitutes Supplier's acceptance of these terms and conditions." (Emphasis added.)

4.24.6 A "master" agreement should preclude a Battle of the Forms

In a New Jersey case, UPS and a GE subsidiary entered into a master agreement, which contained a provision stating that the master agreement would take precedence over any bill of lading or other shipment document:

E. To the extent that any bills of lading, or other shipment documents used in connection with transportation services provided pursuant to the contract are inconsistent with the terms and conditions of this contract (including the terms and conditions of Appendices or Exhibits incorporated by reference), the terms and conditions of this Contract (and any incorporated Appendices and Exhibits) shall govern.

Indem. Ins. Co. of N. Am. v. UPS Ground Freight, Inc., No. 13-3726, slip op. at 3 (D.N.J. Mar. 31, 2016). UPS claimed that its bill of lading limited its liability for damage to some $15,000. In contrast, the GE subsidiary claimed that the bill of lading was inapplicable, and that consequently UPS should be held liable for the full value (some $1 million) of the shipment in question. The court declined to decide the issue on summary judgment.

4.24.7 Appendix: Honeywell battle-of-the-forms terms

The following excerpt is reformatted from a Honeywell purchase-order form archived at http://perma.cc/CUV6-NKTY (Schmiedecorp.com):

1. Acceptance - Order of Precedence - Modification

This Purchase Order is for the purchase of goods, services, or both as described on the face of this document (collectively, "Goods") and is issued by the member of the Honeywell International Inc. group of companies identified on the face of this document ("Honeywell").

This Purchase Order is deemed accepted when Supplier returns the acknowledgment copy of this Purchase Order or begins performing, whichever is earlier.

Honeywell rejects any additional or inconsistent terms and conditions offered by Supplier at any time.

Any reference to Supplier's quotation, bid, or proposal does not imply acceptance of any term, condition, or instruction contained in that document.

No course of prior dealing or usage of the trade may modify, supplement, or explain any terms used in this Purchase Order.

These terms and conditions together with any previously executed non disclosure agreement (the obligations of which remain in effect) and with the exhibits, schedules, specifications, drawings, or other documents referred to on the face of the Purchase Order, or attached, or any documents incorporated by reference, supersede any prior or contemporaneous communications, representations, promises, or negotiations, whether oral or written, respecting the subject matter of this Purchase Order.

Compare the above with the following excerpt from a Honeywell terms of sale document, archived at http://perma.cc/5MB9-H6VK:

1. APPLICABILITY

Unless and to the extent that a separate contract executed between the procuring party ("Buyer") and Honeywell International Inc. ("Honeywell") applies, any purchase order covering the sale of any product ("Product") contained in this Catalog ("Order") will be governed solely by these Conditions of Sale, whether or not this Catalog or these Conditions of Sale are referenced in the Order.

Except as provided in the "Buyer's Orders" section below, all provisions on Buyer's Order and all other documents submitted by Buyer are expressly rejected.

Honeywell will not be deemed to have waived these Conditions of Sale if it fails to object to provisions submitted by Buyer.

Buyer's silence or acceptance or use of Products is acceptance of these Conditions of Sale.

Any modification or addition to these Conditions of Sale must be in writing and signed by an authorized representative of Buyer and Honeywell.

Any irreconcilable conflict among these Conditions of Sale, the General Terms section and the Supplier CAGE Code Information section of this Catalog will be resolved by giving precedence in the following order from highest precedence to lowest: (1) Supplier CAGE Code Information, (2) General Terms, and (3) Conditions of Sale.

This Catalog and price list is not an offer.

Honeywell reserves the right to reject any Order submitted for its acceptance.

4.24.8 Additional reading (optional)

See generally:

4.25 (Study:) Best efforts

4.25.1 CAUTION

Consider a party that agrees to use its "best efforts" to do something, which we'll call "X." Suppose that the party doesn't succeed in doing X. The obligated party might think it won't be in any legal jeopardy, because after all it wasn't obligated to actually do X.

In litigation, though, it usually wouldn't be hard for the other side's lawyer — who of course has 20-20 hindsight — to think of other things the obligated party supposedly could have done, and thus should have done. Therefore (so the lawyer argues), the obligated party clearly didn't use “best” efforts, QED.

This suggests that it can be dangerous to agree to a best-efforts obligation. But sometimes a company feels it has no choice but to undertake such an obligation, and it's willing to take on the resulting business risk. Here are six things the company could consider putting in the contract to help manage that risk.

4.25.2 Diligence might be the touchstone of "best efforts"

the Restatement (Second) of Agency defines best efforts in terms of diligence: "Best efforts is a standard that has diligence at its essence." Restatement (Second) of Agency § 13, comment a (1957), quoted in Corporate Lodging Consultants, Inc. v. Bombardier Aerospace Corp., No. 6:03-cv-01467-WEB, slip op. at 9 (D. Kan. May 11, 2005) (finding that CLC had not failed to use its best efforts to obtain lowest and most-competitive hotel rates for Bombardier) (citation and alteration marks omitted).

4.25.3 Business context of best-efforts requests

Best-efforts obligations are especially common when one party grants another party exclusive rights, for example exclusive distribution rights or an exclusive license under a patent, trademark, or copyright. That was the situation in the Kevin Ehringer Enterprises case, for example. See Kevin M. Ehringer Enterprises, Inc. v. McData Serv. Corp., 646 F.3d 321, 325-27 (2011) (holding that best-efforts clause was too indefinite to be enforceable under Texas law).

To many business people, it may seem self-evident that when a contract uses the term best efforts, it calls for "something more" than mere reasonable efforts — otherwise, why bother even saying best efforts? That is, reasonable efforts will cover a range of possibilities, while best efforts refers to somewhere near the top of that range. I have no formal research to support this view, but I've negotiated more than a few contracts with best-efforts clauses in them, so I'd like to think I have at least some sense of what many business people are after.

4.25.4 A sports analogy: Bring your "A" game

By analogy, to many business people:

  • "C" is a passing grade in (U.S.) schools, and is equivalent to reasonable efforts.
  • In contrast, best efforts means an "A" effort — or in basketball slang, bring your "A" game, buddy, not your "C" game.

Another analogy:

  • On major U.S. highways, the speed-limit signs often include both maximum and minimum speeds of (say) 60 mph and 45 mph. Those two speeds establish the upper- and lower bounds of reasonableness.
  • Now, suppose that a trucking company were to agree that its driver would use her "best efforts" to drive a shipment of goods from Point A to Point B on such a highway, where drivers must drive between 45 mph and 60 mph.
  • In good weather with light traffic, driving at 45 mph might qualify as reasonable efforts. But driving at that speed likely wouldn't cut it as best efforts.

4.25.5 Possible variation: "All reasonable efforts" instead of "best efforts"

  • A drafter could specify that best efforts requires the diligent making of all reasonable efforts. Reportedly, that's a common formulation in the UK; see the Helms et al. article cited below.
  • A drafter could also add, at the end of sub­div­i­sion (a), the phrase, leaving no stone unturned in seeking to achieve the stated objective. This language is from an opinion by the supreme court of British Columbia. See Atmospheric Diving Systems Inc. v. International Hard Suits Inc., 89 B.C.L.R. (2d) 356 (1994). I've not been able to find the full text of this opinion freely available online. It's extensively excerpted by Ken Adams in his posting "Best Efforts" Under Canadian Law. (Warning: I strongly disagree with Ken's view that "best efforts" means simply "reasonable efforts.")

4.25.6 Best efforts means different things to different courts

Depending on the jurisdiction, a court might not share the view of best efforts just described.

• As one court explained, "[c]ontracting parties ordinarily use best efforts language when they are uncertain about what can be achieved, given their limited resources." See CKB & Assoc., Inc. v. Moore McCormack Petroleum, Inc., 809 S.W.2d 577, 581-82 (Tex. App. – Dallas 1990) (affirming summary judgment that defendant had failed to use its best efforts).

On the facts of the case, the court affirmed summary judgment that an oil refiner had failed to use its best efforts to produce specified volumes of refined petroleum products. The refiner had focused its efforts on high-priced products, while making no effort to produce the specific products that it was contractually obligated to produce. The court remarked that "[a]s a matter of law, no efforts cannot be best efforts."

• Some — but not all — U.S. courts have seemingly equated best efforts with mere reasonable efforts, contrary to what business people are likely to think they're getting in a best-efforts clause.

As one 2005 review of case law puts it, "For years U.S. courts have used the phrases 'reasonable efforts' and 'best efforts' interchangeably within and between opinions. Where only one of the terms is used, the best-efforts obligation frequently appears indistinguishable from a reasonable-efforts obligation. Some recent cases have gone so far as to equate best efforts and reasonable efforts." See Scott-Macon Securities, Inc. v. Zoltek Cos., Nos. 04 Civ. 2124 (MBM), 04 Civ. 4896 (MBM), part II-C (S.D.N.Y. May 11, 2005) (citing cases).

(Some of those cases, though, might be interpreted more narrowly as holding merely that a best-efforts obligation does not require the obligated party to make unreasonable efforts, while still requiring diligence in the making of reasonable efforts.)

• Fortunately, still other U.S. courts seem to have recognized that best efforts means something more than merely reasonable efforts.

For example, in the Tigg Corp. v. Dow Corning Corp. case, the Third Circuit held that, at least where the contract involved an exclusive-dealing arrangement, "[t]he obligation of best efforts forces the buyer/reseller to consider the best interests of the seller and itself as if they were one firm." the appellate court affirmed a trial court's judgment, based on a jury verdict, holding Dow Corning liable for breaching a best-efforts obligation in an exclusive-dealing agreement. The appellate court agreed with Dow Corning, however, that the trial court had erred in entering judgment on the amount of monetary damages Dow Corning should pay, and remanded the case for a new trial on that issue. Tigg Corp. v. Dow Corning Corp., 962 F.2d 1119 (3d Cir. 1992).

Likewise, in Macksey v. Egan, a Massachusetts appeals court construed the term best efforts "in the natural sense of the words as requiring that the party put its muscles to work to perform with full energy and fairness the relevant express promises and reasonable implications therefrom." Macksey v. Egan, 36 Mass. App. Ct. 463, 472, 633 N.E.2d 408 (1994) (reversing judgment on jury verdict that defendant had breached best-efforts obligation; extensive citations omitted).

• Some UK and Canadian courts have defined the standard of performance for best efforts as, in essence, all reasonable efforts. For a survey of such cases, see Shawn C. Helms, David Harding, and John R. Phillips, Best Efforts and Endeavours – Case Analysis and Practical Guidance Under U.S. and U.K. Law, July 2007.

For example, in its Atmospheric Diving Systems opinion (1994), the supreme court of British Columbia held that best efforts requires "taking, in good faith, all reasonable steps to achieve the objective, carrying the process to its logical conclusion and leaving no stone unturned. … doing everything known to be usual, necessary and proper for ensuring the success of the endeavour."

Similarly, in Australia, the term best endeavours seems to be treated as synonymous with all reasonable endeavours; in its Hospital Products opinion (1984), that country's highest court held that "an obligation to use 'best endeavours' does not require the person who undertakes the obligation to go beyond the bounds of reason; he is required to do all he reasonably can in the circumstances to achieve the contractual object, but no more … [A] person who had given such an undertaking … in effect promised to do all he reasonably could …." Hospital Prods. Ltd v. United States Surgical Corp., 1984 HCA 64, 156 CLR 41, paras. 24, 25.

Adding to the difficulty, some U.S. courts have held that the term best efforts is too vague to be enforceable unless the parties agree to some sort of objective standard of performance, "some kind of goal or guideline against which best efforts may be measured," in a case quoted by the court in the Kevin Ehringer Enterprises case.

One court held that "as promptly as practicable" and "in the most expeditious manner possible" were sufficient to meet that requirement. See Herrmann Holdings Ltd. v. Lucent Technologies Inc., 302 F.3d 552, 559-61 (5th Cir. 2002) (reversing dismissal under Rule 12(b)(6); citing cases).

With all of this in mind, the definition of best efforts in this clause attempts to draw at least a somewhat-bright line that provides an objective standard of performance (albeit one that might require a trial to determine whether it had been met).

[TO DO: Look up California law – all efforts even if bankruptcy? https://www.linkedin.com/grp/post/4036673-6027114806685810691]

4.25.7 "Best efforts" might be held to be unenforceably vague

According to some U.S. courts, the term best efforts is too vague to be enforceable unless the parties agree to some sort of objective standard of performance. In the Kevin Ehringer Enterprises case, the Fifth Circuit, quoting a Texas appellate court, held that under state law, "to be enforceable, a best efforts contract must set some kind of goal or guideline against which best efforts may be measured."

4.25.8 "Every effort" clauses and the like are often interpreted similarly

"When confronted with idiosyncratic contractual language expressing sentiments akin to doing all that one can or 'all that is necessary' to complete a task, Texas courts often interpret such language as requiring 'best efforts'–an expression with a more clearly established meaning and history." Hoffman v. L & M Arts, 774 F. Supp. 2d 826, 833 (N.D. Tex. 2011) (citing cases).

"[C]ourts and arbitrators interpreting similar phrases [the phrase in question was 'every effort'] have determined, like the district court here, that they impose an obligation to make all reasonable efforts to reach the identified end." Aeronautical Indus. Dist. Lodge 91 v. United Tech. Corp.., 230 F.3d 569, 578 (2d Cir. 2000) (citations omitted).

4.25.9 Asking for a best-efforts commitment can make business sense

Sure, there's some legal uncertainty associated with a best-efforts commitment. But from a business perspective it can make good sense to ask the other side for such a commitment anyway: a party that makes a best-efforts commitment — to the extent that it later thinks about that commitment at all — will at least be aware that it might well have to make more than just routine, day-to-day, "reasonable" efforts. That alone might be worthwhile to the party asking for the commitment.

4.25.10 Agreeing to a best-efforts commitment might lead to trouble

If you commit to a best-efforts obligation, and the other side later accuses you of breaching that obligation, and you can't settle the dispute, then you're likely to have to try the case instead of being able to get rid of it on summary judgment. That's because:

  • No matter what you do, if a problem arises, the other side's lawyers, with 20-20 hindsight, will argue that there were  Xnumber of things that you supposedly could have done to achieve the agreed goal.
  • You're unlikely to be able to get summary judgment that you didn't breach the best-efforts obligation. Instead, you're likely to have to go to the trouble and expense of a full trial or arbitration hearing. The judge or arbitrator may well say that the question involves disputed issues of material fact. Those issues will have to be resolved by witness testimony and cross-examination about such things as industry practices; the then-existing conditions; etc. According to the rules of procedure in many jurisdictions, that will require a trial and will not be able to be done in a summary proceeding. Your motion for summary judgment is therefore likely to be denied.
  • The tribunal, after hearing the evidence, may find that in fact you did not use your best efforts. If that happens, you're going to have a very hard time convincing an appeals court to overturn that finding.

4.25.11 Best-efforts takeaways

• Drafters should try very hard to be as precise as possible in specifying just what goal the best efforts are to be directed to achieving.

• Obligated parties should think long and hard before agreeing to a best-efforts obligation, because in the long run it could prove to be burdensome and expensive.

4.25.12 Further reading about best efforts

See also:

4.25.13 Best-efforts obligations

Best-efforts obligations could divert substantial resources, because some courts have held that best efforts means, in essence, all efforts short of bankruptcy.

Tip: Consider using alternative language such as reasonable efforts or commercially-reasonable efforts (but watch out for all reasonable efforts).

Tip: If you must agree to a best-efforts obligation, see if you can define it in a reasonable way; one possible definition might be: [ADD LINK]

4.26 (Skim:) "Bribing" foreign "officials"

In recent years the U.S. Government has been enforcing the Foreign Corrupt Practices Act (FCPA) with increasing vigor, resulting in an aggregate of almost $1.8 billion in fines in 2010 alone.

For example, former KBR CEO Albert "Jack" Stanley was sentenced to 30 months in prison and a restitution payment of $10.8 million. Stanley pled guilty to conspiracy to bribe Nigerian officials to obtain construction contracts for KBR.

Here's how the Department of Justice describes the basic workings of the FCPA, with bulleting added: [link]:

… the anti-bribery provisions of the FCPA prohibit • the willful use of the mails or any means of instrumentality of interstate commerce • corruptly • in furtherance of any offer, payment, promise to pay, or authorization of the payment of money or anything of value to any person, • while knowing that • all or a portion of such money or thing of value will be offered, given or promised, directly or indirectly, to a foreign official • to influence the foreign official in his or her official capacity, induce the foreign official to do or omit to do an act in violation of his or her lawful duty, or to secure any improper advantage • in order to assist in obtaining or retaining business for or with, or directing business to, any person.

The Justice Department also has a useful on-line guide resource guide about the FCPA (Justice.gov: https://goo.gl/PpAFZU).

4.27 (Extra:) Browse-wrap agreements (notes only)

CAUTION: Anyone drafting a Web site terms-of-service agreement should seriously consider doing this one thing: State explicitly — and, preferably, conspicuously (see § 4.36) — that use of the Web site will constitute assent to the terms of service. Even that might not be enough, for reasons discussed in the cases mentioned below.

Barnes & Noble's Web site terms of service didn't do that. As a result, the company is now facing a class-action lawsuit, because its terms of service were insufficient to bind the user to an arbitration clause. See Nguyen v. Barnes & Noble, Inc., 763 F.3d 1171 (9th Cir. 2014). Drafters would do well to study this scholarly opinion, which surveys case law from other circuits and concludes that Barnes & Noble's "terms of service" notice was insufficient.

Another detailed and scholarly opinion is that in Berkin v. Gogo LLC, No. 14-CV-1199, parts IV and IV (E.D.N.Y. Apr. 9, 2015), in which Judge Jack Weinstein denied Gogo's motion to compel arbitration; see especially the slip opinion beginning at page 61 for the court's summary of "general principles regarding the validity and enforceability of internet agreements …." The court said that "[p]roof of special know-how based on the background of the potential buyer or adequate warning of adverse terms by the design of the agreement page or pages should be required before adverse terms, such as compelled arbitration or forced venue, are enforced." Id., slip op. at 64.

A September 2015 article surveying the case law: Francine D. Ward, Brian D. Sites, Michelle L. Gregory, Janice Phaik Lin Goh, Timothy Lewis, Terms of Use Case Update (AmericanBar.org 2015).

Long v. Provide Commerce and Sgouros v. TransUnion – discussed in http://www.mondaq.com/article.asp?articleid=491570:

On March 17, 2016, a California Court of Appeals, in Long v. Provide Commerce, Inc., refused to enforce a website's Terms of Use (Terms), holding that hyperlinks to Terms are not enough to put users on notice of the Terms and to effectuate the users' consent thereto. The next week, the Seventh Circuit Court of Appeals, in Sgouros v. TransUnion, refused to enforce the arbitration clause of a website's agreement because the "layout and language of the site" did not provide users with "reasonable notice that a click" would manifest assent to arbitrate. These cases serve as reminders of the weaknesses of online agreements and provide insight into what facts would give rise to making them enforceable.

4.28 (Extra:) Click-wrap agreements (notes only)

http://www.mondaq.com/article.asp?articleid=482600&email_access=on: Seventh Circuit case – click-wrap reference in credit-reporting order form "actively misle[d]" the customer about what it was clicking for.

4.29 (Skim:) Commas

22 Reasons Why Commas Are The Most Important Things In The World (BuzzFeed.com) (warning: contains graphic foul language in text messages).

Village of West Jefferson v. Cammelleri, 2015 Ohio 2463 (Oh. App.) – a woman was issued a parking citation for leaving her pickup truck parked on the street overnight, in violation of a village parking ordinance. The ordinance stated that "[i]t shall be unlawful for any person  *  to park  *  upon any street * * * in the Village, any motor vehicle camper, trailer, farm implement and/or non-motorized vehicle for a continued period of twenty-four hours  * ." The woman successfully argued that her pickup truck was not a motor vehicle camper, and that it didn't fit into any of the other categories stated in the ordinance; therefore, it was not a violation for her to park the truck on the street overnight.

Stark v. Advanced Magnetics, Inc., 119 F.3d 1551, 1555 (Fed. Cir. 1997): The U.S. patent statute uses a comma in one provision but not in a related, substantially-identical provision; the appeals court held that the comma made a substantive difference in the proof required to show that a patent is invalid.

4.30 (Study:) Commercially reasonable (efforts, etc.)

4.30.1 Overview: "Commercially reasonable" is a kick-the-can provision

Commercially-reasonable is a kick-the-can-down-the-road term; it's often used in routine contracts, especially for matters for which the parties are confident they can amicably resolve any disputes that might arise.

4.30.2 Commercial reasonableness might be proved up indirectly

A party seeking to prove (or disprove) commercial reasonableness of a transaction, contract term, decision, etc., might want to focus on the process by which the transaction, etc., came into being. The U.S. Court of Appeals for the Fifth Circuit has said that "Where two sophisticated businesses reach a hard-fought agreement through lengthy negotiations, it is difficult to conclude that any negotiated term placed in their contract is commercially unreasonable." West Texas Transmission, LP v. Enron Corp., 907 F.2d 1554, 1563 (5th Cir. 1990) (affirrming district court's refusal to grant specific performance of right of first refusal) (extensive citations omitted).

4.30.3 Is the term commercially reasonable too vague?

See the commentary to (Read:) Reasonable efforts, § 4.86 for a discussion of the vagueries of that term, which of course are inherited by the term commercially reasonable.

4.30.4 A court might apply a "prudence" standard

In a major lawsuit between the (U.S.) state of Indiana and IBM, the contract in question took a stricter view of commercially reasonable efforts. That contract defined the term as "taking commercially reasonable steps [circularity, anyone?] and performing in such a manner as a well managed entity would undertake with respect to a matter in which it was acting in a determined, prudent, businesslike and reasonable manner to achieve a particular result." Indiana v. IBM Corp., 4 N.E.3d 696, 716 n.12 (Ind. App. 2014) (reversing trial court in pertinent part) (emphasis added, citation to trial record omitted), affirmed, 51 N.E.3d 150 (Ind. 2016), after remand, No. 49A02-1709-PL-2006 (Ind. App. 2018) (affirming in part, reversing in part, trial court's recalculation of damages).

In that case, the contract in suit called for IBM to overhaul Indiana's computer system for managing its welfare program; the project ended up being in essence a train wreck, after which the parties sued each other. The trial court rendered judgment in favor of IBM, but a state appellate court reversed in part and remanded, holding that while IBM was entitled to be paid for its work, that payment would be subject to offset (to be determined on remand), on grounds that IBM had materially breached the contract.

Epilogue: In a bench trial on remand, the trial judge held IBM liable for $78 million; an appeals court upheld the trial court's new damages computation, while reversing and remanding the trial court's determination of interest. See No. 49A02-1709-PL-2006 (Ind. App. 2018).

4.30.5 Giving preference to one's own interests

In a 2014 English case arising from the financial crisis of late 2008, the Barclays bank had the right to consent to a particular type of financial transaction, but it was obligated to grant or withhold such consent in a commercially-reasonable manner. The England and Wales Court of Appeals rejected Unicredit's argument that this meant that Barclays was required to take Unicredit's interests into account, not merely Barclays's own interests. Barclays Bank PLC v. Unicredit Bank AG, [2014] EWCA Civ 302 ¶ 16 (affirming trial-court ruling).

4.30.6 Is "doing the needful" the standard for commercially reasonable efforts?

A holding by the Delaware chancery court suggests that the Indian-English expression do the needful might be a useful short­hand reference for commercially reasonable efforts.

  • The case involved a multi-billion-dollar oil industry merger agreement in which a buyer was to acquire the assets of a seller.
  • The agreement gave the seller an "out" from the deal: The seller would not have to close the deal if it did not get a favorable opinion from its own tax counsel (as opposed to, say, getting an opinion from an independent expert) about the deal's expected tax consequences.
  • The agreement, though, also required the seller to use commercially reasonable efforts to get a favorable opinion. After the merger agreement was signed, the market price of crude oil collapsed. This brought with it a drastic drop in the value of the seller's assets, making the deal much less attractive to the buyer.
  • The buyer ended up backing out of the deal, citing newly-discovered concerns about the expected tax consequences. The seller tried to assuage the buyer's new concerns; when that failed, the seller sued the buyer for breach of contract. The seller alleged, among other things, that the buyer had failed to honor its commitment to use commercially reasonable efforts to obtain a favorable tax opinion.

The chancery court noted that the merger agreement did not define "commercially reasonable efforts"; it found that:

… by agreeing to make “commercially reasonable efforts” to achieve the 721 Opinion, the Partnership [i.e., the seller] necessarily submitted itself to an objective standard—that is, it bound itself to do those things objectively reasonable to produce the desired 721 Opinion, in the context of the agreement reached by the parties.

Williams Cos. v. Energy Transfer Equity, L.P., No. 12168-VCG, slip op. at 46 (Del. Ch. Ct. June 24, 2016) (emphasis added), aff'd, 159 A.3d 264 (Del. 2017). The chancery court held that, in view of the facts of the case, the buyer had not breached its obligation to use commercially reasonable efforts.

4.31 (Read:) Conditions in contracts

4.31.1 Conditions precedent vs. conditions subsequent

Conditions can be loosely classified as:

  • prerequisites, formally known as conditions precedent; and
  • exceptions, formally known as conditions subsequent.

EXAMPLE: Except in case of emergency, Landlord must give Tenant at least 24 hours notice before entering the Leased Premises: Here, the 24hour notice requirement is a (partial) prerequisite, and thus a condition precedent, to Landlord's being able to enter the Leased Premises.

EXAMPLE: Landlord will allow Tenant to use the Apartment Complex's recreational facilities unless Tenant is delinquent in rent payments: Here, the delinquency exception is a condition subsequent that excuses Landlord from this particular obligation.

4.31.2 Courts prefer to interpret obligations as covenants (i.e., promises), not as conditions

From a Utah supreme court case:

… the parties employed explicitly mandatory language to characterize [one contract] provision, while using explicitly conditional language elsewhere in the agreement. Based on these features of the [contract], we conclude that there is no plausible way to read the [relevant] provision as anything other than a covenant.

Mind & Motion Utah Investments, LLC, v. Celtic Bank Corp., 2016 UT 6, 367 P.3d 994 para. 45 (affirming summary judgment). The court later explained:

Although Celtic Bank‘s ability to meet the recording deadline hinged in large part on the approval of county officials, the parties couched the recording obligation in mandatory language while employing explicitly conditional language elsewhere in the REPC to describe other performance obligations. This shows that Celtic Bank and Mind & Motion, both sophisticated parties, knew how to draft a condition when they so desired. Accordingly, it is not plausible to read Celtic Bank‘s duty to record the phase 1 plat as anything other than a covenant, and the REPC is therefore not facially ambiguous.

Id. at para. 16. And:

… when parties employ mandatory terms to characterize an obligation whose fulfillment hinges on the action of a third party, this may indicate an express assumption by one party of the risk that the condition will remain unfulfilled.

Id. at para. 23 (cleaned up).

4.32 (Read:) Confidential Information

In the U.S. and probably many other jurisdictions, if you want to disclose your confidential information to another party, you must get the other party to agree to keep the information confidential — otherwise, you're likely to forfeit any legal control you might have otherwise had over the information.

4.32.1 (BL) Whose information should be protected?

In the U.S. and probably most other jurisdictions, the law sets forth requirements for a party's information to be protectable as a trade secret or otherwise as confidential.

But whose information should be protected — that of each party, or just of one party only? A confidentiality agreement could take either approach, but the author believes that the former, two-way approach is often the safest, because a one-way confidentiality provision could cause problems in the future.

(BL) WARNING 1: Just because a contract nominally protects each party's information, that's not the end of the inquiry. A party that knows that it will be the only one to disclose its confidential information can write the contract to be highly favorable to disclosing parties (or vice versa).

4.32.2 Pro tip: Three rules for protecting confidential information

If you ever have to sue someone for misappropriating its confidential information, your lawyers will almost certainly want to put on evidence about the efforts that you made to keep the information confidential. In fact, the law might well require that your lawyers put on such evidence — as in, otherwise you'd lose the case.

The author has often used three rules of thumb as a shorthand for the things companies ought to do to protect their confidential information:

Rule 1: Lock it up (within reason)

A company seeking legal protection for its confidential information must implement sensible security measures for its physical premises and its computer network(s). Failure on this point can be fatal to a trade-secret claim; as just one example, the Seventh Circuit noted pointedly that the party asserting misappropriation had made no effort to preserve the so-called trade secrets in confidence. See Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant; applying Illinois law).

Security measures don’t have to rise to the level of Fort Knox. But they do have to be perceived, in hindsight, as having been reasonable under the circumstances. Depending on the situation, simple, obvious precautions might be enough — for example:

  • Locks on doors, windows, and file cabinets;
  • Single-use visitor sign-in sheets at the reception desk, to show that you didn’t let just anyone onto your premises — the disadvantage of conventional multi-line sign-in sheets is that everyone can see who came to see whom;
  • Need-to-know access restrictions;
  • Passwords, virus scanners, and firewalls for your computers and networks;
  • Don’t leave confidential stuff lying around.

Some people mistakenly think that legal protection won't be available for confidential information unless every possible security measure is taken. That's not how the law works; as one court remarked:

… there always are more security precautions that can be taken. Just because there is something else that Luzenac could have done does not mean that their efforts were unreasonable under the circumstances. In light of undisputed precautions that Luzenac took, we do not think that the record demonstrates beyond dispute that Luzenac's measures to protect the secrecy of 604AV were merely "superficial." … Whether these precautions were, in fact, reasonable, will have to be decided by a jury.

Hertz v. Luzenac Group, 576 F.3d 1103, 1113 (10th Cir. 2009) (emphasis added, citations omitted); in that case, the appeals court vacated a summary judgment that legal protection was not available for a company's talc-production process, and remanded the case back to the lower court for a trial.

Still, a party seeking legal protection for confidential information will have to show that it made at least some efforts to keep the information confidential — obviously "more is better," but more is also more costly.

Caution: Don’t build a world-class security system, but then do the equivalent of having automatic door locks but then leaving the doors propped open  — in the courtroom, opposing counsel purely love to hammer on that sort of thing.

Rule 2: Label it (within reason)

Appropriate confidentiality labels can help persuade a court that a disclosing party took its self-help obligations seriously. But don’t overdo it — it can be embarrassing (or worse) for opposing counsel to show the jury the local restaurant take-out menu that someone mindlessly stamped "confidential."

Marking confidential information might be more than just a good idea: A disclosing party might have signed nondisclosure agreements containing a mandatory marking requirement under which unlabeled information is not deemed confidential at all.

Even without mandatory marking, failing to mark could cause a judge to conclude that information wasn’t confidential, because the presence or lack of marking often carries significant weight. For example:

  • In the Seventh Circuit's Fail-Safe case, the court pointedly noted that the plaintiff had not marked its information as confidential; the court affirmed the district court's summary judgment dismissing the plaintiff's claim of misappropriation. See Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (applying Illinois law).
  • To like effect was another Seventh Circuit case, nClosures, Inc. v. Block & Co., 770 F.3d 598, 600 (7th Cir. 2014), where the court affirmed a summary judgment that "no reasonable jury could find that nClosures took reasonable steps to keep its proprietary information confidential," and therefore the confidentiality agreement between the parties was unenforceable.
  • A court might hold that the failure to mark, by itself, killed the disclosing party's claim to trade-secret rights in the information in question. That happened in Convolve, Inc. v. Compaq Computer Corp., No. 2012-1074, slip op. at 14, 21 (Fed. Cir. July 1, 2013) (affirming summary judgment; nonprecedential).
  • In a more-questionable case, Storage Technology’s corporate-raiding lawsuit against Cisco failed in part because a Storage Tech PowerPoint deck wasn't marked as confidential; while that alone didn’t lose the case for Storage Tech, it didn’t help. See Storage Technology Corp. v. Cisco Systems, Inc., 395 F. 3d 921 (8th Cir. 2005) (affirming summary judgment in favor of defendant). (For the author's more-detailed critique of the trial court's decision, see this posting.)

But that won't always be the case: A jury might simply overlook the failure to comply with the marking requirement, and hold the receiving party liable for misappropriation. That happened in Celeritas Technologies Ltd. v. Rockwell Int'l, Inc., 150 F.3d 1354 (Fed. Cir. 1998), where a federal-court jury in Los Angeles awarded a startup company more than $57 million because the jury found that Rockwell had breached a confidentiality agreement, even though the only information that had been marked per the agreement was later ruled by the appellate court to have been previously published by a third party. (Disclosure: The author was part of Rockwell's trial team in that case.)

Rule 3: "Safe sex"

Whether a party is giving or receiving confidential information, it should use "protection" in the form of a suitable confidentiality agreement to put fences around the parties’ rights and obligations.

And it pays to be choosy in one's choice of partners:

• If you'll be disclosing your own confidential information, you'll want to restrict the other party's ability to use and disclose your information, for reasons discussed in § Rule 1: Lock it up (within reason).

• If you'll be receiving the confidential information of another party, you'll want to put fences around your confidentiality obligations and be prepared to wall off your people who are "contaminated" by the other party's information. Failure to do so cost Rockwell International more than $57 million, because a federal-court jury found that Rockwell, in developing cellular-modem technology, had breached a confidentiality agreement with a small company, because some of Rockwell's engineering personnel who worked on the project had been exposed to the small company's allegedly-secret information. Celeritas Technologies Ltd. v. Rockwell Int'l, Inc., 150 F.3d 1354 (Fed. Cir. 1998). (Disclosure: The author was part of Rockwell's trial team in that case.)

The risk of contamination can be a particular, costly problem when you hire employees from competitors; this is discussed in James Pooley, How to Recruit and Hire While Avoiding Data Contamination (JDSupra.com 2017).

4.33 (Extra:) Confidentiality of parties' dealings

4.33.1 Business context

Parties often want the mere fact that they are in discussions to remain confidential, let alone the  details of their business dealings. That can present some tricky issues, though, especially in an employment-related agreement, as discussed in more detail below.

For example, in a sales agreement: • The vendor might want for the pricing and terms of the agreement to be kept confidential. Otherwise, a buyer for a future prospective customer might say, "I know you gave our competitor a 30% discount, and I want to show my boss that I can get a better deal than our competitor did, so you need to give me a /35/% discount if you want my business.” • Conversely, the customer might not want others to know who its suppliers are, possibly because the customer doesn't want its competitors trying to use the same suppliers.

Likewise, parties to “strategic” contracts such as merger and acquisition agreements very often want their discussions to be confidential. If the word leaks out that a company is interested in being acquired, that could send its stock price down.

Tangentially: Agreements to settle disputes sometimes require that the settlement terms be kept confidential. /See, e.g./, [[https://scholar.google.com/scholar_case?case=2824717101498685866][Caudill

  1. Keller Williams Realty, Inc.]], 828 F.3d 575 (7th Cir. 2016) (Posner,

J.) (affirming district-court holding that settlement agreement's liquidated-damages provision, calling for $20 million payment for breach of agreement's confidentiality requirement, was unreasonable).

4.33.2 Confidentiality of parties' dealings, not of their relationship

Drafters should be careful to make it clear that the parties' /dealings/ are confidential, not their /relationship/. If it were otherwise — that is, if an agreement said that the parties' /relationship/ was confidential — then the confidentiality provision might be (mis)interpreted as a declaration of a “confidential relationship”; that in turn might imply unwanted fiduciary obligations.

4.33.3 Confidential-dealings clauses have been enforced

Clauses requiring parties' contract terms to be kept confidential have been enforced. For example, in 2013 the Delaware chancery court held that a party materially breached an agreement by publicly disclosing the agreement's terms in violation of a confidentiality clause, thereby justifying other party's termination of agreement. /See/ eCommerce Indus., Inc. v. MWA Intelligence, Inc., No. 7471-VCP, part II-A, text accompanying notes 117 et seq. (Del. Ch. Oct. 4, 2013).

4.33.4 But a confidential-dealings clause might not be "material"

In a different case, the Supreme Court of Delaware held that in a patent license agreement, a provision requiring the terms of the license to be kept confidential was /not/ material, because the gravamen of the contract was the patent license, not the confidentiality provision; as a result, when the licensee publicly disclosed the royalty terms, the patent owner was not entitled to terminate the license agreement for material breach (see § 4.76).  Qualcomm Inc. v. Texas Instr. Inc., 875 A.2d 626, 628 (Del. 2005) (affirming holding of chancery court).

4.33.5 Beware of confidential-dealings clauses in employment agreements

In employment agreements, confidentiality provisions sometimes require the employee to keep confidential all information about salary, bonus, and other compensation. The NLRB and some courts have taken the position that such a requirement violates Section 7 of the National Labor Relations Act, as explained in this Baker Hostetler memo. (See also the discussion of how the [U.S.] Securities and Exchange Commission has taken a similar view about employees' reporting possible criminal violations to government authorities.)

4.34 (Skim:) Consent – unreasonable withhholding (rough notes)

For a discussion of one particular type of situation where this issue can arise, i.e., consent to assignment of an agreement, see How does the law treat "unreasonable" withholding of assignment consent?, § How does the law treat "unreasonable" withholding of assignment consent?.

For a review of English case law — and a reminder that such cases will usually be highly fact-intensive — see generally Porton Capital Technology Funds v. 3M UK Holdings Ltd, [2011] EWHC 2895 (Comm), paragraphs 219 et seq. In that case:

  • A biotech company sold itself to 3M. As is not uncommon in such cases, the biotech company's shareholders received not only cash but, importantly, an earn-out, that is, the right to a series of future payments whose amounts would rise or fall with the success of the company under 3M's ownership.
  • The agreement required 3M to obtain the consent of the shareholders before shutting down the business (because shutting the business down would deprive the shareholders of potential earn-out payments), but the shareholders could not unreasonably withhold their consent.
  • The business did not do well, and 3M wanted to shut it down; the shareholders refused to consent, but 3M shut the business down anyway, and the shareholders sued.
  • After reviewing prior holdings and the evidence in the case, the court held that the shareholders' withholding of consent had not been unreasonable, and awarded them damages equivalent to USD $1.3 million.

See id. at paragraphs 234, 353. Hat tip: David Nayler, who cited this case in a LinkedIn discussion (membership in the LinkedIn Drafting Contracts discussion group is required, and recommended).

But the opposite result occurred in Barclays Bank PLC v. Unicredit Bank AG, [2014] EWCA Civ 302 (affirming trial-court ruling). There:

  • Barclays had the right to consent to a particular type of financial transaction, but it was obligated to grant or withhold such consent in a commercially-reasonable manner.
  • The England and Wales Court of Appeals rejected Unicredit's argument that this meant that Barclays was required to take Unicredit's interests into account, not merely Barclays's own interests.

See id. at ¶ 16.

4.35 (Read:) Consequential damages

4.35.1 What ARE "consequential" damages, exactly?

The difference between consequential damages and "general" damages can sometimes be unclear. The commentary to the Restatement (Second) of Contracts contrasts the two terms:

Loss that results from a breach in the ordinary course of events is foreseeable as the probable result of the breach. Such loss is sometimes said to be the "natural" result of the breach, in the sense that its occurrence accords with the common experience of ordinary persons. … The damages recoverable for such loss that results in the ordinary course of events are sometimes called "general" damages.

If loss results other than in the ordinary course of events, there can be no recovery for it unless it was foreseeable by the party in breach because of special circumstances that he had reason to know when he made the contract. … The damages recoverable for loss that results other than in the ordinary course of events are sometimes called "special" or "consequential" damages.

These terms are often misleading, however, and it is not necessary to distinguish between "general" and "special" or "consequential" damages for the purpose of the rule stated in this Section.

Restatement (Second) of Contracts § 351, "Unforeseeability And Related Limitations On Damages," comment b (citations omitted, emphasis and extra paragraphing added).

FOOTNOTE: The above-quoted Restatement excerpt exemplifies what seems to be a modern trend of collapsing the traditional two-prong formulation of Hadley v. Baxendale into a single test: Whether the claimed damages were foreseeable by the breaching party. Under that test, one way for the non-breaching party to establish that its particular damages were foreseeable is for the non-breaching party to inform the breaching party, at the time the breaching party became bound by the obligation, of the non-breaching party's particular requirements or circumstances. See generally, e.g., Thomas A. Diamond & Howard Foss, Consequential Damages for Commercial Loss: An Alternative to Hadley v. Baxendale, 63 Fordham L. Rev. 665, part I-B, esp. n.35 & accompanying text (1994) (reviewing modern approaches to Hadley).

In the Uniform Commercial Code, section 2-715(2) defines consequential damages as follows:

Consequential damages resulting from the seller's breach include[:] (a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise …."

(Emphasis added.)

The Supreme Court of Texas has observed that:

Direct damages are the necessary and usual result of the defendant's wrongful act; they flow naturally and necessarily from the wrong…. Consequential damages, on the other hand, result naturally, but not necessarily.

El Paso Marketing, L.P. v. Wolf Hollow I, L.P., 383 S.W.3d 138, 144 (Tex. 2012) (internal quotation marks and footnote omitted, alterations by the court, emphasis added), subsequent proceeding, 450 S.W.3d 121 (Tex. 2014) (reversing court of appeals's order remanding for new trial on damages).

4.35.2 "Consequential" damages can be big

Noted practitioner-commentator Glenn D. West observes:

In 1984, an Atlantic City casino entered into a contract with a construction manager respecting the casino’s renovation. The construction manager was to be paid a $600,000 fee for its construction management services. In breach of the agreement, completion of construction was delayed by several months. As a result, the casino was unable to open on time and lost profits, ultimately determined by an arbitration panel to be in the amount of $14,500,000. There was no consequential damages waiver in the contract at issue in this case.

Glenn D. West, Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements, 70 Bus. Law. 971, 984 (Weil.com 2015) (footnote omitted), citing Perini Corp. v. Greate Bay Hotel & Casino, Inc., 129 N.J. 479, 610 A.2d 364 (1992) (affirming judgment confirming arbitration award), abrogated on other grounds by Tretina Printing, Inc. v. Fitzpatrick & Assocs., Inc., 35 N.J. 349, 640 A.2d 788 (1994) (restricting grounds on which arbitration awards can be reviewed by courts, but stating that parties could expand those grounds by contract).

As another example, a Dr. Kitchen, an Australian opthmalmologist, wrongfully terminated his service agreement with an eye clinic. The service agreement did not include an exclusion of consequential damages. The Supreme Court of Queensland held him held liable for the clinic's lost profits and other amounts, in the total sum of AUD $10,845,476. See Vision Eye Institute Ltd v Kitchen, [2015] QSC 66, discussed in Jodie Burger and Viva Paxton, Australia: A stitch in time saves nine: How excluding consequential loss could save you millions (Mondaq.com 2015).

4.35.3 Consequential damages — other specific examples

Some drafters like to enumerate specific categories of risk for which damages cannot be recovered, and cross their fingers that a court will enforce the enumeration congenially to them. The following categories have been harvested from various agreement forms but should be reviewed carefully, as some could be a bad idea:

  • breach of statutory duty;
  • business interruption;
  • loss of business or of business opportunity;
  • loss of competitive advantage;
  • loss of data;
  • loss of privacy;
  • loss of confidentiality [Editorial comment: This would normally be a really bad idea, at least from the perspective of a party disclosing confidential information.]
  • loss of goodwill;
  • loss of investment;
  • loss of product;
  • loss of production;
  • loss of profits from collateral business arrangements;
  • loss of cost savings;
  • loss of use;
  • loss of revenue.

For a summary of cases in U.S., English, and Australian courts addressing such "laundry lists," see West, Consequential Damages Redux, supra, 70 BUS. L. at 987-91.

4.35.4 "Lost profits" will often be deemed direct damages, not consequential damages

The laundry list of excluded damages (see § 4.35.3) should not be drafted, though, so as to be overly broad for the situation. That's why the lost-profits exclusion in this clause is phrased as lost profits from collateral business arrangements. See, e.g., Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 2014 NY Slip Op. 02101, where New York's highest court, reviewing case law held that, on the facts of the case, "lost profits were the direct and probable result of a breach of the parties' agreement and thus constitute general damages" and thus were not barred by limitation-of-liability clause.

As the Second Circuit explained:

Lost profits are consequential damages when, as a result of the breach, the non-breaching party suffers loss of profits on collateral business arrangements.

In the typical case, the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transactions, is contingent on the performance of the primary contract. When the breaching party does not perform, the non-breaching party's business is in some way hindered, and the profits from potential collateral exchanges are "lost."

Every lawyer will recall from his or her first-year contracts class the paradigmatic example of Hadley v. Baxendale, where Baxendale's failure to deliver a crank shaft on time caused Hadley to lose profits from the operation of his mill.

In New York, a party is entitled to recover this form of lost profits only if (1) it is demonstrated with certainty that the damages have been caused by the breach, (2) the extent of the loss is capable of proof with reasonable certainty, and (3) it is established that the damages were fairly within the contemplation of the parties.

By contrast, when the non-breaching party seeks only to recover money that the breaching party agreed to pay under the contract, the damages sought are general damages. The damages may still be characterized as lost profits since, had the contract been performed, the non-breaching party would have profited to the extent that his cost of performance was less than the total value of the breaching party's promised payments.

But, in this case, the lost profits are the direct and probable consequence of the breach. The profits are precisely what the non-breaching party bargained for, and only an award of damages equal to lost profits will put the non-breaching party in the same position he would have occupied had the contract been performed.

Tractebel Energy Mktg., Inc. v. AEP Power Mktg., Inc., 487 F.3d 89, 109-110 (2d Cir. 2007) (reversing judgment, after bench trial, denying plaintiff its lost profits) (citations and footnote omitted, emphasis and extra paragraphing added).

See also:

4.35.5 Fourth Circuit's lecture to negotiators of consequential-damages exclusions

The Fourth Circuit 'splained things to customers that negotiate services contracts containing consequential-damages exclusions:

Companies faced with consequential damages limitations in contracts have two ways to protect themselves.

First, they may purchase outside insurance to cover the consequential risks of a contractual breach, and second, they may attempt to bargain for greater protection against breach from their contractual partner.

Severn apparently did take the former precaution – it has recovered over $19 million in insurance proceeds from a company whose own business involves the contractual allocation of risk.

But it did not take the latter one, and there is no inequity in our declining to rewrite its contractual bargain now.

Severn Peanut Co. v. Industrial Fumigant Co., No. 15-1063, slip op. at 9 (4th Cir. Dec. 2, 2015) (affirming summary judgment in favor of service provider that had caused millions of dollars to its customer's facility) (extra paragraphing added).

4.35.6 Further reading

See:

4.36 (Black letter:) Conspicuous text

4.36.1 Overview: All-caps isn't necessary and might not be sufficient

In some jurisdictions, certain types of clauses might not be enforceable unless they are "conspicuous." For clauses in this category, courts typically want extra assurance that the signers knowingly and voluntarily assented to the relevant terms and conditions.

(Spoiler alert: A long provision in all-capital letters ("all-caps") won't necessarily be deemed conspicuous; it's just less readable.)

The SEC's Plain English Handbook (at 43) points out that:

… All uppercase sentences usually bring the reader to a standstill because the shapes of words disappear, causing the reader to slow down and study each letter. Ironically, readers tend to skip sentences written in all uppercase.

To highlight information and maintain readability, use a different size or weight of your typeface.

Try using extra white space, bold type, shading, rules, boxes, or sidebars in the margins to make information stand out. …

Whatever method you choose to highlight information, use it consistently throughout your document so your readers can recognize how you flag important information.

(Extra paragraphing added.)

The Handbook gives a "before" example:

THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

It suggests replacing the all-caps with italics:

The Securities and Exchange Commission has not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Or bold-faced type:

The Securities and Exchange Commission has not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

4.36.2 (Extra:) The UCC definition of conspicuousness

The [U.S.] Uniform Commercial Code doesn't apply to all types of transaction, nor in jurisdictions where it has not been enacted. Still, the Code's definition of "conspicuous" in section 1-201(10) (Texas version) nevertheless provides useful guidance:

A term or clause is conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it.

A printed heading in capitals (as: NON-NEGOTIABLE BILL OF LADING) is conspicuous.

Language in the body of a form is "conspicuous" if it is in larger or other contrasting type or color.

But in a telegram any stated term is "conspicuous".

Tex. Bus. & Com. Code § 1.201(10) (extra paragraphing added).

4.36.3 (Black letter:) In judging conspicuousness, courts tend to focus on "fair notice"

In a non-UCC context, the Supreme Court of Texas held that — with a possibly-significant exception — an indemnity provision protecting the indemnitee from its own negligence must be sufficiently conspicuous to provide "fair notice." The supreme court adopted the conspicuousness test stated in the UCC, quoted above; the court explained:

This standard for conspicuousness in [Uniform Commercial] Code cases is familiar to the courts of this state and conforms to our objectives of commercial certainty and uniformity. We thus adopt the standard for conspicuousness contained in the Code for indemnity agreements and releases like those in this case that relieve a party in advance of responsibility for its own negligence.

When a reasonable person against whom a clause is to operate ought to have noticed it, the clause is conspicuous.

For example, language in capital headings, language in contrasting type or color, and language in an extremely short document, such as a telegram, is conspicuous.

Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (citations omitted, emphasis and extra paragraphing added).

The Dresser court also pointed out that the fair-notice requirement did not apply to settlement releases: "Today's opinion applies the fair notice requirements to indemnity agreements and releases only when such exculpatory agreements are utilized to relieve a party of liability for its own negligence in advance." Id., 853 S.W.2d at 508 n.1 (emphasis added).

4.36.4 (Black letter:) Fair notice will often depend on the circumstances

What counts as "conspicuous" will sometimes depend on the circumstances. In still another express-negligence case, the Texas supreme court said that the indemnity provision in question did indeed provide fair notice because:

The entire contract between Enserch and Christie consists of one page; the indemnity language is on the front side of the contract and is not hidden under a separate heading.

The exculpatory language and the indemnity language, although contained in separate sentences, appear together in the same paragraph and the indemnity language is not surrounded by completely unrelated terms.

Consequently, the indemnity language is sufficiently conspicuous to afford "fair notice" of its existence.

Enserch Corp. v. Parker, 794 S.W.2d 2, 8-9 (Tex. 1990) (extra paragraphing added).

4.36.5 (Black letter:) Actual knowledge – when proved – might substitute for conspicuousness

Texas's Dresser court noted an exception to the conspicuousness requirement: "The fair notice requirements are not applicable when the indemnitee establishes that the indemnitor possessed actual notice or knowledge of the indemnity agreement." Id., 853 S.W.2d at 508 n.2 (emphasis added, citation omitted).

Note especially the italicized portion of the quotation, which implies that the burden of proof of actual notice or knowledge is on the party claiming indemnification from its own negligence.

In contrast, a federal district judge in Houston granted Enron's motion to dismiss Hewitt Associates' claim for indemnity, on grounds that the contract in question did not comply with the conspicuousness requirement of the express-negligence rule (see § 4.68.6); the judge surveyed prior cases in which actual knowledge (of an indemnity clause) had been sufficiently established, including by ways such as:

  • evidence of specific negotiation, such as prior drafts;
  • through prior dealings of the parties, for example, evidence of similar contracts over a number of years with a similar provision;
  • proof that the provision had been brought to the affected party's attention, e.g., by a prior claim.

See Enron Corp. Sav. Plan v. Hewitt Associates, LLC, 611 F. Supp. 2d 654, 673-75 (S.D. Tex. 2008).

4.36.6 (Black letter:) Conspicuous doesn't necessarily mean all-caps or bold-faced type

Contract drafters sometimes put entire paragraphs into all-capital letters in the hope of making them "conspicuous." You've probably seen examples of this particular disorder in warranty disclaimers and limitations of liability.

But keeping the all-caps going for line, after line, after line, can be self-defeating. The Georgia supreme court observed acidly (but arguably in dicta):

No one should make the mistake of thinking, however, that capitalization always and necessarily renders the capitalized language conspicuous and prominent.

In this case, the entirety of the fine print appears in capital letters, all in a relatively small font, rendering it difficult for the author of this opinion, among others, to read it.

Moreover, the capitalized disclaimers are mixed with a hodgepodge of other seemingly unrelated, boilerplate contractual provisions — provisions about, for instance, a daily storage fee and a restocking charge for returned vehicles — all of which are capitalized and in the same small font.

Raysoni v. Payless Auto Deals, LLC, 296 Ga. 156, 766 S.E.2d 24, 27 n.5 (2014) (reversing and remanding judgment on the pleadings) (emphasis and extra paragraphing added).

The drafting tips here, of course, are:

  • Be judicious about what you put in all-caps.
  • Don't use too-small a font for language that you want to be conspicuous.

See also Linda R. Stahl, Beware the Boilerplate: Waiver Provisions (Andrews Kurth Jan. 14, 2013) (citing Texas cases).

4.37 (Skim:) Consumer Price Index ("CPI")

4.37.1 Basic definition

A typical definition for CPI will be the Consumer Price Index – All Urban Consumers ("CPI-U"), as published from time to time by U.S. Bureau of Labor Statistics.

4.37.2 Business context

CPI clauses are sometimes included in contracts for ongoing sales or goods or services. Such contracts will typically lock in the agreed pricing for a specified number of years, subject to periodic increases by X% per year (let's say) or by the corresponding increase in CPI, whichever is greater (or sometimes, whichever is less).

Depending on the industry, CPI-U might or might not be the best specific index for estimating how much a provider's costs have increased. this is explained in the FAQ page of the Bureau of Labor Statistics (accessed Aug. 16, 2012).

4.37.3 (Black letter:) Caution: "The lesser of CPI or X%" could be dangerous

Prohibiting a provider from increasing its pricing by more than the increase in CPI or X percent per year, whichever is less, would force the provider to 'eat' any increases in its own costs that exceeded the increase in the particular index chosen.

4.37.4 (Extra:) Consider: What if CPI goes down?

A drafter might want to specify whether agreed pricing, rent, etc., can ever decrease as a result of changes in CPI.

4.37.5 (Extra:) Consider: Are pricing increases to be compounded?

If price increases are limited to adjusting for increases in CPI over a baseline figure, that will automatically take care of compounding. But if the permissible price increase is "the change in CPI or X%, whichever is greater," then the X% might end up being compounded over time, so that the X% increase in Year One would itself be increased by another X% in Year Two. [NEED EXAMPLE]

4.37.6 Optional reading

4.38 (Read:) Contra proferentem

4.38.1 Overview

Drafters should keep firmly in mind the contra proferentem principle of contract interpretation. That principle holds that if an ambiguity in particular language cannot be resolved by other conventional means (such as those discussed above), then the ambiguity should be resolved against the party that drafted the ambiguous language and thus is "to blame" for the problem. (If a contract provision is not ambiguous, then contra proferentem won't come into play in the first place.)

The contra proferentem principle gives drafters a powerful incentive to draft clearly: As between the drafter of ambiguous language, on the one hand, and the "innocent" other party, it's the drafter that must bear the consequences of the ambiguity.

The (U.S.) Supreme Court explained the concept of contra proferentem: "Respondents drafted an ambiguous document, and they cannot now claim the benefit of the doubt. The reason for this rule is to protect the party who did not choose the language from an unintended or unfair result." Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62-63 (1995) (reversing 7th Circuit) (citations and footnotes omitted).

For additional information, see generally:

4.38.2 (Extra:) Typing a provision doesn't necessarily mean drafting it

In Song v. Iatarola, 83 N.E.3d 80 (Ind. App. 2017), one party to a contract lost a case because of the way the court interpreted a particular provision in the contract. On appeal, the losing party claimed that the provision should have been interpreted against the winning party because the winning party supposedly "wrote" the provision. The record, though, contained evidence that, while the winning party had typed the provision into the Word document, the parties had jointly drafted the actual wording of the provision. That sank the losing party's argument; the appellate court held that:

During the summary judgment stage and in their appeal, the Iatarolas failed to establish that no genuine issue of material fact existed about whether Song independently drafted the addendum such that its interpretation should be construed against him. Rather, the evidence outlined above indicates that it was the Iatarolas who wanted the addendum drafted, and that both parties contributed to its preparation.

Id. at 81 (on rehearing; emphasis added).

4.38.3 (Read:) Caution: Disclaiming contra proferentem could cause problems

Suppose that a court or arbitrator concluded (1) that there was no way to resolve an ambiguity in a contract, other than by applying the contra proferentem principle, but (2) the parties had agreed that contra proferentem was not to be applied. The results in that situation might be unpredictable:

  • The tribunal might disregard the contra proferentem prohibition and apply the principle to resolve the ambiguity; or
  • The tribunal might rule that the ambiguous provision could not be enforced — which in some circumstaces might jeopardize the enforceability of the entire contract.

(Hat tip: Jonathan Ely, in a comment in a LinkedIn group discussion (group membership required).)

4.39 (Read:) Contracting mechanics

In American law schools, students learn very early that under the Statute of Frauds, many and even most business contracts must take the form of a signed writing — but also that such a writing can be enforceable in court even if it's not terribly detailed.

4.39.1 (Black letter:) A countersigned letter can be enough.

(Just skim this section to the extent that you care to, but remember the heading.)

Not long after the author started work as an associate at Arnold, White & Durkee, the senior name partner, Tom Arnold,* called me to his office. Tom asked me to draft a confidentiality agreement for a friend of his, “Bill,” who was going to be disclosing a business plan to his (Bill’s) friend, “Jim.”

* The late Tom Arnold founded Arnold, White & Durkee, which grew to become what we think was the second-largest intellectual property boutique in the United States, with some 150 lawyers in six cities. Tom was everything a lawyer should be; for many years he and his wife, the late (and aptly-named) Grace, were very good to my wife Maretta and me.

Tom instructed me not to draft a conventional contract. Instead, the confidentiality agreement was to take the form of a short letter along approximately the following lines, paraphrased from memory:

Dear Jim,

This confirms that I will be telling you about my plans to go into business [raising tribbles, let's say] so that you can evaluate whether you want to invest in the business with me.

You agree that unless I say it's OK, (1) you won’t disclose what I tell you about my plans to anyone else, and (2) you won’t use that information yourself for any other purpose.

You won't be under this obligation, though, to the extent that (A) the information in question has become public, or (B) you get the information from another source that has legitimately acquired or developed the information itself.

If this is agreeable, please countersign the enclosed copy of this letter and return it to me.

I look forward to our working together.

Sincerely yours,

Bill

When I’d prepared a draft, I asked Tom, isn’t this pretty sparse?

Tom replied, yes it was sparse, but:

  • The signed letter would be a binding, enforceable, workable contract, which Bill could take to court if his friend Jim double-crossed him (which Bill judged to be very unlikely); and
  • Equally important to Bill: Jim would almost certainly sign the letter immediately — whereas if Bill had asked Jim to sign a full-blown confidentiality agreement, Jim likely would have asked his lawyer to review the agreement, and that would have delayed things.

That experience was an eye-opener. It taught me that contracts aren’t magical written incantations: they’re just simple statements of simple things. It also was my first lesson in a fundamental truth: Business clients are often far more interested in being able to sign an "OK" contract now than they are in signing a supposedly-better contract weeks or in the future.

As another example, see the 2006 letter agreement for consulting services between Ford Motor Company and British financial wizard Sir John Bond (for USD $25,000 per day), at https://goo.gl/cXMrX5 (archive.org):

[Letterhead for Secretary of Ford Motor Company]

September 13, 2006

Sir John Bond
[Address redacted]

Dear Sir John:

This letter will confirm our discussions on the terms of your consultancy to Ford Motor Company:

  • We have agreed that you will be a consultant to Ford Motor Company and William Clay Ford, Jr., generally spending the whole of the Tuesday and the morning of the Wednesday preceding each of our seven regular Board of Directors meetings in consultation with senior management of Ford Motor Credit Company and senior finance management of Ford.
  • We will compensate you at the rate of $25,000 per day, which amount would be pro-rated for each Wednesday that you consult with Company management. Accordingly, you would receive $37,500 for each Tuesday/Wednesday that you consult with Company management, or $262,500 per 12 month period. Any additional consulting and resulting compensation would have to be specifically agreed between you and Ford. We will pay you in arrears at the end of each calendar quarter. Of course, we will also reimburse you for normal and customary travel and business expenses incurred by you in providing the consulting services upon submission of appropriate documentation. As a member of the Board of Directors of Ford, you also will continue to receive the fees paid and other benefits provided to non-employee directors.
  • We will provide you with office, computer and other incidental support when in Dearborn, Michigan.
  • Either you or Ford can terminate the consulting arrangement at any time, in your or Ford's sole discretion, in which event Ford will pay you for consulting services previously rendered and reimburse you for travel and business expenses previously incurred.
  • The effective date of our agreement shall be the date of your concurrence, below; however, the Company shall pay you in accordance with this agreement for the time you spent consulting with Ford executives in connection with the July meeting of the Board of Directors.
  • Your signature, below, will also confirm your resignation from the Compensation Committee and the Nominating and Governance Committee of the Company.

If you concur in the consulting arrangement as described above, please so indicate by signing and dating this letter at the space below.

[Signature blocks]

(Optional reading:) For more on this particular consulting agreement, see Rob Cox, The $25,000 Bond (TheBreakingNews.com 2006).

4.39.2 (Black letter:) An exchange of texts or emails might be sufficient.

(Just skim this section to the extent that you care to, but remember the heading.)

In a federal-court lawsuit in Florida (decided under Delaware law), a text-message exchange served as a binding agreement to modify an existing contract — and that agreed modification went on to cost one of the parties more than a million dollars. In that case:

  • An Internet advertising agency had a contract to supply online sales leads to its client, a manufacturer of electronic cigarettes.
  • The contract limited the client's payment obligation to 200 leads per day.
  • But a vice-president of marketing at the client had a text-message conversation with the account manager at the Internet ad agency; the operative part of the conversation was as follows:

[Account manager:] We can do 2000 orders/day by Friday if I have your blessing

[Client VP:] NO LIMIT

[Account manager:] awesome!

But then when ad agency billed the client for the higher number of sales orders, the client didn't pay, and so the ad agency sued and won a judgment for $1,240,655, because:

  • the account manager's text proposing 2,000 orders per day constituted an offer to modify the contract to modify the 200-per-day limit;
  • the manufacturer's vice president's "NO LIMIT" response constituted a counteroffer; and
  • the account manager accepted the counteroffer with the "awesome!" reply.

The court therefore held that the text-message exchange was a binding agreement to modify the existing contract. CX Digital Media, Inc. v. Smoking Everywhere, Inc., No. 09-62020-CIV, slip op. at 8, 17-18 (S.D. Fla. Mar. 23, 2011).

4.39.3 (Optional:) To close more business, a GE unit streamlined its contract forms

Contract forms tend to grow by accretion, as lawyers think of issues that could arise. As a result, what a commenter said about politicians fearful of voter backlash might apply equally to contract drafters fearful of client finger-pointing: “As with mass incarceration, efforts to reform airport security are hamstrung by politicians and administrators [read: lawyers] who would prefer to inflict hassle on millions than be caught making one mistake.” Henry Grabar, Terminal: How the Airport Came to Embody Our National Psychosis (Slate.com 2017).

Not surprisingly, the legal department of one General Electric business unit found that its "comprehensive" contract documents were sabotaging its ability to close sales deals:

When GE Aviation combined its three digital businesses into a single Digital Solutions unit nearly four years ago, their salespeople were eager to speed up the growth they had seen in the years before the move. They found plenty of enthusiastic customers, but they struggled to close their deals.

The reason: Customers often needed to review and sign contracts more than 100 pages long before they could start doing business.

The new business inherited seven different contracts from the three units. The clunky documents were loaded with legalese, redundancies, archaic words and wordy attempts to cover every imaginable legal [sic]. No wonder they languished unread for months.

"We would call, and customers would say, 'I can’t get through this,'" says Karen Thompson, Digital Solutions contracts leader at GE Aviation. “And that was before they even sent it to their legal team!

"Who is going to pick up a 100-plus-page document and sort through it to find language they disagree with? We were having trouble moving past that part to what we needed to do, which was sell our services.”

For those customers who did read the contract, negotiations would drag on and on.

Kristin Kloberdanz, Honey, I Shrunk The Contract: How Plain English Is Helping GE Keep Its Business Humming, (GE.com 2017) (extra paragraphing added).

What was a surprise was that the legal department actually did something about i. The general counsel of that GE business unit described his team's motivations in a Harvard Business Review article:

… For the most part, the contracts used in business are long, poorly structured, and full of unnecessary and incomprehensible language. …

A contract should not take countless hours to negotiate. Business leaders should not have to call an attorney to interpret an agreement that they are expected to administer.

We should live in a world where contracts are written in accessible language—where potential business partners can sit down over a short lunch without their lawyers and read, truly understand, and feel comfortable signing a contract. A world where disputes caused by ambiguity disappear.

Shawn Burton, The Case for Plain-Language Contracts, Harv. Bus. Rev., Jan.-Feb. 2018, at 134 (extra paragraphing added). Burton provides several examples of streamlined provisions, such as the following revision:

Before:

Customer shall indemnify, defend, and hold Company harmless from any and all claims, suits, actions, liabilities, damages and costs, including reasonable attorneys’ fees and court costs, incurred by Company arising from or based upon (a) any actual or alleged infringement of any United States patents, copyright, or other intellectual property right of a third party, attributable to Customer’s use of the licensed System with other software, hardware or configuration not either provided by Company or specified in Exhibit D.3, (b) any data, information, technology, system or other Confidential Information disclosed or made available by Customer to Company under this Agreement, (c) the use, operation, maintenance, repair, safety, regulatory compliance or performance of any aircraft owned, leased, operated, or maintained by Customer of [sic; or] (d) any use, by Customer or by a third party to whom Customer has provided the information, of Customer’s Flight Data, the System, or information generated by the System.

After:

If an arbitrator finds that this contract was breached and losses were suffered because of that breach, the breaching party will compensate the non-breaching party for such losses or provide the remedies specified in Section 8 if Section 8 is breached.

(DCT comment: Substantively, the After version arguably has some minor problems, but what's of interest here is how the drafters were able to streamline the wall-of-words ("WOW") provision pretty significantly.)

4.39.4 (Optional:) The Pathclearer approach uses letter agreements and business motivations

It's optional, but worth your time, to read a coldly-realistic article about the drawbacks of long, detailed contracts, in contrast to the benefits of the Pathclearer approach developed by in-house counsel at Scottish & Newcastle, a brewery in the UK. The Pathclearer approach involves using short letter agreements instead of long, complicated contracts, and relying on commercial motivations — i.e., each party's ability to walk away, coupled with the desire to retain a good business partner — and the general law to fill in any gaps that might be left. See Steve Weatherley, Pathclearer: A more commercial approach to drafting commercial contracts, Practical L. Co. L. Dept. Qtrly, Oct.-Dec. 2005, at 40 (emphasis added).

4.40 (Optional:) Cross-references

A UK legislative drafting guide suggests, at page 25, § 3.10 (with examples):

  • A cross-reference might not be needed.
  • "3.10.2 It is helpful to refer to a substantive rule or proposition, rather than the statutory provision containing it (in which readers are unlikely to be interested)."
  • "3.10.4 It is generally helpful to provide a parenthetical description [of a cross-referenced provision] …. But consider the usefulness of the descriptive words against the disadvantage of interrupting the flow of text."

(Thanks to English solicitor Paul de Cordova for the above link.)

4.41 (Study:) Course information

4.41.1 General course information

The course materials are available online

The main reading material will be the following.

WARNING: The documents below are long, so I would not suggest printing them out. (I'm working on consolidating them but it's taking time.)

• This book, which is still very much a work in progress. I intend to keep making it available at no charge. Students are encouraged to make suggestions and comments as the semester progresses.

• a Supplement, consisting of several real-world contracts that I've annotated and printed to PDF. We'll study selected portions of some of these contracts.

• the Common Draft annotated catalog of contract terms, a side project of mine.

Objective: An exposure to the tools of the trade

Our primary course objectives and learning outcomes are to give each student an initial, survey-type exposure to the following tools of the contract drafter's and reviewer's trade:

  1. Techniques for drafting simple, understandable sentences and paragraphs to cover complex topics;
  2. Important legal doctrines, e.g., laws governing interest charges, indemnities, implied warranties, etc.;
  3. Crucial business issues that are commonly addressed in contracts;
  4. Practicing spotting and fixing language ambiguities that could cause problems down the road;
  5. The psychology of likely future readers such as business people, judges, and jurors;
  6. Finding and harvesting useful "precedents" (past contracts);
  7. Recognizing when to ask the partner or the client — and getting in the habit of documenting that you did so.
What this course won't do

First: Do NOT assume that we will "cover the material" in class, because:

  • We have a total of 35 hours together in class; that's not enough nearly time to do justice to all the material you'll need to be aware of in order to be a competent contract drafter or reviewer. Possibly more than in your other courses, you'll need to be sure to do the reading if you want to get maximum benefit from the course.
  • As discussed in § A variation on Socratic method, with inclass study groups, the sage-on-a-stage lecture approach has been shown to be significantly less effective when it comes to comprehension and retention, so we will focus the class time on trying to make sure you understand and retain as many crucial points as possible.

Second: This course isn't like a driver's ed class, where completing the course will make you at least minimally competent to "go out on the road" by yourself. Becoming a competent contract drafter far more time and effort than can be provided in a single three-semester-hour course. Even after you finish this course, you likely will — and should — worry that you don't know what you don't know.

(You could think of this course as being akin to a surgical-tools class in which medical students learn the basics of using scalpels, clamps, suture needles, and other surgical tools, and practice using those tools by doing a few simple procedures on an anatomical mannequin. Completing such a class, without more, should not make a student feel "comfortable" doing any kind of surgery on a live person; that's why newly-graduated doctors must still spend years in residencies to learn their trade. Much the same would be true if you were to try drafting a contract for a real client with no other training than this course.)

A variation on Socratic method, with inclass study groups

We will use a supposedly-new approach known as "flipping the classroom." This approach has become popular in educational circles, because it has been shown to be more effective than the trad­i­tion­al lecture format. See, e.g., Cyn­thia J. Brame, Flipping the Classroom (Vand­er­bilt.edu 2013: https://goo.gl/trS6e4). It has also been popular with many students in past semesters of this course, as noted in the social-proof discussion (§ Social proof: Past student comments (good and bad)).

Flipping the classroom is what law schools have been doing for years: The concept was pioneered by Harvard physics professor Eric Mazur, but he himself cites the law-school case study method as "one of the first implementations of the flipped classroom." The flipped classroom will redefine the role of educators (an interview with Eric Mazur) (Harvard.edu 2013: https://goo.gl/bSdh55).

Contract revising as well as drafting

In this course, we will practice good drafting skills — in part — by revising the work of others. This reflects what you're almost certain to see in practice: Contract drafters spend far less time drafting contracts than they do in reviewing and revising others' drafts, whether a given existing draft was prepared by "the other side" or was used in a previous deal.

Even when you're the one who must prepare the first draft, your partner will almost always tell you to find a previous form of agreement and modify it (and perhaps will suggest one). An existing form will encode , instead of starting from scratch with a blank screen. In part, that's because it can be

An analogy: When Princess Diana was killed in a car accident, her funeral plans were not drawn up from scratch; instead, the British government modified an existing plan (code-named Operation Tay Bridge, previously prepared and rehearsed for the Queen Mother's funeral). See https://goo.gl/S7U8Qr (Wikipedia.org).

Peer review of much student work

I will of course review and provide feedback on the assigned writing projects, and I will walk around and offer real-time comments during the in-class drafting sessions. To make it possible for you to do more practice-type exercises, some of your drafting- and revision assignments will be "reviewed" by your colleagues in your small groups, often by comparing them with model answers that I provide.

Spaced repetition, with (some) jumping around

Some of the short exercises and quizzes that we do will seem repetitive; they also will seem to jump around from topic to topic. This is a feature, not a bug, because:

  • It mirrors what you'll almost certainly see in practice; and
  • pedagogically it's been shown to be more effective at promoting long-term memory than lecture and repetitive reading. See generally Spaced retrieval (Wikipedia: https://goo.gl/4PRZTy).

This approach might strike a few students as disorganized. Over the years, though, most students seem to have come to appreciate the value of the approach, as mentioned in some of the student comments in § Social proof: Past student comments (good and bad).

Incidentally, you can do your own spaced-retrieval practice by using the online flashcards. The in-class quizzes and the non-essay portions of the final exam will be drawn very largely from these flashcard questions.

Social proof: Past student comments (good and bad)

Following the sales-and-marketing principles of (i) using social proof, and (ii) "setting the hook," here are some student comments from official course evaluations and from virtual-whiteboard feedback at the end of various past semesters:

• "Great job! Loved the quizzes. Very helpful class."

• "I saw what I learned in class be used at my job, so that was great to be able to use what I learned already as a student practicing."

• "One of the best classes of my time in law school. Great progressive approach to teaching. I can only hope that UH will adopt Toedt's methodology for other classes."

• "I liked the practical approach of the course – very effective teaching technique by using repetition and in class exercises."

• "You learn piece by piece the process throughout the semester to be able to effectively draft/redline contracts."

• "His course is different from the norm and his methods are re­freshing. … Professor Toedt's approach allows students to figure out the issue on their own but provides students with the tools necessary to reach an answer (which he then explains/corrects)."

• "… really enjoyed the approach to class and quizzes."

• "I like the in class exercises. Very helpful to lock in the concepts. I would recommend more of these types of exercises throughout the class. Amount of reading was reasonable."

• "Love the quizzes! They are really helpful to learn things, and the spaced repetition was excellent. Also they were a good way to test what we knew and where we were in class so we had an idea of how things were going."

• "I liked both the class and instructor and would recommend this course."

* * * 

Here are some less-positive comments, along with my responses.

• "I also felt that we did not have enough time to complete the quizzes." (From a different student's review:) "Most tests/exams we are used to taking in law school last hours, not minutes. If the timing is off on a test, then that basically destroys the effectiveness of the actual test as a way to measure how students are learning."

DCT response: By design, each quiz has too many questions. That way, students won't have time to look up many of the answers on-the-fly, and so those who don't need to do so will get a better score. (This practice also has a pedagogical aspect to it: If you don't remember an answer while taking a quiz, it's better for you to be able to look it up right then and there, instead of guessing, because that little bit of real-time review will make you somewhat more likely to remember the correct answer next time.)

• "The classes felt a little haphazard on a weekly basis." (From a different student's review:) "[T]he course is extremely unorganized …."

DCT response: The topics covered in the course are arranged in very rough order of importance (in my experience). And, as noted in § Spaced repetition, with (some) jumping around, spaced repetition can indeed feel like jumping around, but it's key to the approach of this course.

• "I thought some of the reading assignments were a little long. It just looks daunting and I am not motivated when one section has 20-50 subsections."

DCT response: Noted — I've redone the reading assignments to indicate more what must be read closely, versus what can be merely looked over or skimmed (so that you'll likely remember that it's there and can look it up if you ever need it in the future).

• "I felt like we spent a ton of time revising contracts and simplifying them, but I'm still not sure that I have a great grasp of all the sections of a contract." (From a different student's review:) "I liked that the class stressed practical knowledge and what to look out for when reviewing contracts but I do not feel like that this has translated into me feeling confident (or even semiconfident) writing or reviewing a contract in real life."

DCT response: It's normal not to feel confident until you've had a fair amout of real-world experience that didn't blow up on you. Think back to when you first drove a car by yourself; see also What this course won't do, § What this course won't do.

• "To me, I think the stress of a contract for a law student is the idea of, if you're assigned to write up a contract from scratch, your thought is, where do I even begin?"

DCT response: Noted; I'm thinking about how to remedy this with some kind of step-by-step procedure — although as pointed out in § Contract revising as well as drafting, contract drafters almost never start with a clean sheet of paper or blank computer screen.

• "[W]hile I found it helpful that we started the pass-fail assignments in class and could discuss with fellow students and the instructor I would have liked more personal comments back on the finished product." (From a different student's review:) "Overall, I thoroughly enjoyed this class and learned a significant amount. The only change that I would be recommend [sic] is for the instructor to if at all possible decrease the amount of peer review of homework and substitute it with his own review."

DCT response: As discussed in § Peer review of much student work, peer review enables us to provide each student with more opportunities to do short drafting assignments and get feedback on them. If we only did instructor feedback, we'd necessarily have fewer of these opportunities, and consequently less practice in drafting. That said, I've reworked the schedule of homework assignments and plan to do more review and commenting myself.

• "I do think you could go without any reference that might offend students. For example, I think there is a "safe sex" reference that is unnecessary …."

DCT response: "Safe sex" is a metaphor that I use as Rule 3 of my Three Rules for Protecting Trade Secrets. To make the underlying principle more memorable, I've been using the safe-sex metaphor for probably 20-plus years, in dozens of presentations to CLE audiences, business managers, entrepreneurs, law students, and business students — during that time, only this student and one business manager several years ago have ever complained the metaphor was offensive. (I also refer to "d[**]kish documents" in § 4.24.1.)

These metaphors seem to help convey the underlying concepts to adult audiences, so I anticipate that I will continue to use them.

4.41.2 Administrative details

Computer use; email addresses

» Computer use in class is not just encouraged but required; you will need in-class Web access for many of the in-class exercises. If this will be a problem, be sure to contact me well in advance.

(You might, however, want to rethink the extent to which you use laptops in your other classes; see, e.g., this article by a professor at the University of Michigan about how classroom laptop users not only do worse than those who take notes by hand, they also interfere with the learning of non-laptop users around them.)

» On the first class day I will be asking for your email addresses so that I can include it in a class Google Group. Please provide an email address that you check regularly.

Extra class time each day (to avoid needing a makeup class)

I'm a practicing attorney and arbitrator; I normally don't have to miss class, but it has been known to happen, e.g., when I've had out-of-town commitments. There have also been times when class has been canceled due to weather. (And on the evening of Game 7 of the 2017 World Series, we canceled the evening class.)

The ABA requires 700 minutes of instruction for each credit hour; that means we need 2,100 minutes of instruction for our three-hour course. Because of holidays, we have only 27 scheduled class meetings. We will achieve the needed minutes of instruction by a combination of the following:

  1. meeting for 80 minutes per class for 26 classes — but that will leave us 20 minutes short;
  2. having a 27th class meeting if necessary, e.g., as a makeup day;
  3. as permitted by ABA rules, doing one or two classes "online"; I haven't figured out the details yet but will keep you posted; and/or
  4. as a last resort, meeting on one of our scheduled Friday-evening makeup days.
Recording my lectures: Go ahead if you want

I don't make audio recordings of my lectures, but I have no objection to students doing so and sharing the recordings with other UHLC students.

Last-day agenda: Reviews, Jeopardy, pizza

The last day of class will generally include:

  • Pizza for the section (6:00 p.m. or 7:30 p.m.) that has the highest average total score, including the class attendance, homework, and quizzes;
  • An overview of the final exam plan;
  • A collaborative review of key concepts, using the virtual whiteboards to create a master outline for each group — the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section );
  • A group discussion of what would make the course and/or the materials more useful to next semester's students, and what didn't work so well, again using the virtual whiteboard;
  • Course evaluations, using the UH online system; and
  • As one last review: a Jeopardy! game.

4.42 (Read:) Contact information; office hours

4.42.1 My contact information

I can be reached at dc@toedt.com or (713) 364-6545 (which forwards to my cell); see also my About page.

I respond pretty quickly to email questions. If I think that a question might be of interest to other students, I'm likely to copy and paste it (possibly edited, and with identifying information redacted) into an email to one or both sections.

4.42.2 Office hours

As an adjunct professor, I generally don't physically come to the school except to teach class. I'm happy to meet with students as follows:

HOW WHEN APPT. NEEDED?
In person MW 5:30 p.m. Yes
In person MW 8:50 p.m. No
Skype or Zoom video; phone MTWThF 3:00 p.m. Yes

I strongly encourage each student to make at least one appointment during the semester to discuss any questions that they or I might have.

4.43 (Read:) Counseling available

Counseling and Psychological Services (CAPS) can help students who are having difficulties managing stress, adjusting to the demands of a professional program, or feeling sad and hopeless. You can reach CAPS (http://www.uh.edu/caps) by calling 713-743-5454 during and after business hours for routine appointments or if you or someone you know is in crisis. No appointment is necessary for the “Let's Talk” program, a drop-in consultation service at convenient locations and hours around campus. Go to http://www.uh.edu/caps/outreach/lets_talk.html for more information.

4.44 (Study:) Grading: Quizzes, final exam, etc.

4.44.1 The school's required average: 3.0 to 3.4

As required by law school policy for a writing class, raw grades will be adjusted pro­por­tion­al­ly to the extent necessary to make the average of the final class grades fall within the range specified in the heading of this section. (My usual practice — but not a guaranteed one — is to "move the curve" up or down as necessary so that the average is as close as practicable to the high end of the required range.)

4.44.2 Your final grade is based on 900 total possible points

Your course grade will be based on how many points you earn out of 500 900 total possible points, as explained below.

4.44.3 100 points: Class attendance — a "signing bonus" (that can be lost)

How to lose points for non-attendance

Every student starts out with the above "freebie" points for class attendance, but can lose points for missing class, as follows:

TOTAL CLASSES MISSED TOTAL POINTS LOST
1 0
2 10
3 30
4 60
5 or more all 100

This means, of course, that students who miss more than one class will have to do that much better on the final, the quizzes, and homework in order to keep up with their classmates on the school-required average.

Some absences won't lose points

• I don't count absences for "official" law school travel, e.g., for moot-court competitions, etc., as long as I'm informed in advance.

• I also don't count up to two absences for illness --• if you're ill, please don't come to class and infect the rest of us. Please email me if you'll be absent for illness; I'll take your word for it without a doctor's note.

• Other absences, e.g., for job interviews, office visits, work trips, etc., will be counted as missed classes and will lose points as set forth above; please schedule accordingly.

On any given day, if I see that one or more students are missing, I will circulate an attendance sign-in sheet. If I see that everyone is present, I normally won't bother doing so.

For regular "classroom" sessions, I no longer let students attend remotely, because experience has shown that realistically, remote attenders don't participate in the small-group discussion.

Why attendance is especially important

The class attendance policy arises from the fact that we will be doing:

  • a significant amount of in-class discussion; and
  • a significant number of in-class exercises, in two- to four-person teams.*

* Notice how it’s a significant amount of discussion, versus a significant number of exercises, as explained in the Grammarist.com discussion.

Consequently, it's important for all students to attend each class, not just for their own benefit, but so that their teams won't be shorthanded.

ABA accreditation rules and school policy require attendance at 80% of the class meetings for each course. We will meet a total of 26 times; rounding to the nearest whole number of classes, a student therefore must attend at least 21 class periods to comply with the 80% rule.

4.44.4 200 points: Short drafting homework assignments (mostly pass-fail)

Homework will be due each Wednesday at the beginning of class. The fact pattern and specific assignments are at § 3.

General instructions for the drafting homework:

  1. Many drafting-assignment homeworks will be pass-fail; any that are not pass-fail will be "flagged" as such in advance.
  2. For each provision you draft, do so from the perspective of the client you're representing — but keep in mind that the client might be more interested in getting an "OK" contract to signature as soon as possible, and then going about its business, than in negotiating the absolute best possible deal for all hypothetical risks.
  3. If you want to include information that isn't given in the facts, either leave a placeholder note or make something up.
  4. Feel free to compare notes with your counterparts in other groups — i.e., if you represent Gigunda, feel free to talk to the other Gigunda representative(s) in your own group and in other groups.
  5. Feel free to "soften" (or leave out entirely) one or more provisions that you might otherwise include, e.g., in the interest of getting to signature sooner. If you do so, then include a brief note to that effect in your homework.
  6. Feel free to briefly explain any decisions or recommendations you make, in the same way that you might if you were sending the draft to a partner or to the client. BUT: I don't want any long essays or extensive annotations!
  7. Drafting homework is to be printed out with your name on it and brought to class.
  8. At the beginning of class on the due date, you'll exchange papers within your group; look over what your colleague did; and make any comments.
  9. At the end of class on the due date, turn in your homeworks. OPTION: If you want to revise your own homework based on comments from your colleague(s), you can keep your printed-out copy and instead email me a revision NO LATER THAN 11:59 p.m. the following day.
  10. I expect to provide a model answer that you should study.
  11. I'll normally return marked-up homework papers the following Monday. Don't expect a lot of individualized comments — instead, you should study the model answer and email me with any questions you have.

WARNING: In one past semester, a student failed the course — even though the student had received a (very-low) passing grade on the final exam — and therefore didn't graduate that semester as the student had planned, because the student had turned in almost none of the homework assignments.

4.44.5 200 points total: Four, in-class, mid-term quizzes

On four different Wednesdays (generally every third one), at the beginning of class, we will have an in-class, mid-term quiz. (See the dates listed in § 1.)

Each quiz will:

  1. be administered on-line via Blackboard;
  2. be timed for FIVE MINUTES each (people with accommodations can get extra time — ask Dean Tennessee's office to let me know if you're one of those people);
  3. be open-everything (book notes, Internet), but NO communicating with other students;
  4. very likely include more questions than almost anyone could answer in the allotted time — that's a corollary of having the quizzes be open-everything (people who spend time looking up answers won't score as well);
  5. include a mix of true-false, multiple-choice, fill-in-the-blank, and/or "micro-essay" (short answer) questions;
  6. be set up on Blackboard so that questions are presented in random order, and you can't backtrack to previous questions;
  7. cover only the following:
    • the readings assigned up through and including the quiz date, whether or not we discuss any particular topic in class;
    • the associated flashcards in § 6;
    • anything in the in-class and homework exercises that we have done to date — the quizzes themselves will thus serve as a reinforcing review that takes advantage of the testing effect;
  8. be graded partly anonymously — the Blackboard software shows me students' names; I can't do anything about that, but:
    • Blackboard automatically grades the true-false, multiple-choice, and fill-in-the-blank ("FITB") questions.
    • I review any "incorrect" fill-in-the-blank answers so that I can give credit for simple misspellings, which Blackboard can't always pick up. (I program the quizzes on Blackboard to accept as many misspellings as I can think of, but you'd be surprised how … creative students can be ….).
    • If a quiz includes any micro-essays, they will not be anonymous at all.

The mid-term quizzes will include progressively-more review material and accordingly will count for an increasing number of points, as follows:

Quiz 1: 20 points
Quiz 2: 30 points
Quiz 3: 40 points
Quiz 4: 60 points

In past quizzes, a few students have gotten the right answer to every question on every quiz. In response, one student suggested that I should "[d]esign quizzes to have a wider score dis­tri­bu­tion." I'm less interested in that than in helping all students to understand and retain the material.

4.44.6 400 points: Final exam

The final exam will be:

  • be one hour in length;
  • consist in large part of what amounts to a mid-term quiz on steroids;
  • take place in the to-be-designated final-exam room; and
  • be open-book, open-notes, open-browser (but no communication with anyone else, whether by text, email, IM, or anything else).

What's fair game for the final exam? Anything:—

  • in the reading materials;
  • in the homework, quizzes, and in-class exercises.

The honor code will of course apply.

4.44.7 Extra credit: Open-book review quizzes about readings — up to 100 points

Most weeks you'll have the opportunity to earn extra-credit points by completing an online review quiz about the reading from previous weeks, on Blackboard. Each review quiz:

  • will be untimed;
  • will be open-book, open-notes, open-browser — BUT each student must do his or her own work;
  • can be attempted as often as you like before the due date, and the grade for the highest attempt will count.

NOTE 1: This is a new thing this semester; I'll be drafting these review quizzes as we go.

NOTE 2: Keep in mind that your final grade will still necessarily be tied to the class average required by school policy (see § 4.44.1). But still, you'll improve your chances of placing higher on the grade-distribution curve by earning more points.

4.44.8 Class participation bump-up

As permitted by law-school policy, I reserve the right:

  • to award discretionary increases in student grades by one-third of a grade level for excellent class participation, e.g., from a B to a B-plus, assuming that this doesn't cause the class average to exceed the maximum permitted; and
  • to reduce grades for sub-standard class participation. (I've almost never done that, except for a couple of students for whom it was like pulling teeth to get them to participate even minimally.)

4.45 (Optional:) Dealer agreements (notes only)

4.46 (Study:) Defined terms

4.46.1 Some style preferences

The following are some personal style preferences that enhance readability (in the author's view):

• Put the defined term in quotes and bold-faced type to make it stand out on the screen or page and thus make the term easier to spot while scanning through the document.

• Use refers to instead of means, because the former often just sounds better in different variations.

Before: Confidential Information means information where all of the following are true ….
After: "Confidential Information" refers to information where all of the following are true ….

4.46.2 Where to put definitions?

Definitions in contracts are typically found:

  1. in a separate section of the contract;
  2. as the defined terms occur in the contract text (see the examples in § 4.83.2); or
  3. as a combination of both 1) and 2) in the same contract.

4.46.3 Caution: Consistency in capitalizing defined terms can be crucial

It's a really good idea to be consistent about capitalization when drafting a contract. If you define a capitalized term but then use a similar term without capitalization, that might give rise to an ambiguity in the language — which in turn might preclude a quick, inexpensive resolution of a lawsuit.

Something like that happened in the Clinton Ass'n for a Renewed Environment case:

  • The defendant asserted that the plaintiff's claim was barred by the statute of limitations and therefore should be immediately dismissed.
  • The plaintiff, however, countered that the limitation period began to run much later than the defendant had said.
  • The court held that inconsistency of capitalization of the term "substantial completion" precluded an immediate dismissal of the plaintiff's claim.

See Clinton Ass'n for a Renewed Environment, Inc., v. Monadnock Construction, Inc., 2013 NY Slip Op 30224(U) (denying defendant's motion to dismiss on the pleadings).

In a similar vein, a UK lawsuit over flooding of a construction project turned on whether the term "practical completion" (uncapitalized) had the same meaning as the same term capitalized. The court answered that the terms did not have the same meaning; as result, a sprinkler-system subcontractor was potentially liable for the flooding. See GB Building Solutions Ltd. v. SFS Fire Services Ltd., (2017) EWHC 1289, discussed in Clark Sargent, Antonia Underhill and Daniel Wood, Ensure That Defined Terms Are Used Consistently; Ambiguity Can Be Costly (Mondaq.com 2017).

4.46.4 Put the definitions at the back of this Agreement? Or in an exhibit or schedule?

A drafter can place a separate "definitions" section:

  • near the beginning of the agreement — this is perhaps the most-common practice;
  • at the back (with results that might be surprising);
  • in a separate exhibit or schedule (which can be handy if using the same definitions for multiple documents in a deal).

On his blog, IACCM founder and president Tim Cummins tells of an IACCM member whose company saved hours of negotiating time — up to a day and a half per contract — by moving the "definitions" section from the front of its contract form to an appendix at the back of the document. Cummins recounted that "by the time the parties reached 'Definitions', they were already comfortable with the substance of the agreement and had a shared context for the definitions. So effort was saved and substantive issues were resolved." Tim Cummins, Change does not have to be complicated (July 21, 2014).

4.46.5 Further reading about definitions and usages

See, e.g.:

4.47 (Read:) Discretion

4.47.1 (Black letter:) U.S. law about discretion might vary by jurisdiction

In Illinois, a party's discretion might be constrained by an obligation of reasonableness. See Han v. United Continental Holdings, Inc., 762 F.3d 598 (7th Cir. 2014) (affirming dismissal with prejudice of purported class-action complaint). As it happens, in that case the appeals court upheld a ruling that United Airlines did not unreasonably exercise its discretion in interpreting the term "miles flown," in the rules for its frequent-flier program, as the miles between the relevant airports and not the miles actually flown by the aircraft in traveling between the two airports.

On the othert hand:

[U]nder Alabama law "sole discretion" means an absolute reservation of a right. It is not mitigated by an implied covenant of good faith and fair dealing in contracts because an unqualified reservation of a right in the sole discretion of one of the parties to a contract expresses the intent of the parties to be subject to terms that are inconsistent with any such implied covenant.

Shoney's LLC v. MAC East, LLC, 27 So.3d 1216, 1220-21 (Ala. 2009) (on certification by Eleventh Circuit; emphasis added, footnote and citations omitted).

(When In Doubt: Define!)

4.47.2 UK: Arbitrary, capricious, or irrational exercise of discretion might be actionable

There is case law in the UK indicating that discretion cannot be exercised arbitrarily, capriciously, or irrationally. See Barry Donnelly and Jonathan Pratt, Are you obliged to act reasonably?, in the In-House Lawyer [UK] (June 12, 2013); they summarize the case law as indicating that:

Where a contract confers on one party an absolute discretion to take a decision, choosing from a range of options which will have an impact on the interests of another contracting party, the court will, as a bare minimum, imply a term that the discretion must be exercised in good faith in a manner which is not arbitrary, capricious or irrational.

Subject to those limitations, the decision maker will be entitled to act in accordance with its own best interests.


It is very difficult, albeit not ‘utterly impossible', to exclude such an implied term.


Where, however, the only choice conferred on a contracting party is whether or not to exercise an absolute contractual right provided under the contract, no such term will be implied.


(Emphasis and extra paragraphing added.)

See also:

It is now well established that, in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably (in the sense of irrationally)[.]

Novus Aviation Ltd. v. Alubaf Arab Int'l Bank BSC(c), [2016] EWHC 1575 (Comm) (citations omitted).

4.48 (Optional:) Disparagement prohibition

4.48.1 Business context

Manufacturers sometimes ask for clauses like this in their distribution- or reseller agreements, with the idea that they can prohibit their distributors and resellers from making negative comments to end-customers. Distributors and resellers might well object to this statement, wanting to preserve their freedom to say whatever they please to their own customers.

4.48.2 Legal prohibitions

In 2014, California enacted Cal. Civ. Code § 1670.8 prohibiting such clauses in consumer contracts, with civil penalties for violation. (Hat tip: Prof. Nancy Kim.)

And the (U.S.) Consumer Review Fairness Act, enacted in 2016, prohibits such restrictions in consumer contracts; see the Federal Trade Commission's summary.

Long before that, the New York attorney general obtained an injunction against the manufacturer of McAfee anti-virus software for including, in its end-user license agreement (EULA), a prohibition against disclosure of benchmark test results or publication of product reviews without the manufacturer's approval. See People v. Network Assoc., Inc., 758 N.Y.S.2d 466, 195 Misc.2d 384 (2003).

4.48.3 Bad publicity

A disparagement prohibition can lead to terrible PR, as companies have discovered to their regret.

And consider how Donald Trump's presidential campaign required its volunteers to sign agreements forever prohibiting them from disparaging "Mr. Trump" or any member of his family, his company, or their products. See Jeremy Fugelberg, Want to dial for Donald Trump? First, sign this legal form, Cincinnati Enquirer, Sept. 2, 2016.

4.48.4 The "Streisand effect"

Parties wanting a clause like this should consider the Streisand effect, which is named for the famed singer and actress: When word got out that she was trying to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her original purpose of her suppression attempt. (The Wikipedia article contains numerous other examples.)

4.48.5 The litigation privilege might trump a non-disparagement provision

The litigation privilege might trump a non-disparagement provision. See the decision of Maryland's highest court in O’Brien & Gere Engineers, Inc. v. City of Salisbury No. 15 (Md. Apr. 26, 2016).

4.49 (Read:) Drafting mechanics

4.49.1 The contract drafter's job is to educate and persuade

(Read:)

The author of a contract-drafting style manual once opined that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.” Ken Adams, More Words Not to Include in a Contract— “Therefore” and Its Relatives, at http://www.adamsdrafting.com/therefore/ (2008).

That view would be fine if people were computers, which do exactly as they're told: nothing more, nothing less. But:

  • People aren't computers.
  • Even in a corporation-to-corporation contract, it's people who carry out obligations and exercise rights.
  • People's memories are often short and can sometimes be "creative"; people sometimes need to be reminded of what they agreed to.
  • A contracting party's circumstances can change after the contract is signed — by the time a dispute arises, key employees and executives of a party could have different views of what's important, and they might have forgotten (perhaps conveniently) what mattered during the con­tract negotiations.

Let's not forget another important group of people: Judges, jurors, and arbitrators who are asked to enforce a contract can be influenced by what they think is right and fair. Sometimes, the wording of the contract's terms can make a difference.

In sum: People sometimes need to be educated, and even persuaded, to do things.

That is the contract drafter's mission: To (re)educate the parties — and sometimes judges and jurors — and, if necessary, to persuade them, to do what your client now wants them to do.

4.49.2 Three crucial questions asked by judges and juries

(Just skim this section to the extent that you care to, but remember the heading.)

Most contracts stay buried in the (electronic) file drawer. The contracting parties either don't get into disputes in the first place, or they successfully resolve any disputes on their own.

But woe betide the drafter (or reviewer) who forgets that ultimately a contract might have to serve as Exhibit A in a lawsuit or arbitration. For such a contract, the most important reader is the judge or arbitrator — who almost certainly is very busy; who might have little or no knowledge of the parties' business; and who would appreciate it if the contract quickly conveyed the answers to three crucial questions:

  1. Exactly what — if anything — did the defendant commit to do or not do in the contract?
  2. What event or events could trigger the defendant's commitment, and did the necessary triggering event or -events actually occur?
  3. Was the defendant's commitment subject to any relevant exceptions or other limitations?

Clumsy drafting can sometimes make these three contract questions very difficult for the judge, arbitrator, or other reader to puzzle out. During negotiation, this can slow up the non-drafting party's legal review and delay getting the contract to signature, and in litigation or arbitration, it can increase the chances of an unforeseen result.

The drafters and reviewers of a contract can serve all future readers  — not least, the business people who must read the contract — by being as clear as possible about these questions. Clarity thus helps to reduce the odds of a dispute arising in the first place.

4.50 (Optional:) Economic loss doctrine (notes only)

The economic loss doctrine generally precludes recovery in tort for purely-economic losses resulting from a party’s failure to perform under a contract when the harm consists only of the economic loss of a contractual expectancy.

  • Under this doctrine, if the defendant’s conduct would give rise to liability only because it breaches the parties’ agreement, the plaintiff’s claim ordinarily sounds only in contract.
  • However, the doctrine does not bar all tort claims arising out of a contractual setting. A party states a tort claim when the duty allegedly breached is independent of the contractual undertaking and the harm suffered is not merely the economic loss of a contractual benefit.

In this analysis, the nature of the injury most often determines which duty or duties are breached.

  • If the injury would give rise to liability independent of the fact that a contract exists between the parties, the plaintiff’s claim may also sound in tort.
  • The economic loss rule does not preclude tort recovery if the injury involves physical harm to the ultimate user or consumer or other property.

The foregoing summary is adapted from the text (which contains extensive citations of Texas law) of Shakeri v. ADT Security Services, Inc., 816 F.3d 283, 292-93 (5th Cir. 2016) (per curiam). In that case:

  • The owners of a jewelry store sued an alarm-system company for damages after the store were robbed at gunpoint and one of the owners was severely beaten and tasered; the alarm system's panic button failed, allegedly because of faulty workmanship by a technician working for the alarm-system company. See id., slip op. at 4. The owners pleaded that the technician failed to properly repair the alarm system, left it in a condition where it did not work, yet told the owner that the alarm was in working order. See id., slip op. at 13 n.2.
  • The appeals court held that the district court had improperly dismissed the owners' negligence claim against the alarm-system company because the owner's physical injuries were not covered by the economic loss rule.

See also Restatement (Third) of Torts: Liab. for Econ. Harm § 3 cmt. b (Am. Law Inst. 2012) (“An actor whose negligence causes personal injury or physical harm to the property of another can be held liable in tort regardless of whether the negligence occurs in the performance of a contract between the parties.”), quoted in Shakeri, 816 F.3d at 293.

For more on the economic-loss doctrine, see Economic Loss Doctrine in All 50 States (MWL-Law.com 2013).

4.51 (Study:) Effective date

4.51.1 The best way to state the effective date in the preamble

In most contracts, the preamble states the effective date; strictly speaking, that's usually unnecessary unless the contract is to be effective as of a specific date (and not before or after), but many drafters like to include the effective date anyway.

To state the effective date, the author prefers the “last date signed” approach that's used in the following example:

THIS AGREEMENT ("Agreement") is between ABC Corporation [state of incorporation and address for notice omitted] and XYZ LLC [ditto]. This Agreement is effective the last date written on the signature page.

Here's a different version of the last-date-signed approach:

This Agreement is made, effective the last date signed as written below, between ….

In reviewing others' contract drafts, you're likely to see some less-good possibilities, as discussed in (Study:) Agreement date, § 4.5; the stated date might turn out to be inaccurate, depending on when the parties actually sign the contract — and as discussed in § 4.97.8, more than one corporate executive has gone to prison for doing so.

On the other hand, it might be just fine to state that a contract is effective as of a different date.

EXAMPLE: Alice discloses confidential information to Bob after Bob first orally agrees to keep the information confidential; they agree to have the lawyers put together a written confidentiality agreement. That written agreement might state that it is effective as of the date of Alice's oral disclosure. The following might work if it's for non-deceptive purposes:

This Agreement is entered into, effective December 31, 20XX, by ….

(Alice and Bob would not want to backdate their actual signatures, though.)

4.52 (Study:) Entire agreement

The current Common Draft version is as follows:

  1. This Agreement is the parties final, complete, exclusive, and binding expression of their agreement concerning its subject matter.
  2. This Agreement supersedes any prior offers, negotiations, agreements, and commitments (collectively, "Prior Discussions"), whether written or oral, between or on behalf of the parties, with respect to that subject matter; all such Prior Discussions, if any, are merged into this Agreement.
  3. Other Substantive Terms, defined below, will be of no effect unless the amendment requirements of this Agreement are satisfied so as to modify this Agreement, either generally or for one or more specific transactions or situations.
  4. refers to any substantive term that:
    1. is contained in a document that is provided by a party in connection with a transaction pursuant to this Agreement; and
    2. is in addition to, or otherwise different from, the terms and conditions of this Agreement.
  5. The documents referred to in subdivision D above include, without limitation, any quotation, purchase order, confirmation of order, shipping manifest, invoice, receipt, bill of sale, bill of lading, or similar document.
  6. The term Other Substantive Term does not encompass case-specific details that are not addressed in this Agreement such as (for example, and to the extent applicable):

    1. the price, quantity, and delivery date of goods being sold in a particular sale transaction under this Agreement;
    2. the services to be performed under a work order;

    and the like.

  7. For purposes of (non-exclusive) illustration, a party is not to be deemed to have assented to Other Substantive Terms by doing any or all of the following in connection with a previous contract:
    1. performing one or more actions called for by, or otherwise described in, Other Substantive Terms as defined above;
    2. shipping goods pursuant to an orally-agreed order after receiving a written purchase order containing Other Substantive Terms;
    3. paying an invoice that contains Other Substantive Terms; and/or
    4. accepting or paying for goods or services after receiving an order confirmation or other document that contains Other Substantive Terms.

Reliance on external representations isn't necessarily ruled out; see (Study:) Reliance disclaimer, § 4.88 and its commentary.

Subdivision G lists some specific examples of things that do not count as assent to additional terms, in the interest of discouraging parties from claiming that such terms supposedly govern. For a review of some of the case law on this point, see C9 Ventures v. SVC-West, L.P., 202 Cal. App. 4th 1483 (2012), where the court held that, in the particular circumstances of the case, the fact that a buyer paid a seller's invoice did not mean that the buyer had agreed to the seller's terms that were printed on the invoice.

4.53 (Read:) Evergreen extensions

4.53.1 Basic operation

Evergreen-extension clauses are typically used by parties who expect to be in a long-term contractual relationship but want the ability to opt out every now and then in case things aren't going well.

Here's how an evergreen extension typically works:

  • Some right or obligation is time-limited, or perhaps the entire agreement is time-limited.
  • But the time will be automatically extended unless a party opts out within X days before the end of the time (or even within X days after the time has expired, but that's not customary).

Some checklist questions are set forth below.

4.53.2 Checklist question: Which party has the right to opt out?

This provision allows either party to opt out, but in some contractual relationships (e.g., a customer-supplier relationship), one party might might feel that it should have more flexibility than the other party to opt out of an evergreen extension.

4.53.3 Choosing the deadline for non-extension notice

The deadline for giving notice of non-extension should be considered carefully for its possible business implications.

In some supplier-customer relationships, a customer might want the ability to opt out right up to the then-current expiration date, or even for a limited period of time after the automatic extension.

On the other hand, a supplier might want several months' advance warning that its customer was opting out of the relationship, or vice versa, to allow time for planning to wind down the relationship, find replacement business, etc.

Pro tip: Be sure to calendar the Opt-Out Deadline — a client of the author's once missed an important opt-out date, as discussed in § 4.53.5 below.

4.53.4 Evergreen extension periods could be of different lengths

It's not carved in stone that all automatic-extension periods should be of the same duration. For example, in some contractual relationships, a first extension period might be relatively short, to give the parties a chance to find out what it's like working together. Then, if neither party opts out, subsequent extension periods could be of longer duration.

4.53.5 Long extension periods can be problematic

Here's a real-world example of an evergreen automatic-extension provision gone awry:

  • A client of mine once agreed to give a steep pricing discount to a particular customer for five years, if memory serves. (I hadn't been involved in that deal.)
  • The agreement provided that the the discount would be automatically extended for another five years if my client didn't opt out when the first five-year period was expiring.
  • Sure enough, no one in the client's organization noticed that the five-year discount period was ending.
  • As a result, the client didn't send the customer a notice that the client was opting out of the pricing commitment.
  • The client had to honor the steeply-discounted pricing for that customer for another five years. This, even though the client had raised its prices significantly for the rest of its customer base.

4.53.6 Maximum number of extensions

If the parties' relationship is working well and either party can opt out, then there might be no reason to have it come to an end unless one party wants it to end.

On the other hand, it might be that only one party has the right to opt out. This might be the case in a supply agreement, in which the customer may opt out but the supplier may not. In that situation, the supplier might want to limit the number of automatic extension periods.

4.53.7 Caution: Statutory restrictions on evergreen extensions

Some states restrict automatic extension or renewal of certain contracts unless specific notice requirements are met. Examples of such states include California, Illinois, New York, North Carolina, and Wisconsin. See Cal. Bus. & Prof. Code § 17600-17606 (consumer contracts); 815 ILCS § 601 (consumer contracts); N.Y. Gen. Oblig. L. § 5-903, contracts for services, maintenance or repair N.C. Gen. Stat. § 75-41 (consumer contracts); Wis. Stat. § 134.49 (business equipment leases and business services).

4.54 (Skim:) Exclusive dealing (notes only)

Exclusivity arrangements ideally should include limitations on time, place and manner:

  • a "sunset" provision stating that the exclusivity ends (and perhaps the entire agreement ends) after a certain period if not extended:
    • by agreement;
    • unilaterally by one party (see § 4.102) if the other party does not opt out;
    • automatically, on an "evergreen" basis (see § 4.53], if neither party opts out.
  • time – , place, and subject matter.

4.55 (Skim:) Exclusive-rights provisions

Exclusive-rights grants can limit your flexibility, possibly making it difficult or impossible to do similar business with other companies. A grant of exclusivity can also make your company fatally unattractive to a potential acquirer or merger partner.

Tip: Consider trying to limit any grant exclusivity by putting time- or geographic limits on it, and/or by requiring The Other Side to hit periodic performance targets to maintain exclusivity.

4.56 (Skim:) Export controls for products and technical data

(Black letter:) Some key takeaways:

The export-controls laws in the U.S. are a bit complicated, but it's extremely important for companies to sort them out. Here are a couple of examples of "exports" that might be surprising:

  • Disclosure of controlled technical data to a foreign national in the U.S. can constitute an "export" that requires either a license or a license exception.
  • Emailing controlled technical data to a U.S. citizen located in a foreign country could constitute an export of the data.

Failure to get an export license (or come within a license exception) can lead to all kinds of trouble, including imprisonment for up to ten years; millions of dollars in fines and civil penalties; and denial of export privileges.

For example: A 71-year old emeritus professor at the University of Tennessee was sentenced to four years in prison for export-controls violations (Bloomberg.com 2012: https://goo.gl/gfvGhR) (FBI.gov 2012: https://goo.gl/jtZR7C). The professor had been doing research, under an Air Force contract, relating to plasma technology designed to be deployed on the wings of remotely-piloted drone aircraft. Apparently, his crime was to use, as part of the project staff, two graduate students who were Iranian and Chinese nationals respectively. It probably didn't help that he was found to have concealed those graduate students' involvement from the government.

Optional: For additional information, see, e.g., a University of Southern California primer about export controls (USC.edu: https://goo.gl/EjnztS) and a slide deck from an Association of Corporate Counsel presentation (ACC.com 2003: https://goo.gl/qN7diu).

4.57 (Skim:) Fiduciary duty

4.57.1 Safe-harbor language can sometimes contractually eliminate fiduciary duties

See Dieckman v. Regency GP LP, No. 11130-CB (Del. Ch. Mar. 29, 2016), where the court dismissed a complaint, by a former limited partner, that the general partner breached its fiduciary duty. The limited-partnership agreement contained a (typical) safe-harbor provision that expressly authorized certain potentially-conflicted transactions as long as any one of several stated procedures was followed:

(a) Unless otherwise expressly provided in this Agreement . . ., whenever a potential conflict of interest exists or arises between the General Partner or any of its Affiliates, on the one hand, and the Partnership, any Group Member or any Partner, on the other,

any resolution or course of action by the General Partner or its Affiliates in respect of such conflict of interest shall be permitted and deemed approved by all Partners, and shall not constitute a breach of this Agreement . . . or of any duty stated or implied by law or equity,

if the resolution or course of action in respect of such conflict of interest is

(i) approved by Special Approval [defined elsewhere as approval by a Conflicts Committee of directors of the corporate general partner],

(ii) approved by the vote of a majority of the Common Units (excluding Common Units owned by the General Partner and its Affiliates),

(iii) on terms no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or

(iv) fair and reasonable to the Partnership, taking into account the totality of the relationships between the parties involved (including other transactions that may be particularly favorable or advantageous to the Partnership).

Id. at part I.B, text accompanying n.2 (footnote omitted, extra paragraphing added). The chancery court held that this provision, and the defendants' compliance with one of the safe-harbor procedures, eliminated the defendants' putative fiduciary duty.

4.58 (Skim:) Flip insurance

Flip insurance is (my term for) a type of clause sometimes seen in, for example, asset-sale agreements. Such a clause provides that if the buyer sells the purchased asset at a higher price within a stated period of time (often one year), then the seller is entitled to a share of the difference.

HYPOTHETICAL EXAMPLE: Buyer pays Seller $100 for an asset. Their contract contains a flip-insurance clause stating that Seller is entitled to 50% of Buyer's profit if Buyer sells the asset within one year after the closing of Buyer's purchase from Seller.

Other terms for this type of clause are jerk insurance and schmuck insurance — see Peter Mahler, “Jerk Insurance” Takes on New Meaning in Buyout Dispute (NYBusinessDivorce 2015).

In one example of a badly-drafted flip-insurance clause, a federal district court held that Seller was entitled to 20% of the entire proceeds of Buyer's flip sale, not just to 20% of Buyer's profit on the flip sale. See Charron v. Sallyport Global Holdings, Inc., No. 12cv6837, part III (S.D.N.Y. Dec. 10, 2014) (setting forth findings of fact and conclusions of law after bench trial).

4.59 (Optional:) For the avoidance of doubt

The term for the avoidance of doubt seems to be frequently used in British contracts.

In his customary collegial style (not), Ken Adams describes the term as "a turkey"; he says: "How’s this for a categorical statement: Never use for the avoidance of doubt."

(Ken's injunction illustrates something I've said from time to time: All categorical statements are bad, including this one.)

Willem Wiggers is more restrained on this subject; at his WeAgree contract-drafting site, he says that the term for the avoidance of doubt could be used, for example, when "considering the agreement as a whole, the subject matter is important enough to be addressed (i.e. not being aware of the to-be-avoided doubt may be a source of disputes or disappointment for the parties)."

My own view is that drafters should use the term for the avoidance of doubt when they want their client's litigation counsel to have a "sound bite" to use in a lawsuit or arbitration, e.g., by quoting it in a brief or showing it on a PowerPoint slide or poster board.

4.60 (Read:) Forum selection

4.60.1 (Black letter:) Legal background

U.S. federal courts routinely enforce forum-selection clauses "unless extraordinary circumstances unrelated to the case clearly disfavor a transfer." Atlantic Marine Construction Co., Inc. v. United States District Court, 571 U.S. 49, 134 S.Ct. 568, 575 (2013); Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 n.14 (1985); BouMatic LLC v. Idento Operations BV, 759 F.3d 790, 793 (7th Cir. 2014) (vacating and remanding dismissal for lack of personal jurisdiction).

"It is well established that forum selection clauses are prima facie valid and should be enforced unless enforcement is shown by the resisting party to be unreasonable under the circumstances. More specifically, a forum selection clause should be enforced unless the resisting party can show that enforcement would be unreasonable and unjust, or that the clause was invalid for such reasons as fraud or overreaching or that enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision." Rivera v. Centro Medico de Turabo, Inc., 575 F.3d 10, 18 (1st Cir. 2009) (affirming dismissal of action based on forum-selection clause), in part quoting M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 10, 15 (1972) (internal quotation marks, alteration marks, and citations by First Circuit omitted).

Likewise, state courts in the U.S. generally honor forum-selection provisions "unless the party challenging enforcement establishes that such provisions are unfair or unreasonable, or are affected by fraud or unequal bargaining power." Paul Business Systems, Inc. v. Canon U.S.A., Inc., 97 S.E.2d 804, 807-08 (Va. 1990) (affirming dismissal of complaint) (emphasis added, extensive citations and internal quotation marks omitted).

Optional: See generally Byron F. Egan, Forum-Selection, Jury-Waiver, and Choice-of-Law Provisions in Acquisition Agreements (2018) (archive: https://perma.cc/3G4L-UVZB).

4.60.2 (Extra:) Scope of forum-selection provisions?

It's arguably inappropriate to agree in advance to a choice of forum that applied to more than just actions "arising out of" this Agreement. Here's a hypothetical example: • Provider licenses its software to Customer. • The license agreement requires any litigation arising from the agreement to be brought in the city of Customer's principal place of business; let's assume that's Atlanta. • One day, though, a different division of Customer, located in, say, Zion (Illinois), rolls out a new product that performs some of the functions of Provider's software and bears a trademark that's confusingly similar to Provider's trademark. ¶ In that situation, if Provider wanted to sue Customer for trademark infringement, then Provider might well want to bring the lawsuit in Zion because of the better availability of witnesses and documents. But Provider might not be able to do so if the license agreement required all disputes relating to the license agreement to be brought in Atlanta.

4.60.3 (Skim:) CAUTION: China might be a special case

Anyone drafting a contract with a Chinese counterparty should consider:

  • whether the contract meets the language- and governing-law requirements of Chinese law to make the contract enforceable by a Chinese court (discussed in the [TO DO: LINK] governing-law section); and
  • if not, whether the counterparty has sufficient reachable assets in a more-friendly jurisdiction (because Chinese courts purportedly won't enforce foreign judgments or arbitration awards).

4.60.4 (Read:) Caution: Saying "the courts of " a jurisdiction could be dangerous

Drafters should be careful about specifying that lawsuits are to be heard "in the courts of" the specified forum location. A U.S. court might find that such language precluded the defendant from removing the suit to federal court. That happened in Doe 1 v. AOL, LLC, 552 F.3d 1077, 1081-82 (9th Cir. 2009) (per curiam). (The appeals court also held that the forum-selection clause was unenforceable.)

4.60.5 (Black letter:) Caution: The term "shall be subject to" might confer exclusive jurisdiction

In an English case, a Hong Kong freight forwarder used its standard bill-of-lading form in accepting cargo for shipment from China to Venezuela. The form provided in part that "[t]his Bill of Lading and any claim or dispute arising hereunder shall be subject to English law and the jurisdiction of the English High Court of Justice in London." The UK Court of Appeal, after reviewing case law concerning similar language, held that the bill of lading's wording conferred exclusive jurisdiction on the English courts. Hin-Pro International Logistics Limited v Compania Sud Americana De Vapores S.A. [2015] EWCA Civ 401 ¶¶ 4, 61-78. (Hat tip: Mark Anderson, who in his write-up makes additional observations about the case.)

4.60.6 (Black letter:) A court might not honor the parties' agreement to an improper forum

In many American states, a statute specifies the location where a lawsuit must be brought. Typically, this will be either the county where the plaintiff resides or the county where the defendant resides. If a contract's forum-selection clause specifies a county that does not meet the statutory requirement, a court might refuse to enforce the forum selection. This happened in A&D Envt'l Serv., Inc. v. Miller, No. 14 CVS 6328 (N.C. App. Apr. 7, 2015) (affirming denial of defendant's motion to enforce forum-selection clause).

The A&D court noted, though, that "a forum selection clause which favored a court in another State was enforceable …." Id., slip op. at 4 (emphasis in original, citation and internal quotation marks omitted).

4.60.7 (Skim:) A forum-selection clause might be disregarded for policy-based reasons

Courts will sometimes refuse to honor a contract's forum-selection clause if the clause offends a strong public policy of the forum location. For example:

Doe 1 v. AOL, LLC, 552 F.3d 1077, 1084 (9th Cir. 2009): a group of users of the America OnLine (AOL) service sued AOL in California and sought class-action status. The AOL user agreement required all disputes to be litigated in Virginia. Citing the forum-selection clause, a federal district court in California dismissed the case but said it could be re-filed in Virginia state courts as required by the user agreement.

The federal appeals court disagreed. It held that California had a strong public policy favoring class-action relief, and noted that such relief was not available in Virginia state courts. Therefore, said the appeals court, "the forum selection clause in the instant member agreement is unenforceable as to California resident plaintiffs bringing class action claims under California consumer law."

In re AutoNation, Inc., 228 S.W.3d 663 (Tex. 2007): this Texas case had a very different outcome: a Florida-based car dealer filed suit, in Florida, against a former employee who lived in Texas and had worked for the car dealer there. The former employee's employment agreement contained a choice-of-law clause calling for Florida law to apply, together with a forum-selection clause requiring any litigation to take place in Florida.

Before learning of the Florida action, the former employee sued the car dealer in Texas, seeking a declaratory judgment that the non-competition covenant of the employment agreement was unenforceable under prior Texas supreme court precedent. Granting a writ of mandamus, the Texas supreme court ruled that while it was not questioning the validity of its prior precedent, it would still enforce the "freely negotiated" [sic] forum-selection clause to allow the first-filed suit in Florida to proceed.

(Thanks to my then-student Glen Tedham for alerting me to this case.)

For additional discussion and case citations, see generally PauloB. McKeeby, Solving the Multi-State Non-Compete Puzzle Through Choice of Law and Venue (2012).

QUESTION: On the AutoNation facts, what are the odds that the Florida court would have applied Texas law, given that the contract included a Florida choice-of-law clause?

4.60.8 (Extra:) Caution: A Massachusetts forum might be dangerous for defendants

If a contract specifies Massachusetts as the forum state for litigating disputes, the defendant might find that its bank account and other assets have been "attached" even before trial if the plaintiff can show a likelihood of success on the merits. See Shep Davidson, When an Out-of-State Company Can Be Sued in Massachusetts and Why You Should Care (2013).

4.61 (Skim:) Fraud allegations

4.61.1 Motivation: "They lied!" is a go-to phrase for trial counsel

When a big contract fails, trial counsel will pretty much always try hard to find opportunities to accuse the other side of having misrepresented facts. Why? Because it can work, sometimes spectacularly well. Jurors and even judges might not understand the nuances of the dispute, but they will definitely undertand the accusation that "they lied!"

Consequently, every contract drafter should be mindful of the possibility that if a serious dispute were ever to arise concerning the contract, the other side might claim that the drafter's client engaged in fraudulent behavior. We see this in the civil complaint filed by the state of Oregon against Oracle, in which the second paragraph said, in its entirety (with extra paragraphing added for readability):

Oracle lied to the State about the “Oracle Solution.”

Oracle lied when it said the “Oracle Solution” could meet both of the State’s needs with Oracle products that worked “out-of-the-box.”

Oracle lied when it said its products were “flexible,” “integrated,” worked “easily” with other programs, required little customization and could be set up quickly.

Oracle lied when it claimed it had “the most comprehensive and secure solution with regards to the total functionality necessary for Oregon.”

As another example, consider BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC). In that case:

  • British Sky Broadcasting ("Sky") contracted with EDS to develop a customer relationship management (CRM) software system.
  • Things didn't go as planned, and Sky eventually filed suit.
  • In the (non-jury) trial, the judge concluded that EDS had made fraudulent misrepresentations when one of EDS's senior UK executives, wanting very much to get Sky's business, lied to Sky about EDS's analysis of the amount of elapsed time needed to complete the initial delivery and go-live of the system. See id. at ¶ 2331 and ¶¶ 194-196.
  • The judge also concluded that during subsequent talks to modify the contract, EDS made additional misstatements that didn't rise to the level of fraud, but still qualified as negligent misrepresentations. See id. at ¶ 2336.
  • A limitation-of-liability clause in the EDS-Sky contract capped the potential damage award at £30 million.
  • By its terms, though, that limitation did not apply to fraudulent misrepresentations; the judge held that the limitation didn't apply to negligent misrepresentations either. See id. at ¶¶ 372-389.

(One of the most interesting aspect of the judge's opinion, it seems to me, is its detailed exposition of the facts, which illustrate the ‘sausage factory' by which technology deals sometimes get made — and how even just one vendor representative can make a deal go terribly wrong for his employer.)

In early June 2010, EDS reportedly agreed to pay Sky some US$460 million — more than four times the value of the original contract — to settle the case. See Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.

Still another example is Waste Management, Inc.'s lawsuit against SAP over a failed enterprise resource planning (ERP) software implementation, reported to have settled for an undisclosed sum. At the heart of Waste Management's case was its allegation, not just that SAP had breached the contract, but that it was guilty of fraudulent inducement, fraud, and negligent misrepresentation. See Chris Kanaracus, SAP, Waste Management settle lawsuit, Computerworld, May 3, 2010.

4.61.2 The threat of punitive damages and rescission raises the stakes

If a customer's lawyers can prove fraud by the vendor, then the customer may be able to recover not just ‘benefit of the bargain' contract damages, but possibly punitive damages as well. This is important because "punis" ordinarily aren't available in garden-variety contract cases. For that reason, even when evidence of fraud is weak, the mere threat of punitive damages can give the customer more leverage in making settlement demands.

A fraud claim also raises the spectre of rescission, that is, unwinding the transaction and putting the parties back at Square One, which conceivably could be equally scary to the claim's target.

4.61.3 Fraud claims can be expensive to defend against

A fraud claim might well be more expensive to defend against than would a garden-variety breach-of-contract claim. That's because the defendant's intent is relevant to the fraud inquiry, which opens up all kinds of possibilities for requests by the claimant for costly discovery.

4.61.4 In California, mere negligent misrepresentation counts as "fraud"

"Under California law, negligent misrepresentation is a species of actual fraud and a form of deceit." Wong v. Stoler, No. A138270, part III-B(2), slip op. at 12 (Cal. App. May 26, 2015) (designated as not for publication; citing cases).

4.62 (Skim:) Good cause

Executives' employment agreements commonly prohibit the employer from terminating the employment except for "cause," which is typically defined with great care. See, e.g., the 2012 employment agreement between Facebook and its chief operating officer Sheryl Sandberg.

In a Seventh Circuit case, the contract in suit defined good cause, allowing a dairy-equipment to terminate a dealership, as "Dealer’s failure to comply substantially with essential and reasonable requirements imposed upon Dealer by BouMatic." Tilstra v. BouMatic LLC, 791 F.3d 749, 751 (7th Cir. 2015) (Posner, J). In that case, the manufacturer eliminated the dealer's territory, under a clause giving the manufacturer the right to adjust territory boundaries, in order to force the dealer to sell out to another dealer. The jury concluded that the manufacturer had effectively terminated the dealership, but without good cause, and awarded damages; the appeals court affirmed judgment on the jury's verdict.

4.63 (Skim:) Good faith

4.63.1 Legal background

"The doctrine [of good faith and fair dealing] is invoked in practically every type of commercial contract dispute, including insurance, employment contracts, franchise and dealer contracts, leases, and construction disputes." Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 6 (MayerBrown.com 2014.)

In many — but not all — U.S. jurisdictions, and in Canada, every contract includes an implied covenant of good faith and fair dealing. See, e.g., the following:

  • Uniform Commercial Code § 1-304, which imposes a duty of good faith on all contracts and duties within the UCC;
  • UCC § 2-103(b), which defines good faith (in the case of a merchant) as "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade";
  • Restatement of Contracts (Second) § 205, which states: "Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement";
  • For Canada: Bhasin v. Hrynew, 2014 SCC 71 [2014] 3 S.C.R. 495 (Canada).

UK courts, on the other hand, have rejected the notion of a general duty of good faith and fair dealing, on grounds that "if a general principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement." Paul Davis, English Court Of Appeal Rejects The "Organizing Principle Of Good Faith" (Mondaq.com 2016), quoting MSC Mediterranean Shipping Company S.A. v. Cottonex Anstalt, [2016] EWCA Civ 789 ¶ 45; see also Claire Haynes, What Does A Duty To Act In Good Faith Mean? (Mondaq.com 2017).

4.63.2 Business rationale for good-faith commitment

In Bhasin v. Hrynew, 2014 SCC 71 [2014] 3 S.C.R. 495, Canada's supreme court explained the business rationale for implying an obligation of good faith:

[60] Commercial parties reasonably expect a basic level of honesty and good faith in contractual dealings. While they [the parties] remain at arm’s length and are not subject to the duties of a fiduciary, a basic level of honest conduct is necessary to the proper functioning of commerce.

  • The growth of longer term, relational contracts that depend on an element of trust and cooperation clearly call for a basic element of honesty in performance,
  • but, even in transactional exchanges, misleading or deceitful conduct will fly in the face of the expectations of the parties[.]

[61] … [E]mpirical research suggests that commercial parties do in fact expect that their contracting parties will conduct themselves in good faith[.]

It is, to say the least, counterintuitive to think that reasonable commercial parties would accept a contract which contained a provision to the effect that they were not obliged to act honestly in performing their contractual obligations.

Id. at ¶¶ 60-61 (citations omitted, bracketed paragraph numbers in original, extra paragraphing and bullets added).

4.63.3 Examples of bad faith

The Restatement lists examples of conduct that would breach the duty of good faith:

A complete catalogue of types of bad faith is impossible, but the following types are among those which have been recognized in judicial decisions:

  • evasion of the spirit of the bargain,
  • lack of diligence and slacking off,
  • willful rendering of imperfect performance,
  • abuse of a power to specify terms, and
  • interference with or failure to cooperate in the other party’s performance.

Restatement of Contracts (Second) § 205, comment d, quoted in Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 1 (MayerBrown.com 2014).

See also, e.g., Steven J. Burton, Good Faith in Articles 1 and 2 of the U.C.C.: The Practice View, 35 Wm. & Mary L. Rev. 1533 (1994),

In a 2016 decision, Massachusetts's highest court upheld a trial court's award of $44 million in damages and interest against a financial company's CEO on grounds that the CEO had violated the implied covenant of good faith and fair dealing by failing to pay an investor and friend who had staked the CEO to more than $650,000 to buy additional shares in the company. See Robert and Ardis James Foundation v. Meyers, 474 Mass. 181 (2016), reversing 87 Mass. App. Ct. 85 (2015).

4.63.4 Should a contract try to define good faith?

The [U.S.] Supreme Court has noted that:

While most States recognize some form of the good faith and fair dealing doctrine, it does not appear that there is any uniform understanding of the doctrine's precise meaning. The concept of good faith in the performance of contracts is a phrase without general meaning (or meanings) of its own.

Of particular importance here, while some States are said to use the doctrine to effectuate the intentions of parties or to protect their reasonable expectations, other States clearly employ the doctrine to ensure that a party does not violate community standards of decency, fairness, or reasonableness.

Northwest, Inc. v. Ginsberg, 134 S. Ct. 1422, 1431, at part III (2014) (internal quotation marks, alteration marks, and extensive citations omitted).

Parties' use of a good-faith standard, though, itself usually results from their inability (or unwillingness to invest the time and money) to compile an exhaustive list of what will constitute a particular type of breach. Two commentators have proposed that:

… "good faith" is interpreted by the law as meaning honesty in fact and the observance of reasonable commercial standards of fair dealing. We have suggested that the parties agree to such a standard when they wish to harness the benefit of a court’s hindsight and to address the risk that the debtor will game specific events of default. It is tempting to argue, nonetheless, that this vague standard of good faith—standing alone—is simply not verifiable or is too uncertain.

Robert E. Scott and George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 852 (2006) (footnotes omitted). The authors discuss several examples in which this is the case, such as acceleration rights in loan agreements; franchisee obligations; force majeure; and liquidated damages. See id. at 852-56.

4.63.5 Good faith in performance, not negotiation, of the contract

The implied duty of good faith and fair dealing will normally apply (if at all) to the performance and enforcement of an agreement, not to negotiation of the agreement (unless the agreement obligates one or both parties to negotiate in good faith). See generally Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 5 (MayerBrown.com 2014).

4.63.6 Limitations on the duty of good faith

The Supreme Court of Canada discussed some of the limitations of the duty of good faith (in Canadian law) in the important case of Bhasin v. Hrynew, 2014 SCC 71 [2014] 3 S.C.R. 495:

[65] … While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith.

This general principle has strong conceptual differences from the much higher obligations of a fiduciary. Unlike fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first.

[70] The principle of good faith must be applied in a manner that is consistent with the fundamental commitments of the common law of contract which generally places great weight on the freedom of contracting parties to pursue their individual self-interest.

In commerce, a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self-interest[.] Doing so is not necessarily contrary to good faith and in some cases has actually been encouraged by the courts on the basis of economic efficiency[.]

The development of the principle of good faith must be clear not to veer into a form of ad hoc judicial moralism or “palm treeˮ justice. In particular, the organizing principle of good faith should not be used as a pretext for scrutinizing the motives of contracting parties.

Id. (citations omitted, extra paragraphing added).

4.64 (Read:) Governing law

4.64.1 Legal background of choice-of-law provisions

(Black letter:) In the U.S., courts typically enforce choice-of-law provisions in a contract — with exceptions, as noted in the discussion below. In fact:

• A California statutory provision expressly validates a contractual choice of California law for non-personal contracts having a value of at least $250,000, even if there is no relationship between the contract and California. See Cal. Civ. Code § 1646.5. (Of course, a non-California court might not give effect to that provision, as discussed below.)

• By statute, some other states have declared that a written contract's choice of the law of the state is valid, even without any other connection to the state. See, e.g., 6 Del. Code Ann. § 2708; Fla. Stat. § 685.101; 735 Ill. Comp. Stat. 105/5-5; NY Gen. Oblig. L. § 5-1401; Ohio Rev. Code Ann. § 2307.39; Tex. Bus. & Com. Code §§ 271.001 et seq.

• New York courts won't even undertake a conflict-of-law analysis when the parties have agreed to a choice of law. See Ministers and Missionaries Benefit Bd. v. Snow, 26 N.Y.3d 466, 45 N.E.3d 917, 25 N.Y.S.3d 21 2015 NY Slip Op 09186, on certification from 780 F.3d 150 (2d Cir. 2015).

See generally Byron F. Egan, Forum-Selection, Jury-Waiver, and Choice-of-Law Provisions in Acquisition Agreements (2018) (archive: https://perma.cc/3G4L-UVZB), part V, n.100 & accompanying text.

4.64.2 (Black letter:) But public policy might trump a choice-of-law clause

A court might not give effect to a governing-law clause in a contract if doing so would lead to a result that contravened a fundamental public policy of the law of the jurisdiction in which the court sits. Here are some examples.

• In New York, a non-solicitation provision in an employment agreement (as in, no soliciting our customers after you leave), purporting to bind an employee in that state, is judged by New York law, not the governing law stated in the employment agreement. Brown & Brown, Inc. v. Johnson, 25 N.Y.3d 364, 34 N.E.3d 357, 12 N.Y.S.3d 606 (2015) (affirming, in pertinent part, judgment that choice-of-law clause was unenforceable in respect to non-solicitation clause).

Pathway Medical Technologies, Inc. v. Nelson, No. CV11-0857 PHX DGC (D. Ariz. Sept. 30, 2011): a medical-device sales representative quit his job in Arizona and started working for a direct competitor of his former company. So, the former company filed a lawsuit in federal court in Arizona. The former company wanted to enforce a non-competition covenant in the sale rep's employment agreement; it asked the court for an immediate temporary restraining order (TRO) to prohibit the sales rep from working for the competitor.

The Arizona federal court refused to grant the requested restraining order. The court recognized that the employment agreement's governing-law clause specified that the law of Washington state would apply. But, said the Arizona court, in this area the laws of Arizona gave more weight to employees' right to earn a living than did Washington law, and this was an area of fundamental public policy for Arizona law. Consequently, the court refused to give effect to the agreement's choice of Washington law; the court also held that under Arizona law, the sales rep's non-competition covenant was unenforceable.

Narascyan v. EGL Inc., 616 F.3d 895 (9th Cir. 2010): a California truck driver sued the Texas-based trucking company for which he worked for violating California employment law. The driver's contract with the company specified that Texas law would apply and said that the driver was an independent contractor, not an employee.

A California federal court granted summary judgment in favor of the employer. The court reasoned that Texas law governed, as required by the contract. Applying Texas law to the facts of the case, the court concluded that the driver was indeed an independent contractor and therefore could not sue the company for violating California employment law.

The federal appeals court, though, reversed. It held that California courts would not give effect to the contract's choice of Texas law, but instead would apply California law. Under California law, said the appeals court, the driver was really an employee, not an independent contractor, and therefore could properly sue the trucking company for violating California employment law.

Dinan v. Alpha Networks, Inc., 764 F.3d 64 (1st Cir. 2014) (vacating judgment on jury verdict): The parties were a Maine-based sales representative and his employer, a California company. The sales rep's employment agreement included a California choice-of-law clause. The company failed to pay commissions on certain sales. The appeals court held that Maine law governed, and therefore the sales rep was entitled, not only to back commissions, but also to treble damages and attorney fees under a Maine statute.

• But see Exxon Mobil Corp. v. Drennen, 452 S.W.3d 319 (Tex. 2014): The Supreme Court of Texas held that it was permissible for Exxon Mobil to choose New York law for its employee stock-option and restricted-stock programs, because multi-national companies should be able to choose the laws they want to follow, in the interest of uniformity. (OK, the "choose the laws they want to follow" part does overstate the court's holding just a bit, but not by much; I agree with the court's holding on the merits of the specific issue, but the court arguably opened the door wide for corporations to purport to impose onerous terms and conditions on their employees while using a choice-of-law clause to strip the employees of their legal protections.)

4.64.3 (Skim:) Which governing law to choose?

Drafters wondering which governing law to choose should give some thought to the specifics of the laws being considered. Several years ago I started a choice-of-law cheat sheet for U.S. states (still a work in progress) that might be helpful.

4.64.4 (Skim:) Which governing law for international transactions?

In international transactions, a party from a jurisdiction with a civil code (e.g., continental Europe; Latin America) might be reluctant to agree to the law of a common-law country (e.g., England and its former colonies), or vice versa. Those parties might find the UN CISG (discussed below) to be somewhat of a "neutral" choice.

English law is often chosen for multi-national transactions. See generally, e.g., Melanie Willems, English Law – a Love Letter (AndrewsKurth.com 2014).

4.64.5 (Skim:) Choose the law of the agreed forum?

If the parties are also going to agree to a choice of forum — for which they can use one or more of the forum selection provisions — then they might want to choose the law of the agreed forum as their governing law. That could increase the chances of having their choice of law enforced in a dispute.

For example: the parties might agree to New York law, in part to take advantage of the statutory provision validating clauses requiring amendments to be in writing in certain contracts; see the commentary to § 4.9. A New York court would seem to be more likely to give effect to that provision, and thus to an amendments-in-writing clause, than a court in another jurisdiction.

4.64.6 (Skim:) CAUTION: China might be a special case

At the China Law Blog, Dan Harris asserts that as a practical matter, Chinese courts:

  • will not enforce a contract unless the contract is written in Chinese and the governing law is Chinese;
  • will not enforce judgments of other nations' courts in contract lawsuits; and
  • are unlikely to enforce arbitration awards from non-Chinese jurisdictions.

4.64.7 (Extra:) A governing-law clause might backfire

Specifying the law that you want to govern your contract, or your contractual relationship, might lead to unexpected results.

• Consider the case of Taylor v. Eastern Connection Operating, Inc., 465 Mass. 191 (2013): this was an overtime case; a group of couriers, working in New York as couriers for a Massachusetts-based company, sued the company in Massachusetts. These New-York based couriers claimed to be entitled to the protection of Massachusetts statutes governing independent contractors, wages, and overtime.

Normally, people who file employment-type lawsuits against their companies tend to do so in their own home jurisdictions. That's understandable; the home-court advantage is not to be sneezed at – and it's also why companies like for their contracts to specify their home court for any lawsuits.

Well, that's just what had happened here: the courier company had used a standard form for its contracts with its New York courier personnel. The contract form stated that Massachusetts law would apply and that all disputes would be litigated in Massachusetts.

When confronted by an actual employee lawsuit in the forum it had specified, the company moved to dismiss the case — and the Massachusetts trial court granted the motion — on the theory that the employment laws of Massachusetts did not apply to people who worked in New York.

The Massachusetts supreme court disagreed; it reversed the trial court's decision, giving an interim win to the New York-based courier personnel. The supreme court held that it would not be unfair to enforce the courier company's own forum-selection and governing-law clauses against the company. Moreover, said the supreme court, enforcement of those clauses would not contravene a fundamental policy of the state of New York, where the couriers actually worked.

The supreme court said that the trial court would need to conduct an evidentiary hearing to determine whether, on the facts of the case, the forum-selection and governing-law clauses should be enforced. The court remanded the case to the trial court for further proceedings.

• To similar effect was another Massachusetts case, Dow v. Casale, 83 Mass. App. Ct. 751 (2014): a Florida-based employee of a Massachusetts-based company successfully sued the CEO of his employer — personally — for unpaid sales commissions and other amounts, under a Massachusetts statute that created a private right of action. The employment agreement stated that Massachusetts law applied. The court, citing Taylor, held that the Massachusetts statute applied and affirmed summary judgment in favor of the employee.

• In a Canadian franchise-dispute case, an appeals court held that Ontario law — which gave franchisees specific rights — applied even to franchisees outside Ontario because the franchise agreement specified that Ontario law would apply. See 405341 Ontario Ltd. v. Midas Canada Inc., 2010 ONCA 478 ¶¶ 40-45. In that case, a provision in the franchise agreement stated that a franchisee, as a condition of renewing or transfering its rights, must release the franchisor from liability. The appeals court affirmed the trial court's ruling that, for purposes of the instant class action, that franchise-agreement provision was unenforceable and void.

• But in contrast, in O'Connor v. Uber Tech., Inc., No. C-13-3826, at part II-F (N.D. Cal. Sept. 4, 2014) a federal district court in San Francisco held that Uber drivers working outside California could not sue the company for violation of a California wage-and-hour statute, even though the drivers' contract with Uber included a California choice-of-law clause:

Under California law, a presumption exists against the extraterritorial application state law.  

[A] contractual choice of law provision that incorporates California law presumably incorporates all of California law — including California's presumption against extraterritorial application of its law.

Id. at part II-F. The court granted Uber's motion for dismissal on the pleadings.

4.64.8 (Extra:) Too-narrow a governing-law clause can be problematic

Drafters and reviewers should pay attention to the scope of the governing-law clause. For example: a Canadian software company had too-narrow a clause in its end user license agreement ("EULA") and, as a result, found itself forced to defend a class-action lawsuit in Chicago instead of in Victoria, B.C. See Beaton v. SpeedyPC Software, No. 13-cv-08389 (N.D. Ill. June 5, 2015) (denying defendant's motion to dismiss for forum non conveniens). In that case, the court said:

Here, the EULA states only that "[t]his Agreement shall be governed exclusively by the laws of the Province of British Columbia and the laws of Canada applicable therein …." The plain language of this provision limits its effect to the interpretation of the EULA itself, and is significantly more limited than broadly-stated choice of law provisions that apply the choice of law to all claims "arising out of" or "relating to" the contract.

Thus, the Court finds that there was no intent for the EULA to apply Canadian law to all claims relating to the Software. …

[T]he claims being asserted are not sufficiently related to the EULA for the choice of law provision to govern them. Beaton's claims under the ICFA and Illinois common law of fraudulent inducement and unjust enrichment have nothing to do with the subject matter of the EULA, which dictates only the terms on which the purchaser of the SpeedyPC Pro license may use the Software, rather than the specifications and functions of the Software itself.

Instead, Beaton's claims against SpeedyPC are based on its marketing and advertising activities, which are separate and apart from the specifications set out in the EULA

Id. (emphasis by the court, citations and footnote omitted, extra paragraphing added).

(Hat tip: Richard Raysman.)

Another example: Family Endowment Partners, L.P. v. Sutow, NO. 2015 CV 1411-BLS1 (Mass. Superior Ct. Nov. 16, 2015). In that case:

  • The contract in suit was between an investment firm and one of its clients (a married couple).
  • The contract contained an arbitration provision that applied broadly, encompassing all disputes relating to the agreement.
  • The contract also contained a choice-of-law provision, but it applied only to the interpretation and enforcement of the agreement — and, notably, not to related claims as did the arbitration provision.
  • The client's claims against the investment firm included claims under a Pennsylvania unfair-trade-practices statute. The arbitrator held that, because the choice-of-law provision did not apply to non-contract claims, the Pennsylvania statute was available to the client; the arbitrator awarded treble damages under that statute.

The court upheld the arbitration award, holding that the contract's provision excluding "special, consequential or incidental damages" was not sufficient to exclude punitive- or multiple damages.

See, e.g., Pat Murphy, $48M arbitration award vs. investment advisor upheld (McCarter.com 2015).

4.64.9 (Skim:) Subject-specific exceptions?

The parties' agreement might specify the law of other jurisdictions for particular subjects such as arbitration.

4.64.10 (Skim:) Territory-specific choice of law?

Some companies' boilerplate terms include territory-specific choices of law (and forum selections). For example, here's one from Carson Wagonlit Travel, at https://perma.cc/6RJK-57EM:

18.1     This Agreement shall be exclusively governed by the exclusive laws of and all disputes relating to this Agreement shall be resolved exclusively in (i) England and Wales and governed by English law if the Seller's registered office is located in the Europe, Middle East, Africa (EMEA) region; (ii) Singapore if the Seller's registered office is located in Asia Pacific (APAC) region; or (iii) the State of New York, USA if the Seller's registered office is located the Americas region.

4.65 (Optional:) Government subcontracting

Depending on the law, a subcontractor under a government contract could be subject to specific requirements imposed by statute or regulation such as:

  • equal-opportunity reporting requirements;
  • affirmitive-action obligations;
  • prohibitions of various employment practices;
  • restrictions of various kinds, e.g., on assignments.

See, e.g., Robin Shea, Applicant tracking and the EEOC: "You can SUE us for that?" (EmploymentAndLaborInsider.com 2016). For that reason, a disclaimer might be in order. [TO DO: NEED CITES]

Entire books have been written on the issues arising from government subcontracting, of course; this disclaimer is intended to try to rule out the need to understand those issues.

4.66 (Optional:) Gross negligence

4.66.1 New York's definition of gross negligence is fairly reasonable

A useful definition of gross negligence can be adapted from an opinion of the Court of Appeals of New York (that state's highest court) in Sommer v. Federal Signal Corp., 79 N.Y.2d 540, 554 (1992), which seems to achieve a reasonable balance of fairness and precision:

The term , whether or not capitalized, refers to conduct that evinces a reckless disregard for or indifference to the rights of others, tantamount to intentional wrongdoing; it differs in kind, not only in degree, from ordinary negligence.

Drafters can consider requiring clear and convincing evidence of gross negligence, the same standard as is required in many jurisdictions for proof of fraud. [DCT TO DO: CITATIONS NEEDED]

4.66.2 Alternative: Texas-law definition of gross negligence

A Texas statute, in the context of establishing prerequisites for awards of punitive damages, sets out a far-more restrictive definition of gross negligence, added as part of a far-reaching 2003 tort-reform package enacted by the legislature. See Tex. Civ. Prac. & Rem. Code § 41.001(11), discussed in Robert J. Witte and James G. Ruiz, House Bill 4 – Article 13 – Damages, J. Tex. Consumer L. 33 (date not available). The definition is used in § 41.003 of the Code, which conditions an award of punitive damages on a showing, by clear and convincing evidence, of fraud, malice, or gross negligence:

      (11) "Gross negligence" means an act or omission:

           (A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and

           (B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

4.66.3 Alternative: California-law definition of gross negligence

The California supreme court, in its 2007 Janeway opinion, noted that "[g]ross negligence long has been defined in California and other jurisdictions as either a want of even scant care or an extreme departure from the ordinary standard of conduct." City of Santa Barbara v. Janeway, No. 1111681, slip op. at 6, 161 P.3d 1095 (Cal. 2007) (internal quotation marks and citations omitted, emphasis added). The supreme court held that in cases of gross negligence, advance releases of liability are unenforceable as being against public policy; the court affirmed a judgment that release language in a contract did not shield a defendant from an allegation of gross negligence in the drowning death of a disabled teen-ager at a city pool.

4.66.4 Alternative: Federal-law definition of gross negligence

In the litigation over the notorious "BP oil spill" in the Gulf of Mexico, a federal district court wrote at length about the definition of gross negligence in the context of the (federal) Oil Pollution Act of 1990 and how BP was guilty of gross negligence; the court held that gross negligence was less than reckless conduct (much as in the California definition discussed above). See In re: Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mexico, on April 20, 2010, paragraphs 481 et seq., esp. 494 & n.180, 495 (E.D. La. Sept. 4, 2014) (findings of fact and conclusions of law).

4.66.5 Business context

Contracts sometimes use the term gross negligence, as distinct from ordinary negligence. For example, a contractual limitation on a party's liability for negligence might include a carve-out saying that the limitation will not apply if the party is grossly negligent. Unfortunately, the difference between negligence and gross negligence may be hard to assess in practice.

4.66.6 Texas-law definition of gross negligence

A Texas statute, in the context of establishing prerequisites for awards of punitive damages, sets out a far-more restrictive definition of gross negligence, added as part of a far-reaching 2003 tort-reform package enacted by the legislature. See Tex. Civ. Prac. & Rem. Code § 41.001(11), discussed in Robert J. Witte and James G. Ruiz, House Bill 4 – Article 13 – Damages, J. Tex. Consumer L. 33 (date not available). The definition is used in § 41.003 of the Code, which conditions an award of punitive damages on a showing, by clear and convincing evidence, of fraud, malice, or gross negligence:

      (11) "Gross negligence" means an act or omission:

           (A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and

           (B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

4.66.7 California-law definition of gross negligence

The California supreme court, in its 2007 Janeway opinion, noted that "[g]ross negligence long has been defined in California and other jurisdictions as either a want of even scant care or an extreme departure from the ordinary standard of conduct." City of Santa Barbara v. Janeway, No. 1111681, slip op. at 6, 161 P.3d 1095 (Cal. 2007) (internal quotation marks and citations omitted, emphasis added). The supreme court held that in cases of gross negligence, advance releases of liability are unenforceable as being against public policy; the court affirmed a judgment that release language in a contract did not shield a defendant from an allegation of gross negligence in the drowning death of a disabled teen-ager at a city pool.

4.66.8 Federal-law definition of gross negligence

In the litigation over the notorious "BP oil spill" in the Gulf of Mexico, a federal district court wrote at length about the definition of gross negligence in the context of the (federal) Oil Pollution Act of 1990 and how BP was guilty of gross negligence; the court held that gross negligence was less than reckless conduct (much as in the California definition discussed above). See In re: Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mexico, on April 20, 2010, paragraphs 481 et seq., esp. 494 & n.180, 495 (E.D. La. Sept. 4, 2014) (findings of fact and conclusions of law).

4.67 (Skim:) Guaranties

4.67.1 Spelling: Guaranty, or gurantee?

In U.S. law, the terms "guaranty" and "guarantee" are usually associated with a third party's commitment to make good on a principal party's failure to comply with an obligation. Traditionally, "guaranty" is the noun, while "guarantee" is the verb; see, e.g., Uhlmann v. Richardson, 287 P.3d 287 (Kan. App. 2012), citing Bryan Garner, Garner's Dictionary of Legal Usage 399 (3d ed. 2011).

For example, when the author's daughter was in college, the author signed a guaranty (noun) by which the author guaranteed (verb) her payment of her apartment rent.

A related point: People sometimes use the terms guarantee (or guaranty) and warranty interchangeably; the two terms are close in meaning but warranty is broader.

4.67.2 Just what obligations are guaranteed?

Drafters of guaranties should consider guaranteeing only payment obligations; that's because guaranties of performance of other types of obligation (for example, an obligation to perform consulting services, repair work, building construction, etc.) might well require considerably-more negotiation and customized language.

Drafters representing guarantors will want to be careful to define just which payment obligations are being guaranteed. A bit of an oddball case on this point was McLane Foodservice, Inc. v. Table Rock Restaurants, LLC, 736 F.3d 375 (5th Cir. 2013) (affirming district-court judgment in favor of alleged guarantor):

  • A restaurant company, Table Rock, went out of business owing a food-service company, McLane Foodservice, some $447,000.
  • McLane Foodservice apparently noticed that nearly 14 years earlier, the treasurer and 40%-owner of the Table Rock restaurant company had signed a personal guaranty of the debts of another restaurant company, Border Patrol, to a division of PepsiCo.
  • In the interim, the PepsiCo division had sold its assets to another company, Ameriserve, which later filed for bankruptcy protection and sold its assets to McLean Foodservice, which presumably had the treasurer's signed guaranty in the files it inherited.
  • Importantly (at least to the courts), the PepsiCo division never extended credit to the Table Rock restaurant company; it was McLane Foodservice, PepsiCo's successor-twice-removed, that did so.

Both the trial court and the appellate court held that the treasurer's guaranty, by its terms, covered only debts to the PepsiCo division — and because Table Rock had never incurred any such debts, its treasurer wasn't liable to McLane Foodservices under the guaranty.

The appellate court's opinion didn't even mention that, judging by the facts recited in the opinion, Table Rock's treasurer apparently had not guaranteed Table Rock's debts — his guaranty, from nearly 14 years before, was for the debts of the Border Patrol restaurant company, which had no evident connection to Table Rock. (If those were indeed the facts, then I'm surprised that McLane Foodservices' counsel wasn't sanctioned by the court for bringing a frivolous lawsuit against the treasurer.)

LESSON: Leaving aside the problem mentioned in the previous paragraph, the guaranty in McLane Foodservices could have recited that the guaranty covered all credit extended to the by the PepsiCo division and by PepsiCo's successors and assigns.

4.67.3 Consideration for a guaranty

Guaranties will often recite that the guarantor agrees to the guaranty in consideration of the creditor's entry into an agreement, or some such. Absent consideration, a court might hold a guaranty to be unenforceable. The required consideration might well be the guarantor's desire to support the debtor — but not always.

Example: In Yellow Book, Inc. v. Tocci, 2014 Mass. App. Div. 20 (2014), a company's bookkeeper signed an order for ad space in a Yellow Pages phone book; unhappiily for her, she didn't read the fine print, which contained a statement that she personally guaranteed payment. A court held that she was not liable on the guaranty, because she had received no consideration for it. See id. at 22-23. The case is discussed in Robert W. Stetson, Four Tips for Drafting Enforceable Personal Guarantees, in (BNA) Corporate Counsel Weekly Newsletter, Apr. 9, 2014, which includes numerous case citations.

4.67.4 Forum selection

A guaranty might include a provision stating that the guarantor agreed to personal jurisdiction in a court convenient to the creditor. Such a forum-selection provision was readily enforced by the Seventh Circuit in the Knauf Insulation case, even though the guarantors purportedly did not have "minimum contacts" with the selected forum; the court remarked that the guarantors "didn't have to have any contacts" with that forum. See slip op. at 3 (citing cases; emphasis in original).

4.67.5 Waiver of creditor signature

Many guaranty clauses include language stating that the guarantor waives acceptance and signature by the creditor. Such language might very well merely duplicate applicable law. See, e.g., US Bank Nat'l Ass'n v. Polyphase Elec. Co., No. 10-4881 (D. Minn. Apr. 23, 2012): In that case, the court granted granted summary judgment that a bank was entitled to enforce guaranties of loans made by the bank, even though the bank had not signed the guaranty documents.

4.67.6 Guarantor pays collection expenses

A guaranty will often require the guarantor to pay any expenses incurred by the creditor in collecting the debt. See, e.g., clause 4 of the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 305 (Ala. 2012).

4.67.7 Refunds in bankruptcy

If a debtor of a guaranteed payment obligation were to file for bankruptcy protection (under U.S. law), then the obligation's creditor might be forced to return any payments that were made by the principal within the 90 days preceding the bankruptcy filing date. Such payments are known as "avoidable preferences." See generally, e.g., Patricia Dzikowski, The Bankruptcy Trustee and Preference Claims (Nolo.com; undated); see also the last paragraph of the guaranty language in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753, 25 N.Y.3d 485, 488-89, 36 N.E.3d 80 15 N.Y.S.3d 277, at part I.

A creditor in bankruptcy has the right to contest its obligation to refund an avoidable preference. That can be difficult, though; the creditor must successfully jump through some hoops to prove that it was entitled to the payment. See generally, e.g., Kathleen Michon, Pre-Bankruptcy Payments to Creditors: Can the Trustee Get the Money Back? (Nolo.com; undated).

As a practical matter, many avoidable-preference cases are settled, with the creditor making a partial refund in lieu of incurring the expense of jumping through those proof hoops. In such a situation, if the original obligation had been guaranteed, then the creditor likely would want to try to recoup the partial refund from the guarantor.

"Courts have uniformly held that a payment of a debt that is later set aside as an avoidable preference does not discharge a guarantor of its obligation to repay that debt." Coles v. Glaser, 2 Cal. App. 5th 384, 389-90 (2016) (extensive citations, internal quotation marks, and alteration marks omitted).

4.67.8 Guarantor liability for deficiencies

Guaranty language often states that the guarantor will be liable This language is based on that of the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 309 (Ala. 2012); see also the similar language of the guaranty in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753, 25 N.Y.3d 485, 488-89, 36 N.E.3d 80 15 N.Y.S.3d 277, at part I.

4.67.9 Waiver of defenses, etc.

A guaranty might state that the guarantor waives any defense or right of setoff that might be asserted by the guarantor and even by the debtor. See, for example:

4.67.10 Joint and several guarantor liability

It's a really good idea for drafters (and reviewers) to be clear about the extent to which multiple guarantors are to be jointly and severally liable for the guaranteed payment obligation(s). In a given transaction, for example, Alice might guarantee the obligations of Alan, and Bob might guarantee the obligations of Betty, but not vice versa — that is, Alice does not guarantee Betty's obligations nor does Bob guarantee Alan's obligations.

4.67.11 Unconditional guarantor liability

An "absolute and unconditional" guaranty is likely to be enforced even in what might seem like unfair circumstances such as collusion between the lender and the principal. For an example of this, see the decision by the Court of Appeals of New York (which is that state's highest court) in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753, 25 N.Y.3d 485, 36 N.E.3d 80 15 N.Y.S.3d 277. In that case, a guarantor sought to avoid liability as provided under an "unconditional and absolute" guaranty in favor of plaintiff, on grounds that the default judgment against the guarantor was obtained by the plaintiff's collusion. The court of appeals concluded that the plaintiff's collusion claim constituted a defense, and therefore was barred by the express language of the guaranty. See 25 N.Y..3d at 492, 495,97 (The court of appeals also concluded that the guarantor's claim of collusion was contradicted by the record.)

4.67.12 Alteration of guaranteed obligation

A guaranty might provide that an alteration of the guaranteed obligation does not affect the guaranty. The intent of such language would be to override the general rule — which is strictly applied by courts — that "a guarantor is discharged if, without his or her consent, the contract of guaranty is materially altered." Eagerton v. Vision Bank, 99 So. 3d 299, 305-06 (Ala. 2012) (holding that modification of loan discharged guarantors from further obligations) (citations, quotation marks, and alterations omitted); accord, Sterling Development Group Three, LLC, v. Carlson, 2015 N.D. 39 (affirming holding that guaranty was discharged by alteration of guaranteed obligations without guarantor's knowledge or consent) (citing state statute). For an example of clause language like this, see the guaranty in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753, 25 N.Y.3d 485, 488-89, 36 N.E.3d 80 15 N.Y.S.3d 277.

4.67.13 Reasonable collection efforts

A guarantor might want the guaranty to state that, before the creditor can come after the guarantor, the creditor must first obtain a judgment against the debtor and then be unable to collect on the judgment. Creditors, of course, will typically object to this language; they normally want to be able to go after guarantors immediately to get their money, as opposed to incurring the delay, burden, expense, and uncertainty of first having to file suit against their debtors.

4.67.14 Guarantor liability cap?

In some transactions a cap on the liability of some or all guarantors might be a possible negotiation point.

4.67.15 Consider other ways of "guaranteeing" payment, too

Drafters representing a guaranty creditor should consider other possible ways of securing the guaranteed payment obligation, such as (for example):

An interesting form of payment security can be seen in Falco v. Farmers Ins. Gp., 795 F.3d 864 (8th Cir. 2015) (affirming summary judgment in favor of defendants). In that case:

  • An independent insurance agent's contract with an insurance carrier entitled the agent to a certain termination payment if he ever ceased representing the carrier.
  • Some 16 years after signing on with the insurance carrier, the agent took out a line-of-credit loan from the carrier's employee credit union.
  • As part of the loan documentation, the agent signed a power of attorney giving the credit union the power to submit the agent's resignation from representing the carrier, in which case the carrier would pay the agent's termination payment to the credit union.
  • Five years later, the agent didn't make his payments on his line-of-credit loan, so the credit union did just as described above: It tendered the agent's resignation from representing the insurance carrier; collected the termination payment and applied it to the agent's outstanding loan balance; and remitted the balance to the agent.

The agent filed suit against pretty much everyone in sight. The district court granted summary judgment in favor of all defendants; the appeals court affirmed.

4.67.16 Additional reading about guaranties

See, e.g., Henri Chalouh, The Commercial Lease Guarantee: An Overview For Landlords And Tenants (Mondaq.com 2015).

4.67.17 [DCT to-do items]

Add language for:

  • Guarantor must provide audited financials periodically
  • Guarantor consents to jurisdiction somewhere convenient to the creditor (e.g., where leased property is located if guarantor is guaranteeing tenant's payment of lease)
  • Guarantor appoints an agent for service of process
  • Representation by signer of corporate guaranty that the signer is duly authorized to do so.

These are inspired by Pamela Westhoff, Charles Donovan and Lydia Lake, Commercial Lease Guaranties From Foreign Entities: What You Need to Know to Safeguard Your Security (Shepard Mullin 2015).

4.68 (Study:) Indemnities

4.68.1 What exactly is an "indemnity" obligation?

In many contracts, indemnity provisions are intensely-negotiated. As explained by a California appeals court:

Generally, indemnity is defined as an obligation of one party to [i] pay or [ii] satisfy the [x] loss or [y] damage incurred by another party.

A contractual indemnity provision may be drafted either[:]

  • to cover claims between the contracting parties themselves, or
  • to cover claims asserted by third parties.

Indemnity agreements are construed under the same rules which govern the interpretation of other contracts. Accordingly, the contract must be interpreted so as to give effect to the mutual intention of the parties.

The intention of the parties is to be ascertained from the clear and explicit language of the contract.

And, unless given some special meaning by the parties, the words of a contract are to be understood in their ordinary and popular sense.

In interpreting an express indemnity agreement, the courts look first to the words of the contract to determine the intended scope of the indemnity agreement.

Rideau v. Stewart Title of Cal., Inc., 235 Cal. App. 4th 1286, 1294, 185 Cal. Rptr. 3d 897 (2015) (interal quotation marks, alteration marks, and extensive citations omitted; extra paragraphing, bracketed numbering, and bullets added).

4.68.2 Caution: Is the indemnity obligation backed by enough money?

A right to be indemnified (like any other) might be worthless if the indemnifying party can't afford to do the needful. Consequently, a party wanting an indemnity commitment should consider negotiating backup sources of cash to support the indemnity obligation, commonly in the form of (for example) an insurance policy; a  from a third party; an escrow; and/or a standby letter of credit (which of course is itself a form of guaranty).

4.68.3 Caution: Is an indemnity obligation a good idea?

Any party asked to agree to an indemnity obligation should think about it carefully. That's especially true if the indemnity obligation would apply regardless of the other party's own negligence or other "misconduct"; if you agree to that kind of obligation, in effect you've become the other party's insurance carrier.

4.68.4 Indemnity liability might be much more than plain breach-of-contract damages

Suppose that Alice agreed to indemnify Bob from all losses, damages, etc., arising from Alice's breach of contract (or breach of warranty or misrepresentation). That might open up Alice to far-greater liability than she would normally risk for a "garden variety" breach of contract. That's because, at least in Anglo-American jurisprudence:

  • Damages for breach of contract are generally limited to those that are foreseeable, and a non-breaching party will generally have a duty to mitigate its damages;
  • In contrast, liability for indemnity might not be subject to such a foreseeability limitation (although the case law is unclear on this point).

See generally:

4.68.5 An obligation to indemnify a party against its own fault might be unenforceable

In the interest of deterring negligent conduct, some jurisdictions entirely bar a party from being indemnified for the consequences of its own negligence. As the South Carolina supreme court explained:

The policy basis for the negligence rule is simple—barring indemnification when the indemnitee is at fault for the damages serves to deter negligent conduct in the future, for the indemnitee will know that the indemnification agreement will not save it from liability if it fails to act with due care.

Ashley II of Charleston, L.L.C. v. PCS Nitrogen, Inc., No. 27420, part II-A (S.C. July 23, 2014) (on certified question) (emphasis added). The supreme court held that the same rationale did not apply in cases of strict liability, because the same deterrent effect would not be present. See id.

Likewise, California Civil Code Section 1668 provides that "[a]ll contracts which have for their object, directly or indirectly, to exempt any one from responsibility for [i] his own fraud, or [ii] willful injury to the person or property of another, or [iii] violation of law, whether willful or negligent, are against the policy of the law." (Bracketed lettering added.) Such contracts are therefore void under section 1667(2).

In some jurisdictions, legislatures have enacted anti-indemnity statutes that, for certain types of contract, prohibit indemnity clauses that would shift the risk of Bob's own negligence onto Alice. Such indemnity clauses are often found in construction contracts, in which prime contractor Bob might require subcontractor Alice to indemnify him even against the consequences of Bob's own negligence. See, e.g., the Texas Anti-Indemnity Act, codified in Chapter 151 of the Texas Insurance Code. See also Foundation of the American Subcontractors Association, Inc., Anti-Indemnity Statutes in the 50 States (2013).

4.68.6 The "express negligence rule" might impose conspicuousness requirements for some indemnity obligations

Less restrictively than the outright ban just discussed: In some jurisdictions the "express-negligence rule" precludes enforcement of a contract provision requiring Bob to indemnify Alice for the consequences of Alice's own negligence unless the contract provision is both express and (Black letter:) Conspicuous text, § 4.36. See, e.g., Crawford v. Weather Shield Mfg. Inc., 44 Cal. 4th 541, 552 (2008); Dresser Industries v. Page Petroleum, Inc., 853 S.W.2d 505, 508 (Tex. 1993) (conspicuousness requirement); Ethyl Corp. v. Daniel Constr. Co., 725 S.W.2d 705, 708 (Tex. 1987) (express-negligence doctrine). See generally, e.g., Byron F. Egan, Indemnification in M&A Transactions for Strict Liability or Indemnitee Negligence: The Express Negligence Doctrine (JW.com 2014).

4.68.7 Caution: Will a contractual indemnity be excluded from the indemnifying party's insurance coverage?

Any party that is asked to agree to indemnify another party should consider checking whether its applicable insurance policies exclude coverage for indemnity obligations. This was an issue in Ewing Constr. Co. v. Amerisure Ins. Co., 420 S.W.3d 30 (Tex. 2014), which is discussed in this blog post by insurance agent Randy Maniloff.

4.68.8 Watch out for particular scope-of-indemnity language

In an Alabama case:

  • A lease agreement for retail space contained an indemnity provision that required the retailer to indemnify its landlord against, among other things, "any [losses, etc.] caused by injuries to persons or property while in, on or about [the retail premises] …."
  • An employee of the retalier became sick while working in vacant retail space in the building, which the landlord had allowed the retailer to use for temporary storage after flooding.
  • The employee sued the landlord, which cross-sued the retailer on the indemnity provision.

The state supreme court held that the indemnity provision did not apply. Once Upon a Time, LLC v. Chappelle Properties, LLC, 209 So.3d 1094 (Ala. 2016) (reversing and remanding trial court's denial of retailer's motion for summary judgment).

4.68.9 The law might require an indemnifying party to defend against a claim as well

The California Supreme Court has held that, by statute — specifically, Cal. Civ. Code § 2778(3) — unless the parties to a contract agree otherwise, a party having an indemnity obligation under the contract is also obligated, upon request, to provide a defense for the protected party. See Crawford v. Weather Shield Mfg. Inc., 44 Cal. 4th 541, 553, 79 Cal. Rptr. 3d 721, 187 P.3d 424 (2008) (affirming court of appeal’s affirmance of trial-court judgment).

The same might be true in other states; see Gilson S. Riecken, The Duty to Defend under Non-Insurance Indemnity Agreements … 50 Santa Clara L. Rev. 825, 874 (appendix listing other states with similar rule).

4.68.10 Optional additional reading

4.68.11 In-class exercises about indemnities

Indemnities: Duty to defend

FACTS: Suppose that:

  • You draft an indemnity obligation that does not expressly require the subcontractor to defend your client, the general contractor, from claims, but merely obligates the subcontractor to indemnify the general contractor.
  • An employee of the subcontractor writes a letter to the general contractor, asserting a claim. Assume for this purpose that the employee's claim comes within the scope of the subcontractor's indemnity obligation.
  • The general contractor forwards the employee's letter to the subcontractor and demands that the subcontractor engage outside counsel to investigate the claim.

QUESTIONS:

  1. Must the subcontractor engage outside counsel for the general contractor?
  2. Would your answer be different if all of this were taking place in Los Angeles instead of Houston? Cite the relevant authority.
Indemnity exercise: The spontaneously-combusting widgets

FACTS:

  1. Alice manufactures electronic widgets. Each widget has a battery that is sealed into the widget and not replaceable.
  2. Bob manufactures electronic gadgets that include electronic widgets.
  3. Bob enters into a contract with Alice to buy electronic widgets from her.
  4. The contract includes, among other provisions:
    • a warranty that the widgets do not contain any defects in design or manufacture;
    • a provision requiring Alice to indemnify Bob against any harm Bob suffers from defects in the widgets; and
    • an exclusion of incidental and consequential damages.
  5. Bob takes delivery of a large quantity of Alice's widgets and stores them in an appropriate storage room.
  6. In the storage room, the batteries in several of Alice's widgets spontaneously catch fire, resulting in major damage and causing significant "down time" for Bob's gadget-manufacturing operations. (Think: Hoverboards.)
  7. Citing the indemnity provision, Bob demands that Alice reimburse him for the cost of:
    • repairs;
    • replacement of the damaged contents of the storage room;
    • the travel expenses that Bob incurred in going to China and India to check out alternative sources of widgets;
    • the profits that Bob lost from the manufacturing down time.

QUESTIONS:

  1. EXPLAIN IF FALSE: Alice is not required to reimburse Bob because an indemnity provision covers claims by third parties against the protected party, not direct claims by the protected party against the indemnifying party.
  2. EXPLAIN IF FALSE: If Bob sues Alice for breach of her indemnity obligation, Alice can probably get Bob's claim for lost profits thrown out early (by moving for partial summary judgment) as barred by the contract's exclusion of consequential damages.
  3. EXPLAIN IF FALSE: If Alice had negotiated the indemnity provision to cover only third-party claims, the provision likely would be enforceable.
  4. EXPLAIN IF FALSE: Alice can probably get Bob's claim for travel expenses dismissed on partial summary judgment as barred by the contract's exclusion of incidental damages.
Exercise: Defense against indemnified claims
  1. FACTS:
    A. Alice's contract with Bob obligates her to reimburse Bob for his attorney fees and expenses in defending against certain third-party claims.
    B. A third party, Carol, brings such a claim against Bob.
    C. Bob hires Skadden Arps (a top NYC firm) to defend him against Carol's claim.
    D. Alice has plenty of money to pay legal bills.
    QUESTION: Speculate about what incentives might motivate Skadden in conducting Bob's defense.
    QUESTION: Name two ways that Alice, during negotiation of her contract with Bob, could have limited her financial exposure to Bob's cost of defending against Carol's claim.
  2. MORE FACTS:
    E. Alice's contract with Bob also requires her to indemnify Bob against any monetary awards resulting from such third-party claims.
    F. Bob neglects to mention to either Alice or Skadden that Carol had filed her third-party claim weeks before, and that when Bob failed to file a timely answer, Carol moved for and obtained a default judgment for a large amount of money.
    QUESTION: Name two ways that Alice, during negotiation of her contract with Bob, could have limited her exposure to Bob's screw-up.
  3. ALTERNATE FACTS:
    G. Alice's contract with Bob requires her to provide Bob with a defense, as opposed to reimbursing Bob for his defense expenses.
    H. Alice engages her regular lawyer, Andy, to conduct Bob's defense against Carol's claim.
    I. Bob finds that he and Andy don't get along so well.
    QUESTION: During negotiation of the contract, what sort of clause could Bob have asked to be included in the contract to protect him against this uncomfortable situation?
  4. ALTERNATE FACTS:
    J. It turns out that Alice can't afford to pay Bob's legal bills for defending against Carol's claim.
    QUESTION: What if anything might Bob have done during contract negotiation to mitigate this problem?

4.68.12 Flashcards: Indemnities

You could see quiz questions based on one or more of the following:

QUESTION 1: How does an indemnity relate to a warranty?

A: An indemnity is a reimbursement; a warranty is a promise to reimburse (i.e., indemnify) someone if a warranted state of affairs turns out not to be true.

QUESTION 2: IF FALSE, EXPLAIN WHY: IF: Alice agrees to indemnify Bob against damage arising from occurrence of Event X; THEN: This reduces the risk to the parties associated with the (possible) occurrence of Event X. (CAUTION: Read this carefully.)

A: False — it doesn't reduce the risk, it allocates the risk.

QUESTION 3: IF FALSE, EXPLAIN WHY: An indemnity obligation allocates at least some of the financial risk of Event X.

A: True.

QUESTION 4. IF FALSE, EXPLAIN WHY: The following is an acceptable conventional phrasing: Alice hereby indemnifies Bob against any damage Bob might incur if it rains tomorrow.

A: False — it should be "Alice will indemnify Bob [i.e., future tense] …."

4.69 (Read:) Independent contractors (disclaimer)

4.69.1 (Black letter:) Stating that the parties are independent contractors will not necessarily work.

For example, in 2014 a three-judge panel of the Ninth Circuit held that the plaintiffs in a class-action suit, who were drivers for FedEx, were not independent contractors but employees; the panel reversed summary judgment in favor of FedEx and remanded to the trial court with instructions to enter summary judgment for the drivers on the question of their employment status. See Alexander v. FedEx Ground Package System, Inc., 765 F.3d 981 (9th Cir. 2014). A separate concurring opinion noted that "[l]abeling the drivers 'independent contractors' in FedEx’s Operating Agreement does not conclusively make them so …." Id. at 998 (Trott, J., concurring).

On the other hand, such a statement of intent — in an unsigned agreement, no less — paid off for one company: The statement of intent helped to defeat a claim that the company had entered into a partnership. See nClosures, Inc. v. Block & Co., 770 F.3d 598, 604 (7th Cir. 2014) (affirming summary judgment dismissing claim for breach of fiduciary duty).

4.69.2 (Skim:) Supreme Court precedent: "No shorthand formula or magic phrase" for independentcontractor status

In 2014, a 3-1 decision by the National Labor Relations Board addressed whether, under U.S. law, certain FedEx home delivery drivers were independent contractors or employees. The majority opinion reiterated the need to rely on general principles of agency in making the determination:

[T]he Board is bound by the Supreme Court’s decision in [NLRB v. United Insurance Co. of America, 390 U.S. 254 (1968)]. … The Court acknowledged that the application of the common-law agency test may be challenging, given the “innumerable situations which arise in the common law where it is difficult to say whether a particular individual is an employee or an independent contractor.” Id. at 258. Nonetheless, the Court emphasized that “there is no shorthand formula or magic phrase that can be applied to find the answer.” Id.

Instead, the Court stated that “all of the incidents of the relationship must be assessed and weighed with no one factor being decisive. What is important is that the total factual context is assessed in light of the pertinent common-law agency principles.” Id.

In identifying the relevant common-law factors to consider in distinguishing between employees and independent contractors …. the Court has cited with approval the nonexhaustive, multifactor test articulated in the Restatement (Second) of Agency § 220 (1958), and has reiterated that no single factor of that test is determinative. [Citations omitted] Restatement § 220 provides that:

In determining whether one acting for another is a servant or an independent contractor, the following matters of fact, among others, are considered:

(a) The extent of control which, by the agreement, the master may exercise over the details of the work.

(b) Whether or not the one employed is engaged in a distinct occupation or business.

(c) The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision.

(d) The skill required in the particular occupation.

(e) Whether the employer or the workman supplies the instrumentalities, tools, and the place of work for the person doing the work.

(f) The length of time for which the person is employed.

(g) The method of payment, whether by the time or by the job.

(h) Whether or not the work is part of the regular business of the employer.

(i) Whether or not the parties believe they are creating the relation of master and servant.

(j) Whether the principal is or is not in the business

FedEx Home Delivery, 361 NLRB No 55 (2014), at 2 (emphasis and extra paragraphing added), discussed in, e.g., John P. Furfaro and Risa M. Salins, Independent Contractor Update: Courts, NLRB, Legislatures Weigh In, N.Y.L.J., Apr. 3, 2015 (Skadden.com).

4.69.3 (Skim:) The Internal Revenue Service's guidance on independent contractors

The [U.S.] Internal Revenue Service's Web site offers easy-to-read guidance about what the Service considers in determining whether someone is an employee (for whom the employer must pay certain taxes) or an independent contractor:

Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed. [Emphasis edited]

The IRS Web site also provides a more-detailed but still-readable explanation of how the law generally works:

Facts that provide evidence of the degree of control and independence fall into three categories:

 1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

 2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

 3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

4.69.4 (Read:) Improper classification of employees as independent contractors can attract class-action attorneys

Independent-contractor litigation can be expensive because it can attract the attention of class-action attorneys. For example, ride-sharing service Uber has been deluged with class-action lawsuits alleging that Uber violated the (U.S.) Fair Labor Standards Act by not treating its drivers as employees; the company settled two such lawsuits in California and Massachusetts for up to $100 million, but then was hit with more suits in other states.

As an older example, Microsoft had contracts with a number of alleged independent contractors who were not entitled to employee benefits, such as the right to participate in Microsoft's employee stock purchase plan. Microsoft, however, later conceded to the IRS that the workers were indeed employees. After extensive litigation, an appeals court held that the now-employees were entitled to employee benefits after all. Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997).

4.70 (Read:) Injunctive relief

4.70.1 (Skim:) The need for caution

Contracts sometimes state that a party:

  1. stipulates that its breach will cause irreparable harm to the other party — this should normally be modified to say that a breach could cause irreparable harm; and
  2. sometimes, waives any requirement of posting a bond — this is a bad idea, if you're representing the party that might be the target of injunctive relief —

A potential future respondent might not want to stipulate to irreparable harm, because doing so would absolve the movant from what might be a significant burden of proof, as discussed below.

On the other hand, in some cases — e.g., misappropriation of crucial trade secrets — the existence of irreparable harm might be pretty obvious. In such a case, it might not be much of a concession for a potential Respondent to stipulate in advance to the existence of irreparable harm.

4.70.2 (Skim:) Legal background: The four-factor proof requirement for injunctive relief

In U.S. jurisdictions, a party seeking an injunction or similar equitable relief must show, not merely allege, that (among other things) it has suffered or is likely to suffer irreparable harm that could not be adequately compensated by remedies available at law, such as monetary damages.

As explained by the Supreme Court of the United States:

According to well-established principles of equity, a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief.

A plaintiff must demonstrate:

(1) that it has suffered an irreparable injury;

(2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury;

(3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and

(4) that the public interest would not be disserved by a permanent injunction.

The decision to grant or deny permanent injunctive relief is an act of equitable discretion by the district court, reviewable on appeal for abuse of discretion.

eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388, 391 (2006) (describing traditional four-factor test in context of patent-infringement injunctions) (citations omitted, emphasis and extra paragraphing added).

4.70.3 (Read:) Caution: Stipulating "irreparable harm" is likely to be dangerous

An injunctive-relief provision in a contract might contain:

  • a stipulation that the party seeking injunctive relief will suffer irreparable harm from a breach of the contract; and/or
  • a waiver of any requirement that the party seeking injunctive relief must post a bond.

Reviewers should pay careful attention to such language, because it could end up significantly disadvantaging the party against whom injunctive relief is sought.

In a 2012 opinion, then-chancellor Strine of the Delaware chancery court (now chief justice of the state's supreme court) relied in part on a similar clause in granting a four-month injunction against one company's hostile takeover bid targeting another company:

In Delaware, parties can agree contractually on the existence of requisite elements of a compulsory remedy, such as the existence of irreparable harm in the event of a party's breach, and, in keeping with the contractarian nature of Delaware corporate law, this court has held that such a stipulation is typically sufficient to demonstrate irreparable harm.

Martin Marietta Materials, Inc v. Vulcan Materials Co., 56 A.3d 1072, 1144-45 (Del. Ch.), aff'd, 45 A.3d 148 (Del. 2012) (en banc) (footnotes with extensive citations omitted).

4.70.4 (Skim:) But a stipulation to irreparable harm might also be disregarded

Just because a contract stipulates that a party will suffer irreparable harm from a breach, doesn't mean that a court will give effect to the stipulation. The Delaware chancery court disregarded such a stipulation in a 2015 case:

Parties sometimes, as Renco and M&F did here, agree that contractual failures are to be deemed to impose the risk of irreparable harm. Such an understanding can be helpful when the question of irreparable harm is a close one.

Parties, however, cannot in advance agree to assure themselves (and thereby impair the Court’s exercise of its well-established discretionary role in the context of assessing the reasonableness of interim injunctive relief) the benefit of expedited judicial review through the use of a simple contractual stipulation that a breach of that contract would constitute irreparable harm.

[In footnote 20 the court added:] In part, this is simply a matter that allocation of scarce judicial resources is a judicial function, not a demand option for litigants.

AM General Holdings LLC v. The Renco Group, Inc., No. 7639-VCN, slip op. at 10, text accompanying nn.19-20 (Del. Ch. Dec. 29, 2015) (denying request for preliminary injunction) (footnotes omitted, extra paragraphing added).

4.70.5 (Read:) A waiver of bond might prove costly

When a party seeks preliminary or temporary injunctive relief in a U.S. court, the court will often (and possibly must) require that party to post a bond as security. The purpose of the bond is to guarantee that at least some money (provided by the insurance company that writes the bond) will be available to compensate the defendant for any damage it might have suffered from an improvidently-granted preliminary injunction.

A party agreeing in advance to waive a bond requirement might later find itself subjected to a preliminary injunction, but then prevail at trial — only to find itself unable to otain any meaningful recovery for the wrongful injunction, because the plaintiff was unable to pay a damage award.

Optional reading:

4.71 (Read:) Insurance

4.71.1 (Read:) Types of coverage

Insurance-requirement clauses commonly mandate at least the following types of insurance:

  • Commercial general liability coverage, including bodily injury, personal injury, and property damage liability, along with contractual liability coverage for Insured-Party's indemnity obligations under the contract, if any.

    The laundry list of specific perils might not be necessary if an ISO CGL form is used; according to one reference, “Unlike older forms that required endorsements to broaden coverage, the CGL provides very broad coverage that can be narrowed by endorsement. It is a modular policy that can provide several coverages in combinations.” Rupp's Insurance & Risk Management Glossary, Commercial General Liability (accessed Aug. 22, 2007).

  • Errors and omissions / professional liability coverage.
  • Business automobile bodily injury and property damage liability for owned, non-owned, and hired automobiles.
  • Worker's compensation coverage and employer-liability coverage as required by applicable law (including maritime-related law where applicable) where work is to be performed pursuant to the contract or anywhere else an employee performing such work is normally employed.

4.71.2 (Read:) Duration of coverage

The time during which insurance coverage must be maintained will sometimes be a matter to be negotiated. In services contracts, it's not uncommon for coverage to be required at any time services are being performed, at any time the service provider is present at the customer's premises, and for one- to three years thereafter.

4.71.3 (Skim:) Carrier ratings

Coverage is often required to be maintained with carriers having at least a stated A.M. Best rating.

4.71.4 (Read:) Occurrence- or claims-made basis?

“The coverage trigger of an occurrence form is bodily injury or property damage that occurs during the policy period.” Chubb Commercial Insurance General Liability Definitions (accessed Aug. 22, 2007).

In contrast, “[t]he coverage trigger of a claims-made form is the making of a claim against the insured during the policy period.” Id.

4.71.5 Combined single limit

See generally Leland-West Insurance Company, What is a Combined Single Limit? (accessed Aug. 22, 2007).

4.71.6 (Skim:) How much coverage to require a vendor to maintain?

Jeff Gordon's Insurance Basics posting makes specific suggestions about coverages that a customer might want to request in a services contract.

4.71.7 (Read:) Certificates of insurance

Customers often want their contractors to provide proof of insurance coverage. A contractor might be able to do this informally by simply emailing a scanned PDF of its file-copy certificate.

But many times the customer (really the customer's lawyer) will want the proof of insurance to be in the form of one or more original certificates of insurance. These are issued by the insurance carrier(s) and are normally sent directly to the other party, with the other party's name in the "Certificate holder" box.

For an example of an insurance certificate on an ACORD industry-standard form, see this annotated version from the Environmental Systems Research Institute.

Ordinarily, a plain-vanilla certificate of insurance is purely informational and does not give the certificate holder any rights under the policy. That's where "endorsements" come in. Two commonly-used endorsements, as seen in the example ACORD certificate cited above, are:

  • Additional-insured endorsements, discussed in more detail below
  • Notification endorsements, requiring the insurance carrier to endeavor to give prior notice to the certificate holder before termination or expiration of the policy (it can be difficult or impossible to get a carrier to agree to an absolute obligation to give prior notice).

4.71.8 (Optional:) Managing insurance certificates

Providing insurance certificates and endorsements can be a low-grade administrative annoyance; it often isn't a high priority for either party's operational people. Even if the contract requires the insured to do so, it can sometimes fall through the crack (possibly putting the insured in breach of contract).

PRO TIP: Keep insurance certificates where they can be found, even years later — failing to do so could end up costing a lot of money if they can't be found when a claim arises.

4.71.9 (Read:) Additional-insured status

Introduction

Contract drafters can sometimes get confused about the nature and purpose of additional-insured endorsements. These endorsements commonly arise when a party negotiating a contract is concerned that it might be sued by a third party for acts or omissions by the other party.

For example, a customer hiring a contractor to perform services might be concerned that it could be sued by by one of its own employees who is physically injured by the contractor's negligence.

Or, the customer might fear being sued by a contractor employee who is injured by negligence of just about anyone — the contractor, a subcontractor, the customer, etc.

Consequently, the customer might negotiate a contract requirement that contractor defend and indemnify the customer against such third-party claims.

But what if the contractor doesn't have the money to make good on this obligation? That's where negotiating for an additional-insured endorsement clause comes in: The customer requires the contractor to name the customer as an additional insured on the contractor's own relevant policies. That way, the odds are greater that at least some money will be available to defend and indemnify the customer from a third-party claim.

Mechanics

An additional-insured endorsement might take the form of a specific line item on the certificate of insurance, or it might take the form of a separate document; both types are shown in [[this annotated version ][this document]].

Whose insurance coverage is primary?

Some insurance clauses require additional-insurance endorsements to contain primary-insurance language. This is something that a customer will usually press for: The customer wants to spend the contractor's insurance coverage first, so that its claims history with its own carrier, and thus its premium expenses, will be less likely to take a hit from such a claim.

Customers might want the primary-insurance statement to be included in the endorsement document provided by the insurance carrier, not just in the contract clause between the parties. Otherwise, a court might not enforce it; the general but not unanimous rule has been that, even though a contract might state which insurance carrier has primary responsibility, such a statement isn't binding on the carrier without the carrier's agreement. See generally Joseph P. Postel, How Does an Extrinsic Contract Impact Additional Insured Coverage? (2003) (reviews several court cases in which primary- versus excess coverage was disputed; accessed Apr. 14, 2007); Can an Indemnity Agreement Determine Who's Primary and Who's Excess? (2002) (accessed Apr. 14, 2007).

This problem can be handled — and the risk of expensive satellite litigation over insurance coverage reduced — by expressly requiring the primary-insurance language to be included in the additional-insurance endorsement.

(Black letter:) Additional-insured endorsements and E&O policies: Not a good fit?

Some parties might seek additional-insured coverage under the named insured's professional liability / E&O policy. Their reasoning might be that, if the named insured is negligent in performing services, the additional insureds want to be able to make a claim directly to the carrier, instead of having to go to court.

An E&O claim by an additional insured against a primary insured, however, might well be blocked by the "insured versus insured" exclusion found in many such policies. See generally Tennant Risk Services, Who is an Insured – Professional Liability (2000) (accessed Apr. 14, 2007).

Moreover, there seems to be some opinion in the insurance bar that it's inappropriate and even dangerous for an E&O policy to name customers or other professionals as additional insureds.

(Skim:) Exclusion of completed operations?

An additional-insured endorsement might not cover the insured's completed operations, for example, a contractor's work on a completed project. See generally Craig F. Stanovich, Additional Insured Endorsements—A Potential Minefield (Part 3) (2006).

(Skim:) Exclusion of additional insured's own negligence?

It's possible that a customer's own negligence might not be covered by an additional-insured endorsement. In 2004, an Oregon court held in 2004 that under that state's statutes, an additional-insured endorsement in an insurance policy did not cover the additional insured's alleged negligence. The court upheld a summary judgment that the insurance company did not have a duty to defend the additional insured. See John W. Ralls, Oregon Court Voids Subcontract's Insurance Provision Because It Would Cover General Contractor's Own Negligence (2004) (accessed Apr. 14, 2007).

(See also the the express-negligence rule applicable in some jurisdictions, under which a contractual indemnity will not extend to the indemnified party's own negligence unless the indemnity language is explicit on that point (and it may need to be conspicuous as well). See generally, e.g., The "express negligence rule" might impose conspicuousness requirements for some indemnity obligations, § 4.68.6.

4.71.10 (Read:) Subrogation waiver

"A waiver of subrogation clause is placed in the … contract to minimize lawsuits and claims among the parties. The result is that the risk of loss is agreed among the parties to lie with the insurers, and the cost of the insurance coverage is contractually allocated among the parties as they may agree. The risk, once assigned to the insurers by the parties, is determined to stop there, without allowing the insurer to seek redress from the party ‘at fault.'" Kenneth A. Slavens, What is Subrogation . . . and Why Is My Contract Waiving It? (2000; accessed Aug. 22, 2007) (emphasis added); see also the Wikipedia article on Subrogation.

4.71.11 (Skim:) Appendix: Honeywell purchase-order insurance requirements

The following excerpt is reformatted from the PDF document at http://perma.cc/CUV6-NKTY (Schmiedecorp.com):

24. Insurance

Supplier will maintain and carry liability insurance in an amount no less than the greater of

(a) the minimum amount required by applicable law, or

(b) the following coverages:

commercial general liability (including product liability and, for services to be performed, completed operations liability) in a sum no less than $5 million,

automobile liability in a sum no less than $5 million,

worker's compensation in an amount no less than the applicable statutory minimum requirement, and

employer's liability in an amount of no less than $5 million,

all with insurance carriers with an AM Bests rating of no less than A- or equivalent.

In addition, Supplier is responsible for maintaining an adequate level of insurance to cover any potential losses due to damage to Honeywell Property, as defined in Section 10.

All insurance required by this Section must cover Honeywell, its subsidiaries and affiliates, and their respective officers, directors, shareholders, employees and agents as additional insureds.

Before delivery of any Goods or commencement of any services under the Purchase Order, Supplier will provide to Honeywell evidence that Seller maintains the described insurance, and that the coverage will not be changed without 30 days advance written notification to Honeywell from the carrier(s).

Except where prohibited by law, Supplier will require its insurers to waive all rights of recovery or subrogation against Honeywell, its subsidiaries and affiliated companies, and its and their respective officers, directors, shareholders, employees, and agents.

The amount of insurance carried in compliance with the above requirements is not to be construed as either a limitation on or satisfaction of the indemnification obligation in this Purchase Order.

4.72 (Study:) Interest on past-due amounts

4.72.1 (Black letter:) Usury laws can have real teeth

If a party will be charging "interest," then before specifying an interest rate (or an interest start date), the party should be sure to check applicable usury laws, which can have real teeth, including forfeiture of principal and perhaps even criminal penalties. For example, in a case under Rhode Island's usury statute, a court found that "a $4 filing fee — which accounted for the only interest in excess of the maximum interest rate — rendered the entire loan usurious." NV One, LLC v. Potomac Realty Capital, LLC, 84 A.3d 800 (R.I. 2014), citing In re Swartz, 37 B.R. 776, 779 (Bankr. D.R.I. 1984).

4.72.2 (Black letter:) Usury: Even invoicing excess interest can cause serious trouble

Vendors sometimes add interest charges to invoices; doing so without the customer's prior agreement can result in the charge being usurious. See generally Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at part VI-B at 24-25, (SnowSpenceLaw.com; undated), which includes extensive citations to Texas case law. (The author is a friend.)

4.72.3 (Black letter:) Usury-savings provisions might not be given effect

Contractual interest provisions sometimes state that any excess interest will be promptly refunded. Such usury savings clauses, however, might or might not be effective in a given jurisdiction. Consider two contrasting examples:

  • Texas law permits usury-savings clauses. See Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at 34 (SnowSpenceLaw.com; undated).
  • Rhode Island law gives no effect to usury-savings clauses; the state's supreme court acknowledged that the statute was "draconian" and "strong medicine." American Steel Coatings, LLC v. New England Development R.I., LLC, 93 A.3d 537, 543 (R.I. 2014). The supreme court said that the legislature had put the risk of charging too-high an interest rate onto the lender in "an inflexible, hardline approach to usury that is tantamount to strict liability[.]" Id. at 544. As a result, a commercial lender found itself unable to collect more than $400,000, on grounds that the loan agreement was void as usurious.

4.72.4 (Black letter:) Interest start dates can also implicate usury laws

The usury statutes in some states (e.g., Texas) might prohibit charging interest before the end of a specified grace period.

4.72.5 (Read:) Is a given late charge really "interest"?

Not all so-called "interest" charges will be subject to usury laws. For example, in Texas, interest is defined by statute as "compensation for the use, forbearance, or detention of money. The term does not include time price differential, regardless of how it is denominated. …" Tex. Fin. Code § 301.002(4); See Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at 9 (SnowSpenceLaw.com; undated).

What is this "time price differential" of which the statute speaks? One article explains the quoted term in relation to Texas law:

If certain requirements are met and a transaction is not designed to circumvent the usury laws, a merchant may sell merchandise at a higher price for credit than for cash and the price difference is not usurious. The new statute codifies the common law time-price doctrine.

In order to apply the time-price doctrine, it must be shown that the seller clearly offered to sell goods for both a cash price and a credit or time price, that the purchaser was aware of the two offers, and that the purchaser knowingly chose the higher time or credit price.

If an agreement fails to qualify as a time-price differential contract, then the finance charges may be found to constitute usurious interest.

Spence, supra, part VI-F at 27 (citations omitted, extra paragraphing added).

4.72.6 (Extra:) How are payments to be applied?

An interest provision might well specify that payments will be applied first to accrued interest, then to unpaid interest; typically the application will be oldest-first. See generally David Cook, The Interest Tail Wags the Profit Dog, in Business Law News Issue No. 3, 2014 (State Bar of California Business Law Section; available on-line to Section members).

4.72.7 (Extra:) Will a payee really try to collect interest?

Whether a payee will actually charge and try to collect interest is a real question. For example, suppliers sometimes hesitate to charge interest to their customers, even if their contracts permit them to do.

Some large customers have been known to announce, imperiously: We don't pay interest, period. (On the other hand, some customers can be notoriously slow payers.)

When a drafter's client will be the payee, it's worth considering whether to push hard for an interest provision.

4.72.8 (Skim:) Putting an “interest on past due amounts” clause in an “audit rights” provision might backfire

It's probably a good idea to separate an interest clause from an audit-rights clause (see § 4.89.1). Cellport Systems, Inc. won a lawsuit against Peiker, a German company, for unpaid patent royalties under a license agreement. The agreement included an audit provision that required Peiker to pay interest on past-due royalties at 1.5% per month. The trial court, however, awarded Cellport interest at the (lower) statutory rate, on grounds that, in context, the contractual interest rates was intended to apply only to underpayments revealed in an audit. The Tenth Circuit agreed that the lower rate was proper:

According to Cellport, the License Agreement's reference to the [interest] rate contains no limitations on its application. As the district court explained, however, the sentence is in the middle of a paragraph devoted to Cellport's right to verify the royalty payments it is owed through audits. And we must interpret this provision in its context. We agree with the district court that the interest rate was contractually intended to apply only to accounting disputes. The application of the [lower] statutory rate [to the unpaid patent royalties] was appropriate.

Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016, 1028-29 (10th Cir. 2014) (affirming trial-court judgment in part; emphasis added).

4.73 (Read:) Jury trial waiver

(Black letter:) Jury trial waivers:

  • Should normally be two-way, because a court would be more likely to disregard a one-way waiver.
  • Should be conspicuous (see § 4.36)
  • Should be included in the "correct" agreement document, otherwise disputes might be tried to a jury even if other related agreement documents include a waiver. That happened in Bank of America, N.A. v. JB Hanna, LLC, 766 F.3d 841 (8th Cir. 2014). That case involved a tangle of loan agreements, interest-rate swap agreements, and personal guaranties. All contained jury-trial waivers except two loan agreements. The trial court let the jury decide the bank's entire case against the borrowers, on all agreements, notwithstanding the jury-trial waivers in the other agreements; the appeals court affirmed that much of the judgment.

(BL) A jury-trial waiver in a contract might be unenforceable in some states; for example:

Optional reading: See generally Byron F. Egan, Forum-Selection, Jury-Waiver, and Choice-of-Law Provisions in Acquisition Agreements (2018) (archive: https://perma.cc/3G4L-UVZB).

4.74 (Read:) Letters of Intent: Like Teenaged Sex (SFW)

(Black letter:) Letters of intent (LOIs) and business people can be like sex and teenagers: You tell them not to do it, but sometimes they really, REALLY want to. You won't always be there to chaperone them, and let's face it, in the throes of desire they're likely to forget — or ignore — your abstinence advice. So they need to use "protection" in the form of provisions emphatically stating which provisions are binding and which aren't. (See the Common Draft LOI provisions for ideas.)

The “consequences” of entering into an LOI can be significant if a court finds that the parties intended to enter into a binding contract. The canonical example of this danger, of course, is that of Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex.App.—Houston [1st Dist.] 1986, writ. ref'd n.r.e.). In that case, Texaco was hit with a damage award of some $10.5 billion, or more than $22 billion in 2014 dollars, for interfering with Pennzoil's agreement with Getty Oil — in the form of a memorandum of understanding — under which Pennzoil would buy Getty.

Unless you want to be stuck dealing with such consequences, it might be a good idea to try to make sure that your "teenagers" use protection if they ignore your advice and start messing around with LOIs. The usual form of protection takes the form of various disclaimers of any intent to be bound. For sample “protection” language and extensive research notes, see the annotated clauses at Commondraft.org.

4.75 (Skim:) Master Agreements

4.75.1 Business purpose of a master-agreement acknowledgement

Companies often enter into master agreements that don't create any obligations of their own, but do set up a framework for any agreed transactions. Such a master agreement can be useful in business by allowing parties to pre-negotiate the "legal T&Cs" just one time; the parties can later re-use those T&Cs in future transactions by signing short-form contracts that (ideally) incorporate the master agreement by reference and set forth any transaction-specific terms.

4.75.2 Some specific terms to consider for master agreements

  • Pricing terms are sometimes pre-negotiated in master agreements. When that happens, it is useful also to include an agreed mechanism for periodically adjusting the pricing, so that the supplier won't potentially be stuck with outdated pricing long after the deal was struck.
  • (Skim:) Unilateral extensions, § 4.102 and (Read:) Evergreen extensions, § 4.53 can also be useful, but should be approached with caution.

4.75.3 A company can negotiate a master agreement for its corporate "family"

Companies sometimes want to negotiate pricing and other terms & conditions on behalf of their affiliates; that can help to reduce the transaction costs that would attend negotiation of individual contracts between each affiliate and the same counterparty. An easy way to do this is to pre-negotiate a "master" agreement that can be incorporated by reference into other contracts.

EXAMPLE: A company signs a master purchase agreement. It wants its affiliates to be able to make purchases from the seller, on the same negotiated terms and conditions and/or at the same negotiated pricing. By having the master agreement say just that, the company can ensure that its affiliates won't have to negotiate their own deals with the seller. (Of course, any given affiliate might want to negotiate its own deal.)

In that situation, consider doing the following:

  • The parent company signs a master agreement with stated pricing and other T&Cs.
  • The master agreement states that either party and its affiliates can utilize the master agreement by entering into a short-form agreement (for example, a purchase order) that incorporates the master agreement by reference.
  • If a buyer's subsidiary places a purchase order with the seller, then the subsidiary doesn't become a party to the master agreement per se; it's a party only to the contract formed by its own purchase order.
  • The purchasing subsidiary is a third-party beneficiary of the master agreement, but only in the limited sense that it has the right to place orders at the stated pricing and under the stated T&Cs.
  • The purchasing subsidiary's parent company avoids being liable for the subsidiary's financial obligations under the subsidiary's purchase orders (unless of course the seller negotiates a guarantee from the parent). That's something the parent company's lawyers and finance people will usually want.
  • If a lawsuit should come to pass over a particular purchase order, there's little room for satellite disputes about who has standing to sue whom and who the necessary parties are.

See also: (Black letter:) Include affiliates as "parties" to the contract? (Probably not.), § 4.4.3.

4.75.4 Pro tip: Have "subsidiary" contracts expressly state that the master agreement controls

CAUTION: When using a master agreement, it's best for any subsequent contracts to expressly state that the master agreement's terms are to control. Consider See CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, 829 F.3d 1201 (10th Cir. 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015). In that case:

A Chinese manufacturer of solar-panel products entered into a co-branding agreement with a U.S. retailer. That agreement called for the retailer to order solar-panel products from the manufacturer at stated prices. The co-branding agreement contained an arbitration provision, which expressly required that arbitration proceedings be in English.

  • The retailer also entered into specific written sales contracts with the manufacturer; the sales contract contained an arbitration provision, but that provision did not require English-language arbitration.
  • The retailer's CEO testified, and the U.S. trial court accepted, that the parties had intended for the co-branding agreement to be a "master" agreement that would govern all sales contracts.
  • Apparently, though, neither the co-branding agreement nor the sales contract in question actually said referred to the master agreement (the courts' opinions were not specific on this point).
  • The manufacturer and the retailer communicated exclusively in English.
  • One shipment of goods had quality problems; the retailer refused to pay. After negotiations went nowhere, the manufacturer filed a demand for arbitration with the Chinese arbitration institution designated in the earlier, co-branding agreement.
  • The Chinese arbitration institution sent the U.S. retailer a notice of arbitration, in Chinese. The U.S. retailer did not realize what the notice of arbitration was. Consequently, the retailer did not realize that under the agreed arbitration rules, a 15-day clock was ticking on the retailer's right to participate in selecting the members of the arbitration panel. That deadline passed, and the panel members were selected without input from the retailer.
  • The arbitration panel ruled that the so-called master agreement did not apply and that the sales contract controlled. The arbitration panel awarded damages to the manufacturer, which then sought to enforce the award against the retailer in a U.S. court.

The Colorado district court ruled that, contrary to the decision of the arbitration panel, the testimony of the retailer's CEO established that the co-branding agreement had indeed been a "master" agreement; this meant that the Chinese-language notice of arbitration had been insufficient, and that in turn meant that, under the New York Convention, the court could decline to enforce the damages award.

Citing the virtual unreviewability of arbitration awards even when grounded on errors of law, the Tenth Circuit chose not to address the master-agreement issue:

[O]ur holding does not rely on the conclusion that the [sales contract] was bound by the terms of the [co-branding agreement].

Rather, the [co-branding agreement] is one piece of evidence demonstrating that the parties understood their relationship would proceed in English,

and that [the manufacturer] suddenly deviated from that understanding and practice when providing notice.

Id., 829 F.3d at 1207 n.2 (emphasis and extra paragraphing added).

DRAFTING LESSON: It's best if purchase orders, statements of work, etc., expressly identify a "master" agreement and state that the master agreement applies.

4.75.5 Should a master agreement override purchase orders, etc., no matter what?

A master agreement might state that its terms apply to all transactions between the parties, even if the parties use a purchase order, statement of work, etc., that doesn't refer to the master agreement. This was suggested in a LinkedIn comment (group membership required) by attorney Michael Little.

I'm on the fence about that one:

  • In one sense, Mike's suggestion might be safer, at least in the short term, in that the parties (and thus the client) wouldn't have to remember to incorporate the master agreement by reference.
  • On the other hand, it might not be ideal for parties that did a lot of business together in different divisions, geographic territories, etc.
  • And this practice could lead to parties, long afterwards, inadvertently incorporating a forgotten "zombie" master agreement by reference, to unclear effect.

My own preference is often to be silent on this point in the master agreement, so that the parties will have to remember to expressly incorporate the master agreement by reference. My guess is that they'll be more likely to remember to do that than to research whether any previously-negotiated master agreement still applies. But this is a judgment call, to be made based on the particular circumstances and the client's desires.

4.75.6 Danger of a master agreement's setting the bar too high

In an Eighth Circuit case, the parties' master services agreement set the bar too high for services agreements, and as a result the master agreement was found not to apply. The master agreement prescribed the exact language that a statement of work was required to include to incorporate the master agreement by reference:

Barkley shall performfor [Gabriel Brothers] certain services which shall be agreed to by the parties on a project-by-project basis . . . . The Services agreed to for each Project shall be designated in a written Statement of Work (“Statement of Work”).

Each Statement of Work shall contain the following provision:

“This Statement of Work is incorporated into, and made a part of, that certain Master Services Agreement . . . between the parties dated [October 5,] 2012, which Agreement governs the relationship of the parties. All terms and conditions provided in the Agreement shall apply to this Statement of Work.”

Barkley Inc. v. Gabriel Bros. Inc., 829 F.3d 1030, 1034-35 (8th Cir. 2016) (extra paragraphing added, alteration marks by the court).

As to the relevant statement of work:

  • The service provider began working while the parties were negotiating the statement of work.
  • At some point the customer pulled the plug by invoking a termination-at-will provision in the master agreement — and at that point the parties had not signed the statement of work; consequently, there was no signed statement of work containing the prescribed incorporation-by-reference language.
  • The provider sued the customer; it alleged that, because the customer failed to pay for the work already started for the (unsigned) statement of work, the customer thereby breached the master agreement.

The district court granted partial summary judgment in favor of the customer, on grounds that because the statement of work was never signed, the specific requirements of the master agreement had not been met, so there was no breach of that agreement. The appeals court affirmed:

The Agreement states that "[t]he services agreed to for each Project shall be designated in a written Statement of Work" and that "[e]ach Statement of Work shall contain" the Agreement's incorporation clause. The use of the word "shall" indicates that a written statement of work is required and that any statement of work must contain the incorporation clause. Accordingly, because the alleged February 21, 2013, draft 2013 statement of work was not part of a written contract and the document did not contain the Agreement's incorporation clause, the district court did not err in granting summary judgment to Gabriel Brothers on Barkley's breach-of-the-Agreement claim.

Id., 829 F.3d at 1038-39 (alteration marks by the court). In the court below, though, a jury held the customer liable for damages for breaching a subsequent [oral?] agreement that apparently wasn't "under" the master agreement; the appeals court affirmed judgment on that verdict.

4.75.7 Should a master agreement specify the form to be used?

In a thoughtful LinkedIn group discussion comment (group membership required), attorney Michael Little suggested that a master agreement should "specify" the form of purchase orders, statements of work, etc., by including the form(s) in an exhibit.

My own view is different: It can be useful to include such a form as an example, but I don't like to specify that use of that form is required. That's because, in a particular transaction, the parties might thoughtlessly (or intentionally) use a different form instead of one matching the exhibit. That, in turn, might give rise to a dispute over whether the master agreement's terms applied to that transaction, just as happened in the Barkley v. Gabriel Bros. case discussed in section 4.75.6.

4.75.8 A master agreement might contain an entire-agreement clause

For an example of a master agreement with an entire-agreement clause, see Grandoe Corp. v. Gander Mountain Co., 761 F.3d 876 (8th Cir. 2014) (affirming denial of defendant's motion for judgment as a matter of law). In that case:

  • The plaintiff was a manufacturer of gloves; the defendant was a national retailer of outdoor sporting goods.
  • The manufacturer and the retailer entered into a written contract (the "RAC") that established percentage discounts and a few other terms that would apply to the retailer's oral orders for gloves.
  • The written contract did not obligate either party to sell or buy gloves.

The court noted that:

… notwithstanding the RAC's integration clause, it does not appear that the parties intended the RAC to be the final expression of their agreement.

Rather, the RAC explicitly contemplates a future contract for the sale of gloves, and it does not specify that such a contract must be in writing.

The RAC's integration clause itself reflects this understanding: it states that the RAC “is the entire agreement between the parties with respect to the subject matter of this Agreement” (emphasis added), but the subject matter of the RAC does not include the actual sale or purchase of gloves.

If that were the case, then no gloves would ever have been exchanged, since the RAC does not include a quantity term.

Id. at 887 (emphasis by the court, extra paragraphing added).

4.76 (Read:) Material breach

Some contracts specify that particular types of breach will be considered material. For example, a real-estate lease might state that a failure to pay rent, after notice and an opportunity to cure, is a material breach.

Key takeaway: Under U.S. law, even if a contract is silent on the subject, a major consequence of an uncured breach's being "material" is that the breach excuses further performance by the other party. See, e.g., Ryan Data Exchange, Ltd. v. Graco, Inc., No. 17-1451, part II-A, slip op. at 810 (8th Cir. Jan. 10, 2019) (affirming judgment on jury verdict; breach was not material).

4.76.1 The Restatement's factors

Many U.S. courts look to the Restatement (Second) of Contracts § 241 (1981) in determining the materiality of a breach. The Restatement lists five factors that are to be taken into account, with no single factor being decisive:

(a)     the extent to which the injured party will be deprived of the benefit which he reasonably expected;

(b)     the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;

(c)     the extent to which the party failing to perform or to offer to perform will suffer forfeiture;

(d)     the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;

(e)     the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.

Norfolk Southern Ry. Co. v. Basell USA Inc., 512 F.3d 86, 92 (3d Cir. 2008) (vacating and remanding summary judgment that breach of contract was not material), quoting Restatement (Second) of Contracts § 241 (1981).

4.76.2 Caution: "Letting it slide" could result in a waiver even of repeated material breaches

In a 2015 case, the Connecticut supreme court noted that "it is a settled principle of contract law that a party to an executory bilateral contract waives a material breach by the other party if he continues the business relationship, and accepts future performance without some warning that the contract is at an end." RBC Nice Bearings, Inc. v. SKF USA, Inc., 318 Conn. 737, 123 A.3d 417, 425 (2015) (citations omitted, emphasis added). In that case:

  • A group of ball-bearing manufacturers (referred to here as just "the manufacturer") and a distributor entered into a long-term supply agreement.
  • Under that agreement, the distributor was required to make minimum purchases from the manufacturer each year.
  • Of historical interest: The distributor itself had formerly been a  manufacturer of ball bearings and had sold its business to the manufacturer-plaintiffs.
  • As time passed, the distributor repeatedly failed to meet the contract's minimum-purchase requirements.
  • The manufacturer, in essence, did nothing about the distributor's failures to meet the purchase requirements.
  • Eventually, the manufacturer terminated the contract and filed a breach-of-contract lawsuit against the distributor. According to the trial court, the evidence was overwhelming that the manufacturer did this in order to "cut out the middle man" and take over direct-to-market distribution on its own.

The trial court held, and the state supreme court agreed (although the intermediate appellate court didn't), that the manufacturer, by doing nothing about the distributor's repeated failures to meet the minimum-purchase requirement, had waived that requirement for the years in question in the lawsuit.

4.76.3 Just complaining about a material breach won't preclude a finding of waiver

In the RBC Nice Bearings case discussed above, the Connectituc supreme court also noted that, just because you complain to the other side that they're breaching the contract, that won't necessarily preclude a finding that you waived the breach:

[T]he fact that an obligee repeatedly reminds an obligor of its contractual duties, or complains of the obligor’s noncompliance, does not preclude a finding of waiver, when the obligee nevertheless continues to acquiesce in the obligor’s noncompliance and to perform under the contract.

The rule applies with particular force in the present case, where there was evidence that the plaintiffs gave the defendant intentionally mixed signals with regard to its minimum purchase requirement, and where the trial court found that the plaintiffs always had intended to terminate the contract prematurely and merely used the shortfall invoices as a pretext to do so when they decided that the time was right.

RBC Nice Bearings, Inc. v. SKF USA, Inc., 318 Conn. 737, 123 A.3d 417, 432-33 (2015) (extra paragraphing added, footnotes omitted).

4.76.4 Getting a summary judgment about materiality can be problematic

In Norfolk Southern, the Third Circuit noted that issues of materiality of a breach of contract might not be resolvable on summary judgment:

Whether the breach of a contract is material is generally an issue of fact. However, as is true of virtually any factual question, if the materiality question in a given case admits of only one reasonable answer (because the evidence on the point is either undisputed or sufficiently lopsided), then the court must intervene and address what is ordinarily a factual question as a question of law.

Norfolk Southern Ry. Co. v. Basell USA Inc., 512 F.3d 86, 92-93 (3d Cir. 2008) (vacating and remanding summary judgment that breach of contract was not material) (citations, alteration marks, internal quotation marks, and footnote omitted).

The court also pointed out the difficulty of rendering summary judgment on materiality when intent was at issue:

In addition, we note that, although it is not impossible, determining whether a breach is material on summary judgment is inherently problematic where, as here, the materiality analysis might well turn on subjective assessments as to the state of mind of the respective parties.

As we have emphasized in the past, a court should be reluctant to grant a motion for summary judgment when resolution of the dispositive issue requires a determination of state of mind, for in such cases much depends upon the credibility of witnesses testifying as to their own states of mind, and assessing credibility is a delicate matter best left to the fact finder.

Id. at 96 (extra paragraphing added, internal quotation marks omitted).

4.76.5 Indiana v. IBM (1): An appeals court substitutes its judgment about materiality

A fascinating material-breach case was (is) Indiana v. IBM Corp., 4 N.E.3d 696 (Ind. App. 2014) (reversing trial court in pertinent part), affirmed, 51 N.E.3d 150 (Ind. 2016), after remand, No. 49A02-1709-PL-2006 (Ind. App. 2018) (affirming in part, reversing in part, trial court's recalculation of damages). In that case:

  • The state of Indiana and IBM entered into a ten-year, $1.3 billion contract to modernize and improve the state's welfare system. Things did not go as expected; three years in, the state terminated the contract, alleging material breach by IBM.
  • The state and IBM sued each other; the trial court conducted a six-week bench trial, hearing 92 witnesses and admitting 7,500 exhibits. See id., 4 N.E.3d at 713.
  • While the trial court held that IBM had not materially breached the contract, the appeals court reversed on the materiality question, asserting:

While IBM’s software, computers, and employee training aided in delivering welfare services, the primary focus of the contract was to provide food and medical care to our poorest citizens in a timely, efficient, and reliable manner within federal guidelines, to discourage fraud, and to increase work-participation rates. In the most basic aspect of this contract — providing timely services to the poor — IBM failed. We therefore reverse the trial court’s finding that there was no material breach.

Id., 4 N.E.3d at 702 (emphasis added).

One judge, though, dissented on the materiality standard to be applied, asserting that the parties' agreement went into great detail about the standard of performance and therefore should be followed by courts. The dissenting opinion quoted the agreed standard of performance:

Vendor will ensure that the Services will be performed and delivered in a manner that (i) meets or exceeds the required levels of performance, including the Performance Standards specified in or pursuant to this Agreement, (ii) is effective, efficient and courteous to the Clients, and (iii) uses Commercially Reasonable Efforts to support the State's achievement of its Policy Objectives.

[IBM's performance was to be evaluated by reference to:]

  1. Adherence to all the terms of this Agreement, including all covenants, obligations, representations and warranties;
  2. Performance in accordance with and compliance with the Modernization Project work plans, schedules, and milestones agreed to by the Parties;
  3. Performance of the Services in accordance with all applicable requirements of this Agreement, including the Performance Standards set forth in Schedule 10 [Performance Standards];
  4. Satisfactory results of Audits by the State, its representatives, or other authorized Persons in accordance with Art. 9 (with all results of such Audits being addressed in accordance with the Government's Plan);
  5. Attendance at and participation in the DFR financial review and other meetings conducted from time to time by FSSA (both internally and with the public);
  6. Timeliness, completeness, and accuracy of required reports;
  7. Determination by the State of (i) Vendor's satisfactory performance of the Services and the Delegated Activities, and (ii) Vendor's satisfactory oversight and management of the Subcontractors; and
  8. Vendor's effort to assist the State in achieving the Policy Objectives.

Id. at 747-48 (Friedlander, J., dissenting in part; citations omitted).

4.76.6 Indiana v. IBM (2): The contract's standards trump the Restatement

The Indiana supreme court apparently agreed with the court of appeals's holding that IBM had materially breached, but like the dissenting judge below, the court disagreed with the appellate court's reliance on the Restatement factors in lieu of the factors listed in the parties' agreement:

Both the trial court and the Court of Appeals majority cite to the common law Restatement (Second) of Contracts § 241 factors for analyzing the materiality of a breach. However, here, the MSA [Master Services Agreement] itself sets forth the standard for assessing the materiality of a breach. The MSA also provides performance standards and indicators to measure IBM’s performance. The policy objectives of the MSA are incorporated into those performance standards.

Consistent with Indiana’s long tradition of recognizing the freedom to contract, we hold that when a contract sets forth a standard for assessing the materiality of a breach, that standard governs. Only in the absence of such a contract provision does the common law, including the Restatement, apply.

… We hold that under the facts and circumstances of this case, looking at the performance standards and indicators provided in the MSA, IBM’s collective breaches were material in light of the MSA as a whole.

Indiana v. IBM Corp., 51 N.E.3d 150, 153 (Ind. 2016) (emphasis and extra paragraphing added).

4.76.7 Materiality of breach to the agreement as a whole

In the Indiana v. IBM case, if the state wanted to terminate the agreement for breach, it was required to prove that the breach was "'material considering this Agreement as a whole.” Indiana v. IBM Corp., 51 N.E.3d 150, 155 (Ind. 2016) .

CAUTION: The "as a whole" language probably increases the likelihood that a party's motion for summary judgment about the materiality or immateriality of a breach would be denied, as discussed in § 4.76.4.

4.76.8 A series of non-material breaches could be material

Some contracts include language similar to that in section 16.3.1(1)(C) of the master service agreement in the Indiana v. IBM case — under that language, the state of Indiana could terminate IBM's contract in the event of:

… a series of breaches of [IBM]'s obligations, none of which individually, constitutes a breach of this Agreement which is material considering this Agreement as a whole, but which, in view of [IBM]'s history of breaches, whether or not cured, collectively constitute a breach of this Agreement which is material when considering this Agreement as a whole ….

Indiana v. IBM Corp., 51 N.E.3d 150, 155 (Ind. 2016) (alteration marks and ellipsis by the court).

4.77 (Read:) May vs. might

To avoid confusion:

  • Use may to indicate permission.
  • Use might to indicate possibility.

Example: Consider the two possible meanings of the following statement: Consultant may not send the invoice before December 31.

4.78 (Skim:) Merchant status

The term merchant comes into play in various sections of article 2 of the [U.S.] Uniform Commercial Code, which governs the sale of goods.

Both buyers and sellers can be "merchants," according to the commentary to the UCC's definition of that term in section 2-104, apparently reproduced in Nebraska Uniform Commercial Code 2-104; see also, e.g.:

  • Wisconsin Knife Works v. Nat'l Metal Crafters, 781 F. 2d 1280, 1284 (7th Cir. 1986) (Posner, J., on a panel with Easterbrook, J.) (reversing and remanding judgment on jury verdict that contract had been orally modified): "Although in ordinary language a manufacturer is not a merchant, 'between merchants' is a term of art in the Uniform Commercial Code. It means between commercially sophisticated parties (see UCC § 2-104(1); White & Summers, Handbook of the Law Under the Uniform Commercial Code 345 (2d ed. 1980)), which these were." Id.
  • Brooks Peanut Co. v. Great Southern Peanut, LLC, 746 S.E.2d 272, 277 n.4 (Ga. App. 2013) (citing another case that cited cases)
  • Sacramento Regional Transit v. Grumman Flxible [sic], 158 Cal. App.3d 289, 294-95, 204 Cal. Rptr. 736 (1984) (affirming demurrer), in which the court held that a city's transit district, which had bought buses from a manufacturer, was a merchant within the meaning of § 2-104
  • Douglas K. Newell, The Merchant of Article 2, 7 Val. U. L. Rev. 307, 317, part III (1973).

4.79 (Study:) Microsoft Word: Crucial things to know

1.     The safest way to format a paragraph without corrupting the document and crashing the Word program is to format the style of the paragraph, not the individual paragraph itself. See generally, e.g., The Styles advantage in Word (support.microsoft.com: https://goo.gl/v8Jbej); Item 3 in the 2013 list of tips to avoid crashing Word, by John McGhie (answers.microsoft.com: https://goo.gl/VxqJKs). NOTE: McGhie's tip no. 2 is to avoid Track Changes, but I've never had a problem with it — at least so far as I know.

2.    To create a heading, use Heading styles: Heading 1, Heading 2, etc.

3.    Headings can be automatically numbered by using the Bullets and Numbering feature under Format.

The following apply mainly to the formatting of styles, but can be used with caution to format individual paragraphs:

4.    On rare occasions, to adjust the line spacing within a specific paragraph, use the menu sequence: Format | Paragraph | Indents and Spacing | Spacing (almost smack in the middle of the dialog box on a Mac).

5.    To adjust the spacing between paragraphs, use the menu sequence: Format | Paragraph | Indents and Spacing menu. Don’t use a blank line to separate paragraphs — adjust the spacing instead.) See generally Practical Typography: Spacing Between Paragraphs (PracticalTypography.com: https://goo.gl/vNjeKF).

6.    To keep one paragraph on the same page with the following paragraph (which is sometimes useful), use the menu sequence Format | Paragraph | Line and Page Breaks | Keep with Next. (For headings, this should be done in the relevant heading style, e.g., Heading 1, etc.)

Optional: Other Word tips

7.    A table of contents can be useful in a long contract. To create a table of contents, in the References tab, use the Table of Contents dropdown box and select Custom Table of Contents.

8.   Tables can sometimes be useful in contracts. To remove the borders from a table (the way Word normally creates them), first use the menu sequence: Table | Select | Table. Then use the menu sequence: Format | Borders & Shading | Borders | None.

9.   To copy and paste a short snippet from a Web page into a Microsoft Word document without messing up the formatting of the paragraph into which you’re pasting the snippet, use the menu sequence: Edit | Paste Special | Unformatted text. (Alternatively: Edit | Paste and Match Formatting.)

4.80 (Optional:) Pay If Paid, or When Paid

4.80.1 Introduction and example

Suppose that:

  • A contractor enters into a contract with a homeowner, under which the contractor will remodel the homeowner's kitchen.
  • The contractor enters into a subcontract with a painter, under which the painter will do the necessary painting in the kitchen.

In this example, pay if paid means that the contractor is not required to pay the painter unless the homeowner pays the contractor.

4.80.2 A pay-if-paid clause might preclude collecting on a surety bond

See BMD Contractors, Inc. v. Fid. & Dep. Co., 679 F.3d 643 (7th Cir. 2012) (applying Indiana law; affirming summary judgment in favor of surety). (The Common Draft pay-if-paid language is modeled in part on the pay-if-paid provision in that case; see id. at 647.) Hat tip: Steven L. Jones, “Paid If Paid” Clauses – Who Is Left Holding the Bag When a Project Owner Fails to Pay? (IceMiller.com 2015).

4.80.3 Pay-if-paid might be void as against public policy

In some jurisdictions, a pay-when-paid clause implicitly means within a reasonable time; for example, if an end-customer does not pay a prime contractor within a reasonable time, then the prime contractor — or more likely, the insurance carrier that wrote the prime contractor's payment bond — must pay the subcontractor anyway.

On the other hand, in a situation like this, a pay-if-paid clause makes the end-customer's payment a condition precedent to the subcontractor's right to payment; in other words, if the end-customer doesn't pay the prime contractor, then the subcontractor isn't entitled to payment even from the prime contractor's performance bond. This essentially puts the risk of non-payment on the subcontractor — and as a result, in in some jurisdictions the clause might be void as against public policy.

• For example, in New York, pay-if-paid clauses are void, but pay-when-paid are enforceable, according to that state's highest court:

We hold that a pay-when-paid provision which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy set forth in the Lien Law.

By contrast, a pay-when-paid provision which merely fixes a time for payment does not indefinitely suspend a subcontractor's right to payment upon the failure of an owner to pay the general contractor, and does not violate public policy as stated in the Lien Law.

West-Fair Elect. Contractors v. Aetna Cas. & Surety Co., 87 N.Y.2d 148, 158, 661 N.E.2d 967 638 N.Y.S.2d 394 (1995) (on certification from Second Circuit) (extra paragraphing added). The contract clause in question was this:

"IT IS SPECIFICALLY UNDERSTOOD AND AGREED THAT THE PAYMENT TO THE TRADE CONTRACTOR [plaintiff] IS DEPENDENT, AS A CONDITION PRECEDENT, UPON THE CONSTRUCTION MANAGER [the general contractor] RECEIVING CONTRACT PAYMENTS, INCLUDING RETAINER FROM THE OWNER".

Id. at 154 (alterations by the court, capitalization in original).

• In contrast, the Ohio supreme court upheld a pay-if-paid clause in Transtar Electric, Inc. v. A.E.M. Electric Serv. Corp., 2014 Ohio 3095; the court affirmed a summary judgment that the contract's "condition precedent" payment language was sufficient to transfer the risk of nonpayment by a customer from the prime contractor to its subcontractor. That language was as follows:

{¶ 4} … (c) the Contractor shall pay to the Subcontractor the amount due under subparagraph (a) above only upon the satisfaction of all four of the following conditions: * * * (iv) the Contractor has received payment from the Owner for the Work performed by the Subcontractor. RECEIPT OF PAYMENT BY CONTRACTOR FROM THE OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK.

Id. (capitalization in original, bolding omitted). The decision was subject to some criticism for not addressing public-policy considerations; see Scott Wolfe, Jr., Ohio Supreme Court Gets Pay If Paid Decision Wrong, Hurts Subcontractors (ZLien.com 2014).

• In New Jersey, the courts are split about pay-if-paid clauses, according to Michelle Fiorito, The Consequences of "Pay-If-Paid" and "Pay-When-Paid" Construction Contracts Clauses (ZDLaw.com 2012).

• Still another court — in passing, and arguably in a dictum — seems to have implicitly treated a pay-if-paid clause as a pay-when-paid provision. The case was Allstate Interiors & Exteriors, Inc., v. Stonestreet Constr., LLC, 730 F.3d 67 (1st Cir. 2013) (affirming judgment below; rejecting end-customer's challenge to district court's exercise of supplemental jurisdiction). In that case, the relevant contract clause was as follows: "It is agreed that the Contractor [Stonestreet], as a condition precedent to payment of any monies which become due to the Subcontractor, must first receive payment from the Owner." Id. at 70 (emphasis added). The court described the clause as a pay-when-paid clause. See id.

4.81 (Skim:) Payment bonds

Payment bonds are in essence a type of insurance policy. They are often required by contracts such as, e.g., construction contracts:

  • The prime contractor is likely to have to buy materials from suppliers, and might engage subcontractors. Those costs are normally built into the prime contractor's bid price.
  • The customer doesn't want to pay the prime contractor but then have the prime contractor go out of business or file for bankruptcy protection, stiffing one or more suppliers and/or subcontractors.
    • Those companies might have a legal right to sue the customer for payment.
    • A stiffed supplier or subcontractor might also have the statutory right to put liens [LINK] on the customer's relevant property or properties. Such liens could well impede the customer's ability to get financing; the existence of liens could also constitute a breach of covenants in the customer's financing agreement(s) with lender(s).
  • To avoid these hassles, customers often insist on a requirement, in the prime contract, that the prime contractor must buy a payment bond. (The cost of the payment-bond premium will of course be factored into the prime contractor's bid price.)

Government contracts often require payment bonds. Think about why that is the case: A government contract will often be for a local contruction project, with local suppliers and subcontractors — and those people vote and make political contributions.

See also Performance Bonds [LINK]

4.82 (Study:) Payment terms

4.82.1 Payment due date

Contracts often specify that payments are due "net X days," meaning that payment in full is due in X days, where X is 30 days, 10 days, 60 days, etc. Longer time periods favor the payer, obviously.

TERM FAVORS
Net X days from receipt of invoice Payer
Net X days from date of invoice Payee
Net X days from [receipt / date] of correctly stated invoice Payer

For an example of very customer-biased payment terms, see section 13 of a Honeywell purchase order form archived at http://perma.cc/CUV6-NKTY, which provides not only for net-120-day terms, but for payment not even to be scheduled until after that:

Payment terms are net 120 days from receipt of a Honeywell-approved invoice unless otherwise stated on the face of the Purchase Order or other written agreement executed by both parties. Invoices will not be approved unless they accurately reference conforming Goods received by Honeywell or services satisfactorily performed for Honeywell. Payment will be scheduled for the first payment cycle following the net terms for the Purchase Order.

4.82.2 Discounts — e.g., 2% 10 net 30

Sometimes payment terms are phrased as, for example, "2%/10 net 30"; this means that the payer may take a 2% discount for full payment in ten days, otherwise payment in full is due in 30 days.

4.82.3 Payment methods

Acceptable payment methods might be specified as, for example:

  1. Any method to which the payee does not reasonably object in writing;
  2. A check — see generally Investopedia at https://goo.gl/19C7Rv:
    • The agreement might require the check to be drawn on a U.S. bank, or on a specified bank, or on any bank to which the payee does not reasonably object in writing.
    • The money stays in the payer's account until the check clears.
    • If the payer files for U.S. bankruptcy protection before the check clears, then the check might never clear; see the bankruptcy discussion in section [TODO].
  3. An automated clearing house ("ACH") debit transaction in lieu of a check — see generally Investopedia at https://goo.gl/1P9EQa;
  4. A certified check — see generally Investopedia at https://goo.gl/aVLbsE:
    • This is a check (see above) written by the payer and drawn on the payer's account.
    • The bank guarantees to the payee that the bank has put a hold on the payer's account for the amount of the check, meaning that the check should not bounce.
    • The money stays in the payer's account until the check clears.
    • The same bankruptcy issues exist as for regular checks.
    • Caution: Certified checks can be counterfeited, in which case the bank might not have to pay, and if the payee cashes the check, the payee might have to refund the money.
  5. A cashier's check — See generally Investopedia at https://goo.gl/EZ7Vec:
    • This is a check (see above) written by the bank itself, not by the payer.
    • When writing the check, the bank transfers the stated amount of money from the payer's account to the bank's own account. (Note the difference between this and a certified check, discussed above.)
    • The parties' agreement might specify what bank, or what type of bank, is to be used.
    • Caution: Cashier's checks can be counterfeited.
  6. A "wire transfer" (Investopedia at https://goo.gl/t6kisl) to give the payee "immediately-available funds" that can be immediately withdrawn and spent (Investopedia at https://goo.gl/51Ai5A).

4.82.4 Notification of payment disputes

Payment terms might require a party disputing an invoice (or other amount that it putatively owes) to alert the invoicing party, so that the invoicing party can correct any discrepancies, or so that the parties can start trying to iron out the dispute.

4.83 (Study:) Preamble of the agreement

This is the preamble from the hypothetical "A Somewhat-Barebones Contract" in the Supplement (at page 1).

Purchase and Sale Agreement for 2012 MacBook Air Computer

THIS AGREEMENT ("Agreement") is between (i) Betty's Used Computers, LLC, a limited liability company organized under the laws of the State of Texas ("Buyer"), with its principal place of business and its initial address for notice at 1234 Main St, Houston, Texas 77002; and (ii) Sam Smith, an individual residing in Houston, Harris County, Texas, whose initial address for notice is 4604 Calhoun Rd, Houston, Texas 77004 ("Seller"). This Agreement is effective the last date written on the signature page.

4.83.1 "This Agreement"

Many drafters would start this preamble by repeating the title of the agreement in all-caps:

THIS PURCHASE AND SALE AGREEMENT (this "Agreement") ….

But others, including your author, prefer the shorter approach shown above and reproduced just below:

THIS AGREEMENT ("Agreement") ….

That's because:

  • It's doubtful that anyone would be confused about what "This Agreement" refers to; and
  • The shorter version reduces the risk that a future editor might (i) revise the large-type title at the very top of the document but (ii) forget to change the all-caps title in the preamble. (This is an example of the rule of thumb: Don't Repeat Yourself, or D.R.Y., discussed in § 4.104.1.)

In the second bullet point just above, note how the first sentence is broken up (i) with bullets, and (ii) with so-called “romanettes,” that is, lower-case Roman numerals, to make the sentence easier for a contract reviewer to skim. (This follows the maxim: Serve the Reader, discussed in § 4.49.2.)

4.83.2 Bold-faced defined terms

Note how our preamble defines the terms Agreement, Buyer, and Seller:

THIS AGREEMENT ("Agreement") is between (i) Betty's Used Computers, LLC, … ("Buyer") … and (ii) Sam Smith, … ("Seller").

These defined terms are not only in bold-faced type: they're also surrounded by quotation marks and parentheses. This helps to make the defined terms stand out to a reader who is skimming the document.

When drafting "in-line" defined terms like this, it's a good idea to highlight them in this way; this makes it easier for a reader to spot a desired definition quickly when scanning the document to find it. Imagine the reader running across a reference to some other defined term and starting to flip through the document, wondering to herself, “OK, what does ‘Buyer' mean again?”

NOTE: If you also have a separate definitions section for defined terms (see § 4.46), it's a good idea for that section to include cross-references to the in-line definitions as well, so that the definitions section serves as a master glossary of all defined terms in the agreement.

4.83.3 Specific terms: "Buyer" and "Seller"

One more point about how we identify the buyer and the seller in this contract:

THIS AGREEMENT ("Agreement") is between (i) Betty's Used Computers, LLC, … ("Buyer") … and (ii) Sam Smith, … ("Seller").

This preamble uses the defined terms Buyer and Seller instead of the parties' names, Betty and Sam, because:

  • Doing this can make it easier on future readers … such as a judge … to keep track of who's who.
  • Doing this also makes it easier for the drafter to re-use the document for another deal by just changing the names at the beginning. Sure, global search-and-replace can work, but it's often over-inclusive; for example, automatically changing all instances of Sam to Sally might result in the word samples being changed to sallyples.

4.83.4 Agreement "between" (not "by and between") the parties

Our preamble says that the contract is between the parties — not by and between the parties, and not among them:

THIS AGREEMENT ("Agreement") is between ….

True, many contracts say "by and between” instead of just “between.” The former, though, sounds like legalese, and the latter works just as well.

For contracts with multiple parties, some drafters will write among instead of between; that's fine, but between also works.

4.83.5 Stating details about the parties

Our preamble provides certain details about the parties:

THIS AGREEMENT ("Agreement") is between (i) Betty's Used Computers, LLC, a limited liability company organized under the laws of the State of Texas … and (ii) Sam Smith, an individual ….

When a party to a contract is a corporation, LLC, or other organization, it's an excellent idea for the preamble to state both (i) the type of organization, in this case "a limited liability company," and (ii) the jurisdiction under whose laws the organization was formed, in this case "organized under the laws of the State of Texas." This has several benefits:

  • It reduces the chance of confusion in case the same company name is used by different organizations in different jurisdictions … imagine how many "Acme Corporations" or "AAAAAA Dry Cleaning" there must be in various states;
  • it helps to nail down at least one jurisdiction where the named party is subject to personal jurisdiction and venue, saving future trial counsel the trouble of proving it up; and
  • it helps to establish whether U.S. federal courts have diversity jurisdiction (a U.S. concept that might or might not be applicable).

(A shorter version might be "Betty's Used Computers, LLC, a Texas limited liability company ….")

Including the jurisdiction of organization can simplify a litigator's task of "proving up" the necessary facts: If a contract signed by ABC Corporation recites that ABC is a Delaware corporation, for example, an opposing party generally won't have to prove that fact, because ABC will usually be deemed to have conceded it in advance. (See also (Study:) Acknowledgements in a contract, § 4.3 and its field notes.)

This particular hypothetical agreement is set up to be between a limited liability company, or "LLC," and an individual; in that way, the signature blocks will illustrate how organizational signature blocks should be done. See the (Study:) Signature blocks, § 4.97 chapter for more details.

4.83.6 Principal place of business (or residence) and initial address

The preamble states some geographical information about the parties:

THIS AGREEMENT ("Agreement") is between (i) Betty's Used Computers, LLC, … with its principal place of business and its initial address for notice at 1234 Main St, Houston, Texas 77002; and (ii) Sam Smith, an individual residing in Houston, Harris County, Texas, whose initial address for notice is 4604 Calhoun Rd, Houston, Texas 77004 ("Seller"). …

Principal place of business: Stating Betty's principal place of business helps trial counsel avoid having to prove up personal jurisdiction. For example, a Delaware corporation whose principal place of business was in Houston would almost certainly be subject to suit in Houston.

Residence: Likewise, if a party to a contract is an individual, then stating the individual's residence helps to establish personal jurisdiction and the proper venue for a lawsuit against him or her.

County: Stating the county of an individual's residence might be important if the city of residence extends into multiple counties. For example, Houston is the county seat of Harris County, but just because Sam lives in Houston doesn't automatically mean that he can be sued in the county's courts in downtown Houston. That's because Houston's city limits extend into Fort Bend County to the southwest and Montgomery County to the north; Sam might live in the City of Houston but in one of those other counties, and so he might have to be sued in his home county and not in Harris County.

Addresses for notice: It's convenient to put the parties' initial addresses for notice in the preamble. That way, a later reader won't need to go paging through the agreement looking for the notice provision. Doing this also makes it easy for contract reviewer(s) to verify that the information is correct.

4.83.7 Stating the effective date in the preamble

The preamble states the effective date; that's usually unnecessary unless the contract is to be effective as of a specified date, but many drafters like to include the effective date anyway.

I prefer the “last date signed” approach that's used in the example above:

THIS AGREEMENT ("Agreement") is between …. This Agreement is effective the last date written on the signature page.

Here's a different version of the last-date-signed approach:

This Agreement is made, effective the last date signed as written below, between ….

In reviewing others' contract drafts, you're likely to see some less-good possibilities:

This Agreement is made December 31, 20XX, between ….
This Agreement is dated December 31, 20XX, between ….

Either of these can be problematic because the stated date might turn out to be inaccurate, depending on when the parties actually sign the contract.

CAUTION: Never backdate a contract for deceptive purposes, e.g., to be able to book a sale in an earlier fiscal period — as discussed in § 4.97.8, that practice has sent more than one corporate executive to prison, including at least one general counsel.

On the other hand, it might be just fine to state that a contract is effective as of a different date. EXAMPLE: Alice discloses confidential information to Bob after Bob first orally agrees to keep the information confidential; they agree to have the lawyers put together a written confidentiality agreement. That written agreement might state that it is effective as of the date of Alice's oral disclosure. The following might work if it's for non-deceptive purposes:

This Agreement is entered into, effective December 31, 20XX, by ….

(Alice and Bob would not want to backdate their actual signatures, though.)

4.83.8 Include affiliates as "parties"? (Probably not.)

Some agreements, in identifying the parties to the agreement on the front page, state that the parties are, say, ABC Corporation and its Affiliates. That's generally a bad idea unless each such affiliate actually signs the agreement as a party and therefore commits on its own to the contractual obligations.

The much-better practice is to state clearly the specific rights and obligations that (some or all) affiliates have under the contract. This is sometimes done in "master" agreements negotiated by a party on behalf of itself and its affiliates. For example, consider a negotiated master purchase agreement between a customer and a provider. The master agreement might require the provider to accept purchase orders under the master agreement from the customer's affiliates as well as from the customer itself, so that the customer's affiliates can take advantage of the pre-negotiated pricing and terms.

CAUTION: An affiliate of a contracting party might be bound by the contract if (i) the contracting party — or the individual signing the contract on behalf of that party — happens to control the affiliate, and (ii) the contract states that the contract is to benefit the affiliate. That was the result in Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10948-CB, slip op. at 3, 52-53 (Del. Ch. Aug. 18, 2016). In that case, (i) the contract stated that a strategic alliance was being created for the contracting party and its affiliates, and (ii) the contract was signed by the president of the contracting party, who was also the sole managing member of the affiliate. The court held that the affiliate was bound by (and had violated) certain restrictions in the contract.

4.83.9 Naming the "wrong" party can screw up contract enforcement

Be sure you're naming the correct party as "the other side" — or consider negotiating a guaranty from a solvent affiliate. Failing to name the correct corporate entity could leave your client holding the bag. This seems to have happened in Northbound Group, Inc. v. Norvax, Inc., 795 F.3d 647 (7th Cir. 2015):

  • Northbound Group was a company that generated leads for life-insurance sales. Facing financial difficulties, it agreed to sell its assets to Norvax, which generated leads for health-insurance sales.
  • The actual asset-purchase agreement, though, was not between Northbound and Norvax, but between Northbound and a newly-created subsidiary of Norvax.
  • Northbound later claimed that both the named contracting party and its parent company Norvax had breached the asset-purchase agreement in various ways.
  • When Northbound filed suit, though, it sued only Norvax, not the named contracting party; the latter purportedly had no assets, see id. at 650, and thus might well have been judgment-proof.

Northbound found that it had shot itself in the foot when it sued the parent company and not the named contracting party. The Seventh Circuit affirmed summary judgment in favor of the parent company, saying:

It goes without saying that a contract cannot bind a nonparty. … If appellant is entitled to damages for breach of contract, [it] can not recover them in a suit against appellee because appellee was not a party to the contract. These are the general rules of corporate and contract law, but they come with exceptions, of course. Northbound tries to create one new exception and invokes two established ones. We find no basis for holding Norvax liable for any alleged breach of the contract between Northbound and … the Norvax subsidiary.

Id. at 650-51 (internal quotation marks and citations omitted).

4.83.10 Does each party have legal capacity to contract?

Depending on the law of the jurisdiction, an unincorporated association or trust might not be legally capable of entering into contracts. See generally Ken Adams, Can a Trust Enter Into a Contract? (AdamsDrafting.com Dec. 2014).

If a contract is purportedly entered into by a party that doesn't have the legal capacity to do so, then conceivably the individual who signed the contract on behalf of that party might be personally liable for the party's obligations.

4.83.11 Country-specific required information?

Apparently the Czech Republic and some other Central- and Eastern-European countries require contracts to include specific identifying information about the parties, e.g., the registered office, the company ID number. and the registration in the Com­mer­cial Register. See this Ken Adams blog post; also this one from 2007. Similar information can be found in this apparently-Israeli contract.

4.84 (Read:) Price-fixing and other unlawful collusion

Sometimes it might seem tempting to agree with a competitor to divvy up customers, or to keep your prices at an agreed level, or to take turns submitting the winning bid in response to RFPs. Those activities, though, can lead to indictment and prosecution by federal- or state authorities for violation of the antitrust laws.

For example, in 2005, the German airline Lufthansa and the British airline Virgin Atlantic blew the whistle on a price-fixing scheme by a total of 21 non-U.S. airlines, including British Airways, Qantas, and Korean Air. The U.S. Department of Justice prosecuted, resulting in a total of some $1.7 billion in fines, and in four airline executives being sentenced to prison terms in the U.S. (NBCNews.com 2011: https://goo.gl/UQQTKH) (Justice.gov 2007: https://goo.gl/i75Knn).

Don't forget that prosecutors might reach for the low-hanging fruit — instead of trying to prove up an antitrust violation, they might bring charges of obstruction of justice (akin to prosecuting Al Capone for tax evasion, or Martha Stewart for making a false statement to the SEC). For example, in December 2010 a British executive, after being extradited to the U.S., was sentenced to 18 months in prison and a $25,000 fine — not for price fixing itself, but for conspiring to obstruct a price-fixing investigation (Justice.gov 2010: https://goo.gl/5ch725).

For more information about unlawful collusive practices, the Department of Justice has a useful antitrust primer that explains many of the relevant concepts (Justice.gov: https://goo.gl/vMMb7m).

4.85 (Read:) R.O.O.F. — Root Out Opportunities for F[oul]-ups

D.R.Y.  — Don't Repeat Yourself — is an example of this.

4.86 (Read:) Reasonable efforts

4.86.1 It's vague, but clients (sometimes) like to use it

The word reasonable is vague, but contract drafters sometimes use it in setting out specific rights and obligations. Most of the time that's not an unreasonable choice — no pun intended — because:

  • Clients are typically eager to get to signature and get on with their business; and
  • The odds are that:
    • a dispute about reasonableness won't arise; and
    • if a dispute does arise, the parties will be able to work it out themselves on a business basis.

4.86.2 Pay me now, or pay me later

Drafters should always keep in mind, though, that this might be a case of "you can pay me now, or you can pay me even more later" — if a dispute about reasonableness ever did arise, then each party might:

  • spend a lot of time and money on discovery and expert witnesses to prove what is or isn't reasonable; and
  • roll the dice about what the fact-finder decides is reasonable.

Opinions vary whether the term reasonable effort necessarily requires taking every conceivable reasonable action. In an extended LinkedIn group discussion (membership required), a commenter opined that anything less than all reasonable efforts was, by definition, unreasonable. I responded that many people would disagree: Reasonable efforts can encompass a range of efforts; it doesn't have to be a binary, yes-no dichotomy.

  • Consider Scenario 1, in which Alice's contract with Bob requires Alice to make reasonable efforts to advise Bob in writing if some (non-emergency) Event X occurs. If Event X were to occur, then Alice might send Bob an email to that effect, using the email address that Bob has consistently used in his dealings with Alice.

    In this scenario, many business people would think that Alice had complied with her contractual obligation to advise Bob, even if for some reason Bob never got the email.

  • Now consider Scenario 2, in which the contract requires Alice to make all reasonable efforts to advise Bob in writing that Event X has occurred. In that scenario, if Event X were to occur, then Alice might have to try every available means of written communication — email, FAX, certified mail, FedEx, UPS, showing up at Bob's house, etc. — until she received positive confirmation that Bob had in fact received the message.

4.87 (Skim:) Recordkeeping

4.87.1 What records to keep?

It might be important to specify just what records are required to be kept. According to a study of U.S. construction companies, interviewees reported that unless a contract spelled out in detail just what records were to be kept, "it is incredibly difficult to obtain the proper records from the Contractor in order to conduct a proper audit." Albert Bates, Jr. and Amy Joseph Coles, Audit Provisions in Private Construction Contracts: Which Costs Are Subject to Audit, Who Bears the Expense of the Audit, and Who Has the Burden of Proof on Audit Claims?, 6 J. Am. Coll. Constr. Lawyers 111, 114 (2012) (footnote omitted).

sample clause published by the Association of Certified Fraud Examiners contains a laundry list of specific types of documents that a vendor might want to require a contractor to maintain.

A contract could require a recordkeeping party to keep records of:

  • deliveries of goods and services;
  • billing of charges or other amounts;
  • payments of amounts not verifiable by the payee, such as, for example, royalties or rents to be paid to the other party as a percentage of the recordkeeping party's sales.

The required records could include, for example: Sales journals; purchase-order journals; cash-receipts journals; general ledgers; and inventory records. (This list is adapted from the contract in suit in Zaki Kulaibee Establishment v. McFliker, 771 F.3d 1301, 1308 n.13 (11th Cir. 2014).)

In some situations, parties might want to negotiate specific records to be kept.

4.87.2 What recordkeeping standards should be required?

Records could be required to be materially-complete and accurate. Some drafters use the term true and correct, but that seems both redundant and incomplete; perhaps in an archaic sense the term true might be interpreted broadly to mean materially complete and accurate, but there seems to be little reason to take a chance that a judge would see it that way.

In some situations, parties might want to negotiate specific recordkeeping standards, such as those imposed by the (U.S.) Federal Acquisition Regulations ("FARs"), Contractor Records Retention, 48 C.F.R. Subpart 4.7.

4.87.3 How long should records be kept?

It might well make sense to require records to be kept for:

  • any retention period required by applicable law; and
  • the duration of any timely-commenced audit.

When services are involved, retaining records for two- to four years after final payment seems to be a not-uncommon requirement. See, for example, the [U.S.] Federal Acquisition Regulations, e.g., Contractor Records Retention, 48 C.F.R. §§ 4.703(a)(1), 4.705.

Some industries or professions might require specific record-retention periods.

4.87.4 Audit rights

If a party is required to keep records, the other party might want to have audit rights (see § 4.20).

4.88 (Study:) Reliance disclaimer

4.88.1 Black letter

An entire-agreement provision in a contract (see § 4.52) , standing alone, generally won't preclude "Bob" from claiming that "Alice" should be liable for "fraud in the inducement" in convincing Alice to enter into the contract in the first place.

BUT: In some jurisdictions, including Texas, if the contract states that Alice has not relied and will not rely on any representation by Bob outside the four corners of the contract, that might do the trick.

4.88.2 Legal background of reliance disclaimers

Under the law in many U.S. jurisdictions, a contracting party that claims misrepresentation by the other side normally would have to prove, among other things, that it reasonably relied on the alleged misrepresentation. That gives the other side's contract drafter a reason to include a disclaimer of reliance.

Suppose that the following takes place:

• Alice and Bob enter into a contract for Alice to sell Bob a house located several hundred miles away from either of them.

• In the contract, Alice represents to Bob that the house is in good condition, but does not warrant it.

• After the closing, the house turns out to be a wreck.

Even though Alice didn't warrant the condition of the house, Alice might be liable for misrepresentation. For Bob to succeed with a misrepresentation claim, though, he would have had to jump through some additional proof hoops: He would have to show (probably among other things) that (1) Alice had acted (i) negligently or (ii) with intent to deceive, and (2) that he (Bob) had reasonably relied on Alice's representation.

Of course, Bob might well have a powerful incentive to try to jump through these proof hoops: If he could establish liability for misrepresentation, then he might be able to rescind the contract, and perhaps even recover punitive damages. Neither of those remedies is normally available in a breach-of-warranty action.

Moreover, a non-expert fact finder, such as a judge or juror, might not fully understand the technical aspects of a case — but she probably would understand the simple claim "they lied!" (See § 4.61 for more discussion.)

Alice will want to try to prevent Bob from even starting down that road. those possibilities. One way to try to do that is to include a statement in the contract that Bob isn't relying on any representations by Alice. That way, if Bob were to sue her for misrepresentation, a judge might very well rely (pardon the expression) on the disclaimer and summarily toss out Bob's claim by dismissing it on the pleadings. Courts have been known to give effect to no-reliance disclaimer clauses, especially when the parties are sophisticated (but often not in cases of intentional false representations).

If Hewlett-Packard's EDS subsidiary had included a no-reliance disclaimer clause in its software-system development agreement with British Sky Broadcasting, then perhaps it might not have had to pay some $ 460 million to settle Sky's successful claim for fraudulent inducement. See BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC).

In the same vein, a software developer found itself having to defend against a customer's claim that the developer had not only "breached its obligations under the contract … but also that [the developer] wrongfully induced [the customer] into entering a contractual relationship knowing that [the developer] did not have the capability to perform any of the promised web-related services." The Colorado supreme court held that those allegations "state a violation of a tort duty that is independent of the contract" and thus should not have been dismissed under the economic-loss doctrine. Van Rees v. Unleaded Software, Inc., 2016 CO 51, 373 P.3d 603, 608 (Colo. 2016).

4.88.3 An entire-agreement "merger" clause alone won't defeat "they lied!"

Standing alone, a clause such as (Study:) Entire agreement, § 4.52, also known as a merger clause or integration clause, generally won't protect Alice if Bob claims that Alice fraudulently induced Bob to enter into the contract in the first place. The Supreme Court of Texas explained:

Pure merger clauses, without an expressed clear and unequivocal intent to disclaim reliance or waive claims for fraudulent inducement, have never had the effect of precluding claims for fraudulent inducement. …

There is a significant difference between a party[:]

  • disclaiming its reliance on certain representations, and therefore potentially relinquishing the right to pursue any claim for which reliance is an element, and
  • disclaiming the fact that no other representations were made.

[DCT comment: In the context of a fraudulent-inducement analysis, though, don't these two disclaimers amount to exactly the same thing? As explained further down in this excerpt, though, the Texas supreme court seems to have felt that a disclaimer of extrinsic representations, standing alone, wasn't sufficiently explicit and "in your face" to alert the other side about what it was being asked to give up.]

 * * *

Here, the only plain reading of the contract language in sections 14.18 and 14.21 is that the parties intended to include a well-recognized merger clause. Nothing in that language suggests that the parties intended to disclaim reliance.

 * * *

We have repeatedly held that to disclaim reliance, parties must use clear and unequivocal language. this elevated requirement of precise language helps ensure that parties to a contract — even sophisticated parties represented by able attorneys — understand that the contract's terms disclaim reliance, such that the contract may be binding even if it was induced by fraud.

Here, the contract language was not clear or unequivocal about disclaiming reliance. Forinstance, the term "rely" does not appear in any form, either in terms of relying on the other party's representations, or in relying solely on one's own judgment.

This provision stands in stark contrast to provisions we have previously held were clear and unequivocal [three-column table, contrasting different clauses, omitted].

Italian Cowboy Partners, Ltd. v. Prudential Ins. Co., 341 S.W. 3d 323, 333-37 (Tex. 2011) (reversing court of appeals; merger clause did not preclude tenant's claim that landlord had fraudulently induced lease agreement by misrepresenting condition of property) (extra paragraphing and bullets added, citations and some internal quotation marks omitted).

As another example, Bank of America sold a foreclosed home subject to an "as-is" disclaimer, but the bank stated that it had "little or no direct knowledge" of problems, when in fact it knew that there were serious mold problems. The appeals court affirmed judgment on a jury verdict in favor of the buyer, saying that:

There was sufficient evidence to support the jury’s verdict that the Bank made a deceptive statement concerning the sale of the property [namely, that the bank had little or no direct knowledge of the condition of the house] with the intention of inducing the sale of the property and that Fricano suffered a loss as a result of that representation. The “as is” and exculpatory clauses in the parties’ contract do not, as a matter of law, relieve the bank/seller of liability under § 100.18(1) for its deceptive representation in the contract which induced agreement to such terms. We affirm.

Fricano v. Bank of America NA, 2016 WI APP 11 (2015).

4.88.4 But a clear non-reliance disclaimer might work

When a reliance disclaimer is sufficiently clear, courts might well give effect to it. For example:

Shakeri v. ADT Security Services, Inc., No. 15-10539, slip op. at 10-11 (5th Cir. Mar. 7, 2016) (per curiam): The contract between an alarm-system company and its jewelry-store customer contained the following reliance disclaimer: "In executing this Agreement, Customer is not relying on any advice or advertisement of ADT." Id., slip op. at 3 (capitalization omitted). The Fifth Circuit held that this language "was sufficiently clear as to disclaim any reliance by plaintiffs on any alleged misrepresentation ADT made prior to Plaintiffs entering into the contract. Accordingly, Plaintiffs’ fraudulent inducement claim is barred under Texas law." Id., slip op. at 17.

Pappas v. Tzolis, 20 N.Y.3d 228 (2012): Tzolis, a businessman, owned part of a limited liability company ("LLC") along with two colleagues, Pappas and Tziolis invested $50,000 in the company, while Ifantopoulos invested $25,000. The LLC acquired a long-term lease on a building in Lower Manhattan.

The three got into a dispute over subleasing the building. Tzolis bought out Pappas and Ifantopoulos for 20 times their investment. The buyout-agreement documents included statements by Pappas and Ifantopoulos disclaiming any reliance on representations by Tzolis, and vice versa.

A few months later, Tzolis sold the building lease for $17.5 million. Pappas and Ifantopoulos sued Tzolis for (among other things) fraud, claiming that Tzolis had arranged the sale before he bought them out, without telling them he was doing so.

New York's highest court ruled that Pappas's and Ifantopoulos's complaint should have been summarily dismissed:

Plaintiffs' cause of action alleging fraud and misrepresentation must be dismissed ….

Plaintiffs principally allege that Tzolis represented to them that he was aware of no reasonable prospects of selling the lease for an amount in excess of $2,500,000.

However, … in [one of the buyout-agreement documents], plaintiffs in the plainest language announced and stipulated that they were not relying on any representations as to the very matter as to which they now claim they were defrauded.

Moreover, while it is true that a party that releases a fraud claim may later challenge that release as fraudulently induced if it alleges a fraud separate from any contemplated by the release, plaintiffs do not allege that the release was itself induced by any action separate from the alleged fraud consisting of Tzolis's failure to disclose his negotiations to sell the lease.

Id. at 233-34 (extra paragraphing added, internal quotation marks, alteration marks, and citations omitted).

Bank of America, N.A. v. JB Hanna, LLC, No. 12-3239, part V, slip op. at 22 (8th Cir. Sept. 8, 2014) (affirming summary judgment in favor of bank);

One Communications Corp. v. JP Morgan SBIC LLC, Nos. 09-1815-cv, 10-0424-cv, slip op. at 4-5 (2d Cir. June 17, 2010) (affirming summary judgment dismissing misrepresentation claim);

K3C Inc. v. Bank of America, N.A., No. 06-50343, slip op. at 13-14 (5th Cir. Nov. 6, 2006) (unpublished) (affirming judgment after bench trial; non-reliance clause in interest-rate swap agreement precluded plaintiffs' negligent-misrepresentation claim against defendant bank);

Abu Dhabi Comm'l Bank v. Morgan Stanley & Co., No. 08 Civ 7508, slip op. at part IV (S.D.N.Y. March 5, 2013) (Scheindlin, J., citing New York law in granting defendant Morgan Stanley's motion for summary judgment dismissing negligent-misrepresntation claim as to some plaintiffs but not others);

Bristol Bay Prods., LLC v. Lampack, 2013 CO 60, No. 12SC138, slip op. at ¶ 26 (Colo. Oct. 21, 2013) (recapitulating Colorado law in case where author Clive Cussler was accused of fraud in misrepresenting the number of copies of his books that had been sold; "There is no dispute that the elements of fraud in California and Colorado are identical in all substantive respects" [footnote omitted]);

• Mark P. Gergen, Negligent Misrepresentation as Contract, 101 Cal. L. Rev. 953 (2013);

• Daniel W. Bishop II, Business Tort Update 2005, part I (reviewing Texas law).

• Brian S. Fraser, Paul B. Haskel, and Tamala E. Newbold, Litigating and Drafting Contractual Disclaimers of Reliance in a Post-Financial Crisis World, Bloomberg BNA Banking Report, June 17, 2014.

For a useful review of Texas jurisprudence in this area, see Dragon Fish, LLC v. Santikos Legacy, Ltd., 383 S.W.3d 175 (Tex. App.–San Antonio 2012). In that case, the court affirmed a trial court's partial summary judgment dismissing a claim by shopping-center tenants against the shopping center's developers; the dismissal was based on a reliance disclaimer contained in the lease agreements.

Of course, fraud claims might survive even a no-reliance provision. Suppose that Alice claims that Bob misrepresented facts to induce Alice to enter ito a contract, and that Bob's misrepresentation wasn't merely negligent, but intentional. And suppose also that the contract contains a no-reliance clause. In that situation, Bob should not hold out much hope that a court would summarily toss out Alice's fraudulent-inducement claim against him; the judge might very well insist on a full trial. See generally Andrew M. Zeitlin & Alison P. Baker, At Liberty to Lie? the Viability of Fraud Claims after Disclaiming Reliance, Apr. 23, 2013.

See also Neal A. Potischman, Stephen Salmon, Alyse L. Katz, John A. Bick, Kirtee Kapoor and Lawrence Portnoy, Will Anti-Reliance Provisions Preclude Extra-Contractual Fraud Claims? Answers Differ In Delaware, New York, And California (Mondaq.com 2016).

4.88.5 Drafting tip: Be specific about what's disclaimed?

Courts seem to have more sympathy for a reliance disclaimer if, in the words of the Second Circuit's Caiola v. Citibank opinion, the disclaimer "tracks the substance of the alleged misrepresentation." the court reversed a lower court's dismissal of a claim under federal securities law, but the underlying principle might well apply in contract cases as well. See Caiola v. Citibank, NA, 295 F.3d 312, 330 (2d Cir. 2002) (reversing dismissal of claim under federal securities law) (citing cases; internal quotation marks and alteration omitted).

4.88.6 Drafting tip: Initial the disclaimer?

If there's a concern that a party might someday try to repudiate its reliance disclaimer, it can't hurt to have that party separately initial the contract as close as possible to the disclaimer, and be sure the party actually does initial it.

For example: In a New York case, an estranged married couple reconciled — temporarily, as it turned out. During their reconciliation, the wife voluntarily dismissed her three pending lawsuits against the husband, and they signed a settlement agreement to that effect. But then the couple separated again, and the wife sued the husband again, this time claiming that he had fraudulently induced her to dismiss her other lawsuits by promising that he would return to her and permanently resume their marital relationship. Unfortuantely for the wife, the settlement agreement she signed included a reliance disclaimer, which she had specifically initialed; as the court acidly noted: "There is no allegation in the complaint that plaintiff did not read or did not understand the agreement; in fact, she initialed the agreement in the margin opposite the very paragraph disclaiming the alleged representation." Cohen v. Cohen, 1 A.D.2d 586 (N.Y. App. Div. 1956) (per curiam; affirming dismissal of complaint for insufficiency).

In this situation, the drafting party should make damned sure the signing party actually does initial the disclaimer where indicated. Otherwise the drafting party might have an even worse problem: the uninitialed blank line could help persuade a judge or jury that the signing party really did overlook the disclaimer; that's just the opposite of what the drafting party wanted.

4.88.7 One-way or two-way disclaimer of reliance?

In some situations, a one-way disclaimer of reliance might be appropriate, i.e., if one party really was relying on the other party's extrinsic representations.

Of course, in that situation the better practice might be to list such external representations in the parties' agreement, so that the representations were no longer extrinsic but instead were express.

4.88.8 Even a non-reliance disclaimer might not be enough, depending on the facts

A no-reliance clause in a contract might not enough to convince a court to toss out a fraudulent-inducement or negligent-misrepresentation claim. That was the outcome in a case due to factors explained by the court of appeals:

In this case, the parties did not enter into the agreement containing the disclaimer to resolve an ongoing dispute. There was, in fact, no existing dispute at the formation stage of the agreement.

Unlike the Schlumberger agreement, which contemplated the termination of a business relationship, the agreement entered into in the instant case contemplated creating a business relationship.

Considering that no dispute existed between the parties during the formation of the agreement creating the parties business relationship, when compared to Schlumberger, the disclaimer clause in this case is not an important part of the basis of the bargain.

Furthermore, Carousel did not retain counsel to negotiate with Marble Slab, and Marble Slab has not directed us to evidence in the record suggesting that the parties negotiated at arms-length in arriving at the final terms of the agreement.

Finally, considering that the supreme court decided Schlumberger on its specific facts, we note that the level of sophistication exhibited by Carousel does not rise to that of the Swansons in Schlumberger.

Carousel's Creamery, L.L.C. v. Marble Slab Creamery, Inc., 134 S.W.3d 385 (Tex. App.–Houston [1st Dist.] 2004) (reversing and remanding directed verdict for defendant on negligent-misrepresentation claim) (emphasis and extra paragraphing added).

4.88.9 Further reading about non-reliance provisions

4.89 (Study:) Reps and warranties

4.89.1 (Black letter:) Key takeaways about reps and warranties

Parties entering into a contract almost always make assumptions about past, present, or future facts. The parties are likely to want to expressly allocate responsibility for ensuring the truth of those facts, or at least for checking on them. (The alternative might be to roll the dice on doctrines such as mistake.) Representations and warranties are classic ways of allocating that responsibility; here are some things every contract drafter and reviewer should know about them.

1.  A representation is not the same thing as a warranty, at least not in U.S. law. The two terms relate to different categories of fact, and they have different legal ramifications in litigation.

2. A representation is, in essence, a statement of past or present fact. Example: Alice represents that her car has never been in an accident [past fact] and is in good working order [present fact].

3. A representation might be paraphrased as: So far as I know, X is true, but I'm not making any promises about it.

4. When qualifying a representation as in #3 above, use a term such as, so far as I know, and not the term to my knowledge: In a lawsuit, an aggressive trial counsel might claim that the latter term amounts to an implicit representation that the representing party did indeed have knowledge.

5. A representation can include the disclaimer without any particular investigation; this could be paraphrased as: I represent that X is true, but I'm not saying that I've done any particular investigation into the question.

6. The term warranty is a shorthand label for a kind of conditional covenant, a promise that if the warranted fact(s) are shown to be untrue, then the warranting party will make good on any resulting losses suffered by the party to whom the warranty was made.

Example: Consider the simple warranty, Alice warrants to Bob that Alice's car will run normally for at least 30 days. This is tantamount to a promise by Alice that, if Alice's car fails to run normally for at least 30 days, then Alice will pay for repairs, a rent car, and any other foreseeable damages resulting from the failure.

7. A warranty might be paraphrased as: I'm not going to say whether X is or isn't true, but I'll commit that, if it turns out that X isn't true, then I'll reimburse you for any resulting foreseeable losses that you suffer (or alternatively: then I'll take the following specific steps, and only those steps, to try to make it right for you).

8. Representations and warranties can be carefully drafted so as to be narrowly specific.

9. A warranty can be drafted to limit the remedies available if the warranted facts turn out not to be true. (A typical triad of remedies can be summarized as, repair, replace, or refund.)

10. A party that is asked to make a representation and warranty about particular facts (e.g., a seller of goods being asked to represent and warrant the quality of the goods) should consider whether it really wants to make both of those commitments for all the requested facts — that party might want to make only representations as to some facts and only warranties as to other facts.

On the other hand, suppose that a services provider and a customer are entering into a contract for services. If the provider will be giving any kind of warranty about its services, the customer should always at least try to get both a representation and a warranty; that will give the customer more flexibility in litigation.

11. Don't use the term represents to indicate that a party will take or abstain from action — commitments to future action should instead be written as promises (covenants).

Before: Bob represents that he will pay Alice ….
After: Bob will pay Alice …

In the "Before" example above, if Bob failed to pay Alice, he might try to claim that he should not be liable for nonpayment because when he made the representation, he had no reason to believe that he would not make the payment. A court might treat such a "representation" as a simple promise, see Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539 (Minn. 2014) (on cert­if­i­ca­tion from 7th Circuit), but the drafter would do all concerned a disservice by not making the obligation clear.

4.89.2 (Black letter:) Representations vs. warranties

Suppose that the following takes place: • Alice and Bob enter into a contract for Alice to sell Bob a house located several hundred miles away from either of them. • In the contract, Alice represents to Bob that the house is in good condition, but she does not warrant it. • After the closing, the house turns out to be a wreck.

Even though Alice didn't warrant the condition of the house, Alice might be liable for misrepresentation. For Bob to succeed with a misrepresentation claim, though, he would have had to jump through some additional proof hoops: He would have to show (probably among other things) that (1) Alice had acted (i) negligently or (ii) with intent to deceive, and (2) that he (Bob) had reasonably relied on Alice's representation.

Of course, Bob might well have a powerful incentive to try to jump through these proof hoops: If he could establish liability for misrepresentation, then he might be able to rescind the contract, and perhaps even recover punitive damages. Neither of those remedies is normally available in a breach-of-warranty action.

Moreover, a non-expert fact finder, such as a judge or juror, might not fully understand the technical aspects of a case — but she probably would understand the simple claim "they lied!" (see § 4.61 for more discussion.)

From a litigator's perspective, the following chart summarizes the key differences between representations and warranties under American law (see also the notes following the chart):

ITEM REP. WARRANTY
Can be disclaimed [a] [b]
Can relate to past facts x x
Can relate to present facts x x
Can relate to future facts   x
Plaintiff must prove falsity x x
Strict liability if false   x
Plaintiff must prove reliance [c]  
Plaintiff must prove reasonable reliance [c] [d]
Plaintiff must prove materiality of statement x  
Plaintiff must prove scienter [e]  
Proof of due diligence can help defeat liability [f]  
Remedy: Expectancy damages   x
Remedy: Rescission x  
Remedy: Restitution / reliance damages x  
Remedy: Punitive damages [g]  

NOTES:

[a] Disclaimers of representations usually relate to representations external to the contract; under Texas law, such extrinsic representations technically can't be disclaimed, but the contract can state that a party is not relying on such representations, as discussed in § 4.88.

[b] Warranties can typically be disclaimed, but in some U.S. jurisdictions, some warranties might be non-disclaimable; see § Effect of consumer-protection statutes on warranty disclaimers.

[c] A party's reasonable reliance on a representation will probably be a given if the contract expressly uses the term represents. For example, if a contract stated that "Alice represents to Bob that her candy meets the health-code requirements for human consumption," then it seems very likely that a jury would find both (i) that Bob relied on Alice's representation and (ii) that his reliance was reasonable.

[d] Normally, a plaintiff claiming that a warranty was breached need not prove that it reasonably relied on the warranty. In some jurisdictions, though, the warranting party might be able to defeat the plaintiff's claim by showing that the warranting party itself disclosed facts to the plaintiff that made it unreasonable for the plaintiff to have relied on the warranty; see § Warranties carry fewer proof requirements.

[e] For misrepresentation, scienter could take the form of (i) negligence in making the representation; (ii) reckless disregard for the truth; or (ii) intentional misstatement. (This gives plaintiff's trial counsel a reason to use "They lied!" in front of a jury.)

[f] Proof of due diligence in making a representation would normally defeat a claim of scienter (see above).

[g] Punitive damages would be available in cases of intentional misrepresentation, and possibly in cases of negligent misrepresentation as well.

4.89.3 (Read:) More about warranties

What is a warranty (1): Learned Hand's view

The concept of "warranty" is not necessarily an easy one to grasp. One widely-held view was expressed by the legendary judge Learned Hand:

[A warranty is] an assurance by one party to a contract of the existence of a fact upon which the other party may rely. It is intended precisely to relieve the promisee of any duty to ascertain the fact for himself; it amounts to a promise to indemnify the promisee for any loss if the fact warranted proves untrue …. To argue that the promisee is responsible for failing independently to confirm it, is utterly to misconceive its office.

CBS, Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503, 553 N.E.2d 997, 1001 (1990), quoting Metropolitan Coal Co. v Howard, 155 F.2d 780, 784 (2d Cir 1946) (cleaned up).

What is a warranty (2): A conditional covenant

The author submits that a warranty is best thought of as a conditional covenant, tantamount to an insurance policy: In effect, the warranting party promises that, if the warranted state of affairs turns out not to be true, then the warranting party will do as stated in the contract — or, if the contract is silent, then the warranting party will make good on any foreseeable damages that, as a result, are incurred by the party (or parties) to whom the warranty was made.

Consider a contract for Alice to sell a car (the "Car") to Bob. The contract says: Alice warrants that the Car, when delivered, will be in good working order. Now consider two, alternative, fork-in-the-road scenarios:

  1. In Scenario 1, the contract also says: IF: Bob shows that the Car was not in good working order when delivered; THEN: AS BOB'S EXCLUSIVE REMEDY, Alice will reimburse Bob for up to $X in repair costs. (This means that Alice and Bob are voluntarily sharing the risk that the Car isn't in good working order; that sharing of the risk presumably is reflected in the negotiated price of the Car.)
  2. In Scenario 2, the contract is silent about what Alice will do if the Car turns out not to have been in good working order when delivered. Under the law, that is equivalent to the contract's saying: IF: Bob shows that the Car, when delivered to him, was not in good working order; AND: As a result, Bob suffers foreseeable damages; THEN: Alice will pay Bob the amount of those damages.
The warranty as insurance policy

A warranty is akin to an insurance policy: both are contractual commitments to assume certain risks. As the Restatement (Second) of Contracts puts it:

d. Promise of event beyond human control; warranty. Words which in terms promise that an event not within human control will occur may be interpreted to include a promise to answer for harm caused by the failure of the event to occur. An example is a warranty of an existing or past fact, such as a warranty that a horse is sound, or that a ship arrived in a foreign port some days previously. Such promises are often made when the parties are ignorant of the actual facts regarding which they bargain, and may be dealt with as if the warrantor could cause the fact to be as he asserted. …

Restatement (Second) of Contracts § 2 cmt. d.

Warranties carry fewer proof requirements

A party to whom a warranty is given doesn't need to prove that the warranting party acted negligently or intentionally in misstating the warranted state of affairs. This is in contrast to tort-based theories of misrepresentation, where a party claiming misrepresentation must provide such proof.

And in the so-called modern [U.S.] view, the beneficiary of a warranty is not required to prove that it justifiably relied on a warranty. A leading case on point is from the Court of Appeals of New York (that state's highest court). See CBS, Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503, 553 N.E.2d 997, 1001 (1990).

Cf. also Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539, 543-44 & n.6 (Minn. 2014) (declining to decide whether requirement of reliance in 1944 opinion of supreme court was still good law); see generally Matthew J. Duchemin, Whether Reliance on the Warranty is Required in a Common Law Action for Breach of an Express Warranty, 82 Marq. L. Rev. 689 (1999).

The warranting party's timely "whoops" might matter

A different situation might be presented if, before the contract was signed, a warranting party disclosed that a warranty in the contract was not accurate. While the law seems still to be evolving in this area, the influential U.S. Court of Appeals for the Second Circuit summarized New York law thusly:

… a court must evaluate both the extent and the source of the buyer's knowledge about the truth of what the seller is warranting.

Where a buyer closes on a contract in the full knowledge and acceptance of facts disclosed by the seller which would constitute a breach of warranty under the terms of the contract, the buyer should be foreclosed from later asserting the breach.

In that situation, unless the buyer expressly preserves his rights under the warranties … The buyer has waived the breach.

The buyer may preserve his rights by expressly stating that disputes regarding the accuracy of the seller's warranties are unresolved, and that by signing the agreement the buyer does not waive any rights to enforce the terms of the agreement.

On the other hand, if the seller is not the source of the buyer's knowledge, e.g., if it is merely "common knowledge" that the facts warranted are false, or the buyer has been informed of the falsity of the facts by some third party, the buyer may prevail in his claim for breach of warranty.

In these cases, it is not unrealistic to assume that the buyer purchased the seller's warranty as insurance against any future claims, and that is why he insisted on the inclusion of the warranties ….

In short, where the seller discloses up front the inaccuracy of certain of his warranties, it cannot be said that the buyer — absent the express preservation of his rights — believed he was purchasing the seller's promise as to the truth of the warranties.

Accordingly, what the buyer knew and, most importantly, whether he got that knowledge from the seller are the critical questions.

Rogath v. Siebenmann, 129 F. 3d 261, 264-65 (2d Cir. 1997) (vacating and remanding partial summary judgment that seller had breached contract warranty; emphasis edited, extra paragraphing added, internal quotation marks and extensive citations omitted).

Special case: Sales of goods under the Uniform Commercial Code

In a contract for the sale of goods, if Vendor were only to represent that X were true, that representation might well constitute a warranty anyway under the Uniform Commercial Code. UCC § 2-313 provides that, if the representation is related to the goods and forms part of the basis of the bargain, it's deemed a warranty, no matter what it's called.

Is a warranty a guarantee?

Colloquially the terms "warranty" and "guarantee" are alike, but technically there are some differences; see generally § 4.67.

Materiality of warranties

Some contracts provide that each stated warranty is a material provision of the agreement. Warranting parties should be careful about agreeing to a provision such as this, because it might mean that even an inconsequential breach of warranty might be a material breach that could entitle the other party to terminate or even rescind the agreement.

Is "represents and warrants" necessary?

It's tempting to write the well-known couplet represents and warrants as if by reflex. As discussed above, however, the two are distinct legal concepts, with different proof requirements and different legal effects.

Be careful what you warrant

In a British Columbia case:

  • A supplier sold water pipes to a customer for use in a construction project designed by the customer.
  • The pipes conformed to the customer's specifications — in other words, the supplier delivered what the customer ordered.
  • Flaws in the customer's design led to problems.
  • The contract's warranty language stated that the supplier warranted that the pipes were "free from all defects arising at any time from faulty design" (emphasis added).
  • As a result, the supplier was held liable because of its warranty, even though the problem was the customer's fault.

See Greater Vancouver Water Dist. v. North American Pipe & Steel Ltd., 2012 BCCA 337 (CanLII) (reversing trial court's judgment in favor of supplier). The appeals court said:

[24] North American was obliged to deliver pipe in accordance with the appellant’s speci­fi­ca­tions. North American agreed to do so.

Quite separately, it warranted and guaranteed that if it so supplied the pipe, it would be free of defects arising from faulty design. These are separate contractual obligations. The fact that a conflict may arise in practice does not render them any the less so.

The warranty and guarantee provisions reflect a distribution of risk.

* * * 

[34] Clauses such as 4.4.4 distribute risk. Sometime they appear to do so unfairly, but that is a matter for the marketplace, not for the courts.

There is a danger attached to such clauses. Contractors may refuse to bid or, if they do so, may build in costly contingencies. Those who do not protect themselves from unknown potential risk may pay dearly. …

Parties to construction or supply contracts may find it in their best interests to address more practically the assumption of design risk. To fail do to so merely creates the potential for protracted and costly litigation.

Id. at ¶¶ 24, 32 (emphasis and extra paragraphing added).

Warranty survival

Anyone drafting a warranty provision in a contract for the sale of assets should consider whether to specify whether, and for how long, specified warranties will survive the closing. That's because, in some circumstances, the so-called merger doctrine can extinguish contractual warranties upon closing.

For example: In a contract for sale of real property, the seller will generally make certain stated war­rant­ies (which are often extensively negotiatied). In some jurisdictions, at the closing of the sale, all such warranties are deemed to "merge" into — and thus be extinguished by — the seller's delivery of the deed conveying the property, that is unless the contract provides otherwise. That way, "the deed is deemed to express the final and entire contract between the parties." Ram's Gate Winery, LLC v. Roche, 235 Cal. App. 4th 1071, 1079, 185 Cal. Rptr. 3d 935 (2015) (reversing and remanding summary adjudication and holding that fact issue remained as to whether parties intended warranties to survive closing) (citations and internal quotation marks omitted).

A similar but not-identical issue can arise in corporate merger & acquisition (M&A) transactions: Careless use of the phrase "warranties will survive the closing" can create confusion: If a warranty breach allegedly occurs, it might be unclear whether the non-breaching party must merely notify the breaching party witnin a stated period of time after closing, or whether the non-breaching party must file a lawsuit or demand for arbitration within that time. See, e.g., Jeffrey H. LaBarge, They don't call it a survival clause for nothing … (NixonPeabody.com 2011).

4.89.4 (Study:) Disclaiming implied warranties

Overview

Many contracts include disclaimers of implied warranties; the idea could be paraphrased as, whatever representations and warranties are in this contract, that's it. For a detailed example with commentary, see the Common Draft disclaimer provision at https://goo.gl/uWzWES.

A disclaimer of implied warranties and representations could usefully include a disclaimer of conditions and of terms of quality to address the requirements of disclaimers under UK law; see § Warranty disclaimers for UK transactions should also disclaim “conditions”.

The word DISCLAIMS could be in bold-faced, all-caps type for conspicuousness (see § 4.36 to meet the special requirements for disclaimers of the implied warranty of merchantability (see https://www.law.cornell.edu/ucc/2/2-314) of goods sold (which arises automatically under the (U.S.) Uniform Commercial Code), specifically UCC § 2-316]](2) and (3) (see https://www.law.cornell.edu/ucc/2/2-316).

Effect of consumer-protection statutes on warranty disclaimers

Any company offering consumer-product warranties (in the U.S.) should carefully study the requirements of various federal- and state consumer protection laws, such as:

  • the Magnuson-Moss Warranty Act, which is the federal law that governs consumer product warranties; it requires manufacturers and sellers of consumer products to provide consumers with detailed information about warranty coverage, and also affects both the rights of consumers and the obligations of warrantors under written warranties (this paragraph is adapted from the FTC guide linked above); and
  • state statutes such as California's Song-Beverly Act, which requires manufacturers of consumer goods sold in California to jump through various hoops (and imposes stringent requirements if the manufacturer wants to disclaim the implied warranties of merchatability and fitness).

The E-Warranty Act of 2015 requires any written warranty for consumer products costing more than $15 to be made available before the sale, as discussed here.

In Texas and probably other jurisdictions, homebuilders cannot disclaim the implied warranty of habitability. See Centex Homes v. Buecher, 95 S.W.3d 266 (Tex. 2002).

Warranty disclaimers for UK transactions should also disclaim “conditions”

If you're a vendor doing a sales transaction under UK law (England, Wales, Northern Ireland), be sure that your warranty disclaimer addresses not just implied warranties but also implied “conditions.”  An oil seller failed to do so and learned that its disclaimer didn't preclude liability.  See KG Bominflot Bunkergesellschaft Für Mineralöle mbh & Co KG v. Petroplus Marketing AG, [2009] EWHC 1088 (Comm). In that case:

  • The parties entered into a contract for the sale of gasoil, a type of heating oil.  The contract was governed by English law. 
  • The contract provided that delivery was complete, and title and risk passed to the buyer, when the gasoil was loaded onto a certain ship.
  • The gasoil met the contractual specifications when it was loaded. By the time the ship arrived at its destination, however, the gasoil no longer met the agreed specifications.  The claimed damages were in excess of USD $3 million. Id. ¶ 8.

The seller took the position that all title and risk had passed, therefore the damages were the buyer's problem. The buyer, though, argued that under the Sale of Goods Act 1979, “it was an implied condition of the sale contract that the goods would be reasonably fit for the purpose of remaining, during their time on the vessel and for a reasonable time thereafter, within the specifications set out in the sale contract." Id. ¶ 7 (quoting buyer's argument).

The judge agreed with the buyer, holding that by failing to disclaim implied conditions as well as implied warranties, the seller had left itself open to the buyer's claim:

49. If the failure to use the word “condition” renders clause 18 [the warranty dis­claim­er] of little or no effect, so be it. The sellers agreed to the wording of clause 18 in the face of Wallis v Pratt and must live with the consequences.

4.89.5 Possible quiz & exam questions

Question: Warranty disclaimers in England

FACTS:

  • Your client, Seller, headquartered in Dallas, manufactures widgets.
  • Seller's CEO, while on a vacation in London, had the good fortune to make friends with a prominent British industrialist; the CEO landed a big order to deliver 1 million widgets to the industrialist's company in Liverpool, and brought back a signed purchase order.
  • You happen to know that Seller's standard terms-of-sale document:
    • includes a statement of limited warranties and remedies;
    • includes the following statement: "ALL OTHER WARRANTIES ARE DISCLAIMED"; and
    • is silent about choice of law.
  • You don't know whether the British industrialist's company has seen Seller's standard terms-of-sale document.

QUESTIONS:

(1) T/F: Texas law will likely apply.

A: On these facts, English law will probably apply.

(2) T/F: If article 2 of the Texas UCC applies, Seller's disclaimer will be enough, under UCC § 2-312, to disclaim an implied warranty that Seller has the legal right to convey ownership of the widgets to the purchaser.

A: Under UCC § 2-312(2), the implied warranty of title must be expressly disclaimed (or the disclaimer must be apparent from the circumstances).

(3) T/F: If English law applies, Seller's disclaimer will likely be enough to disclaim all potential liability about the widgets other than as stated in Seller's standard terms-of-sale document.

A: No - need a disclaimer of implied conditions and (probably) terms of quality as well.

(4) QUESTION: Could Seller's disclaimer language be improved? How?

Question: Reps and warranties strategy

FACTS: You've passed a bar (exam) and are a licensed attorney. As a favor to a friend, you're helping the friend sell a car to a stranger. The friend says that s/he doesn't know of any mechanical problems with the car.

MORE FACTS: The buyer asks the seller to represent and warrant that the car has no problems.

QUESTION: how might you respond?

A: Perhaps by having the seller say simply, "so far as I'm aware, the car has no significant problems, but I'm not a mechanic and haven't had a mechanic check it out."

QUESTION: T/F: It's acceptable for the seller to phrase the statement as, "to my personal knowledge the vehicle has no problems"? [Note where the question mark is, i.e., outside the quotation mark.]

A: That'd be a bad idea — phrased that way, the statement is likely to be taken as a definitive statement that indeed there are no problems.

Review questions

QUESTION 1: Does a representation normally relate to:
(A) a past fact?
(B) a present fact?
(C) a future fact?
(D) all of the above?
(E) none of the above?

A and B. In rare circumstances, courts will treat C, a representation of a future fact, as a covenant or warranty (in essence, bailing out the incompetent drafter), e.g., I represent that I will pay you Tuesday for a hamburger today. NOTE: For drafting purposes, treat A and B as the only correct answers.

QUESTION 2: What are the basic elements that a plaintiff generally must establish to succeed in a claim for misrepresentation?

A: Here's the general "proof checklist" for an action for misrepresentation?

(a) A statement, made by the defendant;

(b) The statement was false or misleading when made;

(c) (With variations:) The defendant knew, or should have known, that the statement was false or misleading;

(d) (With variations:) The defendant knew, or should have known, that the plaintiff would rely on the statement;

(e) The plaintiff did in fact rely on the statement;

(f) The plaintiff's reliance was reasonable; and

(g) The plaintiff suffered damage attributable to the statement.

QUESTION 3: Should factual representations normally be included in an agreement's recitals? Why or why not?

A: This is a matter of convention – like It's not customary to include factual representations in the recitals. It might also be dangerous to do so: If memory serves, in some jurisdictions the courts might not treat the recitals as part of the contract.

The safer thing to do would be to rework the recitals as a "1. Background" section and have the parties make whatever initial representations they're willing to make.

4.89.6 Further reading (optional)

For a succinct overview of the practical differences between representations and warranties, it's well worth the time to read Professor Stephen L. Sepinuck's article, The Virtue of “Represents and Warrants”: Another View, Business Law Today, Nov. 2015 (AmericanBar.org: https://goo.gl/jxNmBc);

For extensive citations in this area, see Professor Tina Stark's scholarly pummeling of the misguided notion that represent and warrant are supposedly interchangeable, in two comments on Ken Adams's blog (AdamsDrafting.com 2013: https://goo.gl/q7PdrG and https://goo.gl/vD5Apk). Disclosure: Tina is a friend and mentor and the author of the well-regarded textbook Drafting Contracts: How and Why Lawyers Do What They Do (second edition 2013). See also Tina L. Stark, Nonbinding Opinion: Another view on reps and warranties, Business Law Today, January/February 2006 (AmericanBar.org: https://goo.gl/4aAGQh).

Bryan Garner goes into more detail in a passage quoted in this Ken Adams blog post (AdamsDrafting.com 2011: https://goo.gl/wysCUc). As will be apparent, the present author disagrees completely with Adams's contention that the terms Alice represents X and Alice warrants X are supposedly synonyms and that both should be replaced with Alice states, as he argues in the other posts linked at the beginning of the cited blog post.

A claim of misrepresentation can have massive real-world consequences. For example, HP's EDS unit ended up paying more than US$ 460 million to settle British Sky Broadcasting's successful claim for fraudulent inducement and misrepresentation in connection with a software-development contract — this, even though the contract limited EDS's liability to around 10% of that number. See BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC) and Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.

Concerning insurance to cover misrepresentation claims, see Howard T. Spilko and Scott A. Abramowitz, Use of Representations and Warranties Insurance Grows in Middle-Market Transactions (NYLJ.com 2015: https://goo.gl/N837Uo).

For an overview of UK Law about representations, see generally two articles addressing the High Court's decision in Idemitsu Kosan Co. v. Sumitomo Corp., [2016] EWHC 1909:

For an earlier piece on the same subject by Stark, see her Nonbinding Opinion: Another view on reps and warranties, Business Law Today, January/February 2006.

Some of Ken Adams's earlier essays espousing the purported synonymity of the two terms can be found at:

See also Robert J. Johannes & Thomas A. Simonis, Buyer's Pre-Closing Knowledge of Seller's Breach of Warranty, Wis. Law. (July 2002) (surveying case law).

An English court decision highlighted the difference between representations and warranties: See Sycamore Bidco Ltd v Breslin & Anor [2012] EWHC 3443 (Ch) (2012), discussed in, e.g.:

Concerning reliance disclaimers:

4.90 (Skim:) Review restrictions

Some contracts prohibit one party from participating in reviews of products of the other company. This type of provision, though, could lead to serious complications down the road, such as adverse publicity and even litigation. See, for example:

  • As of September 2016, the U.S. House and Senate have passed slightly-different versions of a bill that, according to one expert, "voids any effort in a form contract to ban consumer reviews, impose fines for writing consumer reviews, or take the IP rights to consumer reviews. It also makes such contract efforts unlawful and authorizes the FTC to bring enforcement actions (and, in some cases, state AGs)." Eric Goldman, House Passes Consumer Review Fairness Act. Professor Goldman predicts that President Obama will sign the bill.
  • The New York attorney general obtained an injunction against the manufacturer of McAfee anti-virus software for including, in its end-user license agreement (EULA), a prohibition against disclosure of benchmark test results or publication of product reviews without the manufacturer's approval. See People v. Network Assoc., Inc., 758 N.Y.S.2d 466, 195 Misc.2d 384 (2003).
  • Eric Goldman, California Moving To Protect Consumer Reviews (Forbes.com 2014) (describing pending legislation to ban contractual prohibitions of product- and service reviews).
  • Eric Pfeiffer, Woman gets $3,500 fine and bad credit score for writing negative review of business (Yahoo News Nov. 15, 2013).
  • Mara Siegler, Hotel fines $500 for every bad review posted online (New York Post Aug. 4, 2014); see also the Hacker News discussion of this news item.

Consider also the so-called Streisand effect: When the legendary singer and actress tried to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her purpose. (The Wikipedia article linked at the beginning of this paragraph contains numerous other examples.)

4.91 (Skim:) Round-trip sales transactions

Round-trip sales transactions are those in which, in essence, one company says to another, You'll buy my stuff, but I'll buy enough of yours to cover your cost. (It's sometimes referred to as "buying revenue.") This type of deal can be a species of securities fraud, and can get companies and individuals sued by the SEC and/or by securities plaintiffs.

The SEC explained the basics of round-trip transactions in a 2005 press release charging Time Warner (then AOL) with the practice, a charge that eventually cost Time Warner nearly $3 billion (extra paragraphing has been added for readability):

[AOL] effectively funded its own online advertising revenue by giving the counterparties the means to pay for advertising that they would not otherwise have purchased.

To conceal the true nature of the transactions, the company typically structured and documented round-trips as if they were two or more separate, bona fide transactions, conducted at arm's length and reflecting each party's independent business purpose. The company delivered mostly untargeted, less desirable, remnant online advertising to the round-trip advertisers, and the round-trip advertisers often had little or no ability to control the quantity, quality, and sometimes even the content of the online advertising they received. Because the round-trip customers effectively were paying for the online advertising with the company's funds, the customers seldom, if ever, complained.

AOL / Time Warner almost immediately settled with the SEC for $300 million; in 2009 it settled a related class-action lawsuit for $2.65 billion.

4.92 (Skim:) Savings clause

A contract will sometimes include a provision along the lines of the foregoing:

If a provision of this Agreement is held unenforceable, then all other provisions of this Agreement will remain enforceable in accordance with their terms.

Sometimes the contract will also include a provision like this:

… and the provision in question will be deemed modified as necessary to make it or, if necessary, severed.

Both of these provisions need work; see the Common Draft savings clause for another version.

4.93 (Read:) Sayings

Sayings with an asterisk* might be on a quiz.

Don't Repeat Yourself* (with some exceptions) — see § 4.104.1

First Offer = First Look

First Refusal Is Last Look

One Throat to Choke! (Think of two baseball outfielders letting a fly ball drop to the ground between them because neither one "calls it.")

Plan B beats a lawsuit for breach.

R.O.O.F.* — Root Out Opportunities for F[oul]-ups (D.R.Y. is an example of this)

Serve the Reader

White Space Is Your Friend (for readability and faster review and -signature)

When In Doubt:

  • Define
  • Ask the partner
  • Ask the client (and consider documenting that you did so)

Whose Throat to Choke?* (Or, be careful about possible false imperatives—who gets sued if X doesn't get done?)

You get what you INspect, not what you EXpect.*

4.94 (Skim:) Security interests, liens, etc.

4.94.1 Introduction

Overly simplified: Contracts often require one party, the "debtor," to pay money to another party, the "creditor." As a Plan B, the creditor might want to have the debtor, and/or a guarantor (section 4.67), grant the creditor a "security interest" in saleable property, referred to as "collateral." Assuming that the i's are dotted and the t's crossed, when the debtor doesn't pay, the creditor — after jumping through various hoops — can foreclose on the collateral (that is, seize and sell it) and use the sale proceeds to pay down the debt, with any remaining proceeds going to the collateral's former owner.

In the U.S., depending on the type of collateral, a security interest or other lien can be created:

4.94.2 Caution: Must the security interest be "perfected"?

Just because Creditor A acquires a security interest (or other lien) doesn't automatically mean that Creditor A would get to seize and sell the collateral if the debtor didn't pay. Either intentionally or inadvertently, the debtor might grant a different Creditor B a security interest in the same collateral without telling either creditor about the conflicting security interests. That might well trigger a dispute over which creditor — each having a legitimate claim to the collateral or its proceeds — was entitled to priority. (We won't address here the rules for resolving such a dispute.)

Perfection by public notice: Creditor A might well be able to cut off claims of later creditors by timely filing a public notice of Creditor A's security interest or other lien. That way, by law, future creditors won't be able to claim that they had no reason to know of Creditor A's security interest because the future creditors could and should have searched the appropriate public records as part of their due diligence.

In many cases, such a public notice will take the form of a UCC-1 financing statement, filed by Creditor A with the state secretary of state (or, for some types of collateral, in county records). See generally the Wikipedia article UCC-1, at https://goo.gl/g0FnIg.

"Perfection" by possession: Some security interests and liens can be "perfected" by taking possession of the collateral (and, in the case of mony, only that way): Under UCC § 9-313, "a secured party may perfect a security interest in negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession of the collateral. A secured party may perfect a security interest in certificated securities by taking delivery of the certificated securities under Section 8-301." A practical implication is that a creditor, seeking to take a security interest in such collateral, might insist on seeing the collateral to confirm that it wasn't in someone else's possession under a prior, perfected security interest.

4.94.3 Pro tips for taking security interests in collateral

When drafting a contract that calls for your client to take a security interest in collateral of another party, consider the following:

  • For collateral consisting of negotiable documents, goods, instruments, money, or tangible chattel paper (see above), confirm that the collateral is not in the possession of some other creditor and thus would presumably be already subject to that creditor's security interest;
  • Check the appropriate public records to find out whether any existing security interests or liens might impair your client's ability to claim proceeds from the collateral;
  • In the contract, expressly prohibit the debtor (i) from granting any other security interest or lien in the collateral, or (ii) from allowing a lien to attach as a matter of law, e.g., through the debtor's failure to pay taxes or other amounts owed;
  • File a UCC-1 financing statement in the appropriate location (or locations?) to put future creditors on notice of your client's claim to the collateral;
  • Get a representation [LINK NEEDED], and/or a warranty, that no other security interests or liens have been granted except as expressly disclosed;

4.95 (Read:) Services

4.95.1 Written statements of work

(BL) Caution: Don't assume legal review of work orders won't be necessary

Some contract reviewers make the mistake of ignoring work orders, on the sometimes-mistaken assumption that only "technical" information is to be found there. It's a worthwhile exercise for a contract drafter or reviewer (here, "reviewer") at least to glance through any work order, because:

  • The reviewer will be better able to negotiate the terms and conditions if she has some idea of the technical details; and
  • Perhaps unconsciously — or perhaps deliberately — the other side's drafter might have included important "legal"-type terms and conditions in the work order, in the hope that the contract reviewer might overlook them.
Modifications to statements of work

Services agreements typically provide that changes to a statement of work must be in writing and signed by the parties. It's not clear, though, that a court would enforce such a requirement; see the discussion in the commentary to (Black letter:) Amendments in writing, § 4.9.

No obligation to agree to statement of work?

Both parties to a services agreement might want the Agreement to state that neither of them is obligated to enter into or agree to any particular statement of work. That would rule out (for example) claims by a contractor that a customer implicitly guaranteed that the contractor would get X amount of work. This was litigated in a case by a small contractor against IBM (if the author remembers correctly); IBM won the case on summary judgment, but it still had to defend against the claim. Unfortunately the author is unable to find a citation for the case.

(BL) Statements of work as separate agreements?

A "master" services agreement will often provide that each statement of work is to be governed by the master agreement. But which way should it go —

  1. Should each statement of work incorporate the master agreement by reference?
  2. Or should each statement of work become part of the master agreement?

In the author's view, each statement of work should be a separate agreement. True, some services contracts purport to incorporate each statement of work into the "main" agreement, so that each statement of work becomes part of the main agreement. But this is potentially dangerous, because:

  • a default in one statement of work could affect other statements of work (this is sometimes referred to as "cross-default"); and
  • if the vendor's liability for damages were to be capped at "the amounts paid under this Agreement," then, over time, that amount would increase as more statements of work were completed; the customer might like that just fine, but the vendor likely wouldn't be wild about the idea.

Contrast this approach with that of the IDSA Master Agreement, published by the International Securities and Derivatives Association. That master agreement is set up in the opposite way, so that "all of the derivative transactions entered into between the parties are documented under one single agreement. This becomes important on insolvency when there are multiple trades between the same parties because it prevents a liquidator from affirming the most favourable trades and disclaiming the unfavourable trades." Master agreements and schedules—overview, archived at https://perma.cc/HS3N-7Q5Q (LexisNexis.com).

(BL) Which takes precedence: The master agreement, or the statement of work?

Not without reason, some corporate legal departments want to maintain tight control over contract-related documentation; they don't want statements of work — which might not be reviewed by "Legal" and could raise all kinds of legal issues — to supersede the contract provisions. (To paraphrase a private remark by a lawyer acquaintance who shall remain nameless, I keep trying to make my master services agreements idiot-proof, but they keep making better idiots.)

That approach, though, can conflict with the way parties actually do business and could delay getting things done.

One compromise is for the master agreement to provide that a statement of work can override the terms of a master agreement — but the parties must be explicit and even conspicuous about it.

(BL) Mandating a particular form of work order is probably not a great idea

Some services agreements state that a work order must include various details. For example, one outsourcing agreement states: "Any subsequent work order shall be substantially in the form of the Statements of Work attached as Appendix 2 …." (Emphasis added.)

In the author's view, that's not a great idea, because the parties might do a work order that doesn't comply with that mandate — but then what?

The better approach is that taken by an AT&T master service agreement, in which section 1.OO (oh-oh, not zero-zero) defines a work order as "a written description of the professional service and/or Custom Product Supplier is providing AT&T, pursuant to the terms and conditions of the Custom Development and Professional Services Exhibit." (That exhibit is not part of the SEC filing, so it's possible that the exhibit itself prescribes a form of work order.)

Electronic signatures for statements of work?

Some companies are reluctant to allow electronic signatures for statements of work — because of the wide variety of communications that might qualify as "signatures," for example, emails (see § 4.97.6) — and instead prefer to require "wet ink" signatures on paper.

4.95.2 (BL) Licenses and permits

One or more government licenses or permits might be required for a provider's activities in providing the services.

  • The required authorizations might be relatively straightforward, as in local building permits for building a house or office building.
  • On the other hand, in some circumstances — for example, building a nuclear reactor or an oil pipeline — the government-permitting process could be a decidedly non-trivial matter.

In addition, one or more intellectual-property licenses from third parties might be required for the customer to use any resulting deliverables.

Not getting the proper permits and licenses could have serious consequences. For example:

  • In California and possibly other jurisidctions, a contractor that undertakes work required to be done by a licensed contractor (e.g., certain construction- or remodeling work), but that does not itself have the proper license(s) at all times while performing the work, may forfeit its right to be paid for any of the work. See, e.g., Great West Contractors, Inc., v. WSS Industrial Construction, Inc., 162 Cal. App. 4th 581, 76 Cal. Rptr. 3d 8 (2d Dist. 2008) (reversing $220,000-plus judgment in favor of subcontractor, on grounds that subcontractor had not obtained the required license when it prepared initial shop drawings and did other preliminary work).
  • Under a 2002 'disgorgement' amendment to the California statute, such a contractor might have to repay any payments it did receive for the work. Cf. The Fifth Day, LLC v. Bolotin, 72 Cal. App. 4th 939 (2d Dist. 2009) (reversing summary judgment that party was barred from recovering compensation for services; party was not a "contractor" within the meaaning of the statute).
  • California courts have looked to Cal. Lab. Code § 2750.5 to hold that a contractor that uses an unlicensed subcontractor is responsible for unpaid wages, withholding, and worker’s compensation premiums of the subcontractor’s employees; see generally this Pillsbury Winthrop memo.

4.95.3 Permits, licenses, and inspections

Typical provider permit responsibilities

It's not uncommon for services agreements to state that the provider, at its own expense, will cause to be timely obtained:

  1. any professional- or occupational licenses required by law for the performance of services generally (e.g., contractor licenses) by the provider and/or its subcontractors (if any) to the extent necessary for performance of the services;
  2. any government permits (for example, building permits and the like) that are required by law for performance of the services;
  3. any third-party intellectual-property licenses required for the provider to take the specific actions involved in performing the services, including for example any licenses required for the provider's use of software, data compilations, and similar tools;
  4. any inspections required, e.g., by city building inspectors.

Obtaining government permits (see subdivision 2) could be a decidedly burdensome undertaking; for example, recall the signficant controversies associated with the permitting process for the Keystone XL pipeline to carry Canadian oil to refineries in Illinois and Texas.

Typical customer permit responsibilities

It's also not uncommon for services customers to be required to obtain any intellectual-property licenses or other authorizations that might be needed for the customer to use the deliverables.

The agreement might include a warranty by the provider that the deliverables per se do not infringe third-party IP rights. Under the Uniform Commercial Code, if the agreement is considered primarily for the sale of goods, with the services being incidental, then UCC § 2-312 might imply such a warranty:

(3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications.

Such an as-delivered warranty might not provide customer with much comfort about third-party infringement claims arising from the customer's use of the deliverables. A customer, of course, could ask the provider to warrant expressly that the customer's use of the deliverables will not infringe any third-party IP rights; that, though, would likely be the subject of negotiation (because non-infringement assurances concerning patents and design patents are not cheap and carry significant liability exposure).

Disagreement about permit- and license requirements?

It's been known to happen: A services provider tells a customer that a particular permit or license (or other third-party approval) is needed. But then the customer says nah, we don't need no stinkin' permit; get to work.

In that situation, the provider might want to:

  • have the right to suspend work; and/or
  • be able to require the customer to defend and indemnify the provider (and its affiliates, etc.) from any claim arising from the lack of the third-party approval. (Of course, anyone drafting or reviewing an indemnity obligation should consider whether the indemnifying party will have the necessary financial wherewithal, failing which an insurance policy might be appropriate.)
Danger: Starting licensed work without a license

In some jurisdictions, a contractor that undertakes work required to be done by a licensed contractor (e.g., certain construction- or remodeling work), but that doesn't itself have the proper license(s) at all times while performing the work, might forfeit its right to be paid for any of the work. See, e.g., Great West Contractors, Inc., v. WSS Industrial Construction, Inc., 162 Cal. App. 4th 581, 76 Cal. Rptr. 3d 8 (2d Dist. 2008) (reversing $220,000-plus judgment in favor of subcontractor, on grounds that subcontractor had not obtained the required license when it prepared initial shop drawings and did other preliminary work).

Moreover, under a 2002 'disgorgement' amendment to the California statute, such a contractor might have to repay any payments it did receive for the work. Cf. The Fifth Day, LLC v. Bolotin, 72 Cal. App. 4th 939 (2d Dist. 2009) (reversing summary judgment that party was barred from recovering compensation for services; party was not a "contractor" within the meaaning of the statute).

Danger: Using an unlicensed subcontractor

California courts have looked to Cal. Lab. Code § 2750.5 to hold that a contractor that uses an unlicensed subcontractor is responsible for unpaid wages, withholding, and worker’s compensation premiums of the subcontractor’s employees; see generally this Pillsbury Winthrop memo.

Indemnity obligation?

When drafting a permits-and-licenses obligation, consider whether to include an accompanying indemnity obligation. Suppose that:

  • Alice enters into a construction contract with Bob, under which Alice will build a strip-mall shopping center for Bob.
  • Bob has pre-leased space in the shopping center to a variety of tenants; each lease agreement sets forth a specific date for the tenant to move into the leased space.
  • The construction contract requires Alice to obtain the necessary building permits from the city, but she fails to do so, thus breaching the construction contract.
  • City inspectors see the un-permitted construction going on and issue a cease-and-desist order shutting down the job. This results in weeks of delay — and, as a ripple effect, in Bob's tenants' not being able to move in on their scheduled move-in dates.
  • Bob's tenants want Bob to reimburse them for their resulting damages.

Under standard contract law, Bob might well be able to recover any amounts for which he must reimburse his tenants because of Alice's breach. But if the construction contract included a consequential-damages disclaimer [LINK], then (i) Alice might claim that the disclaimer covered those reimbursement amounts, and (ii) therefore, Alice argues, she need not pay Bob those amounts.

And keep in mind that damages for breach of a contractual obligation would normally be limited to foreseeable damages, whereas an indemnity obligation might encompass even unforeseeable damages (unless otherwise specified in the indemnity language). [LINK: #IndemnVsBreach]

So, in our hypothetical case, it might have been better for the construction contract to have stated explicitly that Alice must indemnify Bob against any failure by Alice to obtain the necessary permits.

4.95.4 Performance standards

Workmanlike performance

A "standard standard" of services performance is workmanlike, or sometimes good and workmanlike, or perhaps even careful, skillful, and workmanlike (the latter two seem redundant). See generally Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 292-93 (Tenn. 2011) (extensively reviewing case law and treatises).

The Supreme Court of Texas has framed the meaning of workmanlike in pragmatic, market-based, but fact-intensive terms:

We have defined “good and workmanlike” as “that quality of work performed by one who has the knowledge, training, or experience necessary for the successful practice of a trade or occupation and performed in a manner generally considered proficient by those capable of judging such work.”

Ewing Constr. Co. v. Amerisure Ins. Co., 420 S.W.3d 30, 37 (Tex. 2014) (responding to certified question from Fifth Circuit), citing and quoting Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 354 (Tex. 1987) (discussing the implied warranty of good and workmanlike quality of services in connection with the repair of tangible goods).

The "without necessarily rising to the level of being exceptional, outstanding, or original" language is adapted from an alternate definition in the Merriam-Webster dictionary, namely "competent and skillful but not outstanding or original."

Implied warranties of workmanlike performance

Drafters should be aware that in some states the law might automatically impose a warranty of workmanlike performance, or something close to it. See, e.g., Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 291-94 (Tenn. 2011) (citing numerous authorities but not explicitly defining workmanlike).

Implied warranties of workmanlike performance come into play especially in connection with the sale of a new residence. The imposed warranty might even be non-waivable and/or non-disclaimable. For example:

  • Home construction: Forty-three states provide an implied warranty of habitability for new residences, according to the Utah supreme court, while three others provide a warranty of workmanlike manner. See generally Davencourt at Pilgrims Landing Homeowners Association v. Davencourt at Pilgrims Landing LC 30, 2009 Utah 65, 221 P.3d 234, 250 (reversing dismissal of implied-warranty claim; "in every contract for the sale of a new residence, a vendor in the business of building or selling such residences makes an implied warranty to the vendee that the residence is constructed in a workmanlike manner and fit for habitation").
  • Repairs of tangible goods or property: In its Melody Homes decision, cited above, the Texas supreme court held that an implied warranty of good and workmanlike performance extends to repairs of tangible goods or property. Two sharp dissents (in the form of concurrences in the judgment) noted that the court had defined that implied warranty in a manner that might well require expert testimony in many cases (but that would seem to be true of almost any standard of performance of services).

See also (Study:) Disclaiming implied warranties, § 4.89.4 and its associated commentary.

Alternatives to "workmanlike"

Some service providers might balk at using the term "workmanlike" performance because they fear the term could be ambiguous. They might prefer in accordance with the specifications, or perhaps competent and diligent.

Of course, any of those terms is likely to involve factual determinations in litigation or arbitration, so it's hard to see how one is more- or less favorable than the other.

On the other hand, some customers prefer stricter standards of performance such as, for example:

  • In a professional manner: This is found in many customer-oriented forms, but providers don't like it because of a concern that, in the minds of judges and juries, the term professional might subtly raise the bar of expected performance.
  • In accordance with industry standards: This phrase and workmanlike seem synonymous, in which case the latter term is more conventional and more likely to find acceptance among contract reviewers and the courts.
  • In accordance with the highest professional industry standards: For a provider, this is the worst of all worlds: Not only is the phrase vague, but a provider that agreed to this might as well have hung a "Kick Me" sign on its own back, because anything less than perfection would be open to cricitism in court. (On a related note, see also (Study:) Best efforts, § 4.25.)
Performance standards: Further reading

See generally, e.g.:

4.95.5 Who should do (or furnish) what, exactly?

Some services contracts state that the provider is to cause:

  1. the performance of all individual tasks necessary for the proper rendering of the services as set forth in the statement of work, even if one or more such individual tasks is not expressly set forth there; and
  2. the provision of all materials, equipment, supplies, computer hardware and -software, work locations, electrical power, Internet- and other communications capability, and other items that might be needed for the provider's performance of the services, with that obligation includes any necessary acquisition, installation, and maintenance of all such items.

Such requirements are arguably redundant, but they can be useful reminders; some customers are likely to want such language for comfort purposes.

A provider might be concerned that such language could lead to disputes about expensive (and delay-causing) "scope creep." It seems likely, though, that such language wouldn't do any significant harm. Here's why: Suppose the parties were to end up fighting about the scope of what the provider is supposed to do. In that case, the presence or absence of this language seems unlikely to make a difference one way or the other. So, if this language gives a customer some comfort, why not include it; doing so can help to remove a potential delay on the path to signature.

Another issue that for some projects, it might make sense for the customer, not the provider, to furnish some of the listed items. If so, that can be documented in the statement of work on an exception basis.

4.95.6 HSSE: Health, safety, security, and environment

Many services contracts include detailed written compliance requirements concerning health, safety, security, and environment (“HSSE”) issues. Providers typically take these requirements into account in pricing their work.

4.95.7 Provider's control of means and manner

Many services contracts state that, as between the provider and the customer, the provider will at all times have the exclusive right and the exclusive obligation to control 1) the means and manner, and 2) except as otherwise specified in the statement of work, the time and place, of the performance of the services. A customer is likely to want such language to help establish that that the provider is truly an independent contractor, and thus that the provider's employees are not considered employees of the customer. [LINK: #IndepContractor].

4.95.8 Defects in services or deliverables

A services contract will typically obligate the provider to fix problems with the services and/or the deliverables as delivered in accordance with a specified procedure or protocol; one common protocol can be summed up as "repair, replace, or refund" (see [LINK]).

Specifying that the provider's obligation applies to deliverables as delivered takes into account the possibility that the customer might modify a deliverable after delivery. If that were to be the case, then the provider likely wouldn't want to have to fix defects for free, or at least not if the defect were not the provider's doing.

4.95.9 Reports of bodily harm or significant property damage

A services agreement might require the provider to promptly report to the customer any bodily harm or significant property damage that occurs in connection with the services, so that the customer will be aware of the incident — and possibly report the incident to the customer's insurance carrier and/or to government authorities. See [LINK: reporting] for further discussion.

4.95.10 Billing for services

Services agreements typically require billing by the provider to be 1) as specified in the statement of work, e.g., with progress payments; and 2) accompanied by supporting detail sufficient to document the invoiced charges.

A customer might want a service provider to issue interim invoices as specified milestones are completed, or perhaps at specified time intervals.

A customer also is likely to want an audit provision (see § 4.20) if the service provider will be billing on anything other than a flat-fee, all-inclusive fee.

4.95.11 Customer's rights in deliverables

Express right to utilize?

When a customer pays a service provider to create a deliverable, the customer might assume that it (the customer) is free to do whatever it wants with the deliverables. That will not always be the case: if the provider owns intellectual-property rights in the deliverable, the customer might be limited in what it can do with the deliverable.

For that reason, a master services agreement might state explicitly that the customer may utilize any deliverable in any way that the customer sees fit, except to the extent that the agreement or the relevant statement of work expressly states otherwise.

Restricted service-bureau use?

A provider of computer software might want to consider restricting the customer's use of the software to provide services for others, because otherwise the customer might in effect use the provider's own software to compete with the provider. (The provider, though, should ask itself 1) how likely is it that this might happen, and 2) whether the associated business risk is worth arguing about it with the customer.)

As when drafting any restriction or prohibition, the drafter should consider whether also to prohibit the restricted party from "knowingly assisting or permitting" others to engage in the restricted activity. [LINK]

Customer's further development of deliverables

A customer negotiating a service contract might want the contract expressly to state that the customer has the unfettered right: 1) to modify or further develop one or more deliverables furnished by the provider, and/or 2) to have other contractors do such modification or further development. do so for the customer. The general attitude of customers on this point can be summed up as: We paid for you to build this, so we should be able to do whatever we want with it.

A customer's right to modify a deliverable is not always a given, though. Under standard intellectual-property law, just because a customer paid for a deliverable does not mean it necessarily gets to do whatever it wants with the deliverable. In particular, if the deliverable is a copyrighted work of authorship such as computer software, the provider might have the right to prevent the customer from modifying or inproving the deliverable without the provider's permission.

(In litigation the customer might be able to argue successfully that the provider implicitly granted the customer a license to do whatever it wanted with the deliverable; see, e.g., TO DO: CITATION TO SOFTWARE DEV. CASES NEEDED.)

If a provider will be creating something that the customer will be using in its business, the customer might well want to nail down its right to modify or further develop the deliverable.

Some software-related deliverables, though, might include trade secrets of the provider. In that type of situation, the provider likely won't want any of its competitors to have access to the deliverables. In such a case, the provider might want the agreement to prohibit the customer from modifying or further developing the deliverable in violation of the provider's intellectual-property rights.

The provider might also want 1) a written assurance that the customer's modification or further development will comply with any applicable law, and perhaps 2) an indemnity obligation burdening the customer as a Plan B.

The provider might also want to explicitly state that the provider need not provide technical support for deliverables modified by others.

Timely payment as prerequisite of customer's rights

A services provider, concerned about the possibility of not getting paid, might seek to include a contract provision that the customer's rights in the deliverables are dependent on the customer's timely payment of amounts required by the statement of work.

A customer likely would object to such a provision; the customer would assert that a minor payment dispute should not call into question the customer's right to use the deliverable(s), possibly even disrupting an M&A transaction.

A provider, on the other hand, will legitimately be concerned that the customer might file for bankruptcy protection, meaning that the customer would continue to enjoy its rights in the deliverable(s) while paying the provider pennies on the dollar if anything.

In the U.S., as a compromise the provider might want:

  • to take a security interest in the customer's right to use the deliverable(s), using a clause provision such as [TO BE DRAFTED]; and
  • to "perfect" the security interest by filing a UCC-1 financing statement.

4.95.12 Who owns services-created intellectual property?

A project undertaken under a services agreement will often result in the creation of one or more forms of intellectual property. This is especially true of software-development agreements, but also when an outside consultant is hired to create an illustration, to draft marketing materials, and the like. So who should own that intellectual property?

When the customer insists on owning the IP rights

It's not unusual for a big customer with barganing power to insist on owning the IP rights in any intellectual property that a smaller provider might create in the course of a services project. Such a customer's attitude is usually along the lines of, "if I pay for it, I own it."

Often, though, a customer's insistence on IP ownership simply won't make business sense:

  • The customer might not have any real use for the IP rights and might have no reason to insist on ownership, other than sheer willfulness;
  • The provider's cost structure and pricing probably depend on its ability to re-use its prior work product on current- and future projects; and
  • The customer's ownership of the IP rights could choke the provider's ability to compete in its own market, and might deprive the provider from the necessary standing to sue for infringement of the IP rights.
Compromise: Allocating the ownership of specific items

One possible compromise to the IP-ownership dispute might be as follows:

  1. The customer would own the intellectual-property rights to the specific deliverables identified in the statement of work.
  2. The provider would continue to own its rights in any preexisting work.
  3. The provider would also own the rights in any "toolkit items" that might be developed in the course of the project, namely any inventions, concepts, procedures, materials, tools, ideas, etc., that were not specific, and/or were not unique, to the customer and its business.
  4. The customer would have a permanent, irrevocable, worldwide, royalty-free, "background rights" license, under the provider's IP rights, to use the deliverables, subject to any limitations stated in the statement of work.
  5. The provider would not have any right to use the customer's confidential information except for purposes of the project.
Third-party IP rights

Services customers should keep in mind that their legal right to utilize deliverables might be subject to the IP rights of third parties. That can be the subject of one or more representations and/or warranties from the provider. [LINK]

4.95.13 Can services be suspended?

It's not uncommon for service providers and customers to get into disputes. A typical vignette might be the following:

  • The customer finds fault with the service and refuses to pay an invoice.
  • The provider asserts that its services were just fine, thank you, and stops work because of the nonpayment.

So then what? In the contract, the customer might want to restrict or even eliminate the provider's ability to suspend work; on the other hand, the provider might want to expressly preserve that right in the event of nonpayment. See, e.g., U.W. Marx, Inc. v. Koko Contracting, Inc., 124 AD 3d 1121 (N.Y. App. 2015): In that case, the contract in suit was based on an American Institute of Architects agreement form, which expressly gave the contractor the right to suspend work for nonpayment, but only after notice.

(Drafters should consider providing for an independent expert to determine whether the work was in fact up to par and thus whether the customer's withholding of payment was or was not warranted.)

4.95.14 Termination or expiration of statement of work

A statement of work for services might expire by its terms. For example, the term of an outsourcing agreement will come to an end and one or both parties doesn't want to extend the term.

Or, one party or another might want to "pull the plug" early on the statement of work. For example, the customer might want to fire the provider, or vice versa.

The customer's post-termination wish list

In any of these situations, the customer will generally want the option to keep the project going on its own or to transfer it to another provider. The customer will thus want the provider to turn over:

  • undelivered deliverables;
  • work in progress, in whatever stage of completion the work happens to be;
  • relevant data maintained by the provider, in a usable form; this would be especially important in, say, an outsourcing agreement;
  • materials, tools, equipment, etc., that the provider acquired for the project (the cost of which was presumably priced into the contract price).

To the same end, the customer likely will also want the provider:

  • to assign any relevant software licenses or other third-party contracts — this presupposes that those agreements are in fact assignable;
  • ideally, to allow the customer or a replacement contractor to continue using the provider's proprietary technology, if applicable; and
  • to make the provider's personnel available to the customer or a replacement contractor.

See generally Blaine Green and Michael Murphy, Lessons from Litigating Technology Services Agreements (PillsburyLaw.com 2014).

The provider's post-termination wish list

Upon a termination or expiration of a services agreement or statement of work, the provider's first priority will probably be to get paid. That might be an awkward discussion if the customer claims that the provider failed to meet its obligations.

4.96 (Read:) Side-letter agreements

Key takeaway: Signing a side letter agreement, and then concealing the side letter from the company's accountants, can lead to a prison sentence for securities fraud.

In this context, a "side letter" is, in essence a secret annex to a sales contract, allowing the buyer to cancel the transaction. That means the deal is a sham, because the seller does not have a binding contract and cannot enforce a right to payment. If the seller reports the revenue as part of its periodic financial reporting, it likely will constitute securities fraud, and both the vendor and the customer can get in serious trouble for it. Here are some examples from the news:

  • The former CEO of McKesson Corporation was sentenced to ten years in prison for concealing side letters, as well as for backdating contracts (SFGate.com: https://goo.gl/vcy4eM).
  • A Kansas City bank president was convicted of bank fraud for signing a side letter in connection with a questionable loan to a real-estate developer, but then concealing the side letter from bank examiners. See Feingold v. United States, 49 F.3d 437 (8th Cir. 1995) (affirming conviction).
  • In one case, the SEC didn't just go after a vendor that used a secret side letter, it also filed a civil lawsuit against an executive of a customer that made a sham $7 million purchase. According to the SEC's complaint, the customer executive not only knew that the vendor planned to fraudulently misstate its financial results, he even advised the vendor's sales people how to conceal the cancellation right from the vendor's finance department (SEC.gov: https://goo.gl/8sfMWL).

For additional information, see What to Do When You Find the Side Letter… (BorisFeldman.com 2001), at https://goo.gl/ehJbzm, archived at https://perma.cc/NG3H-R7UW.

And see also Don't backdate a contract for deceptive purposes, § 4.97.8.

4.97 (Study:) Signature blocks

4.97.1 Overview

"AGREED:"

It's helpful to start out a signature block with the word "AGREED:" in all-caps and followed by a colon, as shown in the examples below, thusly:

AGREED: BUYER
Betty’s Used Computers, LLC, by:


Betty Boop, Manager


Date signed

Use a concluding paragraph? (No.)

The author prefers not to use an entire concluding paragraph such as the following:

To evidence the parties' agreement to this Agreement, each party has executed and delivered it on the date indicated under that party's signature.

First, that kind of concluding paragraph is overkill. There are other ways of proving up that The Other Side in fact delivered a signed contract to you … for starters, the copy in your possession that bears The Other Side's signature.

Second, at the instant of signature, a past-tense statement that each party “has delivered” the signed contract is technically inaccurate — even more so at the moment when the first signer affixes his (or her) signature.

Blank space for date signed

Look again at the signature block above for Betty's Used Computers, LLC. It's a good idea to include, as part of each signature block, a blank space in which the signer can hand-write the date signed. The last date signed is often used to establish the effective date of the contract, and for certain sales contracts the date the agreement is completed might be necessary to establish when the seller can recognize revenue.

[TODO]

Signature blocks for organizations

Look again at the signature block above for Betty's Used Computers, LLC. In addition to AGREED and a date-signed blank space, an organization's signature block should include:

  • the organization's name (or its abbreviation, e.g., "Seller," if an abbreviation has been defined);
  • the word "by," followed by a colon; and
  • the signer's title, to establish that the signer has at least apparent authority. If the employee's title includes the word "president," "vice president," "manager," or "director," that might well be enough for apparent authority. Consider also including a representation by the signer that s/he has such authority.

If you don't know the name of the individual who will be signing:

AGREED: BUYER
Betty’s Used Computers, LLC, by:


Signature


Printed Name


Date signed

Using a suitably-worded power of attorney, the signing organization could designate an individual or organization as its attorney-in-fact to sign the contract on its behalf. (NOTE: Whoever signs the power of attorney should be – and possibly might have to be — someone who could sign the contract itself.)

AGREED: BUYER
Betty's Used Computers, LLC, by:


Jimmy John,
Attorney-in-fact


Date signed

Caution: A party's counsel normally won't want to sign a contract on behalf of his or her client, as discussed in section Counsel normally won't want to sign contracts

Special case: Signature block for an LLC

Look again at the signature block above for Betty's Used Computers, LLC. When a signatory party is a limited-liability company ("LLC"), check whether the LLC is member-managed or manager-managed. In the latter case, a "mere" member, acting in that capacity, might not have authority to sign on behalf of the LLC.

Special case: Signature block for a limited partnership

In many U.S. jurisdictions, a limited partnership might be able to act only through a general partner, in which case a signature block for the limited partnership might need to include the general partner's name. And the general partner of a limited partnership might very well be a corporation or LLC; in that case, the signature block would be something like the following:

 AGREED: ABC LP, by:
 ABC LLC, a Texas corporation, 
 general partner, by:

__________________________
 Ron Roe, Manager

__________________________
 Date signed

On the other hand, in some jurisdictions, a limited partnership might be able to act through its own officers; for example, Delaware's limited-partnership statute gives general partners the power "to delegate to agents, officers and employees of the general partner or the limited partnership …." Del. Code § 17-403(c) (emphasis added). In such cases, the signature block of a limited partnership might look like the signature block of a corporation or LLC, above (link).

CAUTION: A limited partner that, acting in that capacity, signed a contract on behalf of the limited partnership could be exposing itself to claims that it should be held jointly and severally liable as a general partner. (Of course, some general partners also hold limited-partnership interests and thus are limited partners in addition to being general partners.)

Signature blocks for individuals

If an individual is a party to the contract, the signature block can be just the individual's name under an underscored blank space:

Example:

 AGREED:

__________________________
 Jane Doe

__________________________
 Date signed

But you might not know the signer's name in advance, in which case you could use the following format:

 AGREED:

__________________________
 Signature

__________________________
 Printed name

__________________________
 Date signed

Keeping signature blocks on the same page

I like to keep all of the text of a signature block together on the same page (which might or might have other text on it). That looks more professional, in my view, than having a signature block spill over from one page onto the next. This can be done using Microsoft Word's paragraph formatting option, “Keep with Next."

Separate signature pages

Sometimes drafters put signatures on a separate page to make it easier to FAX just the signed signature pages back and forth (see the next section). That can give rise to a couple of problems, but those can be addressed with some advance planning.

Include a running header with version date: If signatures are on a separate page, then someday The Other Side might claim that it signed a different version of the contract than the one you claim it signed. One way to try to forestall such a claim would be to include, at the top of every page of every draft, a running header with a version date and time, such as that shown at the top right of this page. (Don't use Microsoft Word's automatic date fields – you don't want the date field automatically updating itself every time the document is printed.)

Include a "Page X of Y" running footer: Microsoft Word's PAGE and NUMPAGES fields can be used to create a running footer that automatically says, for example, "Page 5 of 11."

Eliminate blank space on the penultimate page: If you leave significant blank space on the last page before the signature page (the "Penultimate Page"), then a fraudster might be tempted to fill that blank space with additional provisions and then claim that the added provisions were part of the signed contract. One way to guard against that is to include — on a separate line just after the final text on the Penultimate Page — a parenthetical note such as, "(Signature page follows)" or "(Remainder of page intentionally left blank)" to signal that any additional text was not agreed to.

4.97.2 Signature mechanics

Pro tip: Be sure a corporate title is in your client's signature block

If your client is a company, some individual human, typically an officer or manager of the company, will be signing on behalf of the client. In that situation, the client's signature block in the contract should normally state that it's the company, not the individual human in his or her personal capacity, that is signing the document. [LINK]

If your client is the company and not the human signer, then technically you're under no professional obligation to make sure that the human signer is protected from personal liability. But it's normally not a conflict of interest for you to simultaneously look out for the human signer as well as for the company.

(Reminder: As a lawyer, you might find yourself dealing with an employee of a client company in a situation where the interests of the employee and the company diverge or even conflict. One example might be an investigation of possible criminal conduct such as fraudulent backdating of a contract signature (see § 4.97.8). In circumstances such as those, you'll want to consider whether you should affirmatively advise the employee, preferably in writing, that you're not his or her lawyer; conceivably you might even have an ethical obligation to do so.)

How it's done (usually)

At least in the U.S., a contract between two parties (Alice and Bob) will typically be signed and delivered in one of several different ways:

  1. Old school (1): Alice and Bob meet to sign the contract; think of the treaty-signing ceremonies that you've probably seen on TV. Alice signs multiple physical copies of the contract; Bob likewise signs the same physical copies. Alice and Bob each keep (at least) one fully-signed "original."
  2. Old school (2): Alice, sitting in her office (or wherever), signs two hard copies of the contract and mails them to Bob. Bob countersigns the hard copies, keeps one of them, and mails the other fully-signed hard copy back to Alice for her files.
  3. Exchanging signed counterparts: Alice signs two hard copies ("counterparts") of the complete contract and sends just one of the signed hard copies to Bob. Bob does exactly the same thing. So, each party ends up with two, signed, hard copies of the contract, but each hard copy has been signed by just one of the parties.
  4. Delivering signed signature pages only: In the era of electronic communication, the following is increasingly common: The final contract draft is agreed to, typically going back and forth by email and phone. Alice, in her office, signs a hard copy of the final agreed draft; Bob, in his office, does likewise. Each party scans his or her signed signature page to a PDF file, then emails the PDF to the other party as an attachment.
  5. Round-robin signing of the signature page only: A variation on #4 is: Alice emails Bob a PDF of her signed signature page. Bob prints out Alice's signed signature page; countersigns it himself; scans the fully-signed signature page; and emails it back to Alice.
Counsel normally won't want to sign contracts

A lawyer for a party entering into a contract normally won't want to be the one to sign the contract on behalf of her client, because:

  • Doing so could raise questions whether, in the negotiations leading up to the contract, the lawyer was acting as a lawyer or as a business person. This could be an important distinction: in the latter case, the lawyer's communications with her client might not be protected by the attorney-client privilege and thus might be subject to discovery by third parties.
  • If the lawyer's signature is on the contract, the lawyer is almost certain to be deposed in the event of a lawsuit or arbitration about the contract. This might lead to disqualification not only of the lawyer herself but also of her entire firm — and her litigation partners would not be happy about that.
  • From a client-relations perspective: If the contract later "goes south," the lawyer won't want her client's business people pointing the finger at her for having made (what in hindsight they claim was) a bad business decision.
Pro tip: Hang on to fully-signed originals

A party that wants to rely on a contract, but can't produce a copy signed by the other side, might not be completely out of luck, but it definitely will have more burden and expense at trial.

For example: In a 2014 New Hampshire case, a husband was sued for divorce by his wife of 22 years. He moved to enforce a pre-nuptial agreement.

Unfortunately for the husband, the only copy he had was not signed by his wife. The wife claimed that she didn't recall signing the agreement, that she hever possessed a signed original, and even if she did sign it, she did so under duress.

The husband had to take his case had to go all the way to the state supreme court. That court held that the husband was entitled to introduce secondary evidence to try to persuade the fact-finder that the pre-nup existed. In re Serodio & Perkins, No. 2013-199, slip op. at 5-6 (N.H. Aug. 22, 2014) (citation omitted).

The husband would have had much smoother sailing if he had just made sure to keep a fully-signed copy of the pre-nup.

4.97.3 Will an unsigned contract be enforceable anyway?

Signatures might be necessary

In C.G. Schmidt, Inc. v. Permasteelisa North America, a general contractor (CGS) selected the bid of a potential subcontractor (PNA) to provide a glass curtainwall for a building project. PNA's bid was submitted on the bid form specified by CGS, which stated in part that "[i]n submitting and signing this bid form, Bidder agrees with all terms and conditions of the standard [CGS] agreement forms." But the subcontractor repeatedly stated that it needed to review the final prime contract before it would sign the actual subcontract. Moreover, CGS's bidder's manual "contemplated that the parties would eventually sign a formal subcontract," and additionally, "CGS's policy was to require written agreements for all subcontracts …." C.G. Schmidt, Inc. v. Permasteelisa North America, 825 F.3d 801, 803 (7th Cir. 2016) (affirming summary judgment in favor of subcontractor)

And, as the Seventh Circuit noted:

In addition, CGS and PNA did not execute a subcontract because they had not settled on the terms of the subcontract agreement. Over the next year, CGS and PNA engaged in a “value engineering process” during which they refined the price and other terms of the subcontract as they worked towards a final, signed agreement. PNA regularly updated the proposed contract price and communicated these updates to CGS. And on multiple occasions, PNA raised concerns with some of the terms of the subcontract. At no point during the negotiation process did CGS express to PNA that, in CGS’s view, there was already an existing agreement in place.

Id. The general contractor and prospective subcontractor never did enter into a formal subcontract agreement, and the prospective subcontractor eventually withdrew. The prime contractor therefore had to find another subcontractor to provide the curtainwall, at greater expense; the prime contractor sued the subcontractor for the difference, asserting that the subcontractor's bid acceptance had created a binding contract and that the parties had been negotiating changes to that contract. Both the district court and the Seventh Circuit disagreed; in affirming summary judgment in favor of the subcontractor, the appeals court said:

Before negotiations began, PNA made clear that it intended to be bound only after reviewing the prime contract and executing a formal subcontract with agreed upon language. PNA manifested a belief that it was not bound throughout negotiations, and CGS never corrected this understanding nor expressed a contrary belief.

The course of negotiations and slow build up to an integrated subcontract confirm that the parties had not yet entered into a binding agreement[.] * * * 

To put this point another way, CGS never accepted PNA’s bid. Quite the opposite, CGS deliberately refrained from accepting while it reached the necessary agreements with the project owner and continued to negotiate the price and terms of the subcontract with PNA.

Id. at 806 (footnote omitted).

(The district court also rejected the prime contractor's promissory-estoppel claim. See id. at 807-09.)

But: A party might be bound by its unsigned contract draft

Suppose that:

  • Alice sends Bob a draft of a contract so that Bob's attorney can review the draft.
  • Bob signs the draft, without modifying it, and returns it to Alice.
  • The parties perform their obligations under the contract.
  • Later, in litigation, the parties are unable to find any copy of the contract that was signed by Alice.

Under classic offer-and-acceptance doctrine, Alice might very well be bound to the terms of her contract draft anyway, even if she never did sign the contract. Consider this real-world example:

  • A party to a lawsuit drafted a settlement agreement and sent it to the other party.
    • The other party signed the draft agreement as-is and returned it.
    • In a later, unrelated lawsuit, the parties could not find any copy of the settlement agreement that had been signed by the drafting party itself.
    • The parties, though, had complied with the terms of the settlement agreement.
    • In the later, unrelated lawsuit, a court held that the settlement agreement was binding on the drafting party — even though the drafting party itself had not signed that agreement — and so the drafting party's unrelated claims against the other party were barred by the sweeping release language in the settlement agreement.

See Baker Hughes Inc. v. S&S Chemical, LLC, 836 F.3d 554, 561-62 (6th Cir. 2016). The result might have been different if the draft contract itself had expressly stated that Alice's offer in the draft was conditioned on both parties' signing the document. See id. at 562.

Unsignature

There are three kinds of situations where an unsigned contract might be enforced:

  1. The statute of frauds doesn't apply;
  2. A contract isn't the only way to become bound by legal duties (Enterprise Producs)
  3. The parties "agreed" via some other written communication(s).

The following types of non-"contract" written communication might bind the paries to an unsigned contract:

  1. Email
  2. Text message
  3. IM / Slack / other chat
  4. Social media
  5. Inadvertently-binding LOI.

In every organizational signature block, the signature line for the individual signer (the person signing on behalf of the organization) should include the organizational __ of the individual.

Every organizational signature block should include the name of the organization followed by (1) the word "_," (2) a colon, and (3) a signature line for the individual signer.

4.97.4 Signature authority

Be sure the other side's signer has authority to agree

A contract signed by an individual who doesn't have authority to commit his principal might be worthless. EXAMPLE: Liberty Ammunition, Inc. v. United States, No. 2015-5061 (Fed. Cir. Aug. 26, 2016):

  • Liberty Ammunition signed several nondisclosure agreements (NDAs) with the U.S. Government.
  • Under the applicable regulations, the specific individuals who signed those NDAs on behalf of the government did not have authority to bind the government.

The court held that the government was not bound by some of the NDAs, and thus was not liable for breach for its disclosure and use of the purportedly-secret technology, because (i) the lower court did not err in finding that the Army officer who signed the NDAs on behalf of the government did not have actual authority to do so, and (ii) Liberty Ammunition did not contend that the Army officer had apparent authority. See id. at part II, slip op. at 21-23.

Rules of thumb for signature authority

The person signing a contract for The Other Side should have a title that leaves no doubt that she has authority to make binding commitments on behalf of her company. If there's going to be a problem on that score, far better to find out now, instead of when The Other Side tries to get out of its contractual obligations. Here are a few rules of thumb:

  • The president of a company almost certainly has authority to commit the company to a contract.
  • A vice president, "director" (not the same as a member of the board of directors, discussed below), or "manager" is very likely to have authority to commit the company in matters within their stated domains, but that might not be the case if they go outside their areas. For example, the director of marketing communications might not have authority to sign a big sales contract.
  • Any other job title or purported authority should be scrutinized carefully. (Some companies seem to delight in strange titles; for example, Jerry Yang, co-founder and former CEO of Yahoo, was once called the company's "Chief Yahoo.")
  • For corporations, a member of the board of directors might, but often will not, have authority to commit the company, at least not without a special authorization by the board.
The gold standard: A secretary's certificate of a board resolution

The gold standard of corporate signature authority is probably a certificate, signed by the secretary of the corporation, that the corporation's board of directors has granted the signature authority. You've probably seen paperwork that includes such a certificate if you've ever opened a corporate bank account. The language, which is invariably drafted by the bank's lawyers, normally says something to the effect that the company is authorized to open a bank account with the bank in question and to sign the necessary paperwork, along with many other things the bank wants to have carved in stone. See this example.

Asking for written representation of signature authority can help to smoke out problems

Suppose that an individual is designated to sign a contract on behalf of a party, but the individual balks at including this clause in the contract. That might be a sign that the other party should investigate whether the individual in fact has authority to sign on behalf of his or her party. [TODO: Link to Common Draft]

Apparent authority

A person with "apparent authority" can bind a company to a contract, unless the other side has reason to know otherwise. So the question is: Would "a reasonable person" think the signer for The Other Side had authority to commit that company to the contract? For more information, see the Wikipedia entry on apparent authority.

Limitations on signature authority

Even if a signer were to make a written representation that s/he had signature authority, the other side might not be able to rely on it. That happened in a Utah case:

  • One Sorpold, who was one of the two managers of a limited liability company (LLC), signed an agreement granting, to a tenant, a 99-year lease on a recreational-vehicle pad and lot.
  • But there was a problem: The LLC's publicly-filed articles of organization stated that neither of the two company's managers had authority to act on behalf of the LLC without the other manager's approval.
  • Therefore, said the court, the tenant was on notice of manager Sorpold's lack of authority to grant the lease on just Sorpold's own signature. (The court remanded the case for trial as to whether the LLC subsequently ratified the lease agreement.)

See Zions Gate RV Resort, LLC v. Oliphant, 2014 Ut. App. 98, 326 P.3d 118, 122-23 (2014).

Apparent authority to sign

Normally, a company officer will have at least apparent authority to commit the company, especially if the officer's title indicates he or she is responsible for a relevant area of the company's business. See, for example, Digital Ally, Inc., v. Z3 Tech., LLC, 754 F.3d 802, 812-14 (10th Cir. 2014). In that case:

  • Digital Ally signed a contract with Z3, under which Z3 would design and manufacture circuit-board modules, which Digital Ally would then incorporate in its own products.
  • The contract was actually signed by one Robert Haler, whose title at Digital Ally was executive vice president of engineering and production.
  • Things did not go entirely as planned, and a lawsuit ensued.
  • Digital Ally claimed that it was not bound by the contract because, under the company's internal signature-authority policies, Haler did not have authority to sign a contract of that type.

Digital Ally's argument didn't fly: the district court granted, and the appeals court affirmed, partial summary judgment that Haler did have at least apparent authority to sign the contract.

4.97.5 Electronic delivery of signed documents

Electronic transmission: Background

In modern practice it's quite common for parties to sign a contract by simply FAXing signed signature pages to each other, or scanning the signed signature pages to PDF files and emailing them to each other. (Often the parties won't even bother to circulate hard copies for joint signature.) This language expressly authorizes that practice.

Pro tip for electronic transmission: Use a running header in the document

One way to make it clear that the signed signature page is from the final version of this Agreement or other document is to include a unique identifying code in the running header on each page of each draft. I've long used the following format for such a running header: "Draft 2014-10-08 09:20 CDT" (with the date and time inserted manually, not automatically).

Pro tip for electronic transmission: Circulate a "master" PDF with all signatures

After a contract is signed, consider:

  • adding all signed pages to a PDF file of the entire Agreement;
  • emailing the PDF file to all parties (or their counsel); and
  • in the body of the email, explaining what you've done.

That will leave an email "paper trail" (so to speak) in the files of all concerned; that in turn should reduce the risk of a future dispute about which version the parties thought they were signing.

4.97.6 "Signing" electronically

Electronic signatures can create enforceable contracts

In the U.S., the federal Electronic Signatures in Global and National Commerce Act (E-SIGN Act), 15 USC § 7001 et seq., provides in part (subject to certain stated exceptions) that, for transactions "in or affecting interstate or foreign commerce," electronic contracts and electronic signatures may not be denied legal effect solely because they are in electronic form.

At the U.S. state level, 47 states, the District of Columbia, and Puerto Rico, and the U.S. Virgin Islands have adopted the Uniform Electronic Transactions Act (UETA).

(The remaining three states — Illinois, New York, and Washington — have adopted their own statutes validating electronic signatures.)

The Texas version of the UETA, at Tex. Bus. & Comm. Code § 322.001 et seq., provides in part that, when the parties have agreed to conduct transactions by electronic means — which is something determined from the context and surrounding circumstances, including the parties' conduct (§ 322.005) —

  • A document or signature may not be denied legal effect or enforceability solely because it is in electronic form (§ 322.007);
  • an electronic "record" suffices as a writing (§ 322.007); and
  • evidence of a record or signature may not be excluded solely because it is in electronic form (§ 322.013)

Courts now routinely honor electronic "signatures; see, e.g., Naldi v. Grundberg, 80 A.D.3d 1, 908 N.Y.S.2d 639 (N.Y. App. Div. 2010): the appellate court rejected the defendant-appellant's contention that a right of first refusal could not properly be granted by email; the court said that "an e-mail will satisfy the statute of frauds so long as its contents and subscription meet all requirements of the governing statute." Id., 80 A.D.3d at 3. In the slip opinion, see the transitional paragraph at pp. 6-7 through the transitional paragraph at pp. 10-11.

Pro tip: Be able to prove up electronic signatures

In Ruiz v. Moss Bros. Auto Group, Inc., 181 Cal. Rptr.3d 781, 232 Cal. App.4th 836, 844-45 (Cal. App. 2014), a California appeals court affirmed denial of an employer's petition to compel arbitration of a wage-and-hour claim by one of its employees. The arbitration agreement had an electronic signature, but according to the court, the employer had not sufficiently proved that the purported electronic signature on the arbitration agreement was in fact that of the employee. The court seems to have given guidance about what would suffice to prove up an electronic signature:

[The employer's business manager] Main never explained how Ruiz’s printed electronic signature, or the date and time printed next to the signature, came to be placed on the 2011 agreement.

More specifically, Main did not explain how she ascertained that the electronic signature on the 2011 agreement was “the act of” Ruiz. This left a critical gap in the evidence supporting the petition.

Indeed, Main did not explain[:]

  • that an electronic signature in the name of “Ernesto Zamora Ruiz” could only have been placed on the 2011 agreement (i.e., on the Employee Acknowledgement form) by a person using Ruiz’s “unique login ID and password”;
  • that the date and time printed next to the electronic signature indicated the date and time the electronic signature was made;
  • that all Moss Bros. employees were required to use their unique login ID and password when they logged into the HR system and signed electronic forms and agreements;
  • and the electronic signature on the 2011 agreement was, therefore, apparently made by Ruiz on September 21, 2011, at 11:47 a.m.

Rather than offer this or any other explanation of how she inferred the electronic signature on the 2011 agreement was the act of Ruiz, Main only offered her unsupported assertion that Ruiz was the person who electronically signed the 2011 agreement.

Id., slip op. at 11, 12 (extra paragraphing and bullets added, citation omitted).

An electronic signature won't always work

In SN4, LLC v. Anchor Bank, FSB, 848 N.W.2d 559 (Minn. App. 2014), two related companies wanted to buy an apartment building from the bank that had acquired title through foreclosure. The resulting email exchanges made it clear that the parties contemplated hand-signed, "wet ink" signatures on the purchase contract. The bank never hand-signed any contract draft, and ultimately decided not to sell to the buyers. The buyers sued the bank, claiming that the email exchanges themselves amounted to binding contracts. The court disagreed and granted summary judgment for the bank. Citing the Minnesota version of the UETA, an appeals court affirmed, holding:

Here, there was no express agreement between the buyers and the bank to electronically subscribe to the purported agreement. Moreover, their conduct does not evidence an implied agreement to do so.

The buyers hand-signed the initial version of the purchase agreement that was first sent to the bank on July 13. The buyers also hand-signed the purported final agreement.

Berg [the bank's attorney] and Puklich [the buyers' attorney] both stated a