The Tango Terms: A Contracts Manual

Standard operating protocols for everyday business dealings, explained; with citations to laws, court cases, and contracts. Version 2020-E; rev. Sep. 16, 2020

Offered "AS IS"; not a substitute for legal advice.
A work in progress; see the Disclaimer.

Preface

This manual aspires to help law students, lawyers, and business people to do two things:

  • get readable, workable contracts to signature sooner; and
  • gain insight into how companies get everyday business done together.

This manual consists of:

  • targeted "takeaway" readings about contract drafting in general (Chapters 1 through XX), useful for law- and business-school courses; and
  • a set of annotated contract protocols, definitions, and other clauses (Chapters YY through ZZ), with links to the corresponding discussions in the takeaway chapters.

For students: Simulation facts: For teaching purposes, this manual is organized in part around representing a hypothetical company that wants to do business with a larger company.

  1. Your (i.e., students') client will be "MathWhiz LLC" in Houston.
  2. MathWhiz is headed by Mary Marshall, an expert in analyzing seismic data to predict where oil or natural gas deposits might be.
  3. Mary "came up" in the industry working for major oil companies, then started her own company, MathWhiz.
  4. MathWhiz's business has grown; it now employs several junior analysts, and also selectively subcontracts work to others (usually, longtime friends or colleagues of Mary's) to carry out specialized tasks.
  5. The other party is "Gigunda Energy," a (hypothetical) global oil-and-gas company that's headquartered in California but has a significant campus in Houston:
  6. Gigunda Energy expects to collect seismic data, over a period of about a year, from a potential oil field in Outer Mongolia.
  7. As an initial engagement, Gigunda wants to hire Math-Whiz to analyze the seismic data that Gigunda expects to collect.
  8. Gigunda and Math-Whiz have discussed the likely amount of work that will be involved for this initial project.
  9. The parties have agreed that Gigunda will pay Math-Whiz a flat monthly fee of $20K for up to 200 staff hours of work per month.
  10. Additional work is to be billed at $150 per hour.
  11. A partner in your law firm has asked you to prepare a draft contract and to help MathWhiz and Gigunda negotiate it.

Dedication

To the insightful, ever-patient, and (she says) long-suffering
Maretta Comfort Toedt,
and to Tina Stark, mentor and friend

1 Show me the money: Payments

1.1 Invoicing: Background

A paying party will almost invariably want to receive an invoice before paying an amount alleged to be due. (Paying parties might even be legally required to do so as part of their internal financial controls to help detect and prevent fraud.)

And a payee will want to use invoices (generally with invoice numbers or other identifiers) to help the payee to keep track of:

  • which of its bills have been paid, and
  • which of its bills are past due and might need follow-up with the payer.

On the other hand, if a contract involves a large, one-time payment, the paying party might not find it necessary to get an invoice, because an invoice might not be necessary for the paying party's internal controls.

Tango Terms: Clause 1.2 (Invoicing Protocol)

1.1.1 What information should an invoice include?

A paying party will often want invoices to itemize amounts paid for sales tax and similar taxes.

A paying party will usually want the invoice to be detailed enough to permit the paying party to exercise any audit rights that it might have under the Contract (see § 3.6).

Some paying parties want invoices to include information such as, for example:

  • a purchase-order number;
  • a supplier identification code;
  • a contract identifier;
  • part numbers;
  • quantities;
  • units of measure;
  • hours billed;
  • unit- and total prices;
  • export- and safety-related information.

For some very-detailed invoicing requirements, see section 13 of a Honeywell purchase order at https://perma.cc/84BS-KYXB.

1.1.2 Invoice schedule: When should invoices be sent?

Invoices are often sent upon completion of supplier performance under the Contract, e.g., upon delivery of ordered goods or completion of services performance.

In construction- and other services agreements, the provider will generally hope to be paid as work is done, as opposed to waiting to be paid until the work is 100% complete. In that situation, the parties' agreement will typically state when interim invoices are to be sent, e.g., • every month or quarter, and/or • when specified performance targets are reached.

Caution: An excessively-late invoice might cause serious accounting problems for a paying party. Consequently, it's not unknown for a customer to say (for example, in the boilerplate terms and conditions of its purchase-order form) we must receive your invoices no later than X days after the end of our fiscal quarter — and we need not pay the invoice if we receive it after that.

When a customer wants this kind of invoicing deadline, it generally wants to avoid having to "restate" financial results for the relevant fiscal period. That could happen if a late invoice were to turn out to materially alter those results. And for a public company, a restatement of financial results is a Very Bad Thing; it can lead to a sharp drop in the company's stock price, resulting from diminished investor confidence in the company's accounting practices. See generally Investopedia, Restatement.

Example: In 2006, Calgon Carbon Corporation, a public company (NYSE), learned that outside-counsel invoices, totaling some $1.4 million over nine months, had not been properly recorded as expenses for the relevant financial periods. An internal audit revealed the discrepancy, which led to the company's announcing that it would be restating its results for those three quarters. See SEC filing about forthcoming restatement (Mar. 27, 2006)

Epilogue: On the same day as Calgon Carbon's restatement announcement, the company's general counsel left the company and his employment agreement was terminated. See SEC filing about GC's termination on the same day as the restatement filing (Mar. 31, 2006); Calgon Carbon releases lawyer, reports more losses (TribLive.com Mar. 28, 2006).

1.1.3 Pro tip: Confirm the proper address for invoicing

A party sending an invoice might do well to confirm the current address to which the invoice should be sent. Otherwise, the invoice might get lost in the payer's internal correspondence routing system. (Companies using electronic invoicing- and payment systems are less likely to be concerned about this.)

1.1.4 "Drawbacks": Refunds of certain taxes and fees

In the global economy, goods are often manufactured in stages in various countries. For example, aluminum components in a car might have started out as bauxite that is "mined and refined in Jamaica, shipped to northern Quebec for smelting, then hammered into car parts in Alcoa, Tenn." Binyamin Appelbaum, American Companies Still Make Aluminum. In Iceland., New York Times, July 2, 2017, section BU, at 1 (NYTimes.com).

Each destination country might charge an import fee in an attempt to protect the local economy.

Many countries, however, will refund some or all of the import fee upon request if the relevant imports are used, for example, in local factories that employ local workers. These refunds are sometimes referred to as "drawbacks." A drawback is, according to one explanation, "[a] partial refund of an import fee. Refund usually results because goods are re-exported from the country that collected the fee." Supply Chain Glossary (scm-portal.net).

Collecting a drawback usually entails filing administrative paperwork, not unlike filing for a tax refund, with documentation sufficient to convince local authorities that the drawback is authorized by local law.

For that reason: In some customers' standard forms of purchase order, the boilerplate terms and conditions:

  • state that all drawback refunds belong to the customer, not to the supplier; and
  • require the supplier to help the customer to apply for drawbacks, e.g., by providing copies of paperwork.

See, e.g., § 2.4 and § 8 of a Honeywell purchase order form archived at https://perma.cc/CUV6-NKTY.

1.2 Invoicing Protocol

The parties are to proceed as stated in this Protocol when one party, referred to as the "Invoicing Party," is to invoice another party, the "Payer," for amounts due under the Contract.

1.2.1 Invoice contents

Each invoice is to include whatever information the Payer reasonably requests in writing.

1.2.2 Invoice language

Each invoice is to be written:

  1. in the language in which the Contract is written; and
  2. in the official language of the destination country, if required by law or by the Contract.

1.2.3 Itemization

Each invoice must itemize all charges for:

  1. shipping and/or delivery; and
  2. insurance.

See also Clause 1.2.4 concerning itemization of sales taxes.

1.2.4 Sales taxes

  1. Each invoice must separately list all sales taxes and similar taxes being billed to the Payer.
    • Note: This section, in itself, neither authorizes nor prohibits billing taxes to the Payer, but only requires that any taxes that are billed are to be itemized on the invoice.
  2. The Invoicing Party must timely report and remit all applicable sales taxes to the appropriate taxing authorities.

1.2.5 Drawbacks

The Invoicing Party must provide the Payer, at at no extra charge,

  • with all paperwork reasonably requested by the Payer to help the Payer to claim any available drawbacks,
  • such as certificates of origin and the like,
  • where the Invoicing Party can do so without undue burden or expense.

1.2.6 Invoice timing

  1. The Invoicing Party must send invoices according to whatever schedule the Invoicing Party and the Payer have agreed to in writing, for example, in the Contract or in a statement of work.
  2. If no invoice schedule has been agreed to, then the Invoicing Party must send invoices only when the Invoicing Party has finished its required performance under the Contract, for example, when all deliveries have been made or all services have been completed.

1.2.7 Payment method preference

The Invoicing Party is to timely (as defined in Clause 22.46) advise the Payer if the Invoicing Party prefers, or objects to, any particular payment method.

1.3 Payment terms: Background

Payment terms are very often expressed using shorthand terms such as "net-30" or "net 30 days." See generally Net D (Wikipedia.com). This means that payment in full (after all discounts have been applied; see below) must be received by the supplier (or other creditor) no later than the specified number of days after … when?

1.3.1 "Net X days" — from what date?

A supplier would of course like to have payment be due net X days after the date of the invoice. That gives the supplier an easy way of tracking its accounts receivable: The invoice is overdue on the date X+1 days after the date of the invoice, as recorded in the supplier's books.

On the other hand, a customer will normally prefer payment to be due net X days after the customer has received the invoice in question, because the customer needs (or simply wants) more time to process the invoice — and because the customer might wonder whether the supplier's billing system will send invoices out on or shortly after the invoice date.

It makes some sense to do it the second way, as the customer prefers, because the supplier has more control over when the invoice will be received, and the supplier can also follow up to make sure that the customer in fact received the invoice.

(In the modern era of electronic invoicing, much of the above "admin" work is done automatically.)

For additional discussion, see Joanne Simpson, Extended payment terms: who really pays the price? (IACCM.com 2016), https://perma.cc/43ZF-8PMU.

1.3.2 How long should X days be?

It's not unheard of for customers to want to make suppliers wait a long time for their money. Net 45 days and even net 60 days are generally considered to be within the band of reasonableness, more or less.

But some customers demand net 75, net 90, and even net 120 days. And a Honeywell purchase-order form says: "Payment terms are net 75 days …. Payment will be scheduled for the first payment cycle following the net terms for the Purchase Order." See § 13 of a Honeywell purchase-order form archived at https://perma.cc/CUV6-NKTY.

Contractors and other service providers often ask for net 10 or net 15 day terms, or even "due on receipt."

1.3.3 Early-payment discounts

Some contracts will say, for example: "Invoice payments are due 2% 10 days, net 30 days …" This means that:

  • the paying party may deduct 2% as a discount for payment in full within 10 days,
  • but payment in full is due in any case within 30 days.

1.3.4 Offsets

An "offset" occurs when Alice owes money to Bob but reduces her payment by the amount that she claims that Bob owes to her.

A supplier might be reluctant to agree to allow payment offsets, because the supplier might be depending on the customer's timely payment for the cash flow that the supplier needs to run its business.

Moreover, offsets could lead to difficulties in tracking invoice payments.

Caution: Apparently in some places (e.g. France), an automatic right of offset might not be enforceable, according to a LinkedIn comment. See http://goo.gl/aWpjDv (LinkedIn group membership required).

1.3.5 Must late-submitted invoices be paid?

Caution: A late supplier invoice might cause serious accounting problems for a customer. Consequently, it's not unknown for a customer to say (for example, in the boilerplate terms and conditions of its purchase-order form) we must receive your invoices no later than X days after the end of our fiscal quarter — and we need not pay the invoice if we receive it after that.

When a customer wants this kind of invoicing deadline, it generally wants to avoid having to "restate" financial results for the relevant fiscal period. That could happen if a late invoice were to turn out to materially alter those results. And for a public company, a restatement of financial results is a Very Bad Thing; it can lead to a sharp drop in the company's stock price, resulting from diminished investor confidence in the company's accounting practices. See generally Investopedia, Restatement.

Example: In 2006, Calgon Carbon Corporation, a public company (NYSE), learned that outside-counsel invoices, totaling some $1.4 million over nine months, had not been properly recorded as expenses for the relevant financial periods.

  • An internal audit revealed the discrepancy; that led to the company's announcing that it would be restating its results for those three quarters.
  • On the same day as the company announced its restatement, the company's general counsel left the company and his employment agreement was terminated.

See SEC filing about forthcoming restatement (Mar. 27, 2006); SEC filing about GC's termination on the same day as the restatement filing (Mar. 31, 2006); Calgon Carbon releases lawyer, reports more losses (TribLive.com Mar. 28, 2006).

1.3.6 Payment methods

Some widely-used payment methods include the following:

Check: The check could be required to be drawn on (i) a U.S. bank, or (ii) a specifically-identified bank, or (iii) any bank to which the Creditor does not reasonably object in writing. Important: When an ordinary check is written, the money stays in the payer's account until the check is "presented" to the payer's bank for payment. This means that the check might not clear if the payer were to file for bankruptcy protection, because the account might be frozen. (These days, check clearance is almost always done electronically if the Creditor uses a different bank.) See Check (Investopedia.com).

Automated clearing house ("ACH") electronic debit transaction in lieu of a check. Caution: Again, 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 [TO DO]. See Automated Clearing House (ACH) (Investopedia.com).

Certified check: A certified check is written by the payer and drawn on the payer's account, but the bank guarantees to the Creditor 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. Note: With a certified check, the money stays in the payer's account until the check clears — this means that 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 Creditor cashes the check, the Creditor might have to refund the money. See Certified check (Investopedia.com).

Cashier's check: A cashier's check is 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, meaning that the payee might be on the hook as noted above. See Cashier's check (Investopedia.com).

Wire transfer to give the Creditor "immediately-available funds" that could be immediately withdrawn and spent if desired. Caution: Don't include bank-account information in the contract itself: Sometimes you'll see a contract that includes bank-account information for payments. That's not a good idea: If for any reason the contract were to become publicly available — such as one of the parties' having to file it with the SEC as a "material agreement" — then the bank-account information could end up floating around out there on the Internet for all to see. (A better way to do that is to say in the contract that the paying party will separately provide written wire-transfer information.) See Wire transfer and Available funds (each at Investopedia.com).

1.3.7 Would nonpayment create infringement liability?

Nonpayment of an amount due — for example, the fee due for a software license — might means that the non-paying user was infringing the payee's intellectual property rights, such as the Creditor's copyright in its software. See MDY Indus., LLC v. Blizzard Entm't., Inc., 629 F.3d 928, 939-41 at n.4 (9th Cir. 2010) (dictum).

If use of copyrighted material without paying the required license fee is indeed infringement, then the damages award might be significantly more than simply having to pay the required license fee. For example, the MGM Grand Hotel ("MGM") casino floor show was found to infringe the copyright in the Broadway musical Kismet because:

  • MGM was licensed to use the copyrighted material for a movie and for elevator music.
  • MGM was not licensed to use the material for a floor show.

The resulting damage award against MGM for copyright infringement included 2% of MGM's profits from the hotel operations as a whole, including the casino itself. See Frank Music Corp. v. Metro-Goldwyn-Mayer, Inc., 886 F.2d 1545 (9th Cir. 1989) (Frank Music II).

It didn't help MGM's case that MGM's annual report had praised the infringing floor show's contribution to the hotel- and casino operations, saying that "the hotel and gaming operations of the MGM Grand — Las Vegas continue to be materially enhanced by the popularity of the hotel's entertainment[, including] 'Hallelujah Hollywood', the spectacularly successful production revue…." Frank Music I, 772 F.2d 505, 517 (9th Cir. 1985) (alterations by the court).

See also ECIMOS, LLC v. Carrier Corp., No.19-5436, slip op. at 18, 22-24 (6th Cir. Aug. 21, 2020): The appellate court upheld a jury's award of $5 million, or 2.2% of defendant's total profits for the period in question, as "disgorgement" copyright damages for defendant's infringement of plaintiff's computer software.

1.4 Payment Protocol

The parties are to proceed as stated in this Protocol when one party, referred to as the "Payer," is to pay another party, the "Creditor," for amounts due under the Contract.

1.4.1 Invoice requirement

The Creditor must send the Payer an invoice, conforming to the requirements of Clause 1.2, if:

  1. the Contract requires invoices for payment, or
  2. the Payer asks for an invoice.

1.4.2 Payment terms

  1. The Payer must pay each invoice provided by the Creditor [net 30 days] after the Payer receives the invoice (except as provided in subdivision b).
  2. But if the Contract provides for an amount to be "pay when paid" or "pay if paid," then Clause 1.12 (Pay-When-Paid or If-Paid Protocol) will govern.

1.4.3 Payment method

The Payer may pay using any reasonable means to which the Creditor has not reasonably objected.

1.4.4 Offsets

  1. The Payer must not reduce its payment by amount(s) that the Payer believes the Creditor owes to the Payer UNLESS the Contract unambiguously allows the Payer to do so, in which case subdivisions b and c will govern.
  1. The Payer must not reduce its payment by more than the amount that the Creditor owes to the Payer.
  2. No later than the due date of the Payer's payment, the Payer must:
    1. advise the Creditor in writing that the Payer is taking an offset;
    2. provide the Creditor with a reasonable written explanation of each offset; and
    3. provide the Creditor with: (i) citations to specific portions of supporting documentation, and (ii) copies of such documentation that the Creditor does not already have.

1.4.5 Late invoices

  1. The Payer is to pay an invoice even if the invoice is submitted after an agreed deadline for doing so.
  2. A reasonable delay in payment will not be a breach if the payment delay is made necessary by the invoice delay.

1.4.6 No effect on warranty rights

The fact of a Payer's payment, standing alone, will not limit any warranty rights that the Payer has concerning the subject of the payment unless the Payer unambiguously agrees otherwise in writing.

1.4.7 Order of application of payments

The Creditor must apply payments:

  1. first to accrued interest, if any, then
  2. to unpaid principal,

in each case in the order in which the Payer's payment obligations were incurred (that is, oldest-first).

1.4.8 COD terms after late payment

The Creditor may require a Payer to pay cash-on-delivery (COD) in the future if the Payer:

  1. has been repeatedly late in paying the Creditor; or
  2. has been significantly late with one or more significant payments.

1.4.9 No liability for IP infringement

The Creditor must not seek remedies for infringement of its intellectual-property rights solely because the Payer did not timely pay the Creditor one or more amounts required by the Contract.

1.5 Expense Reimbursement Protocol

The parties are to proceed as stated in this Protocol when one party, referred to as the "Payer," is to reimburse another party, the "Incurring Party," for expenses under the Contract.

In case of doubt: Each party is responsible for its own expenses relating to the Contract except to the extent (if any) that the Contract clearly states otherwise.

1.5.1 Eligible expenses only

The Incurring Party must not seek reimbursement for a particular expense unless:

  1. the expense is of a type that the Contract unambiguously says is reimbursable;
  2. the Incurring Party actually incurred the expense; and
  3. the expense is reasonable in amount.

1.5.2 Expense markup

The Incurring Party must not mark up expenses when seeking reimbursement unless the Payer, in writing, has unambiguously authorized doing so.

1.5.3 Submission of receipts

The Incurring Party must submit complete and accurate copies of receipts for each requested expense reimbursement unless the Payer has specified otherwise in writing.

1.5.4 Compliance with Payer's written expense policy

The Incurring Party will not be eligible for reimbursement of expenses that do not conform to a written expense policy that the Payer provides to the Incurring Party a reasonable time in advance, for example, before the Incurring Party incurs an expense that cannot be canceled or refunded.

1.5.5 When preapproval is required

If the Contract requires the Incurring Party to obtain the Payer's preapproval for certain expenses, then the Payer must not seek reimbursement for any such expense unless:

  1. the Incurring Party obtained such preapproval, or
  2. the Incurring Party obtained the Payer's specific, written permission to seek reimbursement without such preapproval.

1.5.6 Direct billing

  1. The Incurring Party must not have expenses direct-billed to the Payer unless the Payer has authorized doing so.
  2. The Payer must timely pay any expense that — with the Payer's agreement, before or after the fact — the Incurring Party arranged to be billed directly to the Payer.

1.5.7 Option: Expense-Flagging Requirement

If the Contract adopts this Option, the Incurring Party is to suitably flag any expense as to which the Payer might reasonably disagree that the expense is eligible for reimbursement.

1.6 Payment Disputes Protocol

1.6.1 Deadline for written advice of dispute

  1. The Payer must advise the Creditor, in writing, of the Payer's position, no later than [five business days before the putative payment due date].
  2. The Payer's written advice of its position must include the following:
    1. an explanation, in reasonable detail, why the Payer believes it does not owe the amount(s) in question;
    2. citations to specific portions of supporting documentation; and
    3. copies of such documentation that the Creditor does not already have.

1.6.2 Partial payment requirement

  1. The Payer must pay any undisputed amounts on or before the original putative payment due date.
  2. Subdivision a, however, does not in itself excuse the Payer's obligation to timely pay the disputed amount(s).
  3. If the Creditor provides the Payer with information that satisfactorily demonstrates that some or all of the disputed charge(s) are in fact correct,
    • then the Payer must pay those correct charges immediately,
    • or (if later) no later than the original putative due date.

1.6.3 Credit advice and replacement invoice

The Creditor must promptly send Payer:

  1. a written advice of refundable credit for any amount that the Creditor agrees need not be paid; and
  2. (if the Payer asks:) a replacement invoice for any remaining balance(s).

1.6.4 If dispute not resolved at working level

If the Creditor and Payer are unable to resolve a payment dispute at the working level, then they must follow Clause 16.9 (Dispute Management Protocol).

1.7 Interest & usury savings: Background

It's not uncommon for contracts to allow a payee to charge interest on past-due payments, for example at 1.5% per month on the amount past due.

1.7.1 Caution: Usury statutes can have teeth

Even invoicing for unlawfully-excessive interest — or charging interest too early — can trigger usury statutes. And in some jurisdictions, if you charge interest that violates applicable usury law, you could end up forfeiting your claim to the entire amount owed to you, not just to that portion of the interest that exceeds the maximum amount. See generally Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at part VI-B, pp.24-25, (SnowSpenceLaw.com; undated), which includes extensive citations to Texas case law.

1.7.2 What constitutes "usury"?

Not all charges that someone tries to characterize as "interest" will be subject to usury laws — especially if the charge reflects work done or service rendered. For example:

• A bank's service fee for a bounced check (an "NSF charge") was held not to constitute usury in First Bank v. Tony's Tortilla Factory, Inc., 877 S.W.2d 285, 285 (Tex. 1994).

• A cable-TV provider's administrative fee, charged for late bill payment, was held not to constitute usury in Garcia v. Texas Cable Partners, L.P., 114 S.W.3d 561 (Tex. App.—Corpus Christi 2003) (affirming summary judgment in favor of cable company) (citing cases); see also, e.g., Gomez v. Niemann & Heyer, L.L.P., No. 1:16-CV-119-RP (W.D. Tex. Oct. 7, 2016) (denying motion to dismiss claims against debt-collector law firm; citing Garcia) (see also earlier order explaining background).

Moreover, offering a lower price for cash payment is not usury, because in Texas, by statute, the term interest "does not include time price differential, regardless of how it is denominated. …" Tex. Fin. Code § 301.002(4) (emphasis added); see Spence, supra, at 9. What is "time price differential"? 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, at part VI-F, p.27 (citations omitted, extra paragraphing added).

1.7.3 A usury savings clause might work

Usury "savings clauses," along the general lines of Clause 1.9, are often included in promissory notes and other contracts that allow for charging interest. But: Usury savings clauses might — or might not — be effective in a given jurisdiction. For example:

• Texas law permits usury-savings clauses. See generally Spence, supra, at 34.

• On the other hand, Rhode Island's state supreme court acknowledged that Rhode Island's usury statute was "draconian" and "strong medicine"; The 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 …." The court affirmed a trial-court ruling that a commercial loan agreement for more than $400,000 was void as usurious. LaBonte v. New England Development R.I., LLC, 93 A.3d 537, 544 (R.I. 2014).

1.7.4 Pro tip: Is an interest-charge clause even worth seeking?

If you expect to get paid, it's understandable that you might want to include an interest-charges clause in your draft contract. But whether you'll actually charge and try to collect interest is a real question. For example:

  • If you're a supplier that gets repeat business from a customer, you might hesitate to to charge interest on late payments because you don't want to annoy the customer and jeopardize the repeat business.
  • Some large customers have been known to announce, imperiously: We don't pay interest, period, and if you want our business, that's the way it is.

But on the other hand, some customers can be notoriously slow payers, insisting on as high as 120-day terms from their suppliers.

In the end, it's a business decision whether to include an interest-charges clause in a contract.

1.7.5 Further reading about interests and usury (optional)

See generally, e.g.:

1.8 Interest Charges Protocol

  1. When this Protocol is agreed to, it applies when a party ("Debtor") owes money to another party ("Creditor") under the Contract.
  2. The Creditor may invoice Payer for interest on any unpaid, past-due amount,
    • at [5% per annum simple interest], or if less, the maximum rate allowed by law,
    • beginning [on the first day after the due date], or if later, the first day allowed by law,
    • and continuing, on remaining unpaid amounts only, until the past-due amount is paid in full.
  1. The Debtor must pay any interest charged under subdivision a.
  2. Clause 1.9 (Usury Savings Protocol) is incorporated by reference.

1.9 Usury Savings Protocol

1.9.1 Party intent to comply with law

The parties intend for all charges and payments under the Contract to comply with law,

  • and agree that the unlawful interest is to be considered the result of an inadvertent error,
  • even if one or both parties intended to take the specific action(s) that resulted in the unlawful interest being charged or paid.

1.9.2 Creditor's actions in case of usury

  1. This section applies if a party, referred to as the "Creditor," has charged another party, the "Payer," one or more amounts, or the Payer has paid one or more amounts, where
    1. those amounts are properly characterized as interest; and
    2. and the interest rate exceeded the maximum rate permitted by law, after taking all permitted steps to spread the charges and/or payments over time.
  2. The Creditor must do the following:
    1. cancel the excess-interest charge, and
    2. advise the Payer in writing that the Creditor has done so.
  3. If the Payer has paid excess interest, then the Creditor must do the following:
    1. promptly refund the excess interest to the Payer, and/or credit the excess interest to any balance still owed by the Payer, at the Creditor's election,
      • together with interest on the excess interest at the maximum rate permitted by law; and
    2. advise the Payer in writing that the Creditor has done so.

1.10 Tax Responsibility Protocol

1.10.1 Income tax responsibility

No party is to look to any other party to the Contract to pay or reimburse taxes based on, or computed from, the first party's income.

1.10.2 Reimbursement obligation for third-party claims

Each party is to defend (as defined in Clause 14.5) each other party's Protected Group (as defined in Clause 22.38) against any claim by a third party,

  • including but not limited to claims by any taxing authority (as defined in Clause 1.10.3),
  • that the protecting party failed to pay any tax (as defined in Clause 1.10.3) — of any kind, not just income taxes — for which the protecting party was legally responsible,
  • whether that responsibility arose under the Contract or otherwise.

1.10.3 Definitions: Tax; Sales Tax; Taxing Authority

  1. The term tax refers to any tax, assessment, charge, duty, levy, or other similar governmental charge of any nature, imposed by any government authority.
  2. The term tax, however, does not encompass a price charged by a government authority for (i) services rendered, nor (ii) goods or other assets sold or leased, by the government authority.
  3. Illustrative examples of taxes include the following, without limitation, whether or not an obligation to pay the same is undisputed, and whether or not a return or report must be filed:
    1. taxes on:
      • income;
      • gross receipts;
      • employment;
      • franchise;
      • profits;
      • capital gains;
      • capital stock;
      • transfer;
      • sales;
      • use;
      • occupation;
      • property;
      • excise;
      • severance;
      • windfall profits;
      • sick pay;
      • or disability pay;
    2. ad valorem taxes;
      • alternative minimum taxes;
      • environmental taxes;
      • license taxes;
      • payroll taxes;
      • registration taxes;
      • social security (or similar) taxes;
      • stamp taxes;
      • stamp duty reserve taxes;
      • unemployment taxes;
      • value added taxes;
      • or withholding taxes; and
    3. all other taxes;
      • assessments;
      • charges;
      • customs and other duties;
      • fees;
      • levies;
      • or other similar governmental charges of any kind; and
    4. all estimated taxes;
      • deficiency assessments;
      • additions to tax;
      • and fines, penalties, and interest on past-due tax payments.
  4. The term "taxing authority," whether or not capitalized,
    • refers to any government authority exercising de jure or de facto power
    • to impose, regulate, or administer or enforce the imposition of taxes.
  5. The term "sales tax," whether or not capitalized, includes (without limitation) all of the following:
    1. sales taxes;
    2. use taxes;
    3. value-added taxes;
    4. excise taxes;
    5. other forms of ad valorem tax and consumption tax;
    6. and equivalent taxes.

1.11 Pay-when-paid: Background

Tango Terms: Clause 1.12 (Pay-When-Paid or If-Paid Protocol).

Pay-when-paid and pay-if-paid clauses are sometimes seen in subcontracts where the prime contractor (or general contractor) would prefer not to have to lay out its own cash to pay subcontractors. Suppose that:

  • A general contractor enters into a contract with a homeowner, under which the general contractor will remodel the homeowner's kitchen.
  • The general 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 general contractor need not pay the painter unless the homeowner pays the general contractor.

In some jurisdictions, the painter likely wouldn't be able to seek payment from the general contractor's payment bond (see § 1.13) if there is one. 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).

Caution: Because a pay-if-paid clause essentially puts the risk of non-payment on the subcontractor, 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 clauses are enforceable, according to that state's highest court. See 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).

• In contrast, the Ohio supreme court upheld a pay-if-paid clause, affirming a summary judgment that the contract's "condition precedent" payment language was sufficient totransfer the risk of nonpayment by a customer from the prime contractor to its subcontractor. See Transtar Electric, Inc. v. A.E.M. Electric Serv. Corp., 2014 Ohio 3095, 140 Ohio St. 3d 193. The decision was criticized 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. See 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. See Allstate Interiors & Exteriors, Inc., v. Stonestreet Constr., LLC, 730 F.3d 67, 70 (1st Cir. 2013) (affirming judgment below).

For additional information, see generally, e.g., Robert Cox, Pay-if-Paid Clauses: a Surety's Defense for Payment Bond Claims? (JDSupra.com 2019).

1.12 Pay-When-Paid or If-Paid Protocol

1.12.1 Applicability of this Protocol

When this Protocol is agreed to, it applies when, under the Contract:

  1. a party (the "Payer") must make a particular payment (the "contingent payment") to another party (the "Creditor"),
  2. but the Contract clearly indicates that payment to the Creditor is contingent on the Payer's receipt of one or more third-party payments;
  3. and the contingency referred to above is either "pay if paid" or "pay when paid," or comparable wording in either case.

1.12.2 Payer obligations

Payer must do following:

  1. Pay the Creditor no later than just after the Payer (i) receives, on an unconditional basis, and (ii) accepts, the specified third-party payment(s);
  2. For a pay-when-paid obligation: Pay the Creditor as soon as a reasonable time has passed, even if the Payer has not yet received the relevant third-party payment(s);
  3. For a pay-when-paid obligation: Make commercially-reasonable efforts (as defined in Clause 9.5) to collect all relevant third-party payments.

1.12.3 Creditor assent for pay-if-paid obligation

  1. For a pay-if-paid obligation, the Payer need not make any particular efforts to collect the third-party payment on which the Payer's payment depends.
  2. If the Payer does make such efforts, then those efforts will be:
    1. at the Payer's sole discretion (as defined in Clause 22.17); and
    2. solely for the Payer's own benefit.
  3. The Creditor CERTIFIES — with the intent that the Payer rely on the certification —
    1. that the Creditor has taken into account the risk that the Payer might not get paid, and therefore that the Creditor might not get paid;
    2. that the Creditor is relying on the credit and willingness and ability to pay of the relevant third party or -parties, and not on that of the Payer; and
    3. that the Creditor KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY ASSUMES AND ACCEPTS THE RISK that the Creditor might not get paid (or you might not get paid in full).

1.13 Payment security: Background

Business bad? F*** you, pay me. Oh, you had a fire? F*** you, pay me. Place got hit by lightning, huh? F*** you, pay me. —Henry Hill in Goodfellas.

If you're a supplier and expect a customer to pay you, it might make sense to negotiate to have the customer arrange backup sources of funding, "just in case." The same is true if you're a customer and you hire a contractor whose subcontractors might put a lien on your property if they don't get paid.

Here are some possible backup sources of funding:

1.  As a supplier, you could ask your customer for a deposit — possibly into "escrow," to be held by a third party until stated conditions are met. A deposit does several things:

  • It gives you, the supplier, a pot of money already in hand, to pay you in case your customer fails to pay on time.
  • It can provide you with working capital, so that you don't have to use your own money to buy raw materials, hire subcontractors, etc. (If this will be the case, the contract should specify what you're allowed to do with the deposit.)
  • It can cause the customer to feel more of a sense of commitment, because the customer has some financial "skin in the game" of its own.

Concerning deposits, see Clause 1.15. Concerning escrow payments, see generally Escrow (Investopedia.com);

2.  You could ask for a form of payment security, for example a standby letter of credit ("SLOC") — in return for a fee, a bank agrees to pay the amount due if necessary; in effect, a SLOC is a prearranged line of credit for the payee with the payer's bank, with the payer being responsible for repaying the bank. See generally Standby Letter of Credit (Investopedia.com); concerning payment security, see Clause 1.14;

3.  You could ask for a guaranty from a third party — see § 1.16 and Clause 1.17;

4.  You could ask to take a security interest in real estate or other property (tangible or intangible), referred to as "collateral."

Note: A security interest in collateral must be properly established and "perfected" (the manner of perfection depends on the nature of the collateral; it generally involves filing a notice of some kind in public records, so as to put the public on notice of the payee's security interest).

An advantage of a security interest is that, if an amount due remains unpaid, then the payee can force a sale of the collateral and keep as much of the proceeds as is needed to pay the amount due, with any remaining proceeds going to the party that owed the money.

Two disadvantages of a security interest are (i) that parties don't always get around to perfecting a security interest, and (ii) that it's somewhat of a burden, and it costs time and money, to foreclose on and sell collateral, especially if the collateral owner tries to get a court to stop the process.

See generally Security interest and Foreclosure (Investopedia.com).

5.  As a customer hiring a contractor, you could ask the contractor to buy a payment bond from an insurance carrier: If the contractor fails to pay its subcontractors, then the insurance carrier is responsible for paying any unpaid suppliers and subcontractors. (The insurance carrier will usually try to recoup its payment(s) from its insured, the nonpaying contractor.) See generally Payment bond (IRMI.com).

Payment bonds are usually required in "prime" contracts between a customer and a prime- or general contractor. The intent is to keep the prime contractor's unpaid subcontractors and suppliers from filing a mechanic's lien or materialman's lien (nowadays often referred to as a "supplier's lien") on the customer's project. See generally Mechanic's lien (Wikipedia.org).

6.  As a customer hiring a contractor, you could ask the contractor to buy a performance-type bond, a.k.a. a contract bonds, to have a backup pot of money available:

  • to fund a party's performance of its contractual obligations, such as the bonds required of companies holding certain oil and gas leases granted by the U.S. Government — see 30 C.F.R. § 556.900, cited in Taylor Energy Co. v. United States, No. 19-1983, slip op. at 4-5 (Fed. Cir. Sept. 3, 2020) (affirming dismissal of Taylor Energy's complaint for failure to state a claim upon which relief can be granted); and/or
  • to hire a replacement contractor to finish work that the original contractor either failed to do or failed to do correctly.

See generally Performance bond (Investopedia.com).

If a contractor is required to obtain and pay for a payment bond and/or a performance bond, the contractor generally will build the cost of the bond (i.e., the premium that the contractor pays to the insurance carrier) into the price of the project.

1.14 Payment Security Protocol

1.14.1 Applicability of this Protocol

  1. When this Protocol is adopted in an agreement (the "Contract"), it applies if and when the Contract calls for one party, the "Payer," to establish security for payments, by the Payer or someone else, to one or more other parties (each, a "Supplier"), in connection with an order for goods or services or other agreement.
  2. This Protocol refers to a single Supplier for convenience; the terms of this Protocol likewise apply when more than one party is a Supplier under the Contract.
  3. [Brackets] indicate an item that the parties may modify by unambiguously saying so in the Contract.

1.14.2 Requirements for payment security

  1. Payer must establish, and keep in force as set forth in this Protocol, payment security that meets any and all requirements that are (i) stated in this Protocol, and/or (ii) otherwise agreed to in writing,
  2. The payment security must —
    1. take the form of an irrevocable, unconditional (i) sight letter of credit or (ii) bank guarantee, in either case on terms reasonably acceptable to the Supplier; and
    2. be issued (or confirmed) by a financial institution that is reasonably acceptable to the Supplier; that financial institution is referred to as the "Bank."
  3. The payment security must provide for payments by the Bank to the Supplier as follows:
    1. pro-rata payments:
      • for goods as they are shipped,
      • and for services as they are performed,
      • as applicable to the relevant order;
    2. payment of any cancellation- or termination charges under the order; and
    3. payment of any other amount that the Payer owes to the Supplier in connection with the order.

1.14.3 Modification of payment security if requested

  1. The Supplier may request modification of the payment security if —
    • in the Supplier's reasonable judgment, modification of the payment security is appropriate in view of the circumstances,
    • including, without limitation, (i) payment history, and (ii) any other fact that the Supplier reasonably deems relevant to the Payer's ability and/or willingness to pay.
  2. A requested modification could include, without limitation, one or more of the following:
    1. an increase in the coverage amount of the payment security;
    2. an extension of the term of the payment security;
    3. changing to another Bank; and/or
    4. any other appropriate modifications to the payment security reasonably requested by the Supplier.
  3. The Payer must modify the payment security when reasonably requested by the Supplier under subdivision a.
  4. The modification must be effective no later than [ten business days] after receiving the Supplier's written request.
  5. The modification must be confirmed in accordance with Clause 1.14.4.

1.14.4 Confirmation requirement

The Payer must cause the Supplier to be provided with written confirmation — from the Bank — that the payment security has been established;

  • this must be done so no later than [five business days] after the parties' agreement to the purchase order or other order that requires payment security.

1.14.5 Supplier delay until payment security confirmed

  1. The Supplier need not begin its performance under an order,
    • nor need the Supplier continue its performance, if already begun,
    • until the Supplier has received confirmation the fully effective payment security,
    • and/or any confirmation of required modified payment security,
    • as required by this Protocol and/or the applicable order.
  2. In any case coming within subdivision a, all deadlines for Supplier performance will be automatically extended accordingly.

1.14.6 Required duration of payment security

The Payer must arrange to keep the payment security in effect for at least [three months] after the latest to occur of the following:

  1. the last scheduled shipment of ordered goods, if any;
  2. completion of all ordered services, if any; and
  3. the Supplier's receipt of the final payment covered by the payment security.

1.14.7 Payer's responsibility for payment-security costs

As between the Payer and the The Payer must see to the payment pay all costs and expenses associated with establishing and maintaining the payment security.

1.14.8 Failure to maintain payment security as material breach

The Payer's failure to timely provide, maintain, and/or update, the required fully effective payment security,

1.15 Deposits Protocol

Any party receiving a deposit under the Contract must do the following:

  1. Apply any deposits as agreed; and
  2. Promptly refund any remaining balance — without interest unless the Contract unambiguously says otherwise.

1.16 Guaranties: Background

Tango Terms: Clause 1.17 (Guaranty Protocol).

It sometimes happens that a party with comparatively-few financial assets will enter into a contract requiring the party to pay money. In that situation, it's not uncommon for the other party to ask for a more-solvent third party to guarantee payment.

Guaranties typically cover payment obligations; 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.

Spelling: 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).

1.16.1 Pro tip: Creditors want their money now, without effort

In dealing with guaranties, it helps to keep in mind that creditors, like other people, dislike having to chase after money owed to them. That's why, in a creditor's ideal world, whenever a debtor fails to pay a guaranteed amount, the guarantor will immediately step up and make the payment as soon as the creditor asks for it.

1.16.2 Guaranty of payment, or of collection?

A guaranty can be:

  • a guaranty of payment: that is, a creditor can demand payment from the guarantor as soon as the main debtor fails to pay;
  • a guaranty of collection (as in Clause 1.17.4), meaning that the creditor must first go through court proceedings against the debtor — and so the guarantor is liable only if the creditor obtains a judgment against the debtor and is unable to collect on the judgment.

Creditors will typically object to getting a guaranty only of collection, because 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.

Note: Under Texas law, a guarantor of payment would have the right to demand that the creditor, "without delay," file a lawsuit against the debtor, failing which the guarantor would not be liable for the guaranteed payment obligation; subdivision b waives this right. See Tex. Civ. Prac. & Rem. Code § 43.002.

1.16.3 Successors' right to enforce guaranty

Creditors will often word a guaranty so that any creditor's successors may also enforce the guaranty. That's because:

  • loans are often packaged and sold to different parties ("successors and assigns") that collect payments (which are sometimes "sliced and diced" in the process);
  • guaranties are often part of the "collateral" in the loan package; and
  • any of the original lender's successors and assigns will therefore want to be able to enforce a guaranty as part of their "collateral" for the loan.

Concerning third-party beneficiaries generally, see Clause 14.4 (Third-Party Beneficiary Disclaimer).

1.16.4 Into what court(s) can a guarantor be haled?

If you're a guarantor in the United States, under the Constitution you normally can't be sued for payment in, say, North Dakota if you don't have "minimum contacts" with that state. But there's an exception: You can agree, in what's called a "forum selection clause" (see Clause 16.11), that another party is allowed to sue you in a given state. See Knauf Insulation, Inc. v. Southern Brands, Inc., 820 F.3d 904, 906 (7th Cir. 2016) (affirming judgment that guarantors were liable for payment obligations) (Posner, J) (citing cases).

Corporate-finance instruments often specify that guarantors can be sued in New York City. This is done because the right to payment is often sliced, diced, and sold to other parties. With an NYC forum-selection, successive buyers of the payment rights will know that they can sue for payment in NYC, probably using their regular law firm(s), no matter where any given guarantor happens to be located.

On the other hand, if a particular guarantor had enough bargaining power, it might insist that it could be sued under the guaranty only in a particular jurisdiction, e.g., the guarantor's own home jurisdiction. See generally, e.g., Anthony R. McClure, There's No Place Like Home—To Establish Personal Jurisdiction (AmBar.org 2018), archived at https://perma.cc/6UJM-HSG6.

1.16.5 What law will govern a guaranty?

In a complex- or sophisticated transaction, a guaranty document might provide that, say, New York law governs the guaranty, even if some other state's law governs the rest of the transaction — or vice versa. Cf. 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, cited in Restatement (Second) of Conflicts of Laws, comment i to § 187 (1988 update).

1.16.6 Joint and several guarantor liability

Suppose that you're one of several people who agree to guarantee a payment obligation, with joint and several liability. This means, basically, that any one of you might have to pay as much as the entire total of the payment obligation, if the others don't come up with their shares.

Pro tip: If multiple guarantors will be guaranteeing multiple payment obligations, it's a really good idea for each guaranty to be clear about the extent to which guarantors are liable for which obligations. As a hypothetical example, suppose there's a transaction in which:

  • Four college students want to rent a four-bedroom apartment.
  • The landlord wants the students' parents to guarantee payment of the rent.

Any given parent likely would not be eager to guarantee payment of any rent except for the parent's own child, so the guaranty should be clear about that.

1.16.7 Guarantor reimbursement of refunds to bankrupt debtors

Clause 1.17.6 reflects the way bankruptcy law works in the United States. Suppose that:

  • You guarantee a customer's payment to a supplier;
  • The customer pays a supplier's invoice;
  • Within the next 90 days, the customer files for protection under the bankruptcy laws.

In that situation, the supplier might be compelled to refund the customer's payment (which is referred to as an "avoidable preference") See, e.g., Patricia Dzikowski, The Bankruptcy Trustee and Preference Claims (Nolo.com; undated); Kathleen Michon, Pre-Bankruptcy Payments to Creditors: Can the Trustee Get the Money Back? (Nolo.com; undated); see also the guaranty language in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 25 N.Y.3d 485, 488, 36 N.E.3d 80, 15 N.Y.S.3d 277 (2015).

That's where a guaranty can come in: If you guaranteed the (now-bankrupt) customer's payment to the supplier, then you'd be on the hook to reimburse the supplier for the refund that the supplier had to give to the customer. "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, 205 Cal. Rptr.3d 922 (2016) (cleaned up; extensive citations omitted).

To be sure, the supplier would have the right to contest its obligation to refund the customer's payment. For example, the supplier could show that the customer's payment had been made in the ordinary course of business. That can be difficult, though: The supplier would have to successfully jump through some hoops to prove that it was entitled to the customer's payment.

In any event, as a practical matter many avoidable-preference cases are resolved by agreement. In our hypothetical case, the bankrupt customer would likely settle for less than a complete refund of what it paid the supplier, and in return, the supplier would give the customer a partial refund so as to avoid the expense and hassle of jumping through the required proof hoops. If that were to happen, then the supplier might well go after you, the guarantor, to recoup the money that the supplier had to refund to its customer (as well as the supplier's associated legal expenses).

1.16.8 Consideration for a guaranty

Clause 1.17.11 explicitly states that a guarantor's consideration is the creditor's entry into the guaranteed agreement in question. This normally won't be an issue in business-to-business ("B2B") transactions, but sometimes the issue does come up. Example: In a Massachusetts case:

  • A company's bookkeeper signed an order for ad space in a Yellow Pages phone book. (Remember those?)
  • Unhappily for the bookkeeper, 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 — although the result would have been different, the court said, had the bookkeeper been an owner, investor, or principal who signed the order. See Yellow Book, Inc. v. Tocci, 2014 Mass. App. Div. 20, 22-23 (2014), discussed in Robert W. Stetson, Four Tips for Drafting Enforceable Personal Guarantees, in (BNA) Corporate Counsel Weekly Newsletter, Apr. 9, 2014 (archived at https://perma.cc/4TWZ-FM5X), which includes numerous additional case citations.

1.17 Guaranty Protocol

1.17.1 Applicability of this Protocol

  1. When this Protocol is agreed to, it applies when,
    • under the Contract (which may be a standalone guaranty agreement),
    • a party (the "Guarantor")
    • guarantees a payment obligation (a "Guaranteed Payment Obligation")
    • that is owed to another party (the "Creditor")
    • by a third party (the "Debtor")
    • under an agreement (the "Guaranteed Agreement").
  2. The Guarantor's obligation is referred to as the "Guaranty."
  3. For convenience, this Protocol refers to a single Guarantor and a single Creditor, but the terms of this Protocol apply in the same way when there are multiple Guarantors and/or multiple Creditors.

1.17.2 Payment obligation for unpaid amounts due

  1. Except as provided in subdivision b, the Guarantor must pay any amount due to the Creditor under the Guaranteed Payment Obligation within [five business days] after the Creditor asks — in writing — that the Guarantor do so.
  2. The Guarantor need not make such a payment, however, unless:
    1. The Debtor has failed to pay that amount; and
    2. any relevant cure period for that nonpayment has expired.

1.17.3 No collection efforts needed against Debtor

Unless the Guaranty is unambiguously a guaranty of collection, as opposed to a guaranty of payment (see Clause 1.17.4),

  • the Guarantor's obligation to pay is not affected by the extent, if any,
  • to which the Creditor did or did not try to collect the Guaranteed Payment Obligation from the Debtor before seeking payment from the Guarantor,
  • and the Guarantor WAIVES (as defined in Clause 17.7) any requirement that the Creditor make any attempt at such collection.

1.17.4 Ground rules for guaranty of collection

If the Guaranty is of collection and not of payment,

  • then the Creditor must not request payment from any Guarantor,
  • nor seek to enforce the Guaranty against any Guarantor,
  • until:
  1. the Creditor has obtained, in a court or other forum of competent jurisdiction, a final judgment against the Debtor, from which no further appeal is taken or possible, that enforces — in whole or in part — the Guaranteed Payment Obligation; and
  2. the Creditor has been unable to collect the judgment from the Debtor after diligently making reasonable efforts to do so.

1.17.5 Collection expense reimbursement obligation

The Guarantor must pay, or reimburse the Creditor for, any court costs and other reasonable expenses that the Creditor incurs:

  • in successfully enforcing the Creditor's rights under the Guaranty,
  • and/or in successfully enforcing the Guaranteed Payment Obligation in question against the Debtor,
  • including but not limited to attorney fees (as defined in Clause 16.3);
  • this payment or reimbursement is due immediately upon request from the Creditor.

1.17.6 Bankruptcy refunds obligation

  1. This section applies if a Creditor refunds some or all of a payment made by the Debtor on the Guaranteed Payment Obligation, either:
    1. because of a requirement of bankruptcy law; fraudulent-transfer law; or comparable law, or
    2. in settlement of a claim for such a refund.
  2. In such a case, the Guarantor must pay, or reimburse the Creditor for,
    1. the amount refunded by the Creditor; and
    2. the Creditor's attorney fees (as defined in Clause 16.3) incurred in dealing with the claim for refund, if any;

immediately upon written request from the Creditor.

1.17.7 Broad scope of Guarantor obligations

For purposes of the Guaranty, unless the Guaranty unambiguously says otherwise, it does not matter:

  1. how or when the Guaranteed Payment Obligation in question came into being, including, without limitation, by acceleration or otherwise;
  2. whether the Guaranteed Payment Obligation is direct or indirect, absolute or contingent; nor
  3. whether the Debtor's own liability for the Guaranteed Payment Obligation was wholly- or partly discharged under a statute or judicial decision.

1.17.8 Waiver of Creditor acceptance and signature

Unless the Guaranty unambiguously says otherwise, it does not matter:

  1. whether the Creditor accepted and/or signed the Guaranty; nor
  2. whether the Guarantor was notified that the Creditor did accept the Guaranty.

1.17.9 Guarantor certification of its financial information

The Guarantor represents (as defined in Clause 2.3) and warrants (as defined in Clause 2.4),

  • to each Creditor,
  • and to that Creditor's successors and assigns, if any,
  • that the credit-related information provided by the Guarantor in connection with the Guaranty (if any),
  • is complete, up to date, and accurate,
  • except to the extent (if any) that the Guarantor have unambiguously disclosed otherwise to the Creditor in writing.

1.17.10 No double-dipping

The Creditor must refund any duplicate payment that it receive from multiple Guarantors and/or the Debtor.

1.17.11 Consideration for Guaranty

Each Guarantor undertakes that Guarantor's obligations under the Guaranty in consideration of each Creditor's entry into the Guaranteed Agreement.

1.17.12 Guarantors' joint and several liability

  1. This section applies if multiple Guarantors guarantee the Guaranteed Payment Obligation.
  2. Each Guarantor is jointly and severallly liable for all Guarantor obligations under the Guaranty.
  3. If Guarantor A pays some or all of Guarantor B's share of an amount due under the Guaranty because Guarantor B failed to timely due so,
    • then Guarantor B is to reimburse Guarantor A for that payment,
    • plus interest on that payment at the highest rate allowed by law, beginning on the date of that payment.

1.17.13 No cap on Guarantor liability

The amount the Guarantor might have to pay under the Guaranty could be as high as the entire, aggregate amount due under the Guaranty.

1.17.14 Rights of Creditors' successors

The successors and assigns of any Creditor may enforce the Guaranty. (In legalese: All successors and assigns (if any), of all Creditors, are intended third-party beneficiaries of the Guaranty.)

1.17.15 Effect of modification

The Guaranty will be void if the Guaranteed Payment Obligation is modified in any material respect,

  • unless the Guarantor consented in writing to the modification.

1.17.16 Governing law for Guaranty

The Guaranty is to be interpreted and enforced,

  • and any dispute arising out of or relating to the Guaranty is to be decided,
  • under the law specified in the Contract — see Clause 16.15 (Governing Law),
  • or if none, by the law that governs the interpretation and enforceability of the Contract.

1.17.17 Agreed court(s) for Guaranty enforcement

a.  Any Creditor may sue any Guarantor to enforce the Guaranty in respect of that Creditor's rights under the Guaranteed Payment Obligation,

  • in [the state and federal courts having jurisdiction in the Borough of Manhattan, New York, New York, USA]
  • or any other forum unambiguously specified in the Guaranty,
  • without regard to where the Guarantor happens to be domiciled or otherwise located.

b.  In case of doubt, when a Guarantor agrees to a particular forum under subdivision a, that does not mean that the Guarantor is submiting to the general jurisdiction of that forum.

1.17.18 Option: Financial Statement Updates

  1. If this Option is agreed to, then —
    • no later than [45 days] after the end of each [calendar quarter],
    • the Guarantor must provide the Creditor with a copy of the Guarantor's financial statement for that period (the "updated financial statement").
  2. The Guarantor will be deemed to have certified the accuracy of each updated financial statement as stated in Clause 1.17.9,

1.17.19 Option: Standard for Guarantor Financial Statements

If this Option is agreed to, then the Guarantor must ensure that each set of financial statements that the Guarantor provides to the Creditor is prepared in accordance with the disclosure requirements applicable to guarantors of guaranteed debt under the U.S. securities laws.

1.17.20 Option: Audits of Guarantor Financials

If this Option is agreed to, then:

  1. The Guarantor must ensure that the year-end financial statements that the Guarantor provides to the Creditor are audited,
    • and that such quarterly financial statements are reviewed,
    • by an independent public accounting firm.
  2. For each audit and each review, the Guarantor must cause the public accounting firm to promptly provide the Creditor with a complete and accurate copy of the accounting firm's report.

1.17.21 Option: Guarantor Waiver of Defenses

  1. The Guarantor acknowledges (as defined in Clause 22.1) that the Guarantor's obligations under the Guaranty are absolute, unconditional, direct and primary.
  2. The Guarantor WAIVES (as defined in Clause 17.7):
    1. any claim or defense that those obligations under the Guaranty are allegedly illegal, invalid, void, or otherwise unenforceable;
    2. any claim or defense that the Guarantor might have pertaining to any part of the Guaranteed Payment Obligation, other than the defense of discharge by full performance;
      • this includes, without limitation,
      • any defense of waiver, release, statute of limitations, res judicata, statute of frauds, fraud, incapacity, minority, usury, illegality, invalidity, voidness, or other unenforceability
      • that might be available to the Debtor or any other person who might be liable in respect of any Guaranteed Payment Obligation;
    3. any setoff available to the Debtor or any other such person liable, whether or not on account of a related transaction;
    4. all rights and defenses arising out of an election of remedies by a Creditor,
      • such as, for example (as defined in Clause 22.21), a nonjudicial foreclosure with respect to security for a Guaranteed Payment Obligation,
      • even if that election of remedies resulted, or could result,
      • in impairment or destruction of the Guarantor's right of subrogation and/or reimbursement against the Debtor; and
    5. any other circumstance that might otherwise absolve the Guarantor of any obligation under the Guaranty.

1.18 "Hollywood accounting"

Suppose that Party A and Party B agree that A will share in the profits from B's business — after Party B deducts its expenses. This type of "net profit" is common in movie- and TV-series production deals, where actors, producers, and others get (percentage) "points" that can add up to large sums over time. See generally Wikipedia, Hollywood Accounting.

Obviously, in this type of arrangement, Party B has an incentive to take as many deductions from gross revenue as it can, to try to minimize its payout to Party A. That can produce bizarre results:

Example — Return of the Jedi: In 2009, actor David Prowse, a.k.a. Darth Vader in the Star Wars films, said that Lucasfilms had notified him that Return of the Jedi had still not made a profit, some 26 years after its initial release and grossing nearly half a billion dollars on a $32 million budget. (And that was probably before the incessant replaying of the film on cable TV.) See Derek Thompson, How Hollywood Accounting Can Make a $450 Million Movie 'Unprofitable' (TheAtlantic.com 2009). For more examples, see Wikipedia, Hollywood Accounting.

Example — Home Improvement: An audit deadline came into play in a dispute over profits from the TV show Home Improvement: The plaintiffs were writers and producers of the show. Their contract with the Walt Disney company required Disney to pay them a percentage of the show's profits and to periodically provide accounting statements. The plaintiffs claimed that Disney had underpaid them. Disney responded that under the contract's 24-month deadline for requesting an audit, the accounting statements, and thus the payments, were incontestable. (A trial court granted summary judgment in favor of Disney on grounds that the plaintiffs' claims were time-barred by the 24-month deadline provision. The appeals court reversed, holding that a jury must decide whether Disney orally waived or agreed to modify the incontestability provision.) See Wind Dancer Production Group v. Walt Disney Pictures, 10 Cal. App. 5th 56, 78-79, 215 Cal. Rptr. 3d 835 (2017).

An online commenter once opined that in Hollywood, net points "are about as valuable, and confer as much status, as collecting beads for taking your top off at mardi gras. Everyone gets them and they're never worth anything." Gabriel Snyder, How Movie Stars Get Paid (Gawker.com 2009). The Gawker piece provides a readable overview of how movie deals supposedly work for actors.

1.19 Factoring (commentary to come)

Please check back later …

Weil Gotshal article about factoring, securitization, asset-based lending

1.20 Exercises and discussion questions

1.20.1

1.20.2 Payment terms: Early payment

From a contract clause: "10.1 Invoiced payments are due net 30 days from the date that the Buyer receives a correctly stated invoice. 10.2. Invoice payments are due 2% 10 days, net 30 days."

QUESTION: Any issues here?

D.R.Y. — Don't Repeat Yourself

1.20.3 Late payment

From a contract clause: "(4) Penalty for late payments: Late payments are subject to a penalty of 5%."

QUESTION: Any issues here?

(Hint: See § 16.20.2.)

1.20.4 Exercise: Payments based on net revenue

FACTS: You represent

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?

1.20.5 Review: Interest rate

FACTS: A partner in your firm asks you to review a contract for one of her clients. The contract contains the following language:

Past-due amounts will bear interest at 5% per month, compounded monthly, beginning on the day after the due date until paid. [1]

QUESTION (for breakout rooms): What are you going to recommend to the partner about this provision?

2 Assurances: Reps and warranties

2.1 Introduction

When parties do business together, each party generally presupposes that certain things were true in the past, or are true now, or will be true at some point in the future. But sometimes those presuppositions turn out to be wrong. With that in mind, it's often prudent for parties to divvy up the responsibility for making sure that things were, or are, or will be, as planned. This can include provisions for specific parties representing and/or warranting certain things, as discussed in this chapter.

  • recordkeeping- and reporting requirements; and
  • provisions for audits, inspections, and personnel background checks.

2.2 Representations and warranties: Background

Many contracts contain various representations and warranties. Each does two things:

  1. sets out a particular factual state of affairs that one party (or both) wants to be true; and
  2. allocates, as between the parties, the risk that the state of affairs might turn out not to be true.

But representations and warranties have different proof requirements and, upon proof, different available remedies.

2.2.1 Ninja Warrior: Two paths up "The Hill of Proof"

To help visualize how this works, think in terms of the American Ninja Warrior TV show, but with an evidentiary “Hill of Proof” that a plaintiff “Bob” must climb in making a claim against a defendant “Alice”:

  • The Hill of Proof has evidentiary checkpoints along the way up the hill.
  • The “prizes,” i.e., the remedies available to our plaintiff Bob, are positioned at different points up the hill.
The Hill of Proof

(“The Hill of Proof” sounds like something from a Harry Potter novel, no?)

2.2.1.1 Misrepresentation: Must prove reasonable reliance and scienter

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].

As seen at the upper left side of the Hill of Proof, if Bob wants to sue Alice for misrepresentation, he must show:

  1. that Bob in fact relied on Alice's representation — although that usually won’t be a heavy burden if that representation is explicitly stated in the contract;
  2. that Bob's reliance on Alice's representation was reasonable under the circumstances; reasonableness of reliance would likely be presumed, but reliance could be unreasonable if the representation was obviously false or misleading when made; and
  3. that Alice acted negligently, or recklessly, or even intentionally (i.e., fraudulently), in making the (mis)representation — i.e,. he must show that Alice acted with scienter.

If Bob successfully proves his claim of misrepresentation against Alice, then he could be entitled to tort-style remedies such as punitive damages and/or rescission of the contract.

2.2.1.2 Breach of warranty: Less to prove — but fewer remedies

In contrast: As seen on the right side of the Hill of Proof, if Bob sues Alice for breach of warranty, he needn't show reasonable reliance nor scienter. A leading case on the reliance point is CBS v. Ziff-Davis, from the Court of Appeals of New York (that state's highest court), which in essence characterized a warranty as a kind of conditional covenant, akin to an insurance policy, a contractual commitment to assume certain risks:

[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[.]

[I]t amounts to a promise to indemnify the promisee for any loss if the fact warranted proves untrue ….

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) (Learned Hand, J.) (emphasis by the Ziff-Davis court edited, extra paragraphing added).

A different situation might be presented, however, if — before the contract was signed — the warranting party disclosed that a warranty was inaccurate. While the law seems still to be evolving in this area, the influential U.S. Court of Appeals for the Second Circuit once summarized New York law thusly:

[W]here 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 and extra paragraphing added).

2.2.1.3 Additional citations

For extensive additional citations in this area, see Professor Tina Stark's scholarly pummeling of the misguided notion that representations and warranties amount to the same thing, which she offered in two comments on Ken Adams's blog. (Disclosure: Tina is a friend and mentor and the author of Drafting Contracts, a highly-regarded law school course book.)

For an earlier piece on the same subject by Stark, also responding to an Adams essay, see her Nonbinding Opinion: Another view on reps and warranties, Business Law Today, January/February 2006.

Some of Adams's earlier pieces espousing the purported synonymity of representation and warranty can be found at: • A lesson in drafting contracts — What's up with 'representations and warranties'?, The Business Lawyer, Nov./Dec. 2005, as well as • here, here and here.

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.: • Raymond L. Sweigart and Christopher D. Gunson, ‘Reps’ and Warranties: One Could Cost More Than the Other Under English Contract Law (PillsburyLaw.com 2013); and • Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 Bus. Lawyer LAW. 1049, 1058 n.47 (2014).

2.2.2 Drafting goof: Don't use represents to commit to future action

Contract drafters shouldn'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 …

Why? Consider 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, but the drafter would do all concerned a disservice by not making the obligation explicit and unconditional. See Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539 (Minn. 2014) (on certification from 7th Circuit) (holding that "a claim for breach of a contractual representation of future legal compliance is actionable under Minnesota law without proof of reliance").

2.2.3 Disclaim investigation of representations?

Clause 2.3.2 explicitly states that a party making a representation is also certifying that the party has a reasonable basis for the representation. This is to try to forestall parties from recklessly making representations about things of which they know not.

This could end up being important; for example, in 2019 a natural-gas provider was hit with a judgment for some $9 million for fraudulent inducement and negligent misrepresentation, because (the court found) the provider had recklessly represented to a customer that the provider had certain capabilities, when the provider "did not do any investigation as to whether [it] could satisfy this obligation …." Rainbow Energy Marketing Corp. v. American Midstream (Alabama Intrastate) LLC, No. 17-24591 slip op. ¶ 54 (Harris Cty. Dist. Ct. Jul. 29, 2019) (findings of fact and conclusions of law).

Here's a hypothetical example: Suppose that Alice is selling Bob a used car that she has been keeping in a garage in another city; she wants to represent, but not warrant, that the car is in good working order. She could phrase her representation in one of two basic ways:

Phrasing 1: Alice says, "I represent that the car is in good working order." Under Clause 2.3.2, Alice is implicitly making an ancillary representation, namely that she has a reasonable basis for her main representation that the car is in good working order, perhaps because she recently drove it or had it checked out by a mechanic.

Phrasing 2: "So far as I know, the car is in good working order." By using the phrase so far as I know, Alice should be held to have implicitly disclaimed any such ancillary representation.

(Alice could make the disclaimer of Phrasing 2 even strongly by saying, for example: "So far as I know, the car is in good working order, but it's been sitting in the garage for years and I have no idea what kind of shape it's in.")

Pro tip: Some representations use phrasing such as "to Representing Party's knowledge, X is true" — this is unwise, in the author's view, because it could be argued to mean that Representing Party is implicitly representing that it does indeed have knowledge that X is true. That argument should not prevail, but (to paraphrase a former student) that's a conversation we don't want to have.

2.2.4 Warranting a present or future fact? (It matters.)

Drafters of representations and warranties should be careful to be clear just what is being represented warranted: Is it a present fact, or is it a future fact? The distinction can be important because in many jurisdictions:

  • the "clock" for the statute of limitations will not start to tick for a warranty of future performance (for example, by goods) until the warranty failure is discovered;
  • in contrast, for a warranty of present fact  — for example, that goods as delivered /are free from defects — the clock starts ticking at delivery.

This is illustrated in an Indiana case in which the state's supreme court noted that:

Under the UCC, a party's cause of action accrues (thus triggering the limitations period) upon delivery of goods.

However, if a warranty explicitly guarantees the quality or performance standards of the goods for a specific future time period, the cause of action accrues when the aggrieved party discovers (or should have discovered) the breach. This is known as the future-performance exception.

Kenworth of Indianapolis, Inc., v. Seventy-Seven Ltd., 134 N.E.3d 370, 374 (Ind. 2019). In that particular case, said the supreme court, a truck manufacturer's warranty for its vehicles was worded in such a way as to constitute a warranty of future performance; the court said that:

Courts and commentators generally agree that, in order to constitute a warranty of future performance under UCC section 725(2), the terms of the warranty must unambiguously indicate that the seller is warranting the future performance of the goods for a specific period of time.

Id. at 378 (cleaned up). The court also said:

[W]e reject the premise that Sellers' duty to repair and replace defective goods alone constitutes a future-performance warranty under the UCC. The promise must explicitly extend to the goods' performance, not the sellers' performance, for a specific future time period.

Id. at 379 (emphasis added).

2.2.5 Be careful what you warrant

Recall that a warranty is in effect an insurance policy against the occurrence of a future event — even if the future event is someone else's fault. 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 (extra paragraphing added).

2.2.6 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. That's because under UCC § 2-313, if the representation (i) is related to the goods and (ii) forms part of the basis of the bargain, then the representation is deemed a warranty, no matter what it's called.

2.2.7 Is a warranty a guarantee?

Colloquially the terms "warranty" and "guarantee" are alike, but technically there are some differences; see the commentary at § 1.16 and the terms at Clause 1.17 (Guaranty Protocol).

2.2.8 A hypothetical case: Alice and Bob, again

Let's return to our Alice-and-Bob hypothetical to examine the differences between a representation and a /warranty.

2.2.8.1 Alice and Bob (1): Warranty only

Suppose that Alice only warranted a fact, but she did not represent it. For example, suppose that Alice sold her car to Bob, and she suspected, but didn’t know for sure, that the engine was going to need work.

In that case, Alice might:

  • warrant, but not represent, that the car was in good working order, and
  • limit Bob’s remedy to Alice’s reimbursing Bob for up to, say, $200 in repair costs.

In that situation, at trial Bob would be trying to climb the right side of the above Hill of Proof. The only three evidentiary checkpoints that Bob would need to reach, in trying to climb that side of the Hill, would be the following:

  1. Proof that Alice warranted a statement of past or present fact, to use Tina Stark’s formulation [I’ll leave out future facts for now]. Here, Alice’s statement is “the car is in good working order”;
  2. Proof that Alice’s statement was false — her car, as delivered to Bob, turned out to need some significant work; and
  3. Proof that Bob incurred damages as a result, i.e., repair costs.

If, at the trial, Bob can successfully get past those three evidentiary checkpoints on the Hill of Proof, then he will be entitled to recover warranty damages (generally, benefit-of-the-bargain damages) for Alice’s breach of warranty — but in this case, limited by the contract to $200 in repair costs.

And that’s it; without more, Bob needn't prove that he reasonably relied on Alice's warranty — but neither will he be entitled to tort-like remedies for fraudulent inducement or negligent misrepresentation, such punitive damages and/or rescission, i.e., unwinding the contract.

2.2.8.2 Alice and Bob (2): Representation and warranty

But now suppose that Alice both represented and warranted the statement of fact, i.e., that her car was in good working order. In that case, after Bob makes it up to the first three evidentiary checkpoints on the Hill of Proof, he can try to keep going to hit still more checkpoints on the left side of the Hill, namely:

  1. Proof that Bob in fact relied on Alice's representation — that will probably be almost a given, of course, by virtue of the representation’s being expressly set forth in the contract;
  2. Proof that Bob's reliance was reasonable — ditto, although Alice could try to prove that Bob's reliance was not reasonable under the circumstances; and
  3. Proof that Alice intended for Bob to rely on Alice’s representation — ditto; and
  4. Proof that Alice made the false representation intentionally (or possibly, in some jurisdictions, was negligent or reckless in doing so). This is usually the biggie, from a proof perspective.

If Bob can successfully reach all of these additional evidentiary checkpoints as he climbs up the left side of the Hill of Proof (and if Alice fails to show that Bob’s reliance on her representation was unreasonable), then Bob would be additionally entitled to more “prizes,” namely tort-like remedies such as rescission and perhaps punitive damages.

At trial, Bob might well assert both breach of warranty and fraudulent inducement or negligent misrepresentation. That way, if Bob proves unable to show scienter on Alice’s part, then he can still fall back on his warranty claim.

The same would be true if Alice could persuade the factfinder that Bob’s reliance on her (mis)representation was unreasonable: Bob would lose on his claim for fraudulent inducement or negligent misrepresentation would fail, but he might still be able to win on his warranty claim.

2.2.8.3 Alice and Bob (3): Representation only

Let’s change up the hypothetical once more: Suppose that Alice had no reason to think her car had any problems, but she also didn’t want to bear any risk that it did have problems. In that case, Alice might represent, but not warrant, something like the following: "So far as I know, the car is in good working order, but I'm not a mechanic and I haven't had it checked out by a mechanic."

In that situation, if the car did turn out to have problems, then Bob would have to hit all six checkpoints on the left side of the Hill of Proof to recover damages from Alice; the first three alone, from the right side (breach of warranty) would not be enough — even though the first three would be enough if Alice had warranted the car’s good condition.

2.2.9 "Which do I want for my client – a rep, or a warranty?"

Here's a rule of thumb:

• A party that is asked to represent or warrant something (such as a seller) will always want to consider whether to warrant the thing or to represent it; this might well vary depending on the party's actual knowledge and the potential financial exposure if the represented- or warranted thing turns out not to be true.

• In contrast, any party asking for a representation or warranty (such as a buyer) will always want to push for both a representation and a warranty, so as to give that party more flexibility in litigation — in deciding which side(s) of the Hill of Proof, see § 2.2.1, to try to climb — in case the represented- or warranted thing turns out to be false.

This suggests the following strategy for drafting with a future trial in mind:

– If your client is being asked to represent and warrant some fact — say, if your client is a supplier being asked for a commitment about its products or services — then consider whether the client should only represent the fact, or whether the client should only warrant the fact. As a matter of negotiation strategy the client might eventualy end up agreeing to do both, but as a drafter it’s worth giving some thought to the question.

– On the other hand, if your client is asking someone else to represent and warrant a fact — say, if you're a customer asking for a commitment from a supplier — then you’ll want to ask for the contract language to include both a representation and a warranty. Your client might not have the bargaining power to insist on getting both, but if it does, then having both will give the client more flexibility if litigation should ever come to pass.

Why would a customer ask for both a representation and a warranty? Because "they lied!" is a stinging charge — and 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. Doing so 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!"

Bryan Garner points this out in his famed dictionary of legal usage:

representations and warranties. … Some have asked this: if the warranty gives so much more protection than a representation, why not simply use warranty alone—without representation? It’s a fair point, perhaps, but here’s the reason for sticking to both: some parties to a contract don’t want merely a guarantee that so-and-so will be so in the future; they also want an eye-to-eye statement (representation) that the thing is so now. If it later turns out not to have been so when the representation was made, the the party claiming breach can complain of a lie. …

If only a warranty were in place, the breaching party could simply say, “I’ll make good on your losses—as I always said I would—but I never told you that such-and such was the case.” Hence representations and warranties.

Bryan A. Garner, Representations and warranties, Garner’s Dictionary of Legal Usage (3d ed. 2011) (emphasis edited, extra paragraphing added), quoted in Ken Adams, Revisiting “Represents and Warrants”: Bryan Garner’s View (AdamsDrafting.com 2011).

Example: Oregon v. Oracle. We see the above in the civil suit filed by the state of Oregon against Oracle, in which the second paragraph of the complaint 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.”

The state named various Oracle managers and executives, personally, as co-defendants in a multi-million lawsuit over a failed software development project, with the state suing one Oracle technical manager for $45 million (!). (See § Commentary for a discussion of the state's possible motivations for suing these individuals personally.)

The lawsuit was later settled — Oracle agreed to pay Oregon $25 million in cash and provide the state with another $75 million in technology.

Example: British Sky Broadcasting v. EDS. 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. See BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC).

  • 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.

Arguably one of the most interesting aspect of the judge's opinion is its detailed exposition of the facts, which illustrate 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.

2.2.10 Insurance for representations & warranties?

If you're being asked — or asking another party — to make representations and warranties, you might want to investigate whether insurance coverage is available for those reps and warranties. (It appears that such insurance might be available primarily for merger- and acquisition ("M&A") deals.) See generally, e.g.:

2.2.11 Recap: Key takeaways about reps and warranties

Here are some things every contract drafter and reviewer should know about representations and warranties:

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.

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'm not aware that X isn't true, but I’m not saying that I’ve looked into it.

6.  In contrast: 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 that 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, as discussed in Clause 5.3.4.)

10.  A party that is asked to make both 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.

2.2.12 Warranties can be disclaimed (mostly)

If you've ever even partially read a contract, such as the online "terms of service" for a Website, you've almost certainly seen disclaimers of (implied) warranties.

(Disclaiming representations is trickier in some jurisdictions, but generally it's still doable, as explained in § 2.2.14).

In the (U.S.) Uniform Commercial Code, section 2-316 (governing sales of goods) specifically allows sellers to disclaim warranties that are not expressly stated in the contract, with some limits:

(2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous. Language to exclude all implied warranties of fitness is sufficient if it states, for example, that "There are no warranties which extend beyond the description on the face hereof."

(3) Notwithstanding subsection (2)

(a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like "as is", "with all faults" or other language which in common understanding calls the buyer's attention to the exclusion of warranties and makes plain that there is no implied warranty; and

(b) when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to examine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and

(c) an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade.

A special case is the warranty of title: UCC § 2-312, which requires that any disclaimer of the automatic warranty of title must be expressly stated:

(1) Subject to subsection (2) there is in a contract for sale a warranty by the seller that

(a) the title conveyed shall be good, and its transfer rightful; and

(b) the goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge.

(2) A warranty under subsection (1) will be excluded or modified only by specific language or by circumstances which give the buyer reason to know that the person selling does not claim title in himself or that he is purporting to sell only such right or title as he or a third person may have.

(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.

(Extra paragraphing added.) From a business perspective this makes sense, of course; as an example, even if Alice were to sell Bob a car "as is," Bob should still be entitled to assume that Alice isn't trying to sell him stolen property.

2.2.13 (UK:) Disclaiming only implied warranties isn't enough

A vendor doing a sales transaction under UK law (England, Wales, Northern Ireland) will want to be sure to disclaim not only implied warranties but also implied conditions and implied terms of quality. An oil seller failed to do so and learned that its disclaimer of implied warranties didn't shield it from liability. See KG Bominflot Bunkergesellschaft Für Mineralöle mbh & Co KG v. Petroplus Marketing AG, [2009] EWHC 1088, ¶ 49 (Comm), where:

  • 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 — but by the time the ship arrived at its destination, the gasoil no longer met the agreed specifications.
  • The claimed damages were in excess of US$3 million.
  • 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.

2.2.14 Reliance disclaimers can defeat misrepresentation claims

Suppose that "Alice" and "Bob" enter into a contract, and later Bob wants to claim that Alice misrepresented something to induce him to enter into the contract. The discussion above shows that Bob must persuade the judge or jury that he (Bob) reasonably relied on Alice's representation.

For that reason, Alice might want to include, in the contract, a disclaimer of Bob's reliance, such as the disclaimer in Clause 2.7. Suppliers often take this approach because:

  • in some jurisdictions such as Texas, an entire-agreement provision (as defined in Clause 17.4) in a contract, standing alone, generally won't preclude Bob from claiming that Alice should be liable for "fraud in the inducement" in getting Bob to enter into the contract in the first place;
  • but if the contract states that Bob has not relied and will not rely on any representation by Alice outside the four corners of the contract, then that might do the trick. See, e.g., IBM v. Lufkin Industries, LLC, 573 S.W.3d 224 (Tex. 2019).

Note that reliance disclaimers are probably not needed to disclaim warranties, as opposed to representations, because warranties can be disclaimed by just saying so — perhaps conspicuously, see § 2.2.12 — as discussed above.

In merger- and acquisition ("M&A") deals, reliance disclaimers are often used because one party, typically the seller,

doesn't want to be deceived by the buyer into entering into an agreement (with agreed caps on liability) based on something that may or may not have been said by someone that is not written in the agreement,

and of which the selling shareholders may not even be aware,

and that the buyer may determine to use post closing to make a claim not subject to the cap.

And this is particularly true for the private equity seller concerned about post closing certainty in distributing proceeds to its limited partners.

Glenn D. West, Private Equity Sellers Must View "Fraud Carve-outs" with a Gimlet-Eye, Weil Insights, Weil's Global Private Equity Watch (2016) (emphasis and extra paragraphing added).

Delaware courts are likely to hold parties to the terms of their non-reliance disclaimers — "[b]ut even when fraud claims premised upon extra-contractual representations have been precluded by a non-reliance clause, the express written representations can sometimes provide a basis for a claim of fraud, at least at the motion to dismiss stage." See Glenn D. West, Recent Delaware Cases Illustrating How Uncapped Fraud Claims Can and Cannot Be Premised Upon Written Representations (PrivateEquity.Weil.com 2020) (emphasis added).

2.2.15 Epilogue: Does the "economic loss doctrine" play a role?

In some jurisdictions and some circumstances, the "economic loss doctrine" might bar tort-like claims for negligent misrepresentation relating to a party's performance, and thus preclude recovery of punitive damages. For example, the Texas supreme court concluded that the economic loss doctrine did not allow a general contractor "to recover the increased costs of performing its construction contract with the owner in a tort action against the project architect for negligent misrepresentations—errors—in the plans and specifications." LAN/STV v. Martin K. Eby Constr. Co., 435 S.W.3d 234, 236 (Tex. 2014) (reversing judgment of court of appeal and rendering judgment for architect).

The economic loss doctrine might not bar tort-like claims for misrepresentations made in a contract, for example in cases of fraudulent inducement to enter into the contract. But it seems that not all courts necessarily share that view. See generally Matthiesen, Wickert & Lehrer, S.C, Economic Loss Doctrine in All 50 States (mwl-law.com 2020); Formosa Plastics Corp. USA v. Presidio Eng’rs & Contractors, Inc., 960 S.W.2d 41, 47 (Tex. 1998) (economic loss doctrine does not preclude recovery in tort for fraudulent inducement to enter into contract) (citing cases).

2.3 Representation Definition

When this Definition is adopted in an agreement (the "Contract"), it applies if and when a party (a "representing party")

  • makes a representation,
    • that is, a statement of past‑ or present fact,
  • to a specified other party
  • in connection with:
    • the Contract, or
    • a matter relating to:
      • (x) the Contract, and/or
      • (y) a transaction or relationship resulting from the Contract.

2.3.1 Basic definition

  1. A representation is an assertion of past or present fact.
  1. By making a representation, the representing party asserts that,
    • so far as representing party knows (as defined in Clause 22.30):
    • at the time the representing party makes the representation,
    • the stated fact is true.

2.3.2 Representations must have a reasonable basis

a.  By making a representation (the "main representation"), the representing party implicitly makes an ancillary representation

  • that the representing party has a reasonable basis for the main representation,
  • unless, in the representation itself, the representing party limits the basis for the representation.

2.3.3 The other party may rely on the representation

By making a representation to another party, the representing party states its intent

  • that the other party may rely on both the main representation and the ancillary representation about reasonable basis (see Clause 2.3.2),
  • but the representing party may attempt to show
    • that it was unreasonable for the other party to rely
    • on one or both of the main representation and/or the ancillary representation.

2.3.4 [New York] law is to govern claims of misrepresentation

In any Agreement-Related Dispute (as defined in Clause 22.3),

  • any claim of misrepresentation,
  • whether the misrepresentation was allegedly negligent, reckless, or intentional,
  • is to be decided under the substantive law of the specified jurisdiction,
  • regardless what law might govern the dispute in other respects.

2.4 Warranty Definition

2.4.1 Basic definition

The noun warranty and the verb warrant refer to:

  • a statement,
  • by a party ("warranting party"),
  • that a specified state of affairs:
    • exists, or existed, or will exist,
    • at or during a specified time,
      • which is the time at which the document containing the warranty is agreed to,
      • if not otherwise specified in writing.

2.4.2 What is the effect of a warranty?

A warranty is a conditional promise — in legalese: a conditional covenant —

  • by a party,
  • that if the warranted statement proves untrue,
  • then:
  1. the warranting party will take one or more actions clearly specified in the Contract , if any;
  2. or if no such actions are specified in the Contract,
    • then the warranting party will reimburse the warranty beneficiary (or -beneficiaries)
    • for the foreseeable, ordinary-course, economic losses
    • that are incurred by the warranty beneficiary
    • as a result of the untruth of the warranted statement.
Commentary

The "foreseeable, ordinary-course economic losses" language draws on the well-known English case of Hadley v. Baxendale, discussed in the commentary to the definition of consequential damages at Clause 15.2.3.

2.4.3 A warranty and/or its obligations [can be] limited

A warranting party's obligations will be subject to any applicable exclusions of remedies or other limitations of liability in the Contract.

2.4.4 Who may assert warranty rights?

a.  A warranty will benefit only the specific individuals and organizations clearly identified as such,

  • in the warranty itself,
  • or otherwise in the Contract.

b.  If a warranty does not clearly identify its beneficiaries,

  • then the only beneficiary is the other party,
  • or if more than one, all other relevant parties,
  • to the Contract.
Commentary

A party that wants its own affiliates, etc., to benefit from a warranty should make that clear in the warranty language itself. Here is a hypothetical example: "ABC warrants to XYZ and XYZ's Affiliates that …."

2.4.5 Reliance on a warranty is presumed

Each beneficiary of a warranty is to be rebuttably presumed to have relied on that warranty as part of the basis of the bargain of the Contract.

2.5 Warranty options (rough draft; in progress)

See also the Implied Warranties Disclaimer Definition in the XXX.

With advice of counsel, drafters of an agreement could create warranties using these shorthand terms in much the same way as the famous INCOTERMS three-letter abbreviations such as EXW, DDP, and so on.

Sample language:

ABC makes the following Tango 2020-E warranties to XYZ: [List shorthand terms].

(END)

2.6 Implied Warranty Disclaimer

2.6.1 [Each party] is a "disclaiming party"

The Contract may clearly states otherwise.

2.6.2 Express warranties [are not] affected

This Definition does not affect any express warranties, representations, or other factual commitments

  • that are clearly stated in the Contract.

2.6.3 This implied-warranty disclaimer [is broad]

a.  Each disclaiming party disclaims, not only all implied warranties,

  • but also all purportedly-implied representations, conditions, terms of quality, and other commitments,
  • each, an "implied factual commitment."

b.  In addition, this disclaimer applies regardless whether any purported implied factual commitment was claimed to arise:

  1. by law;
  2. by an alleged custom, practice, or usage in the trade; and/or
  3. by an alleged course of dealing or performance by the parties themselves.

c.  No party will assert that the disclaiming party is liable for breach of any implied factual commitment of a type listed in this section.

2.6.4 Examples of disclaimed implied warranties

A disclaimer of implied warranties has the effect of disclaiming — without limitation — any and all implied factual commitments concerning any and all of the following matters:

  1. merchantability;
  2. fitness for a particular purpose — whether or not the disclaiming party or any of its suppliers or affiliates know, have reason to know, have been advised, or are otherwise in fact aware of any such purpose;
  3. quiet enjoyment;
  4. title — but only if title is specifically mentioned in the disclaimer;
  5. noninfringement;
  6. absence of viruses or other malware in software;
  7. results;
  8. workmanlike performance or ‑effort;
  9. quality;
  10. non-interference;
  11. accuracy of content;
  12. correspondence to description.
Commentary

Subdivision 1: See the UCC definition of merchantability.

2.7 Reliance Disclaimer

If this Disclaimer is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

2.7.1 Who is disclaiming reliance

[Each party] (each, a "Disclaiming Party") DISCLAIMS reliance, as stated in this Disclaimer, on any representation or other statement outside the four corners of:

  1. the Contract, and
  2. any document attached to, or incorporated by reference in, the Contract.

2.7.2 Purpose of reliance disclaimer

When this Disclaimer applies, the parties have agreed to it as part of their knowing, intentional allocation of the risks and benefits associated with the Contract.

2.7.3 Disclaiming Party's warranty

By entering into the Contract, the Disclaiming Party both represents (as defined in Clause 2.3) and warrants (as defined in Clause 2.4),

  • to [each other party],
  • as follows:
  1. the Disclaiming Party is capable —
    • on its own behalf, and/or or through independent professional advice —
    • of evaluating and understanding the terms, conditions and risks
    • of the Contract and the transaction(s) contemplated by the Contract;
  2. the Disclaiming Party understands and accepts those terms, conditions, and risks;
  3. the Disclaiming Party is not relying, and will not rely,
    • on any representation, warranty, recommendation, advice, statement, or other communication,
    • written or oral,
    • by that other party,
    • other than:
      • (i) the specific representations and warranties set forth in the Contract (if any),
        • including without limitation in applicable exhibits, schedules, etc., and
      • (ii) any representations or warranties expressly incorporated into the Contract;
  4. the Disclaiming Party intends for that other party to rely on the reliance disclaimer; and
  5. the Disclaiming Party agrees that such reliance by that other party is reasonable.

2.7.4 Release of future claims

a.  The Disclaiming Party releases each other party

  • from any and all claims
    • by the Disclaiming Party,
    • or anyone claiming through the Disclaiming Party,
  • arising from any reliance,
    • on the part of the Disclaiming Party,
  • on any extra-contractual statement by (or otherwise attributable to) that other party.

b.  The Disclaiming Party WAIVES (as defined in Clause 17.7) the benefits (if applicable) of Section 1542 of the California Civil Code,

  • which states: "A general release does not extend to claims which the creditor does not know or suspect to exist in his or her favor at the time of executing the release, which if known by him or her must have materially affected his or her settlement with the debtor."

2.7.5 Disclaimer limitations

The Contract may limit the scope or effect of this Disclaimer, for example (as defined in Clause 22.21), by stating that Disclaiming Party is disclaiming reliance only on specified categories of statement.

2.8 Background checks: Background

It's not uncommon for customers to want service providers to have background checks done on the providers' key personnel. The goal is normally to identify people with criminal records, drug problems, or other indicia of potential trouble. 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; or
  • if the supplier's personnel will "face" the customer's own customers or clients, that is, be seen or heard by them.

Contract drafters can use the defined terms in Clause 2.9.9 to specify particular background checks to be performed.

2.8.1 Hazards of doing background checks

Background checks can pose dangers for parties requiring them:

  • Suppose that a customer requires a provider to have background checks done on all provider personnel who will be accessing the customer's premises.
  • Then suppose that an employee of the provider complains that the background check violated his rights under applicable law.

The provider's employee might be tempted to sue the customer, not just the provider.

(In that situation, Clause 2.9.8 would require the provider to protect the customer from the cost of defending and/or paying damages for such claims.)

2.8.2 Who will actually do background checks?

Contracting parties don't always conduct their own background checks: Even if they're capable of doing so, they're likely to want to outsource the job and offload the responsibility by engaging a reputable outside service, because professionals in that field —

  • can use economies of scale to do the work more cost-effectively;
  • can be thrown under the bus if something goes wrong; and
  • can provide a layer of liability protection against claims by people who had their backgrounds checked (but claims of negligent hiring against the engaging party could still be viable).

2.8.3 Criminal-records background checks

Criminal records checks in basic form seem to be available from any number of Web sites at low cost, including from government agencies such as the FBI (see https://www.edo.cjis.gov) and the Texas Department of Public Safety (see https://records.txdps.state.tx.us/DpsWebsite/CriminalHistory/).

Caution: Using criminal-records checks to deny employment might lead to trouble with government agencies or with the persons checked if the denials have the effect of unlawful discrimination against minorities or other protected classes. 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.

• The U.S. Equal Employment Opportunity Commission (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; see generally the EEOC general counsel's enforcement guidance published in April 2012.

For example, a blanket prohibition against using personnel with criminal records could be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the United States. See generally the EEOC general counsel's enforcement guidance published in April 2012.

• 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 California, New York, Massachusetts, Illinois, and Pennsylvania (not necessarily an exhaustive list). This is because in recent years the practice of automatically disqualifying people with criminal convictions has come under fire from government regulators and the plaintiff's bar as being potentially discriminatory (the so-called "ban the box" movement).

For a list of states and cities with ban-the-box laws, see Beth Avery, Ban the Box: U.S. cities, counties, and states adopt fair hiring policies (NELP.com 2019).

2.8.4 Drug testing in background checks

Customers with safety concerns might want its contractors' employees to be drug-tested. Depending on the position, even legal drugs might disqualify an individual. For example, an individual taking certain prescription medications might be disqualified from (say) driving a bus or other commercial vehicle.

Caution: Companies, though, should 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.

Companies might also consider the possible effect on employee morale of asking them to take a drug test – and about what they might have to do if a valued employee were to bust the test. As the saying goes, be careful about asking a question if you're not prepared to deal with the answer.

2.8.6 Indemnity and defense against background-check claims

Consider this scenario:

  • Party AA and Party BB enter into a contract under which AA will perform services for BB.
  • Under the contract, AA is to have background checks conducted on certain personnel who will actually be performing the services.
  • BB is concerned about possible liability if the background checks are done badly and someone sues BB for it.
  • So BB wants AA to defend BB (see Clause 14.5) and indemnify it (see Clause 14.2) from third-party claims arising from the conduct of the background checks.

Clause 2.9.8 imposes such an obligation — but as with any indemnity obligation, BB should consider pairing AA's indemnity- and defense obligation with an insurance requirement (or other backup financing source; see § 1.13) in case AA doesn't have the money to comply when the time comes.

2.9 Background Checks Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract:

  • a specified party (a "checking party"),
  • must have background checks performed,
  • on one or more individuals (each, a "checked individual"),
  • in connection with the performance of services or other obligations for another party (a "requesting party").

Discussion checklist:

2.9.1 What specific background checks are required?

[Criminal History Checks] are required,

  • if not otherwise specified in the Contract.
Commentary

See the definitions in Clause 2.9.9 (and consider other possible background checks).

2.9.2 Whose backgrounds must be checked?

The backgrounds of [anyone engaged in Restricted Activities] must be checked.

Commentary

See the definitions in Clause 2.9.9 (and consider other possible background checks).

2.9.3 Who must pay for background checks?

[The checking party] must pay for background checks,

  • unless the Contract specifies otherwise.
Commentary

Service providers often take the view that any customer that wants background checks to be conducted on the provider's personnel should pony up for that cost. On the other hand, a customer might take the position that background checks should be an overhead expense that the provider must bear.

2.9.4 What if a criminal history is revealed?

If a checked individual's background check reveals any Criminal History,

  • then the checking party must not assign, nor permit, that individual
  • to engage in any Restricted Activity for the benefit of the requesting party
  • without first consulting with the requesting party.

2.9.5 What if possible drug misuse is revealed?

a.  This section applies if a checked individual's background check indicates use, by that individual, of one or more of the following:

  1. illegal drugs; and/or
  2. prescription drugs other than in accordance with a lawfully-issued prescription.

b.  The checking party must not assign, nor permit, that individual:

  1. to engage in any Critical Activity for the requesting party
    • without the express prior written consent of the requesting party; nor
  2. to engage in any other Restricted Activity for the requesting party
    • without first consulting with the requesting party.

2.9.6 What standards must background checks meet?

a.  If the checking party performs the background check itself, it must do so:

  1. in a commercially-reasonable manner; and
  2. in compliance with law, including without limitation:
    • any applicable privacy laws,
      • including for example any requirement to obtain the consent of the checked individual; and
    • any applicable requirement,
      • for example, in credit-reporting laws,
    • that the checked individual must be notified
    • before or after a decision is made using information learned in the background check.

b.  If the checking party does not perform the background check itself, it must:

  1. engage a reputable service provider to do so; and
  2. contractually obligate the service provider to comply with the requirements of subdivision a.
Commentary
Strict liability for DIY background checks

This section sets out a strict-liability standard for a checking party that does background checks itself, as opposed to hiring out the job to a reputable service provider — but if the checking party does the latter, it's a safe harbor, meaning that the checking party will have complied with its obligation under this provision.

2.9.7 Some contact information must be independently obtained

As a safeguard against falsified references, all reference checks, if any,

  • other than personal character references,
  • are to be completed using contact information obtained from a source other than from the checked individual him- or herself.

2.9.8 Responsibility for third-party claims

a.  This section applies if a third party (see subdivision c) makes any kind of claim against the requesting party, and/or any other member of the requesting party's Protected Group (as defined in Clause 22.38), where:

  1. the claim arises out of the conduct of a background check under the Contract; and
  2. the background check is done:
    • (i) by the checking party and/or
    • (ii) at the checking party's request or direction.

b.  In such an event, the checking party must Protect,

  • as defined in Clause 14.5.2,
  • the Protected Group member against the claim.

c.  In case of doubt: The checking party's obligation under this section applies, without limitation, to any claim:

  1. by a Checked Individual, and/or
  2. by a government authority.

2.9.9 Definitions for Background Checks

a.  Applicable Background Checks refers to the specific background check(s) that are to be performed under the Contract (see § 2.9.1).

b.  Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question.

c.  Criminal History, as to a checked individual, refers to the checked individual's having been convicted of, or having pled guilty or no contest to, one or more of:

  1. a felony; and/or
  2. a misdemeanor involving fraud or moral turpitude.

d.  Criminal-History Check refers to a nationwide check of records of arrests, convictions, incarcerations, and sex-offender status. A Criminal-History Check is not required to include fingerprint submission to confirm identity.

e.  Critical Activity refers to any activity involving a substantial possibility of:

  1. bodily injury to or death of one or more individuals, including but not limited to a checked individual; and/or
  2. loss of, or damage to, tangible or intangible property, of any kind, of any party other than the checking party; such loss or damage might be physical and/or economic.

f.  Driving-Record Check refers to a check of records of accidents; driver's-license status; driver's-license suspensions or revocations; traffic violations; and driving-related criminal charges (e.g., DUI).

g.  Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals.

h.  Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.

i.  Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years.

j.  Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings.

k.  Personal Reference Check refers to telephone- or in-person interviews with at least [three] personal references, seeking information about the individual's ethics; work ethic; reliability; ability to work with others (including, for example and where relevant, peers, subordinates, superiors, customers, and suppliers); strengths; areas with room for improvement; personality.

l.  Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years.

m.  Restricted Activity refers to any one or more of the following, when engaged in, in connection with the Contract, by an employee of, or other individual under the control of, a checking party:

  1. working on-site at any premises of a requesting party;
  2. having access (including without limitation remote access) to the requesting party's equipment or computer network;
  3. having access to the requesting party's confidential information;
  4. interacting with the requesting party's employees, suppliers, or customers; and
  5. any Critical Activity.
Commentary
Applicable Background Checks

The defined term Applicable Background Checks is used here, as opposed to Required Background Checks, for two reasons:

  1. To avoid creating the implication that the Applicable Background Checks are always an absolute, mandatory requirement, because that could create future difficulties if a background check were skipped and then the checked individual did something bad; and
  2. less importantly, to have the term be alphabetized first with the other definitions below.

Some drafters will want to specify additional background checks than those listed.

Critical Activities

This definition is used in the restrictions on assigning personnel to engage in such activities if their background checks indicate drug misuse.

Educational reference checks

Educational-reference checks are sometimes used as a way of detecting people who falsify their résumés about their education. Sadly, résumé padding is not an uncommon occurrence. For example, in 2014 the chief spokesman of Walmart resigned after the retail giant learned that he had falsely claimed to have graduated from college, when in fact he had not finished his course work (DailyMail.com 2014). Ditto the former dean of admissions at MIT (NPR.org 2015).

Employment verifications

Verification of employment dates, in particular, can help expose undisclosed résumé gaps — or "fudging" of employment dates as listed on the résumé to shorten or eliminate gaps.

It's thought by some that a good practice is not to rely on employer contact information provided by the (former) employee, but instead to find the contact information independently. Otherwise, it's possible that the "employer" is actually someone colluding with the former employee to provide false information.

Some parties might want to obtain more than just the listed information, adding (for example) job duties, salary history, reason for leaving, and/or eligibility for rehire.

Some parties want employment history for the past five to ten years, or for the past two to five employers.

Residence address checks

The residence-address check has in mind that an individual might omit one or more previous residence addresses in the hope of evading a criminal-records check.

2.9.10 Option: Checks by Requesting Party

a.  If this Option is agreed to, the requesting party may cause its own background checks to be conducted on any or all checked individuals.

b.  In conducting any such background checks, the requesting party will:

  1. comply with the background-check provisions of the Contract, and
  2. Protect (as defined in Clause 14.5.2) the checking party's Protected Group (as defined in Clause 22.38) against any claims arising out of noncompliance,

as though the requesting party were the checking party and vice versa.

a.  [@2] The requesting party must bear its own expenses associated with any background checks that it conducts.

b.  The checking party is to provide reasonable cooperation with the requesting party in attempting to obtain any necessary consent for checks from checked individuals.

c.  The requesting party must provide the same defense and indemnity to the checking party and its Protected Group (as defined in Clause 22.38) (if any) as the checking party must provide under this Option (that is, the parties' roles for this purpose will be deemed reversed).

2.9.11 Exercises and discussion questions

2.9.11.1 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?

2.9.11.2 Exercise: Background check clause review & revision

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

EXERCISE: 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.

(You'll probably want to break up the wall of words.)

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 Exercises and discussion questions

2.10.1 Miscellaneous review points

In a past semester, a student wrote: "Provider warrants that all work product provided by MathWhiz to Gigunda will be produced in a workmanlike manner." Two comments:

1.  This is a product warranty, not a services warranty, so it would normally be phrased as, for example, "free from defects in [design?], materials, and workmanship."

  1. If you're representing MathWhiz, you'd want the disclaimer to be "conspicuous" in some way, just in case applicable law required it.

It might be that the conspicuousness requirement would be satisfied if Gigunda's lawyer reviewed the contract, but that's a conversation — or litigation — you don't want to have if you can avoid it, so A.T.A.R.I. (see § 25.6.6)!

2.10.2 Exercise: Reps and warranties strategy

FACTS: Your Aunt Jean is selling her car to a stranger. She says she doesn't know of any mechanical problems.

QUESTION: If the stranger asks Aunt Jean to represent and warrant in writing that the car has no problems, how might she respond?

2.10.3 Implied-warranty disclaimers: Drafting fails

In your groups, discuss the following:

1.  "The Disclaimed Implied Warranties disclaims any implied warranties and representations that may otherwise apply to amendments and waivers of this (i) Agreement, and (ii) any documents relating to this Agreement, unless this Section is expressly waived in accordance with Paragraph C below." QUESTION: Does this make sense?

2.  "Each Party may revoke this disclaimer, in whole, or in part as provided below." QUESTION: Does this make sense from a business perspective?

3.  "This Disclaimer has the effect of diminishing – without limitation – any and all Implied Warranties concerning the following: (a) merchantability; (b) …." QUESTION: What does it mean to "diminish" an implied warranty?

4.  "No person except an officer of Client at the vice-president level or higher is authorized to agree to any other Implied Warranty on behalf of Client." QUESTION: Does this make any sense?

5.  "Except as expressly provided in this Agreement neither party makes any other representation or warranty, express or implied, either in fact or by operation of law, statute, or otherwise, and each party specifically disclaims any and all implied or statutory warranties including warranties of merchantability, of fitness for a particular purpose and non-infringement." REVIEW QUESTION: What are the warranties of: (i) merchantability, and (ii) fitness for a particular purpose?

6.  "Each party acknowledges and agrees to the foregoing and that the foregoing disclaimer is 'Conspicuous.'" QUESTION: Does "Conspicuous" need to be capitalized? QUESTION: Is it legally meaningful for parties to agree to a definition of conspicuous?

7.  "Disclaimer. Except as set forth in this Agreement, each party disclaims any express, statutory, or implied warranty or representation of any kind, including warranties or representations relating to:
(i) The condition of [maybe either the “Specific Location” or the “Seismic Data”]
(ii) Any implied or express warranty of noninfringement
(iii) Any implied or express warranty of merchantability
(iv) Any implied or express warranty of fitness for a particular purpose …."

QUESTION: Is this likely to fly with Gigunda?

2.10.4 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? [2]

QUESTION 2: As ABC's lawyer, how could you improve the warranty provision on this point? [3]

2.10.5 Warranty review questions

2.10.5.1 Review: Must a warranty specify a remedy?

FACTS: A contract states that "Alice warrants that the car is in good condition," but it is otherwise silent about what will happen if the car isn't in good condition.

[Zoom poll:] TRUE OR FALSE: This contract provision isn't really a warranty because it doesn't specify a remedy if the warranty were to be breached.

2.10.5.2 Planning exercises: Warranty duration

FACTS: Consider a contract for the purchase of 1,000 small electric motors, which Buyer intends to use in manufacturing small, battery-powered nose-hair trimmers. (Yes, there is such a thing.) All parties are in Texas. The contract, drafted by Seller, states in part as follows:

Seller warrants to Buyer, for 30 days after delivery, that the motors will have a service life of at least one hundred (100) hours.

QUESTION 1: What if anything is wrong with this provision?

MORE FACTS: A summer associate is reviewing and redlining Seller's draft contract for you on behalf of your client Buyer. The summer associate notices that there is no disclaimer of implied warranties in the draft. After looking up the the Common Draft implied-warranty disclaimer language, the summer associate inserts the following text into the draft (with redlining, of course):

Seller DISCLAIMS all other warranties, express or implied.

QUESTION 2: What if anything is wrong with this provision?

2.10.6 Negotiation exercise: Warranties – who can sue?

FACTS:

  • You have been asked to represent Gigunda USA in negotiating a master purchase agreement under which Gigunda USA and its various affiliates can issue purchase orders to buy widgets from Widgets Inc. You've been asked to review a draft of the master agreement, prepared by Widget's lawyers.
  • The preamble of the master purchase agreement begins: "This 'Agreement' is between Gigunda USA Corporation ('Gigunda'), a California corporation …."
  • One provision of the draft states that "Widgets warrants to Gigunda that the widgets, as delivered, will be free from defects in materials and workmanship."

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

QUESTION 1: Would Gigunda Europe be able to sue Widgets for breach of warranty? [4]

QUESTION 2: As Gigunda USA's lawyer, how could you improve the warranty provision on this point? [5]

2.10.7 Exercise: A CarMax warranty limitation

TEXT: In California, an automobile sales contract disclaimed implied warranties beyond the remedies set forth in an express warranty, which stated: “The dealer will pay 100% of the labor and 100% of the parts for the covered systems that fail during the [30-day] warranty period." The contract also limited the customer's remedies to those stated in the contract.

FACTS: Gutierrez bought the car on May 5, 2013. The car started having transmission problems, including making a grinding noise and having trouble accelerating in traffic. Gutierrez took the car to the dealer for warranty work on June 7.

QUESTION 1: Was the transmission trouble covered by the 30-day warranty?

QUESTION 2: If CarMax engaged you to review the warranty provision, what if any advice might you give about its wording? (Hint: Consider the problems of proof.)

2.10.8 Appendix: Honeywell warranty text

From this purchase-order form:

  1. Warranty

16.1. Supplier warrants to Honeywell, its successors, assigns, customers, and end users that during the entire Warranty Period specified below, all Goods furnished (including all replacement or corrected Goods or components and regardless of whether all or any part of such furnished Goods or any replacement or corrected Goods was manufactured, distributed or otherwise commercialized by a third party prior to delivery by or on behalf of Supplier to Honeywell) will (a) be free from defects in material, workmanship, and design, even if the design has been approved by Honeywell, (b) conform to applicable drawings, designs, quality control plans, specifications and samples and other descriptions furnished or specified by Honeywell, (c) be merchantable, (d) be fit for the intended purposes and operate as intended, (e) comply with all laws and regulations, (f) be free and clear of any and all liens or other encumbrances, and (g) not infringe any patent, published patent application, or other intellectual property rights of any third party and not utilize misappropriated third party trade secret information. Goods that fail to meet the preceding standards are collectively called “non-conforming Goods.” Supplier must obtain third party warranties consistent with Section 16 for all raw materials, components, and services required by Supplier to perform under this Agreement (“Components”) and Supplier is solely responsible for ensuring that all Components meet these requirements. Any Component that fails to meet these requirements will be deemed to be a non-conforming Good.

16.2. As to services, in addition to any express or implied warranties, Supplier warrants that (a) it possesses the requisite expertise, facilities and equipment necessary and appropriate to perform the services, (b) the services will be performed in a safe and workmanlike manner, and (c) the services will be performed in accordance with the highest standards in the industry.

16.3. The Warranty Period is 36 months from the date of delivery to the end user or such longer period of time mandated by any longer government requirement covering the Goods. In addition to the warranties described above, Supplier also warrants all Goods to the same extent and for the same time period (if extending beyond 36 months) as the warranties provided by Honeywell to Honeywell’s customers relating to such Goods. These warranties are for the benefit of Honeywell, Honeywell’s customers, and any other person claiming by or through Honeywell. These warranties will survive any delivery, inspection, acceptance, or payment by Honeywell. Claims for breach of warranty do not accrue until discovery of nonconformance, even if the Goods were previously inspected. Any applicable statute of limitations runs from the date of discovery. If conforming Goods are not furnished within the time specified by Honeywell then Honeywell may, at its election, have the nonconforming Goods repaired, replaced, or corrected at Supplier’s expense or credited to Honeywell. Supplier is responsible for the costs of repairing, replacing or correcting nonconforming Goods or crediting them to Honeywell, and for all related costs, expenses and damages including, but not limited to, the costs of removal, disassembly, failure analysis, fault isolation, reinstallation, re-inspection, and retrofit of the nonconforming Goods or of Honeywell’s affected end-product; all freight charges, including but not limited to incremental freight expenses incurred by Honeywell for shipments of repaired, replaced, or corrected Goods to Honeywell and for shipments of repaired, replaced, or corrected Goods or finished product containing or incorporating repaired, replaced, or corrected Goods from Honeywell to any customer of Honeywell; all customer charges; and all corrective action costs. Unless set off by Honeywell, Supplier will reimburse Honeywell for all such costs upon receipt of Honeywell’s invoice. Any replacement Goods are warranted for the same period as the original Goods. Additionally, if any services are found not to be performed as warranted within a period of 36 months after the conclusion of the performance of the services by Supplier, Honeywell may direct Supplier to either refund to Honeywell the amount paid for the services, or perform the services again in a proper manner to the extent necessary to provide Honeywell with the result originally contemplated by Honeywell. The warranties and rights provided are cumulative and in addition to any warranty provided by law or equity.

16.4. If, following delivery, Goods exhibit a substantially similar repetitive root cause, failure mode or defect indicating a common or systemic failure (“Epidemic Failure”), then, without prejudice to Honeywell’s rights under Section 22: (a) the party discovering the failure will promptly notify the other and Supplier will provide to Honeywell a preliminary plan for problem diagnosis within one business day of such notification, which plan Supplier will revise at Honeywell’s request; (b) Supplier and Honeywell will diagnose the problem, plan an initial work-around and effect a permanent solution; (c) Supplier and Honeywell will agree on a plan for customer notification, replacement scheduling and remediation, including identification of suspect population, field removal, return and reinstallation, work in process (“WIP”), inventory replacement, and repair, or retrofitting, regardless of location or status of WIP completion; and (d) Supplier is responsible for all costs and damages associated with any Epidemic Failure. Honeywell and Supplier will work together in good faith to establish and expeditiously implement an Epidemic Failure action plan. If Supplier or any of its Component suppliers initiate any Product or Component recalls, retrofits, or service bulletins that affect Product quality, Supplier will immediately communicate this information to Honeywell.

16.5. [Omitted]

16.6. Goods and Services covered by this Purchase Order will comply with all applicable treaties, laws, regulations of the place of manufacture and Canadian, European Union and U.S. state and federal laws, regulations and standards (a) concerning the importation, sale, design, manufacture, packaging and labeling of its Goods, (b) regulating the sale of Goods, and (c) relating to the environment and/or the toxic or hazardous nature of Goods or their constituents, including (without limitation) the U.S. Toxic Substances Act, the U.S. Occupational Safety and Health Act, the U.S. Hazardous Communication Standard, the Federal Hazardous Substances Act, the California Proposition 65, European ROHS standards, and other current and subsequently applicable requirements; and Supplier agrees that it shall furnish promptly on request and provide all information and certifications evidencing compliance with such laws, regulations, standards and requirements.

2.10.9 Study guide for the Honeywell warranties

Suggestion: Copy and paste these terms into a Word document, then break them up into "chunks" to make them easier to read and study.

QUESTIONS:

  1. Who could sue Supplier for breach of warranty?
  2. How long do Supplier's warranties last?
  3. Do Supplier's warranties say that:
    • goods will be in a specified condition at delivery; and/or
    • goods will perform in a certain way for a certain period of time? Does that make any difference?
  4. What if goods are bad due to a design flaw for which Honeywell is responsible?
  5. In 16.1(c), what does "merchantable" mean?
  6. In 16.1(d), what is "the intended purpose"?
  7. In 16.1(g), what would it take for Supplier to know whether goods infringed a patent?
  8. In 16.2, is there any inconsistency between (b), "safe and workmanlike," and (c), "in accordance with the highest standards in the industry"?
  9. In 16.2(a), why does Honeywell want Supplier to warrant Supplier's skill, etc. — why not just ask for a warranty of results?
  10. In 16.2, what is the implication of "in addition to any express or implied warranties"?
  11. In 16.3, second and third sentences: Any issues here?
  12. In 16.3, what could be the significance of the following:
    • "These warranties are for the benefit of Honeywell, Honeywell’s customers, and any other person claiming by or through Honeywell"
    • "Any applicable statute of limitations runs from the date of discovery."
    • Any replacement Goods are warranted for the same period as the original Goods." Any ambiguity here?
    • "The warranties and rights provided are cumulative and in addition to any warranty provided by law or equity."
  13. In 16.3, do you see any potentially-enormous financial exposure for Supplier?
  14. In 16.4(c): "Supplier and Honeywell will agree on a plan for customer notification, replacement scheduling and remediation, including identification of suspect population, field removal, return and reinstallation, work in process (“WIP”), inventory replacement, and repair, or retrofitting, regardless of location or status of WIP completion[.]" QUESTION: Any issues here?
  15. In 16.6: Any potential problems here?

2.10.10 Warranty drafting exercise

  1. In pairs (or triples), representing MathWhiz, draft a set of reps and/or warranties that you think:
    • contains the bare minimum that Gigunda will insist on – use the Honeywell warranty provisions above as a guide to what a tough set of customer T&Cs might require; and
    • has terms that you think MathWhiz should be able to support operationally.
  2. Draft a disclaimer of other reps and warranties.
  3. Copy and paste your work into virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ); we'll go over them in class. (Do this anonymously if you want.)

2.10.11 Drafting exercise: Widget warranties

FACTS:

  1. You represent Alice, who 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. Alice wants you to draft a contract for her to enter into with Bob; under that contract, Bob will buy electronic widgets from Alice.
  4. Bob has told Alice that he wants the contract to include, among other provisions:
    • a warranty that the widgets do not contain any defects in design or manufacture; and
    • a provision requiring Alice to indemnify Bob against any harm Bob suffers from defects in the widgets.

EXERCISE:

A. In your groups, discuss what "fences" Alice might want in the two provisions.

B. In virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), draft the two provisions referred to above. Feel free to use whatever language you come across.

2.10.12 Continuation of Widget Warranties exercise

MORE FACTS to continue this exercise:

  1. The negotiated contract between Alice and Bob includes an exclusion of incidental- and consequential damages.
  2. Bob takes delivery of a large quantity of Alice's widgets and stores them in an appropriate storage room.
  3. 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.)
  4. 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 need not 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.

2.10.13 General comments on drafting homework for week 6 (indemnities)

  1. Review: Suppose that MathWhiz agrees to indemnify Gigunda for for any damage that results from MathWhiz's breach of its warranty.
  2. If MathWhiz agrees to indemnify Gigunda from all damages, etc., arising from MathWhiz's negligent performance, that might swallow whatever warranty that MathWhiz makes about its performance (e.g., a warranty that MathWhiz will perform in a workmanlike manner, or professional manner, or whatever). Better to be specific — for example, MathWhiz will indemnify Gigunda against any third-party claims of bodily injury or property damage arising from MathWhiz's negligence, perhaps with a specific carve-out for claims that MathWhiz was negligent in its performance of the services.
  3. Release language might not be appropriate — if MathWhiz agrees in advance to indemnify, defend, hold harmless, and release Gigunda, then in effect MathWhiz is giving Gigunda a get-out-of-jail-free card: Even if Gigunda is responsible for the damage in question, MathWhiz is agreeing to be financially responsible for the damage. (This is referred to as "moral hazard.")
  4. Patent infringement is not something that most service providers want to warrant against or to agree to indemnify, because of the possibility that a patent troll could pop up out of nowhere and claim entitlement to enormous damages from use of an infringing product or service.
  5. Some students said, in effect, (A) MathWhiz will indemnify Gigunda from all Losses (capital L), and (B) Losses are defined as losses, etc., caused by MathWhiz's negligence. The students were laudably trying to break up a long provision, but it's problematic:
    1. Part A creates the initial impression that MathWhiz is taking on very, VERY broad liability. Part B cuts back on the liability, but by then the reader has an inaccurate impression.
    2. The better approach might be to use a different defined term such as "MathWhiz-Responsibility Losses," so that the provision would say that MathWhiz will indemnify Gigunda against all MathWhiz-Responsibility Losses.

2.10.14 Reps and warranties review (2)

The following are examples of reps and warranties drafted by students. Review and note any that "speak to you." (The paragraph numbering below is a continuation from last week's review.)

  1. "Math-Whiz warrants to Gigunda Energy that Math-Whiz’s seismic data analysis will come from the oil field in Outer Mongolia." DCT COMMENT: Does this do much good for Gigunda, in terms of allocating risk and providing assurance that MathWhiz will do something that Gigunda finds useful?
  2. "Contractor represents [and warrants] that it has the experience and knowledge required to perform its obligations under this Agreement in a commercially reasonable manner." DCT COMMENTS: (A) QUESTION: Instead of "in a commercially reasonable manner," what should the drafter have said? (B) This is a good representation in principlr, but the student didn't include an actual commitment (warranty or otherwise) that MathWhiz would do the work properly.
  3. "Contractor warrants that any employees or contractors hired while this Agreement is in effect will be required to pass a background check, approved by Company, before working on any matter associated with this Agreement." DCT COMMENTS: (A) Good point about the background check. (B) QUESTION: What could this have been, instead of a warranty?
  4. "Each Party has made reasonable investigation concerning the matters in this section four." QUESTION: What two things are issues here?
  5. "The Supplier will make commercially reasonable efforts to furnish a report that is complete and accurate in every material respect." QUESTION: How could this be improved, from Gigunda's perspective?
  6. "The Supplier acknowledges that the Report is proprietary to the Customer. Accordingly, the Report will not be shared with any third parties without the Customer’s express written authorization." QUESTION: How could the second sentence be improved? (Hint: Think active vs. passive voice.)
  7. "Unless otherwise provided below, the representations and warranties herein are made only after the representing party has personal knowledge, or has inquired, researched, or otherwise confirmed that the items represented are true." QUESTION: Any issues here?
  8. "Provider represents and warrants it will exercise commercially reasonable efforts, and follow industry standards when analyzing Company’s data." QUESTION: How could this be improved?
  9. "Upon Company’s request, Contractor will provide Company with evidence reasonably satisfactory to Company confirming the foregoing representations and warranties." DCT COMMENT: This is creative thinking. QUESTION: What other, analogous provisions could be included for Gigunda's benefit in this regard?
  10. "Supplier represents to Client that, so far as Supplier is aware, the following assertions are true: [¶] a. Supplier is a limited liability company, duly organized, validly existing, and in good standing under the laws of the Texas; [¶] b. Supplier is duly qualified to do business and is in good standing in every jurisdiction in which such qualification is required for purposes of this Agreement, except where the failure to be so qualified, in the aggregate, would not reasonably be expected to adversely affect its ability to perform its obligations under this Agreement; …." QUESTION: How might Gigunda react to the preamble of this provision?
  11. "Supplier has all of the requisite resources, skill, experience, and qualifications to perform all of the Services under this Agreement in a professional and workmanlike manner, in accordance with generally recognized industry standards for similar services …." QUESTION: Any issues here for Gigunda?
  12. "Math-Whiz represents and warrants that: … (ii) It will provide Gigunda a detailed report on potential oil or gas deposits in a timely manner." QUESTION: How could this be improved?
  13. "Math-Whiz and Gigunda represents and warrants that all information obtained in accordance with this Agreement will be kept confidential." QUESTION: What issues do you see here?
  14. "Math-Whiz and Gigunda represents and warrants that knowledgeable and experienced personnel in the type of services to be rendered in this Agreement will perform such services in a professional, workman-like manner consistent with industry standards and such services will meet all specifications set forth in this Agreement." QUESTION: What issues do you see here?
  15. "Math-Whiz and Gigunda represents and warrants that all information obtained in accordance with this Agreement will be kept confidential." QUESTION: What issues do you see here?
  16. "Company represents to Analyst that if has full ownership of the seismic data collected from the OM Field ('Outer Mongolia Data')." DCT COMMENT: Good job proposing that Gigunda represent its ownership of the data — that'll help MathWhiz smoke out any issues that might be lurking there.
  17. "The Contractor represents that any analyst performing work for the Client is minimally competent and received the requisite education required to perform adequately prior to performing their work for the Client." QUESTION: Any issues here for Gigunda?
  18. "The Contractor represents that it will not grant, directly or indirectly, any right or interest in the Client’s intellectual property to any other person or entity. "QUESTION: Any issues here for Gigunda?
  19. "The Client represents that it will not grant, directly or indirectly, any right or interest in the Contractor’s intellectual property to any other person or entity." QUESTION: Any issues here for either party?
  20. "1. Math-Whiz represents that: (a) it has the legal power to enter into and perform its obligations under the Agreement; and (b) it has experience in analyzing seismic data for oil companies; and (c) so far as it knows, the service provided does not infringe third-party patent rights. [¶] 2. Math-Whiz warrants that: (a) it will not make any unauthorized use of any confidential or proprietary information of any other person or entity; and (b) the analysis of data will be performed in a workman-like manner." DCT COMMENT: Commendably succinct, and gets the job done.
  21. "1. Math-Whiz’s Representations and Warranties. Math-Whiz represents and warrants to Gigunda Energy: (i) represents that it will not grant, directly or indirectly, any right or interest in the (“Intellectual Property”) received from its analysis to any other person or entity; …." QUESTION: Any issues here?
  22. "1. Math-Whiz’s Representations and Warranties. Math-Whiz represents and warrants to Gigunda Energy: … (ii) represents that it will perform the services to the best of their ability and not use the Intellectual Property for personal gain …." QUESTION: Any issues here?
  23. "5.1 REPRESENTATIONS. … 5.4 During the term of this Agreement, neither party will enter into any agreement that would interfere with that party’s performance of its obligations under this Agreement." QUESTION: Any issues here?
  24. "Service Provider represents to Customer that, so far as Mary, the “Representing Party”, is aware, the following assertions are true: …." QUESTION: Any issues here for Gigunda?
  25. "Service provider is qualified to do business under the Laws of every other jurisdiction in which such qualification is necessary under applicable Law, except where the failure to be so qualified or otherwise authorized would not, individually or in the aggregate, reasonably be expected to have a Business Material Adverse Effect." DISCUSS.
  26. "… this Agreement has been executed and delivered by Seller …." QUESTION: Does this make sense?
  27. "… [Seller] has obtained all licenses, authorizations, approvals, consents, or permits required by applicable laws … to perform its obligations under this Agreement …." DISCUSS.

2.10.15 Review question: Key difference between rep and warranty

From a litigation perspective, what is likely to be the most-significant difference between a representation and a warranty, in terms of being able to get summary judgment?

3 Trust, but verify: Due diligence (and ongoing oversight)

Trust, but verify. — Russian proverb, often quoted by the late President Ronald Reagan.

You get what you inspect, not what you expect. — Admiral H.G. Rickover, USN, father of the nuclear Navy.

Contents:

3.1 Introduction

The term "due diligence" is used in a wide variety of transactions to describe the investigations that a party undertakes before deciding whether to enter into a transaction, in an attempt to verify that things are as they have been represented.

Ongoing oversight is largely the same as due diligence, but taking place after agreement to a transaction.

Due diligence/ongoing oversight can take a wide variety of forms, some of which are discussed in this chapter.

3.2 Inspections: Background

Most people try to live up to their commitments. But it might be unwise to count on that, because sometimes, people —

  • can get in over their heads;
  • can misunderstand instructions — possibly because the people who gave the instructions didn't state them clearly;
  • can cut corners, perhaps because they'd prefer — or they're under pressure — to do other things;
  • can suffer a brain cramp, i.e., a momentary mental lapse;
  • can lie, cheat, and/or steal.

These all-too-human tendencies can have severe adverse consequences. It's not hard to find examples:

Volkswagen logo

Dieselgate: German car maker Volkswagen caused certain of its car models to cheat on pollution-control tests so that they would appear to be "cleaner" than they really were: For some types of diesel engine, the company designed the software that controlled the engines to detect when the engines were being tested for pollution and only then activate certain pollution controls. As of June 2020, the resulting cost to Volkswagen of recalls and legal actions had reached $33 billion and the company had pleaded guilty to criminal charges — and criminal charges had also been brought against various engineers and executives who were accused of being involved in the test-rigging. See Volkswagen emissions scandal (Wikipedia.com).

Olympic rings

Falsified earthquate safety data: A Japanese firm "admitted to doctoring earthquake safety data for buildings across the country, including some venues for the 2020 Tokyo Olympics." This represented "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 [sic] maker Nissan had to halt production after problems in its inspection process emerged." Junko Ogura and James Griffiths, Tokyo 2020 Olympics venues linked to earthquake safety data scandal (CNN.com Oct. 20, 2018).

NYC crane collapse - OSHA photo

NYC building-crane collapse: Seven people were killed, and numerous others injured, in the collapse of a building crane in New York City in 2008; the accident was attributed to sloppy work on the part of workers involved in erecting the crane; both criminal charges and civil actions were brought against various people and companies. See John Eligon, Rigging Contractor Is Acquitted in the Collapse of a Crane (NYTimes.com 2010).

Thresher photo

Submarine sinking: In 1963, the American nuclear-powered submarine USS Thresher sank, killing all 129 people aboard, likely because of defective work on non-reactor systems by shipyard workers. See generally USS Thresher (SSN 593) (Wikipedia.com).

Fyre: A planned music festival on a Bahamian island ended up as a train wreck because the promoters were in way over their heads — the chief promoter was sentenced to prison and ordered to forfeit $26 million for wire fraud. See Fyre Festival (Wikpedia.com).

So: If you're expecting another party to a contract to live up to its commitments, consider adding inspection provisions to the contract, perhaps including incorporation of Clause 3.3 (Inspections Protocol) by reference.

3.3 Inspections Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract:

  • a specified party ("inspecting party"),
    • is authorized to have one or more inspections, audits, or other examinations (collectively, "Inspections") conducted,
    • of facilities, products, books, records, or other items,
    • of another party (a "host").

3.3.1 How much advance notice of an Inspection is required?

The inspecting party must give the host

  • at least [ten business days'] advance notice of any desired Inspection,
  • except for good reason (as defined in Clause 3.3.10).

3.3.2 By when must an Inspection be completed?

The inspecting party must ensure that each Inspection is completed

  • no later than [five business days]
  • after the effective date of the notice of the Inspection
  • unless more time is needed for good reason (as defined in Clause 3.3.10).

3.3.3 What information may be included in an Inspection report?

Inspectors may report their findings to the inspecting party,

  • subject only to any applicable confidentiality restrictions.

3.3.4 Who may conduct Inspections?

Inspections may be performed by one or more inspectors that the inspecting party proposes to the host, in writing,

  • if the host does not respond, in writing, with a reasonable objection to the proposal within a reasonable time.

3.3.5 What hours may Inspections be conducted?

The host — in consultation with the inspecting party —

  • may make reasonable decisions about just when an Inspection is to be conducted,
    • e.g., what day(s) and what time(s) of day,
  • with a view toward balancing the needs of the Inspection
    • against possible interference with the host's business.

3.3.6 What workspace must the host provide for inspectors?

  1. The host must provide the inspector(s) with reasonable, visitor-type facilities,
    • such as office space and -furniture, lighting, air conditioning, electrical outlets, and Internet access,
    • all of the type customarily used by office workers.
  2. The inspector(s) are responsible for bringing, setting up, and using any equipment necessary for the Inspection.

3.3.7 What access to host personnel must inspectors be given?

The host must require its personnel to provide reasonable cooperation with the inspectors,

  • including without limitation answering reasonable questions from the inspectors,
  • to the extent not inconsistent with this Protocol.

3.3.8 What may inspectors do with confidential information?

a.  The inspecting party must take prudent measures to keep confidential any non-public information that it learns via the Inspection.

b.  The inspecting party must not use non-public information learned through the Inspection, except for:—

  1. correcting discrepancies identified in the Inspection; and/or
  2. enforcing the inspecting party's rights under the Contract.

c.  The inspecting party must not disclose any non-public information of the host to any third party,

  • except as required by compulsory legal process (see below);
  • and/or as expressly permitted by law,
    • including without limitation the (U.S.) Defend Trade Secrets Act.

d.  The inspecting party must:

  1. promptly advise the host
    • if the inspecting party or any of its affiliates or personnel is served with compulsory legal process (such as a subpoena or a search warrant) covering the host's information,
    • unless the inspecting party's doing so is prohibited by law;
  2. provide reasonable cooperation with the host,
    • if and as requested by the host,
    • to preserve the confidentiality of the host's information after a compulsory legal demand to the inspecting party; and
  3. disclose only the minimum information required by a compulsory legal demand.

e.  The inspecting party must ensure that its inspectors have agreed in writing to comply with the confidentiality obligations of this Protocol.

3.3.9 Is any host information off-limits to inspectors?

The host must give inspectors access to all information reasonably related to the subject of the Inspection,

  • except that the host need not give inspectors access to information,
  • if, under applicable law, the information would be immune from discovery in litigation,
  • for example due to attorney-client privilege, work-product immunity, or any other privilege.

3.3.10 What constitutes "good reason"?

For purposes of this Protocol,

  • and any other Inspection-related provisions of the Contract,

good reason includes, without limitation, any one or more of the following:

  1. significant lack of cooperation by the host; and/or
  2. the discovery of substantial evidence of:

3.3.11 Inspection rights will survive termination

The Inspection-related provisions of the Contract,

  • including but not limited to those of this Protocol:
  1. will survive any termination or expiration of the Contract —
    • but only as to matters that would have been subject to Inspection before termination or expiration; and
  2. will remain subject to all deadlines and other limitations stated in the Contract.

3.4 Recordkeeping & reporting: Background

Many business dealings require parties to depend on information provided by other parties. For example:

  • A commercial lease might require the tenant to pay not just a base rent, but also a percentage of gross revenue, which the tenant must periodically report to the landlord.
  • A technology license agreement might require the licensee to pay the licensor a royalty computed as a percentage of the licensee's gross- or net sales involving the licensed technology, as reported periodically by the licensee.

In many such contract relationship, one party might want to propose that the other side:

  • keep specified records — in part because if a business is sloppy in its recordkeeping, it could be a red-flag warning that the business is sloppy in other areas;
  • make periodic reports; and
  • provide copies of supporting documentation.

See Clause 3.5 for a recordkeeping protocol.

This manual doesn't include a reporting protocol, because the reports desired are very likely to be quite situational in nature.

But if your client will want reports, you can consider including custom-drafted provisions that address issues such as:

  • how often a party must make periodic reports;
  • what sorts of events could trigger a nonperiodic report;
  • when are reports due, e.g., within X days after the end of a month, a quarter, a year, or some specified type of event;
  • what information must be included in a report;
  • whether any particular method is to be used to generate the reports, e.g., using specific auditing software to collect and summarize electronic data;
  • whether reports must be certified, and if so:
    • what the certification should say;
    • who should "sign" the certification — this could be an internal certifier and/or an independent body such as an accounting firm;
  • what if any supporting documentation must be provided with reports.

Consider also whether to propose:

  • audit rights such as in Clause 3.7 (Audit Protocol);
  • inspection rights such as in Clause 3.3; and/or
  • periodic status /conferences, such as by incorporating Clause 20.7 (Status Conferences Protocol).

3.5 Recordkeeping Protocol

When this Requirement is adopted in an agreement (the "Contract"), it applies if and when, under the Contract, a party (a "Recordkeeping Party") must keep records.

Contents:

3.5.1 During what time period must records be kept?

The Recordkeeping Party must cause records to be made and kept,

  • as stated in this Requirement,
  • at all times during [the term of the Contract].

3.5.2 What records must be kept?

a.  The Recordkeeping Party must cause records (the "Required Records") to be made and kept as stated in this section.

b.  The term "Required Records" refers to [records sufficient to document the following], when and as applicable:

  1. all deliveries of goods and services under the Contract by the Recordkeeping Party to another party;
  2. billing of charges or other amounts under the Contract by the Recordkeeping Party to another party;
  3. all payments, by the Recordkeeping Party to another party, under the Contract,
    • of amounts not verifiable by the Recipient, such as, for example,
    • commissions, royalties, or rents to be paid to the other party as a percentage of the Recordkeeping Party's sales; and
  4. all other information (if any) that the Contract requires the Recordkeeping Party to report to another party.

3.5.3 What quality standards must records meet?

The Recordkeeping Party must cause all Required Records:

  1. to be accurate and materially complete;
  2. to comply with at least commercially reasonable (as defined in Clause 9.5) standards of recordkeeping; and
  3. to comply with any stricter recordkeeping standards specified in the Contract.

3.5.4 How long must records be retained?

The Recordkeeping Party must cause each of the Required Records to be kept

  • for at least the longest of the following (the "Record-Retention Period"):
  1. any retention period required by applicable law;
  2. the duration of a timely-commenced audit (see § 3.7) of the Required Records
    • that is permitted by the Contract, if any; and
  3. such other period as is clearly specified in the Contract, if any.

3.5.5 Option: Record Retention per FAR Standard

If this Option is agreed to,

  • the Recordkeeping Party must cause each of the Required Records to be maintained
  • for at least the period that the record would be required to be maintained
  • under the (U.S.) Federal Acquisition Regulations ("FARs"), Contractor Records Retention, 48 C.F.R. Subpart 4.7.

(Note: This citation is merely a convenient shorthand reference in lieu of setting out the cited substantive terms; the parties do not intend to imply or concede that the Contract and/or their relationship are in fact subject to the FARs.)

3.6 Audits: Background

3.6.1 Reasons to ask for audit provisions

Tango: Clause 3.7.

One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships"; he 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;
  • cheating on 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 Craig L. Greene, Audit Those Vendors (2003).

3.6.2 Issues to address in an audit provision

The table of contents of Clause 3.7 (Audit Protocol) provides a list of issues that an audit provision could address, such as:

  • how often audits may be conducted;
  • deadlines for asking for an audit of a particular record;
  • how much advance notice of an audit must the auditing party give;
  • how big a discrepancy should be required before the recordkeeping party will be required to reimburse the auditing party for its audit expenses;
  • whether the recordkeeping party should be entitled to reimbursement for its audit expenses.

3.7 Audit Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract:

  • a specified party (an "auditing party") may have audits conducted,
  • of specified records kept by another specified party (a "recordkeeping party").

[Brackets] indicate an item that the parties may modify by unambiguously saying so in the Contract.

3.7.1 Auditable records

The term "auditable records" refers to records sufficient to document each of the following, as applicable under the Contract:

  1. labor and/or materials billed to the auditing party;
  2. other items billed to the auditing party;
  3. compliance with specific requirements; and
  4. any other clearly-agreed auditable matters;

unless the Contract clearly provides otherwise,

3.7.2 Maximum audit frequency

An auditing party may request an audit only up to once per [12-month] period,

  • and [once] per period audited,
  • whichever is more restrictive,
  • unless good reason (as defined in Clause 3.3.10) exists for more-frequent audits.
Commentary

An audit might well be at least somewhat burdensome and disruptive to the recordkeeping party. Some recordkeeping parties might therefore want to negotiate the limits stated in this section.

3.7.3 Advance notice requirement

An auditing party must give the recordkeeping party at least [ten business days'] notice (as defined in Clause 20.6) of any proposed audit,

Commentary

A recordkeeping party will want to negotiate for reasonable advance notice of an audit, because normally both parties will benefit if the recordkeeping party has a reasonable time to collect its records, remedy any deficiencies, etc., before the auditor(s) get there.

On the other hand, a surprise audit might be in order if the auditing party has reasonable grounds to suspect cheating or other malfeasance.

3.7.4 Deadline for requesting an audit

a.  An auditing party may request an audit of any particular record only on or before the later of the following dates:

  1. the end of any legally enforceable record retention period for that record, if any; and
  2. the end of [three years]
    • following the end of the calendar quarter,
    • in which the substantive content of the record was most-recently revised.

b.  After the relevant date under subdivision a has passed,

  • the particular record in question is deemed uncontestable,
  • absent a showing,
  • by clear and convincing evidence (defined in Clause 22.12),
  • of good reason (defined in Clause 3.3.10).
Commentary

A recordkeeping party might want to negotiate a deadline for requesting an audit, after which the records in question become uncontestable absent good reason. That's because:

  • at some point, the recordkeeping party might want to be able to get rid of its records;
  • the recordkeeping party likely wouldn't want to have to support an audit of (say) 20 years of past records;
  • "sunset" provisions can be a Good Thing generally.

EXAMPLE: In a Hollywood-related case, an audit deadline came into play in a dispute over profits from the TV show Home Improvement:

  • The plaintiffs were writers and producers of the show. Their contract with the Walt Disney company required Disney to pay them a percentage of the show's profits and to periodically provide accounting statements.
  • The plaintiffs claimed that Disney had underpaid them. Disney responded that under the contract's 24-month deadline for requesting an audit, the accounting statements, and thus the payments, were incontestable. A trial court granted summary judgment in favor of Disney on grounds that the plaintiffs' claims were time-barred by the 24-month deadline provision. The appeals court reversed, holding that a jury must decide whether Disney orally waived or agreed to modify the incontestability provision.

Absent a deadline for requesting an audit, a creative counsel might try to argue that the counsel's client had the right to conduct an audit even when, for example, the underlying agreement had expired or been terminated — a labor union tried (unsuccessfully) to make such an argument in a First Circuit case.

3.7.5 Interest rate for past-due amounts

A party that is found by an audit to owe money,

  • due to that party's error (or other fault),
  • must pay simple interest to the other party on the amount(s) owed,
  • at [1.5% per month],
    • or the maximum rate permitted by law, if less,
  • from the date the money was originally due
    • or if later, from the earliest start date permitted by law,
  • until paid in full,
  • in accordance with Clause 1.8 (Interest Charges Protocol).

3.7.6 Audit expense shifting

a.  The recordkeeping party must reimburse the auditing party

  • for its reasonable out-of-pocket expenses actually incurred,
  • including without limitation reasonable fees and expenses charged by the auditor(s),
  • if the audit was occasioned by, or revealed or confirmed, one or more of the following:
    • that the recordkeeping party overbilled (or underpaid) the auditing party,
      • by more than [5%]
      • for the period being examined; and/or
  • fraud,
    • and/or material breach (see § 22.31.2) of the Contract,
  • by the recordkeeping party,
    • or for which the recordkeeping party is responsible,
    • either by law or as stated in the Contract.

b.  Otherwise, as between the recordkeeping party and the auditing party,

  • the auditing party is responsible for all audit expenses referred to in subdivision a
  • unless the Contract clearly says otherwise.
Commentary

The threshold for shifting audit expenses to the recordkeeping party might well be negotiable. It often will fall in the range between 3% and 7% for royalty-payment discrepancies and perhaps 0.5% for billing discrepancies in services.

This section calls for expense-shifting if a discrepancy of a stated percentage is revealed "for the period being examined." Why? Suppose that in an audit of five years' worth of your records, the auditors discover a 5% discrepancy in your records for a single month. In that situation, you shouldn't have to foot the bill for the expense of the entire five-year audit.

But now looking at the other side of the reimbursement issuse: Should the auditing party be required to reimburse you for your expenses in an audit? Your expenses might not be trivial; an article notes that "audit provisions rarely address the apportionment of the costs incurred by the contractor or its subcontractors in facilitating the audit, managing the audit, reviewing and responding to the audit results, and other related activities if the audit fails to demonstrate significant overbilling by the contractor."

Reimbursement of the recordkeeping party's expenses can be addressed with Clause 3.7.17 (Option: Recordkeeping Party Expense Reimbursement).

3.7.7 Form of records

The recordkeeping party must make all auditable records available to the auditors

  • in the form in which the records are kept in the ordinary course of business.
Commentary

Auditors will usually want to see records in the form in which they're kept in the ordinary course of business. That's because:

  • Handing auditors a stack of hard-copy printouts of computer records would no doubt significantly increase the cost of the audit; and
  • Seeing the records in their original forms could help auditors detect signs of tampering, which might indicate fraud.

Pro tip: a recordkeeping party might want to restrict auditors' access to the party's facilities, computers, etc. For example, in audits of a licensee's usage of software, a possible compromise might be to allow a third-party auditor to have limited access to the licensee's computer systems, etc., under a strict confidentiality agreement.

3.7.8 Cooperation with auditors

Except as otherwise provided in this Protocol, the recordkeeping party must:

  1. make its relevant personnel reasonably available to the auditors, and
  2. direct those personnel to answer reasonable questions from the auditors.

3.7.9 Permissible auditors

a.  An auditing party may engage any of the following to conduct an audit:

  1. [any Big Four] accounting firm; and/or
  2. any independent accounting firm that regularly audits the recordkeeping party's relevant records;
    • the auditing party WAIVES (as defined in Clause 17.7) any conflict of interest in that regard.

b.  Any other auditor(s) must have the recordkeeping party's consent, as follows:

  1. The recordkeeping party [must not] unreasonably withhold its consent to proposed auditors.
  2. The recordkeeping party is deemed to have consented to a proposed auditor
    • if the recordkeeping party does not give the auditing party notice (as defined in Clause 20.6) of its objection
    • within [five business days] after receiving or refusing the auditing party's written proposal to use that auditor.
Commentary

An auditing party might not want to bear the expense of having an outside auditor do the job, and instead might prefer to send in one of its own employees to "look at the books."

On the other hand, a recordkeeping party might not want the auditing party's own personnel crawling around in the recordkeeping party's records, but might be OK with having an outside accountant (or other independent professional) do so.

Subdivision a.2: Contracts consultant John Tracy, suggests, in a LinkedIn discussion thread (membership required), that an auditing party should consider engaging the outside CPA firm that regularly audits the recordkeeping party's books. He says that this should reduce the cost of the audit and assuage 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 [sic] license and accreditation and get sued for malpractice."

Subdivision b: 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. This provision represents a compromise.

3.7.10 Working hours for audits

Unless otherwise agreed, the recordkeeping party must allow each audit to be conducted:

  1. at the location or locations where the auditable records are kept in the ordinary course of business;
  2. during the regular working hours,
    • at that location,
    • of the party having custody of the records; and/or
  3. at one or more other reasonable times and places,
    • designated in advance by the recordkeeping party,
    • in consultation with the auditing party.

3.7.11 Off-limits information

The recordkeeping party need not allow the auditor(s) to have access to any of the following:

  1. information that, under applicable law, would be immune from discovery in litigation, including without limitation on grounds of attorney-client privilege, work-product immunity, or any other privilege;
  2. trade secrets and other confidential information relating to formulae and/or processes; and
  3. clearly-unrelated or -irrelevant information.
Commentary

In the case of the attorney-client privilege, disclosure of privileged information to outsiders likely would waive the privilege in many jurisdictions and thus make the privileged information available for discovery by others, including third parties.

A recordkeeping party might also want to specify other particular audit exclusions.

Subdivision 3's exclusion might be open to dispute, but at least it gives the recordkeeping party ammunition with which to oppose an unreasonable "fishing expedition" by the auditing party.

3.7.12 What auditor workspace must the recordkeeping party provide?

IF: An audit is to be conducted at one or more sites controlled by the recordkeeping party; THEN: The recordkeeping party, at its own expense, must cause the audit site(s) to be furnished with appropriate facilities, of the type customarily used by knowledge-based professionals.

Commentary

In an unfriendly audit, an uncooperative recordkeeping party might try to make the auditors work in a closet, a warehouse, or worse.

3.7.13 Auditors' confidentiality obligations

Auditors must agree in writing to comply with the same confidentiality obligations that apply to the auditing party.

3.7.14 Auditor retention of copies

a.  The auditors may make and keep copies of auditable records,

  • subject to the confidentiality- and return-or-destruction provisions of this Protocol.

b.  In due course, the auditors must destroy or return any copies that they retain under subdivision a,

  • in accordance with the auditors' regular, commercially-reasonable policies and processes.
Commentary

An auditing party's auditors might well find it burdensome (and therefore more expensive for the auditing party) to be precluded from making copies of the recordkeeping party's records. Moreover, outside auditors might insist on being able to take copies with them to file as part of their work papers.

However, in some circumstances, the recordkeeping party might want to negotiate for limits on the types of records that the auditor(s) are allowed to copy and take away.

3.7.15 Will the recordkeeping party get copies of audit reports?

If the recordkeeping party so requests in writing to the auditors,

  • with a copy of the request to the auditing party,
  • the auditors must promptly furnish the recordkeeping party
  • with a complete and accurate copy of the audit report,
  • at no charge.
Commentary

A recordkeeping party might not care about getting a copy of the audit report if all the report says is, basically, everything's cool here.

But if the recordkeeping party will have to come up with extra money — or if the audit report says that the auditing party has materially breached the Contract — then the recordkeeping party likely will indeed want a copy of the audit report.

An auditing party might not want to provide a copy of the audit report to the recordkeeping party. But let's face it:

  • If the dispute goes to litigation or even arbitration, the odds are high that the recordkeeping party's lawyers will be able to get a copy of the audit report as part of the discovery process (for example, by issuing a subpoena to the auditors).
  • And any confidential information in the audit report is presumably the recordkeeping party's confidential information.

So it's hard to think of a good reason for the recordkeeping party not to get a copy of the audit report.

3.7.16 Corrective action after an audit

a.  Each party must promptly correct any discrepancy revealed in an audit,

  • where that party was responsible for the discrepancy,
  • for example, an overbilling or an underpayment.

b.  No invoice need be sent for a payment required under § 3.7.16,

  • other than the audit report and a written request for payment.

3.7.17 Option: Recordkeeping Party Expense Reimbursement

a.  If this Option is agreed to,

  • and for a particular audit, the recordkeeping party is not required to reimburse the auditing party's expenses of the audit,
  • then the auditing party must reimburse the recordkeeping party,
    • and the recordkeeping party's subcontractors, if applicable,
  • for reasonable expenses that the recordkeeping party (and/or its subcontractors) actually incurred in connection with the audit.

b.  Such expenses would include, without limitation,

  • reasonable fees and expenses for an auditor engaged by the recordkeeping party (if any)
  • to monitor the audit.
Commentary

See the commentary to § 3.7.6 (audit expenses).

3.7.18 Option: True-Up as Exclusive Audit Remedy

a.  If this Option is agreed to, it will apply if both of the following are true:

  1. The auditor's report provides clear support
    • for the existence of a discrepancy
    • for which the recordkeeping party is responsible; and
  2. The recordkeeping party complies
    • with the discrepancy-related requirements of this Option
    • within [ten business days]
    • after the recordkeeping party receives a copy of the auditor's report.

b.  Except as provided in subdivision c,

  • the recordkeeping party's compliance with those discrepancy-related requirements
  • will be the recordkeeping party's only liability,
  • and THE AUDITING PARTY'S EXCLUSIVE REMEDY,
  • for the discrepancy.

c.  The exclusive-remedy limitation of subdivision b will not apply, however, if the audit revealed or confirmed—

  1. fraud (see § 16.13); or
  2. a material breach (see § 22.31.2) of the Contract,

in either case for which the recordkeeping party was responsible by law and/or under the Contract.

Commentary

If you're an auditing party, you might object to this provision if you wanted to be free also to demand a greater measure of damages for the discrepancy revealed by the auditor's report if that were available by law — such as indirect damages resulting from copyright infringement if the audit showed that the recordkeeping party had used your software for more than it had paid you for. This came to pass in a lawsuit involving the MGM Grand Hotel and the Broadway musical Kismet, as discussed in the commentary to [BROKEN LINK: pmt-ne-infr][BROKEN LINK: pmt-ne-infr].

As a contrary example, though: A software customer might want to include this Option in the Contract as a shield against a forceful software licensor (cough, Oracle), if an audit by the licensor revealed that the customer was making more use of the software than it had paid for.

Software licensors might well be willing to go along with such a limitation of liability — but possibly with the proviso that any catch-up license purchases would be at full retail price, regardless of any negotiated discount; otherwise the customer would have an incentive to roll the dice and cheat on obtaining licenses.

3.7.19 Option: Audit Requirement Flowdown

If this Option is agreed to,

  • the recordkeeping party must make sure
  • that each of its subcontracts under the Contract, if any,
  • includes "flowdown" provisions as follows:
  1. a requirement that the subcontractor permit audits by the auditing party
    • in accordance with the Contract's audit provisions; and
  2. an authorization for the subcontractor
    • to deal directly with the auditing party and its auditors
    • in connection with any such audit.

3.7.20 Exercises and discussion questions

3.7.20.1 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.

3.7.20.2 Audits and inspections — topics for discussion
  1. When a customer wants the contract to say that it can audit the supplier's invoices and billing records, who should pay for any audit that gets conducted?
  2. Who should be a permissible auditor?
  3. Should any supplier information be off-limits to an auditor?
3.7.20.3 Audits exercise: Gigunda & MathWhiz

FACTS: Gigunda wants MathWhiz to undertake a time-and-materials project. (What's that?) Gigunda is proposing a draft contract in which MathWhiz must keep records for five years and allow Gigunda to audit the records.

QUESTION: What kind of fences might you want to try to put around Gigunda's audit right in order to save MathWhiz from unnecessary burden and expense? Use the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ) to make a list (no need for exact language).

3.7.20.4 Audit clause (for in-class exercise)

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. (and/or R.O.O.F.O.).

x.x Audits. Upon request, Provider and Provider Agents will provide Customer and internal and external auditors, inspectors, governmental authorities and other representatives that Customer may designate (collectively, “Customer Auditors”), with timely and unrestricted access to the Project Staff, the locations at which the Services are performed at or from, systems, records documenting the performance of the Services and the invoicing of the fees hereunder, and other pertinent data and information for the purpose of inspecting, examining and auditing the Services and the operations of Customer relating to the Services, including to verify (a) the fees invoiced and paid hereunder, (b) performance of the Services, (c) compliance with the Agreement, (d) the use of Customer property and (e) the integrity of those elements of Customer’s corporate control processes that are performed by Provider. If any such audit reveals an overcharge to Customer, then within thirty (30) days following the completion date of such audit, Provider will pay to Customer the amount of such overcharge, plus interest at JPMorgan Chase & Co.’s then current prime commercial lending rate, calculated from the date of receipt by Provider of the overcharged amount until the date of payment to Customer. In addition, if any such audit reveals an overcharge to Customer by an amount greater than five percent (5%) of the audited invoices, then Provider will reimburse Customer for the costs and expenses of such audit.

QUESTION 1: To what extent will Provider even have the power to cause "Provider Agents" to comply with the first sentence? How could that be addressed?

QUESTION 2: What if any "fences" are there around the right of Customer Auditors to come in and poke around? To what extent might that be a concern for Provider?

QUESTION 3: What other concerns might Provider have about this clause?

4 Services

It's probably a decent bet that contracts for services are among the ones most commonly entered into by businesses, at least in the U.S. (In part, that's because sales of goods have less need for elaborate contracts, again at least in the U.S., because sales of goods are governed by article 2 of the Uniform Commercial Code, which provides standard- and/or gap-filler terms and conditions.)

Contents:

4.1 Services: Background

4.1.1 Written statements of work are important

Services agreements almost universally state that services will be rendered as set forth in an applicable statement of work. This is important, especially in high-dollar projects, to help make sure that the parties are (more or less) on the same page about what will be done, when, with what limitations and constraints (if any), and, crucially, for what cost, paid when.

How to write a statement of work is beyond the scope of this manual, but a Google search will reveal plenty of resources with tips for drafters.

4.1.2 Starting work before signing might be a roll of the dice

It can be risky to start work on a services project without having something in writing to nail down what will be done and how much is to be paid. Consider a California case about the Fast & Furious movies and a dispute about whether a producer was entitled to a percentage of the studio's earnings:

• Neal Moritz was a producer who worked for Universal Studios on the Fast & Furious series of movies, entered into a series of written contracts with the studio that covered "sequels" and "remakes."

• Moritz started work on the Hobbs & Shaw spinoff, which was not a sequel or remake. (The parties agreed that this was the case.)

• Moritz did this without a finalized written contract, just drafts that had been exchanged with the studio; the court recounted that:

In the FAC [first amended complaint], Moritz alleges that in connection with the Fast & Furious contracts, Moritz and Universal had fully negotiated and agreed upon an oral producer deal before any writings were exchanged, and that typically, Moritz would begin working on the production of the film prior to the oral producer deal being reduced to writing.

Moritz alleges that this again occurred with respect to Hobbs & Shaw, but this time, Universal failed to honor the terms of the parties’ oral agreement.

• The studio decided it didn't want Moritz involved, nor to pay him what he claimed was his customary first-dollar percentage.

• Moritz sued for breach of the alleged oral contract — and at this writing, it's unknown what the outcome of the case will be.

4.1.3 Even a very-short written contract can suffice

In the Hobbs & Shaw litigation discussed just above, the parties likely could have avoided litigation altogether if they had signed even a very-short written agreement. The court noted that for the Fast & Furious movies 8 through 10, the parties' contract was less than two pages long because it simply adopted a previous written contract with limited modifications. (Slip op. at 3.)

(For a few more examples of short contracts, see § 25.4.6.)

4.1.4 Caution: Not having licenses and permits can be costly

Tango: Clause 4.2.4.

Imagine that you're a service provider. Now imagine that for a particular project, you don't have all your required licenses and permits in place, at all times. That could give your customer the legal right to "stiff" you — and even to demand that you repay money you've already been paid.

For example: Under a California statute, a contractor might forfeit its right to be paid if it undertakes work required to be done by a licensed contractor (e.g., certain construction- or remodeling work), but does not itself have the proper license(s) at all times while performing the 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.

4.1.5 What if conditions "on the ground" aren't as believed?

Tango Terms: Clause 4.3.1 (Option: Provider's Investigation)

Both service providers and customers should consider specifying who is responsible for making sure that the relevant portion of "the real world" is what the parties think it is, and expressly allocating that responsibility in the contract. This proved dispositive in a Fifth Circuit case stemming from the construction of a new apartment complex in Corpus Christi, Texas:

• The general contractor solicited a bid from an excavation company (referred to here as the "digging company") for site grading and excavating work; the general contractor sent documents to the digging company, including proposed contract terms, a topographical survey of the site, and the planned final elevations.

• The subcontract between the digging company and the general contractor included the following provision:

Execution of this Agreement by the Subcontractor is a representation that the Subcontractor has visited the Project site, become familiar with local conditions under which the Work is to be performed and correlated personal observations with requirements of the Contract Documents.

The Subcontractor shall evaluate and satisfy itself as to the conditions and limitations under which the Work is to be performed, including without limitation: (1) the location, condition, layout, and nature of the Project site and surrounding areas; (2) generally prevailing climactic conditions; (3) anticipated labor supply and costs; (4) availability and cost of materials, tools, and equipment; and (5) other similar issues.

Accordingly, Subcontractor shall not be entitled to an adjustment in the Contract Price or an extension of time resulting from Subcontractor’s failure to fully comply with this paragraph.

• But the digging company did not visit the project site as represented in the above contract clause — and as it turned out, more dirt needed to be removed than either party had anticipated; after a bench trial, the district court awarded damages to the digging company for that additional work.

The Fifth Circuit vacated that part of the district court's judgment, holding that the digging company was not entitled to be paid for the additional dirt removal, because the digging company had assumed the risk that conditions at the site were not what it anticipated. The appellate court noted:

The default rule in Texas … is that the party doing the work bears the risk that it will end up being more difficult than anticipated unless the contract shifts that risk to the buyer of the services.

In order for an owner to breach a contract by supplying inadequate plans to a contractor, Texas law requires that the contract evidence an intent to shift the burden of risk of inadequate plans to the owner.

This default rule flows from the basic contract principle that where one agrees to do, for a fixed sum, a thing possible to be performed, he will not be excused or become entitled to additional compensation, because unforeseen difficulties are encountered.

If a factory agrees to manufacture 100 widgets for $500, it cannot later charge $600 if it ends up taking more labor or materials to produce the widgets than expected.

The default rule applies here because the excavation contract does not allocate to Thompson the risk that the site would be unbalanced. If anything, it placed that risk on D2. …

As a result, D2 would not be entitled to an adjustment in the Contract Price or an extension of time resulting from its failure to fully comply with those conditions. That agreement to verify the topography of the site put the risk on D2. Someone has to bear the loss of additional costs, and the excavation contract did not shift those costs to Thompson.

 * * *

If the contract had required less excavation work than the parties expected, Thompson would not be able to get a refund on the $630,000 it agreed to pay. Likewise, when the work turned out to involve more work than the parties expected, D2 cannot recover more than the $630,000. Thompson did not breach its contract with D2 when the site turned out to be unbalanced. …

4.1.6 Adopting a standard of "professional" performance

Tango: Clause 4.2.10 ("Professional" service performance is required).

4.1.6.1 "Professional" is a synonym for "workmanlike"

The term professional is used in Clause 4.2.10 instead of workmanlike because the former term sounds more, well, professional. But Clause 4.2.10 defines the term professional by borrowing from the Supreme Court of Texas's definition of workmanlike.

In that section's definition of professional, the phrase "without necessarily rising to the level of being exceptional, outstanding, or original" is adapted from an alternate definition of workmanlike in the Merriam-Webster dictionary, namely "competent and skillful but not outstanding or original."

4.1.6.2 A covenant, not a representation or warranty

The performance-requirement language in Clause 4.2.10 sets forth a covenant, that is, a promise, and not a representation or warranty – although a warranty is a type of covenant (specifically, a conditional covenant).

4.1.6.3 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.

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.
  • 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. But 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 Clause 2.6 (Implied Warranty Disclaimer) and its associated commentary.

4.1.6.4 Alternative performance standards

Some service providers might balk at using the term professional or workmanlike performance because they fear the term could be ambiguous; these providers 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 accordance with industry standards: This phrase and professional (or workmanlike) seem synonymous, in which case professional is more likely to find acceptance among customers.
  • 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 agrees to this might as well hang 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 the discussion of best efforts (as defined in Clause 9.6).)
Performance standards: Optional Further reading

See generally, e.g.:

4.1.7 What to do about defective work?

A sensible approach (in the author's view) approach to handling defective work is shown in Clause 5.3.

4.1.8 Are authorizations for use of deliverables needed?

Tango: Clause 4.2.5.

In any services contract, both the provider and the customer should give some thought to whether any third-party authorizations might be needed for the customer to be able to use the deliverables.

4.1.8.1 Use of deliverables and third parties' IP rights

Services contracts sometimes include a warranty by the provider that, in performing the services, the provider will not infringe any third party's intellectual-property rights. The provider might even warrant that the deliverables themselves do not infringe third-party IP rights. And under the (U.S.) Uniform Commercial Code, a merchant seller of goods (not services) implicitly warrants the goods' noninfringement:

(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 those warranties might not protect the customer from third-party infringement claims arising from the customer's use of the deliverables, which is a distinct issue. Example: Under U.S. patent law, use of a patented product or method, without permission of the patent owner, would infringe the patent:

(a) Except as otherwise provided in this title, whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefor, infringes the patent.

* * * 

(g) Whoever without authority imports into the United States or offers to sell, sells, or uses within the United States a product which is made by a process patented in the United States shall be liable as an infringer, if the importation, offer to sell, sale, or use of the product occurs during the term of such process patent. …

For that matter, the responsibility for infringement might even rest with the customer, not the provider, because the rest of UCC § 2-312(3) provides as follows:

(3) … 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.

4.1.8.2 Use of deliverables might violate other laws

It should be apparent that a services provider can't necessarily warrant that the customer's use of deliverables won't violate applicable law. Example: Suppose that a freelance software developer is engaged by a customer to write a computer program that scans the customer's network in search of security gaps.

  • Such a computer program might also be usable for nefarious purposes — most obviously, scanning someone else's network in an attempt to break in.
  • It follows that the software developer would not want to warrant that the customer's use of the computer program would not infringe any third-party rights.

4.1.9 Is Provider guaranteed a certain amount of work (or money)?

Tango: Clause 4.2.3.

It's not unheard of for service providers (and their lawyers) to claim that they were somehow entitled to a certain minimum amount of billable work or of compensation.

• This was seen a Louisiana case in which Dow Chemical Co. terminated a contractor "at will" on 90 days' notice, as permitted by the contract, but then did not assign the contractor any work during the 90-day notice period. A jury awarded the contractor the lost profits it supposedly would have received if it had gotten work; the Fifth Circuit, however, held that the contract unambiguously did not require Dow to assign the contractor work during the termination-notice period.

• In a Chicago case, a subcontractor claimed that its prime contractor, IBM, had breached an alleged promise to provide the subcontractor with $3.6 million of work on a project for the Chicago Transit Authority. IBM won the case on summary judgment, but again it still had to defend against the claim.

For that reason, § 4.2.3 specifically rules out any obligatory assignment of work to Provider unless unambiguously agreed otherwise.

4.1.10 Should either party be allowed to terminate "at will"?

Tango: Clause 4.2.25.

Sometimes, services customers want the right to terminate a statement of work "at will" (or "for convenience"). For many situations, that might be entirely sensible.

On the other hand, a provider might want to bargain for:

  • an earliest permissible date for termination-at-will, so that the customer's payments will cover at least some of the the investment that the provider makes in tooling, materials, training, etc., for the project;
  • a minimum advance-notice period, for the same reason, and to give the provider time to find other work for the provider's people who were assigned to the customer's project; and/or
  • an early-termination fee.

4.2 Services Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • a specified party ("Provider")
  • is to cause services to be provided to, or for,
  • another party ("Customer").

[Brackets] indicate an item that the parties may modify by unambiguously saying so in the Contract.

Contents:

4.2.1 Written statements of work are required

a.  If the parties have not signed an agreed written statement of work,

  • then Provider need not provide services under the Contract,
  • nor need Customer need not pay for services rendered.

b.  Each written statement of work must be "signed" by each party,

  • but "signature" can be in any way that the law allows.
Commentary

See the commentary at § 17.6.1.

4.2.2 Statements of work can be modified by agreement

a.  Any change to a statement of work,

  • and any waiver of a right or obligation under it,
  • should be in a written change order;
  • see subdivision c concerning claims of oral changes
  • to statements of work.

b.  A written change order or waiver must be signed

  • by the party that is supposedly obligated by the change,
  • or that has supposedly waived a right or obligation.

c.  Here are two examples to illustrate:

  • Example 1: Suppose that —
    • Provider does extra work,
    • and asserts that the extra work was under a written change order,
    • and now Provider wants Customer to pay extra money,
    • as specified in that change order.
  • In that situation, the change order is not enforceable against Customer
    • unless Customer signed it.
  • Example 2: Suppose that Customer pays Provider
    • and asserts that the payment is for Provider to do additional work under a written change order,
    • and now Customer wants Provider to actually do the work,
    • but Provider does not want to do so.
  • In that situation, the change order is not enforceable against Provider
    • unless Provider signed it.

d.  The parties may agree orally to a change in a statement of work,

Commentary

See generally Clause 17.1 (Amendments Protocol) and its commentary.

4.2.3 Provider [is not] entitled to a minimum amount of work

The Contract does not entitle Provider to any minimum amount of work, nor to any minimum compensation.

Commentary

This section is intended as a roadblock to "creative" contractor claims to the contrary, as discussed in the commentary at § 4.1.9.

4.2.4 Provider is to obtain licenses & permits for the work itself

a.  Provider is to timely obtain any permits and licenses that might be needed for performance of the services,

  • for example, building permits; contractor- and occupational licenses; etc.

. If Provider needs any special authorizations for the specific services,

  • then [Provider] will also obtain those authorizations unless the Contract clearly says otherwise.
Commentary

Subdivision b: As a made-up example, suppose that Provider is to paint a room, but the room is part of the intensive-care unit at a hospital. That might require a special authorization from health authorities. (Again, this is just a made-up example.)

Caution: A contractor that doesn't have all of its required licenses in place, even for preliminary work, could be setting itself up to be "stiffed" by its customer, as explained in the commentary at § 4.1.4.

4.2.5 [Customer] is to obtain authorizations for deliverables use

Customer* is to timely obtain any licenses or permits needed

  • for use of deliverables,
  • by Customer or others authorized by Customer,
  • for example, any necessary patent licenses.
Commentary

Authorization for use of deliverables is distinct issue from authorization to perform the services, as discussed in the commentary at § 4.1.8.

4.2.6 What if the parties disagree about the need for an authorization?

a.  This section will apply if Provider and Customer disagree about the need for a particular third-party authorization.

b.  Provider will not be in breach of the Contract if, with prompt notice (as defined in Clause 20.6) to Customer, Provider suspends the relevant work until the parties resolve the disagreement.

c.  The parties are to attempt to resolve their disagreement in accordance with Clause 16.9 (Dispute Management Protocol).

d.  If the parties are unable to resolve their disagreement themselves, then Clause 16.4 (Baseball-Style Dispute Resolution) will apply.

Commentary

Subdivision b: Suppose that Provider believes that (let's say) performance of the services would infringe a third party's patent rights, but Customer disagrees. In that situation, Provider might want:

Subdivisions c and d are designed to promote settlement by giving each party a strong incentive to be reasonable, as discussed in the commentary to the referenced Tango clauses.

4.2.7 Failure to obtain authorizations will bring consequences

If a party fails to obtain a particular permit or license as required by the Contract,

  • and as a result, a third party makes a claim against another party to the Contract,
  • then the first party will defend and indemnify the other party and its Protected Group (as defined in Clause 22.38) against all foreseeable damages and losses arising from the third party's claim.
Commentary

Such a third-party claim could include — without limitation — something like a building inspector's ordering Customer to move out of a building because Provider failed to get an occupancy permit. (Years ago, that happened to the author and his family when moving into a just-finished new house; we had to stay in a hotel for several days, at the builder's expense.)

4.2.8 Assigned personnel must meet certain qualifications

Provider is to see to it that all individuals who are assigned to perform services under a statement of work:

  1. are competent and suitably trained for the task;
  2. are bound by confidentiality- and invention-assignment obligations to Provider sufficient to support any corresponding obligations that Provider has to Customer under an agreement;
  3. are legally able to be employed in any jurisdiction where those personnel are to be physically present; and
  4. meet any specific qualifications set forth in the statement of work.

4.2.9 Background checks might be required

If the statement of work clearly so states, then:

  • Provider is to cause background checks to be performed,
  • in accordance with Clause 2.9 (Background Checks Protocol),
  • on all non-Customer personnel who, under the statement of work, will do any of the following:—
  1. providing services while physically on-site at Customer's site;
  2. having access to Customer confidential information — including but not limited to protected health information of Customer's customers or patients;
  3. interacting with Customer's customers; and/or
  4. having access to Customer's computers or network.

4.2.10 "Professional" service performance is required

a.  Provider is to see to it that all services are performed: (i) safely; and (ii) in a professional manner,

  • where professional refers to work that is performed:
    • by people who have the knowledge, training, and/or experience necessary for the successful practice of the relevant trade or occupation; and
    • in a manner that is generally considered proficient by those capable of judging such work.

b.  If the Contract uses the term workmanlike, the term has the same meaning as professional as defined above.

Commentary

The term professional is used here instead of workmanlike — because the former term sounds more, well, professional — but the definition of professional in subdivision a is drawn from the Supreme Court of Texas's definition of workmanlike in connection with the implied warranty of good and workmanlike quality of services for repair of tangible goods, as explained in the commentary at § 4.1.6.

4.2.11 Provider is responsible for [all] required tasks, materials, etc.

Provider is to see to:

  1. the successful completion
    • of all individual tasks and other actions
    • necessary for the proper rendering
    • of the services set forth in the statement of work,
    • even if one or more such individual tasks is not expressly set forth there; and
  2. the furnishing —
    • of all materials, equipment, supplies;
    • computer hardware and -software;
    • work locations;
    • electrical power;
    • Internet- and other communications capabilities;
    • prudent, properly-functioning safety equipment
      • for Provider's personnel
      • and for the personnel of Provider's contractors,
      • including, without limitation, any necessary personal protective equipment (PPE);
    • and other items needed to meet Provider's performance responsibilities;
    • this obligation includes any necessary acquisition, installation, and maintenance of all such items;
  3. * unless the statement of work unambiguously provides otherwise.
Commentary

Some customers are likely to want this language for comfort purposes. A provider might be concerned that such language could lead to disputes about expensive (and delay-causing) "scope creep"; the author's guess, though, is that this 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, because doing so could help to remove a potential delay on the path to signature.

Note: For some services projects, it might make sense for Customer to provide some of the listed items. If so, that should be documented in the statement of work.

4.2.12 Provider is responsible for work supervision and training

Provider is to see to all supervision and, to the extent necessary, training of all individuals engaging in the services.

4.2.13 Provider is to controls the means and manner of the work

In case of doubt: As between Provider and Customer, Provider has the sole responsibility for controlling the means, manner, time, and place of performance of the services.

4.2.14 Customer is to provider reasonable basic cooperation

  1. Customer will provide reasonable basic cooperation with Provider,
    • and with Provider's agents and subcontractors, if applicable,
    • as reasonably requested by Provider from time to time.
    • (Note: This section is not intended to implicitly authorize the use of subcontractors, but it does not prohibit such use either.)

b.  Subdivision a is not intended to diminish Provider's responsibilities for accomplishing the services called for by the statement of work.

4.2.15 Provider is to address defects

Provider is to proceed in accordance with Clause 5.3 (Defect Correction Protocol) in any case of defective performance of services and/or delivery of defective deliverables.

4.2.16 Payments for services are due as agreed

a.  Provider is to invoice Customer, and Customer is to pay Provider, for services, in accordance with the applicable statement of work and [BROKEN LINK: pmts-appx][BROKEN LINK: pmts-appx] (Payments Rider).

b.  If the statement of work does not specify when payments are due,

  • then Provider is to invoice Customer, and Customer is to pay Provider, for services —
    • [one-half] upon agreement to the statement of work,
    • and the balance upon completion and acceptance of the services.

4.2.17 Customer [need not] reimburse Provider for expenses

a.  Customer need not reimburse Provider for expenses incurred in performing services unless the Contract unambiguously says so — in which case Clause 1.5 (Expense Reimbursement Protocol) will govern.

Commentary

Some statements of work might call for Provider to "pass through" to Customer the expenses incurred by Provider, while other statements of work might require Provider to absorb those expenses as part of Provider's fee for services.

4.2.18 Provider [may] suspend services for nonpayment

If Customer does not pay Provider an amount due under the Contract within [seven days] following the original payment due date,

  • and the nonpayment is not clearly due to fault attributable to Provider,

then:

  1. Provider may suspend its performance of the relevant services at any time beginning at the end of [seven days] following the effective date of Provider's notice to Customer of upcoming suspension; and
  2. Any such suspension will be without prejudice to Provider's other remedies for the nonpayment.

4.2.19 May Customer audit Provider's payment-related records?

a.  If the relevant statement of work states that the services are to be provided (i) on a time-and-materials basis, and/or (ii) on a cost-plus basis,

  • then Provider will keep records in accordance with Clause 3.5 (Recordkeeping Protocol),
  • and Customer may audit those records in accordance with Clause 3.7 (Audit Protocol).

b.  Otherwise, Provider need not allow Customer to audit Provider's records concerning the services unless the Contract clearly says otherwise.

4.2.20 [Neither party] has any confidentiality obligations

Neither party has any confidentiality obligations relating to the services.

Commentary

Alternative: "Provider will preserve in confidence the Confidential Information of Customer in confidence per Clause 6.3 (Confidential Information Protocol)."

Alternative: "Each party will preserve in confidence the Confidential Information of the other party per Clause 6.3 (Confidential Information Protocol)."

4.2.21 Customer need not pay Provider more to use deliverables

a.  This section applies if Provider has any legal right to restrict Customer's use of deliverables,

  • for example under a patent or copyright.

b.  In that situation, Provider will not object to Customer's use,

  • in whatever manner Customer sees fit,
  • of any deliverable resulting from services under the Contract,
  • without additional compensation to Provider,
  • unless the Contract or the statement of work clearly says otherwise..

4.2.22 Customer [may] have further work done on deliverables

Unless clearly stated otherwise in the Contract, Customer may:

  1. modify or otherwise continue development of any deliverable, and/or
  2. have the same done by others on behalf of Customer,

but only in accordance with the provisions below in this section.

4.2.23 Provider [need not] support further development by others

Provider may, in its sole discretion (as defined in Clause 22.17), decline to provide support for a deliverable

  • if Provider reasonably determines that the request for support
  • arises from, or relates to, modification of the deliverable
    • by any individual or organization other than Provider,
  • except to the extent — if any — that Provider has:
  1. expressly and in writing, authorized or directed the particular modification, and
  2. committed in writing to support the modification.

4.2.24 Are Customer's developers restricted in their actions?

Possibly: Any permitted deliverable-related modification‑ or development activity, by or on behalf of Customer, must not violate:

  1. applicable law such as export-controls laws; nor
  2. any unrelated IP rights assertable by Provider, if any, nor
  3. any additional restrictions specified in the Contract.

4.2.25 Customer [may] terminate a statement of work "at will"

Customer may terminate any statement of work "at will" (or, "for convenience"),

Commentary

Alternative: "Customer may not terminate a statement of work until the following prerequisites are satisfied: [Describe in detail in the Contract]."

Alternative: "Neither party may terminate a statement of work at will."

A termination at will could leave Provider in the lurch, so Provider might want to bargain for some limits as described in the commentary at § 4.1.10.

4.2.26 [Either party] may terminate for material breach

Any party may terminate a statement of work for material breach (as defined in Clause 22.31.2) by the other party,

  • effective immediately upon notice of termination to the other party,
  • if both of the following prerequisites are satisfied:
  1. The terminating party gives the breaching party notice (as defined in Clause 20.6) that specifies the breach in reasonable detail; and
  2. Before the end of [five business days] after the effective date of the notice of breach, either or both of the following have not occurred:

    • (i) cure of the breach, and
    • (ii) effective notice from the breaching party, accompanied by reasonable supporting evidence, informing the terminating party of the cure.

4.2.27 Some Provider breaches [are] automatically material

Customer may terminate a statement of work for material breach, as provided above, if any one or more of the events listed below occurs:

  1. Provider does not timely start to perform the services, if the parties have agreed in writing that a specific start time is material, AND Customer terminates the statement of work before Provider does start performance;
  2. Provider is clearly shown to have permanently abandoned performance;
  3. Provider is clearly shown to have temporarily suspended performance IF the Contract or the statement of work prohibits suspension; or
  4. Provider does not timely complete the services, in compliance with the standards set forth in the Contract and/or the statement of work, IF the parties have agreed in writing that timeliness is material (for example, by stating that time is of the essence).

4.2.28 Termination [is not] Customer's sole remedy for breach

No: Customer's right to terminate a statement of work for breach by Provider would be in addition to any other recourse available to Customer under an agreement, the statement of work, or the law (subject to any agreed limitations of liability).

4.2.29 What will Provider do after termination?

Promptly after any termination of a statement of work:

a.  Provider is to cause the "Termination Deliverables," namely the following, to be delivered to Customer or to Customer's designee:

  1. all completed deliverables and work-in-progress for that statement of work — those, however, will remain subject to any agreed restrictions on providing them to competitors of Provider;
  2. any equipment that was provided or paid for by Customer for use in connection with that statement of work;
  3. any Customer-owned data that was provided by or on behalf of Customer; and
  4. any Customer-owned data that was generated by or on behalf of Provider, in connection with that statement of work.

b.  Provider is to send Customer one or more final invoices for the statement of work,

4.2.30 What will Customer do after termination?

Promptly upon any termination of a statement of work, Customer is to pay:

  1. all then-pending Provider invoices; and
  2. Provider's subsequent final invoice(s) for previously unbilled services,
    • and/or (if applicable) reimbursable expenses,
    • to the extent consistent with any payment prerequisites in the statement of work,
    • for example, any requirement that particular milestones be achieved as a prerequisite for payment,
    • unless otherwise agreed in writing.

4.2.31 Confidentiality obligations (if any) [will continue]

Upon termination of a statement of work, each party will continue to honor any applicable confidentiality obligations stated in the Contract and/or in the statement of work.

4.2.32 Premises- and computer-network rules apply

a.  Clause 13.16 (Site Visits Protocol) will apply if either party's personnel visit physical premises of another party

b.  Clause 13.3 (Computer System Access Prococol) will apply if either party's personnel access another party's computer system(s) and/or network(s)

4.3 Services terms (optional)

4.3.1 Option: Provider's Investigation

When this Option is agreed to, Provider represents and warrants to Customer

  • that in connection with agreeing to a statement of work for services,
  • Provider has thoroughly investigated the conditions "on the ground" (a figure of speech) in connection with which the services are to be provided,
  • and consequently, if such conditions prove to be other than as Provider expected,
  • then Provider will not be entitled to an adjustment in compensation,
  • nor to an extension of time for performance,
  • because Provider is assuming that risk.
Commentary

This option is adapted from a subcontract provision that determined the outcome in a Fifth Circuit (Texas) case, as discussed at § 4.1.5.

4.3.2 Option: Mitigation of Schedule Slips

a.  When agreed to, this Option applies if a statement of work clearly states that a particular milestone:

  1. is material, and
  2. must be completed by a specified date.

b.  If that milestone is not completed by the specified date,

  • then Provider will make efforts that are reasonable under the circumstances
  • to mitigate any harm resulting from the delay
  • and to get the statement of work back on schedule.

4.3.3 Option: Prohibited Use of Deliverables by Others

When this Option is agreed to, Customer may not allow others (for example, Customer's other contractors) to use deliverables under an agreement,

  • not even for Customer's own business purposes.

4.3.4 Option: Customer Ownership of IP Rights

When this Option is agreed to:

a.  As between Provider and Customer, Customer will own:

  • all intellectual-property rights (if any) in and to any deliverables
  • created in the performance of Provider's obligations under a statement of work,
  • by one or more employees of Provider (and/or of Provider's subcontractors, if any).

b.  Provider is to seasonably (as defined in Clause 22.46) disclose to Customer,

  • in writing, and in as much detail as Customer reasonably requests,
  • all technology and other intellectual property
  • that the statement of work calls for to be owned by Customer.

4.3.5 Option: Loss of Rights for Nonpayment

When this Option is agreed to, Customer's timely payment of any amounts required by the applicable statement of work,

  • in respect of a particular deliverable,
  • is a prerequisite to Customer's continued exercise of its rights in that deliverable.

4.3.6 Option: Post-Termination Deliveries Delay

When this Option is agreed to: If Provider's already-sent invoices,

  • for [any] statement of work,
  • are past due when [any] statement of work is terminated,
  • then Provider may delay delivery of one or more Termination Deliverables,
  • for [any] statement of work
  • until all of Provider's past-due invoices are paid in full.

4.3.7 Option: Customer Post-Termination Payment Delay

When this Option is agreed to: Upon termination of a statement of work,

  • Customer need not pay Provider's final invoice(s) for then-unbilled services, if any,
  • until Provider has complied with its applicable post-termination obligations
  • for that statement of work.

4.3.8 Option: Adjustment of Final Payment for Material Breach

When this Option is agreed to: If a statement of work is terminated for material breach (as defined in Clause 22.31.2) by Provider,

  • then Customer's final payment obligation is to be adjusted appropriately,
  • preferably as agreed by the parties in accordance with Clause 30.1 (Dispute Management Rider),
  • but if not, as determined by a tribunal of competent jurisdiction in accordance with Clause 16.4 (Baseball-Style Dispute Resolution).

4.3.9 Option: Expiration as Termination

When this Option is agreed to: Expiration of a statement of work is to be considered a form of termination.

4.4 Exercises and discussion questions

4.4.1 Discussion: Scope changes not in writing

FACTS: You represent MathWhiz and are helping to negotiate its services agreement with Gigunda.

Gigunda objects to your draft of a "Services" section of the agreement because it says, in effect, that all "scope changes" to the agreed services must be in writing.

Giguna's negotiator says, we don't want to have to bother with a writing — we're in a time-sensitive business where we often have to move fast, so we need to be able to call up MathWhiz and just tell them what changes we need to the services.

QUESTIONS:

  1. If MathWhiz were to accept Gigunda's proposed change, what risks could that pose to MathWhiz?
  2. What kind of language could you propose to address Gigunda's concerns while still providing MathWhiz with protection?

4.4.2 Service agreements – discussion questions (1)

1.  Is it generally a good idea to require that statements of work must be in writing?

2.  Is it generally a good idea to require that changes to statements of work must be in writing?

3.  How much time should a lawyer spend reviewing the statement of work for a client?

4.  Should Provider agree to obtain all permits and licenses needed related to the performance of services? (Careful: Think broadly about what permits and/or licenses might be needed "related to" the services.)

5.  What could happen if Provider failed to get required occupational licenses, e.g., construction-contractor licenses?

6.  FACTS: A home builder finishes a new house and turns the keys over to a young couple, who move in with their new baby (and the wife's in-laws, visiting from out of town). BUT: The builder failed to get the final city inspection done, so the city orders the family to move out, and they have to spend three days in a hotel. QUESTION: Who pays the hotel bills?

7.  Why would a customer/client want to require a contractor to use people who are "competent and suitably trained for the task"? (Think: Litigation proof.)

8.  What does "workmanlike performance" mean? Why is that typically used as a standard of performance for services?

9.  Why might a customer want to state that the service provider is responsible for determining the "means and manner" of the work?

10.  What are "the Three Rs" for defects in deliverables?

11.  Under what circumstances might Provider want to prohibit Customer from modifying deliverables?

4.4.3 Services - topics for discussion (2)

12.  [@12] What's a sensible "default" payment schedule for services?

13.  Under what circumstances might Customer want to prohibit Provider from suspending services, even for nonpayment?

14.  Why might Customer want to specify that failing to start the services on time is a material breach? (What makes a material breach special?)

15.  More generally: Why list specific events of material breach?

16.  Should Customer have the right to terminate a statement of work "at will" (synonym: "for convenience")? What factors would go into that analysis?

17.  Should Customer own the IP rights in deliverables created by Provider under the statement of work?

4.4.4 Drafting quirks: Reps and warranties for services

The following are examples of services-related representations and warranties drafted by students.

1.  "Service Provider warrants that there are no copyright infringement or trade secret violations in the work that Service Provider will provide to Customer." DCT COMMENT: I'd be inclined to say that there will be no copyright infringement, etc. Also: Good job on the "will provide" — MathWhiz will want to warrant only its work as provided, not as perhaps later modified by Gigunda.

2.  "Service Provider warrants that the work will be performed in a professional manner that is serviceable (“Work-Man Like Manner”)." DCT COMMENT: This is three different standards, which could be confusing. "Workmanlike" is pretty much a standard term, as discussed in the reading, so there's no need to define the term (also, it's a single, non-hyphenated word).

3.  "Service Provider represents and warrants that Service Provider’s business includes analyzing seismic data." DCT COMMENT: This doesn't really do much for Customer, and wouldn't normally be included.

4.  "Service Provider represents and warrants that in the past, to individuals and organizations that are not Customer, Service Provider has successfully predicted where oil or natural gas deposits might be." DCT COMMENT: This is creative thinking. One possible problem: If a problem were to arise, Gigunda might demand to see examples of MathWhiz's prior work for other customers — and MathWhiz might be violating confidentiality obligations to its other customers if it were to produce such information.

5.  "Service Provider warrants that Service Provider is headed by Mary." DCT COMMENT: Another interesting idea — although if Mary signs the document on behalf of MathWhiz, does it really do anything significant for Gigunda?

6.  "So far as Service Provider is aware, some individuals have called Mary an “expert” in analyzing seismic data to determine where oil and gas natural deposits may be." DCT COMMENT: Good job in saying "some individuals," but that would open the door to Gigunda's asking (in litigation or arbitration), just who are those individuals, and when can we depose them?

7.  "Service Provider warrants that Service Provider employs several junior associates and subcontracts with others to do specialized tasks to determine where oil and gas natural deposits may be." DCT COMMENT: This doesn't seem necessary; if anything it'd be a disclosure that MathWhiz would want Gigunda to acknowledge so that Gigunda can't later claim that it thought Mary would be doing all the work.

8.  "Unless otherwise provided below, the representations and warranties herein are made only after the representing party has personal knowledge, or has inquired, researched, or otherwise confirmed that the items represented are true." DCT COMMENT: This raises the bar for each representing party; I'd be more inclined to reverse the presumptions.

9.  "The Parties represent that they are not a party to any other agreement or involved in any pending litigation that could reasonably pose a risk of materially interfering with performance of its obligations under this Agreement." DCT COMMENT: I'd change this to say that "Each party represents to the other …." As written, it could arguably be ambiguous, as I'll explain.

10.  "Service Provider represents and warrants it will exercise commercially reasonable efforts, and follow industry standards when analyzing Client’s data." DCT COMMENT: I'd just make this a covenant: Service provider will use commercially reasonable efforts and follow industry standards …. [What standards would those be?]

11.  "Each party to the agreement represents to each other party of the agreement that, so far as the representing party is aware, the following are true:" DCT COMMENTS: (A) Repeating "to the agreement" seems a bit much. (B) I'd be more "granular" in stating the knowledge qualifier: It might be appropriate for some reps and not for others.

12.  "The representing party has made a reasonable inquiry concerning the [above] matters." DCT COMMENT: Same comment as above: This raises the bar.

13.  "Contractor warrants that all of Client’s seismic data relating to the Mongolian Field and all related work product, as well as any other proprietary information shared by Client, will not be shared with any third party unless expressly instructed in writing by Client." DCT COMMENT: I'd make this a covenant, not a warranty — it's a prohibition.

14.  "Client represents and warrants that all seismic data from the Mongolian Field was lawfully obtained and that Client has the legal power to share the data with Contractor." DCT COMMENT: I like this.

15.  "So far as Client knows, without any particular investigation, Client is the true and undisputed owner of the Data at any such time that the Data is submitted to Contractor for analysis." DCT COMMENST: (A) This is a representation — MathWhiz would probably want a warranty. (B) "… true and undisputed owner" seems a bit redundant.

16.  "Contractor represents that all Deliverables will be completed by using Data provided by Client in compiling such Deliverables." DCT COMMENT: It's not clear to me how this works or how it would benefit Client; it seems to state the obvious.

17.  "So far as Contractor knows, Contractor will use only standard industry practices to analyze such Data in completing the Deliverables and will not rely on unproven techniques or methods without Client’s expressed consent." DCT COMMENT: Gigunda would want this to be a covenant, not a knowledge rep. (The student also added a consultation requirement, which is good.)

18.  "[MathWhiz represents that] Math-Whiz LLC employs several junior analysts and selectively engages subcontractors." DCT COMMENT: Same as before: This is more a disclosure, to be acknowledged by Gigunda, than a repreasentation.

19.  "Math-Whiz LLC represents to Gigunda that, so far as it is aware, the following assertions are true: …" (emphasis in original). DCT COMMENT: If I were drafting on behalf of a representing party, I wouldn't italicize "represents"; no point in raising a possible red flag any more than necessary.

20.  "Math-Whiz represents and warrants to Gigunda Energy that: … (iv) that its products do not infringe on any third party’s patent." DCT COMMENTS: (A) "That" is duplicated. (B) MathWhiz would normally not want to represent and warrant that its "products" (meaning what, exactly) don't infringe on third-party patents.

21.  "3.0 GENERAL REPRESENTATIONS AND WARRANTIES [¶] 3.1 During the term of this Agreement, neither party will enter into any agreement that would interfere with that party’s performance of its obligations under this Agreement." DCT COMMENT: Section 3.1 is not a representation, nor is it really a warranty — it's a prohibition.

22.  "Seller represents and warrants that it has or can obtain the necessary tools and expertise to analyze Seismic Data in a manner commensurate with the industry standard at the time of the Seller’s signing of this Agreement." DCT COMMENTS: (A) What industry standard? (B) If I were Gigunda, I'd be nervous about this — I'd want to hire someone who already has "the necessary tools and expertise" to get the job done.

23.  "Seller warrants that it will make a good faith effort to remain in compliance with applicable laws throughout the term of the Agreement." DCT COMMENT: Gigunda will probably want MathWhiz to flat-out commit to remaining in compliance. QUESTION: How might MathWhiz counter such a request?

24.  "Service Provider represents [and warrants] that it has the experience and personnel necessary to perform its obligations under this Agreement in a commercially reasonable manner." DCT COMMENTS: (A) Good idea for Gigunda to ask for this kind of rep — think of the Hill of Proof and how easy it'd be for a judge, jury, or arbitrator to determine (i) that the work wasn't done properly, vs. (ii) that the MathWhiz people didn't know what they were doing. (B) Instead of "in a commercially reasonable manner," use "in accordance with this Agreement" or "in accordance with the Statement of Work." QUESTION: Why B?

25.  "Service Provider represents [and warrants] that it is not infringing on any intellectual property rights." DCT COMMENTS: (A) Gigunda can ask for this, but MathWhiz should be reluctant to agree. QUESTION: Why? (B) "… it is not infringing …." is vague; what should Gigunda want to nail down?

26.  A couple of students wrote really-skimpy warranties that didn't address either (i) performance of the work, nor (ii) infringement risks. Gigunda would definitely want those to be addressed, so it would behoove MathWhiz to offer up something that has a reasonable chance of getting by Gigunda's contract reviewer. Otherwise, Gigunda might copy and paste its preferred language, which might be very onerous to MathWhiz.

4.4.5 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?

5 Sales: Direct and "channel"

It's been famously said that "nothing ever happens until someone sells something." And many everyday contracts relate to selling something, notably goods (whether tangle or intangible) and/or services.

Some key points:

1.  Everyday sales of goods and services are usually documented in purchase orders (from buyers) and/or in order confirmations (from sellers).

2.  Sometimes sales are indirect, going through multiple levels in "the channel," for example via resellers.

3.  At other times, sales might be direct, but a seller might pay a referral fee to a third party.

This chapter addresses some of the issues arising in these three contexts.

Contents:

5.1 Introduction & takeaways (now hidden)

5.1.1 Should orders be separate agreements, or additions to the Contract?

Some contracts state that every order is an "addition" to the underlying agreement; this is seen, for example, in the ISDA Master Agreement, where "netting out" of multiple transactions is desired.

In the author's view, however, the "addition" approach would be unwise, because:

  • a default in one order could affect other orders — this is sometimes referred to as "cross-default" and should be provided for expressly if desired; and
  • if the supplier's liability for damages were to be capped at "the amounts paid or payable under this Agreement," then that amount would grow over time as more statements of work were completed; the customer might like that, but the supplier wouldn't be wild about it.

5.1.2 Battle of the Forms

5.1.2.1 The problem: Dueling standard forms

When a corporate buyer makes a significant purchase, it's extremely common (and essentially a universal practice) for the buyer's procurement people to send the seller a purchase order.

• Typically, the seller's invoice must include the purchase-order number — otherwise the buyer's accounts-payable department simply won't pay the bill.

• These are routine internal-controls measures that are almost-uniformly implemented by buyers to help prevent fraud.

But many buyers try to use their purchase-order forms, not just for fraud prevention, but to impose legal terms and conditions on the seller as well. Some buyers put a lot of fine print on the "backs" of their purchase-order forms (physically or electronically).

Such fine-print terms often include:

  • detailed — and often onerous — terms and conditions for the purchase, such as expansive warranties, remedies, and indemnity requirements; and
  • language to the effect of, only our terms and conditions will apply — your terms won't count, no matter what happens.

For example, a Honeywell purchase-order form states in part — in the very first section — as follows:

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.

Sellers aren't always innocent parties in this little dance, 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 of a customer's purchase order takes the form of an "order confirmation" that itself contains detailed terms and conditions — some of which might directly conflict with the terms in the buyer's purchase order.

For example, the first section of a Honeywell terms of sale document states in part as follows:

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.

In both cases, the "we reject your language!" is keyed to section 2-206 of the (U.S.) Uniform Commercial Code, which states in part that for sales of goods:

(1) Unless otherwise unambiguously indicated by the language or circumstances[,]

(a) an offer to make a contract shall be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances ….

In each of these forms, the quoted language seems to state pretty clearly that acceptance is limited to the terms stated in the form.

Important: Drafters asked to prepare standard forms of this kind should strongly consider whether to include "We reject your terms!" language along these lines.

But it's not unlikely that the parties' business people will pay exactly zero attention to these dueling forms. What could easily happen is the following:

  • The seller's sales people receive the purchase order and send it to the order-fullfilment department.
  • The seller's order-fulfillent department ships the ordered goods — along with a confirmation of sale document and an invoice.
  • The buyer's receiving department takes delivery of the ordered goods and puts them into inventor, distributes them to end users, or whatever.
  • The buyer's receiving department forwards the seller's invoice to the buyer's accounts-payable department, which in due course pays the invoice.

So whose terms and conditions apply — those of the buyer, or those of the seller? 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, to which we now turn.

5.1.2.2 Sidebar: A buyer can be a "merchant"

As discussed in the next section, in some situations it can matter whether a party is considered a "merchant." As used in U.S. commercial law, the term merchant generally includes not only regular sellers of particular types of goods, but also buyers who regularly acquire such goods.

The Uniform Commercial Code states as follows in UCC § 2-104(1):

“Merchant” means a person[:]

  • who deals in goods of the kind
  • or otherwise by his occupation holds himself out
    • as having knowledge or skill
    • peculiar to the practices or goods involved in the transaction
  • or to whom such knowledge or skill may be attributed
    • by his employment of an agent or broker or other intermediary
    • who by his occupation holds himself out as having such knowledge or skill.

(Extra paragraphing and bullets added.)

Federal judge Richard Posner explained:

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 ….

To similar effect is the UCC definition's commentary, apparently reproduced in Nebraska Uniform Commercial Code § 2-104.

5.1.2.3 The UCC's solution to the Battle of the Forms: The Drop-Out Rule

Where sales of goods are concerned, the (U.S.) Uniform Commercial Code has a nifty way of dealing with the Battle of the Forms in section 2-207: When the parties are merchants:

  • whatever terms are common to the parties' respective contract forms is part of "the contract"
  • all other terms in both parties' contract forms drop out — left on the cutting-room floor, if you will; and
  • the UCC's "default" terms also apply.

Here's the text of UCC § 2-207:

(1) A definite and seasonable expression of acceptance

  • or a written confirmation
  • which is sent within a reasonable time
  • operates as an acceptance
  • even though it states terms additional to or different from those offered or agreed upon,
  • unless acceptance is expressly made conditional
  • on assent to the additional or different terms.

(2) The additional terms are to be construed as proposals for addition to the contract.

Between merchants [see § 5.1.2.2 above] such terms become part of the contract *unless:

(a) the offer expressly limits acceptance to the terms of the offer;

(b) they materially alter it; or

(c) notification of objection to them has already been given

          or is given within a reasonable time after notice of them is received.

[DCT comment: Here comes the key part —]

(3) Conduct by both parties which recognizes the existence of a contract

  • is sufficient to establish a contract for sale
  • although the writings of the parties do not otherwise establish a contract.
  • In such case the terms of the particular contract consist of[:]
    • those terms on which the writings of the parties agree,
    • together with any supplementary terms incorporated under any other provisions of this Act.

(Emphasis, extra paragraphing, and bullets added.)

So suppose that:

  • Buyer sends Seller a purchase order with its terms and conditions;
  • Seller sends Buyer an order confirmation — with Seller's terms and conditions — along with the goods ordered, and an invoice.
  • Buyer's payables department pays the invoice.

In that situation, the parties have engaged in conduct that recognizes the existence of a contract. The terms of that contract are whatever "matching" terms exist in the parties' respective forms, plus the UCC's default provisions.

5.1.2.4 Caution: The UN CISG uses the "mirror image" rule

It's a very-different analysis of the Battle of the Forms under the UN Convention on Contracts for the International Sale of Goods. The Seventh Circuit explained:

The 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."

5.1.2.5 Caution: Filling a purchase order might lock in buyer's T&Cs

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 example from a Cisco purchase-order document: "Supplier's electronic acceptance, acknowledgement of this Purchase Order, or commencement of performance constitutes Supplier's acceptance of these terms and conditions."

5.1.2.6 A "master" agreement should prevail

Customer purchase orders sometimes say (and should say) that if the parties have entered into a master agreement, then that master agreement will control.

For example, the Honeywell terms of sale document referenced above states, in the very first sentence:

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 ….

Likewise, a Cisco purchase order form says: "Notwithstanding the foregoing, if a master agreement covering procurement of the Work described in the Purchase Order exists between Supplier and Cisco, the terms of such master agreement shall prevail over any inconsistent terms herein."

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.

In the lawsuit:

  • 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 under the master agreement, UPS should be held liable for the full value (some $1 million) of the shipment in question.

The court granted partial summary judgment that the master agreement controlled.

5.1.2.7 Additional reading (optional)

See generally:

  • Battle of the Forms – UCC and common-law variations
  • Purchase order (Wikipedia)
  • Brian Rogers, Battle of the Forms Explained (Using a Few Short Words) (blog entry March 1, 2012).
  • Marc S. Friedman and Eric D. Wong, TKO'ing the UCC's 'Knock-Out Rule', in the Metropolitan Corporate Counsel, Nov. 2008, at 47.
  • For an eye-glazing set of "battle of the forms" facts, see BouMatic LLC v. Idento Operations BV, 759 F.3d 790 (7th Cir. 2014) (vacating and remanding dismissal for lack of personal jurisdiction) (Easterbrook, J.).
  • An existing teaching case is 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, but 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 a UCC implied warranty of "reasonable" duration. Id. at 1189.
  • Clause 17.1 (Amendments Protocol)
  • Clause 17.4 (Entire Agreement)

5.1.3 Channel partners: Resellers and referral sources

It's fairly common for a seller to establish business relationships with one or more "channel partners" that can:

  • resell some or all of the seller's product line, which the reseller typically acquires from the seller at a discount (so that the reseller can cover its expenses and make a profit on the markup); and/or
  • refer customers to the seller in return for a commission or other compensation.
5.1.3.1 Resale price maintenance agreements could lead to antitrust issues

A seller might be tempted to try to prohibit a reseller from discounting the seller's products or services. That kind of "retail price maintenance" (sometimes known as "vertical price fixing") could lead to issues under antitrust law.

5.1.3.2 Channel partners: Set forth minimum performance requirements?

Channel-partner contracts sometimes set forth minimum performance requirements for the reselling- or referring partner, because a seller obviously would not want to continue in the relationship if the partner was not performing.

Minimum performance requirements could include, for example,

  • For referrals: Minimum referrals, and/or minimum dollar volume of sales made, in a given period;
  • For reseller agreements:
    • Minimum dollar volume in actual sales to end customers (to require market penetration), and/or
    • Minimum dollar revenue to the seller in a stated period ("take or pay")
  • as time goes on, more-stringent standards (to give Reseller a "break-in period")
  • rewards for over-achieving the targets

The consequences for a partner's failing to meet the stated minimums could include:

  • loss of exclusivity (if any exclusivity there be), without loss of the relationship entirely — but that might not be attractive to the seller, because it would leave the underperforming partner in place, which in turn would preclude the seller from entering into a new exclusive arrangement with a new partner; or
  • termination of the channel partner's rights in some or all of the territory.

Tango: See Clause 5.5.10 and [TO DO: Reseller minimums]

5.1.4 An as-delivered warranty doesn't address future performance

Tango: Clause 5.3.4.

Drafters and reviewers should note the crucial distinction between:

  • a warranty that goods as delivered will conform to certain standards, with a cutoff date for the customer to report apparent defects, versus
  • a warranty that, for a stated period of time in the future, the goods will conform to certain standards of performance.

This can make all the difference in determining whether a customer has timely filed a lawsuit for breach of warranty, or whether instead the suit is barred under the relevant statute of limitations: In the former case, the limitation period starts at delivery of the allegedly-defective goods.

For more, see § 2.2.4.

5.1.5 Defect correction might be an "exclusive remedy"

Under section 2-719 of the [U.S.] Uniform Commercial Code, a contract for the sale of goods can specify that a remedy is exclusive (but there are restrictions and exceptions to that general rule).

A real-world example of this supplier approach was the BAE v. SpaceKey case:

  • A supplier delivered lower-quality integrated circuits ("ICs") to a customer than had been called for by their contract. The supplier had previously alerted the customer in advance that the ICs in question would not conform to the agreed specifications; the customer accepted the ICs anyway. (The customer later asserted that it assumed the supplier would reduce the price.)
  • The customer refused to pay for the nonconforming ICs.
  • The supplier terminated the contract and sued for the money due to it.
  • The customer counterclaimed — but it did not first invoke any of the contract's specified remedies, namely repair, replace, or credit (as opposed to refund).

For that reason, the trial court granted, and the appellate court affirmed, summary judgment in favor of the supplier.

5.1.6 Failure of "exclusive" remedies might blow the doors open

Providing the right to a refund as a fail-safe "backup" remedy might be crucial in case other agreed remedies fail.

Consider that UCC § 2-719(2) provides: "Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act."

(True, UCC article 2 applies only to the sale of goods, of course, but courts have sometimes looked to article 2 for guidance in non-goods cases.)

In other words, if providing a correction or workaround for a defect is the customer's exclusive remedy, but the provider is unable to make good on doing so, then in some jurisdictions all limitations of liability might be out the window, including for example an exclusion of consequential damages or a cap on damages.

5.1.7 Exercises and discussion questions

5.1.7.1 Exercise: Order fulfillment

QUESTIONS — discuss in the breakout rooms first, then as a whole:

  1. What are some pros and cons of spelling out, in the contract, the information that Customer must submit in an order?
  2. What are some pros and cons of:
    • having each order become an addition to the master agreement, versus
    • having each order be a separate agreement that incorporates the master agreement by reference.
  3. Why might Supplier want a quotation to have an expiration date?
  4. What are some pros and cons of allowing orders to be modified orally and not requiring written modifications?

FACTS: You represent Supplier. Customer wants its "affiliates" to be listed in the preamble as parties to the agreement, e.g., "The parties are ABC Inc. ('Supplier') and XYZ Inc. and its affiliates ('Customer')."

QUESTIONS: (numbering is continued before)

  1. As Supplier's lawyer, what do you think of this — what do you think Customer really wants?
  2. How might you structure the contract to accommodate Customer's likely desires — and to protect Supplier?
  3. What are the INCOTERMS? What does "EXW" mean?

    (What kind of fences might Supplier and Customer want?)

5.2 Order Submission Protocol

a.  [Brackets] indicate an item that the parties may modify by unambiguously saying so in the Contract.

b.  When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • specified parties, referred to as "Customer" and "Supplier" respectively,
  • agree to conduct one or more transactions,
  • such as, for example,
    • a sale or other delivery of tangible- or nontangible goods or equipment or other deliverables, and/or
    • the performance of services.

c.  Each such transaction agreement is referred to as an "Order."

d.  In case of doubt: Unless otherwise agreed in writing, "Customer" might not be an end-customer, but instead might be a reseller, a distributor, etc.

Note to drafters: See also the optional terms at § 5.4, which are not incorporated by reference into the Contract unless it clearly says so.

5.2.1 Supplier may prescribe order-submission systems

Supplier may decide, from time to time, what mechanism it will use to receive orders,

  • for example via hard copy, email, Web-based portals, etc.
Commentary

Purely out of economic interest, Supplier should want to make it as easy as possible for Customer to place orders. While the Finance- and Legal Departments might want Customer to jump through a lot of hoops, the Sales Department will surely have something to say about that.

Alternative: "Orders are to be submitted as follows: [DESCRIBE]."

5.2.2 Supplier may prescribe information needed for an Order

Supplier may decide from time to time what information is to be included in an Order.

Commentary

Again, allowing Supplier to decide what information must be included in an Order should ordinarily be workable — as a practical matter, Supplier probably won't be unreasonable, because Customer will (usually) have the choice whether or not to place the Order.

Alternative: "Orders are to include the following specific information: [SPECIFY]."

As an example, see section 2 of a Honeywell terms-of-sale document, which calls for orders to specify "(1) Purchase Order number; (2) Honeywell's part number; (3) requested delivery dates; (4) price; (5) quantity; (6) location to which the Product is to be shipped; and (7) location to which invoices will be sent for payment."

5.2.3 A Supplier quotation constitutes an "offer"

a.  If Supplier sends Customer a quotation for a proposed sale or other transaction,

  • then that quotation constitutes Supplier's offer to conduct the transaction,
  • on the terms specified in the quotation,
  • including but not limited to any terms incorporated by reference.

b.  If Customer accepts a Supplier quotation,

  • including but not limited to by sending a purchase order,
  • then that quotation becomes an Order.
Commentary

See also Clause 17.4 (Entire Agreement) concerning the effect of additional terms in purchase orders, etc.

5.2.4 Supplier's catalogs and price lists are not "offers"

Supplier's catalogs or price lists

  • for goods or other deliverables; services; or other items,
  • do not constitute Supplier's offer to sell or otherwise deal in
  • any particular quantity of the items at any particular time or place.
Commentary

The idea for this provision comes from section 1 of a Honeywell terms-of-sale document archived at https://perma.cc/5MB9-H6VK.

5.2.5 Supplier's quotations can expire if so stated

If a Supplier quotation specifies an expiration date,

  • then the quotation will expire on that date,
  • unless Supplier receives Customer's acceptance of the quotation,
  • before the close of business, at Supplier's relevant location,
  • on that date.

5.2.6 Supplier may modify or withdraw a pending quotation

Supplier may withdraw and/or modify a quotation at any time —

  • until Supplier has received Customer's timely acceptance, if any,
  • or the quotation expires,
  • whichever occurs first,
  • unless the quotation expressly states otherwise.

5.2.7 Orders and change orders (must) be in writing

a.  An Order, or a change to an accepted Order ("change order"), must be agreed to in writing unless the requirements of subdivision b are met.

b.  Any assertion of an oral Order, or an oral agreement to modification of an Order, must be supported by clear and convincing evidence (as defined in Clause 22.12).

Commentary

Oral Orders, and oral modifications to Orders, are allowed here because that's how it often happens in the real world.

Alternative: "Any Order, and any change to an Order, must be in writing; no party will assert that an Order was agreed to or modified in any other way."

Caution: In some jurisdictions, courts might not enforce a change-orders-in-writing requirement like the above alternative; see Clause 17.1 (Amendments Protocol) and its commentary.

Subdivision b – corroboration requirement: See Clause 16.8 (Corroboration Requirement) and its commentary.

5.2.8 Each party must agree to an Order

An Order must be agreed to by both Supplier and Customer.

5.2.9 Change orders must be agreed to by the obligated party*

A change order must be agreed to by (at least) the party against which the change order is sought to be enforced.

Commentary

This section borrows from the approach of UCC § 2-201.

Alternative: "A change order must be agreed to by both parties."

5.2.10 Actual- or apparent authority is sufficient* for agreement

An Order or a change order may be agreed to on behalf of a party by any person having actual- or apparent authority.

Commentary

Concerning "apparent authority," see the commentary at § 17.1.3.

Alternative: "An Order or a change order must be agreed to on behalf of a party by an officer of the party at the vice-president level or higher."

5.2.11 Customer's affiliates may submit Orders only if agreed

a.  If the Contract unambiguously says so, Customer's affiliates (as defined in Clause 22.2)

  • may submit one or more proposed Orders for transactions with Supplier under the Contract.

b.  If an Order by a Customer affiliate is accepted by Supplier,

  • then the Order will be governed by the Contract
  • in the same manner as if Customer had submitted the Order.

c.  A proposed Order from a Customer affiliate will not be binding on Supplier

Commentary

A customer will sometimes want its "affiliated" companies to be allowed to take advantage of the contract terms that the customer negotiates with a supplier.

(Caution: This doesn't mean that the preamble of the contract should list "and its affiliates" as parties, as explained in § 25.2.2.9.)

Subdivision c – not binding until acceptance: Supplier might want to decline an order from a Customer affiliate, for example if Supplier doesn't have a basis for believing that the affiliate is sufficiently creditworthy. Supplier might want Customer to guarantee orders from Customer's affiliates.

5.2.12 Customer is not responsible* for affiliates' Orders

Customer is not responsible for its affiliates' obligations under their Orders (if any),

  • unless Customer so agrees in writing, perhaps in the Order itself.
Commentary

Alternative: "If a Customer affiliate enters into an Order with Supplier under the Agreement for a transaction, then Customer is jointly and severally responsible, together with its affiliate, for the affiliate's obligations under that Order."

5.2.13 Appropriate packaging and labeled are required

a.  Supplier is to cause all deliverables to be appropriately packaged and labeled for shipment and delivery; this includes, without limitation, conformance to:

  1. any requirements of law (including for example any required country-of-origin labeling);
  2. any specific packaging- and/or labeling instructions in the order,

b.  If Customer provides a purchase-order number or other identifier for the order,

  • then Supplier is to cause that identifier to be included on shipping labels, shipping documents, and order-related correspondence.

5.2.14 Orders are to be filled as stated

Supplier is to cause deliverables specified in the Order to be delivered as stated in the Order.

Commentary

This is phrased as "Supplier is to cause delivery" instead of "Supplier will deliver" because in many cases Supplier will use a carrier to actually make the delivery.

Alternative: "Supplier is to endeavor to cause delivery …." (Emphasis added.)

5.2.15 Customer may* (normally) specify delivery to a third party

a.  Customer may designate, in writing, a third party to which deliverables are to be shipped.

b.  Customer's designation of the third party must take place a reasonable time before shipment.

c.  Customer will respond promptly

  • to any reasonable requests by Supplier
  • about the third party,
  • for example (as defined in Clause 22.21), to determine whether Supplier may legally ship the deliverables to the third party
    • because of export-control restrictions or other legal factors.

d.  Supplier is to cause the deliverables to be shipped to the third party,

  • absent reasonable objection on Supplier's part.

e.  Customer is to pay any additional costs arising from Customer's designation,

  • e.g., additional shipping, additional insurance, etc.
Commentary

Subdivision d: Supplier might have legitimate reasons for not wanting to ship ordered goods to particular third parties. For example, a third party might be a competitor of Supplier, or the third party might be on a bar list of some kind, e.g., under the export-control laws.

5.2.16 Title and risk of loss will pass per (INCOTERMS 2020 EXW)

An Order may specify other terms for when title and risk of loss will pass to Customer.

Commentary

Drafters should usually try to take advantage of the INCOTERMS 2020 three-letter options, which spell out things such as responsibility for freight charges, insurance, and export- and customs clearance, as well as passage of title and risk of loss.

5.2.17 Reasonable variations in delivery time (are acceptable)

While an Order might specify a delivery time,

  • Supplier will not be liable if the actual delivery time is early or late,
  • as long as the variation is not unreasonable under the circumstances,
  • unless the Order clearly states otherwise.
Commentary

Alternative: "Time is of the essence for delivery." (See generally the commentary on that subject at § 22.44.)

5.2.18 Each Order is a separate agreement*

Each Order is to be considered a separate agreement

  • that incorporates the Contract by reference,
  • including but not limited to this Protocol,
  • whether or not the incorporation is explicit.
Commentary

Alternative: "Each Order is to be considered an addition to this Agreement and not as a separate agreement."

For discussion about the choice of approaches, see § 5.1.1.

5.3 Defect Correction Protocol

a.  When this Protocol is adopted in an agreement (the "Contract"), it applies if and when:—

  • a signatory party specified in the Contract,
    • referred to as "Provider,"
  • must correct defects in goods or services provided to another party,
    • referred to as "Customer."

b.  For clarity: The term "Provider" is used for convenience,

  • but the defective goods or services might actually have been provided by another party,
  • for example (as defined in Clause 22.21), if a third-party service provider is to deal with defects as stated in this Protocol.

Contents:

Commentary

This Protocol represents a fairly-standard protocol for correction of software defects; it should also be useful in other contexts.

5.3.1 Definition: "defect"

For purposes of this Protocol, the term defect, whether or not capitalized, refers:

  • to any failure,
    • by one or more deliverables and/or services provided under the Contract,
  • to comply with agreed written specifications, for example (as defined in Clause 22.21), in:
    • the Contract itself;
    • a purchase order for goods;
    • or a statement of work for services.
Commentary

The definition of defect is fairly standard — notably, it does not include a materiality qualifier, because the materiality of defects can be addressed in other provisions.

5.3.2 Customer must meet a 90-day* deadline for reporting defects

Provider's obligations under this Protocol apply only to purported defects —

  • that Customer reports in writing to Provider (or Provider's designee),
  • on or before the specified time after:
    • the date of delivery of the relevant deliverable,
    • or completion of the relevant service,
    • as applicable.
Commentary

Providers will want to establish a cutoff date for their defect-correction obligations.

Customers, of course, will want to make sure that the cutoff date is far enough ahead that defects are reasonably certain to become apparent.

5.3.3 Provider is to follow Plans A and B for reported defects

Provider is to address defects as specified in Plan A and Plan B below.

5.3.4 Plan A: Repair, replacement, or workaround within 30 days*

For any defect that is timely reported under § 5.3.2,

  • and that Provider is capable of reproducing by making reasonable efforts,

Provider is to do one or more of the following:

  1. Correct the defect, which may include, without limitation:
    • repairing or replacing a defective deliverable, and/or
    • re-performing defective services; or
  2. deliver a commercially-reasonable workaround for the defect,
    • if Provider reasonably determines that correction would be impracticable,

in either case, before the end of the specified time after Provider's receipt of the defect report.

Commentary

The concept of a workaround comes from the software world; it might or might not be relevant in other fields.

Note: This language should not be interpreted as creating a long-term warranty of deliverables' future performance; see the discussion at § 5.1.4.

5.3.5 Plan B: Refund

If Provider does not timely take the action or actions required by this Protocol for a particular defect,

then Provider is to promptly do the following:

  • cancel any unpaid invoice calling for payment, by or on behalf of Customer, for those deliverable(s) and service(s), and
  • cause a refund to be made of all amounts paid, by or on behalf of Customer, for the relevant deliverable(s) or service(s),
  • in either case at Customer's written request.
Commentary

This states that Provider is to "cause" a refund to be made; this language anticipates that Customer might have purchased the relevant goods or services via a reseller or other third party.

Caution: Providing the right to a refund as a "backup" remedy might be crucial in case other agreed remedies fail, as discussed in the commentary at § 5.1.6.

5.3.6 Plans A and B are the EXCLUSIVE REMEDIES* for defects

Provider's defect-correction obligations stated in this Protocol

  • are Provider's only obligations,
  • and the EXCLUSIVE REMEDIES
  • for any defect in goods or other deliverables or in services.
Commentary

Suppliers are very prone to include exclusive-remedy provisions like this in their terms of sale.

Some drafters might want to provide a schedule of different reporting deadlines for different categories of defect, based on (for example) how long it might take for a particular category of defect to become apparent.

Concerning exclusive remedies, see also the commentary at § 5.1.5.

5.4 Orders: Optional clauses

5.4.1 Option: Stocking Point Delivery

a.  An Order may specify that ordered deliverables are to be delivered to a warehouse (or other stocking point) until called for Customer.

b.  For any such Order, both title and risk of loss for the ordered deliverables will pass to Customer only when those deliverables are released for final delivery to Customer.

Commentary

Just-in-time delivery of parts to stocking points is sometimes used by manufacturers to minimize reduce* the amount of their capital that is tied up in inventory. Such a manufacturer might require a supplier to deliver parts and other components — still owned by the supplier, and thus tying up the supplier's capital —until needed by the manufacturer.

5.4.2 Option: Deliverables Substitution

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Supplier may not substitute different deliverables for those specified in the Order without Customer's prior written consent.

Supplier may make substitutions for deliverables specified in an Order, but only if all of the following prerequisites are met:

  1. The substituted deliverables must meet any functional specifications stated in the Order for the ordered deliverables.
  2. Supplier must advise Customer of the substitution, in writing, no later than [the scheduled time for delivery].
  3. Customer may reject the substituted deliverables on or before [14 days] after the date of delivery.

5.4.3 Option: Partial- or Early Deliveries

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

 Customer may, in its sole discretion, reject any delivery that is incomplete or that is not delivered on the date specified in the Order;

  • if Customer does so, that will not affect any right or remedy Customer might have arising from the delivery failure.

Supplier may, in its discretion, ship partial deliveries of ordered deliverables,

  • but not if Customer notifies Supplier otherwise a reasonable time in advance.
Commentary

Customer might want deliveries to be all-or-nothing, so that Customer's people won't have to spend time dealing with deliveries that don't conform exactly to the Order.

On the other hand, Supplier might want to be able to ship things as they're finished, without waiting for the Order to be completed.

5.4.4 Option: Shortages Flexibility

If Supplier runs short of ordered deliverables, for whatever reason or reasons,

then Supplier may do some or all of the following:

  1. allocate Supplier's available production as Supplier deems appropriate;
  2. delay or stop shipments; and/or
  3. send partial shipments with prior notice.
Commentary

This shortages provision amounts to a barebones (and one-sided) force majeure provision.

Supplier and Customer might want to give more thought to this particular "what-if?" scenario; see generally Clause 13.6 (Force Majeure Protocol).

5.4.5 Option: Environmental Damage Responsibility

As between Supplier and Customer, [Supplier] is responsible for any and all environmental damage arising from ordered deliverables to Customer until Customer receives the deliverables.

5.4.6 Option: Shipping-Document Consolidation

Supplier is encouraged to consolidate shipping documents wherever practicable.

5.4.7 Option: Shipment Advice

a.  Supplier will advise Customer in writing when deliverables specified in an Order have been shipped.

b.  Supplier will provide any specific details reasonably requested by Customer,

  • such as tracking information for the shipment.

5.4.8 Option: Release Documentation

Promptly after Supplier delivers ordered deliverables to a carrier for shipment to Customer,

  • Supplier will send Customer any documents necessary for Customer to cause the deliverables to be released
  • to Customer or Customer's designee.

5.4.9 Option: Delivery Delay Warning

Supplier will promptly advise Customer, preferably in writing, if a reasonable person would conclude that a delivery is likely not to meet the schedule specified in the relevant Order.

(In case of doubt: Supplier's advising Customer of a possible delay, in itself, will not affect any right or remedy Customer might have for an actual delay.)

5.4.10 Option: As-Delivered Problem Reporting Requirement

Customer will promptly advise Supplier, in writing,

  • of any mismatch that Customer finds
  • between the type, quantity, and price of deliverables specified in an accepted Order
  • and the deliverables actually delivered.

5.4.11 Option: Customer Handling of Rejected Deliverables

a.  Customer may direct that rejected deliverables be returned to Supplier (at whatever address Supplier specifies) at Supplier's expense.

b.  Customer may store rejected deliverables, at Supplier's risk, pending Customer's receipt of Supplier's return shipping instructions.

c.  Supplier will pay, or reimburse Customer for, all charges for storage, insurance, and return shipping of rejected deliverables.

d.  If Customer rejects one or more deliverables as authorized by this Agreement,

  • but Supplier does not provide Customer with pre-paid return shipping instructions within a reasonable time,
  • then Customer may, in its sole discretion:
    • 1. destroy some or all of the rejected deliverable(s);
    • 2. sell some or all of the rejected deliverable(s), at a commercially reasonable public- or private sale; and/or
    • 3. otherwise dispose of some or all of the rejected deliverables.

e.  If Customer sells some or all of the rejected deliverables, it will apply any proceeds in the following order:

  1. expenses of the sale;
  2. storage charges not paid for by Supplier;
  3. any other amounts due to Customer from Supplier; and
  4. payment of any remaining balance to Supplier.

5.4.12 Option: Supplier Orphaned Deliverables

a.  This Option will apply if,

  • through no fault of Supplier or its contractors,
  • Customer is not ready to receive some or all deliverables under an accepted Order
  • on the schedule specified in the Order.

b.  Supplier may cause the relevant deliverables to be stored at a site reasonably selected by Supplier.

  • Such a site might be under the control of Supplier or a third party (such as, for example (as defined in Clause 22.21), a freight forwarder).

c.  Both title and risk of loss for stored deliverables will immediately pass to Customer (if that has not already happened).

d.  Supplier may deem its delivery of the relevant deliverables to be complete once those deliverables are put into storage

  • (and therefore Supplier may invoice Customer for any remaining amount due).

e.  Customer will reimburse Supplier for all expenses incurred by Supplier in connection with putting the relevant deliverables into storage,

  • in accordance with Clause 1.5 (Expense Reimbursement Protocol).

f.  When Customer is able to accept delivery of the stored deliverables, Supplier will arrange for delivery,

  • but Supplier need not do so if one or more of Supplier's invoice(s) relating to the Order in question is past due.

5.4.13 Option: Terms for Order size

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Customer may submit an Order of any size.

Supplier may decline an Order for goods or other deliverables if the ordered quantity of any single stock-keeping unit (SKU) is less than [QUANTITY].

Supplier may decline an Order where the aggregate Order price is less than [AMOUNT], exclusive of taxes, shipping, and insurance.

Commentary

Suppliers are often concerned with economies of scale — especially for goods that are manufactured to order — and so they might want to establish a minimum order quantity (MOQ).

5.4.14 Option: Terms for Supplier's acceptance of Orders

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Supplier may decline any proposed Order in its sole discretion. (In case of doubt: Here, decline has the same meaning as reject.)

Supplier will not unreasonably decline an Order.

Supplier will not decline any Order.

If Customer has failed to pay amounts due to Supplier when due,

  • then Supplier may decline subsequent proposed Orders by Customer
  • until all such past-due amounts have been paid.

Supplier is deemed to have accepted an Order,

  • and to have waived its right to decline or otherwise reject the Order,
  • if Supplier has not declined the Order in writing
  • within [five business days] after Supplier receives the Order.

If Customer has failed to pay amounts due to Supplier when due,

  • then Supplier may revoke Supplier's acceptance of Customer's Orders that Supplier previously accepted but has not yet filled or completed.

Supplier may not revoke its acceptance of an Order.

Supplier may revoke its acceptance of an Order only under the following circumstances: [DESCRIBE].

5.4.15 Option: Terms for Customer Cancellation of Order

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Customer may cancel an Order for goods that are not to be specially manufactured for the Order — but Customer may do so only before Supplier has shipped the goods — by sending a written cancellation advice to Supplier.

Customer may not cancel an Order for goods that are to be specially manufactured for the Order.

Customer may not cancel an Order for services.

Customer may not cancel an Order for goods once the Order has been accepted by Supplier.

An Order for goods or other deliverables will not be deemed canceled unless Supplier receives a written cancellation request, signed by an authorized representative of Customer, no later than [SPECIFY DEADLINE].

IF: Customer cancels an Order for goods or other deliverables; THEN: Supplier may invoice Customer for, and Customer will pay, a cancellation fee of [SPECIFY AMOUNT].

5.4.16 Option: Advance Payment Requirement

Supplier reserves the right, in its sole discretion (as defined in Clause 22.17),

  • to require Customer to pay in full, in advance for an Order;
  • this will be true even if the Contract otherwise provides for Supplier to perform first and be paid later.

5.5 Referrals Protocol

a.  When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • a specified party ("Company") is to pay another specified party ("Associate")
  • commissions on Company sales
  • during a specified time period ("Commissionable Sales Period")
  • to otherwise-eligible customers in a specified territory and/or market segment ("Territory")
  • that are referred to Company by Associate during a specified time period ("Referral Term").

b.  [Brackets] indicate an item that the parties may modify by unambiguously saying so in the Contract.

Contents:

5.5.1 Commissions will be 0.001%* of eligible sales

(The above percentage is a placeholder that will apply only if the Contract does not specify otherwise.)

5.5.2 All "Company offerings" are eligible for commissions*

The term "Company offerings" refers to Company products and/or services that are —

  • offered for sale by Company,
  • in the Territory,
  • during the Referral Term (defined below).

5.5.3 The "Territory" for referrals is: Worldwide, in all markets*

5.5.4 Referrals for two years* are commission-eligible

a.  The "Referrals Term":

  • begins upon the effective date of the Contract,
  • and ends at the end of the day (as defined in Clause 22.14) on the date [two years] after that.

b.  In case of doubt: Only otherwise-eligible referrals made during the Referrals Term are eligible for commission payments.

5.5.5 A given referral will "go stale" in one year*

For Associate to be entitled to any commissions

  • for Company's sales to an otherwise-eligible referred customer,
  • Company's first sale of a commission-eligible Company offering to that customer
  • must be made on or before the stated time after Associate's initial referral of that customer to Company.

5.5.6 A Company sale is "made" upon a binding agreement

For commission purposes, an otherwise-eligible sale to a customer is considered "made"

  • on the date that Company and the customer in question enter into a binding agreement for that sale,
  • regardless of the putative effective date of that agreement.
Commentary

Caution: Be careful about using terms such as "consummated" sales — that led to what must have been an expensive lawsuit over a finder's fee: the court ruled that a finder's-fee agreement did not require the resulting federal contract to be "performed" in order for the transaction to be "consummated"; the finder's fee was therefore due and owing.

5.5.7 Commissions for a referral will end one year* after first sale

Company need not pay commissions

  • for an otherwise-eligible sale to a customer,
  • if that sale is "made" (see Clause 5.5.6)
  • after the end of the specified time after Company's first sale to that customer is made.
Commentary

Note that under Clause 5.5.11, the due date for a commission payment might be after the end of this period.

5.5.8 The Referrals Term will not be* automatically extended

But if the Contract does provide for automatic extension of the Referrals Term (defined in Clause 5.5.4),

  • then Clause 18.4 (Evergreen Extensions Protocol) will govern.

5.5.9 Associate's referral rights are not* exclusive

If the Contract does provide for any type of exclusivity,

5.5.10 Associate need not* meet any performance requirements

But if the Contract does set forth minimum performance requirements,

  • and Associate fails to perform to those requirements,
  • then Company may terminate Associate's right to receive commissions.

Not unless the Contract clearly says so.

5.5.11 Payments are due 30 days after collection EOQ*

a.  Company will pay Associate commissions due under the Contract no later than the specified time.

b.  "Collection EOQ" refers to the end of the fiscal quarter in which Company collects the associated invoiced price.

c.  Clause 1.4 (Payment Protocol) will govern.

5.5.12 Associate* has confidentiality obligations

a.  Clause 6.3 (Confidential Information Protocol) will apply,

  • [but only as to Company's Confidential Information].

b.  The terms of the parties' commission arrangement are Company's Confidential Information.

5.5.13 Company will provide a report of commissions due

With each commission payment, Company will provide Associate with:

  • a complete and accurate written statement of the amount(s) due,
  • with reasonable supporting detail.

5.5.14 Company will keep supporting records

Company will keep records to support commission amounts due

  • in accordance with Clause 3.5 (Recordkeeping Protocol).

5.5.15 Associate may have commission reports audited

Clause 3.7 (Audit Protocol) will govern any such audits.

5.5.16 Specified sales are eligible for commissions

Associate will be eligible for commissions only —

  • on Company's sales of Commission-Eligible Offerings
  • to new customers that Associate refers to Company (each, a "Prospect"),
  • where each of the following requirements is satisfied:
  1. The Prospect must have substantial operations in the Territory —
    • Company's determination of the substantial-operations question will be final and binding.
  2. Associate must have referred the Prospect to Company during the Referrals Term.
  3. The Prospect must not be barred by law from acquiring the Offering(s) in the Geographic Territory.
  4. The Prospect must not be a competitor of Company
    • unless Company gives its prior written consent.
  5. The Prospect must not have had a previous connection or relationship with Company
    • at the time of Associate's initial referral;
    • Company's determination of that point will be final and binding.

5.5.17 Are any invoiced items not commisionable?

Associate will not be eligible for commissions on any of the following:

  1. separately itemized charges for taxes, shipping, and insurance; nor
  2. a reasonable allowance for returns,
    • in accordance with Company's then-generally-effective return policy,
    • which is to be determined by Company in its sole judgment from time to time,
    • but is to be consistently applied.

5.5.18 May Associate hold itself out as Company's agent?

No.

See also Clause 19.6 (Tango: Independent Contractors Protocol).

5.5.19 Who will control customer sales negotiations?

a.  Associate's role (if any) in Company's sales negotiations with Prospects will be determined exclusively by Company in Company's sole discretion (as defined in Clause 22.17).

b.  Associate will follow Company's lawful directions in that regard.

c.  Associate will not attempt to insert itself into any such negotiation without Company's prior approval.

5.5.20 Who will be responsible for warranty claims?

If a customer or other third party makes a claim (as defined in Clause 22.11) against Associate

  • because of what the third party alleges was a breach of a Company warranty about a Commission-Eligible Offering,

then Company will defend (as defined in Clause 14.5) Associate's Protected Group (as defined in Clause 22.38) against the claim.

5.5.21 Who will be responsible for alleged Associate faults?

If a third party makes a claim (as defined in Clause 22.11) against Company

5.5.22 Referrals exercise

FACTS: MathWhiz is all excited because Gigunda wants to refer potential clients to MathWhiz — but Gigunda wants to be paid a referral fee for each referral.

QUESTIONS:

  1. From MathWhiz's perspective, what should have to happen before MathWhiz is obligated to pay Gigunda a referral fee?
  2. What what Gigunda prefer to be the trigger for getting a referral fee?
  3. Is there any way to compromise between 1 and 2 above?
  4. Is there any way that MathWhiz could avoid paying a referral fee?

5.6 Resale Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract:

  • a specified party ("Reseller"),
  • is to acquire and resell Resale Offerings,
  • of another party ("Supplier"),
  • during a specified Resale Term (as defined in Clause 5.6.4);
  • this arrangement is sometimes referred to as the "Reseller Relationship."

Discussion checklist:

[Note to drafters: See also the optional terms in Clause 5.6.35.]

5.6.1 What Supplier offerings may Reseller resell?

Reseller may resell:

  • [any and all] Supplier products and/or services
  • offered by Supplier
  • during the Resale Term
  • in the Territory,
  • each defined below (the "Resale Offerings").

5.6.2 In what "Territory" may Reseller resell?

Reseller may resell Resale Offerings in the "Territory,"

  • which refers to [anywhere in the world, in all market segments].

5.6.3 What discount will Reseller get?

When Reseller acquires Resale Offerings from Supplier,

  • it may do so at a discount of [0.001%]
  • from Supplier's then-current, published list price
    • that is applicable in the Territory.
Commentary

The discount level in this section is a placeholder, obviously.

5.6.4 How long may Reseller engage in resales?

a.  The "Resale Term":

  • will begin on [the effective date of the Contract],
  • and will end at the end of the day
    • on the date [two years] later.

b.  If and when the Resale Term ends, Reseller will permanently cease:

  1. advertising, marketing, or otherwise promote Resale Offerings; and
  2. identifying itself as a channel associate of Supplier.

5.6.5 Will the Resale Term be "evergreen"?

No: Any extension of the Resale Term must be by affirmative mutual agreement.

Commentary

Alternative: The Resale Term will be extended for successive [one-year] extension terms unless [either party opts out], in accordance with Clause 18.4 (Evergreen Extensions Protocol).

5.6.6 This resale channel is [nonexclusive]

The Resale Relationship is not exclusive to either party unless the Contract clearly says so —

  • but if the Contract does say so,
  • then Clause 22.22 (Exclusivity Definition) will apply.

5.6.7 May Reseller engage subresellers?

a.  Reseller may not appoint a subreseller without first obtaining Supplier's written consent.

b.  Supplier may grant, withhold, or condition its consent to appointment of a subreseller in Supplier's sole discretion (as defined in Clause 22.17).

c.  Before appointing a prospective subreseller (a "prospect"), Reseller must provide Supplier with the following:

  1. the identity of the prospect;
  2. such background information about the prospect as Reseller might reasonably request;
  3. evidence, satisfactory to Supplier in its sole judgment,
    • that the prospect has sufficient training and experience to carry out its duties as a subreseller
    • in a manner that will not reflect adversely on Supplier; and
  4. if requested by Supplier, any authorization required by law
    • for Reseller to cause a background check to be conducted on the prospect.

d.  Each subreseller must enter into an agreement with Reseller (a "Subreseller Agreement"); at a minimum, each Subreseller Agreement must:

  1. impose at least the same restrictions and obligations on the subreseller as this Protocol does on Reseller;
  2. clearly state that Supplier will have no liability to the subreseller
    • in connection with the Subreseller Agreement
    • or the subreseller's dealing in Resale Offerings;
  3. prohibit the subreseller from appointing sub-subresellers without Supplier's prior written consent,
  4. terminate automatically at the end of the Resale Term; and
  5. clearly indicate that Supplier is a third-party beneficiary of the Subreseller Agreement.

e.  Reseller will defend (as defined in Clause 14.5) Supplier's Protected Group (as defined in Clause 22.38) against any claim by a third party

  • if the claim arises out of acts or omissions of a subreseller relating to a Subreseller Agreement.

5.6.8 When are Reseller's payments to Supplier due?

Reseller's payments to Supplier for Resale Offering purchases are [net 30 days] from Reseller's receipt of Supplier's invoice;

5.6.9 Who will support Reseller's customers?

a.  Level 1 support (defined in Clause 8.4) for Reseller's customers for Resale Offerings will be provided by [Reseller];

  • Level 2 and Level 3 will be provided by [Supplier]

b.  If Reseller provides support for its customers for Resale Offerings,

  • Reseller will follow any written- and oral guidance for customer support provided to Reseller by or on behalf of Supplier,
  • to the extent that such guidance is not inconsistent with the Contract.

c.  Reseller will promptly notify Supplier if Reseller finds that it is unable to respond effectively to a request for support from a Reseller customer.

5.6.10 What performance requirements must Reseller meet?

During the Resale Term, Reseller will use [commercially-reasonable efforts] (defined in Clause 9.5) in promoting sales of the Resale Offerings within the Territory.

Commentary

Supplier might want to bargain for more-specific performance requirements, as discussed in more detail in § 5.1.3.2.

5.6.11 What if Reseller fails to perform as agreed?

If Reseller does not meet the performance standard set forth in Clause 5.6.10,

  1. invoke Clause 13.15 (Performance Improvement Plans), and/or
  2. terminate the Reseller Relationship,
    • either immediately
    • or if Reseller does not achieve the goals specified in accordance with Clause 13.15.
Commentary

Subdivision 1, putting Reseller "on plan," allows the parties some flexibility in dealing with Reseller's failure to meet agreed performance goals — in many situations this will be a better approach than having Supplier's only choice be to terminate the Reseller Relationship.

5.6.12 Reseller [must] keep its Supplier pricing confidential

Reseller is to treat the pricing extended to Reseller by Supplier as the Confidential Information of Supplier

  • in accordance with Clause 6.3 (Confidential Information Protocol).

5.6.13 Reseller [must] preserve Supplier's other confidences

Reseller is to preserve in confidence any Supplier Confidential Information to which Supplier obtains access,

  • in accordance with Clause 6.3 (Confidential Information Protocol).

5.6.14 Reseller [will not] be Supplier's "agent"

Unless the Contract clearly states otherwise, Reseller is not Supplier's agent,

  • and will conduct itself accordingly at all times.

5.6.15 How may the Reseller Relationship be publicized?

a.  The authorizations in this section are effective only during the Resale Term (as defined in Clause 5.6.4).

b.  Each party (each, a "Publicizing Party") may:

  1. publicly identify itself,
    • in a non-misleading way,
    • as, in effect, a channel associate of the other party, and
  2. provide contact information for the other party:
    • (i) on the Publicizing Party's Website, and/or
    • (ii) in promotional materials approved in advance by the other party,
    • but only if the other party has either:
      • (x) made that contact information public, or
      • (y) authorized the Publicizing Party, in writing, to use the contact information.

c.  A Publicizing Party's identification of itself as a channel associate under this Protocol may include commercially-reasonable use (as defined in Clause 9.5) use of the other party's relevant logos and other trademarks and service marks (collectively, "Marks");

  • Reseller, however, may not use any Supplier marks other than those under which Supplier markets the Resale Offerings.

d.  A Publicizing Party's use of another party's Marks must conform to Clause 10.7 (Trademark Use).

e.  A Publicizing Party will promptly stop using another party's Marks upon any termination of the Reseller Relationship.

f.  Nothing in this Protocol gives either party any right in, nor any right to use, any Mark of another party except as expressly stated in this Protocol.

5.6.16 Reseller customers will get [Supplier warranties]

a.  Supplier will honor the same Resale Offering warranty terms for Reseller's customers as Supplier does for its own customers of the same Resale Offering(s).

b.  Supplier will defend (as defined in Clause 14.5) Reseller's Protected Group (as defined in Clause 22.38) from any claim by any Reseller customer that acquired a Resale Offering from Reseller,

  • where the customer's claim arises out of an alleged breach of a Supplier warranty concerning the Resale Offering.

c.  Reseller will not purport to make (and has no authority to make), on behalf of Supplier, any commitment to any customer of Reseller except:

  1. as publicly stated by Supplier in, for example (as defined in Clause 22.21), Supplier's published marketing materials, end-user license agreement, terms of service, privacy policy, warranty document(s), etc.; and/or
  2. with Supplier's express, prior, written consent.

5.6.17 Reseller [may] offer its own warranties

Supplier does not object to Reseller's offering Reseller's own additional warranties or other commitments to Reseller's customers that are more favorable to customers than those offered by Supplier, but —

  1. If Reseller does so, it is at Reseller's own risk;
  2. Reseller will make it clear to its customers that Supplier is not liable for Reseller's commitments; and
  3. Reseller will defend (as defined in Clause 14.5) Supplier's Protected Group (as defined in Clause 22.38)
    • against any third-party claim
    • arising from or relating to
    • any such additional warranty or other commitment offered by Reseller.

5.6.18 May Reseller modify Resale Offerings?

a.  Reseller may not package, repackage, modify, or otherwise alter any Resale Offering

  • without Supplier's prior written consent;
  • Supplier may grant or withhold such consent in its sole discretion (as defined in Clause 22.17).

b.  For example (as defined in Clause 22.21), without Supplier's advance written permission:

  1. If any part of a Reale Offering comes to Reseller in a sealed package —
    • for example, a software license-code envelope —
    • then Reseller must not open the package;
  2. If any Resale Offering comes to Supplier in separable components,
    • then Reseller must not separate the components; and
  3. Reseller must not remove or alter any legend or notice,
    • for example, copyright- or trademark notices and the like,
    • and/or warnings or user instructions,
    • on any Resale Offering, promotional materials, or documentation.

5.6.19 Supplier will have [no say] in Reseller's pricing

As between Reseller and Supplier, Supplier has no authority to determine the prices that Reseller charges to Reseller's customers.

Commentary

This section is intended to avoid any possible issues of resale price maintenance (a.k.a. vertical price fixing) under antitrust laws, as briefly discussed at § 5.1.3.1.

5.6.20 Supplier [may] change its Resale Offerings

a.  Supplier reserves the right — at any time and from time to time, in Supplier's sole discretion:

  1. to add to or delete from Supplier's line of offerings (defined below);
  2. to modify any particular item in its line of offerings; and
  3. to modify or discontinue support for any such item.

b.  For this purpose, "line of offerings" includes, without limitation:

  1. items that are part of the Resale Offerings, and
  2. support for any such items.

c.  As a matter of commercial practice, Supplier may elect,

  • in its sole discretion (as defined in Clause 22.17),
  • to consult or notify Reseller in advance of any changes that it makes to Resale Offerings.

Supplier is not obligated to do so, however,

  • and Supplier will have no liability to Reseller for any such action that it does take,
  • whether or not Supplier consults with Reseller about the action.

5.6.21 What if Resale Offerings involve software?

This section applies if the Contract clearly states, in substance,

  • that one or more Resale Offerings includes licenses for the use of software,
  • including but not limited to software-as-a-service, or "SaaS" (the "Software").

Contents:

5.6.21.1 Supplier will provide for customer provisioning

a.  Supplier will provide one or more provisioning systems for Reseller's customers to sign up for access to (and licensing of) the Software,

  • typically Web-based or as part of a Software installation routine.

b.  Reseller is to refer all of its customers to such a Supplier-provided provisioning system.

5.6.21.2 Reseller's customers must agree to Supplier's terms

a.  Supplier may require Reseller's customers to agree to Supplier's then-current terms and conditions

b.  Such Supplier terms and conditions may include, without limitation,

  1. applicable end-user agreement(s);
  2. terms of service or ‑use; and/or
  3. a privacy policy.

c.  Reseller will advise each of its customers in writing,

  • for example (as defined in Clause 22.21), in a written quote form,
  • that the customer will be required to agree to Supplier's terms and conditions.
5.6.21.3 Reseller will "push" Supplier's software updates

If Supplier releases a superseding version of a software Resale Offering —

  • including for example an update, patch, new release, supplement and/or add-on component,
  • then Reseller will promptly:
  1. notify all of Reseller's customers of the availability of the superseding version; and
  2. encourage those customers to acquire and install the superseding version.
5.6.21.4 Reseller may make limited use of the Software

a.  Reseller may use the Software — in executable form only — for purposes of:

  1. demonstrations to prospective customers or clients;
  2. testing; and
  3. internal training for Reseller personnel concerning the Software.

b.  All such use of the Software by Reseller must comply with Supplier's applicable terms and conditions (see Clause 5.6.21.2).

c.  Reseller may make a reasonable number of copies of the Software for purposes of backup, disaster recovery, and disaster testing,

  • in accordance with Reseller's normal IT procedures
  • in conjunction with Reseller's use of the Software under this section.

d.  Otherwise, Reseller will not use the Software in any manner —

  • including, but not limited to, production use for Reseller's own benefit,
  • and/or service-bureau use for the benefit of any Reseller customer —

unless Reseller has obtained the appropriate license(s) from Supplier.

5.6.22 What will Reseller do in case of piracy, etc.?

a.  If Reseller suspects that unauthorized use, copying, distribution, or modification of a Resale Offering (collectively, "unauthorized activities") might be taking place, then Reseller must:

  1. promptly advise Supplier;
  2. provide Supplier with all relevant information reasonably requested by Supplier about the unauthorized activities; and
  3. provide reasonable cooperation with any "Policing Efforts" by Supplier, namely efforts to prevent or stop the unauthorized activities.

b.  Whether Reseller's cooperation under subdivision a.3 above is considered reasonable will depend (in part) on the  following:

  1. the likely expense of such cooperation, and
  2. the extent to which Supplier agrees to bear that expense.

c.  Reseller will not make any Policing Efforts of its own without Supplier's prior written approval.

5.6.23 What will Reseller do with customer feedback?

a.  If Reseller receives any written feedback,

  • as defined in subdivision e,
  • concerning any Resale Offering,
  • at any time,
  • then Reseller will provide Supplier with a complete and accurate copy of the written feedback
  • within a reasonable time after Reseller receives it.

b.  If Reseller receives any oral or other nonwritten feedback, concerning any Resale Offering, at any time,

  • then Reseller will brief Supplier orally about the feedback,
  • on a schedule to be determined by Supplier in its reasonable judgment.

c.  Supplier may use or disclose feedback as Supplier sees fit in its sole discretion (as defined in Clause 22.17).

d.  Supplier will have no financial- or other obligation, of any kind, to Reseller or any of its customers, in respect of feedback,

  • unless expressly agreed otherwise in writing by Supplier.

e.  For purposes of this section, "feedback" refers to any and all suggestions, comments, opinions, ideas, or other input.

5.6.24 What will Reseller do if Supplier issues any recalls?

a.  Reseller will provide reasonable cooperation with Supplier and its designees in connection with any recall of Resale Offerings.

b.  At Reseller's request, Supplier will reimburse Reseller for reasonable out-of-pocket external expenses,

  • such as, without limitation, shipping charges by independent carriers for returning physical Resale Offerings,
  • when actually incurred by Reseller in providing the cooperation required by subdivision a,
  • in accordance with Clause 1.5 (Expense Reimbursement Protocol).

c.  Reseller will make any request for reimbursement under subdivision b no later than [three months] after Reseller pays the relevant expense,

  • otherwise Reseller will be deemed to have WAIVED (as defined in Clause 17.7) reimbursement of that expense.

5.6.25 What rules apply to Reseller's repairs, etc.?

a.  This section applies if Reseller engages in repair or other servicing of Resale Offerings.

  • (This section, in itself, neither authorizes nor prohibits Reseller from engaging in such servicing.)

b.  Reseller will use parts of equal or better quality than the original parts in the Resale Offering.

c.  Reseller may not offer or provide as "new" any Resale Offering that Reseller has repaired after return by a customer.

5.6.26 Reseller [may not] rebrand any Resale Offerings

Reseller will not promote or offer Resale Offerings using any brand name or other trademark (including for this purpose service marks) other than those authorized in advance by Supplier.

5.6.27 [Reseller] is responsible for its business dealings

Reseller will defend (as defined in Clause 14.5) Supplier's Protected Group (as defined in Clause 22.38) from and against any and all claims by any third party arising out of Reseller's activities under an agreement.

5.6.28 Does Reseller get any other rights from Supplier?

No: Supplier reserves all rights not specifically granted by the Contract;

  • this reservation includes (without limitation) copyrights, patent rights, trademark and service mark rights, trade secret rights and other intellectual property rights.

5.6.29 This [is not] a franchise or business opportunity

a.  This section applies unless the Contract clearly and unmistakably provides otherwise.

b.  No party intends, by entering into the Contract, to create a relationship that would be subject to laws governing franchises and/or business opportunities.

c.  Each party WAIVES (as defined in Clause 17.7),

  • to the fullest extent not prohibited by law,
  • any rights or claims,
    • arising out of or relating to the Contract,
  • under laws governing franchises and business opportunities or similar laws.
Commentary

Caution: In some jurisdictions, this clause will be unenforceable or even void; see, e.g., Cal. Corp. Code § 31512: "Any condition, stipulation or provision purporting to bind any person acquiring any franchise to waive compliance with any provision of this law or any rule or order hereunder is void."

Even so, language like this clause is sometimes seen in contracts.

5.6.30 Supplier is not responsible for Reseller's finances

Reseller acknowledges (as defined in Clause 22.1) that Supplier has no responsibility

  • for any dependence that Reseller's business might have on Resale Offerings,
  • nor for any harm that might come to Reseller from the Resale Term's coming to an end.

5.6.31 Neither party* may terminate at will

Neither party may terminate the Reseller Relationship at will unless the Contract clearly provides otherwise.

Commentary

Alternative: "Beginning [one year] after the effective date of the Contract, [either party] may terminate the Reseller Relationship at will upon [30 days' notice] in accordance with the termination-at-will provision in Clause 21.2.8."

Comment: If a party is going to have the right to terminate the Reseller Relationship at will, the other party should carefully consider putting appropriate "fences" around that right, so that the other party does not: • get caught unawares and left in the lurch, and/or • not be able to recoup its investment in the relationship. For more on this subject, see Clause 21.1.1.

5.6.32 Termination will not* cut off Reseller's customers

In case of doubt: The ending of the Reseller Relationship will not affect any then-established rights or obligations of Reseller's customers concerning Resale Offerings.

Commentary

This section Reseller might want it "carved in stone" that Supplier won't abandon Reseller's customers after termination of the Reseller Relationship.

(In many cases that should be a given: Supplier won't want to abandon Reseller's customers because Supplier will want to transition those customers into a direct relationship with Supplier or over to a different reseller.)

5.6.33 May Reseller close pending sales upon termination?

If the Contract clearly says so,

  • after termination of the Reseller Relationship,
  • Reseller may try to close any pending sales,
  • as stated in Clause 21.4 (Wrap-Up Protocol),
  • for [five business days] after the effective date of termination —
  • but not if the Reseller Relationship was terminated by Supplier
Commentary

This Protocol might be a negotiation point.

5.6.34 Other terms to consider

The following terms are not part of this Protocol, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

5.6.35 Resale terms (optional)

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

5.6.35.1 Data About Reseller Customers

a.  Reseller will provide Supplier with data about Reseller's customers and transactions involving Resale Offerings as follows:

  • from time to time, as reasonably requested by Supplier for purposes relating to the Reseller Relationship; and
  • at the end of the Resale Term, as reasonably requested by Supplier to transition Reseller's customers to a relationship directly with Supplier.

b.  Each party is to follow any restrictions imposed by law on the use and/or disclosure of customer data provided by Reseller.

Commentary

If Supplier has other ways of obtaining customer data from Reseller — e.g., software onboarding; warranty registrations; frequent-user clubs; and the like — then Supplier might not need to get Reseller to commit to providing customer data.

5.6.35.2 Reseller's marketing obligations

Without limiting Reseller's other obligations under the Contract, Reseller will engage in the specific marketing efforts set forth in Schedule [FILL IN SCHEDULE NUMBER].

5.6.35.3 Marketing consultation

To reduce the chances of mutual interference between Supplier's and Reseller's marketing activities, Reseller will consult Supplier in advance about Reseller's own proposed marketing activities concerning Resale Offerings.

5.6.35.4 No customers outside the Territory

Reseller will not solicit or support any customer for Resale Offerings if the customer has significant operations outside the Territory.

5.6.35.5 No Reseller facilities outside the Territory

Reseller will not establish or maintain facilities specifically for supporting customers' use of Resale Offerings if such use is reasonably likely to occur outside the Territory.

5.6.35.6 No extra-Territorial availability

Reseller will not make any Resale Offering available to any individual or organization if Reseller knows, or should know, that the Resale Offering will be taken, installed, or used outside the Territory.

5.6.35.7 No competition

During the Resale Term and for [one year] thereafter, Reseller will not participate, nor acquire any interest, in any enterprise that offers or promotes a product or service that competes with any Resale Offering, unless Supplier gives its prior written consent.

5.6.35.8 Minimum inventory

Reseller will keep a minimum quantity of Resale Offerings in inventory as follows: [DESCRIBE].

5.6.35.9 Maximum inventory

Reseller will not keep more than [AMOUNT] of Resale Offerings in inventory without Supplier's prior written consent.

5.6.35.10 Reseller retail sale

Reseller may offer or sell Resale Offerings from physical premises (for example, in stores).

5.6.35.11 Reseller retail sale

Reseller will not offer or sell Resale Offerings from physical premises (for example, in stores) without Supplier's prior written consent

5.6.35.12 No other Resale Offering sources

Reseller will not acquire Resale Offerings from sources other than Supplier.

5.6.35.13 No Resale Offerings to non-end-customers

Reseller will not provide Resale Offerings to others for resale or redistribution.

5.6.35.14 Reseller delivery to its customers

As between Reseller and Provider, Reseller is responsible for acquiring any physical Resale Offerings and — at its own expense and risk — arrange for all storage and/or delivery to Reseller's customers.

5.7 Marketing [to come]

If this Checklist is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

Discussion checklist:

6 Confidential information

Many short- and long-term business dealings begin with confidentiality agreements to allow the parties to check each other out. And many operational contracts include confidentiality provisions.

Contents:

6.1 Introduction & takeaways (now hidden)

6.1.1 Business context for confidentiality obligations

It's quite common for parties:

  • to enter into a confidentiality agreement as a prelude to negotiation of another agreement such as a sale- or license agreement or a merger- or acquisition agreement; and/or
  • to include confidentiality provisions in other types of agreement, for example services agreements; license agreements; and employment agreements.

Caution: In some jurisdictions, the law might restrict parties' ability to enter into confidentiality agreements in certain circumstances, e.g., when settling claims of discrimination.

6.1.2 Reasonable discloser secrecy measures are required

If a party wants to assert legal rights in its confidential information, the party must show that it took reasonable precautions to keep the information secret; such precautions are a sine qua non ("without which not") for legal protection of confidential information in the United States and many other jurisdictions.

• For example, in one case, the Seventh Circuit noted pointedly that the party asserting misappropriation of trade secrets had made no effort to preserve the so-called trade secrets in confidence.

• Similarly, in a Nebraska federal case, the Eighth Circuit agreed with a district court that a trade-secret plaintiff had failed to take reasonable measures:

[The plaintiff] shared the information with a third-party contractor without a confidentiality agreement and without other policies or practices for safeguarding secrets. … [The plaintiff] did not take reasonable steps to safeguard its trade secrets. Without such reasonable efforts or measures, there is no secret to protect, and [the plaintiff] cannot maintain a claim under the [Nebraska Trade Secrets Act] or [federal Defend Trade Secrets Act].

In any given case, what constitutes "reasonable' secrecy measures will depend on the circumstances. Fort-Knox security measures aren't necessary (usually); less-strict security measures might well suffice. 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. … Whether these [specific] precautions were, in fact, reasonable, will have to be decided by a jury.

Pro tip: The author has long used a three-part rule of thumb:

1.  Lock It Up: Require passwords to access confidential information on computer networks. Keep hard-copy confidential information in locked file cabinets and/or behind locked doors.

2.  Label It: When documents contain confidential information, mark the documents as such; failure to do so won't necessarily be fatal, but proper marking is a big help in court.

(But don't be The Boy Who Cried Wolf: If you go crazy with the Confidential stamp and mark obviously-nonconfidential information as confidential, that will work against you.)

3.  "Safe Sex": Be careful both to whom you disclose your own confidential information and from whom you accept confidential information of others; in either case, use "protection" in the form of a confidentiality agreement with terms such as those of Clause 6.3 (Confidential Information Protocol).

6.1.3 Essentially all types of information can be protected

American law doesn't limit the legal protection for confidential information to any particular type of information. Clause 6.2 nevertheless lists some specific types of information as examples of protectable subject matter.

Some drafters (not including the present author) like to include a "laundry list" of specific types of information that can qualify as Confidential Information, using language such as the following:

The term Confidential Information encompasses, by way of example and not of limitation, the following types of information when the information is otherwise eligible under this Agreement:

Algorithms. Audit reports.

Biological materials. Business plans. Business records.

Circuit records. Commercial information. Compounds. Computer programs. Contracts. Construction records.

Data-center designs. Designs. Diagrams. Documents. Draft publications. Drawings.

Engineering records.

Financial information. Financial projections. Financial statements. Forecasts. Formulas.

Hardware items.

Ideas. Interpretations. Invention disclosures.

Leases.

Machine-readable data. Maps. Market projections. Marketing information. Methods.

Offers. Operational data. Opinions.

Patent applications (when unpublished). Plans. Pricing information. Procedures. Processes. Product development plans. Product information programs. Projections. Proposals.

Research data. Research plans.

Samples. Server-configuration designs. Source code for computer programs. Specifications. Strategies.

Tax bills. Technical information. Technical reports. Technological developments. Test data. Title reports.

"Secret sauce": It's well-established in U.S. law that if a party makes a specific selection or combination of one or more particular items of information, then that selection or combination can qualify as Confidential Information, even if the individual items of information are not confidential. A well-known example is Kentucky Fried Chicken's "secret blend of 11 herbs and spices" (whose key ingredient, according to one source, is white pepper).

Negative know-how, i.e., knowledge of experimental dead ends, can qualify as a trade secret. Legendary inventor Thomas Edison is widely quoted as saying, "I have not failed. I've just found 10,000 ways that won't work."

But a court might be skeptical of the economic value of knowing the wrong answers if the right answer has become publicly available. As a federal court explained:

… the plaintiffs have failed to allege how these negative trade secrets derive independent economic value from not being generally known given the existence of volumes of information publicly available ….

It is difficult to see how negative trade secrets consisting of unsuccessful efforts to develop trade secrets and experimental dead ends can have independent economic value when the end result of the process, the positive trade secrets, have in fact been uncovered.

6.1.4 "Trade secrets" must have independent economic value

The law in the U.S. protects "trade secrets," a term defined in Clause 6.2.3; that definition adopts, essentially verbatim, the definition in the (U.S.) Defend Trade Secrets Act ("DTSA"), 18 U.S.C. § 1839(3).

A key feature of the statutory definition is that, for a party to establish that particular confidential information is a trade secret, that party must show that knowledge of the information provides an economic advantage — actual or potential — over those who don't know the information.

How can we tell whether particular confidential information does or doesn't have independent economic value? The Judicial Council of California Civil Jury Instructions, 2017 edition, includes a list of factors that jurors may take into account in determining whether particular information has independent economic value, with extensive citations:

In determining whether [e.g., information] had actual or potential independent economic value because it was secret, you may consider the following:

(a) The extent to which [name of plaintiff] obtained or could obtain economic value from the [e.g., information] in keeping [it/them] secret;

(b) The extent to which others could obtain economic value from the [e.g., information] if [it were/they were] not secret;

(c) The amount of time, money, or labor that [name of plaintiff] expended in developing the [e.g., information];

(d) The amount of time, money, or labor that [would be/was] saved by a competitor who used the [e.g., information];

[(e) [Insert other applicable factors].]

The presence or absence of any one or more of these factors is notnecessarily determinative.

Of course, proving up the independent economic value of particular information has sometimes proved a stumbling block. For example, a physician in New York failed in her trade-secret claim against her former employer for allegedly misappropriating her trade-secret billing template; the court said: "We further conclude that Dr. Kairam fails to plausibly allege that the template [to optimize billing] is a trade secret. She does not allege, for example, how the template derives independent economic value from not being generally known to others …."

In contrast, a Microsoft Excel spreadsheet for estimating the financial viability of a possible senior living community, known as an underwriting template, was held to qualify: "Even if there are other underwriting templates publicly available, Brightview's template — containing its own nuanced, data-specific formulas and data amassed over twenty-five years in business — is not, and it likely holds independent value as a secret …."

Customer lists have been viewed differently by different courts concerning their economic value; some courts have treated such lists as qualifying for protection, others not. Compare, e.g., two cases coincidentally decided on the same day by different federal courts:

• A federal court in Kentucky granted summary judgment in favor of insurance agents who were accused of misappropriating the confidential customer lists of insurance giant Allstate; the court held that on the facts, the customer lists in question were not protectable.

• In contrast, the federal court in Nevada granted a preliminary injunction against a company that had hired away two sales people from the plaintiff; the court held that "Plaintiff's client information, deployment records, and product pilot programs derive economic value through not being readily available to the public …."

6.1.4.1 What can be "improper means" of ascertaining a trade secret?

"Improper means" of ascertaining someone else's trade sedret is defined in the (U.S.) Defend Trade Secrets Act as:

the term "improper means"—

(A) includes theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means; and

(B) does not include reverse engineering, independent derivation, or any other lawful means of acquisition ….

The exception in subdivision (B) echoes the U.S. Supreme Court's famous Kewanee Oil opinion: "A trade secret law, however, does not offer protection against discovery by fair and honest means, such as by independent invention, accidental disclosure, or by so-called reverse engineering[.]"

6.1.4.2 Will a confidentiality breach be considered "improper means"?

Breach of a confidentiality agreement might or might not be considered improper means of acquiring a trade secret:

• A Texas appeals court held that under Texas law, "[a] post-acquisition breach of a confidentiality or nondisclosure agreement … cannot support an improper means finding as a matter of law."

• But then two weeks later, the Fifth Circuit held (in an unpublished opinion) that under Texas law, "a breach of a duty to maintain secrecy is a way of establishing improper means …."

A commentator pointed out that the Fifth Circuit's holding in Hoover Panel "raises a potential Erie concern," in that federal courts sitting in diversity (i.e., the Fifth Circuit) are supposed to apply state law as interpreted by state courts.

6.1.5 Exclusions from Confidential Information status

Clause 6.5 sets out six pretty-standard exclusions from Confidential Information status. That is, the confidentiality obligations of Clause 6.3 (Confidential Information Protocol) do not apply to information that comes within one or more of these exclusions.

6.1.5.1 Caution: Exclusions might be preempted by law

Just because a confidentiality agreement doesn't protect particular excluded information, that would not automatically mean that the information was fair game to use or disclose. Both disclosing- and receiving parties will want to check out privacy laws concerning (without limitation):

  • protected health information, for example under the U.S. Health Insurance Portability and Accountability Act of 1996 ("HIPAA");
  • personal financial information, for example under the Gramm-Leach-Bliley Act;
  • the EU's General Data Protection Regulation (GDPR); and
  • American state laws concerning user privacy such as the recently-enacted California Consumer Privacy Act (CCPA).

See generally the data-privacy commentary at § 11.

6.1.5.2 Caution: Don't categorically exclude subpoenaed information

Some badly-drafted confidentiality exclusions state that subpoenaed information is excluded from confidentiality. This could be a big mistake for a disclosing party — a receiving party could later argue that the mere issuance of a third-party subpoena automatically resulted in the subpoenaed information being excluded from confidentiality status, even if a court were to issue a protective order restricting what the third party could do with the information.

The better approach is to state that disclosures in response to compulsory legal process are explicitly authorized, as provided in Clause 6.3.14.

6.1.5.3 Exclusion of "generally known" information

NDAs typically exclude generally-known information from protection.

Caution: It's not a great idea to say that information is excluded because it is in the "public domain," because (at least to IP lawyers) that term refers to information that is available for use by anyone without restriction — and use of information might subject to restriction under patent- or (in the case of computer software) copyright laws.

Publication is of course a classic way in which allegedly-confidential information can become "generally known." For example: "It is axiomatic that a plaintiff cannot recover for the misappropriation of a trade secret if he revealed that secret in a published patent or patent application."

6.1.5.4 Exclusion of already-known information

NDAs also usually exclude information already known to the recipient when disclosed by the discloser. But therein lies a proof problem: Suppose that a defendant, accused of misappropriating confidential information, asserts that it can't be liable because: We already knew the information before you gave it to us — so there! A judge or jury might be rightly skeptical of an unsupported assertion to that effect.

This proof problem is handled in Clause 6.5 by requiring corroboration of claims of prior knowledge.

Pro tip: One way for a receiving party to add credibility to a claim of prior knowledge would be for the receiving party to notify the disclosing party promptly when the disclosing party discloses information already known to the receiving party. That was an actual contractual requirement in one case, but the defendant did not follow that requirement, which contributed to the court's denial of the defendant's motion for summary judgment.

6.1.5.5 Exclusion of independently-developed information

Another standard exclusion from confidentiality protection is when the recipient develops the information "independently"; as a practical matter, though, an accused misappropriator of confidential information might have a hard time convincing a judge or jury that it really did independently developed the allegedly-misappropriated information.

For an example, see the Celeritas v. Rockwell case, 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 — the jury rejected Rockwell's assertion that its engineers had independently developed the technology in question after having been exposed to the startup company's information.

6.1.6 Why recipients must take reasonable secrecy precautions

A disclosing party's failure to impose secrecy obligations on recipients of confidential information can destroy the disclosing party's claims of secrecy.

• That happened, for example, in a case where a supplier had given specific price-quote information to a customer without any sort of confidentiality obligation — and that defeated the supplier's later claim of trade-secret misappropriation against a former employee.

• To like effect was a case involving a scientist who sued the U.S. Government for infringing his patents and afor misappropriating his allegedly-secret proprietary information. The court granted the government's motion to dismiss the misappropriation claim, saying:

[I]nstances in which Mr. Gal-Or took proactive steps to protect the confidentiality of his trade secrets are simply overwhelmed [emphasis in original] by the number of times he did not. … In sum, because Mr. Gal-Or disclosed trade secrets to others, who were under no obligation to protect the confidentiality of the information, Mr. Gal-Or lost any property interest he may have held.

• And in a different case:

[B]ecause Broker Genius regularly disclosed its alleged secrets to each of its customers without notifying them of the information's confidential nature or binding them to confidentiality agreements, Broker Genius is unlikely to be able to show that it undertook reasonable measures to protect the secrecy of its alleged trade secrets.

• And another: A financial firm lost its claim to trade-secret protection for a particular financial strategy because its customer agreement explicitly authorized disclosure "to any and all persons, without limitation of any kind," so as to avoid adverse consequences under U.S. tax law.

6.1.7 To whom should recipients be allowed to disclose?

Tango Terms: Clause 6.3.12.

Drafters should consider the extent — if any — to which the Recipient's contractors, affiliates, etc., should be permitted to receive Confidential Information. This will be especially true if Recipient's workforce includes so-called leased employees or other individuals working long-term in independent-contractor status.

6.1.7.1 Disclosure in response to a subpoena, etc.

Tango Terms: Clause 6.3.14.

A recipient of confidential information could find itself in an awkward position if it were served with a subpoena or a search warrant demanding that the recipient produce the disclosing party's confidential information. This section provides a mechanism for the recipient to deal with such a situation.

Note that under this section, voluntary or discretionary disclosures of Confidential Information are not allowed, for example in public filings with the Securities and Exchange Commission (SEC). If Recipient were to do that, it would breach its obligations under this Chapter.

If the parties want to allow for disclosures in public filings, they can consider including Clause 6.7.9.

6.1.7.2 Caution: The danger of disclosure in public filings

Related to the question of disclosure in response to a subpoena (see § 6.1.5.2): A receiving party whose shares are (or are to be) publicly traded might feel that it must disclose Confidential Information in its public filings. Such public disclosure, though, would almost certainly destroy the confidentiality of the information.

Example: A financial firm lost its claim to trade-secret protection for a particular financial strategy because its customer agreement explicitly authorized disclosure "to any and all persons, without limitation of any kind," so as to avoid adverse consequences under U.S. tax law.

The mirror-image issue arose in a Delaware case in which Martin Marietta was held to have breached a confidentiality agreement by including Vulcan's confidential information in a public filing with the Securities and Exchange Commission.

Confidential treatment orders are sometimes available to protect confidential portions of filings with the Securities and Exchange Commission.

6.1.7.3 The law might affirmatively authorize certain disclosures

Tango Terms: Clause 6.3.15 (legally-immune disclosures) and [BROKEN LINK: disclosures-labor-law][BROKEN LINK: disclosures-labor-law] (disclosure for labor-law purposes).

In the U.S., the law limits the ability of individuals and companies to restrict disclosure of confidential information where the restriction would contravene public policy — for example, the (U.S.) Defend Trade Secrets Act, enacted in 2016 and codified at 18 U.S.C. § 1833 et seq.

This legislation followed fierce assertions by several U.S. Government agencies that a company may not even arguably discourage, let alone prohibit, the company's employees from disclosing whistleblower information to the agencies. For example:

• In 2015 the Securities and Exchange Commission went after well-known government contractor KBR for warning whistleblowers that they could be fired if they disclosed internal-investigation information with outsiders. KBR agreed to the entry of a cease-and-desist order and to pay $130,000 to settle the matter.

• The (U.S.) National Labor Relations Board has been hostile to contractual confidentiality restrictions that purport to limit employees' discussions of wages and working conditions.

But note: More recently, Trump appointees to the NLRB appear to be willing to revisit employer-employee confidentiality agreements, at least in the context of settlement- and separation agreements.

Caution: The NLRB might regard the "it's not a violation" carve-out of [BROKEN LINK: disclosures-labor-law][BROKEN LINK: disclosures-labor-law] as insufficiently explaining to employees their right to engage in concerted action under the NLRA.

6.1.8 Reverse engineering is often barred

Tango clause: Clause 6.3.11.

When a party to a confidentiality agreement expects to disclose "hidden" confidential information (for example, computer programs in executable form), the disclosing party will often want the confidentiality agreement to prohibit "reverse engineering" of the information, that is, figuratively poking and prodding at the visible information to try to figure out the hidden part.

Courts in the U.S. routinely enforce prohibitions against reverse engineering of confidential information, especially in software. The basic rationale is that:

  • Reverse engineering is normally not considered "improper means" for discovering a trade secret (see § 6.2);
  • But: If a recipient bargains away (i.e., waives) its right to engage in reverse engineering, then courts will enforce that bargain.

6.1.9 Should confidentiality obligations ever expire?

Whether confidentiality obligations should expire, as provided in Clause 6.3.17, might depend on the circumstances.

  • Some types of confidential information will have a limited useful life, e.g., future plans. Such information might reasonably have its protection limited to X months or years.
  • Other types of confidential information might have essentially-unlimited useful life — for example (putatively), the recipe for making Coca-Cola® syrup.

A receiving party might want an expiration date for confidentiality obligations as a safe harbor:

  • After X years have gone by, it might well take time and energy for the receiving party to figure out (1) which information of the disclosing party is still confidential, and (2) whether the receiving party might be using or disclosing confidential information in violation of the NDA.
  • The receiving party likely would prefer instead to have a bright-line "sunset," after which the receiving party can do whatever it wants without having to incur the burden of analyzing the facts and circumstances.

A disclosing party might regard an expiration date for confidentiality obligations as acceptable, depending largely on:

1.  how sensitive the information is, in the disclosing party's eyes, and

2.  how long it will be until the confidentiality obligations expire.

For example, suppose that:

  • The confidential information in question relates to the design of a product manufactured and sold by the disclosing party.
  • The disclosing party knows that, in two years, it will be discontinuing the product and will no longer care about the product-design information.

In that situation, the disclosing party might be willing to have the receiving party's confidentiality obligations expire in three or four years — this would:

  • provide the receiving party with a bright-line sunset date, and
  • provide the disclosing party with a year or two of safety margin.

Caution: If the receiving party's confidentiality obligations are allowed to expire, the disclosing party might thereafter find it difficult — or, more likely, impossible — to convince a court to enforce any trade-secret rights in the relevant information.

As Judge Rakoff put it in one case, "a temporary pledge to secrecy is exactly that: temporary. Once a third party's confidentiality obligation (assuming arguendo one exists) expires, so does the trade secret protection."

Alternatives: The parties could specify that Recipient's confidentiality obligations will expire X months or years after:

  • the date that all copies of the information are returned or destroyed; or
  • the effective date of termination or expiration of the Contract — but sometimes an agreement won't have an expiration date and the parties might forget to terminate it.

6.1.10 Should a recipient be required to return confidential information?

Tango Terms: Clause 6.3.19.

Many confidentiality agreements require the recipient to return or destroy all copies of confidential information upon expiration or termination of the agreement. But that might be impractical if (for example) confidential information is embodied in a deliverable (for example, custom-developed computer software, or a physical object) that the receiving party will have the right to keep on using; this might be the case in a services agreement.

Pro tip: Unfortunately, sometimes parties forget about return-or-destruction obligations. A disclosing party will want to follow up to be sure that the return-or-destruction requirement is actually complied with; if it were to fail to do so, a receiving party (or a third party) could try to use that as evidence that the disclosing party did not take reasonable precautions to preserve the secrecy of its confidential information.

Likewise, if the receiving party were to forget to comply with its return-or-destruction obligations, then the disclosing party might use that fact to bash the receiving party in front of a judge or jury.

Pro tip: Consider requiring segregation of Confidential Information, as discussed in Clause 6.7.6 — or a recipient could elect to segregate Confidential Information on its own initiative, even without a contractual requirement — for easier compliance with a return-or-destroy requirement.

6.1.11 Special topic: Confidentiality of parties' dealings

Tango Terms: Clause 6.6 (Confidentiality of Dealings Protocol).

6.1.11.1 Why companies sometimes want their dealings kept secret

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. 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, a 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.
6.1.11.2 Courts will (sometimes) enforce confidential-dealings clauses

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 the other party's termination of the agreement.

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 (as defined in Clause 22.31.2).

6.1.11.3 The government might have a contrary view

Governmental authorities might object to confidential-dealings clauses. For example, in employment-agreement forms, confidentiality provisions sometimes call for 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.

See also § 6.3.15 and its commentary, concerning how the [U.S.] Securities and Exchange Commission has taken a similar view about employees' reporting possible criminal violations to government authorities.

6.1.11.4 Be careful what disclosures are prohibited

A mother filed a wrongful death suit against a physician, claiming that the mother's daughter died of a drug overdose while under the physician's care. "The patients' deaths were the subject of a Texas Medical Board investigation of Joselevitz, which resulted in a 2014 order curtailing Joselevitz's prescribing privileges and permanently prohibiting him from treating patients for chronic pain."

  • The parties settled the case, entering into an agreement that contained a confidentiality provision.
  • The confidentiality provision prohibited only disclosing the fact or terms of settlement; it did not prohibit the mother from talking about the physician's alleged malpractice.
  • The physician sued for breach of contract and defamation.

A Texas court of appeals affirmed summary judgment in favor of the mother, noting that:

Roane's allegations against Joselevitz were already matters of public record through the filing of her wrongful death lawsuit. Had Joselevitz desired to prevent Roane from speaking further about his treatment of Willens, he could have negotiated that as a term of the Settlement Agreement. Nothing in our record indicates he did so.

6.1.12 Special topic: NDAs for VCs and other potential investors

Potential investors in a company might be reluctant to sign a nondisclosure agreement ("NDA"). Venture capitalists in particular often flatly refuse to do so, because they don't want to say "no" to an investment opportunity with a startup company, only to be sued years later for allegedly disclosing the startup's technology to someone else.

It's not like that sort of thing doesn't happen — even with an NDA in place. Amazon's venture-capital fund allegedly did just that to small tech companies DefinedCrowd, Nucleus, LivingSocial, and others.

As a practical matter, going without an NDA with non-corporate venture capitalists might not be a bad bet, because:

  • You can try to be very, very selective about what you disclose without an NDA, so that you're not giving away the "secret sauce" of your idea.
  • Investors and others generally do have one or two other things on their minds. They generally see lots of entrepreneurs who are convinced they've got a world-beating idea. You'll probably be lucky to get these investors to pay attention for two minutes. Ask yourself how likely it is that they'll want to take your idea and spend time and money building a business around it without you.
  • Contracts aren't the only thing that discourage bad behavior. If an investor stole someone's idea, and if word got around, then that investor might later find it hard to get other people to talk to him.
  • You have to decide what risks you want to take. Your business might fail because an investor steals your idea and beats you to market. Or it might fail because you can't raise the money you need to get started.

It's sort of like having to take a trip across the country. You have to decide whether to fly or drive. Sure, there's a risk you could die in a plane crash flying from one side of the country to the other. But if you were to drive the same route, your risk of dying in a car crash has been estimated as being something like 65 times greater than flying.

As the old saying goes, you pays your money and you takes your choice.

6.2 Confidential Information Definition

6.2.1 Basic definition

Definition text:

a.  Confidential Information refers to information maintained by a party ("Discloser") as to which:

  1. Discloser has taken, and is still taking, reasonable measures to keep the information secret;
  2. the information meets the other eligibility requirements in the Contract; and
  3. the information does not fall within one of the exclusions in Clause 6.5.

(Note: As an aid to readers, Confidential Information is sometimes referred to as "Discloser's Confidential Information.")

b.  [@2] Confidential Information includes, without limitation, the following categories of information when otherwise eligible:

  1. analyses; compilations; forecasts; interpretations; notes; reports; studies; summaries; and similar materials,
    • prepared by or for another party receiving the information ("Recipient") or on Recipient's behalf;
  2. "secret sauce" selections and/or combinations of specific items of information —
    • even if some or all of those items of information, taken individually, would not qualify as Confidential Information; and
  3. the fact that Discloser is using particular nonconfidential information — but only if that fact itself otherwise qualifies as Confidential Information.
Commentary

For a "laundry list" of potential Confidential Information, see the commentary at § 6.1.3.

Subdivision a.1: Concerning reasonable secrecy measures, see the commentary at § 6.1.2.

Subdivision b.2: Concerning "secret sauce," see the commentary at § 6.1.3.

It's not necessary to "own" a trade secret; mere lawful possession of a trade secret that is theoretically "owned" by another is enough to give the possessor legal rights against those who misappropriate it from the possessor. This was the result in Advanced Fluid Systems, Inc. v. Huber, 958 F.3d 168, 177-79 (3d Cir. 2020) (affirming district-court judgment; citing cases): There, the appeals court upheld judgment in favor of AFS against Huber, a former AFS employee, and his new employer: Huber, moving to a new job, took with him trade-secret information that had been developed by AFS but was owned by AFS's customer under a contract between AFS and the customer. Citing the district court's "closely reasoned opinion," the Third Circuit affirmed the lower court's holding that AFS's lawful possession of the trade-secret information was sufficient to give AFS standing to sue.

6.2.2 Third-party information can be protectable

Definition text:

a.  When otherwise eligible, information of third parties that Discloser provides to Recipient can be protectable under this Definition to the same extent as Discloser's own Confidential Information.

b.  If Discloser does provide Recipient with confidential information of a third party, then

  1. Discloser is deemed to represent to Recipient that Discloser is authorized to make the third party's information available to Recipient; and
  2. if the third party claims that Discloser was not authorized to disclose the third party's information to Recipient,
Commentary

Subdivision a is a fairly-standard provision in confidentiality agreements.

Subdivision b is seen less often, but it's something that recipients of confidential information should consider requesting.

6.2.3 "Trade secrets" must be shown to have independent economic value

Definition text:

Trade secret refers to Confidential Information that is shown: —

  • to have independent economic value, actual or potential,
  • from not being generally known to,
  • and not being readily ascertainable by,
    • others who can obtain economic value
      • from the disclosure or use of the information,
    • without using improper means

(Note: Trade secrets are entitled to protection for a longer period of time than ordinary Confidential Information, as explained in Clause 6.3.17.)

Commentary

This definition of trade secret adopts, essentially verbatim, the definition in the (U.S.) Defend Trade Secrets Act ("DTSA"), 18 U.S.C. § 1839(3).

See the commentary at § 6.1.4.

6.3 Confidential Information Protocol

6.3.1 Applicability

Protocol text:

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when the Contract:—

6.3.2 The Disclosing Party: Whose information is protected?

Protocol text:

Unless the Contract unambiguously provides otherwise,

  • the Confidential Information (as defined in Clause 6.2) of each party is eligible for protection under this Protocol;
  • that party is "Discloser" with respect to its own Confidential Information,
  • and each other party is "Recipient" as to Discloser's Confidential Information.
Commentary

One of the first issues the parties likely will confront is whether the agreement should protect just one party's Confidential Information, or that of each party.

In many cases, a two-way confidentiality agreement that protects each party's Confidential Information will:

  • get to signature more quickly;
  • be safer for both sides; and
  • reduce the chance of future embarrassment for the drafter(s).

In contrast, a confidentiality agreement protecting just one party's information will usually take longer to negotiate. That's because a confidentiality agreement will (usually) be more balanced — and therefore quicker to negotiate and easier to work with — if its provisions will apply equally to the confidential information of each party, not just one party.

  • If only one party will be disclosing confidential information, and that party is doing the drafting, then the confidentiality provision might contain burdensome requirements that the receiving party would have to review carefully.
  • Conversely, if the receiving party is doing the drafting, then the disclosing party would have to review the confidentiality provisions carefully to make sure it contained sufficient protection for the disclosing party's Confidential Information

A two-way provision is likely to be more balanced — it's a variation of the "I cut, you choose" principle — because each negotiator keeps in mind that today's disclosing party might be tomorrow's receiving party or vice versa.

(Caution: Even if an agreement is nominally a two-way agreement, it might still be drafted so as to favor the drafter's client. Example: Suppose that a drafter knows that her client will be receiving another party's confidential information but won't be disclosing its own confidential information. In that situation, the drafter might write a "two-way" confidentiality provision that provides very little protection for anyone's confidential information, because that lack of protection won't hurt the drafter's client — at least not in the short term.)

Moreover, a two-way agreement can avoid the danger of future, unprotected, "afterthought" confidential disclosures by the receiving party. With a one-way agreement, only the (original) disclosing party's information is protected, and so any disclosures by the receiving party might be completely unprotected, resulting in the receiving party's losing its trade-secret rights in its information.

Just such an own-foot-shooting happened to the plaintiff in a Seventh Circuit case: The plaintiff's confidentiality agreement with the defendant protected only the defendant's information. Consequently, said the court, the plaintiff's afterthought disclosures of its own confidential information were unprotected.

So, a two-way agreement might help avoid future embarrassment: Suppose that Alice and Bob enter into a confidentiality agreement that protects only Alice's information. Also suppose that the agreement's terms were strongly biased in favor of Alice.

But now suppose that, at a later date, the parties decide that they also needed to protect Bob's confidential information as well, so that Bob can disclose it to Alice.

In that case, with the shoe on the other foot, Alice might not want to live with the obligations that she previously made Bob accept. As a result, whoever negotiated the (one-way) confidentiality agreement for Alice might find himself in a doubly-embarrassing position:

  • First, Alice's negotiator would be asking Bob to review and sign a new confidentiality agreement, and having to explain why Alice isn't willing to live with the same terms she pressed upon Bob.
  • Second, Alice might ask pointedly of her negotiator, Why didn't you do this the right way in the first place, instead of wasting everybody's time?

So it's often a good idea to insist that any confidentiality provisions be two-way in their effect from the start, protecting the confidential information of both parties.

6.3.3 Marking of Confidential Information?

Protocol text:

For Discloser: You will want to mark your Confidential Information — especially information that you believe to be a "trade secret" — as stated in Clause 6.4 (Confidential Information Marking Protocol).

Commentary

See the commentary at [BROKEN LINK: conf-info-marking-cmtry][BROKEN LINK: conf-info-marking-cmtry].

6.3.4 Special rules for protected health information ("PHI")

Protocol text:

To: Recipient

Follow Clause 11.5 (Protected Health Information Protocol) for any protected health information (as defined in Clause 11.5) that Discloser makes available to you.

Commentary

Concerning protected health information, see the commentary to § 11.5.

6.3.5 Protection for pre-agreement disclosures?

Protocol text:

For Discloser: If you want the Contract to protect information that you disclosed to Recipient before you both entered into the Contract, then make sure that the Contract specifically says so; otherwise, the Contract will not protect that information.

Commentary

In some cases drafters might want to specify that "Confidential Information" includes information disclosed before the parties signed the Contract. This might be appropriate, for example, if the parties are entering into a written confidentiality agreement to confirm an oral confidentiality agreement that was made during previous, informal discussions.

6.3.6 Separate protection for Affiliates' information?

Protocol text:

a.  For Discloser: If you want your affiliates (as defined in Clause 22.2) to be able to disclose and claim protection for their information under this Protocol, then:

  1. make sure that the Contract specifically says so, and
  2. make sure that the affiliate information is marked as being subject to the Contract,
    • whether or not your own information would need to be marked as Confidential Information (see § 6.4),
    • so that Recipient and its personnel will have fair warning about their obligations concerning your affiliates' information;
    • otherwise, this Protocol will not protect that information
    • unless you disclose it to Recipient as third-party confidential information as stated in Clause 6.2.2.

b.  For Recipient: Treat the information of Discloser's affiliates as Confidential Information, in the same manner as if the information were Discloser's information, if:

  1. the Contract says that affiliate information is protectable,
  2. the information in question meets the marking requirements stated in subdivision a, and
  3. the information otherwise qualifies as Confidential Information.
Commentary

Discloser might want its affiliates' confidential information to be protected without the affiliates' having to negotiate and sign separate confidentiality agreements with Recipient.

On the other hand, Recipient might insist on knowing exactly which companies conceivably might sue the recipient someday for breach of contract and/or misappropriation of trade secrets.

As a compromise, this section:

  • allows Discloser-affiliate information to be protected if the Contract so states; and
  • requires special marking of that information, to reduce the chances that Recipient might someday be ambushed by confidentiality claims concerning information that Recipient's people had no real reason to know was confidential.

6.3.7 Recipient's secrecy measures?

Protocol text:

To: Recipient

Take, at a minimum, prudent measures to keep Discloser's Confidential Information secret;

  • those measures are to include, without limitation, at least the same secrecy measures that you take with respect to your own confidential information of comparable significance.
Commentary

Failure to impose secrecy obligations on recipients of confidential information can destroy the disclosing party's claims of secrecy, as discussed at § 6.1.6.

6.3.8 Recipient's use of Confidential Information?

Protocol text:

To: Recipient

a.  [During the term of the Contract], and only then, you may use Discloser's Confidential Information to the extent – and only to the extent — reasonably necessary for one or more of the following:

  1. performing your obligations under the Contract;
  2. exercising your rights under the Contract;
  3. assessing whether to enter into another agreement with Discloser; and/or
  4. any other use expressly agreed to in writing by Discloser.

b.  Otherwise: Do not use Confidential Information except —

  1. as authorized by the Contract, and/or
  2. as otherwise agreed in writing by Discloser.
Commentary

This section should save the parties some time by pre-specifying certain standard authorized uses of Confidential Information.

A receiving party might want to state explicitly that that certain specified uses are authorized.

6.3.9 Copying of Confidential Information?

Protocol text:

To: Recipient

Do not reproduce Discloser's Confidential Information except to the extent reasonably necessary:

  • for a use or disclosure that is authorized by this Protocol, or that Discloser has otherwise agreed to in writing; and/or
  • for your normal IT processes — for example, automated backups — that would not pose a significant risk of exposing the reproduced Confidential Information to others in violation of the Contract.

6.3.10 Translation of Confidential Information?

Protocol text:

To: Recipient

Do not translate Confidential Information into any other language or form, except:

  • to the minimum extent necessary for an authorized use or disclosure under the Contract,
  • or with Discloser's prior written consent.

6.3.11 Reverse engineering?

Protocol text:

To: Recipient

Do not engage in reverse-engineering,

  • nor otherwise attempt to discover the inner workings and/or structure of any system containing or operating with Confidential Information,
  • without Discloser's prior written consent;
  • this prohibition includes but is not limited to:
    • disassembly and/or decompilation of computer program code, and
    • "black-box" study of internal system functions.
Commentary

See the commentary at § 6.1.8.

6.3.12 No unauthorized disclosure by Recipient

Protocol text:

To: Recipient

Do not make Discloser's Confidential Information available to others —

  • including but not limited to by confirming others' guesses or conjectures —
  • unless the Contract unambiguously allows you to do so.

6.3.13 Recipient disclosure to its employees, etc.

Protocol text:

To: Recipient

a.  During the term of the Contract — and only then — you may disclose Discloser's Confidential Information (to the extent not prohibited by law) to your employees, officers, and directors, BUT ONLY to the extent that those individuals:

  1. have a legitimate "need to know" in connection with your authorized use of the information, and
  2. are bound by obligations of confidence comparable to those of the Contract.

b.  Before you disclose Confidential Information under subdivision a:

  1. Confirm that each intended recipient is bound by the confidentiality obligations of the Contract; and
  2. Make sure each recipient is specifically instructed and/or reminded that he or she is obliged to abide by those confidentiality obligations.
Commentary

Subdivision a.1: Limiting Recipient's disclosures to a need-to-know basis is pretty standard in confidentiality provisions.

See the commentary at § 6.1.7.

6.3.14 Disclosure in response to subpoenas, etc.

Protocol text:

To: Recipient

You will not breach your obligations under this Protocol if you disclose Discloser's Confidential Information to the minimum extent required by law in response to subpoenas and other compulsory legal demands — IF you satisfy the following prerequisites:

  1. DO: Give Discloser as much advance notice of the impending disclosure as is allowed by law — but you may use reasonable discretion on that score if a government authority asks you not to notify Discloser.
  2. DO: Provide reasonable cooperation with any effort by Discloser to limit the disclosure in response to the demand.
  3. DO NOT: Disclose more Confidential Information than, in the written opinion of your counsel, is required by the demand. (In case of doubt, this subdivision doesn't require you or your counsel to disclose counsel's written opinion to anyone.)
Commentary

See the commentary at § 6.1.7.1.

6.3.15 Disclosures authorized by law

Protocol text:

To: Recipient

a.  NO OBJECTION: It will not be a breach your obligations under this Protocol if you disclose Discloser's Confidential Information to the minimum extent that:

  • the disclosure would be immune from liability under Title 18, Section 1833(b) of the United States Code, and/or
  • the disclosure is affirmatively authorized by law or regulation, for example the (U.S.) National Labor Relations Act or other applicable labor- or employment law.

b.  RECOMMENDED: Advise Discloser in advance of any disclosure under this section.

Commentary

See the commentary at § 6.1.7.3 (legally-immune disclosures).

6.3.16 Restraining orders

To: Recipient

a.  This section applies in any case in which you disclose or use Confidential Information other than as provided in the Contract,

  • or the same is done by an individual or organization to which you disclosed the information.

b.  This section will also apply if it appears that such unauthorized disclosure or use is about to happen.

c.  In either case described in subdivisions a and b,

  • Discloser may go to court (or to private arbitration, if that has been agreed to)
  • to seek an injunction or similar restraining order against you,
  • and/or against the other individual or organization,
  • as stated in Clause 16.10 (Equitable Relief Policy).
Commentary

This section uses the well-known term "restraining order" because it's likely to be more familiar to non-lawyer readers than "injunctive relief" or "specific performance." In this context, all of these terms are meant to be more-or-less synonyms. See also Clause 16.10 (Equitable Relief Policy).

6.3.17 Expiration of confidentiality obligations

To: Recipient

Some of your confidentiality obligations under this Protocol will expire in time, but others will not, as stated below.

Commentary

See the detailed discussion of confidentiality expiration at § 6.1.9.

6.3.17.1 Confidentiality expiration when an exclusion applies

To: Recipient

IF: Certain Discloser Confidential Information becomes subject to one or more of the exclusions in Clause 6.5;

THEN: Your confidentiality obligations under the Contract will automatically expire as to that Discloser information.

6.3.17.2 No expiration of trade-secret confidentiality obligations

To: Recipient

IF: Discloser discloses trade-secret information (as defined in Clause 6.2.3) to you, AND: Discloser complies with the requirement to assert trade-secret status in writing, as stated in § 6.4.6;

THEN: Continue honoring your confidentiality obligations under the Contract,

  • unless and until the information in question becomes subject to one or more of the exclusions from Confidential-Information status in Clause 6.5.
6.3.17.3 Expiration of confidentiality obligations for non-trade-secrets

To: Recipient

IF: Certain Discloser Confidential Information does not qualify as a trade secret;

THEN: Your confidentiality obligations under the Contract will expire at the end of [three years] after the effective date of the Contract.

6.3.18 Confidentiality expiration and other legal restrictions

To: Recipient

IF: Your confidentiality obligations under the Contract expire;

THEN: Discloser could still enforce its copyrights, patents, and other rights (if any) against you.

6.3.19 Return or destruction of Confidential Information

To: Recipient

a.  You need not return or destroy Confidential Information unless the Contract unambiguously says so.

b.  IF: The Contract requires return or destruction and Discloser so requests in writing; THEN: Return or destroy copies of Discloser's Confidential Information in accordance with Clause 13.8 (Information Purge Protocol) and subdivision c.

c.  You may keep archive copies of Discloser's Confidential Information in accordance with the Archive Copies — but see subdivision d for an exception to this exception.

d.  IF: you are an employee or individual contractor of Discloser; THEN: Do not retain copies of Confidential Information, except solely for the purpose of imminent disclosure under one of the exceptions in this Protocol (response to subpoenas, legally-immune disclosures, and disclosures under labor- or employment law).

e.  Note: Your confidentiality obligations under the Contract will continue in effect for all copies of Discloser's Confidential Information that are not returned or destroyed.

Commentary

See the commentary at § 6.1.10

6.3.20 Survival of confidentiality obligations

Situation: The Contract comes to an end, for example, by being terminated or by expiring.

To: Recipient

Continue to honor your confidentiality obligations concerning Discloser's Confidential Information.

(This applies no matter what other provisions of the Contract might also deal with survival of the terms of the Contract.)

Commentary

See also the Survival Protocol

6.4 Confidential Information Marking Protocol

Confidentiality agreements commonly require — often with stated exceptions — that confidential information be marked as such. Marking can be important for legal protection of confidential information, but it's also something that can slip through the cracks.

Contents:

Commentary

Courts pay attention to the absence of marking: In assessing whether a discloser had in fact maintained particular information in confidence, a court very likely will give significant weight to whether the discloser caused the information to be marked as confidential.

• 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.

• To like effect was another Seventh Circuit case in which 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.

Failure to mark when agreed can be fatal: A disclosing party's failure to mark its confidential information as such, when required by a confidentiality agreement or nondisclosure agreement ("NDA"), can be fatal to a claim of misappropriation of trade secrets or misappropriation of confidential information.

For example, in Convolve v. Compaq, the computer manufacturer Compaq (now part of Hewlett-Packard) defeated a claim of misappropriation of trade secrets concerning hard-disk technology because the owner of the putative trade-secret information did not follow up its oral disclosures with written summaries as required by the parties' non-disclosure agreement.

Caution: Unmarked information might still be confidential by law: Some categories of information might be confidential by law even without marking. That's because applicable law might independently impose a confidentiality obligation benefiting third parties, regardless of marking.

For example, the U.S. Health Insurance Portability and Accountability Act (HIPAA) imposes such obligations in respect of patients' protected health information.

6.4.1 Presumption of confidentiality for marked information

To: Recipient

Treat Discloser's information as Confidential Information if the information is marked as such in accordance with this Chapter,

  • unless you can show that one of this Chapter's exceptions to the marking requirement applies,
  • or that the information is excluded from Confidential Information status under § 6.5.

6.4.2 Required prominence of confidentiality markings

For Discloser:

a.  Make sure that the confidentiality markings on your Confidential Information — as initially disclosed to Recipient —

  • are in a reasonably-prominent, human-readable form.

b.  In case of doubt: You aren't obligated to do as stated in subdivision a, but if you don't, then your information might not be treated as Confidential Information.

6.4.3 Marking exception for obviously-confidential information

To: Recipient

Treat Discloser's information as Confidential Information,

  • even if the information isn't marked as such,
  • if the information is clearly of a type that reasonable people in the business would readily recognize as likely to be confidential,
  • unless you can show that the information is excluded from Confidential Information status under § 6.5.

6.4.4 Marking exception for Discloser's internal files

To: Recipient

DO: Treat Discloser's information as Confidential Information,

  • even if the information isn't marked as such,

IF: Discloser:

  1. made the information available to you ONLY by allowing you to have access to Discloser's internal files (hard copy, electronic, etc.); and
  2. didn't give you permission to make and/or take away copies of the information.
Commentary

A slightly-tricky situation arises when a recipient's people are allowed to look at a discloser's internal files but aren't allowed to make notes, take away copies, etc. In such a situation, it might well be burdensome for the discloser to have to go through each of its files to ensure that all confidential information is marked, on pain of losing confidentiality protection.

(There might also later be a he-said, she-said proof problem if a dispute were to arise about whether particular information had in fact been marked.)

This section addresses that situation by relaxing the marking requirement — but subject to conditions.

6.4.5 Catch-up marking

To: Recipient

DO: Treat Discloser's information as Confidential Information,

  • even if the information wasn't marked as confidential when Discloser initially made it available to you —
    • for example, if Discloser initially disclosed the information to you orally,
    • or in a demonstration, or in an unmarked written disclosure —

IF: All of the following are true:

  1. Within [ten business days] after that initial, unmarked disclosure,
    • Discloser followed up by sending you a reasonably-detailed written summary of the information;
  2. The follow-up summary was itself marked as confidential as prescribed in this Chapter; and
  3. Discloser gave you notice (as defined in Clause 20.6)
    • that Discloser had sent the follow-up summary,
    • so as to leave a paper trail confirming the follow-up.

6.4.6 Trade secret labeling requirement

For Discloser:

a.  If you want information to be considered your trade secret (as defined in Clause 6.2.3),

  • then you must clearly assert to Recipient, in writing, that the information is a trade secret;
  • this would be true even if the Contract wouldn't otherwise require the information to be marked as confidential.

b.  Your written assertion of trade-secret status:

  1. must be reasonably prominent;
  2. must contain reasonable identifying details about the information in question; and
  3. must be received by Recipient before Recipient's confidential obligations would otherwise have ended as to the information in question under § 6.3.17.

d.  As one (non-exclusive) "safe harbor" example,

  • your written trade-secret assertion may take the form, without limitation,
  • of a reasonably prominent, human-readable marking to that effect
  • on the copy of the information initially provided to Recipient.
Commentary

Under Clause 6.3.17, Recipient's confidentiality obligations will last indefinitely for trade secrets; in contrast, "mere" Confidential Information would automatically lose its protection after a time. For greater fairness to Recipient, this section requires Discloser to alert Recipient about trade-secret claims because of Recipient's continuing confidentiality obligations.

This requirement that trade secrets be explicitly claimed in writing is part of a compromise:

  • it encourages parties to mark all of their confidential information as such;
  • but it doesn't require marking for garden-variety confidential information that doesn't qualify as a trade secret (for example, because the information lacks independent economic value).

The written-claim requirement comports with the litigation requirement in some states that a party claiming misappropriation of a trade secrets must identify the alleged trade secret with particularity.

6.5 Confidential Information Exclusions

Unless otherwise required by the Contract or by law, the obligations of Clause 6.3 (Confidential Information Protocol) do not apply to particular information that is shown to be or to have been,

  • at the relevant time or times,
  • within one or more of the following categories:
  1. The information in question was generally known
    • to people within the circles that normally deal with that kind of information —
    • unless the information became generally known
    • because Recipient did something,
      • or someone to whom Recipient provided the information did something,
    • that breached Recipient's obligations under this Chapter; or
  2. The information was readily ascertainable,
    • without using improper means,
    • by people of the kind described in subdivision 1; or
  3. A third party made the information available to Recipient —
    • without restriction, and
    • without breaching an obligation of confidence to Discloser; or
  4. Recipient already knew the information when Discloser first gave Recipient access to it —
    • but on that point,
    • Recipient must provide reasonable corroboration (as defined in Clause 16.8)
    • of any statements by interested witnesses; or
  5. Recipient developed the information independently,
    • or someone did so on Recipient's behalf,
    • without using information of Discloser that was not itself excluded from the definition of Confidential Information —
    • but here again, Recipient must provide reasonable corroboration of statements by interested witnesses; or
  6. Discloser disclosed the information to a third party
    • without requiring the third party to agree to confidentiality obligations
    • that are comparable to those of this Chapter.
Commentary

See the detailed commentary about exclusions from confidentiality at § 6.1.5.

Subdivision 1: The phrasing here is a mashup of:

  • section 1(4)(i) of the U.S. Uniform Trade Secret Act, https://perma.cc/XK9G-CLJA at 5, and
  • the UK's 2018 draft regulations implementing the EU Trade Secrets Directive (2016/943); see UK IP Office, Consultation on draft regulations concerning trade secrets at 19 (2018), https://perma.cc/PHT8-DQFJ.

Subdivision 2: See Clause 6.2.3 (defining trade secret) concerning "improper means."

Subdivision 5: See the commentary at § 6.1.5.5 for a discussion of the problem of persuasively proving independent development.

6.6 Confidentiality of Dealings Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when the Contract requires that the parties' dealings be kept confidential.

Discussion checklist:

6.6.1 What information will the parties keep confidential?

In addition to any general requirements of the Contract concerning confidential information, if any,

[each party] will preserve in confidence,

  • all nonpublic information about the fact, and the terms,
  • of the parties' dealings under the Contract,
  • unless and until particular information becomes public.
Commentary

See the commentary at § 6.1.11.

6.6.2 To whom may the parties' dealings be disclosed?

[Neither party] may disclose, nor confirm, the fact or the terms of the parties' dealings to any third party, except:

  1. to those of the first party's officers, directors, employees, and agents who —
    • have a need to know in connection with the parties' dealings, and
    • are bound by the same nondisclosure obligation as the first party; or
  2. or as would be authorized for disclosure under Clause 6.3 (Confidential Information Protocol), for example (as defined in Clause 22.21),
Commentary

See generally the commentary to Clause 6.3 (Confidential Information Protocol).

6.6.3 The Contract (normally) does not establish a fiduciary relationship

This Protocol is not intended as evidence of, nor as establishing, a "confidential relationship" or "fiduciary relationship" unless it unambiguously says otherwise.

Commentary

See the commentary at § 19

6.7 Optional confidentiality terms

6.7.1 Option: Disclosure to Prospective Acquirer

6.7.1.1 Only certain M&A prospects are eligible

a.  Prospect may be a prospective acquirer of substantially all assets of Recipient's business specifically associated with the Contract.

b.  If Recipient is an organization, Prospect may be —

  1. a prospective acquirer of substantially all shares of Recipient —
    • or equivalent ownership interest under applicable law, if Recipient is an organization that does not have shares; and/or
  2. a party (or an affiliate (as defined in Clause 22.2) of a party) with which Recipient anticipates engaging in a merger, or similar transaction, in which Recipient would not be the surviving entity.
Commentary

Business background: In a merger or acquisition, a company that will be acquired will generally be asked to "open the kimono" to the potential acquiring company, very often by allowing the acquiring company to access electronic documents in a secure data room.

This specific provision was inspired by a blog posting by English lawyer Mark Anderson.

Caution: NDAs and prospective BigCo partners / acquirers: It's not unheard of for a big company to approach a small company about being "partners," perhaps hinting that the big company might want to acquire the small company. In that situation, the small company should be alert to the possibility that the big company might be trying to get a free look at the small company's confidential information. See, e.g., this story told by an anonymous commenter on Hacker News.

An NDA can come in very handy in such situations.

Enforcing an NDA can take a lot of time and money, especially if the big company is convinced (or convinces itself) that it hasn't done anything wrong — or simply folds its arms and says, tough [expletive], sue us.

But a jury might well punish a company that it found breached the NDA. See, e.g., Celeritas v. Rockwell, where a federal-court jury in Los Angeles awarded a startup company more than $57 million because the jury found that Rockwell had breached an NDA.

Similarly, but not quite on point: A Texas jury awarded more than $730 million in damages to a real estate data analytics company because one of its customers, a title-insurance company, had misappropriate the analytics company's trade secrets; the jury also found that the customer had breached its confidentiality agreement with the analytics company, but the supplier elected to recover for fraud and misappropriation instead of for breach of contract. (The appeals court reversed and remanded for a new trial on the fraud and misappropriation claims.)

6.7.1.2 The Prospect must agree to secrecy obligations

a.  Prospect must agree in writing with Recipient to abide by Recipient's obligations concerning Discloser's Confidential Information.

b.  Discloser will be an intended third-party beneficiary of Prospect's agreement with Recipient.

c.  A copy of Prospect's agreement with Recipient must be provided to Discloser if Discloser so requests,

  • but in case of doubt, neither Recipient nor Prospect are required to advise Discloser that they are contemplating a possible transaction.
6.7.1.3 Disclosure to Prospect's fiduciary advisers is OK

Recipient and Prospect may disclose Discloser's Confidential Information to Prospect's attorneys, accountants, and other advisers having a fiduciary- and/or contractual duty to preserve the information in confidence.

6.7.1.4 Disclosure must be in a secure data room

Any disclosure under this Option must be done:

  1. in one or more secure physical data rooms, and/or
  2. via a secure online data room.
6.7.1.5 Prospect may not take copies without Recipient's consent

Recipient will not allow or knowingly assist Prospect, nor any of Prospect's recipients under this Option, to keep copies of Discloser's Confidential Information, unless Discloser gives its prior written consent.

(Accessing information, without more, is not considered keeping a copy of the information.)

6.7.2 Option: Recipient Indemnity Obligation

Recipient will defend (as defined in Clause 14.5) Discloser's Protected Group (as defined in Clause 22.38) against any claim, by a third party, arising out of any of the following:

  1. Recipient's use of Discloser's Confidential Information, and/or
  2. Recipient's disclosure of the Confidential Information to other parties, whether or not as authorized by the Contract.
Commentary

As with any indemnity- or defense obligation, Discloser should consider:

  • whether Recipient has the financial wherewithal to meet this obligation; and
  • whether to ask Recipient also to contractually commit to maintaining appropriate insurance coverage. [TO DO: LINK].

6.7.3 Option: Recipient's Compliance Responsibility

If a third party obtains or otherwise accesses Discloser's Confidential Information

  • as a result of the third party's relationship with Recipient;

and the third party uses, discloses, and/or copies Discloser's Confidential Information in a manner not permitted by the Contract;

then:

  • Recipient will be liable to Discloser for any resulting harm to Discloser or to Discloser's interests,
  • to the same extent as if the damage had been caused by Recipient's own use, disclosure, or copying of the Confidential Information.

Note: For this purpose, the term third party includes, without limitation, any employee of Recipient.

Commentary

Recipients might push back if asked to agree to this, but disclosers will usually want "one throat to choke" (a trite but useful expression).

6.7.4 Option: Recipient's Assignment-Consent Requirement

Recipient may not assign the Contract without Discloser's written consent

Commentary

Consider agreeing to one or more of Clause 18.3 (Assignment Consent Protocol).

6.7.5 Option: Copies of Confidentiality Agreements

a.  If Discloser so requests, Recipient will provide Discloser with a copy of a signed written confidentiality agreement between (i) Recipient and (ii) each individual or organization to which Recipient makes Discloser's Confidential Information available.

b.  Each such agreement must obligate the individual or organization, in effect, to give Discloser's Confidential Information the same protection as is required by the Contract.

c.  Recipient may have such copies redacted — to a reasonable extent — so that Discloser will not get to see confidential information of Recipient and/or of the individual or organization in question.

Commentary

This requirement might be burdensome for Recipient, but sometimes Discloser might have a legitimate need for it.

Subdivision c: The reasonableness requirement for redaction has in mind that some government documents are sometimes supposedly declassified but issued with a risible number of redactions.

6.7.6 Option: Required Segregation of Confidential Information

Recipient will keep Discloser's Confidential Information reasonably segregated from other information, with a view to:

  • providing additional protection of Confidential Information, and
  • speeding up any necessary return or destruction of Confidential Information (see § 6.3.19).
Commentary

See also the [BROKEN LINK: conf-info-rtn-destr] and its commentary.

This segregation requirement could well be unduly burdensome — on the other hand, a segregation requirement might have been useful in a case where an independent oil-and-gas reservoir engineer disclosed trade-secret information to a production company under a nondisclosure agreement; when the relationship waned, the engineer asked for the information to be returned, but that proved problematic, as one individual ended up retaining some of the information in his files.

6.7.7 Option: Inspections of Recipient's Compliance

a.  Discloser may cause reasonable inspections —

  • of Recipient's relevant properties and premises (see subdivision b)
  • to be conducted from time to time,
  • at any time that Recipient has Discloser's Confidential Information in its possession,
  • to confirm that Recipient is complying with its confidentiality obligations under the Contract.

b.  For this purpose, the term "relevant properties and premises" includes, without limitation,

  • any and all relevant hard-copy and electronic records, of any kind,
  • that are in Recipient's possession, custody, or control.

c.  Any such inspection must be upon written notice, far enough in advance to be reasonable under the circumstances.

d.  Any such inspection must comply with Clause 3.3 (Inspections Protocol).

Commentary

Some Recipients are likely to balk at this Option; in some circumstances, though, Discloser might feel it was necessary.

6.7.8 Option: Required Cooperation Against Misappropriators

If Discloser so requests, Recipient will provide reasonable cooperation,

  • at Discloser's expense,
  • with any efforts by Discloser to take action:
    • to protect Discloser's Confidential Information against misappropriation,
    • and/or to redress such misappropriation and mitigate its effects.
Commentary

The "reasonable cooperation" qualifier should provide some comfort for a Recipient that thinks it might be opening itself up for burdensome expense in supporting Discloser's protection activities.

6.7.9 Option: Disclosure in Public Filings Authorization

a.  Recipient may include Discloser's Confidential Information in a submission to a regulatory agency or other governmental body,

  • but only if all of the prerequisites in this Option are met.

b.  The inclusion must be compelled by law to the same extent as if the inclusion were compelled by law in response to a subpoena or other compulsory legal demand, as provided in Clause 6.3.14.

c.  Recipient must first consult with Discloser a sufficient time in advance to give Discloser a reasonable opportunity to seek a confidential treatment order or other comparable relief.

d.  Recipient must disclose only so much Confidential Information as is required to comply with the law.

e.  Recipient must provide reasonable cooperation with any efforts by Discloser to limit the disclosure,

  • and/or to obtain legal protection for the information to be disclosed,
  • in the same manner as if the proposed disclosure were in response to a compulsory legal demand.

6.7.10 Option: General Skills Safe Harbor

The Contract's restrictions on Recipient's use of Discloser's Confidential Information

  • do not limit the ability of Recipient's personnel
  • to utilize their general knowledge, skills, and experience
  • in the general field(s) of the Confidential Information,
  • even if improved by exposure to such information.
Commentary

This option is inspired by § 3 of an AT&T nondisclosure agreement (archived at http://perma.cc/G974-2ZH5), which states: "… use by a party's employees of improved general knowledge, skills, and experience in the field of the other party's proprietary information is not a breach of this Agreement."

Caution: This option could be dangerous to Discloser because of the difficulty of determining when the exclusion did or did not apply.

"This is not to say that Teeters and Dingman cannot use, or advertise, the general knowledge and experience they have gained in their years working in the senior living industry. An employee enjoys a right, in competing against his former employer, to utilize general experience, knowledge, memory and skill — as opposed to specialized, unique or confidential information — gained as a consequence of his employment."

6.7.11 Option: Residuals-Rights Exclusion

a.  Recipient may use "residuals," defined below, as Recipient sees fit, without obligation to Discloser.

b.  The term "residuals" refers to:

  • ideas, concepts, know-how, techniques, and similar information,
  • that are retained in the unaided memory of Recipient's personnel,
  • who did not intentionally memorize the information for that purpose.

c.  This Option does not negate any restriction of the Contract on Recipient's disclosure of Discloser's Confidential Information to third parties.

d.  For the avoidance of doubt, any use of residuals by Recipient will be subject to any applicable patent rights, copyrights, trademark rights, or other intellectual-property ights owned or assertable by Discloser.

Commentary

Some receiving parties (cough, Microsoft) have sometimes tried to include provisions granting them "residual rights" along the lines of this Option. Such residuals rights could later result in he-said-she-said disputes about whether Recipient's personnel were in fact relying on their unaided memories — and that same uncertainty might well tempt Recipient to treat this language as a get-out-of-jail-free card to do whatever it wanted with Discloser's Confidential Information. For that reason, Discloser likely will push back strongly against any request for residuals rights.

6.7.12 Option: Toolkit Item Exclusion

The term Confidential Information does not include:

  • any concept, idea, invention, strategy, procedure, architecture, or other work,
  • that is, in whole or in part, created by Recipient as a result of working with Discloser's Confidential Information,
  • but is not specific, and/or is not unique, to Discloser and its business,
  • and does not include Discloser's Confidential Information.

6.8 Exercises and discussion questions

6.8.1 Gigunda-MathWhiz confidential information exercise

FACTS:

Gigunda wants MathWhiz to sign a separate confidentiality agreement ("NDA," i.e., nondisclosure agreement) before Gigunda will disclose technical details about a new oilfield project that Gigunda will be undertaking.

Gigunda's draft NDA says that it's a two-way NDA, i.e., it will protect each party's confidential information — but MathWhiz doesn't plan to disclose any confidential information to Gigunda.

QUESTION (with Zoom poll): MathWhiz's project director asks you whether the NDA is safe to sign "as is," because it's a balanced NDA that applies equally to each party's information and each party receiving another party's information — what would you say?

MORE FACTS: MathWhiz's project director wants to know if you can add a clause to Gigunda's NDA, to the effect that MathWhiz's confidentiality obligations as to Gigunda's information will expire in one (1) year.

QUESTIONS:

  1. How do you think Gigunda might react?
  2. Is there a way to compromise?
  3. Any drafting issues in the way the "More Facts" paragraph is set out above?

6.8.2 Confidential Information — discussion and exercise

1.  If a confidentiality provision is written to protect each party's confidential information, does that pretty much guarantee that the provision will be "fair and balanced"?

2.  FACTS: You represent MathWhiz. Gigunda wants access to MathWhiz's proprietary algorithms (data-processing methods) so that Gigunda can decide whether to pay MathWhiz to crunch Gigunda's Mongolia data. Gigunda is willing to sign an "NDA," but its draft NDA states that the term of the NDA will be two years. QUESTION: Any issues here for MathWhiz?

3.  Now suppose you represent Gigunda: What if it turns out that MathWhiz's proprietary algorithms are just a collection of known techniques?

4.  DRAFTING EXERCISE: In your groups, come up with a minimal confidential-information provision (maybe three or four sentences?) to protect Gigunda's confidential information. Then paste onto virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ); we'll discuss.

6.8.3 Exercise: Breaking up a confidentiality clause

Break up the following provision 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, what concern should you have (if any) about the phrases "best efforts" and "all reasonable measures"? (Hint: See the commentary at § 9.3.)

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?

[DCT to show his first pass]

DCT's first pass: (to show on his computer)

6.8.4 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?

6.8.5 NDA "sunset" provisions

MORE FACTS:
(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?

6.8.6 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?

6.8.7 Exercise: Injunctive relief in an NDA (1)

MORE FACTS for the situation in § 6.8.4:

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?

Hint: See Clause 16.10 (Equitable Relief Policy).

6.8.8 Injunctive relief (2)

MORE FACTS for the situation in 6.8.7:
(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?

(Hint: See § 16.6.)

6.8.9 Exercise: Care of confidential information

From a confidentiality agreement that I helped negotiate for a small client, which was to receive 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?

7 Pricing

7.1 Introduction & takeaways (now hidden)

7.1.1 Most favored customer

7.1.1.1 Examples of most favored customer language

Section 12 of a Honeywell purchase order terms-and-conditions document, archived at https://perma.cc/CUV6-NKTY, sets forth a fairly-typical most-favored-customer clause ("MFC") clause and price-reduction clause ("PRC").

12. Price: Most Favored Customer and Meet or Release

[a] Supplier warrants that

  • the prices charged
  • for the Goods delivered under this Purchase Order
  • are the lowest prices charged by Supplier
  • to any of its external customers
  • for similar volumes of similar [sic] Goods.

[b] If Supplier charges any external customer a lower price for a similar volume of similar Goods, Supplier must

  • notify Honeywell
  • and apply that price to all Goods ordered under this Purchase Order.

[Comment: The above language does not limit the price-reduction obligation to goods ordered in the future; Honeywell could try to argue that the obligation applied retroactively as well, requiring refunds for past orders. A court, however, might interpret the language as limited to future orders, under the contra proferentem principle discussed in Clause 16.7.]

[c] If at any time before full performance of this Purchase Order

  • Honeywell notifies Supplier in writing
  • that Honeywell has received a written offer from another supplier
  • for Goods similar [sic] to those to be provided under this Purchase Order
  • at a price lower than the price set forth in this Purchase Order,
  • Supplier must immediately meet the lower price for any undelivered Goods.

If Supplier fails to meet the lower price Honeywell, at its option, may terminate the balance of the Purchase Order without liability.

(Extra paragraphing, bullets, and bracketed text added.)

In a Notre Dame Law Review article, two Skadden Arps lawyers offer other examples of MFC language:

  • "Contractor warrants that the price(s) are not less favorable than those extended to any other customer (whether government or commercial) for the same or similar articles or services in similar quantities."
  • "The Contractor certifies that the prices, warranties, conditions, benefits and terms are at least equal to or more favorable than the prices, warranties, conditions, benefits and terms quoted by the Contractor to any customers for the same or a substantially similar quantity and type of service."
  • "The Contractor warrants that prices of materials, equipment and services set forth herein do not exceed those changed by the Contractor to any other customer purchasing the same goods or services under similar conditions and in like or similar quantities."
7.1.1.2 Dangers of a most-favored-customer clause for suppliers

For a supplier, a most-favored-customer clause and price-reduction clause in a customer contract can be both dangerous and a major compliance burden. For example, in 2011:

  • The software giant Oracle Corporation paid just shy of $200 million to settle a U.S. Government lawsuit claiming that Oracle had overbilled the Government by charging more than allowed by an MFC clause in Oracle's federal-government contract; and
  • The Oracle-employee whistleblower who reported the breach to the government collected $40 million.

The case also attracted class-action plaintiffs, who sued Oracle and the members of its board directors.

In another case in which the present author's former law firm was involved, semiconductor chip maker Texas Instruments settled its patent-infringement lawsuit with Samsung in part because Samsung discovered that Texas Instruments had breached a most-favored-licensee provision in a previous patent-license agreement between the two companies — according to Samsung, when the parties had negotiated the previous license agreement, TI had fraudulently told Samsung that Samsung was getting as good a deal as any other TI licensee for the relevant patent, when apparently that proved not to be the case. See Evan Ramstad, Texas Instruments Reaches Agreement With Samsung (WSJ.com Nov. 27, 1996), archived (behind paywall) at https://perma.cc/PAC5-9VNU; David Beck, The Trial Lawyer: What it Takes to Win at 235-36 (American Bar Association 2006), excerpt at https://goo.gl/ad33DQ.

Both the danger and the compliance burden arise from the fact that business people doing transactions with other customers often won't remember that they must comply with the MFC and PRC clauses in the earlier customer contract. And if the business people do remember the MFC and PRC clauses, they might choose to ignore it, to roll the dice that they won't get caught.

Violating the MFC clause in a U.S. Government contract (a "GSA schedule") can lead to severe consequences, possibly including jail time:

There are significant perils of not complying with the MFC and PRC where questions of compliance or qui tam actions can result in government claims, prosecution under the False Claims Act (FCA), terminations for cause and suspensions and debarments to name a few.

Most Favored Customer Clause (GovContractAssoc.com, undated).

7.1.1.3 How to deal with customer requests for MFC language?

When a customer asks a supplier for an MFC commitment, the supplier can try to limit the commitment. For example:

• Try to limit the MFC commitment to pricing currently offered to other customers, without a "lookback" to prior sales.

• Try to avoid a future price-reduction obligation of the kind seen in paragraph [b] of the Honeywell language quoted above.

• Include limiting qualifiers for "same" and "similar" products and services.

• Limit the universe of other customers that are used for comparison — as an (absurd) illlustrative example, an MFC clause could say something like, "This is the best pricing we're offering today to companies headquartered in Montana whose corporate names begin with the letter 'Y.'" (This brings to mind a line from a Kingston Trio concert album that the present author listened to as a teenager: "We'd like to introduce one of the finest bass players on stage at this time.")

• A U.S. Government manual for contracting officers (purchasers) sets out some factors that suppliers can use to try to limit an MFC clause:

(e) When establishing negotiation objectives and determining price reasonableness, compare the terms and conditions of the … solicitation with the terms and conditions of agreements with the offeror’s commercial customers.

When determining the Government’s price negotiation objectives, consider the following factors:

(1) Aggregate volume of anticipated purchases.

(2) The purchase of a minimum quantity or a pattern of historic purchases.

(3) Prices taking into consideration any combination of discounts and concessions offered to commercial customers.

(4) Length of the contract period.

(5) Warranties, training, and/or maintenance included in the purchase price or provided at additional cost to the product prices

(6) Ordering and delivery practices.

(7) Any other relevant information, including differences between the … solicitation and commercial terms and conditions that may warrant differentials between the offer and the discounts offered to the most favored commercial customer(s).

For example, an offeror may incur more expense selling to the Government than to the customer who receives the offeror’s best price,

or the customer (e.g., dealer, distributor, original equipment manufacturer, other reseller) who receives the best price may perform certain value-added functions for the offeror that the Government does not perform.

In such cases, some reduction in the discount given to the Government may be appropriate.

If the best price is not offered to the Government, you should ask the offeror to identify and explain the reason for any differences.

Do not require offerors to provide detailed cost breakdowns.

• Develop a protocol for cross-checking pending transactions against MFC requirements; train relevant personnel to use the protocol.

7.1.1.4 Additional reading about MFC clauses

See generally:

7.1.1.5 Exercise: Responding to a most-favored-customer demand

FACTS: Your client, Seller, has asked you to review a purchase order from Buyer. The PO includes two pricing clauses that appear to have been copied essentially verbatim from the Honeywell terms of purchase quoted above.

QUESTION: What response to this demand would you try first?

7.1.1.6 Review: Oracle's most-favored-customer problem

QUESTIONS:

  1. What happened to Oracle when it breached its most-favored-customer clause with the U.S. Government (in its GSA contract)?
  2. What specifically did Oracle do that brought down the government's wrath on it?
  3. How much money did the whistleblower get for his trouble?

7.1.2 Price fixing

7.1.2.1 Resale price maintenance is (now) judged by a rule of reason

Again, the FTC:

Reasonable price, territory, and customer restrictions on dealers are legal. Manufacturer-imposed requirements can benefit consumers by increasing competition among different brands (interbrand competition) even while reducing competition among dealers in the same brand (intrabrand competition).

  • For instance, an agreement between a manufacturer and dealer to set maximum (or "ceiling") prices prevents dealers from charging a non-competitive price.
  • Or an agreement to set minimum (or "floor") prices or to limit territories may encourage dealers to provide a level of service that the manufacturer wants to offer to consumers when they buy the product.

These benefits must be weighed against any reduction in competition from the restrictions.

Until recently, courts treated minimum resale price policies differently from those setting maximum resale prices. But in 2007, the Supreme Court determined that all manufacturer-imposed vertical price programs should be evaluated using a rule of reason approach.

According to the Court, "Absent vertical price restraints, the retail services that enhance interbrand competition might be underprovided. This is because discounting retailers can free ride on retailers who furnish services and then capture some of the increased demand those services generate."

Note that this change is in federal standards; some state antitrust laws and international authorities view minimum price rules as illegal, per se.

7.1.2.2 Price fixing by competitors can lead to prison time

In the United States, "horizontal" price-fixing among competitors is per se illegal under section 1 of the Sherman Act and can call down the wrath of government prosecutors and plaintiffs' lawyers.

Corporate executives have gone to prison for price-fixing. EXAMPLE: The former chief executive officer of Bumble Bee Foods was sentenced to more than four years in prison and a $100,000 criminal fine for his leadership role in a three-year antitrust conspiracy to fix prices of canned tuna; the company pleaded guilty and was sentenced to a $25 million fine — and co-conspirator StarKist was sentenced to the statutory maximum $100 million fine.

According to the New York Times, the tuna price-fixing scheme came to light when a food wholesaler in New York noticed that prices for canned tuna were staying the same even though the price of raw tuna were dropping; this led to lawsuits by the wholesaler and by grocers such as Walmart, Target, and Kroger.

What kinds of inter-company dealings can be deemed "price fixing"? The U.S. Federal Trade Commission explains:

Price fixing is an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms.

Generally, the antitrust laws require that each company establish prices and other terms on its own, without agreeing with a competitor. When consumers make choices about what products and services to buy, they expect that the price has been determined freely on the basis of supply and demand, not by an agreement among competitors.

When competitors agree to restrict competition, the result is often higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.

A plain agreement among competitors to fix prices is almost always illegal, whether prices are fixed at a minimum, maximum, or within some range.

Illegal price fixing occurs whenever two or more competitors agree to take actions that have the effect of raising, lowering or stabilizing the price of any product or service without any legitimate justification.

Price-fixing schemes are often worked out in secret and can be hard to uncover, but an agreement can be discovered from "circumstantial" evidence.

  • For example, if direct competitors have a pattern of unexplained identical contract terms or price behavior together with other factors (such as the lack of legitimate business explanation), unlawful price fixing may be the reason.
  • Invitations to coordinate prices also can raise concerns, as when one competitor announces publicly that it is willing to end a price war if its rival is willing to do the same, and the terms are so specific that competitors may view this as an offer to set prices jointly.

Not all price similarities, or price changes that occur at the same time, are the result of price fixing. On the contrary, they often result from normal market conditions.

  • For example, prices of commodities such as wheat are often identical because the products are virtually identical, and the prices that farmers charge all rise and fall together without any agreement among them.
  • If a drought causes the supply of wheat to decline, the price to all affected farmers will increase.
  • An increase in consumer demand can also cause uniformly high prices for a product in limited supply.

Price fixing relates not only to prices, but also to other terms that affect prices to consumers, such as shipping fees, warranties, discount programs, or financing rates. …

7.2 Consumer Price Index / CPI Definition

Consumer Price Index / CPI, unless otherwise specified, refers to the Consumer Price Index – All Urban Consumers ("CPI-U"), as published from time to time by U.S. Bureau of Labor Statistics.

Commentary

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).

Caution: 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.

7.3 Pricing adjustment options

7.3.1 Option: Pricing Adjustment Discretion

Supplier is not restricted

7.3.2 Option: Pricing Cost Pass-Through

a.  During the term of the Contract,

  • if Supplier's relevant costs increase,
  • then Supplier may pass the increase on,
    • without markup,
  • to Customer.

b.  If Customer so requests, Supplier will provide Customer with reasonable supporting documentation

  • that fairly evidences the increase in Supplier's relevant costs.

7.3.3 Option: Pricing Increase Limit

During the term of the Contract,

  • Supplier will not increase the pricing it charges to Customer,
  • for transactions under the Contract:
    • more often than [once per calendar year], nor
    • by more than [20%] for any given [calendar year].

7.3.4 Option: Pricing Increase Notice

During the term of the Contract, Supplier will give Customer at least [30 days] advance written notice of any pricing changes.

7.3.5 Option: Pricing Lock-In

During the term of the Contract, all pricing for transactions under the Contract will be as stated in the Contract.

7.3.6 Option: Pricing Generally-Applicable Increases

  • except as part of,
  • and by a percentage no greater than the percentage of,
  • a price increase to Supplier's customers generally
  • for the same items.

During the term of the Contract, Supplier will not increase the prices charged to Customer —

7.4 Exercises and discussion questions

7.4.1 Exercise: 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?

Answer: The Consumer Price Index.

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

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?

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

8 Software

8.1 Terminology: Software; Licensor; Customer

The clauses in this Chapter 8 relate to computer software of any kind in any form ("Software"),

  • provided to a party to the Contract, referred to as "Customer,"
    • even if that party is technically not a customer,
  • by (directly or indirectly) another party, referred to as "Licensor."

8.2 Software License Protocol

8.2.1 Terminology: Software; Customer; License

Clause 8.1 (Terminology: Software; Licensor; Customer) is incorporated into this Checklist by reference.

8.2.2 Software Licenses are granted in writing

a.  A "Software License" must be granted by a written document,

  • which is referred to for convenience as a "License Granting Document."

b.  In case of doubt: In some circumstances, the Software License might be granted

  • via a reseller or other intermediary
  • and not directly by Licensor.

c.  An orally-granted license may be confirmed in writing by Customer,

  • subject to objection by Licensor within a reasonable time.
Commentary

Subdivision c addresses an "edge case" that seems unlikely to come up very often.

8.2.3 What form(s) may a License Granting Document take?

A License Granting Document might take the form of, for example:

  • a purchase order;
  • a quotation agreed to by (or on behalf of) Customer;
  • and/or an on-line sign-up form:
    • for downloading a copy of the Software,
    • and/or for gaining access to an online version of the Software,
      • for example in the case of so-called software as a service (known in the industry as "SaaS").

e.  The License Granting Document might refer to provisions in one or more external usage plans, service plans, maintenance plans, or similar external documents,

  • in which case those referenced provisions are deemed part of the License Granting Document.

f.  The Contract may specify that the License Granting Document is an Order for purposes of Clause 5.2 (Order Submission Protocol).

8.2.4 When will the Software be delivered?

Licensor will cause the Software,

  • its user documentation (if any),
  • and any required license codes for the Software,
  • to be delivered to Customer promptly upon the parties’ agreement to the License Granting Document,
  • if and to the extent not already done.

8.2.5 What will Customer pay for the Software License?

Customer need not pay anything for the Software License except as clearly stated in the applicable License Granting Document.

8.2.6 What acceptance testing may Customer do?

Once Customer has agreed to the License Granting Document,

  • Customer is deemed to have completed all acceptance testing of the Software that Customer wants to do,
  • unless the License Granting Document clearly says otherwise.
Commentary

Acceptance testing is a revenue-recognition issue for publicly-traded software companies, many of which offer customers a significant pre-license trial period and therefore assume that customers will not buy a license until satisfied with the testing.

8.2.7 What may Customer do with the Software?

a.  Under the Software License, Customer has only a limited, non-exclusive right [to use the executable version of] the Software,

  • only during [a particular time period] specified in the License Granting Document (the "License Term"),
    • although that time period might be perpetual if so stated in the License Granting Document or in the Contract;
  • that right is subject at all times to the terms and conditions of the License Granting Document and the Contract.

b.  The License Granting Document might include limitations

  • on the number of users, servers, and the like,
  • for which use of the Software is authorized by the Software License.

c.  The License Granting Document might also include limitations on replacing one user, server, etc., with another.

Commentary

Here's an example of a real-life license limitation provision that the author once did for a client, adapted to use the above terminology:

3.x Customer may not use the Software in connection with more, in the aggregate, than the number of distinct corresponding "license units" (for example, workstations, servers, users, etc.) for which Customer is licensed as set forth in the applicable License Granting Document, except as otherwise provided in the Contract.

HYPOTHETICAL EXAMPLE: Suppose that Customer is licensed to use the Software for 1,000 users. That means Customer may use the Software for an aggregate of 1,000 individual users in total; it does NOT mean that Customer may use it for an unlimited of total users as long as only 1,000 users are using the Software at any given time.

3.y If Customer permanently replaces one license unit with another one and deletes any and all data maintained by the Software and in respect of that license unit, then Customer may use the Software in connection with the replacement license unit in lieu of the replaced one.

HYPOTHETICAL EXAMPLE: Suppose that Customer is licensed to use the Software, and in fact Customer does use the Service, for 1,000 users. Suppose also that ten of those users leave Customer's company, and that Customer completely deletes all data maintained by the Service for those ten users. In that case, Customer may use the Software for an additional ten users (bringing Customer's total users back up to 1,000) without paying additional license fees.

8.2.8 What could happen if Customer doesn't pay?

a.  Customer's right to use the Software under the Software License is expressly conditioned on Customer's payment of any fees or other charges set forth (or referenced) in the License Granting Document.

b.  If Customer does not timely pay such fees or other charges,

  • then Licensor has the option of revoking the Software License,
  • after any grace period stated in the License Granting Document or otherwise in the Contract.
Commentary

A software customer might want to negotiate to include a provision such as [BROKEN LINK: pmt-ne-infr][BROKEN LINK: pmt-ne-infr] so that continued use of software after nonpayment of fees would not constitute copyright infringement — because that could lead to an award of serious damages, such as the customer's profits arising "indirectly" from the infringement, as discussed at [BROKEN LINK: pmt-ne-infr-cmtry][BROKEN LINK: pmt-ne-infr-cmtry].

8.2.9 Customer may* use the Software for disaster recovery

From time to time during the License Term, Customer may make use of the Software for reasonable disaster-recovery testing and disaster-recovery operations,

  • even if such use technically exceeds the use authorized by the License Granting Document,
  • as long as such excess use does not amount to regular business use.

8.2.10 Service-bureau use is not* permitted

Customer may not use the Software in providing services to third parties,

  • where functions performed by the Software are a material part of those services,
  • unless the License Granting Document clearly says otherwise.

8.2.11 Customer* is responsible for computer hardware, etc.

As between Customer and Licensor,

  • Customer is exclusively responsible for the supervision, management and control of Customer's use of the Software,
  • and for the provision and proper maintenance of Customer's hardware and supporting software,
  • such as, for example, operating-system updates and virus-protection software,
  • unless the License Granting Document clearly says otherwise.

8.2.12 Customer may not bypass usage-control mechanisms

Customer may not attempt (successfully or otherwise) to disable or work around any usage-control mechanism that may be built into the Software,

  • nor permit or assist others to do so or attempt to do so.

8.2.13 Reverse engineering, etc., is prohibited

a.  Customer may not decompile, disassemble, or reverse engineer any part of the Software,

  • nor permit or assist others to do so.

b.  If applicable law permits Customer to engage in such activity notwithstanding the Contract,

  • then Customer will provide Licensor with advance notice and reasonably detailed information concerning Customer's intended activities.

8.2.14 Customer may not* sublicense or transfer the Software

Customer may not rent, lease, sell, or sublicense any part of the Software,

  • except to the extent — if any — permitted by
    • the License Granting Document
    • or the applicable agreed usage plan.

8.2.15 New versions will not* increase Customer's usage limits

a.  If Customer is provided with a new or different version of an item of Software ("New Version"),

  • that fact will not in itself increase the number of license units for which Customer is licensed,
  • even if (for example) the New Version has a different license-installation code than a previous version provided to Customer.

b.  Customer may not use both the New Version and another version if such use would exceed the use permitted by the License Granting Document.

c.  In case of doubt, Customer is not entitled to be provided with any New Version of an item of Software,

  • unless the License Granting Document or the Contract clearly say otherwise.

8.2.16 Customer will not acquire ownership of the Software

a.  The Software is licensed, not sold; Licensor and/or its supplier(s), as applicable, retain title and all ownership rights, of whatever nature,

  • to the Software,
  • and to any tangible copy or copies of the Software provided to Customer.

b.  Customer has no rights in the Software other than those expressly granted by the License Granting Document.

8.2.17 Software copies may not* be provided to others

a.  The Software (and its documentation, if any) remain the confidential property of Licensor or its suppliers, as applicable.

b.  Customer may not provide copies of the Software to others,

  • nor may Customer disclose any license keys or license codes needed to operate the Software to others,
  • except as clearly permitted by the License Granting Document or by the Contract,
  • or with Licensor’s express prior written consent.

8.2.18 Backup copies of the Software are OK

Customer may make a reasonable number of copies of the Software and, if applicable, its documentation, for backup purposes.

8.2.19 Licensor may audit* Customer's Software usage

a.  Licensor may make reasonable requests that Customer report the actual details of usage of the Software under the Software License,

  • to help confirm that Customer is in fact complying with the license-unit restrictions of the License Granting Document and the Contract;
  • Licensor's request may include asking Customer:
    • to run one or more software reporting utilities,
    • and to provide Licensor with electronic and/or hard copies of any output of such reporting utilities.

b.  Licensor will give Customer at least [ten business days] to respond to any such request for a Customer usage report.

c.  Customer will timely comply with any such Licensor request.

d.  Licensor may audit Customer's usage reports,

  • upon reasonable notice to Customer,
  • in accordance with Clause 3.7 (Audit Protocol).

e.  Licensor will not disclose or use information in Customer's usage reports,

  • except to help ensure Customer's compliance with the Contract,
  • or as otherwise permitted by the Contract and/or by Licensor's written privacy policy.

8.2.20 How long will Licensor support "old" versions?

a.  Licensor will continue to support 'outdated' Software versions,

  • that is, any version that released for general availability
    • more than [six months] after release of a subsequent major- or minor version,
  • for that period of time.

b.  Licensor might offer longer support for outdated versions, but:

  • whether to do so is in Licensor's sole discretion (as defined in Clause 22.17); and
  • such longer support might require a separate contract and/or additional fees.

8.2.21 Customer represents that it is not legally barred

Customer represents (as defined in Clause 2.3) that, so far as Customer knows (as defined in Clause 22.30), applicable law does not prohibit Customer from using the Software.

Commentary

It's possible that a customer could be on some sort of government list of prohibited recipients of software under applicable export-control law; see the commentary at § 24.3.

8.2.22 U.S. Government customers: The Software is "commercial"

a.  The Software and its accompanying documentation are "commercial computer software" and "commercial computer software documentation," respectively, pursuant to DFAR Section 227.7202 and FAR Section 12.212, as applicable.

b.  Any use, modification, reproduction, release, performance, display or disclosure of the Software and accompanying documentation by the United States Government shall be governed solely by the terms of the Contract and is prohibited except to the extent expressly permitted by the terms of the Contract.

8.3 Software licenses — optional terms

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Defined terms in these options have the same meanings as in Clause 8.1.

8.3.1 Option: Catch-Up Licenses After Overusage

a.  When agreed to, this Option applies if Customer uses the Software beyond the scope of the Software License.

b.  The parties prefer to resolve the overusage on a business basis, and not as a matter of possible copyright infringement.

c.  Toward that end: Customer will promptly purchase:

  • all additional licenses required for such overuse,
  • plus maintenance for such additional licenses,
    • for the full term of the then-current maintenance subscription for the item(s) of Software in question,
    • or, if longer, for the period during which the unlicensed use has been taking place.

d.  If Customer intentionally used the Software beyond the scope of the Software License,

  • then Customer will purchase enough additional licenses to cover all relevant license units in Customer's entire worldwide network,
  • including but not limited to the network(s) of Customer's affiliates (as defined in Clause 22.2) (if any).

e.  Pricing for catch-up license purchases under this Option will be Licensor's then-applicable list price.

f.  If Customer did not purchase such additional licenses on its own initiative,

  • then as a compromise of any potential dispute over exactly how long Customer was making unlicensed use of the Software,
  • Customer will likewise purchase [one additional year] of back maintenance,
  • for all license units,
  • or such lower amount of back maintenance (not less than [six months]) as the parties may mutually agree, each in its sole discretion (as defined in Clause 22.17).

g.  If Customer purchases additional licenses and maintenance as provided in this Option,

  • then that purchase will be Licensor's EXCLUSIVE REMEDY for Customer's unauthorized use of Software described in this Option;
  • in all other events, Licensor reserves the right, in Licensor's sole discretion, to pursue other remedies for Customer's unauthorized use,
  • to the fullest extent permitted by applicable law,
  • in which case any limitations of Customer's liability in the Contract will not apply.
Commentary

Subdivision d: If Customer were intentionally to use the Software beyond the scope of the paid-for Software License, it would be inappropriate for Customer to demand that Licensor take Customer's word for it that Customer would not do so again. Consequently, subdivision d requires that Customer buy enough licenses to cover Customer's entire worldwide network.

Subdivision g: Under this exclusive-remedy clause, Licensor will be precluded from seeking damages or profits under copyright law.

  • This is not an insignificant concession on Licensor's part, because in certain circumstances, Licensor would be entitled to an award of Customer's indirect profits arising from the infringement, as explained in more detail in the commentary to [BROKEN LINK: pmt-ne-infr][BROKEN LINK: pmt-ne-infr].
  • In return for Licensor's concession, Customer makes a contractual commitment in this Option to pay for catch-up licenses, and possibly back maintenance, as indicated above.

8.4 Level X Support Definition

a.  If this Definition is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

b.  Level 1 support refers to:

  • routine basic support for a product or service; it entails providing customers, where applicable, with:
    • compatibility information,
    • installation assistance,
    • general usage support,
    • assistance with routine maintenance;
    • and/or basic troubleshooting advice.

c.  Level 2 support refers to:

  • more-in-depth attempts to confirm the existence,
  • and identify possible known causes,
  • of a defect in a product or an error in a service that is not resolved by Level 1 support.

d.  Level 3 support refers to advanced efforts to identify and/or correct a defect in a product or an error in a service.

Commentary

See generally, e.g.:

8.5 Software Limited Warranty

When this Checklist is adopted in an agreement (the "Contract"), it applies if and when, under the Contract:

  • a specified party ("Provider"),
  • warrants one or more items of computer software (of any kind, including but not limited to firmware),
  • to another party ("Customer").

Discussion checklist:

8.5.1 Software media are warranted for [90 days]

If Software and/or its documentation are delivered on physical media (for example, on a DVD or USB "thumb drive"),

  • then those media are warranted for the specified time period after their delivery, as follows:

a.  If Customer reports to Provider,

  • within the time period specified above,
  • that the media on which the Software and/or its documentation were delivered
  • contained material defects,
  • then Provider will deliver a replacement for the defective media to Customer
  • at no charge to Customer.

b.  Provider's obligations in subdivision a are Customer's EXCLUSIVE REMEDY for defective media.

Commentary

Inasmuch as software is increasingly delivered by download, not by media, this warranty seems likely to be less and less relevant.

8.5.2 Is the Software warranted against malware, and for how long?

All Software is warranted against malware for [90 days] after delivery of the Software version in question, as follows:

a.  If malware (defined below) is present in any deliverable as furnished by Provider under the Contract,

  • and Customer reports the malware to Provider within the specified time period,
  • then Provider is to pay, or reimburse Customer for:
  • all reasonable foreseeable expenses,
  • actually incurred by Customer,
  • in removing the malware,
  • and of mitigating and repairing any damage caused by the malware,
  • other than expenses that could have been avoided if Customer had taken prudent precautions.

b.  The term "malware" is to be interpreted

  • as those in the computer industry would typically define it at the relevant time;
  • in general, the term refers to computer program instructions and/or hardware designed to do one or more of the following:
    • alter, damage, destroy, disable, or disrupt the operation or use of software, hardware, and/or data;
    • disable or bypass security controls; and/or
    • allow unauthorized personnel to access data (including but not limited to personal data) and/or programming.

c.  The term malware would normally be understood as including, without limitation, the following terms, which are reasonably well-understood in the software- and Internet industry:

  • back doors; ransomware; snoopware; spyware; time bomb; trap doors; Trojan horses; viruses; and worms.

d.  Provider's obligations in subdivision a are Customer's EXCLUSIVE REMEDY for malware in any deliverable furnished by Provider under the Contract.

Commentary

See generally the Wikipedia entry Malware.

Caution: Some customers might ask Provider to commit to making "best" efforts to prevent infection by viruses, etc. The trouble with that is that, if a problem were to arise, with 20-20 hindsight it would almost always be possible for a customer's lawyer and hired expert witness to dream up some additional precaution that theoretically Provider should have taken to prevent the problem, therefore Provider (supposedly) didn't use "best" efforts, Q.E.D. (See also the discussion of best efforts in § 9.3.)

8.5.3 How long is the Software's performance warranted?

8.5.3.1 Applicability; performance warranty

This section will govern if the Software, as delivered, does not perform, in all material respects, in accordance with:

  1. the user documentation furnished by or on behalf of Provider; and
  2. any additional written specifications for the Software's performance,
    • but those additional written specifications must be expressly set forth and identified as such,
    • in a written agreement signed by an authorized representative of Provider.
8.5.3.2 Performance warranty period for paid perpetual license

If the Software is licensed to Customer under a paid, perpetual license,

  • then the performance warranty period stated in the heading of this section (or in the Contract) will apply;
  • that warranty period will begin on the date of delivery
  • of the first version of the Software that is so licensed to Customer.
8.5.3.3 Performance warranty period for time-limited license

If the Software is licensed to Customer under a time-limited license,

  • for example (as defined in Clause 22.21), under a software-as-a-service ("SaaS") subscription,
  • then the performance warranty period will be the entire period of the subscription.
8.5.3.4 Performance remedies

If, during the specified performance warranty period, the Software does not perform as stated in Clause 8.5.3.1,

  • then Provider is to:
  • provide Customer with a repair, replacement, or commercially-reasonable workaround for the defective Software in accordance with Clause 5.3 (Defect Correction Protocol); and/or
  • refund amounts paid by Customer for the defective Software, as follows:
    • the entire amount paid for a paid, perpetual license, and
    • a pro-rata portion (amortized on a daily basis) of the amount paid for a time-limited license.

e.  Provider's obligations in subdivision b are Customer's EXCLUSIVE REMEDY for any failure of performance by the Software.

8.5.4 Is the Software warranted against third-party IP infringement?

a.  Provider warrants that the Software as delivered complies with Clause 10.1 (Infringement Warranty Protocol),

  • subject to the limitations of that warranty,
  • including but not limited to the remedy limitations,
  • during [the entire period of Customer's use].

b.  Customer's EXCLUSIVE REMEDIES for any claim of infringement by the Software are as stated in Clause 10.1 (Infringement Warranty Protocol).

8.5.5 What must Customer do for warranty service?

For Customer to be entitled to the remedies of this Checklist, Customer must, at its own expense:

  1. report a potential breach of this Checklist to Provider,
    • in writing, with reasonable detail,
    • no later than the end of the relevant warranty period; and
  2. at Provider's request from time to time, provide Provider with reasonable information concerning the potential breach.

8.5.6 Are there any general limitations to these warranties?

a.  Provider DOES NOT WARRANT that the Software:—

  1. will be error free;
  2. will meet Customer's need; or
  3. will operate without interruption.

b.  Provider DOES NOT WARRANT that the Software will perform as documented in cases of:

  1. hardware malfunction;
  2. misuse of the Software;
  3. modification of the Software by any party other than Provider —
    • this subdivision is not to be intepreted as implicitly authorizing Customer to make or have made any such modification;
  4. use of the Software in an environment or with other software not described in the documentation or supported by Provider; or
  5. bugs in other software with which the Software interacts.

c.THE SOFTWARE IS NOT DESIGNED OR INTENDED FOR USE IN HAZARDOUS ENVIRONMENTS REQUIRING FAIL-SAFE PERFORMANCE,

  • including but not limited to any application in which the failure of the Software could lead directly to death, personal injury, or severe physical or property damage,
  • except to the extent — if any — explicitly stated otherwise in the Contract.

9 Efforts clauses

9.1 Does "reasonable efforts" require all reasonable efforts?

Tango Terms: Clause 9.4 (Reasonable Efforts Definition).

The term reasonable efforts is of course vague and thus open to after-the-fact argument. Still, parties often use the term as a way of deferring discussion about precisely what a party must do. (Often, this is because at the time the parties are negotiating the contract, they don't really know what efforts should be required.)

One UK trial court decision noted that "[a]n obligation to use reasonable endeavours to achieve the aim probably only requires a party to take one reasonable course, not all of them …."

Likewise, the Tango Terms definition of reasonable efforts, Clause 9.4, doesn't go quite that far, but it does include a roadblock term to the effect that exhaustive efforts aren't required to satisfy a reasonable-efforts commitment.

This is not a universally-held view: Some courts apparently regard reasonable efforts and best efforts as interchangeable — which could leave room to argue that anything less than all reasonable efforts would be, by definition, unreasonable:

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.

  • The Federal District Court for the Western District of Wisconsin said, "The duty to use best efforts requires [a party] to use reasonable efforts and due diligence."
  • The Federal District Court of Kansas examined a recent contract that called for best efforts and said, "Best efforts does not mean perfection and expectations are only justifiable if they are reasonable."
  • The Federal District Court for the Southern District of New York has gone a step further, declaring, "New York courts use the term 'reasonable efforts' interchangeably with 'best efforts.' "
  • The Federal District Court for the District of New Jersey may have summed up the nondistinction best. In a 1997 case, the defendant wanted the court to apply a best-efforts standard to a breach-of-contract counterclaim, while the plaintiffs sought a reasonable-efforts standard. The court imposed "an implied duty to act in good faith and with due diligence" but tellingly added, "The Court, however, views this [debate between best and reasonable efforts] as merely an issue of semantics and notes that its decision would not differ if it adopted the best efforts terminology."

In the present author's view, many people — especially business people — if asked, would say that the term reasonable efforts should encompass a range of efforts and not be a binary, yes-no dichotomy.

Consider a scenario 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 simply send Bob a quick email to that effect, using the email address that Bob has consistently used in his dealings with Alice.
  • In that scenario, many business people would think that Alice had complied with her contractual obligation to use reasonable efforts to advise Bob, even if for some reason Bob never got the email.

But now assume that reasonable efforts means all reasonable efforts. If that's the case, and 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. That might well be economically wasteful.

Drafting lessons:

1.  Define the term "reasonable efforts so as not to require all reasonable efforts; and

2.  If a situation might arise where all reasonable efforts should indeed be made, then the contract should clearly say so.

9.2 "Commercially reasonable efforts": A popular shortcut

Tango Terms: Clause 9.5 (Commercially Reasonable Efforts Definition).

Contract drafters sometimes use the term commercially reasonable efforts:

  • when they don't want (or don't have time) to impose a specific standard of performance;
  • or when the parties simply don't know what the standard should be in as-yet undetermined circumstances;
  • and to emphasize that the term requires what business people would regard as reasonable efforts.

This section discusses some of the pros and cons of that approach, along with how courts have interpreted the term.

9.2.1 Business background

Business people and their counsel are fond of the term commercially reasonable efforts because it basically defers (read: dodges) discussion of and agreement to the precise standard required. That might well be a safe bet in many cases, because parties usually can amicably resolve any disputes that might arise.

But what if the parties end up disputing whether a party has complied with an obligation to make commercially reasonable efforts? Different courts have applied very different standards, which can lead to uncertainty for businesses about what they're getting into. (W.I.D.D.: When In Doubt, Define!)

9.2.2 Commercial reasonableness might lie in the process

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."

9.2.3 Are all reasonable efforts required for "commercially reasonable efforts"?

In a 2017 opinion, the Delaware supreme court held that the term commercially reasonable efforts required taking "all reasonable steps" to achieve the stated objective.

In a dissent on other grounds, Chief Justice Strine opined that commercially reasonable efforts is "a comparatively strong" commitment, one that is only "slightly more limited" than best efforts.

9.2.4 Prudence might be the standard for commercially-reasonable efforts

A prudence standard played a role in defining commercially reasonable efforts in a major lawsuit between Indiana and IBM over a supposedly-failed project to modernize the state's computer system for administering welfare benefits. Relevantly here: The contract defined commercially reasonable efforts 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."

9.2.5 May an obligated party take its own interests into account?

A California federal district court, reviewing (sparse) precedent, held that a party obligated to use commercially reasonable efforts could permissibly take into account its own business interests: "Defendant correctly points out that the limited case law regarding the meaning of ‘commercially reasonable efforts' is consistent with the principle that commercial practices by themselves provide too narrow a definition and that the performing party may consider its own economic business interests in rendering performance."

A tangentially related issue arose in a 2014 English case stemming from the financial crisis of 2008: There, 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.

9.2.6 "Commercially reasonable": Sensible deferral, or lighting a fuse?

Impatient parties might agree to vague and airy terms such as commercially reasonable or negotiate in good faith or use its best efforts --- and those terms could end up being very contentious and expensive to litigate if the parties were unable to agree later.

But that might be the best choice, because they simply might not know what terms they should "carve in stone" in the contract language. This could occur, for example, because the parties don't know (or disagree about) what's even feasible. It could also occur if one or both parties doesn't know what it might want in an actual event.

In some situations like that, it might make sense for the parties to simply defer the discussion, with the intent of working things out later. That could be a very-reasonable calculated risk if the consequences of failing to agree later would be comparatively minor.

Let's look at some considerations that can affect that decision.

The "Mack Truck Rule" of contract drafting: Once upon a time there were two companies that negotiated a very important contract. Each company was represented in the negotiations by a smart, experienced executive who understood the business and also understood the other's company's needs.

During the discussions, the executives hit it off on a personal level. Under pressure to get the deal done, they agreed that they didn't need to waste time on picky details, because they were developing a good working relationship and would surely be able to work out any problems that might arise.

The executives signed the contract and marched off, in great good spirits, to a celebratory dinner. While crossing the street to the restaurant, they were hit by a truck.

Their successors turned out to be idiots who hated each other. Imagine how much fun they had in dealing with the picky details that the faithful departed had left out of the contract.

Agree to a process instead of an outcome? When the parties don't know what outcome they want, perhaps they can agree instead to a reasonable process that they can use later to decide what the outcome will be. Such a process might include, for example:

  • escalation of any disagreement to upper management
  • micro-arbitration — possibly using baseball-arbitration procedures — and perhaps with a partial-retrial option. [TO DO]

See the provisions at [TO DO: Link] for more details on these options.

9.3 Are "best efforts" provisions safe to use?

Tango Terms: Clause 9.6 (Best Efforts Definition).

Best-efforts clauses can be (quite) problematic, for reasons discussed below, but they're often used anyway because many business people like them. Providing a definition such as that in Clause 9.6 can at least reduce some of the associated legal uncertainty. (W.I.D.D.: When In Doubt, Define!)

9.3.1 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.

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 to say:

  • reasonable efforts will cover a range of possibilities,
  • while best efforts refers to somewhere near the top of that range.

9.3.2 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, 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.

9.3.3 Defining the term: Diligence as the key to best efforts

Clause 9.6 (Best Efforts Definition) frames the concept of best efforts in terms of the diligent making of reasonable efforts. This approach comes from Restatement (Second) of Agency, which states: "Best efforts is a standard that has diligence at its essence."

9.3.4 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.

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.

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 …."

9.3.5 Best efforts might mean 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." 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."

(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, 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.

Likewise, 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."

• Some UK, Canadian, and Australian courts have defined the standard of performance for best efforts as, in essence, all reasonable efforts, as discussed above.

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 …."

One court held that "as promptly as practicable" and "in the most expeditious manner possible" were sufficient to meet that requirement.

With all of this in mind, the definition of best efforts in this Definition 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]

9.3.6 "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."

"[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."

9.3.7 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.

9.3.8 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.

9.3.9 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.

9.3.10 Optional: Further reading about best efforts

See also:

9.4 Reasonable Efforts Definition

a.  Reasonable efforts refers to one or more reasonable actions

  • that together, at the time in question,
  • appear to be reasonably likely to achieve a stated objective.

b.  A requirement to make reasonable efforts does not necessarily require taking every conceivable reasonable action.

c.  Any assessment of reasonable efforts is to give due weight to the information reasonably available to the relevant person(s) at the relevant time, about, without limitation:

  1. the likelihood of success and the likely costs of particular actions and alternatives;
  2. the safety of individuals and property; and
  3. where relevant, the public interest.

d.  In complying with an obligation to use reasonable efforts, the obligated party may give due consideration to its own lawful interests, including but not limited to avoiding putting itself in a position of undue hardship or incurring unduly-burdensome costs.

Commentary

Subdivision b – no need to take every conceivable reasonable action: Defining reasonable efforts in this way might be a good idea in case a court were to hold that the term requires making all reasonable efforts. (See also the definition of best efforts.)

Subdivision c.1: The terms "likelihood of success" and "likely cost" are inspired by a comment by Janet T. Erskine, Best Efforts versus Reasonable Efforts: Canada and Australia (Lexology.com 2007).

Subdivision d: The "undue hardship" language is adapted from the Janet Erskine comment cited above. The "incurring unduly-burdensome costs" is adapted from an email suggestion by Houston lawyer Stephen Paine, a colleague of the present author (now retired).

For another possible definition of reasonable efforts, see a Ken Adams blog post from 2016:

“*Reasonable Efforts*” means, with respect to conduct under this agreement, the efforts that a reasonable person in the position of the applicable party would use to engage in that conduct effectively.

9.5 Commercially Reasonable Efforts Definition

a.  The term "commercially reasonable efforts" refers to those efforts that prudent people, experienced in the relevant business, would generally regard as sufficient, in the relevant circumstances, to constitute reasonable efforts.

b.  In case of doubt: If the Contract requires a party to make commercially reasonable efforts to do something (referred to as "X"), then the party:

  1. need not actually succeed in accomplishing X;
  2. need not make all reasonable efforts to accomplish X; and
  3. may take its own business interests into account.

9.6 Best Efforts Definition

a.  Best efforts refers to the diligent making of reasonable efforts to achieve an objective.

b.  In case of doubt, a party obligated to use best efforts:

  1. need not take any unreasonable action;
  2. need not take every conceivable reasonable action to achieve the stated objective; and
  3. need not materially harm its own lawful interests.

9.7 Efforts clauses: Review questions

1.  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?

[TO DO]

  1. QUESTION: Is there any significant difference between "reasonable efforts" and "commercially-reasonable efforts"?

10 Intellectual property

10.1 Infringement Warranty Protocol

10.1.1 When does this Checklist apply?

a.  When this Checklist is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • a specified party ("Supplier")
  • makes any warranty, representation, or other commitment,
    • to one or more specified other parties (each, a "Beneficiary"),
  • that one or more products and/or services
    • each, a "Covered Item,"
    • and a "Covered Product" or "Covered Service" as applicable,
  • as delivered by Supplier,
    • or as otherwise expressly designated in writing by Supplier,
  • do not infringe certain third-party rights
  • as specified in this Checklist.

b.  Such a warranty, representation, or other commitment

  • is referred to as an "Infringement Warranty"
  • for the specified Covered Item(s).
Commentary

Customers might want to consider whether an Infringement Warranty should also cover goods or services provided on behalf of Supplier, not just those provided by Supplier itself.

10.1.2 What does this Checklist cover for copyrights and trade secrets?

An Infringement Warranty covers third-party claims

  • that a Covered Item infringes a copyright
    • and/or misappropriates a trade secret
  • owned or assertable by a third party
    • anywhere in the world,
  • except as otherwise stated in this Checklist.
Commentary

See the commentary to § 10.1.3 for a discussion of why the copyright- and trade-secret warranty has a different scope than the patent- and industrial-design warranty.

10.1.3 What does this Checklist cover for patents and industrial designs?

In making an Infringement Warranty about a Covered Item,

Supplier only represents (as defined in Clause 2.3) —

  • without having made any particular search or other investigation unless clearly stated otherwise in writing —

that Supplier is not aware of any infringement,

  • nor of any claim of infringement,

that the Covered Item,

infringes any valid and enforceable claim of a utility patent or design patent,

  • or any valid and enforceable industrial-design right,

that is owned or otherwise assertable by a third party

  • anywhere in the world,

except as otherwise stated in this Checklist.

10.1.3.1 Why the difference?

Supplier can more readily warrant against claims of infringement of third-party copyrights or misappropriation of trade secrets than it can against infringement of patents. That's because:

  • independent creation — if proved — is generally an absolute defense to claims of copyright infringement or trade-secret misappropriation; and
  • whereas in the case of patents, Supplier might unknowingly infringe an obscure patent that "pops up from out of the woodwork," perhaps asserted by one of the so-called patent trolls (who get offended when called that; they insist that they are "non-practicing entities" or NPEs).

Supplier will generally be able to know whether it improperly copied from a third party's protected subject matter, which puts Supplier in a better position to warrant as to copyrights and trade secrets.

For more about the basics of patent infringement, see the commentary at Clause 10.1.9.

10.1.4 Use of Covered Products as instructed [is] covered

If Supplier provides Beneficiary with instructions for using a Covered Product, for example (as defined in Clause 22.21) in a user manual,

then the Infringement Warranty for the Covered Product extends to use of the Covered Product,

  • in accordance with those instructions,
  • by Beneficiary,
  • and/or by other any users clearly specified in the Contract.
Commentary

In U.S. patent law, you can infringe a patent claim to a product by using — without a license from the patent owner — a product that comes within the scope of the claim. (See generally the discussion of patent infringement in the commentary at Clause 10.1.9.)

This infringement-by-use doctrine is relevant here because under U.S. law, supplier can be indirectly liable for the patent infringement of others if Supplier "actively induced" the infringement — and Supplier's providing instructions to Beneficiary might qualify.

10.1.5 Compliance with a furnished specification [is not] covered

a.  An Infringement Warranty does not cover claims of infringement,

  • where the claimed infringement arises from a Covered Item's compliance with a written- or oral specification
    • (see also subdivision b for assertions of compliance with oral specifications),
  • and where the specification was provided, under the Contract:
    • by any Beneficiary;
    • or by any affiliate (as defined in Clause 22.2) of a Beneficiary (to avoid possible collusion);
    • or by a third party on behalf of a Beneficiary or affiliate of a Beneficiary.

b.  If Supplier asserts that the Covered Item complied with an orally-provided specification,

Commentary

This section mirrors the general law in the U.S. in the Uniform Commercial Code § 2-312(3), which provides that:

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.

(Emphasis and extra paragraphing added.)

10.1.6 Claims of combination-only infringement [are not] covered

An Infringement Warranty does not cover claims of infringement,

  • if the claimed infringement arises from a combination of a Covered Item with any other tangible- or intangible products or services,
  • if no claim of infringement is made in respect of:
    • the Covered Item itself, or
    • use of the Covered Item apart from the combination.
Commentary

This section disclaims warranty liability to Beneficiary. But that might not be enough to save Supplier from liability to a patent owner who claims that Supplier is liable for "contributory infringement" of a patent claim. That's because under U.S. law —

Whoever offers to sell or sells within the United States or imports into the United States

a component of a patented machine, manufacture, combination or composition, or a material or apparatus for use in practicing a patented process,

constituting a material part of the invention,

knowing the same to be

  • especially made or especially adapted for use in an infringement of such patent,
  • and not a staple article or commodity of commerce suitable for substantial noninfringing use,

shall be liable as a contributory infringer.

10.1.7 What will Supplier do in case of a breach of this warranty?

This section specifies Supplier's obligations in case of a claim of infringement that constitutes a breach of the warranty of this Checklist.

10.1.7.1 What must happen to trigger Supplier's obligations?

The "Infringement Remedies" defined in this Clause 10.1.7 will be available to Beneficiary if any of the following "Triggering Events" occurs:

  1. A court of competent jurisdiction enjoins Beneficiary from using a Covered Product
    • as a result of an infringement claim covered by an Infringement Warranty (a "Covered Infringement Claim"),
    • and Supplier is unable to promptly have the injunction stayed or overturned;
  2. or Supplier notifies Beneficiary that Supplier has settled a Covered Infringement Claim,
    • on terms that require Beneficiary to stop using a Covered Product;
  3. or Supplier determines, in its reasonable judgment,
    • that Beneficiary should stop using a Covered Product because of a Covered Infringement Claim.
10.1.7.2 What must Supplier do in case of a Triggering Event?

a.  If a Triggering Event (as defined in Clause 10.1.7.1) occurs in respect of a Covered Product,

  • then Supplier must take one or more remedial actions, selected in Supplier's discretion (as defined in Clause 22.17), as follows:
  • Plan A: Supplier will modify or replace the Covered Product
    • with a non-infringing substitute that, in material respects,
    • performs the same functions as the replaced deliverable.
  • Plan B: For each Beneficiary that was authorized under the Contract to use the Covered Product,
    • Supplier will — at its own expense —
    • procure for that Beneficiary the right to continue using Covered Product.
  • Plan C: If Supplier is unable to follow Plan A or Plan B,
    • or if neither Plan A nor Plan B is commercially feasible in Supplier's judgment;
    • then Supplier will:
      • direct the Beneficiary to stop using the deliverable;
      • and take the refund action specified in Clause 10.1.7.3 below.

b.  If Supplier proceeds under Plan C above (refund),

  • then Supplier will not be responsible
  • for any infringing use of a Covered Item
    • by Beneficiary,
    • or by any other user authorized by the Contract,
  • beginning after a reasonable time for Beneficiary to conduct an orderly transition away from the use in question.
10.1.7.3 Any refund will reflect amortization over [36 months]

If Supplier proceeds under Plan C in Clause 10.1.7.2,

then Supplier must refund—

  • the amount paid for the Covered Product (or its use),
  • reduced pro rata to reflect amortization,
    • on a straight-line monthly basis,
    • of that paid amount,
    • over the applicable time period,

as follows:

SUBJECT OF REFUND:
AMORTIZATION PERIOD:
A paid-up permanent right to use a Covered Item (for example, a deliverable sold outright, or a fee for a paid-up perpetual use license):
The amortization period specified in the Contract (see the heading of this section for the "default" value).
A temporary period of entitlement relating to a Covered Item (for example, a software maintenance subscription period):
The entire duration of that period.
Commentary

The 36-month amortization period is based on the IRS depreciation period for computer software licenses.

10.1.8 EXCLUSIVE WARRANTY & REMEDIES

Unless the Contract expressly states otherwise — specifically mentioning and overriding the Infringement Warranty:

  1. This Checklist states the EXCLUSIVE TERMS of any Infringement Warranty;
  2. All other warranties, representations, conditions, and terms of quality relating to infringement etc., are DISCLAIMED by Supplier —
  3. The remedies stated in this Checklist are each Beneficiary's EXCLUSIVE REMEDIES for:
    • any breach of the Infringement Warranty; and/or
    • any other infringement of third-party intellectual property rights by, or attributable to, Supplier.

10.1.9 Additional commentary: Patent infringement basics

10.1.9.1 The claims of a patent are what determine infringement

People sometimes get all worked up about the fact that a patent describes X or Y or Z that can be found in prior art.

What matters for infringement purposes, however, is not so much what the patent describes, as what it claims. The exact wording of the patent claims will be crucial.

10.1.9.2 Each claim in a patent is a separate infringement checklist

You can also think of each individual claim in a patent as being a separate infringement checklist: At trial, the patent owner’s lawyers and expert witness(es) will methodically talk the jury through that claim (and probably others as well), putting on evidence to show that every claim element is present in what the defendant is doing.

Here are a couple of canonical hypothetical examples (simplified — they do not address the doctrine of equivalents):

Claim 1: A seating structure comprising:

  • (a) a substantially-horizontal seating platform, and
  • (b) at least three legs extending generally downward from the seating platform.

Claim 5: A chair comprising:

  • (a) a substantially-horizontal seating platform; and
  • (b) four legs extending generally downward from the seating platform.

In these examples:

  • A three-legged stool with a back support would infringe our hypothetical claim 1 above, because all of the checklist elements in that claim are present in the three-legged stool. Importantly, the additional presence of the of the stool's back support is irrelevant.
  • In contrast, a three-legged stool would not infringe hypothetical claim 5 above, because that claim requires an infringing chair to have four legs.
10.1.9.3 Claim interpretation is often a big deal

Very often, patent owners and accused infringers engage in expensive legal battles over "claim construction," that is, the proper interpretation of different words and phrases in a patent claim. In the examples above, such a battle might break out over whether the term "seating platform" encompasses a camp chair with a soft, foldable cloth seat.

As a general rule, a given word or phrase in a claim will be interpreted in light of considerations such as the following:

  • the ordinary meaning of the term in the relevant art(s);
  • any special meaning stated by the inventor in the patent’s written description — the inventor is free to be his- or her own lexicographer;
  • how the term was used in the back-and-forth correspondence between the inventor and the patent examiner, referred to as the ‘prosecution history’ of the patent application;
  • whether a particular meaning is required — other things being equal, a narrower interpretation that will preserve the patentability of the claim will be preferred over a broader interpretation that would result in the claim being invalidated by prior art. (If this issue comes up during the prosecution of the patent application, the patent examiner is supposed to require the applicant to amend the claim to eliminate the ambiguity.)
10.1.9.4 Only one claim need be proved infringed

As long as the patent owner proves that at least one claim is infringed, and the defendant doesn’t prove that the infringed claim(s) are invalid, then the defendant is liable for infringement.

Suppose hypothetically that the example claims above were actually in an unexpired patent, and that they were not proved to be invalid.

In that case, anyone who made, used, sold, offered for sale, or imported a three-legged stool would be liable for infringement, even though the stool infringed only claim 5 and not claim 1.

Here's an analogy: Imagine that the claims of a patent are like arrows in a quiver, and that a hostile archer (a patent owner) were to shoot several arrows in your direction:

  • Some arrows might clearly be going to miss you; those are analogous to patent claims that you clearly don't infringe. (This assumes a judge and/or jury agrees that these arrows have missed you, which isn't always a given.)
  • But suppose that some of the arrows in flight appear on their way to hitting you somewhere on your body. It's up to you to try to knock down all of those arrows before they hit you.
10.1.9.5 "Freedom to operate" patent-infringement searches aren't cheap

This section states that Supplier hasn't necessarily made any particular investigation into possible infringement claims of the type covered. Supplier might want to consider commissioning a "freedom to operate" investigation and opinion of counsel to provide both Supplier and Beneficiary with at least some comfort.

Such investigations can be costly, but if there's a lot at stake, that cost might be worthwhile.

10.2 Intellectual Property Definition

a.  If this Tango-2020-09-16 is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

b.  The term "intellectual property," whether or not capitalized, refers broadly to:

  1. approaches, concepts, developments, discoveries, formulae, ideas, improvements, inventions, know-how, methodologies, plans, procedures, processes, techniques, and technology, whether or not patentable;
  2. artwork, audio materials, graphics, icons, music, software, writings, and other works of authorship;
  3. designs, whether or not patentable or copyrightable;
  4. trademarks, service marks, logos, trade names, and the goodwill associated with each;
  5. trade secrets and other confidential information;
  6. mask works; and
  7. all other forms of intellectual property recognized by law.
Commentary

This definition is a composite of language commonly found in contracts that have drafted with input from IP lawyers.

10.3 Intellectual Property Right Definition

a.  If this Tango-2020-09-16 is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

b.  The term "intellectual-property right," whether or not capitalized, refers broadly

  • to any right,
    • existing under any form of intellectual-property law or industrial-property law
    • (see the partial list in subdivision b below),
  • to exclude others from utilizing one or more forms of intellectual property (as defined in Clause 10.2),
  • at a relevant time,
  • in a relevant location,
  • including without limitation the right to seek monetary- and/or injunctive relief,
    • in any judicial, administrative, or other forum having jurisdiction in that location,
    • for present or past infringement of any such right.

c.  The term includes, for example (as defined in Clause 22.21):

  1. all rights (whether registered or unregistered) in, or arising under laws concerning:
    • trade secrets and other confidential information;
    • inventions, utility patents, and industrial designs;
    • trademarks, service marks, and trade names;
    • Internet domain names;
    • copyrights;
    • designs;
    • rights of publicity;
    • and mask works;
  2. any application then pending for such a right,
    • including for example an application for a patent or to register a copyright or trademark;
  3. any right to file such an application; and
  4. any right to claim priority for such an application.
Commentary

This definition spells out in great detail, for the benefit of students and other newcomers to the field, what IP professionals implicitly know but seldom state explicitly. It's a composite of language commonly found in contracts that have been drafted with input from IP lawyers; and

10.4 License (IP) Definition

a.  If this Tango-2020-09-16 is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

b.  In the context of intellectual property, the term "license" (verb), whether or not capitalized, refers to

  • the granting, by a party ("Owner"),
  • to one or more specified other parties (each, a "Licensee"),
  • of a binding Owner commitment
    • not to seek monetary relief (other than agreed compensation) nor injunctive relief
      • against Licensee
      • in any judicial, administrative, or other forum,
      • anywhere in the world if not otherwise specified,
  • on account of Licensee's engaging in one or more activities,
    • for example (as defined in Clause 22.21), the making, using, selling, copying, distributing, or importing of something,
  • on grounds that such Licensee activities,

c.  In the same context, the term "license" (noun) refers to Owner's commitment described in subdivision b.

d.  A license does not authorize Licensee to engage in such activities,

  • because Licensee might be subject to other restrictions, by law or otherwise;
  • instead, the license is only a commitment by Owner
    • that Owner will not seek to exclude Licensee from engaging in such activities,
    • nor seek monetary relief for Licensee's doing so (other than agreed compensation).
Commentary

This definition is intended in part for students and other newcomers to the IP field; it spells out in great detail what IP professionals implicitly know but seldom state explicitly.

10.5 IP Creation Ownership

10.5.1 Definition: Ownership (of IP)

In respect of particular intellectual property (as defined in Clause 10.2) ("IP"),

  • the term "ownership" (and related terms such as "own") — whether or not capitalized — refers to:
    • legal- and equitable ownership,
    • of all right, title, and interest in that IP,
    • anywhere in the world,
    • under any law relating to IP,
    • such as (without limitation), laws governing patents, copyrights, trade secrets, mask works, industrial designs, and trademarks,
  • unless otherwise agreed in writing.
Commentary

Trademarks: If a party is assigning IP rights in a technology, an assignment of trademark rights might or might not be part of the deal as contemplated by the parties — because the assigning party might not want to give up control of the "brand" associated with the rights.

10.5.2 Will ownership of any pre-existing IP change hands?

No: Ownership of any pre-existing IP will not change under the Contract unless the Contract clearly says otherwise.

Commentary

Contents:

This more or less mirrors applicable law in the U.S.; see 17 U.S.C. § 261 (transfers of patent ownership); 17 U.S.C. § 201(d) (transfers of copyright ownership).

10.5.3 Who will own newly-created IP (if any)?

As between the parties:

  • each party will own whatever IP that it creates on its own under the Contract (if any);
  • and the parties will jointly own — in equal, undivided interests — whatever IP that they jointly create under the Contract (if any).
Commentary

Alternative: "[Specify party name] will own all such IP except Tookit Items (see § 10.5.4)."

Contents:

"As between the parties …."

The "as between the parties" language recognizes that other factors — such as preexisting contracts — might affect ownership of newly-created IP.

For example, Stanford University found, presumably to its dismay, that it did not own the entirety of a significant biotech invention by its researchers because one of the researchers had previously signed away his rights to a company that provided him with some technical training.

Special case: Who should own custom-developed computer software?

It's a sad tale: A customer hires a software developer as an independent contractor to create custom software for the customer's business. The relationship eventually breaks down, and the parties get into a dispute over who owns the copyright in the software: The developer, or the customer? If the contract says only that the software is to be a "work made for hire" but the software doesn't fit into one of the nine statutory categories listed above, the parties can settle in for some expensive litigation.

In the author's experience, a reasonable arrangement is:

  • for the customer to own any newly-created IP that's unique to the customer's business or that involves the customer's confidential information;
  • for the software developer to own all other IP created by the developer, so that the developer is free to reuse that IP for other customers.

This arrangement is reflected in the ownership provisions of this Rule.

The current customer should keep in mind that:

  • the pricing quoted by the software developer will be determined in part by the developer's ability to reuse IP that the developer created for previous customers;
  • consequently, if the current customer insists on owning any IP that's created by the software developer, then the developer is likely to insist on revisiting the parties' agreement about the economics of the deal.

10.5.4 Will ownership of Toolkit Items change hands?

No — unless the Contract clearly states otherwise:

a.  Even if other IP is transferred under the Contract,

  • ownership of "Toolkit Items" (defined below) will not change;
  • without limitation, this means that any Toolkit Items created under the Contract
  • are not to be deemed "works made for hire."

b.  For this purpose, "Toolkit Item" refers to any concept, idea, invention, strategy, procedure, architecture, or other work, that:

  1. is, in whole or in part, created by a party in the course of performing under this Agreement; but
  2. in the case of a provider performing services for a customer: is not specific, and/or is not unique, to the customer and its business.

c.  In case of doubt, however,

  • the term Toolkit Item does not encompass Confidential Information,
  • as defined in Clause 6.3 (Confidential Information Protocol),
  • of another party.
Commentary

The definition of "Toolkit Item" comes into play if a service provider wants to retain ownership of the "tooling" that it develops in the course of a project for a client or customer, even if the customer is to own the resulting work product.

10.5.5 Will newly-created IP be a "work made for hire"?

No: Newly-created IP will not be a "work made for hire" unless the Contract clearly says so.

Commentary

Contents:

Work-for-hire status makes a difference in the long term: When an author transfers or licenses a copyright and the work is not a work made for hire, the author or his or her heirs can terminate the transfer or license and, in essence, "recapture" the author's ownership.

This has come up for some famous songwriters, e.g., Paul McCartney, who sought to revoke his transfer of his song copyrights.

10.5.6 Who may may use jointly-created new IP?

Either party may make whatever use it desires

  • of any IP that is jointly created in the course of performance under the Contract.
Commentary

Joint creation of intellectual property can occur, for example:

  • in services-type contracts; and
  • in collaboration agreements of various kinds, e.g., R&D joint-venture agreements.

Who is to own jointly created IP will sometimes be a negotiation point.

10.5.7 Must a party share proceeds from use of jointly-created IP?

If a party makes use of IP that it jointly created with another party;

  • then the first party need not account to the other party for such use;
  • for example, the first party need not share profits with the other party,
    • nor pay royalties to the other party.
Commentary

On the patent side: Unless otherwise agreed in writing, each co-inventor of joint invention may use and/or license the invention with no obligation to account to — i.e., share proceeds with, or pay a royalty to — any other co-inventor.

On the other hand, on the copyright side: While the co-owners of a joint work may make use of the work as they see fit, they must account to one another from their uses of the work unless they agree otherwise in writing.

As an example of this principle, the hit song Let the Good Times Roll was putatively authored by one Leonard Lee; he and his heirs were paid more than $1 million in royalties during the relevant time period. But Lee's childhood friend Shirley Goodman won a lawsuit in which she alleged that she was the co-author of the song — the court awarded her one-half of those royalties.

Another example is the 1967 hit song A Whiter Shade of Pale by the British rock group Procol Harum:

  • In 2009, the group's organist, Matthew Fisher, prevailed in the House of Lords on his claim that he should have been listed as a co-author of the song as released, because the Bach-like part that he played on the organ during the recording session was an addition to the original composition.
  • The Lords agreed that Fisher had waited too long — 38 years — to claim his share of past royalties.
  • But the Lords affirmed a judgment below that Fisher was entitled to a 40% share of ownership in the musical copyright in the song, and thus presumably to that share of future royalties.

10.5.8 Who may authorize others' use of jointly-created IP?

[Each party] may authorize others to use of jointly-created IP,

  • in any manner that would be allowed to the authorizing party itself under the Contract,
    • including without limitation use of the IP for the authorizing party's benefit —
    • this is sometimes referred to as "have-made rights" —
  • and/or use of the IP for the user's own benefit,
  • as a licensee of the authorizing party.
Commentary

In a Second Circuit case, schools paid FedEx Office to make copies of materials that were licensed under a Creative Commons license that prohibited "commercial use." The court held that the copying still qualified as noncommercial, even though FedEx had charged the schools for making the copies: "[U]nder long‐established principles of agency law, a licensee under a non‐exclusive copyright license may use third‐party assistance in exercising its license rights unless the license expressly provides otherwise.ʺ

10.5.9 Future to-be-owned IP rights are transferred now

a.  This section applies if, under the Contract:

  • an individual or organization (the "Owner") is to be the owner of specified intellectual property that will be or might be created in the future;
  • but by law the specified IP is or might be owned by another individual or organization ("ABC"),
  • as opposed to being automatically owned by the Owner upon creation,
  • as in the case of a "work made for hire" under copyright law.

b.  For any case described in subdivision a, ABC hereby assigns all right, title, and interest in all such specified IP to the Owner;

  • but if, by law, any moral rights or other intellectual property rights in the specified IP cannot be assigned to the Owner,
  • then ABC hereby grants to the Owner a perpetual, irrevocable, worldwide, royalty-free, fully transferable license,
  • under all such non-assignable rights.
Commentary

The present assignment of future rights made a huge difference to Stanford University, which found, presumably to its dismay, that it did not own the entirety of a significant biotech invention by its researchers:

  • One of the researchers spent some time at a company, Roche, to obtain technical training;
  • The researcher signed a "visitor NDA" with Roche;
  • Roche's visitor NDA contained "hereby assigns" language, under which the researcher made a {}/present/ assignment of any rights in future inventions that he helped to invent using what he had learned at Roche;
  • In contrast, the researcher's already-existing agreement with Stanford stated that the researcher would assign his rights in future inventions.

The Federal Circuit held that the Roche agreement's present-assignment language took precedence over the Stanford agreement's future-assignment provision, even though Stanford and the researcher had entered into the latter agreement before the researcher entered into the Roche agreement.

Subdivision b – license under moral rights: This is an anchor-to-windward provision. See generally the Wikipedia entry on moral rights.

10.5.10 Who must make arrangements with parties' employees, etc.?

a.  This section applies as to any particular IP that, under the Contract, is to be owned by an Owner (as defined in Clause 10.5.9).

b.  Each other party must ensure that its relevant employees,

  • and its subcontractors (if any),
  • have signed (and, if applicable, notarized) written agreements,
  • sufficient to enable that other party to comply with any obligations that the other party has under this Rule.

c.  In case of doubt: This section in itself neither authorizes nor prohibits the use of subcontractors by any party.

Commentary
Employee agreements

A customer might not need for a supplier's employees to be bound by written agreements to cause the employee's work product to be owned by the customer (at least under U.S. law).

Contractor agreements

On the other hand a subcontractor of a contractor likely would indeed need to sign such an agreement in order to transfer ownership to the contractor's customer; the customer might be able to claim an implied license to use and further-develop the deliverable — but the associated litigation would likely be an expensive headache.

10.5.11 What documents must a party sign if required to "assign" IP?

a.  When a party (a "former owner") is required to "assign" intellectual property in or under the Contract to another party (the "new owner"):

  • the former owner must permanently and irrevocably transfer all ownership of the IP,
  • in writing — see also the documentation requirements in subdivision c —
  • to the new owner and the new owner's successors and assigns.

b.  The written transfer of ownership must encompass, as applicable to the type of IP in question:

  1. any and all patent applications for any portion of the specified IP, no matter when filed —
    • this includes, without limitation, all original, continuation, continuation-in-part, divisional, reissue, foreign-counterpart, or other patent applications;
  2. any and all patents issuing on each patent application described in subdivision b.1;
  3. the right to claim priority in, to, or from any patent application described in subdivision a or any patent described in subdivision b.2;
  4. any and all registrations for, and any and all applications to register, the copyright or trademark rights (if any) in the specified IP;
  5. any other intellectual property rights, of whatever nature, in the specified IP,
    • together with any applications for, or issued registrations for, the same; and
  6. the right to recover, and to bring proceedings to recover, damages and any other monetary awards,
    • and/or to obtain other remedies,
    • in respect of infringement or misappropriation of any item listed in any of subdivisions b.1 through b.5,
    • whether the infringement or misappropriation was committed before or after the date of the transfer of ownership.

c.  Whenever reasonably requested by the new- or existing owner from time to time,

  • the former owner is to cause documents to be signed and delivered to the new owner
  • to establish and/or confirm the new owner's rights in the specified IP.
  • Such documents might include, without limitation: patent applications; copyright- or trademark registration applications; and assignment documents.

d.  The new owner's determinations as to what types of document are appropriate for purposes of this section are final,

  • unless the former owner shows that the new owner's determination is manifestly not commercially reasonable.

e.  As between the former owner and the new owner,

  • the new owner must pay for preparing and filing any such documents,
  • unless otherwise agreed in writing.

f.  In case of doubt: The former owner will not be entitled to additional compensation

  • for doing the things required by this Clause 10.5.11,
  • over and above any compensation clearly stated in the Contract.
Commentary

Subdivision c: The "cause documents to be signed" language recognizes that a corporate party might have to cause its employee inventors and authors to sign individual assignments of rights.

10.5.12 Additional commentary

10.5.12.1 Background: Patent ownership

In the United States, the general rules about patent ownership can be summarized as follows:

• Inventors initially own the legal rights (if any) to their inventions.

Joint inventors ("co-inventors") of an invention jointly own the invention.

• Transfers of patent ownership (or exclusive licenses) generally must be in writing.

• An employee who was "hired to invent" or "set to experimenting" will usually be considered to have an implied obligation to assign the invention rights to the employer.

In a Nebraska federal case, a company was found not to have set its former employees to experimenting, and therefore the company did not own the rights in a new product that the former employees developed at a startup company that they founded:

To prevail on its hired-to-invent theory based on an implied contract, FEI must show that the employees were given a certain amount of specific direction from their employer.

When an employee is hired to devote his efforts to a particular problem, to conduct experiments for a specifically assigned purpose, and an invention results from the results of that work, it belongs to the employer.

The primary factor courts consider in determining whether an employed to invent agreement exists is the specificity of the task assigned to the employee.

FEI has not pointed to evidence in the record that Nuss, Gerlock, and Tatge received an assignment on this occasion to invent. And FEI has not shown there was a meeting of the minds sufficient to form an implied contract.

Teets, on which FEI relies, is inapposite. There, Teets was “specifically directed” to develop a particular product. The court concluded that, having directed Teets to that task, compensated him for his efforts, paid for the refinement of the process, and paid for the patent protection, the employer owns the patent rights in the product.

FEI has not shown that any of the individual defendants was similarly “specifically directed” during their product-development process, so no implied contracts were created under the hired-to-invent doctrine.

10.5.12.2 Background: Copyright ownership

In the United States, the general rules about copyright ownership can be summarized as follows:

• The "author" of a copyrighted work initially owns the copyright; joint authors likewise co-own their jointly created work.

• For copyright purposes, an employer is considered the "author" of a copyrighted work if the work is created by an employee who is working within the "scope of employment."

When a party engages a nonemployee to create a work, the hiring party will be considered the author if:

1. the work is "specially ordered or commissioned" for use as:

  • a contribution to a collective work;
  • a part of a motion picture or other audiovisual wor
  • a translation;
  • a supplementary work;
  • a compilation;
  • an instructional text
  • a test
  • answer material for a test; or
  • an atlas; and

2. the work is a commissioned work that falls into one of nine specific statutory categories, AND the actual author(s) and the commissioning party agree, in a written agreement — which must be signed before the work is created — that the work will be a work made for hire.

• Transfers of copyright ownership (including transfers of the individual exclusive rights that, together, comprise a copyright) must be in writing.

But even a simple writing for ownership transfer will suffice, as the Ninth Circuit noted:

Section 204's writing requirement [17 U.S.C. § 204] is not unduly burdensome; it necessitates neither protracted negotiations nor substantial expense.

The rule is really quite simple: If the copyright holder agrees to transfer ownership to another party, that party must get the copyright holder to sign a piece of paper saying so.

It doesn't have to be the Magna Charta; a one-line pro forma statement will do.

10.5.12.3 Caution: Some state laws might limit employers' ownership

A California statute says that:

2870. (a) Any provision in an employment agreement

  • which provides that an employee shall assign, or offer to assign,
    • any of his or her rights in an invention to his or her employer
  • shall not apply to an invention that the employee developed
    • entirely on his or her own time
    • without using the employer’s equipment, supplies, facilities, or trade secret information
  • except for those inventions that either:
    • (1) Relate
      • at the time of conception or reduction to practice of the invention
      • to the employer’s business,
      • or actual or demonstrably anticipated research or development of the employer;
    • or (2) Result from any work performed by the employee for the employer.

(b) To the extent a provision in an employment agreement

  • purports to require an employee to assign
  • an invention otherwise excluded from being required to be assigned under subdivision (a),
  • the provision is against the public policy of this state and is unenforceable.

2871. No employer shall require a provision made void and unenforceable by Section 2870 as a condition of employment or continued employment.

  • Nothing in this article shall be construed
  • to forbid or restrict the right of an employer
  • to provide in contracts of employment for disclosure,
    • provided that any such disclosures be received in confidence,
  • of all of the employee’s inventions made solely or jointly with others during the term of his or her employment,
  • a review process by the employer to determine such issues as may arise,
  • and for full title to certain patents and inventions to be in the United States,
    • as required by contracts between the employer and the United States or any of its agencies.

2872. If an employment agreement entered into after January 1, 1980, contains a provision requiring the employee to assign or offer to assign any of his or her rights in any invention to his or her employer,

  • the employer must also, at the time the agreement is made,
  • provide a written notification to the employee that the agreement does not apply to an invention which qualifies fully under the provisions of Section 2870.

In any suit or action arising thereunder, the burden of proof shall be on the employee claiming the benefits of its provisions.

Some other states have similar laws; the following list might be out of date:

10.6 Challenges to IP Rights

Commentary

This Procedure draws on ideas found in the trademark license agreement form of The University of Texas at Austin (the present author's alma mater), at https://tinyurl.com/UTTrademarkLicense, discussed in more detail in the introductory commentary to Clause 10.7 (Trademark Use).

10.6.1 What types of "Challenge" are covered by this Procedure?

a.  This Procedure will apply if a third party engages in any of the following activities — each, a "Challenge" — in respect of one or more intellectual-property rights (as defined in Clause 10.3) (each, an "Owner IP Right"), that are owned or otherwise assertable by a party ("Owner"):

  1. the third party putatively infringes the Owner IP Right; and/or
  2. the third party disputes,
    • in any judicial, administrative, or other forum, anywhere in the world,
    • the validity and/or enforceability of the Owner IP Right.

b.  The term "Challenge" in subdivision a includes, without limitation, the filing and/or maintaining, by the third party, of one or more of the following actions, in any forum anywhere in the world:

  1. a pre-grant opposition to an application for the Owner IP Right —
    • for example, an opposition to an application for a patent or for a trademark registration;
  2. an affirmative defense or counterclaim of invalidity or unenforceability of the Owner IP Right;
  3. a petition for an inter partes review of a patent, and/or
  4. a petition to cancel a trademark- or copyright registration.

10.6.2 What must other parties do in the Challenge?

If any Challenge to Owner's IP Rights comes to the attention of a specified other party to the Contract ("Other Party"), then Other Party must:

  1. promptly so advise Owner in writing;
  2. provide Owner (and Owner's counsel) with reasonable information and cooperation concerning the Challenge,
    • on an ongoing basis; and
  3. not take any action concerning the Challenge without first getting Owner's written approval.

10.6.3 Who will make decisions in the Challenge?

It will be entirely up to Owner,

  • in Owner's sole discretion (as defined in Clause 22.17),
  • to decide what action(s) to take, if any,
  • to investigate and deal with the Challenge to Owner's IP Rights,
  • except to the extent, if any, that the Contract provides otherwise.

10.6.4 Do any confidentiality rules apply?

Yes: In any Challenge to Owner's IP Rights,

  • one or both of Owner and Other Party may designate information in its posssession as Confidential Information,
  • in which case Clause 6.3 (Confidential Information Protocol) will govern.

10.6.5 Who will pay costs of the Challenge?

a.  As between Owner and Other Party, Owner will bear all costs (in the sense of court costs only)

  • of any judicial, arbitration, or administrative proceeding,
  • at any level (e.g., trial or appeal),
  • in which the Challenge to Owner's IP Rights is to be decided.

b.  Other Party is not obligated to fund or reimburse any Owner expense in respect of the Challenge

  • unless the Contract clearly says otherwise.

10.6.6 Who will be entitled to any monetary recoveries?

As between Owner and Other Party, Owner will be entitled to any monetary awards,

  • for example (as defined in Clause 22.21), damages, profits, costs, and/or attorney fees,
  • made against a third party in any proceeding concerning the Challenge to Owner's IP Rights.

10.7 Trademark Use

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • a specified party ("User")
  • is authorized to use one or more specified trademarks, service marks, trade names, designs, and/or trade dress ("Marks")
  • of another party ("Owner");
  • this User authorization is referred to as the "Trademark License."

Discussion checklist:

Commentary

This Protocol draws on ideas found in the trademark license agreement form of The University of Texas at Austin (the present author's alma mater), at https://tinyurl.com/UTTrademarkLicense. For many years "The University," as it's known in Texas, has been one of the most successful collegiate brand merchandisers; for example: "Texas football took in $32 million in royalties, licensing and sponsorships during the 2017-18 athletic year, according to the most recent audited data."

10.7.1 Schedule: What are the business details?

The following terms will apply in the Contract if not clearly agreed otherwise in writing; in the Contract, the parties should specify any desired changes:

1. Licensed Marks?
Only those specifically listed or described in the Contract.
2. Territory of Trademark License?
[The city in which User's initial address for notice is located].
Other: [Describe in detail in the Contract].
3. Trademark License Term?
The term of the Contract.
Other: [Describe in detail in the Contract].
4. Licensed Items?
Only those goods and/or services specifed in the Contract.
5. Has Owner promulgated detailed specifications for Licensed Items?
No.
Other: [Describe in detail in the Contract].
6. Has Owner promulgated detailed usage requirements for Licensed Marks?
No.
Other: [Describe in detail in the Contract].
7. Exclusivity of Trademark License?
None.
Other: [Describe in detail in the Contract]. (See also Clause 22.22 (Exclusivity Definition).)
8. Is Owner approval of specific proposed uses required?
No.
Other: [Describe in detail in the Contract]. (See § 10.7.10.)
9. Will approval of specific uses be deemed granted after X days (absent objection)?
No.
Yes, after [ten business days], per § 10.7.10.
10. Are sublicenses authorized?
No.
Other: [Describe in detail in the Contract].

10.7.2 The Trademark License is granted by the Contract

a.  When Owner and User enter into the Contract, Owner, by doing so, grants User the Trademark License.

b.  The Contract does not grant User any other right, title, or interest in any Licensed Mark unless the Contract expressly says so.

10.7.3 What specifications must Licensed Item(s) meet?

If the Contract sets out (or references) specifications for Licensed Items, then all Licensed Items must conform to those specifications.

10.7.4 In what style(s) may Licensed Mark(s) be used?

User will comply with any specific style requirements for use of the Licensed Mark(s) set forth in the Contract —

  • for example, color schemes, fonts, etc. —

or if none, then User will use the Licensed Mark(s) only in styles conforming to both:

  • (i) Owner's then-current use of the Licensed Mark(s), and
  • (ii) generally-accepted good commercial practice.

10.7.5 What marking of Licensed Marks is required?

Whenever displaying or otherwise using any Licensed Mark, User must include any notice or marking required by applicable trademark law or otherwise specified by Owner,

for example, the "®" (r-in-a-circle) symbol for registered marks

or the "TM" or "SM" symbol for unregistered trademarks and service marks, respectively.

10.7.6 What usage specimens must User provide to Owner?

If Owner so requests in writing from time to time,

  • User will provide Owner, at no charge,
  • with representative specimens of Licensed Items
  • and of any other uses of Licensed Marks by User.

10.7.7 May Owner inspect User's usage?

Owner may, from time to time, inspect User's use or display of the Licensed Marks to check for compliance with this Protocol;

  • Clause 3.3 (Inspections Protocol) will apply to any such inspections.

10.7.8 What if Owner modifies a Licensed Mark?

Owner may, from time to time, modify any Licensed Mark;

  • if Owner does so and advises User in writing of the modification,
  • then User must begin using the modified Licensed Mark,
    • in lieu of the previous form,
    • as soon as practicable afterwards.

10.7.9 Option: No Other Marks Allowed

If this Option is agreed to,

  • then User may not use any Mark on Licensed Items other than:
    • the Licensed Mark(s);
    • User's own legal name; and/or
    • User's genuine trade name.

10.7.10 When must User obtain Owner approvals?

a.  This section applies only if and to the extent so specified in the Contract (if any; see § 10.7.1).

b.  User must not use any Licensed Mark, in advertising materials or otherwise, without Owner's specific approval of the proposed use.

c.  Owner will be deemed to have approved a proposed specific use of a Licensed Mark if Owner has not advised User, in writing, of Owner's disapproval on or before the end of the time period specified in the Contract.

Commentary

For a detailed approval requirement, see page 2 of The University of Texas System's trademark license form at https://tinyurl.com/UTTrademarkLicense, which states:

Licensee must obtain prior approval from Trademark Director for the use of Marks

(i) on any products,

(ii) for any services,

(iii) in any form of advertising or other promotion, and

(iv) in any advertising or promotional copy or graphics to be used by Licensee in any media,

including a public address announcement or other audio or video broadcast.

Trademark Director’s approval will not be unreasonably withheld, conditioned or delayed;

provided, however [ugh …], Trademark Director will have the right, in his or her sole discretion, to decline to approve any use of Marks on any products, for any service, or in copy or graphics that

(i) violates any applicable Law, any applicable Athletic Organization Rules, or University Rules; or

(ii) Trademark Director or other designated University Representative considers to be misleading or offensive.

(Extra paragraphing added.)

And at page 4:

In accordance with Section 3.2, Licensee will send to Board for its prior written approval the text and layout of all proposed advertisements and marketing and promotional material relating to or using the Marks,

which approval may be given or withheld in Board's sole discretion.

In the event that Board disapproves, Board will give written notice of its disapproval to Licensee within 14 days after receipt by Board of the material.

In the absence of a written notice of disapproval within 14 days after receipt of the materials, the materials will be deemed to have been disapproved by Board.

Licensee will not use any Mark in any advertising, marketing or promotion if the use has not been approved by Board.

(Extra paragraphing added.)

10.7.11 What if a third party challenges the Licensed Marks?

Clause 10.6 (Challenges to IP Rights) will govern any situation in which a third party:

  1. might be infringing a Licensed Mark; and/or
  2. challenges the validity or enforceability of Owner's rights in any Licensed Mark.

10.7.12 Owner [does not] warrant anything about the Licensed Marks

Unless the Contract clearly and unmistakably says otherwise: Owner DISCLAIMS any representation, warranty, condition, or term of quality, to the effect:—

  1. that any Licensed Mark is legally protectable against use by others; or
  2. that User's use of the Licensed Mark(s) under the Contract will not infringe the rights of one or more third parties.

10.7.13 [User] is responsible for its business liabilities.

User must defend (as defined in Clause 14.5) Owner's Protected Group (as defined in Clause 22.38) against any third-party claim arising out of or relating to:

  1. User's business, including but not limited to any third-party claim of (i) product liability for Licensed Items and (ii) infringement of third-party intellectual property rights by Licensed Items; and
  2. any breach of the Contract by User.

10.7.14 All use by User will establish [Owner's] rights

Any use of a Licensed Mark by User will count as establishing ownership of that Licensed Mark by Owner, not by User.

(In legalese: All use of any Licensed Mark by User will inure exclusively to the benefit of Owner.)

10.7.15 Owner [may] require User to seek in-Territory registrations

If Owner so requests in writing, User will take any steps that Owner reasonably considers necessary to:—

  1. register any Licensed Mark in the Territory,
    • at Owner's expense;
  2. maintain or renew any registration of a Licensed Mark in the Territory,
    • at Owner's expense; and/or
  3. prepare and file any registered-user registration required by applicable law for User's use of Licensed Mark(s) in the Territory,
    • at User's expense;

10.7.16 User [assigns to Owner] any Licensed-Mark legal rights

a.  This section applies in any jurisdiction where, by law, User acquires or otherwise owns any rights or other interest in a Licensed Mark.

b.  User hereby assigns all such rights to Owner,

  • together with all associated goodwill, registrations, applications for registration, and rights to sue for infringement — if any —
  • without any further action by either User or Owner.

c.  User will comply with the ownership-transfer and -confirmation provisions of Clause 10.5 (IP Creation Ownership).

Commentary

For the reasoning behind using the term "hereby assigns," see Clause 10.5.9 and its commentary.

10.7.17 User [may not] do certain things concerning the Licensed Marks

a.  Without limiting User's other obligations under this Protocol, User must not, anywhere, without Owner's discretionary consent (as defined in Clause 22.17):—

  1. assert that User owns any right in any Licensed Mark not expressly stated in the Contract;
  2. challenge Owner's rights in any Licensed Mark;
  3. challenge the legal protectability of any Licensed Mark;
  4. challenge the validity of any registration or application for registration, owned or approved by Owner, for any Licensed Mark;
  5. use any Licensed Mark, or any confusingly similar variation, in User's corporate name or trade name;
  6. apply for registration or recordation of (i) any Licensed Mark, or (ii) the Trademark License;
  7. apply for registration of any Mark confusingly similar to any Licensed Mark;
  8. attempt to register any Web address (URL) that:
    • (i) contains any Licensed Mark or any distinguishing feature of a Licensed Mark, or
    • (ii) is confusingly similar to any Licensed Mark;
  9. purport to grant,
    • or to record or otherwise perfect,
    • a security interest (or comparable lien-type interest) in,
    • or to otherwise encumber,
    • (i) any Licensed Mark;
    • (ii) the Trademark License; or
    • (iii) any registration or application for registration, anywhere, relating to any Licensed Mark;
  10. take any action that could invalidate or jeopardize any registration or application for registration of any Licensed Mark; or
  11. assign the Trademark License.

b.  Owner may terminate the Trademark License — without opportunity to cure — if User takes any of the actions prohibited by subdivision a; any such termination —

  1. will be in Owner's sole discretion (as defined in Clause 22.17), and
  2. will be effective immediately upon notice (see § 20.6).

10.7.18 What steps must User take to protect Owner's goodwill?

a.  User must not use any Licensed Mark in any manner that:—

  1. is misleading or otherwise deceptive;
  2. would, in Owner's sole judgment, be offensive to a relevant segment of the population; or
  3. could otherwise diminish the reputation of Owner, its Marks, or its goods and/or services;

b.  User must not use any Licensed Mark on,

  • or in promoting,
  • Licensed Items that do not meet standards stated or referred to in the Contract.

c.  User must stop any particular use of a Licensed Mark immediately upon notice (as defined in Clause 20.6) from Owner that Owner objects to that particular use.

Commentary

Subdivision b: Under trademark law, it's important for any Mark owner to maintain control over use of the Mark; this subdivision

10.7.19 What are some other rules that User must follow?

10.7.19.1 Owner consent is required for the activities listed here

User must not do any of the things prohibited in this section without Owner's express prior written discretionary consent (as defined in Clause 22.17).

10.7.19.2 User must respect Territory boundaries

User must not:—

  1. use any Licensed Mark, or any confusingly similar variation, in advertising or promotion outside the Territory;
  2. use any Licensed Mark in actively promoting Licensed Items outside the Territory;
  3. establish or maintain facilities specifically for supporting customers' use of Licensed Items bearing any Licensed Mark if such use is reasonably likely to occur outside the Territory; or
  4. establish or maintain facilities outside the Territory for distributing Licensed Items bearing any Licensed Mark.
10.7.19.3 User must not jeopardize the Licensed Marks' economic value

User must not:—

  1. use a Licensed Mark to mark and promote any goods or services other than Licensed Items;
  2. modify any Licensed Mark;
  3. include any Licensed Mark,
    • or any distinguishing feature of a Licensed Mark,
    • as a feature or design element of another Mark; nor
  4. use any Licensed Mark in any manner except as authorized by the Contract.
10.7.19.4 User must not help others to do prohibited things

User must not permit, encourage, or knowingly help, any other individual or organization to take any of the actions prohibited by this section.

10.7.20 What steps must User take after termination?

This section applies if the Trademark License expires or is otherwise terminated in any manner.

10.7.20.1 User must cease all use of Licensed Marks

User must immediately stop all use of the Licensed Mark(s),

  • other than use that would not violate applicable trademark law in the absence of a license,
  • for example, so-called nominative use.
10.7.20.2 User must transfer all related Web address(es) to Owner

a.  User must immediately transfer to Owner the ownership of any Web address, i.e., of any Internet domain name —

  • that contains any Licensed Mark,
  • or that is confusingly similar to any Licensed Mark.

b.  This section does not authorize User to register any such Web address;

10.7.20.3 Delivery of tangible Licensed Items could be required

a.  This section applies only if the Contract clearly so states.

b.  User, at its own expense, must immediately deliver to Owner all tangible Licensed Items bearing any Licensed Mark.

c.  Alternatively, User may remove all Licensed Mark(s) from such Licensed Items and certify the same in writing to Owner.

d.  Alternatively: User must, instead, promptly —

  • destroy all Licensed Items bearing any Licensed Mark,
  • and certify the same in writing to Owner,
  • if Owner so requests by notice (as defined in Clause 20.6) to User.

10.7.21 Option: User must destroy improper specimens

a.  If this Option is agreed to, it applies:

  • if, by notice (as defined in Clause 20.6) to User,
  • at any time,
  • Owner objects to one or more particular uses of a Licensed Mark by User
  • as violating any of the prohibitions of Clause 10.7.18.

b.  In any such situation,

  • User must, at its own expense,
  • deliver to Owner,
    • or, at Owner's option, destroy,
  • all tangible embodiments
  • of the uses of the Licensed Mark to which Owner objects.

11 Privacy

Privacy laws are increasingly important in the modern business world. A discussion of privacy law is far beyond the scope of this book; this chapter's goals are simply:

  • to alert the reader to the subject's importance; and
  • to provide some standard clause language that could be adapted for use in contracts.

Contents:

11.1 Key takeaways

When a company ("Collector") collects personal information of an individual, applicable privacy laws might require Collector to do some or all of the following:

  1. disclose to the individual:
    • what types of information Collector collects;
    • what Collector might do with the information;
    • how long Collector might keep the information;
    • whether Collector will sell the information to others;
  2. take reasonable security measures to protect the information;
  3. alert the individual in cases of security breach (actual or, sometimes, potential)
  4. report security breaches to government authorities;
  5. purge the information upon request (the "right to be forgotten")

Students: You're expected to know that privacy law is most definitely "a thing" — and in many jurisdictions (especially California and Europe) a thing with big, sharp teeth.

For a(n incomplete) list of privacy laws, see Clause 11.2.

Optional reading:

11.2 Privacy Law Definition

a.  "Privacy Law" refers to any applicable law concerning the privacy, security, or processing of personal information,

  • including without limitation the law in jurisdictions where personal information was collected.

b.  Privacy Laws include, without limitation, the following:

  • the California Consumer Privacy Act of 2018 ("CCPA");
  • the Children’s Online Privacy Protection Act ("COPPA");
  • the Computer Fraud and Abuse Act ("CFAA");
  • the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 ("CAN-SPAM Act");
  • the Electronic Communications Privacy Act;
  • the European General Data Protection Regulation ("GDPR");
  • the Fair Credit Reporting Act ("FCRA");
  • the Fair and Accurate Credit Transaction Act ("FACTA");
  • the Family Educational Rights and Privacy Act ("FERPA");
  • the Federal Trade Commission Act;
  • the Gramm-Leach-Bliley Act ("GLBA");
  • the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), as amended and supplemented by the Health Information Technology for Economic and Clinical Health Act ("HITECH Act") of the American Recovery and Reinvestment Act of 2009;
  • the Telemarketing and Consumer Fraud and Abuse Prevention Act (TCFAP") ;
  • the Telephone Consumer Protection Act ("TCPA").
Commentary

This list is adapted from an underwriting agreement filed with the SEC effective Aug. 5, 2020, with a Form 8-K report by a company named "1847 Goedeker Inc."

11.3 Data Privacy Customer Commitment

When this Commitment is adopted in an agreement (the "Contract"), it applies if and when a party ("Customer") manages personal data of one or more individuals,

  • using goods, services, or technology furnished,
  • directly or indirectly,
  • by another party ("Provider").

11.3.1 Customer must have authorization to manage personal data

Customer warrants (as defined in Clause 2.4),

  • to Provider's Protected Group (as defined in Clause 22.38),
  • that Customer has been authorized by each such individual to manage that individual's personal data,
  • to the extent required by applicable law.

11.3.2 Customer must comply with privacy laws

Customer must comply at all times with all applicable Privacy Laws (as defined in Clause 11.2).

11.3.3 Customer might have to do "external" privacy paperwork

Customer acknowledges that applicable Privacy Law (as defined in Clause 11.2) might require, for example,

  • that Customer register as a data controller with a local privacy data office,
  • and/or to pay a fee.
Commentary

The EU's General Data Protection Regulation (GDPR) no longer requires "data controllers" to register, but national laws might still impose such requirements.

11.4 Data Use Authorization

a.  When this Authorization is adopted in an agreement (the "Contract"), it applies if and when a party ("Customer"),

  • directly or indirectly,
  • discloses personal data of one or more individuals,
  • to another party ("Provider"),
  • whether or not any such individual is employed by Customer,
    • or is a customer or client of Customer.

b.  Customer agrees that Provider may collect, store, and use such personal data

  • as stated in Provider's privacy policy.
Commentary

Caution: Data-privacy law is a big, important topic; see the commentary at § 11.

11.5 Protected Health Information Protocol

When this Protocol is adopted in an agreement (the "Contract"), it applies if and when, under the Contract, a specified party ("Provider") is to be given access to protected health information ("PHI") by another party ("Customer").

Commentary

For speedier legal review (and acceptance), this Protocol is based closely on the sample business associates agreement published by the Department of Health and Human Services on January 25, 2013, at http://goo.gl/0OYWs, which is a shortened link for a page at www.hhs.gov. Some language of the HHS sample agreement has been rephrased for easier reading.

Google's HIPAA Business Associate Addendum seems to be similarly based, with a few variations: https://admin.google.com/terms/cloud_identity/3/7/en/hipaa_baa.html.

11.5.1 Catch-all definitions from HIPAA Rules

The following terms used in this Protocol have the same meanings as stated in the HIPAA Rules (defined below):—

In addition:

11.5.2 What must Provider not do with PHI?

Provider must not use or disclose protected health information,

  • other than as permitted or required by the Contract,
  • or as required by law.

11.5.3 What PHI safeguards must Provider take?

Provider must use appropriate safeguards,

  • and comply with Subpart C of 45 CFR Part 164 (with respect to electronic protected health information),
  • to prevent use or disclosure of protected health information other than as provided for by the Contract.

11.5.4 What reports must Provider make to Customer?

Provider must report to Customer, as required at 45 CFR § 164.410,

  • any use or disclosure of protected health information not provided for by the Contract of which Provider becomes aware,
  • including but not limited to breaches of unsecured protected health information,
  • and any security incident of which Provider becomes aware.

11.5.5 What must Provider have its PHI subcontractors do?

Provider must ensure,

  • that any subcontractors that create, receive, maintain, or transmit protected health information on behalf of Provider
  • have agreed to the same restrictions, conditions, and requirements that apply to Provider with respect to such information.

11.5.6 What PHI must Provider make available to Customer?

Provider must make protected health information available to Customer,

11.5.7 What if PHI must be revised?

a.  Provider must:

  • make any amendment(s) to protected health information in a designated record set
  • or take other measures as necessary to satisfy Customer's obligations under 45 CFR § 164.526.

b.  Provider may, at its option, make such amendment(s) or take such other action—

  • by storing an updated copy of the specific record(s) containing the information being amended;
  • Provider need not attempt to edit or otherwise update any individual record previously uploaded to Provider's file system by Customer.

11.5.8 What are Provider's PHI recordkeeping obligations?

a.  Provider must maintain,

  • and make available to Customer,
  • the information required to provide an accounting of disclosures
  • as necessary to satisfy Customer's obligations under 45 CFR § 164.528.

b.  Provider must comply with the requirements of Subpart E of 45 CFR Part 164 that apply to Customer,

  • to the extent that Provider is to carry out one or more of Customer's obligation(s) under that subpart.

c.  Provider must make its internal practices, books, and records available to the Secretary

  • for purposes of determining compliance with the HIPAA Rules.

11.5.9 How may Provider use or disclose PHI?

a.  Provider may disclose protected health information to persons whom Customer has authorized to access Customer's records stored in Provider's file servers.

b.  Provider may use or disclose protected health information as required by law.

c.  Provider may not use or disclose protected health information

  • in any manner that would violate Subpart E of 45 CFR Part 164 if done by Customer as a covered entity,
  • except for the specific uses and disclosures set forth below.

d.  Provider may use protected health information:

  1. for the proper management and administration of Provider,
  2. or to carry out the legal responsibilities of Provider.

e.  Provider may disclose protected health information:

  • for the proper management and administration of Provider
  • or to carry out the legal responsibilities of Provider,
  • if all of the following are true:
    • 1. the disclosures are required by law; or
    • 2. Provider obtains reasonable assurances, from the person to whom the information is disclosed,that:
      • A) the information will remain confidential and be used or further disclosed:
        • only as required by law,
        • or for the purposes for which it was disclosed to the person;
      • and
      • B) the person must notify Provider of any instances of which the person is aware in which the confidentiality of the information has been breached.

11.5.10 To whom must Provider make PHI available?

Provider must allow access to protected health information

  • contained in Customer's files that are maintained on Provider's file-server system,
  • to any person who logs in using login credentials that Customer provided, established, or approved.

11.5.11 How must Provider respond to government PHI requests?

a.  Provider must promptly notify Customer

  • of any demand by a governmental entity for disclosure of personal health information,
  • to the extent not prohibited by law or otherwise requested by law enforcement.

b.  Provider must provide reasonable cooperation with Customer in any attempt by Customer to contest or limit such disclosure.

11.5.12 What is the Term of the parties' business associate agreement?

The Term of the parties business associate agreement is that of the Contract.

11.5.13 When may Customer terminate for cause?

Provider authorizes termination of the business associate agreement by Customer if Customer determines that Provider:

  • has violated a material term of this Protocol, and
  • has not promptly cured the breach or ended the violation.

11.5.14 What must Provider do upon termination?

Provider's obligations under the parties' business associate agreement,

  • to safeguard protected health information that was:—
    • received from Customer,
    • or created, maintained, or received by Provider on behalf of Customer,
  • will survive any termination or expiration of the business associate agreement.

11.6 Privacy law: Review questions

QUESTION 1: What is the U.S. federal statute that governs the use and disclosure of personal health information by "covered entities" and their "business associates"? [6]

QUESTION 2: What is the U.S. federal statute that requires financial-type institutions to explain to consumers how they collect, use, and disclose customer information? [7]

QUESTION 3: Name three jurisdictions that have significant privacy laws — other than U.S. federal law — that could drastically affect businesses that operate in those jurisdictions. [8]

12 Termination of a contract

12.1 Do you really want to terminate the contract?

Drafters should think about whether termination of the Contract is what they have in mind. People routinely refer to termination of a contract, but what they really might mean (and sometimes should mean) is the termination of specific rights and obligations under the contract.

12.2 Is a termination-for-breach clause necessary?

Termination for material breach might be available as a matter of law — but not for nonmaterial breach.

A Texas appeals court explained how a material breach — but not a nonmaterial breach — will excuse future performance by the other party; the court also explained what constitutes a "material" breach (which is also discussed in Clause 22.31.2 and its commentary):

A material breach by one party to a contract can excuse the other party from any obligation to perform in the future.

A material breach is conduct that deprives the injured party of the benefit that it reasonably could have anticipated from the breaching party's full performance.

By contrast, when a party commits a nonmaterial breach, the other party is not excused from future performance, but may sue for the damages caused by the breach.

Be careful about terminating a contract because of the other side's supposedly-"incurable" breach — because a court might later say that the breach wasn't incurable after all, and thus you breached the contract by terminating.

12.3 A termination right should not refer to "the non-breaching party"

If a contract authorizes a party to terminate because of the other party's breach, the authorization should refer to that party as "the terminating party" or "the other party," not as "the non-breaching party." That's because in one case:

  • The contract's termination-for-breach provision referred to the right of the non-breaching party to terminate.
  • That, said the court, meant that the party that had purported to terminate the contract did not have the power to do so — because that party was itself in breach, of a different contract provision.

12.4 Notice of termination should be clear

A notice of termination should be clear that it is a termination notice. Neither the terminating party nor the non-terminating party will want to have to litigate whether a particular communication qualified as a termination notice. That was the unfortunate result in a First Circuit case, where:

  • a drywalling company had a collective bargaining agreement ("CBA") with a carpenter's union;
  • the CBA gave the union's right to audit the company's contributions to various pension funds, etc.;
  • the company sent the union a letter stating that the company was no longer doing any union work;
  • the union asked for a final audit of the company's contributions, but the company refused;
  • the union sued the company to get the final audit — but the court found that the company's letter had the effect of terminating the CBA, and that the union's audit right died with the CBA.

The unfortunate part is that the company and the union had to litigate the issue; they might not have had to incur quite as much expense and inconvenience if the company's letter had been more explicit that the company was terminating the CBA.

12.5 Caution: Don't do an own-goal termination

Improper termination of a contract for breach could itself be an "own goal" breach of contract.

Imagine this:

  • You want to get out of a contract.
  • You conclude that the other side has materially breached the contract.
  • You send a notice of breach, but the other side fails to cure the breach.
  • So, you send a notice of termination.
  • But then a court holds that the other party's breach wasn't "material."
  • As a result, you didn't have the right to terminate — and so your termination was a repudiation, and thus a breach in itself.

This was the result in an Arkansas case, where a party that terminated a contract was held liable for millions of dollars in damages for doing so:

American Castings, LLC (American), terminated an exclusive sales contract with Southland Metals, Inc. (Southland), after Southland allegedly committed an incurable breach.

Southland sued American, claiming American failed to comply with the termination procedure set out in the contract by not providing it with proper notice and an opportunity to cure.

A jury found American breached the contract and awarded Southland approximately $3.8 million in damages.

Much the same thing happened in the Hess case, discussed at § 24.6.1: Hess terminated a contract for breach, but the court held that the breach wasn't a material breach — and, the court said, this assumed that the other party's actions were a breach at all — and so the alleged breach didn't justify Hess's termination.

And in still another case, in Houston: A geothermal HVAC contractor breached a contract with a homeowner, whereupon the homeowner stopped paying the contractor. A jury found that both parties had thereby breached. But: the contractor's prior breach didn't excuse the homeowner's failure to pay, because —

  • at trial, the homeowner's lawyer failed to ask for a specific finding by the jury that the contractor's breach was material;
  • the appeals court held that the evidence did not conclusively establish the materiality of the contractor's breach;
  • consequently, the homeowner was still on the hook to pay the contractor, despite the contractor's prior breach.

The appeals court reversed and rendered judgment to restore the jury's verdict — and ordering the homeowner to pay the contractor's attorney fees as required by the contract.

12.6 What post-termination obligations are appropriate?

In planning for an orderly shutdown, a contract drafter should consider what actions the drafter's client might want to require the other party to take.

Such post-termination actions could include, for example, the following:

  • final deliveries of:
    • goods;
    • intangibles, e.g., reports;
    • work in progress;
  • issuance of final invoices;
  • payment of outstanding amounts;
  • return of confidential information, if applicable (see Clause 6.3.19);
  • continuing confidentiality obligations (see Clause 6.3.20);
  • preparation and signing of intellectual-property assignment documents (see Clause 10.5);
  • a provider's obligation to help a customer transition to another provider (cf. § 4.2.29).

12.7 Survival Protocol

a.  If this Declaration is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 18.1.

b.  All provisions of the Contract in the categories listed in this Declaration will continue in effect beyond any termination or expiration of the Contract.

c.  The surviving provisions are those (if any) concerning:

  • arbitration;
  • attorney fees;
  • confidentiality;
  • early neutral evaluation;
  • expense-shifting after settlement-offer rejection;
  • forum selection (or choice of forum);
  • governing law (or choice of law);
  • indemnification;
  • insurance requirements;
  • intellectual-property ownership;
  • limitations of liability;
  • non-competition;
  • non-solicitation;
  • remedy exclusions and ‑limitations;
  • representations and warranties;
  • warranty disclaimers;
  • warranty rights.

d.  In addition, all provisions of the Contract relating to the recovery of attorney fees and other dispute expenses will survive the entry of a judgment, arbitration award, or other decision in a contested proceeding.

Commentary

Drafters should be careful about what rights and obligations would survive termination – see generally Jeff Gordon, Night of the Living Dead Contracts.

Caution: Some agreements include a survival provision along the following lines: All other provisions of the Agreement that, by their nature, should extend beyond termination or expiration of the Agreement will survive any such termination or expiration. Such language, however, could be dangerously vague.

12.8 Exercises and discussion questions

12.8.1 Survival discussion questions

QUESTION 1: 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 …."

QUESTION 2: Would a survival clause preserve particular provisions after expiration of the agreement, as opposed to after termination?

13 Supporting operations

13.1 Archive Copies

When this Checklist is adopted in an agreement (the "Contract"), it applies if and when:

  • under the Contract, a specified party, referred to here as "Retainer," may retain archive copies (or "archival copies") of documents or other materials,
  • even though the Contract would otherwise require Retainer to return the materials to another party ("Owner") or to destroy the materials.

Discussion checklist:

13.1.1 Who may (or must) keep archive copies?

As a safe harbor, one possible (and non-exclusive) way for Retainer to comply with § 13.1.5 would be:

  • for Retainer to maintain the archive copies in the custody of a reputable commercial storage organization,
  • as long as that organization was contractually obligated to securely maintain the copies in confidence.
Commentary

Alternative: Retainer must use an outside organization to maintain the archive copies; the outside organization must meet the requirements of the safe-harbor option of this section.

Alternative: Retainer must maintain all archive copies itself, without using an outside organization.

13.1.2 Where may archive copies be kept?

Archive copies may be kept in one or more locations reasonably chosen by Retainer.

Commentary

Alternative: "Archive copies may be maintained only in the following location(s): [DESCRIBE]."

13.1.3 [A reasonable number] of archive copies are allowed

Retainer may cause the specified number of archive copies to be maintained.

13.1.4 Archive copies may be retained [indefinitely]

All such retention is subject to the requirements of this Checklist.

13.1.5 [Prudent] security measures are required for archive copies

Retainer must cause at least the specified measures to be taken to maintain the security of archive copies.

13.1.6 Archive copies of what may be retained?

Retainer may cause archive copies to be made and/or retained of the following (without limitation):

  • electronic documents;
  • photographs and video / audio-visual recordings;
    • including, without limitation, those made to document tangible objects and/or events; and
  • sound recordings of audible events,

unless the Contract clearly states otherwise.

Commentary

Alternative: Retainer may cause archive copies to be made, and/or retained, of the following items only: [DESCRIBE].

13.1.7 What confidentiality obligations apply to archive copies?

Retainer must comply with Clause 6.3 (Confidential Information Protocol) for any information in archive copies that qualifies as Confidential Information or trade secrets of Owner (see § 6.2).

Commentary

Alternative: Retainer need not maintain the archive copies or their contents in secrecy.

13.1.8 Who may Retainer allow to access archive copies?

Retainer must take prudent measures to ensure that archive copies are not made accessible to anyone, except in one or more of the following ways:

  • by Retainer's personnel who maintain the archive copies (if applicable);
  • as agreed in writing by Owner;
  • as directed (or permitted) by a legal tribunal having jurisdiction; and/or
  • in response to a compulsory legal demand, as provided in Clause 6.3.14.

13.1.9 How may archive copies be used?

Retainer must not use archive copies, nor allow or knowingly assist in such use by others, except, from time to time, for one or more of the following purposes:

  • determining, and confirming Retainer's compliance with, Retainer's continuing obligations under the Contract;
  • documenting the parties' past- and present interactions relating to the Contract;
  • reasonable testing of the accuracy of the archive copies;
  • and/or as otherwise agreed in writing.

13.2 Code of Conduct Limitation

When this Checklist is adopted in an agreement (the "Contract"), it applies if and when, under the Contract,

  • a party, referred to here as "Customer," whether or not actually a customer,
  • prescribes a code of conduct that must be followed
  • by another party, referred to here as "Supplier," whether or not actually a supplier.
Commentary

The shorthand names "Customer" and "Supplier are used here because as a practical matter, codes of conduct are typically imposed by customers on their suppliers.

13.2.1 What may Customer do if Supplier breaches the code of conduct?

a.  If Supplier fails to follow the code of conduct,

  • then Customer's EXCLUSIVE REMEDY will be to terminate the Contract,
  • in accordance with Clause 21.2.1 ([Either] party may terminate for [material] breach),
  • except as provided in subdivision b.

b.  This Checklist, however, will not preclude Customer from seeking remedies, — subject to any other applicable remedy limitations, in the Contract or otherwise — if Supplier's violation of the code of conduct also:

  1. constituted a breach of the Contract; and/or
  2. would be something that Customer could sue Supplier about even if the code of conduct and the Contract were not involved,
    • for example, if Supplier defrauded Customer or engaged in other tortious conduct.
Commentary

Some customers demand that vendors commit to abiding by their (the customers') codes of conduct. Vendors understandably push back — not because they want to engage in unethical behavior, but because it's a pain in the [neck] even to read different customers' codes of conduct, let alone try to manage compliance with the different codes' various requirements.

This Checklist gives customers what they often really want — namely, the opportunity to publicly thro