The Tango Terms

One lawyer's contract manual for helping business get things done together. For students and practitioners – with checklists; template clauses (including options and alternatives); and extensive annotations.
Version 2020B (beta); last revised 2020-08-24 16:29:18 CDT

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

Preface

This manual collects lessons learned in law practice and teaching contract drafting. It aspires to help law students, lawyers, and business people to do two things:

  • gain insight into some of the ways that companies commonly do their everyday business dealings; and
  • get readable, workable contracts to signature sooner.

Dedication: To the insightful (and ever-patient) Maretta Comfort Toedt.

1 Introduction: MathWhiz & Gigunda

1.1 For students: MathWhiz and Gigunda

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.

1.2 The contract as "deal manual"

Realistically, of course, most contracts stay buried in the (electronic) file drawer. The contracting parties either don't get into disputes in the first place, or they successfully resolve any disputes on their own.

So parties might ask: Why bother with a contract at all?

Prosaically: In the absence of a written contract, it might be that neither party would be able to go to court to enforce its rights under the parties' agreement. That might be fine with the parties if they have a high degree of mutual trust and each party accepts the risk that the other party might not honor its oral commitments.

But in addition, a written contract can and should serve as the "deal manual" for readers — the parties, and sometimes, for a judge, jury, or arbitration tribunal — who want to be able to look up just what the parties agreed to.

Any contract should answer the following questions for each party:

1.  "What are my obligations? That is: In particular circumstances, what must I do — or not do?"

2.  "What are my rights? That is: Again in particular circumstances —

  • "What am I free to do, or not do, whether or not the other party likes it?
  • "What may I expect — and even demand — that the other party do, or not do?

We'll look at this in more detail later.

1.3 Discussion questions

1.3.1 Ambiguity preview: Traffic signs

Ambiguous: See this sign.

More clear: This sign

1.3.2 Selling a used computer

FACTS:

1.  Let's assume you have an Aunt Jean who has no legal background. Aunt Jean wants to sell her used 2012 Macbook Air laptop computer (she wants to "move up" to a more-powerful machine).

Aunt Jean wants to get $350 for her machine (which at this writing is actually close to the going rate) and to sell the computer "as is."

2.  After Aunt Jean mentioned on Facebook that she wants to sell her computer, one of her high-school acquaintances, "Dale," contacted her and said he wants to buy the computer.

3.  Aunt Jean and Dale were never close in high school, and she hasn't seen Dale since graduation 50 years ago.

4.  Aunt Jean has asked you what to do to make sure she's "protected."

QUESTION 1: Is a written contract necessary? Explain your thinking.

QUESTION 2: Assuming Aunt Jean does want to have something in writing, what form could that writing take? (Be creative!)

1.3.3 Ambiguity preview: Nestle and Starbucks

From this BBC.com article: "Nestle has announced that it will pay Starbucks $7.1bn (£5.2bn) to sell the company's coffee products."

QUESTION: Which company will sell which company's coffee —

  • Will Nestle sell Starbucks coffee? or
  • Will Starbucks sell Nestle coffee?

(Which do you think is more likely?)

EXERCISE: In your breakout rooms and the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), rewrite twice — once for each possible interpretation.

2 Drafting the start of the contract

An experienced contract drafter might start with a skeletal template (such as this one) that includes just the preamble and the signature blocks (and perhaps some general terms and conditions), into which the substantive terms and conditions can be copied and pasted. This Part discusses some useful practices for creating such a skeletal template.

(See also § 5.1 for tips on finding previous contract forms to harvest for languge ideas.)

Contents:

2.1 Title of the Agreement: Choose your style

Imagine that you're looking at a simple list of titles of a particular company's contracts. Perhaps you're doing due diligence for a financing- or merger transaction; perhaps you're doing a document review for a lawsuit or arbitration.

Conider the following styles of title:

Style 1 is simplicity itself but not especially informative:

Agreement

Style 2 is fairly typical for contracts:

Agreement and Plan of Merger

Style 3 is more informative but might be overkill:

AGREEMENT AND PLAN OF MERGER
Among
UAL Corporation
Continental Airlines, Inc.
and
JT Merger Sub Inc.
Dated as of May 2, 2010

The example of Style 3, incidentally, is from the 2010 merger agreement between United Airlines and Continental Airlines.

Ultimately it's the drafter's choice.

2.2 Drafting the preamble: Front-load useful information

While very few contracts are ever litigated, it takes very little time for a contract drafter to help out future trial counsel by properly drafting the preamble of the contract. Here's an example for a hypothetical contract:

Purchase and Sale Agreement
for 2012 MacBook Air Computer

This "Agreement" is between (i) Betty’s Used Computers, LLC, a limited liability company organized under the laws of the State of Texas ("Buyer"), with its principal place of business and its initial address for notice at 1234 Main St, Houston, Texas 77002; and (ii) Sam Smith, an individual residing in Houston, Harris County, Texas, whose initial address for notice is 4604 Calhoun Rd, Houston, Texas 77004 ("Seller"). This Agreement is effective the last date written on the signature page.

Let’s look at this preamble piece by piece: The included information is intended to make life easier on trial counsel if litigation should ever occur.

2.2.1 "This Agreement"

Many drafters would repeat the title of the agreement in all-caps in the preamble, thusly: "THIS PURCHASE AND SALE AGREEMENT (this "Agreement") …."

The author prefers the shorter approach shown in the quoted example above. That’s because:

– It’s doubtful that anyone would be confused about what "This ‘Agreement"" refers to; and

– The shorter version reduces the risk that a future editor might (i) revise the title at the very top of the document but (ii) forget to change the title in the preamble. (This is an example of the rule of thumb: Don’t Repeat Yourself, or D.R.Y., discussed at § 6.8.)

2.2.2 Quoted, bold-faced defined terms

In the example above, note how the preamble defines the terms Agreement, Buyer, and Seller: These defined terms are not only in bold-faced type: they’re also surrounded by quotation marks and parentheses. This helps to make the defined terms stand out to a reader who is skimming the document.

When drafting "in-line" defined terms like this, it’s a good idea to highlight them in this way; this makes it easier for a reader to spot a desired definition quickly when scanning the document to find it.

Imagine the reader running across a reference to some other defined term and starting to flip through the document, wondering to herself, "OK, what does 'Buyer' mean again?"

NOTE: If you also have a separate definitions section for defined terms, it’s a good idea for that definitions section to include cross-references to the in-line definitions as well, so that the definitions section serves as a master glossary of all defined terms in the agreement.

2.2.3 Specific terms: "Buyer" and "Seller"

This preamble uses the defined terms Buyer and Seller instead of the parties’ names, Betty and Sam, because:

  • Doing this can make it easier on future readers … such as a judge … to keep track of who’s who.
  • Doing this also makes it easier for the drafter to re-use the document for another deal by just changing the names at the beginning.

Sure, global search-and-replace can work, but it’s often over-inclusive. For example: Automatically changing all instances of Sam to Sally might result in the word samples being changed to sallyples.

2.2.4 Agreement "between (not "by and between") the parties

Our preamble says that the contract is between the parties — not by and between the parties, and not among them.

True, many contracts say "by and between" instead of just "between." The former, though, sounds like legalese, and the latter works just as well.

For contracts with multiple parties, some drafters will write among instead of between; that’s fine, but between also works.

2.2.5 Stating details about the parties (to help in litigation)

Our preamble provides certain details about the parties,such as where Betty's Used Computers, LLC is organized (Texas) and Sam's county of residence.

When a party to a contract is a corporation, LLC, or other organization, it’s an excellent idea for the preamble to state both:

  • the type of organization, in this case "a limited liability company"; and
  • the jurisdiction under whose laws the organization was formed, in this case "organized under the laws of the State of Texas."

Doing this has several benefits:

– It reduces the chance of confusion in case the same company name is used by different organizations in different jurisdictions … imagine how many "Acme Corporations" or "AAA Dry Cleaning" there must be in various states.

– It helps to nail down at least one jurisdiction where the named party is subject to personal jurisdiction and venue, saving future trial counsel the trouble of proving it up; and

– It helps to establish whether U.S. federal courts have diversity jurisdiction (a U.S. concept that might or might not be applicable).

Including the jurisdiction of organization can simplify a litigator’s task of "proving up" the necessary facts: If a contract signed by ABC Corporation recites that ABC is a Delaware corporation, for example, an opposing party generally won’t have to prove that fact, because ABC will usually be deemed to have "acknowledged" it, that is, conceded the point in advance.

This particular hypothetical agreement is set up to be between a limited liability company, or "LLC," and an individual; in that way, the signature blocks will illustrate how organizational signature blocks should be done.

2.2.6 Principal place of business (or residence) and initial address

Note how the preamble above states some geographical information about the parties:

– Principal place of business: Stating Betty’s principal place of business helps trial counsel avoid having to prove up the court’s personal jurisdiction. For example, a Delaware corporation whose principal place of business was in Houston would almost certainly be subject to suit in Houston.

– Residence: Likewise, if a party to a contract is an individual, then stating the individual’s residence helps to establish personal jurisdiction over him or her and the proper venue for a lawsuit against the individual.

– County: Stating the county of an individual’s residence might be important if the city of residence extends into multiple counties.

For example, Houston is the county seat of Harris County, but just because Sam lives in Houston doesn’t automatically mean that he can be sued in the county’s courts in downtown Houston. That’s because Houston’s city limits extend into Fort Bend County to the southwest and Montgomery County to the north. Sam might live in the City of Houston but in one of those other counties, and so he might have to be sued in his home county and not in Harris County.

– Addresses for notice: It’s convenient to put the parties’ initial addresses for notice in the preamble. That way, a later reader won’t need to go paging through the agreement looking for the notice provision. Doing this also makes it easy for contract reviewer(s) to verify that the information is correct.

2.2.7 Stating the effective date in the preamble

The above preamble affirmatively states the effective date; that’s usually unnecessary (and it's not the author's preference) unless the contract is to be effective as of a specified date.

(Many drafters like to include the effective date anyway; it's normally not worth changing if has drafted it this way.)

The author prefers the last-date-signed approach: "This Agreement is effective the last date written on the signature page."

Here’s a different version of that approach: "This 'Agreement' is made, effective the last date signed as written below, between …."

In reviewing others’ contract drafts, you’re likely to see some less-good possibilities, such as:

– "This Agreement is made December 31, 20XX, between …."

– "This Agreement is dated December 31, 20XX, between …."

Either of these can be problematic because the stated date might turn out to be inaccurate, depending on when the parties actually sign the contract.

Caution: Never backdate a contract for deceptive purposes, e.g., to be able to book a sale in an earlier period — as discussed at § 2.2.8, that practice has sent more than one corporate executive to prison, including at least one general counsel.

On the other hand, it might be just fine to state that a contract is effective as of a different date. EXAMPLE: Alice discloses confidential information to Bob after Bob first orally agrees to keep the information confidential; they agree to have the lawyers put together a written confidentiality agreement. That written agreement might state that it is effective as of the date of Alice’s oral disclosure.

The following might work if it’s for non-deceptive purposes: "This Agreement is entered into, effective December 31, 20XX, by …."

(Alice and Bob would not want to backdate their actual signatures, though.)

2.2.8 Caution: Backdating can be dangerous

Signing a contract that is "backdated" to be effective as of an earlier date might well be OK. (This is referred to in Latin legalese as nunc pro tunc, or "now for then.") The contract itself should make it clear that parties are doing this, to help forestall later accusations that one or both parties had an intent to deceive.

Example: Suppose that Alice discloses confidential information to Bob, a potential business partner, after Bob first orally agrees to keep the information confidential. Alice might well want to enter into a written nondisclosure agreement with Bob that states the agreement and its confidentiality obligations are effective as of the date of Alice’s oral disclosure.

On the other hand: Never backdate a contract for deceptive purposes, e.g., to be able to report a sale in an already expired financial period — that practice has sent more than one corporate executive to prison for securities fraud, including at least one general counsel.

• The former CEO of software giant Computer Associates, Sanjay Kumar, served nearly ten years in prison for securities fraud through, among other things, backdating sales contracts (NY Times). Kumar was also fined $8 million and agreed to settle civil suits by surrendering nearly $800 million (NY Times).

Kumar wasn't the only executive at Computer Associates (now known as just CA) to get in trouble for backdating. All of the following went to prison or home confinement: – the CFO: seven months in prison, seven months home detention (NY Times); the general counsel: two years in prison, and also disbarred (court opinion); the senior vice president for business development: ten months of home confinement (NY Times); the head of worldwide sales: seven years in prison (WSJ).

All of this mess came about because the Computer Associates executives orchestrated a huge accounting fraud: On occasions when the company realized that its quarterly financial numbers were going to miss projections, it "held the books open" by backdating contracts signed a few days after the close of the quarter. This practice was apparently referred to internally as the "35-day month." According to CA, all the sales in question were legitimate and the cash had been collected (according to CA's press release).

The only issue was one of the timing of "revenue recognition," to use the accounting term. The company had recorded the sales on its books ("booked the sale") a few days earlier than was proper under generally-accepted accounting principles, or "GAAP." But that was enough to put the sales revenue into an earlier reporting period than it should have been. That, in turn, was enough to send all those CA executives to prison. (CA press release).

• Likewise, the former CFO of Media Vision Technology was sentenced to three and a half years in federal prison because his company had inflated its reported revenues, in part by backdating sales contracts. Because of the inflated revenue reports, the company's stock price went up, at least until the truth came out, which eventually drove the company into bankruptcy.

Even if backdating a contract didn't land one in jail, it could can cause other problems. For example, a California court of appeals held that backdating automobile sales contracts violated the state's Automobile Sales Finance Act (although the state's supreme court later reversed).

2.2.9 Include the parties’ affiliates as "parties"? (Probably not.)

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

The much-better practice is to state clearly the specific rights and obligations that (some or all) affiliates have under the contract. This is sometimes done in "master" agreements negotiated by a party on behalf of itself and its affiliates.

For example, consider a negotiated master purchase agreement between a customer and a provider. The master agreement might require the provider to accept purchase orders under the master agreement from the customer’s affiliates as well as from the customer itself, so that the customer’s affiliates can take advantage of the pre-negotiated pricing and terms.

Caution: An affiliate of a contracting party might be bound by the contract if (i) the contracting party — or the individual signing the contract on behalf of that party — happens to "control" the affiliate, and (ii) the contract states that the contract is to benefit the affiliate. That was the result in a Delaware case where:

  • the contract stated that a strategic alliance was being created for the contracting party and its affiliates, and
  • the contract was signed by the president of the contracting party, who was also the sole managing member of the affiliate.

The court held that the affiliate was bound by — and had violated — certain restrictions in the contract.

2.2.10 Naming the "wrong" party can screw up contract enforcement

Be sure you’re naming the correct party as "the other side" — or consider negotiating a guaranty from a solvent affiliate.

Failing to name the correct corporate entity could leave your client holding the bag. This seems to have happened in a Seventh Circuit case:

– The named party in the contract had essentially no assets (the assets were all owned by the named party’s parent company).

– The other named party sued the parent company for breach of the contract.

The appellate court affirmed summary judgment in favor of the parent company, saying:

It goes without saying that a contract cannot bind a nonparty. … If appellant is entitled to damages for breach of contract, [it cannot] recover them in a suit against appellee because appellee was not a party to the contract. These are the general rules of corporate and contract law, but they come with exceptions, of course. …

We find no basis for holding Norvax liable for any alleged breach of the contract between Northbound and … the Norvax subsidiary.

2.2.11 Does each party have capacity to contract?

Depending on the law of the jurisdiction, an unincorporated association or trust might not be legally capable of entering into contracts.

If a contract is purportedly entered into by a party that doesn’t have the legal capacity to do so, then conceivably the individual who signed the contract on behalf of that party might be personally liable for the party’s obligations.

2.2.12 Is country-specific information required?

Some countries require contracts to include specific identifying information about the parties, e.g., the registered office and the company ID number. This is worth checking for contracts with parties or operations in such countries.

2.3 Drafting the background: No "Whereas"!

2.3.1 Use simple background recitals to tell the story

Instead of "Recitals," describe the background in a (numbered) "Background" section of the contract.

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

As a horror story, consider the WHEREAS example quoted in § 2.3.6 below: Good luck trying to figure out what's really going on — there seems to be some kind of business roll-up going on, with a sale and leaseback of real estate and maybe other assets, but that's not at all clear. Now imagine that you're a judge or a judge's law clerk who's trying to puzzle out the story. Worse: Imagine that you're a juror trying to make sense of this transaction.

Somewhat better is the following excerpt is from a highly publicized stock purchase agreement in the tech industry, rewritten into background-section form:

Before:

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

After:

1.  Background

1.01 At the same time as this Agreement is being signed, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement.

1.02 Under the Reorganization Agreement, Seller and the Company are to complete certain "Reorganization Transactions" at or prior to the Closing.

1.03 The Reorganization Agreement is in substantially the form attached to this Agreement as Exhibit A.

Notice the shorter, single-topic paragraphs, discussed in more detail at § 7.1.

2.3.2 Use plain English

The modern trend is decidedly to use plain language in contracts, and also in just about any other kind of document you can imagine.

Contract drafters can take a leaf from Warren Buffett, who says the following in his preface to the SEC's Plain English Handbook:

When writing Berkshire Hathaway’s annual report, I pretend that I’m talking to my sisters. I  have no trouble picturing them: Though highly intelligent, they are not experts in accounting or finance. They will understand plain English, but jargon may puzzle them

My goal is simply to give them the information I would wish them to supply me if our positions were reversed.

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

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

2.3.3 A contract's background statements might be binding — or not

Different jurisdictions might treat background statements differently. For example:

  • California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added.)
  • But: "Contracts often contain recitals: provisions that do not make binding promises but merely recite background information about factual context or the parties' intentions. Maryland law recognizes the general principle that such recitals are not binding and, while they may aid the court in interpreting the contract's operative terms, cannot displace or supplement operative terms that are clear."

2.3.4 A statement of one party's intent might not be binding

A naked statement of one party's subjective intent in entering into the contract might not suffice to be binding on another party. That happened in a case involving Sprint, the cell-phone service provider:

  • Sprint offered "upgraded" phones to its customers at steep discounts when customers renewed their contracts — the discounts were so steep that the customers paid less than what the phones would bring on the used-phone market.
  • Another company, Wireless Buybacks, bought upgraded phones from Sprint customers and resold them at a profit.
  • Sprint sued Wireless Buybacks for tortious interference with Sprint's contracts with its customers.
  • Sprint claimed that its contract prohibited resale because it said in part: "Our rate plans, customer devices, services and features are not for resale and are intended for reasonable and non-continuous use by a person using a device on Sprint's networks." (Emphasis added.)

The trial court found that this language unambiguously barred resale; the court granted partial summary judgment for Sprint.

On appeal, however, the Fourth Circuit held that the contract language "is a background statement of intent, not an enforceable promise not to resell Sprint phones."

Drafting lesson: Be specific about what a party is:

  • allowed to do, or
  • prohibited from doing — in the Sprint case above, Sprint would have had better odds if its contract had explicitly said, "thou shalt not resell your phone." (Would such a restriction have been enforceable? That's a question beyond the scope of this discussion.)

2.3.5 Special topic: Background section in settlement agreements

When parties enter into an agreement to settle a dispute, it can be really advantageous for the agreement's background section to be clear that the parties were not relying on each other's representations; they could use language such as Clause 20.3 (Reliance Disclaimer) for that purpose. Doing so can help to forestall at least some subsequent fraud claims.

2.3.6 Style tip: Delete "Witnesseth" and "Whereas"

Note: Like all purely-style tips: (1) this particular style tip isn't worth making a big deal about if you're reviewing a draft prepared by The Other Side, see § 5.9; and (2) if your supervising partner has a preference, then do it that way, see § 5.7.

Modern contract drafters avoid using the archaic words "WITNESSETH" and "Whereas.” For an example of what not to do, see the the example below, from a routine commercial real-estate purchase agreement.

(Don't bother reading the text below, just get a sense of how it looks.)

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

W I T N E S S E T H:

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

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

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

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

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

This is pretty hard to read, no?

2.4 Dealing with defined terms

Defined terms can be quite useful — not least because they allow drafters to change the definition for, say, "Purchase Price" to reflect a new dollar figure, without having to revise the dollar figure multiple times throughout the contract.

Contents:

2.4.1 The benefits of "in-line" definitions

It's often convenient to include definitions "in-line" with the substantive provisions in which they are used; for example, see the definitions of Discloser and Recipient in Clause 16.1 (Confidential Information).

When you keep definitions together with their substantive provisions in this way, it makes it easier for future drafters to copy and paste an entire contract article or section into a new contract.

2.4.2 Have a separate section for general definitions?

It's also common to use a separate “general definitions” section and to place it in one of three spots in the contract:

  1. right after the Background section — this is perhaps the most-common practice;
  2. at the back of the contract, just before the signature blocks or as an appendix after the signature blocks (with results that might be surprising, as discussed in the note just below);
  1. in a separate exhibit or schedule (which can be handy if using the same definitions for multiple documents in a deal).

2.4.3 Pro tip: Include cross-references

In some contracts you might have both "in-line" definitions and a separate general-definitions section. In that situation, you should seriously consider serving future readers by including, in the separate general-definitions section, appropriate cross-references (in their proper alphabetical spots) to the in-line definitions.

That way, the general-definitions section does additional duty as a master index of defined terms.

2.4.4 Some defined-terms style preferences

The following are some personal style preferences that enhance readability (in the author’s view):

– Put the defined term in "quotes and italic type" to make it stand out on the screen or page and thus make the term easier to spot while scanning through the document.

– Use the phrase refers to instead of means, because the former often just sounds better in different variations; see the following example (where bold-faced type is used to highlight differences and not to set off defined terms):

Before:

Confidential Information means information where all of the following are true ….

After:

"Confidential Information" refers to information where all of the following are true ….

2.4.5 Don't bother numbering alphabetized definitions

If you alphabetize your defined-terms section (as you should), there's no need to number the paragraphs. The purpose of numbering contract paragraphs is easy referencing, both internally and in later documents. That purpose is sufficiently served just by having the definitions in alphabetical order.

2.4.6 Caution: Consistency in capitalization can be crucial

It’s a really good idea to be consistent about capitalization when drafting a contract. If you define a capitalized term but then use a similar term without capitalization, that might give rise to an ambiguity in the language — which in turn might preclude a quick, inexpensive resolution of a lawsuit.

That kind of bad news happened in a New York case:

  • The defendant asserted that the plaintiff’s claim was barred by the statute of limitations and therefore should be immediately dismissed.
  • The plaintiff, however, countered that the limitation period began to run much later than the defendant had said.
  • The court held that inconsistency of capitalization of the term “substantial completion” precluded an immediate dismissal of the plaintiff’s claim.

In a similar vein, a UK lawsuit over flooding of a construction project turned on whether the term “practical completion” — uncapitalized — had the same meaning as the same term capitalized. The court answered that the terms did not have the same meaning; as result, a sprinkler-system subcontractor was potentially liable for the flooding.

2.5 Skim: Some past student "background" efforts

1.  A student wrote in the background section: "For all purposes, the Data is owned by Client and is provided to Contractor for completion of services under this Agreement."

DCT COMMENT: This shouldn't go into the Background section, but into a substantive section (e.g., concerning IP ownership).

2.  A student used "WHEREAS" several times.

DCT COMMENT: That's OK if the partner wants it, but it's archaic.

3.  A student described Mary as an "expert."

DCT COMMENT: If I were Mary, I wouldn't want that.

4.  A student wrote: "Analyst desires to be retained by Company, and Company desires to retain Analyst, to analyze or cause to be analyzed the seismic data of the OM Field in accordance with the terms and conditions of this Agreement."

DCT COMMENT: That seems superfluous: It's more or less self-evident, and it makes for one more paragraph for the reviewer(s) to have to read.

5.  A student included a section: "Concurrently with the execution and delivery of this Agreement, the Recipient and the Company are entering into a Service Agreement."

DCT COMMENT: No, the agreement we're drafting IS the service agreement.

6.  Several students wrote variations on, e.g., "Gigunda desires for MathWhiz to analyze data, and MathWhiz desires to do so."

DCT COMMENT: I wouldn't phrase it that way; instead, I'd let the rest of the contract speak for itself. (And in any case, the parties' subjective desires don't enter into contract interpretation except in cases of a lack of meeting of the minds or mutual mistake.)

7.  A student wrote that "Gigunda will pay MathWhiz as stated in this Agreement."

DCT COMMENT: I think I'd leave that out — the payment provisions will speak for themselves, and it's not really needed for an "executive summary" (readers will assume that MathWhiz will be paid).

8.  A student writes: "The parties have agreed that Client will compensate Provider with a flat monthly fee of $20,000 for up to 200 staff hours of work per month, with additional work hours being billed at $150 per hour."

DCT COMMENT: As long as this is the only place that the specific compensation details are discussed (D.R.Y.), this would work, in the way that the lease details in the Stanford-Tesla lease (see § 2.6.4) are up front in the document.

9.  A student writes: "Client and Service Provider enter into the Agreement for the term of one year from the effective date of the Agreement."

DCT COMMENT: This is another item that would go into a substantive provision further down, not into the Background section.

2.6 Exercises and discussion questions

2.6.1 Exercise: Draft a title

Draft a title for the Gigunda-MathWhiz agreement.

2.6.2 Questions: Titles

FACTS: Consider this title:

CONSULTING SERVICES AGREEMENT
Among Gigunda Energy and Math-Whiz LLC

QUESTION 1: What's less-than-ideal here?

For the title of a two-party agreement, I'd use "between" instead of "above."

ALTERNATIVE FACTS: Consider another possible title:

CONSULTANT SERVICES AGREEMENT
BETWEEN
GIGUNDA ENERGY,
a California [corporation]
(“Client”)
AND
MATH-WHIZ LLC,
a Texas limited liability company
(“Contractor”)

QUESTION 2: What's a potential concern here?

The title has a bit more information than needed for an index, and there's always the D.R.Y. concern.

STILL OTHER ALTERNATIVE FACTS: Consider another possible title:

SEISMIC DATA ANALYSIS SERVICE AGREEMENT
BY AND BETWEEN
GIGUNDA ENERGY
AND
MATH-WHIZ LLC

QUESTION 3: What could be improved here?

Two things:

  1. For such a long title, all-caps makes the title less readable.
  2. By and between" is perhaps overkill; I'd just say "between."

2.6.3 Exercise: Preamble and background section

In the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), draft a preamble and background section for the Gigunda-MathWhiz agreement.

2.6.4 Discussion: Stanford-Tesla lease intro

Consider the following excerpt from

COMMERCIAL LEASE

THIS LEASE is entered into as of July 25, 2007 (the “Effective Date”), by and between THE BOARD OF TRUSTEES OF THE LELAND STANFORD JUNIOR UNIVERSITY, a body having corporate powers under the laws of the State of California (“Landlord”), and TESLA MOTORS, INC., a Delaware corporation (“Tenant”).

1.  BASIC LEASE INFORMATION. The following is a summary of basic lease information. Each item in this Article 1 incorporates all of the terms set forth in this Lease pertaining to such item and to the extent there is any conflict between the provisions of this Article 1 and any other provisions of this Lease, the other provisions shall control. Any capitalized term not defined in this Lease shall have the meaning set forth in the Glossary that appears at the end of this Lease.

Address of Premises: 300 El Camino Real, Menlo Park, California

Term: Five (5) years

Scheduled Date for Delivery of Premises: August 1, 2007

Commencement Date: August 1, 2007

Expiration Date: July 31, 2012

Base Rent:

Year One: $60,000 ($5,000 per month)
Year Two: $90,000 ($7,500 per month)
Year Three: $120,000 ($10,000 per month)
Year Four: $165,000 ($13,750 per month)
Year Five: $165,000 ($13,750 per month

QUESTIONS FOR CLASS DISCUSSION:

1.  Is "Commercial Lease" the proper term, or should it be "Commercial Lease Agreement"?

"Commercial Lease" is appropriate — a lease is a contract that creates a leasehold interest. See Black's Law Dictionary, 10th ed.

2.  Why state that the Lease is entered into "as of July 25, 2007"?

A contract can state that it is effective as of an earlier- or later date if that's what the parties want. CAUTION: Signers should never backdate their signatures to make it appear that the contract was signed earlier- or later than it was; doing so sent a number of senior executives to prison.

3.  Why do you think the names of the parties are capitalized?

Party names are sometimes capitalized in a preamble so as to make them easy for a skimming reader to spot.

4.  What might be some of the pros and cons of including this kind of "Basic Lease Information" at the beginning of the agreement document, instead of including it "in-line" in the appropriate section(s) of the agreement?

Defining key "business" terms (e.g., "Base Rent") at the beginning of an agreement — and then consistently using those defined terms elsewhere in the agreement — makes it convenient for reviewers and safer for revisers, who need only revised the definitions.

5.  To what extent is the "Each item in this Article 1 incorporates …" worth including?

Including "Each item in this Article 1 incorporates …" is probably unnecessary.

6.  What could go wrong with the italicized portion, "to the extent there is any conflict …"?

Including the italicized portion, "to the extent there is any conflict …" is dangerous because it could lead to inconsistencies during revision of the draft during negotiation.

7.  Note the mention of the Glossary in the last sentence of the first paragraph — where are some other places to include definitions for defined terms? (Hint: See § 2.4.)

Defined terms and their definitions are typically set forth (i) in a separate section at the beginning of the agreement; (ii) in a separate section at the end of the agreement; and/or (iii) "in-line" at the place in the agreement that the defined term is principally used.

8.  Any comments about the way the "Term: Five (5) years" portion is stated? How about the way that the Base Rent amounts are stated?

Both "Term: Five (5) years" and "Year One: $60,000 ($5,000 per month)" violate the "[BROKEN LINK: DRY]" (Don't Repeat Yourself) rule, which can cause major problems if the words are changed but not the numerals, or vice versa; the linked section tells the sad tale of a bank that lost $693,000 because of such a drafting screw-up.

3 Drafting the end of the contract

3.1 Signature blocks

3.1.1 Use a concluding paragraph? (No.)

Some contracts use an entire concluding paragraph such as the following:

To evidence the parties’ agreement to this Agreement, each party has executed and delivered it on the date indicated under that party’s signature.

First, that kind of concluding paragraph is overkill. There are other ways of proving up that The Other Side in fact delivered a signed contract to you … for starters, the copy in your possession that bears The Other Side’s signature.

Second, at the instant of signature, a past-tense statement that each party "has delivered" the signed contract is technically inaccurate — even more so at the moment when the first signer affixes his (or her) signature.

But again: If you see this kind of language in a draft prepared by the other side, don't change it (as discussed in § 5.9).

3.1.2 Corporate- and LLC signature blocks

Here are examples of signature blocks for different types of organization. On the left is a signature block for when the signer’s name and title are known; on the right, when not.

Signature blocks

In the signature blocks above:

• It’s helpful to start out a signature block with the word "AGREED:" in all-caps and followed by a colon.

• Each organization’s signature block lists the organization’s name followed by the word "by" and a colon.

Date signed: Each signer should hand-write the date signed, for reasons discussed at the commentary to Clause 25.21 (Effective Date Definition).

Printed name blank line: In signature blocks with blank lines, be sure to include a space for the printed name, because the signatures of some people are difficult to read.

Title: In any signature block for an organization, be sure to include the signer’s title, to establish a basis for concluding that the signer has authority to sign on behalf of the organization; if the employee’s title includes the word "president," "vice president," "manager," or "director" in the relevant area of the business, that might be enough to establish the employee’s apparent authority. (See the commentary at § 3.2.)

3.1.3 Signature blocks for individuals

If an individual is a party to the contract, the signature block can be just the individual’s name under an underscored blank space.

Example:

AGREED:

………………………………
Jane Doe

………………………………
Date signed

But you might not know the individual signer’s name in advance, in which case you could use the following format:

AGREED:

………………………………
Signature

………………………………
Printed name

………………………………
Date signed

3.1.4 Special case: Signature block for a limited partnership

In many U.S. jurisdictions, a limited partnership might be able to act only through a general partner, in which case a signature block for the limited partnership might need to include the general partner’s name. And the general partner of a limited partnership might very well be a corporation or LLC; in that case, the signature block would be something like the following:

AGREED: ABC LP, by:
ABC LLC, a Texas corporation,
general partner, by:

………………………………
Ronald R. Roe,
Executive Vice President

………………………………
Date signed

On the other hand, in some jurisdictions, a limited partnership might be able to act through its own officers; for example, Delaware’s limited-partnership statute gives general partners the power "to delegate to agents, officers and employees of the general partner or the limited partnership …."

In such cases, the signature block of a limited partnership might look like the signature block of a corporation or LLC, above.

Caution: A limited partner who, acting in that capacity, signs a contract on behalf of the limited partnership could be exposing herself to claims that she should be held jointly and severally liable as a general partner. (Of course, some general partners also hold limited-partnership investment interests and thus are limited partners in addition to being general partners.)

3.1.5 Include company titles for client relations, too

Including company titles is highly advisable to help establish apparent authority, as discussed above. But there's another reason to do so: If your client is a company, then some individual human, typically an officer or manager of the company, will be signing on behalf of the client. In that situation, the client’s signature block in the contract should normally state that it’s the company that is signing the contract, not the individual human in his- or her personal capacity — with the attendant personal liability.

To be sure, if your client is the company and not the human signer, then technically you’re under no professional obligation to make sure that the human signer is protected from personal liability. But it’s normally not a conflict of interest for you to simultaneously look out for the human signer as well as for the company — and doing so in this way can give the human signer a warm fuzzy feeling about you, which is no bad thing.

Caution: A lawyer might find herself dealing with an employee of a client company in a situation where the interests of the employee and the company diverge or even conflict. One example might be an investigation of possible criminal conduct such as deceptive backdating of a contract (discussed in the commentary at § 2.2.8). In circumstances such as those, the lawyer should consider whether she should affirmatively advise the employee, preferably in writing, that she’s not the employee’s lawyer; conceivably, the lawyer might even have an ethical obligation to do so.

3.1.6 Try to keep signature blocks on the same page

The author prefers to keep all of the text of a signature block together on the same page (which might or might have other text on it). That looks more professional, in my view, than having a signature block spill over from one page onto the next. This can be done using Microsoft Word’s paragraph formatting option, "Keep with Next."

3.2 Signature authority

Suppose that Alice signs a contract on behalf of ABC Corporation. The contract is with XYZ Inc. Question: Is it reasonable for XYZ to assume that Alice's signature makes the contract binding on ABC? The answer will depend on whether Alice had authority to do so — either actual authority or apparent authority.

Contents:

3.2.1 Lack of signature authority can kill a contract

A party might not be able to enforce a contract if the person who signed on behalf of the other party did not have authority to do so. This happened, for example, in a federal-contracting case:

  • An ammunition manufacturer signed several nondisclosure agreements (NDAs) with the U.S. Government and, under the NDAs, disclosed allegedly-trade-secret technology to the government.
  • The manufacturer later sued the government for breaching the NDAs by disclosing and using the trade secrets without permission.
  • Under the applicable regulations, the specific individuals who signed the NDAs on behalf of the government did not have authority to bind the government.

The court majority held that the government was not bound by some of the NDAs — and thus the government was not liable for its disclosure and use of the manufacturer's trade secrets.

Here’s another example from the Illinois supreme court: A landlord sued its defaulting tenant, a union local. The landlord won a $2.3 million judgment against the union in the trial court, only to see the award thrown out in the state supreme court. Why? Because in signing the lease, the union official had not complied with the requirements of the state statute that authorized an unincorporated association to lease or purchase real estate in its own name.

3.2.2 An "officer" title won't necessarily indicate signature authority

The Restatement (Third) of Agency notes that just because a person holds the title of president or vice president of a company, that doesn't mean the person has authority to make commitments on behalf of the company.

3.2.3 Apparent authority can save the day

A person with "apparent authority" can bind a company to a contract, unless a hypothetical reasonable person would have reason to suspect otherwise.

Suppose hypothetically that ABC Corporation's actions made it reasonable for others to assume that an individual "Alice" had authority to bind ABC (for example, by allowing Alice to use a title with terms such as "manager" or "executive").

And suppose also that Alice, purportedly on behalf of ABC, signed a contract with XYZ Inc. In that situation, ABC might be bound by the signed contract, even if in fact ABC had directed Alice not to sign it. That happened, for example, in a Tenth Circuit case in which a company claimed that it was not bound by a contract signed by one of its executive vice president ("EVP").

• The company's argument was that, under the company’s internal signature policies, the EVP did not have authority to sign a contract of that type.

• The company's argument didn’t fly — the district court granted, and the appeals court affirmed, partial summary judgment that the EVP did have at least apparent authority to sign the contract.

A Houston appeals court noted that:

Texas law recognizes that:

  • a company's placement of an officer or employee in a certain position
  • will provide the agent
  • with apparent authority to bind the company
  • in usual, customary, or ordinary contracts
  • that a reasonable person would view
  • as being consistent with an agent's scope of authority in that position.

3.2.4 The gold standard: A board resolution

The gold standard of corporate signature authority is probably a certificate, signed by the secretary of the corporation, that the corporation’s board of directors has granted the signature authority.

You’ve probably seen paperwork that includes such a certificate if you’ve ever opened a corporate bank account. The resolution language — which is invariably drafted by the bank’s lawyers— normally says something to the effect that the company is authorized to open a bank account with the bank in question and to sign the necessary paperwork, along with many other things the bank wants to have carved in stone.

3.2.5 Consider asking for a personal signer representation

Suppose that "Alice" is designated to sign a contract on behalf of a party, and that the contract includes a personal representation by Alice that she has authority to sign on behalf of that party, such as the following:

Each individual who signs this Agreement on behalf of an organizational party represents that he or she has been duly authorized to do so.

But now suppose that Alice balks because she doesn't want to put herself on the hook in case she in fact doesn't have authority. That might be a sign that the other party should investigate whether Alice really does have authority to sign.

Caution: Even if a signer were to make a written representation that s/he had signature authority, that might not be enough — because legally the other side might be "on notice" that the signer does not have authority, as discussed in the following example.

3.2.6 Or, just take the risk?

The author once represented a MathWhiz-like client that was negotiating an agreement with a Gigunda-like customer.

  • Gigunda's attorney filled in a name and title for Gigunda's signer: It was a Gigunda individual contributor; let's call her "Sarah" (not her name).
  • I raised the issue of apparent authority with the MathWhiz senior executive.
  • The MathWhiz executive said that he had been dealing exclusively with Sarah in negotiating the agreement, but that Sarah's boss (whom the MathWhiz executive knew well) had been copied on all of the emails going back and forth.
  • The MathWhiz executive also said that MathWhiz had a longstanding good history with Gigunda.

After learning all of the above, my recommendation to MathWhiz was that we not try to change the signature block to reflect someone else's title — it might offend Sarah, and it would certainly delay getting to signature, with little or no real reduction in MathWhiz's business risk.

MathWhiz did as I recommended; the parties signed the contract and carried it out to everyone's satisfaction.

3.2.7 Special case: Who has authority to sign for an organization?

By statute, a contract with an LLC or other organization might not be enforceable, even if signed by an "officer" or by a "manager." That could be the case if the articles of organization (which are usually publicly available) expressly deprive the signer of such authority.

This happened in a Utah case where:

  • One manager of a two-manager LLC signed an agreement granting, to a tenant, a 99-year lease on a recreational-vehicle pad and lot.
  • But there was a problem: The LLC’s publicly filed articles of organization stated that neither of the two company’s managers had authority to act on behalf of the LLC without the other manager’s approval.

The court held that the tenant had been on notice of the one manager’s lack of authority to grant the lease on just his own signature alone — and so the lease was invalid.

3.2.8 Consider including authority-disclaimer language

Some drafters might want to be explicit about who does not have signature authority, to help preclude a party from claiming to have relied on the apparent authority of other would-be signers.

This approach can sometimes be seen in sales-contract forms used by car dealer, which can say, typically in all-caps, something along the lines of, "NO PERSON HAS AUTHORITY TO MODIFY THESE WARRANTIES ON BEHALF OF THE DEALER EXCEPT A VICE PRESIDENT OR HIGHER."

3.2.9 Counsel normally won’t want to sign contracts for clients

A lawyer for a party entering into a contract normally won’t want to be the one to sign the contract on behalf of her client, because:

  • From a client-relations perspective: If the contract later "goes south," the lawyer won’t want her signature on the contract.
  • Signing a contract for a client could later raise questions whether, in the negotiations leading up to the contract, the lawyer was acting as a lawyer or as a business person. This could be an important distinction: in the latter case, the lawyer’s private communications with her client might not be protected by the attorney-client privilege and thus might be subject to discovery by third parties (which is never a good look, in terms of client relations).
  • If the lawyer’s signature is on the contract, it makes it more likely that the lawyer will be deposed as a fact witness in the event of a lawsuit or arbitration about the contract. This might lead to disqualification not only of the lawyer herself but also of her entire firm — and her litigation partners would not be happy about that. (This factor might not be important as a practical matter, though, because as a participant in the negotiations, the lawyer might well be deposed anyway as a fact witness.)

3.3 Exhibits, schedules, etc.

This section describes typical practice in U.S. contract drafting; the terminology might be different in other jurisdictions.

Contents:

3.3.1 Exhibits: Standalone documents (generally)

A contract exhibit is generally a standalone document attached to (or referenced in) a contract. Exhibits are often used as prenegotiated forms of follow-on documents such as forms of real-estate deed.

Example: Imagine that ABC Corporation and XYZ Inc. sign a contract under which XYZ will buy an apartment complex from ABC. Such contracts usually provide:

  • for the buyer to have a period in which to have the house inspected and, if necessary, to obtain financing; and
  • after that, for a "closing" in which:
    • the buyer is to pay the purchase price; and
    • (relevantly here:) the seller is to deliver a deed that conveys title to the buyer.

In a commercial real-estate contract such as the one between ABC and XYZ, the contract might well include, as an exhibit, an agreed form of warranty deed; the contract might say the following, for example:

… At the Closing (subject to Buyer's fulfillment of Buyer's obligations under this Agreement), Seller will deliver to Buyer a general warranty in substantially the form attached to this Agreement as Exhibit A.

(Emphasis added.)

Example: A master services agreement might include, as an exhibit, a starter template for statements of work (discussed in Clause 14.3.1) to be undertaken under the agreement.

Exhibit numbering: Contract exhibits are commonly "numbered" as Exhibit A, B, etc., but that's just a convention; exhibits could alternatively be numbered with numerals, such as Exhibit 1, 2, etc., or even by reference to section numbers in the body of the contract (see the discussion of schedules below). The important thing is to make it easy for future readers to locate specific exhibits.

3.3.2 Schedules: For disclosures of exceptions from a benchmark

Schedules are commonly used in contracts for disclosures of exceptions to representations and warranties in the body of the contract. Example: In the merger agreement between software giant Symantec Corporation and BindView Corporation (of which the author was vice president and general counsel), BindView warranted, among other things, that:

Article 3
Representations and Warranties of the Company * * * 

3.2 Company Subsidiaries. Schedule 3.2 of the Company Disclosure Letter sets forth a true, correct [sic] and complete list of each Subsidiary of the Company (each a “Company Subsidiary”). …

Other than the Company Subsidiaries or as otherwise set forth in Schedule 3.2, the Company does not have any Company Subsidiary or any equity or ownership interest (or any interest convertible or exchangeable or exercisable for, any equity or ownership interest), whether direct or indirect, in any Person.

(Italics and extra paragraphing added.)

In other words: The reps and warranties in the contract set forth a baseline reference point — a benchmark, a Platonic ideal — while the schedule(s) specify how the Company (in this case, BindView) did not conform to that benchmark status.

Schedule numbering: It's conventional to number each schedule according to the section in the body of the agreement in which the schedule is primarily referenced; in the example above, Schedule 3.2 has the same number as section 3.2 of the merger agreement in which that schedule is referenced.

3.3.3 Appendixes, addenda, annexes

Other materials can be attached to a contract as appendixes, annexes, and addenda; there's no single standard or convention for doing so.

3.4 Notary certificates

This section discusses the certificate of acknowledgement by a notary public or other authorized official; that's a different type of certificate than a jurat, in which a notary or other official certifies that the signer of the document personally declared, under penalty of perjury, that the document's contents were true.

Contents:

3.4.1 Litigation advantage: Self-authentication

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

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

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

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

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

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

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

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

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

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

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

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

3.4.2 Other officials might also be able to "notarize"

By statute, certain officials other than notaries public (note the plural form) are authorized to certify the authenticity of signatures in certain circumstances.

For example, Texas law gives the power to certify signature acknowledgements to:

  • district-court and county-court clerks; and
  • in certain cases, to commissioned officers of the U.S. armed forces;

among others.

3.4.3 Notaries and conflicts of interest

A notary public generally can't sign a certificate if the notary has a conflict of interest, e.g., notarizing something for an immediate-familly member.

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

3.4.4 A flawed notarization can cause problems

Parties will want to double-check that the notary "does the needful" (it's an archaic expression, but I like it) to comply with any statutory requirements. In a New York case, a married couple's prenuptial agreement was voided because the notary certificate for the husband's signature didn't recite that the notary had confirmed his identity:

  • It was undisputed that the couple's signatures on the agreement were authentic.
  • There was no accusation of fraud or duress.
  • Even so, said the state's highest court, the notarization requirement was important because it "necessarily imposes on the signer a measure of deliberation in the act of executing the document."

3.4.5 Lawyers might not want to notarize client documents

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

But if a lawyer notarizes a document, then the lawyer might be called someday to testify in a court proceeding about a signed document. For example, the lawyer-notary might have to explain how he or she confirmed the signer's identity if that information isn't stated in the lawyer's notary records. That in turn might disqualify the lawyer from being able to represent the client whose signature was certified.

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

3.5 Put the signature blocks up front?

3.6 Exercises and discussion questions

3.6.1 Exercise: Signature blocks

Draft the signature blocks for the Gigunda-MathWhiz agreement.

3.6.2 Discussion questions: Backdating

In your groups, discuss: When (if ever) might it be appropriate to do the following:

  1. Appropriate to backdate the effective date of a contract
  2. INappropriate to backdate the effective date of a contract
  3. Appropriate to backdate the signers' signatures
  4. INappropriate to backdate the signers' signatures

3.6.3 Discussion questions: Notary certificates

1.  FACTS: Your client, Landlord, has negotiated a five-year commercial lease agreement for one of its office buildings. The tenant's lawyer wants the signers to have their signatures notarized. Landlord agrees to have the signatures notarized. ASSUME: All events take place in Texas and are subject to Texas law.

2.  QUESTION: Why might the tenant's lawyer want the lease agreement to be notarized? Would that be in your client Landlord's best interest? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

3.  QUESTION: If the notary public can't find her notary seal, may she sign the notary certificate and skip applying the seal? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

4.  QUESTION: What must the notary public do before signing the notary certificate to confirm that the signers are who they claim to be? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

#+endaside

5.  QUESTION: Must the notary's certificate say anything in particular about the identity of the signer? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

7.  QUESTION: If no notary is around, can you notarize the signatures as an attorney? Should you? Explain, citing relevant statutory- and regulatory provisions, including the relevant subdivision(s) if any.

8.  QUESTION: Surprise! The person who will sign the lease for the tenant has gone on a business trip to Kuwait and will FAX her signed signature page to you. Can your secretary, who is here in Houston and is a notary public, notarize that signature page? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

9.  QUESTION: Another document in the transaction must be signed and notarized by an individual who's in California. Is anything special required for the notary certificate? What downside risk does the notary have if the notary is asked to sign the certificate in the absence of the individual who's going to sign the document? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

10.  QUESTION: Who in Kuwait could "notarize" the signature? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

11.  QUESTION: Why "notarize" a document signature with an acknowledgement?

To make the document self-authenticating.

4 Contract-law basics: A brief refresher

4.1 Basic requirements for a contract

An agreement will typically be legally binding as a contract if it meets the usual requirements, such as:

1. One party must make an offer, and the other party must accept the offer, so that it's clear that there's been a "meeting of the minds."

2. Both parties have the legal capacity to enter into contracts — a child or an insane person likely would not have legal capacity, nor might some unincorporated associations.

3. "Consideration" must exist; roughly speaking, this means that the deal must have something of value in it for each party — and the "something" can be most anything of value, including for example:

  • a promise to do something in the future, or
  • a promise not to do something that the promising party has a legal right to do; this is known as "forbearance."

4.2 Even emails can form binding contracts

(See also the commentary about the E-SIGN Act and the Uniform Electronic Transactions Act in the electronic-signatures section of Clause 24.19 (Signatures).)

Pro tip: Some might be surprised that in the United States (and the UK, and probably other jurisdictions), you can form a legally-binding contracts by exchanging emails, as long as:

  • the emails, their attachments, and the terms that they incorporate by reference, meet the necessary "content" requirements for contracts — these (usually) aren't an issue for everyday business agreements; and
  • the emails include "signatures" for each party, which can take the form of email signature blocks and even names in email "From" fields.

This has been true for a number of years; in various cases, courts have held that exchanges of emails were sufficient to form binding contracts for:

  • the sale of real property;
  • the sale of goods;
  • the sale of 88 rail freight cars;
  • a broker's commission for a real-estate transaction;
  • an employment agreement including nine months' severance pay in case of termination;
  • a compromise of a past-due bill for legal fees;
  • settlement of a lawsuit.

New York’s highest court upheld denial of a motion to dismiss a breach of contract claim because an exchange of emails — "in essence, we 'offer' and 'I accept,' … sufficiently evinces an objective manifestation of an intent to be bound for purposes of surviving a motion to dismiss."

Of course, an email exchange will not create a binding contract if the content of the emails fails to meet the usual requirements of establishing a meeting of the minds on all material terms as well as an agreement to be bound.

4.3 Contracts by IM or text message?

Pro tip: Even a very-terse exchange of text messages or instant messages ("IM") can create a binding contract. For example:

• Two Texas furniture dealers entered into an agreement — entirely by text message — for one party to sell the entire contents of a showroom to the other. The seller backed out; the court had no difficulty holding that the parties had entered into an enforceable contract.

• In a federal-court lawsuit in Florida (decided under Delaware law), an IM exchange served as a binding agreement to modify an existing contract — and that agreed modification went on to cost one of the parties more than a million dollars.

Caution: When it comes to real-estate contracts, California's version of the Statute of Frauds states that: "An electronic message of an ephemeral nature that is not designed to be retained or to create a permanent record, including, but not limited to, a text message or instant message format communication, is insufficient under this title to constitute a contract to convey real property, in the absence of a written confirmation that conforms to the requirements of [citation omitted]."

4.4 Will all written agreements be legally binding?

It's not uncommon for parties to engage in preliminary discussions, by email or text, about a potential transaction or relationship — but then the discussions end and one party claims that the parties had reached a legally-binding written agreement.

Pro tip: It's quite common for written contracts to include a binding-agreement declaration in the general-provisions section. Drafters who do so are generally desirous of setting up a roadblock to head off "creative" arguments to the contrary by another party's counsel.

Caution: Just saying "this is binding" won't necessarily make it so; if one of the necessary requirements isn't met (see above), then a court might hold that the agreement was not binding, no matter what it said. But it can't hurt to say that the parties intend for the agreement to be binding.

Example: On the other hand, early written communications between the parties might say, in effect, "this is not binding!":

  • A party might include, in an email or other message, an express disclaimer of any intent to be bound.
  • If parties sign a so-called letter of intent ("LOI"), the LOI might state explicitly that the parties do not intend to be bound (except perhaps to a very-limited extent, e.g., perhaps by confidentiality provisions).

4.5 Reminder: Many oral contracts can be binding

There's an old joke that an oral contract isn't worth the paper it's printed on. But that's not quite true: Oral contracts are "a thing," and long have been.

Whether an oral contract is enforceable depends on the evidence that's brought before the court; it basically depends on two things:

  1. The contract cannot be of a type that, by law, must be in writing, as discussed in § 4.6; and
  2. The jury,* after hearing the witness testimony and weighing the evidence, must find that there was, in fact, an oral agreement.

Here's an example from a Texas case:

  • A small company fired its accounting director as part of a corporate reorganization. The fired employee sued for breach of an alleged oral promise to pay him a bonus.
  • The fired employee testified under oath that he had been promised, by the company's vice president of operations, that he would get a bonus, not merely that he might get a bonus.
  • The jury believed the employee — the jurors didn't buy the company's claim that the employee had been told only that he might get a bonus.

And under standard American legal principles — including the Seventh Amendment to the U.S. Constitution — if a reasonable jury could reach the verdict that the actual jury did, then the actual jury's verdict must stand (with certain exceptions).

Incidentally, under Texas law, the fired employee was also entitled to recover his attorney fees for bringing the lawsuit, under section 38.001 of the Texas Civil Practice & Remedies Code, as discussed in the additional commentary at § 23.2.2.

4.6 But: The Statute of Frauds might say otherwise

For public-policy reasons, the law will not allow some oral agreements to be enforced. For some types of contract, in effect, the law says, for this type of contract, we want to be very sure that the parties actually did agree, so we're not going to just take one party's word for it — even that party swears under oath that the parties did agree.

This policy is reflected in the Statute of Frauds, which says (in various versions) that certain types of contract are not enforceable unless they're documented in signed writings — or unless an exception applies.

The typical types of contract subjecto the Statute of Frauds are:

  1. prenuptial agreements and other contracts in consideration of marriage;
  2. contracts that cannot be performed within one year, such as an agreement to employ someone for, say, two years (this usually excludes contracts that don't specify any duration at all);
  3. contracts that call for transfer of an ownership interest of land (or similar interests in land such as an easement);
  4. contracts in which the executor of a will agrees to use the executor's own money to pay a debt of the estate;
  5. contracts for the sale of goods for $500.00 or more (the exact amount might vary);
  6. guaranty agreements in which one party agrees to act as a surety (guarantor) for someone else's debt.

Caution: Even an oral contract that's subject to the Statute of Frauds might be enforced if one of the various exceptions applies, such as partial performance; that's beyond the scope of this discussion.

4.7 Important: Battle of the Forms

4.7.1 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, our terms and conditions are the only ones that will apply — your terms won't count, no matter what you do.

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.

4.7.2 Interlude: 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.

4.7.3 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 § 4.7.2 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.

4.7.4 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."

4.7.5 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 examples:

• From a Honeywell purchase-order form (no longer available on-line) § 1: "This Purchase Order is deemed accepted upon the earlier of the return of the acknowledgment copy of this Purchase Order or the commencement of performance by Supplier."

• From a GE terms-of-sale document (no longer available on-line) § 1: " 'Contract' means either the contract agreement signed by both parties, or the purchase order signed by Buyer and accepted by Seller in writing, for the sale of Products or Services …."

• From Cisco purchase terms § 1: "Supplier's electronic acceptance, acknowledgement of this Purchase Order, or commencement of performance constitutes Supplier's acceptance of these terms and conditions."

4.7.6 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.

UPS claimed that its bill of lading limited its liability for damage to some $15,000. In contrast, the GE subsidiary claimed that the bill of lading was inapplicable, and that consequently UPS should be held liable for the full value (some $1 million) of the shipment in question. The court granted partial summary judgment that the master agreement controlled.

4.7.7 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 an implied warranty of "reasonable" duration.
  • Clause 24.2 (Amendments Procedure)
  • Clause 24.7 (Entire Agreement)

4.8 Exercises and discussion questions

4.8.1 Exercise: Short-form contracts

FACTS: MathWhiz's and Gigunda's respective CEOs have met for dinner at a casual dining restaurant in Houston, with lots of little kids running around the place.

  • The restaurant's menus are inexpensive paper, printed in one corner with animal-drawing outlines that kids can color in.
  • The backs of the menus are blank.
  • Using a crayon, on the back of her menu, MathWhiz's CEO outlines a proposal for MathWhiz to do a project for Gigunda.
  • The proposal states, tersely:
    • just what MathWhiz will do for Gigunda;
    • when MathWhiz will deliver its work product; and
    • a price, payable upon delivery.
  • Gigunda's CEO says, "this is great!" He takes the crayon, writes "Agreed!" at the bottom of the proposasl, and signs and dates it.
  • MathWhiz's CEO does the same: She writes "Agreed!" and signs and dates the proposal.
  • Both CEOs use their phones to take a picture of the signed menu.

QUESTION 1: On these facts, have the parties created an enforceable contract? (Possible answers: Yes, No, Maybe.)

Yes.

QUESTION 2: Assuming that the answer to Question 1 is "yes," is the signed proposal a "verbal" agreement?

Yes.

4.8.2 Questions: Oral contracts

QUESTION 1: TRUE | FALSE | IT DEPENDS: Contrary to popular belief, an oral contract can be binding.

True; see § 4.5.

QUESTION 2: TRUE | FALSE | IT DEPENDS: Contrary to popular belief, an oral contract will generally be binding.

It depends; see § 4.5.

4.8.3 Exercise: Dealing with purchase-order terms

FACTS:

1.  You represent a supplier that has persuaded a large customer to place orders.

2.  The customer has its own purchase-order form  — which has lots of teeny-tiny fine print, stating the customer's terms and conditions, which are pretty onerous in favor of the customer.

QUESTION: What would you recommend that the supplier ask the customer to do, so as to avoid having to read the fine print every time the customer submits an order?

Negotiate a master agreement that will supersede the P.O. terms and conditions.

4.8.4 Exercise: Filling a purchase order

FACTS:

  1.  You get a call from a client that manufactures widgets. The client's sales people have just scored a very-big purchase order from a large customer.

2.  The customer's purchasing department (sometimes known as "sourcing") has asked the client to sign the P.O. and return it to the customer.

3.  The client wants to know: Should we sign the P.O. and return it to the customer?

QUESTION: What do you recommend?

1.  Ask the client whether they have a master agreement in place with that customer — and if not, suggest that they try to put one in place.

2.  Recommend to the client that they NOT sign the P.O. and instead just ship the product, ideally with the client's own terms of sale.

4.8.5 Exercise: Battle of the Forms

FACTS:

(A)  Seller regularly sells generic widgets. Buyer regularly buys widgets and incorporates them into, among other products, the pottery wheels that are manufactured and sold in Buyer's factory.

(B)  Buyer sends Sally Sales Rep a purchase order for 10,000 widgets at stated price- and delivery terms. Sally is delighted: Buyer's purchase order will help her make her sales quota for Seller's fiscal quarter.

(C)  The P.O. contains a lot of detailed fine print — including a provision in which the seller warrants that the seller's goods will be fit for the purpose for which Buyer's customers use Buyer's goods; the P.O. doesn't identify those goods and Seller doesn't know that Buyer has pottery wheels in mind.

(D)  On the front, the P.O. says, in big bold letters, that the seller must sign the P.O. and return it with the ordered goods; the P.O. also says (i) that shipment constitutes acceptance of the terms, and (ii) that Buyer rejects any additional or inconsistent terms in any sales confirmation or other document that Seller provides.

(E)  Sally sends a copy of the P.O. to Seller's fulfillment department and tells them to ship the 10,000 widgets as specified in the P.O., but Sally doesn't sign or return the P.O.; Seller invoices Buyer for the stated price.

QUESTION 1: Was a binding contract formed? Why or why not?

Answer: Yes: The P.O. was an offer that could be — and was — accepted by performance. (Hint: This is Contract Law 101.)

QUESTION 2: If a binding contract was formed, is the fit-for-Buyer's-customer's purpose warranty provision part of the contract? (Hint: This is Contract Law 101.)

Answer: Probably, for the same reason as above.

ALTERNATIVE FACTS: Seller doesn't ship the widgets, but instead sends back a "sales confirmation" form with Seller's own version of detailed fine print, including a conspicuous, legally-adequate disclaimer of all warranties, express and implied, AND a rejection of any additional or different terms. Buyer then cancels the order, which shocks and disappoints Seller.

QUESTION 3: Was a binding contract formed? Why or why not? If yes, is the fit-for-purpose warranty provision part of the contract? (Hint: This is Contract Law 101.)

Answer: No: This is a Battle-of-the-Forms situation; Seller's sales-confirmation form materially altered the terms, and the parties didn't conduct themselves in a manner that recognized the existence of a contract, so no contract. See UCC § 2-207.

ALTERNATIVE FACTS: Seller ships the widgets and includes with the shipment the sales confirmation form mentioned in the previous paragraph, but Seller does not sign or return the purchase order.

QUESTION 4: Was a binding contract formed? Why or why not? If yes, what are the warranty terms of the contract? (Hint: See Battle of the Forms.)

Answer: A contract hasn't been formed yet; it depends on whether Buyer accepts the widgets (and, possibly, on whether Buyer pays Seller's invoice). See UCC § 2-207.

ALTERNATIVE FACTS: Sally — whose title at Seller is "Account Manager" — signs and returns the purchase order to Buyer.

QUESTION 5: Was a binding contract formed? Why or why not? If yes, what are the warranty terms of the contract?

Answer: A contract has probably indeed been formed — although see the discussion of apparent authority at  § 3.2 — and the warranty terms are those in Buyer's P.O. form.

5 Special challenges in drafting contracts

5.1 Finding existing contract forms

Few contract drafters start with a clean sheet of paper — mainly because it's difficult to remember all the issues that might need to be addressed — and so most drafters start with some prior agreement.

Law firms often try to maintain form files, but seldom does anyone get paid or otherwise receive meaningful reward for doing that drudgery. So the quality and currency of law firm form files can be dicey.

Thousands of contract forms are available online from commercial companies that screen and curate contracts filed with the U.S. Securities and Exchanges EDGAR Web site (https://www.sec.gov/edgar/search-and-access). Some of these commercial sites include:

Other sites such as RocketLawyer.com and LegalZoom.com offer forms, but it's hard to know what their quality is, nor whether they take into account the "edge cases" that sometimes crop up in real-world situations.

If you want to search the SEC's EDGAR Web site yourself, it helps to know that many if not most contracts will be labeled as Exhibit 10.something (and possibly EX-4.something) under the SEC's standard categorization. This means that the search terms "EX-10" (and/or "EX-4") can help narrow your search.

Pro tip: Online contract forms are best relied on as sources of ideas for issues to address. The clause language is not necessarily what you'd want to use in a contract for a client.

5.2 A clean sheet of paper can be dangerous

[For students: Skim this section for background information; all you need to remember for testing purposes is the following "Pro tip."]

Pro tip: Throwing out an existing contract, and starting over with a clean sheet of paper to draft a much-shorter contract, can be dangerous:

  • The existing contract might well capture past experience with oddball issues that can cause disputes.
  • The drafters of the new, shorter contract might inadvertently overlook one or more of those issues.
  • A safer approach is to just "clean up" the contract by:
    • breaking its long, "wall of words" provisions into smaller chunks;
    • as necessary, rewriting legalese to make it sound more like how you'd explain the concept to a jury.

Background: Contract forms tend to grow by accretion, as lawyers think of issues that could arise. As a result, what a commenter said about politicians (fearful of voter backlash) might apply equally to contract drafters (fearful of malpractice claims): “[E]fforts to reform airport security are hamstrung by politicians and administrators who would prefer to inflict hassle on millions than be caught making one mistake.”

That attitude of "cover every conceivable risk" can cause problems. For example: The legal department of one General Electric unit found that its "comprehensive" contracts were getting in the way of closing sales deals:

When GE Aviation combined its three digital businesses into a single Digital Solutions unit, their salespeople were eager to speed up the growth they had seen in the years before the move. They found plenty of enthusiastic customers, but they struggled to close their deals.

The reason: Customers often needed to review and sign contracts more than 100 pages long before they could start doing business.

The new business inherited seven different contracts from the three units. The clunky documents were loaded with legalese, redundancies, archaic words and wordy attempts to cover every imaginable legal [sic]. No wonder they languished unread for months.

"We would call, and customers would say, 'I can’t get through this,'" says Karen Thompson, Digital Solutions contracts leader at GE Aviation. “And that was before they even sent it to their legal team! … We were having trouble moving past that part to what we needed to do, which was sell our services.”

For those customers who did read the contract, negotiations would drag on and on.

GE's legal department decided to do something about it. Shawn Burton, the general counsel of that GE business unit, described his team's approach in a Harvard Business Review article.

• First, the legal team met with business people — who were enthusiastic about the prospect of simplifying their contracts — to identify business risks.

• Then:

Next the legal team started drawing up the contract, beginning from scratch.

No templates. No “sample” clauses. No use of or reference to the existing contracts.

We simply started typing on a blank sheet of paper, focusing only on the covered services and the risks we’d identified.

Throughout the process, we applied our litmus test: Can a high schooler understand this?

Burton provides several examples of streamlined provisions, such as the following revision:

Before:

Customer shall indemnify, defend, and hold Company harmless from any and all claims, suits, actions, liabilities, damages and costs, including reasonable attorneys’ fees and court costs, incurred by Company arising from or based upon (a) any actual or alleged infringement of any United States patents, copyright, or other intellectual property right of a third party, attributable to Customer’s use of the licensed System with other software, hardware or configuration not either provided by Company or specified in Exhibit D.3, (b) any data, information, technology, system or other Confidential Information disclosed or made available by Customer to Company under this Agreement, (c) the use, operation, maintenance, repair, safety, regulatory compliance or performance of any aircraft owned, leased, operated, or maintained by Customer of [sic; or](d) any use, by Customer or by a third party to whom Customer has provided the information, of Customer’s Flight Data, the System, or information generated by the System.

After:

If an arbitrator finds that this contract was breached and losses were suffered because of that breach, the breaching party will compensate the non-breaching party for such losses or provide the remedies specified in Section 8 if Section 8 is breached.

(Emphasis added.)

Here's the problem: It can be dangerous to throw out an existing contract form and start over unless you methodically list and address the principal business risks that the parties might encounter, just as the GE Aviation unit did — and even then, how do you know you've thought of all the possible risks?

The language in the previous contracts presumably reflected past experience in how to handle the unusual- or oddball situations that can sometimes arise and lead to disputes. Throwing out the previous contracts might have lost that often-hard-won knowledge.

By analogy: The computer-programming world is quite familiar with this danger of losing knowledge gained from bitter experience. Users of software expect the software to work well even in oddball situations, especially those that the aviation world calls "pilot error," a.k.a. stupid human tricks (just as business clients expect contracts to accommodate unusual situations that might arise between the parties).

A much-cited 2000 essay, by highly-regarded software developer and entrepreneur Joel Spolsky, argues that throwing out the source code of an existing computer program and rewriting it from scratch is a terrible idea, one that has caused major headaches for companies such as Netscape (which developed one of the first widely-used Web browsers):

The idea that new code is better than old is patently absurd. Old code has been used. It has been tested. Lots of bugs have been found, and they’ve been fixed. …

Each of these bugs took weeks of real-world usage before they were found. …

When you throw away code and start from scratch, you are throwing away all that knowledge. All those collected bug fixes. Years of programming work.

The same could be true about contracts: If you throw out existing contract language and start from scratch, you risk losing years of accumulated knowledge of how the real world can work.

There's another, safer approach: Do what software developers refer to as "refactoring," namely cleaning up existing language, breaking it up into more-readable bullet points, as discussed in § 7.5.

5.3 The importance of drafting for future readers

The most important near-term readers of any contract are the parties' own business people, obviously.

On the other hand, the most important potential future reader might well be a judge or arbitrator, in case the parties get into a dispute that they can't resolve themselves by agreement.

For any reader, clear contract drafting is important, because the reader:

  • is almost certainly very busy;
  • might have little or no knowledge of the parties' specific area business; and
  • would definitely appreciate it if the contract quickly conveyed the answers to the above questions.

Clumsy drafting:

  • can slow up the non-drafting party's legal review and delay getting the contract to signature;
  • can make it very difficult for the judge, arbitrator, or other reader to figure out what the parties agreed to;
  • can increase the chances of an unforeseen result in litigation or arbitration.

So the drafters (and reviewers) of a contract can serve future readers — not least, the business people who must read the contract — by being as clear as possible about the above questions.

5.4 Your job is to educate, and sometimes to persuade

The author of a contract style manual once opined (wrongly) that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.”

That view would be fine if people were computers, which do exactly as they're told: nothing more, nothing less. But:

  • People aren't computers.
  • Even in a corporation-to-corporation contract, it's people, not computers, who carry out obligations and exercise rights. (So-called "smart contracts" are a very-different thing.)
  • People's memories are often short and can sometimes be "creative"; this means that people sometimes need to be reminded of what they agreed to.
  • A contracting party's circumstances can change after the contract is signed. For example: By the time a dispute arises, key employees and executives of a party could have different views of what's important. Or, they might have "forgotten" what mattered during the contract negotiations.
  • Let's not us forget another important group of people: Judges, jurors, and arbitrators who are asked to enforce a contract can be influenced by what they think is right and fair. Sometimes, the wording of the contract's terms can make a difference in how those future readers might perceive the parties' positions.

In sum: People sometimes need to be educated, and even persuaded, to do the things called for by a contract.

That is the contract drafter's mission: To (re)educate the parties — and sometimes judges and jurors — and, if necessary, to persuade them, to do what your client now wants them to do.

5.5 Keep in mind everyone's personal incentives

Berkshire Hathaway's vice-chairman Charles Munger has said that "Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower. * * * Never, ever, think about something else when you should be thinking about the power of incentives."

When drafting a contract, it can pay dividends to give some thought to how to manage the so-called "agency costs" that can arise from these personal interests and incentives of individual players. That's because when disputes arise, the involved individuals will naturally want to protect their own interests, such as —

  • not having fingers pointed at them;
  • being thought of by their side as a committed team player who's willing to fight to win, not a defeatist who throws in the towel;
  • protecting their bonus, their commission, their pay raise, their promotion, etc.

These desires can manifest themselves in a variety of ways; some of the clauses discussed in this manual can help to manage expectations.

5.6 A short letter agreement might well be enough

Business people aren't fond of spending time negotiating contract terms and conditions. One approach to getting to signature quickly, for low-risk business contracts, was dubbed "Pathclearer" by the in-house counsel who developed it at Scottish & Newcastle, a brewery in the UK. The Pathclearer approach entails:

  1. using short letter agreements instead of long, complicated contracts, and
  2. relying on the general law and commercial motivations — i.e., each party's ability to walk away, coupled with each party's desire to retain a good supplier or customer — to fill in any remaining gaps in coverage.

(For another example of contract shortening by a General Electric unit, see [BROKEN LINK: ge-slashed][BROKEN LINK: ge-slashed].)

Here's a personal example from years ago, not long after the author started work as an associate at Arnold, White & Durkee. One day, the senior name partner, Tom Arnold, asked me to come to his office.

Tom asked me to draft a confidentiality agreement for a friend of his, "Bill," who was going to be disclosing a business plan to Bill’s friend "Jim."

Tom instructed me not to draft a conventional contract. Instead, the confidentiality agreement was to take the form of a letter along approximately the following lines:

Dear Jim,

This confirms that I will be telling you about my plans to go into business [raising tribbles, let's say] so that you can evaluate whether you want to invest in the business with me. You agree that unless I say it's OK, you won’t disclose what I tell you about my plans to anyone else, and you won’t use that information yourself for any other purpose. You won't be under this obligation, though, to the extent that the information in question has become public, or if you get the information from another legitimate source.

If this is agreeable, please countersign the enclosed copy of this letter and return it to me. I look forward to our working together.

Sincerely yours,

Bill

When I’d prepared a draft, I showed it to Tom and asked him, isn’t this pretty sparse? Tom agreed that yes, it was sparse, but:

  • The signed letter would be a binding, enforceable, workable contract, which Bill could take to court if his friend Jim double-crossed him (which Bill judged to be very unlikely); and
  • Equally important to Bill: Jim would probably sign the letter immediately, whereas if Bill had asked Jim to sign a full-blown confidentiality agreement, Jim likely would have asked his lawyer to review the full-blown agreement, and that would have delayed things — not just by the amount of time it took Jim's lawyer to review the agreement, but for the parties to negotiate the changes that the lawyer likely would have requested.

That experience was an eye-opener. It taught me that contracts aren’t magical written incantations: they’re just simple statements of simple things.

The experience was also my first lesson in a fundamental truth: Business clients are often far more interested in being able to sign an "OK" contract now than they are in signing a supposedly-better contract weeks or more in the future.

As another example of a short-form contract in letter form, see the 2006 letter agreement for consulting services between Ford Motor Company and British financial wizard Sir John Bond — consisting of an introduction, six bullet points, and a closing.

5.7 Your supervisor wins on style preference*

A new lawyer or other contract professional might find that her partner or other supervisor prefers to write out, for example, one million seven hundred thousand dollars ($1,700,000.00), instead of the simpler $1.7 million, even though this manual strongly recommends against doing so.

Don't fight your supervisor over things like this; in purely-stylistic matters, just do it the way that the supervisor prefers. There'll be plenty of time to develop and use your own preferred style as you get more experienced and more trusted to handle things on your own — and especially if you start to bring in your own clients.

In the meantime, of course, you'll have to be extra-careful not to make the kind of mistakes that can result from some of these suboptimal style practices.

5.8 The Check-In Rule

As a junior lawyer, there will be times when you will — and should — be uncertain about what to do in a contract draft. For example:

• When drafting a contract for a client, you might wonder whether to include a forum-selection provision, because doing so can lead to problems.

• In reviewing another party's draft contract, you might see that the draft includes a forum-selection provision that requires all litigation to take place exclusively in the other side's home jurisdiction; you wonder whether the client will be OK with that.

To keep your client and your supervising partner happy (not to mention your malpractice carrier) here's what you do:

1.  Check in with your supervising partner — or, if you're the person who deals with the client, check in with the client — about the issue that concerns you, which here is the forum-selection provision.

Important: Have a well-thought-out recommendation for what to do about the issue of concern, with reasons for your recommendation. This is true even if the recommendation is limited to advising the client to consider Factors X, Y, or Z in making a decision. That will give the partner or client a concrete proposal to consider, instead of just wondering about the issue in the abstract. (Also, superiors and clients tend to think, not unreasonably: Bring me solutions, not just problems.)

Note: Don't pick up the phone and call the partner or client every time an issue pops into your head — no one likes to be repeatedly interrupted with questions. Instead:

  • make a list of things to discuss with the partner or client; and
  • schedule a meeting or phone call (or Zoom call) to discuss the list.

Pro tip: In Microsoft Word, you can add comment bubbles in the margin of a draft contract. Those comment bubbles can then be used as the discussion agenda during what's known as a "page turn" conference call, where the participants go page by page through a draft contract or other document. (Ditto for discussing comments with the other side during a negotiation call.)

2.  Document that you advised the client or partner, in matter-of-fact, non-defensive language, either:

  • in an email to the partner or client, and/or
  • in Word comment bubbles in a draft that you sent to the partner or client, as discussed in the pro tip above.

Here's a real-life example: A client's CEO once asked me to review a draft confidentiality agreement ("NDA") sent to him by a giant company. At the time I'd been working with the CEO for many years, helping him do his job at different companies where he'd been a senior executive (two of which he founded).

Here's the email I sent the CEO about the giant company's NDA form, only lightly edited:

1.  They [the giant company] have their infamous "residuals clause" in this NDA, which is basically a blank check for them to use whatever you tell them — in [section reference] it says:

"Neither of us can control … what our representatives will remember, even without notes or other aids. We agree that use of information in representatives’ unaided memories in the development or deployment of our respective products or services does not create liability under this agreement or trade secret law, and we agree to limit what we disclose to the other accordingly." (Emphasis added.)

BUSINESS QUESTION: Are you OK with giving [the giant company] that kind of a blank check for what you'll be disclosing to them?

2.  Any litigation would have to be in [city]. Meh.

3.  There's no requirement that a recipient must return or destroy confidential information. I'm fine with that; I've come to think that omitting such a requirement is the most-sensible approach.

Otherwise it [the giant company's draft NDA] looks OK.

Notice what I did here: I pointed out three issues — in numbered paragraphs — for which I wanted the CEO's input. He would make the decisions what business risks to accept.

Epilogue: The CEO emailed me back and asked for a phone conference with him and another executive. We discussed the residuals clause and came up with a plan for him to approach his contact at the giant company to ask if that clause could be removed.

In this case I didn't follow up with an email to confirm the plan of action, but if I had, it would have been along the following lines:

[Name1] and [Name2], confirming part of our phone conversation just now: [Name1] is going to call [giant company] to find out if they'd be willing to remove the "residuals" clause from their draft NDA. If they're not willing to do that, then y'all can decide whether you're comfortable with the business risk of signing the NDA with the residuals clause still in it.

[Emphasis added]

Note how, in the first sentence, I left a paper trail for future litigation counsel, documenting the fact that we had a phone conversation, and when that conversation occurred.

Note also my use of the term "business risk."

In other circumstances, I might have said something like the following:

[Name1] and [Name2], confirming part of our phone conversation today: The [giant company] NDA has an exclusive forum-selection provision that requires all litigation to be in [city]; under the circumstances I think that's probably an acceptable business risk.

Please let me know if you'd like to discuss this any further.

[Emphasis added]

IMPORTANT: Be careful about how you phrase your emails and other comments to the client or partner: Assume that anything you put in writing might someday be read by an adversary and possibly used against your client — or against you — in litigation.

Sure, in some circumstances the attorney-client privilege should protect at least some of your written comments from discovery. But the privilege has its limits; moreover, the privilege can be waived (by the client only), or it might even be pierced (if the crime-or-fraud exception applies).

5.9 Tips for dealing with "the other side's" draft

Many contract drafters spend at least as much time reviewing others' draft contracts as they do in drafting their own. Here are a few pointers.

1.  Do ask the other side for an editable Microsoft Word document. And if you send the other side a draft or a redline, don't send a PDF or a locked Word- or PDF document — doing so implicitly signals a lack of trust; between lawyers especially, it's more than a little lacking in professional courtesy.

2.  Do save your own new draft immediately: Open the other party's draft in Microsoft Word and immediately save it as a new document whose file name reflects your revision. Example of file name: "Gigunda-MathWhiz-Services-Agrement-rev-2020-08-24.docx"

3.  Do add a running header to show the revision date: Add a running header to the top right of every page of your revision to show the version date and time (typed in, not an updatable field) (and matching the date in the file name). Example of running header: "REV. 2020-08-24 18:00 CDT" (note the use of military time for clarity).

4.  Don't revise the other side's language just for style: It's not worth spending scarce negotiation time — and it's faintly insulting — to ask the other side to change things that don't have a substantive effect.

Example: Suppose that the other side's draft contract leads off with "WITNESSETH" and a bunch of "WHEREAS:" clauses. You, as a well-trained drafter, would prefer to have a simple background section without all the legalese (see § 2.3 for more details). Let it be: If the other side's "WHEREAS:" clauses are substantively OK, don't revise those clauses just because you (properly) prefer to use a plain-language style.

5.  But do break up "wall of words" provisions in another party's draft to make the provisions easier for your client to review — and to help you to do a thorough review with lower risk of the MEGO factor ("Mine Eyes Glaze Over"). After you save a new Word document (see #2 above), do the following:

  • Double-space the entire text (except signature blocks and other things that should be left in single-space) if not that way already.
  • Break up long sentences, in the manner shown in the template clauses of this manual and as explained in more detail at § 7.1.

6.  And do add an explanation for the added white space: In the agreement title at the top of the draft, add a Word comment bubble along the lines of the following: "To make it easier for my client to review this draft, I'm taking the liberty of double-spacing it and breaking up some of the longer paragraphs." (It's hard for another lawyer to object to your doing something to make things easier for your client, right?)

The author has been doing this for years and has never once gotten pushback on that point from the original drafter — in fact, the parties pretty much always end up eventually signing a double-spaced version with broken-up paragraphs, as opposed to the original wall-of-words format.

7.  Never gratuitously revise another party's draft to favor that other party — even if your revision seems to make business sense — and certainly not if the revision might someday put your client at a disadvantage or give up an advantage.

Example: Suppose that this time your client MathWhiz is a customer. A new vendor has sent MathWhiz a draft contract. The draft calls for MathWhiz to pay the vendor's invoices "net 90 days" — that is, the vendor expects payment in full in 90 days (see the explanation of "net days" in the commentary at § 13.12.1).

  • You know that MathWhiz, like all customers, pretty-much always prefer to hold onto its cash for as long as they can — not least because delaying payment can give a customer a bit of extra leverage over its suppliers.
  • You also know that MathWhiz usually pays net-45 and is not unwilling to pay net-30. You strongly suspect that the vendor's 90-day terms are a mistake, perhaps left over from a previous contract (i.e., the vendor's contract person took a previous contract and changed the names).

Let it be — don't take it on yourself to unilaterally change the vendor's net-90 terms to net-45, which would require MathWhiz to pay the vendor's invoices earlier than the vendor asked in its draft contract.

The vendor might later embarrasedly confess to having overlooked the net-90 terms* and ask to change it to net-30. That gives MathWhiz an opportunity to be gracious, which will usefully signal to the vendor that MathWhiz might well be a Good Business Partner (which most companies like to see).

5.10 Exercises and discussion questions

5.10.1 Exercise: Selling a used computer (continued)

FACTS: Same as in § 1.3.2.

EXERCISE: Draft the simplest language you can think of to serve as the written contract.

QUESTION 3: What are some ways that you might get your mom and her high-school acquaintance to "sign" the contract?

5.10.2 Exercise: Finding contract forms online

QUESTION: What factors should you consider in deciding how much confidence to place in a real-world signed contract that you find online, e.g., on the SEC's EDGAR Website?

EXERCISE: Find one example of a limited-liability company "operating agreement" (a.k.a. "company agreement" in Texas).

EXERCISE: Find one example of a litigation settlement agreement.

See, e.g., the settlement agreement in a lawsuit over mortgage-backed securities between the Federal Home Loan Bank and Goldman Sachs, archived at https://perma.cc/9F44-8D92.

5.10.3 Discussion: What to send the other side

FACTS: MathWhiz has asked you to draft a confidentiality agreement to send to another party.

QUESTION: Should you send the other party:
A.  A PDF document, unlocked
B.   A Microsoft Word document, unlocked
C.  A Microsoft Word document, locked into "Track Changes" mode
D.  A PDF document, locked to prevent changes

Answer: B.

5.10.4 Discussion: A bad contract provision

FACTS: For your client MathWhiz, you're reviewing a contract drafted by Gigunda. MathWhiz doesn't have much bargaining power and would really like to see this contract signed. You see a provision that outrages you.

QUESTION: What should be your first action?

A.  Delete the provision.

B.  Try to put yourself in Gigunda's shoes and ask what problem they were trying to solve.

C:  Revise the provision to make it acceptable to MathWhiz.

D.  Accept the provision and advise MathWhiz about it — in writing.

Answer: B

5.10.5 Discussion: Incentives

QUESTION: What are some examples of individuals' personal incentives that could affect the negotiation, and/or the performance, of a contract?

Here are a couple of examples:

1.  A sales person might be eager to get a deal closed in order to make quota or qualify to go on a "club trip" (an all-expenses-paid group vacation to a very-nice place, with families, for sales people who have sold 100% of their quotas).

2.  A successor to a person who originally put a deal in place might want to kill that deal and make a new deal with someone else — perhaps on better terms, perhaps with someone with whom she'd prefer to do business.

6 Ambiguity and its dangers

Ambiguity gets its own chapter in this manual because in a contract, ambiguity can be seriously-bad news. Many lawyers would surely agree that ambiguous contract language is one of the top sources of legal trouble for parties doing business together. The inadvertent drafting of ambiguous terms is an occupational hazard for contract drafters.

Contents:

6.1 What is "ambiguity" — and why is it bad?

A contract term is ambiguous if it is susceptible to two or more plausible interpretations — and when that happens, the contract term can cause major difficulties for the parties. An ambiguous term in a contract lets one or both parties fight about just what meaning should be ascribed to that term.

There might well be a lot of money riding on the outcome of the ambiguity dispute. For example: In a much-cited case, the Texas supreme court restated the rules about ambiguity in a case about oil-and-gas leases — and in that case, the losing party ultimately missed out recovering the roughly $44 million that it had claimed it was owed under the contract in suit.

Here's what the supreme court had to say about ambiguity in that case:

A contract is not ambiguous if the contract's language can be given a certain or definite meaning.

But if the contract is subject to two or more reasonable interpretations after applying the pertinent construction principles,

[then] the contract is ambiguous, creating a fact issue regarding the parties' intent.

Summary judgment is not the proper vehicle for resolving disputes about an ambiguous contract.

In other words, if a contract is ambiguous, then the trial judge is not allowed to resolve the ambiguity him- or herself in a comparatively-simple summary judgment proceeding — instead, the parties must subject themselves to a full-blown trial (if they're lucky, a trial on just that one issue), with all the attendant burden, expense, and uncertainty.

Incidentally, the supreme court also noted a generally-accepted point in the law:

Mere disagreement over the interpretation of an agreement does not necessarily render the contract ambiguous.

Spotting and fixing ambiguities in a contract before signature should be a prime goal of all contract drafters and reviewers.

6.2 Example: A date-related ambiguity

Here's a simple example of an ambiguity: Suppose that your client MathWhiz has signed a lease for office space, where it is the tenant. Now suppose that the lease says the following:

Tenant will vacate the Premises no later than 12 midnight on December 15; Tenant's failure to do so will be a material breach of this Agreement.

Now suppose that a MathWhiz representative calls you up and says that they can't move out before 10:00 a.m. on December 15.

Question: At that time, of that day:

  • Would MathWhiz still have 14 hours left in which to finish moving out?
  • Or would MathWhiz already in material breach because it didn't move out by the previous midnight?

In other words, does "by midnight" mean before midnight at the start of the day, or before midnight at the end of the day?

Ripple-effect business complications can arise from such ambiguities — in the December 15 example above, the landlord might have already re-leased the premises to a new tenant, with December 15 as the agreed move-in date.

6.3 How do courts "construe" ambiguous terms?

Here's a quick recap of some basic principles of "construing," that is, interpreting, contracts:

• As noted above, in a lawsuit, the judge normally makes the first pass at determining the meaning of a disputed provision; if the provision is unambiguous, then the judge will declare the provision's meaning.

(Conceivably, the appellate court might have a different view: It might conclude that the provision is indeed ambiguous, in which case the matter might well be remanded for a trial to determine the provision's meaning.)

• If all else fails — if the usual contract-interpretation principles don't produce a definitive answer for what a contract provision means — then the judge will rule that provision is ambiguous.

When a provision is ambiguous, the case must (usually) be tried, and the trier of fact (usually, the jury) gets to decide what the parties are deemed to have had in mind; they will often do this by looking to extrinsic evidence under the parol evidence rule, such as witness testimony by the people who negotiated the contract term(s) in question.

• If a trial court hears the witnesses and makes a determination what the parties are deemed to have intended in drafting the ambiguous provision, then the appellate court isn't likely to overrule that determination (at least in the United States). The Seventh Circuit explained:

The district court's job was to look at extrinsic evidence and determine what the agreement was. It did that.

Our job is to decide if the district court's view of that evidence was clearly erroneous (or legally wrong). …

The argument, 'The Borrowers' position was supported by the evidence presented at trial but our interpretation is way, way better' is a nonstarter.

We are looking to correct error, not reward elegance.

Likewise, the Texas supreme court summarized the general ground rules for interpreting contract language (which I've recast into a bullet-point format):

Absent ambiguity, contracts are construed as a matter of law.
[That is, the trial judge, not the jury, construes the contract, and the appeals court is free to overrule the trial judge].

In construing a written contract,

  • our primary objective
  • is to ascertain the parties' true intentions
  • as expressed in the language they chose.

We construe contracts from a utilitarian standpoint

  • bearing in mind the particular business activity sought to be served,
  • and avoiding unreasonable constructions
    • when possible and proper.

To that end, we consider the entire writing,

  • harmonizing and giving effect to all the contract provisions
  • so that none will be rendered meaningless.

No single provision taken alone is given controlling effect;

  • rather, each must be considered
  • in the context of the instrument as a whole.

We also give words their plain, common, or generally accepted meaning

  • unless the contract shows
  • that the parties used words in a technical or different sense.

While extrinsic evidence of the parties' intent is not admissible to create an ambiguity,

  • the contract may be read in light of the circumstances surrounding its execution
  • to determine whether an ambiguity exists.
  • Consideration of the surrounding facts and circumstances
  • is simply an aid in the construction of the contract's language
  • and has its limits.

The rule[,]

  • that extrinsic evidence is not admissible to create an ambiguity
  • obtains even to the extent of prohibiting proof of circumstances surrounding the transaction
  • when the instrument involved, by its terms, plainly and clearly discloses the intention of the parties,
  • or is so worded that it is not fairly susceptible of more than one legal meaning or construction.

6.4 Do courts apply any specific rules of interpretation?

[Note to students: Skim these; you won't be tested on them.]

Courts often look to specific rules of interpretation such as:

• Specific terms normally take precedence over the general.

• A term stated earlier in a contract is given priority over later terms.

• Under the principle of ejusdem generis, "if a law refers to automobiles, trucks, tractors, motorcycles, and other motor-powered vehicles, a court might use ejusdem generis to hold that such vehicles would not include airplanes, because the list included only land-based transportation."

• The rule of the last antecedent can be illustrated with an example: A federal criminal statute included a mandatory ten-year minimum sentence in cases where the defendant had previously been convicted of "aggravated sexual abuse, sexual abuse, or abusive sexual conduct involving a minor or ward." The Supreme Court held that the minor-or-ward qualifier applied only to abusive sexual conduct, not to sexual abuse; as a result, a defendant was subject to the ten-year mandatory minimum sentence for sexual abuse against an adult.

• But see the series-qualifier principle: Dissenting in Lockhart, Justice Kagan argued: "Imagine a friend told you that she hoped to meet 'an actor, director, or producer involved with the new Star Wars movie.' You would know immediately that she wanted to meet an actor from the Star Wars cast—not an actor in, for example, the latest Zoolander."

• Other things being equal, under the contra proferentem principle, discussed at Clause 23.7 (Contra Proferentem Disclaimer), ambiguous provisions will often be construed against the drafting party.

But savvy contract drafters prefer not to roll the dice about whether a court will apply the above principles in a way that favors the drafter's client. So: To repeat, an extremely-useful general principle of contract drafting is, W.I.D.D. – When In Doubt, Define!

6.5 A dispute about ambiguity can have lots of money riding on it

We saw in § 6.1 how a dispute about ambiguity had millions of dollars riding on it. As another high-stakes example, consider a Fifth Circuit case in which:

  • An off-shore drilling rig was severely damaged by fire while in drydock in Galveston for maintenance.
  • The drilling rig's owner and the drydock owner disputed which of the two parties had had "control" of the rig at the time of the fire.
  • The intended meaning of "control" was important because under the parties' agreement, if the drilling rig's owner had control at the time of the fire, then the drydock owner was not financially responsible for the fire damage. Needless to say, that issue was hotly disputed (if you'll pardon the expression).

The trial court held that the term "control" was unambiguous, and granted summary judgment that, on the undisputed facts, the rig owner, not the dock owner, had been in control at the time of the fire.

The appeals court affirmed; thus, the parties were spared the expense, inconvenience, and uncertainty of a trial on the issue of control of the rig.

Of course, the drilling-rig owner would certainly have preferred to go to trial and take its chances, versus losing on summary judgment without ever getting a shot at persuading a jury. But for the drydock owner, not having to go to trial was most assuredly a win in its own right.

6.6 The A.T.A.R.I. Rule

What to do about an ambiguity in a contract draft might well depend on the circumstances:

• On the one hand, unambiguous language is generally a Good Thing, because it tends not to result in disputes between the parties about the language's meaning — although that certainly isn't a universal rule.

And if a dispute does arise over an unambiguous provision, the judge will often decide the case quickly, e.g., on a motion to dismiss on the pleadings or a motion for summary judgment.

That's because in the U.S., as noted above, the interpretation of an unambiguous contract term is generally a "question of law," that is, the proper interpretation will be decided by the trial judge (subject to review by the appeals court) and not by a jury.

• In contrast: When a contract is ambiguous, creative litigation counsel, exercising 20-20 hindsight, can be quite skilled at proposing meanings that favor their clients.

Ambiguities in a contract aren't necessarily fatal, because the law has rules for resolving them, as discussed above.

But an expensive- and time-consuming trial is likely to be needed to determine just what the parties had in mind.

To borrow a phrase from a former student in a different context: "That's a conversation we don't want to have."

When in doubt, A.T.A.R.I. - Avoid the Argument: Rewrite It.

Did your side draft the ambiguous language? If you or one of your colleagues drafted the ambiguous language, then you'll very likely want to fix the ambiguity, especially if the draft hasn't yet been sent to the other side. That's because under the doctrine of contra proferentem, a court might resolve the ambiguity in favor of the other side because your side was responsible for the ambiguity.

What if the other side drafted the ambiguous language? Now consider these points:

– If the other side drafted the ambiguous language, then you might not want to say anything about it, in the hope that contra proferentem would result in an interpretation favorable to your client.

– That could be especially true if your client doesn't have the superior bargaining position: If you call the other side's attention to the ambiguity, the other side might wake up and ask for something that's even worse for your client than living with the ambiguity, because you "kicked the sleeping dog" as discussed in § 9.6.2. That might be another reason to keep silent about the ambiguity.

– BUT: If later the other side can show that you noticed, but failed to raise, an ambiguity created by the other side's drafter, then the other side might try to argue that you waived application of contra proferentem by "laying behind the log."

– AND: No matter what, if you don’t ask the other side to correct an ambiguity they created, then you might be setting up your client for an expensive, burdensome, future fight — a fight that perhaps might have been avoided with clearer drafting.

So what to do?

  • The Check-In Rule applies here (see § 5.8): Check in with the partner and/or the client about this, and have a recommendation with reasons.
  • But the A.T.A.R.I. Rule (see § 6.6) might be more important.

6.7 Vagueness is a type of ambiguity – what to do about it?

As one type of ambiguity, a term is vague if its precise meaning is uncertain.

• A classic example is the term tall: If you say that someone is tall, you could be referring to that a third-grader who is tall for his- or her age but is still very-much shorter than the general adult population.

• Another classic example of vagueness is the word cool; depending on the season and the locale, the term could refer to a wide range of temperatures. For example, in Houston in August a mid-day temperature of 80ºF would be regarded as (comparatively) cool, whereas in Point Barrow, Alaska, the same temperature at that time would likely be thought of as a real scorcher.

(Of course, as any parent in an English-speaking family knows, the word cool could also be ambiguous — in the sense of having multiple possible meanings — in addition to being vague.)

Let's look at another example, this time a silly one. Consider the following provision in a contract for a home caregiver:

Nurse will visit Patient's house each day, check her vital signs, and give her cat food.

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

1. Nurse is to put a bowl of food down for Patient's cat each day.

2. Nurse is to deliver cat food to Patient when Nurse visits.

3. Nurse is to feed cat food to Patient.

In addition, the sentence above might also be vague if it turned out that Patient had more than one cat.

Moreover, meanings #1 and #2 above are vague in another sense as well: The term cat food encompasses wet food, dry food, etc.

Vagueness is not necessarily a bad thing. Parties might be confident that, if a question ever arises, it'll be clear what was intended by, say, the term reasonable efforts (see the definition in Clause 25.41).

So here's a rule of thumb: Vagueness is not always worth fixing.

But a vague term is always worth taking a look at to see if it should be replaced by a more-precise term.

6.8 Special case: D.R.Y. - Don't Repeat Yourself

Stating a term more than once in a contract can cause severe problems if:
(i)  a term is revised during negotiation, and
(ii)  the revision is not made in every place that the term occurs.

Just this type of mistake once cost a bank $693,000:

  • The bank sued to recover $1.7 million from defaulting borrowers and their guarantor. In the lower court, the bank won a summary judgment.
  • Unfortunately for the bank, the loan documents referred to the amount borrowed as "one million seven thousand and no/100 ($1,700,000.00) dollars" (capitalization modified, emphasis added).

The appeals court held that, under standard interpretation principles, the words, not the numbers, controlled; thus, the amount guaranteed was only $1.007 million, not $1.7 million.

(You probably wouldn't want to be the junior associate or paralegal who oversaw the document preparation in that case.)

Likewise, in a Delaware case:

  • A contract's termination provision allowed termination if a material breach was not cured within "fifteen (30) days" after notice of the breach.
  • The breaching party refused to cure the breach, so the non-breaching party terminated the agreement shortly after 15 days had elapsed from the notice of breach.
  • The breaching party had a change of heart after receiving the notice of termination and proceeded to cure the breach.

The court said, in effect, "sorry, too late" — because the word fifteen took precedence over the numerals 30.

Another case:

  • One of the author’s clients was contemplated being acquired.
  • A potential acquiring party proposed a confidentiality agreement (a.k.a. nondisclosure agreement a.k.a. NDA).
  • The text said, in part: "provided, however, that in the event that a court of law shall determine that a fixed duration of survival is required, said [confidentiality] obligations shall survive for a period of five (3) years from the later of the following: the date of termination or expiration of this Agreement, or the date that either party notifies the other party that it has decided not to enter into the transaction or agreement contemplated by the parties."

(In that case I fixed the inconsistency, even though I hadn't created it as discussed in [BROKEN LINK: ambig-yours][BROKEN LINK: ambig-yours].)

Here's an example of how to do it better:

Bob will pay Alice one hundred thousand dollars ($100,000.00) $100,000 for the House, with 50% due upon signing of this Agreement.

Sometimes, though, repetition can be used (cautiously) to emphasize a point — after all, the drafter's mission is still to educate and persuade (see § 5.4), not merely to slavishly follow drafting guidelines.

6.9 Vagueness example: The "false imperative"

Passive voice is often disfavored, but it's not necessarily a serious error — unless the passive-voice provision leaves it unclear who must do what.

(Think of two baseball outfielders who let an easily-catchable fly ball drop to the ground between them because neither one "calls it" and each assumes that the other will get it.)

As a business example, suppose that:

  • a real-estate developer enters into a construction agreement with a general contractor;
  • under the construction agreement, the contractor is to build a building;
  • because of the nature of the building site, special safety procedures will be needed for all personnel coming on the site;
  • the construction agreement says simply: "All Developer personnel are to be trained in special safety procedures for the Building Site."

This is an example of a so-called "false imperative," because it arguably leaves unclear just who is responsible for training the developer's personnel in the special safety procedures.

(Other portions of the construction agreement might shed light on the question, but that's not the ideal situation.)

A useful business expression (albeit a bit trite from overuse) is One Throat to Choke!

Drafting lesson: Even when passive voice is appropriate, a contract provision should not leave any doubt about who is responsible for making Item X happen.

6.10 Optional further reading about ambiguity

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

See also numerous categorized case citations by KPMG in-house attorney Vince Martorana, at A Guide to Contract Interpretation (ReedSmith.com 2014).

6.11 Exercises and discussion questions

6.11.1 Exercise: Selling a house

TEXT: Alice will sell the house at 1234 Main Street to Bob. … [and later in the document:] Alice will not alter the house at 1234 Main Street before the Closing.

EXERCISE: Rewrite.

Alice will sell the house at 1234 Main Street (the "House") to Bob. … Alice will not alter the House before the Closing.

6.11.2 Ambiguity: Lola, by The Kinks

From The Kinks' famous song Lola (play the relevant clip on YouTube):

Well I'm not the world's most masculine man
But I know what I am and I'm glad I'm a man
And so is Lohhh-lahhh
Lo lo lo lo Lohhh-lahhh. Lo lo lo lo Lohhh-lahhhh

(Emphasis added.)

QUESTION: When the artists sing, "And so is Lola," what exactly is Lola?

EXERCISE: How that lyric line could be clarified? (Don't worry about rhyme or meter.)

6.11.3 Ambiguity: Successful men

From a Facebook posting: "A man's success has a lot to do with the kind of woman he chooses to have in his life. (Pass this on to all great women.)"

QUESTION: What's a different (and possibly-offensive) interpretation of this quote?

That successful men are in a better position to choose great women to have in their lives?

6.11.4 Passive voice and pest control

FACTS: An apartment lease states (in part): "The apartment shall be regularly serviced by a professional pest-control service."

QUESTION: This is an example of what? (Two words, not "passive voice.")

Answer: False imperative

6.11.5 Ambiguity: Plush carpets

From an article in The Guardian:

There will be plush lecture theatres with thick carpet, perhaps named after companies or personal donors.

QUESTION: What, exactly, is named after companies or personal donors?

QUESTION: How could this sentence be rewritten to clarify it?

Rewritten: There will be plush lecture theatres (with thick carpet), perhaps named after companies or personal donors.

Not quite as good: There will be plush lecture theatres — with thick carpet — perhaps named after companies or personal donors.

7 Drafting for readability

7.1 Draft short, single-topic paragraphs (don't be a L.O.A.D.)

You might decide you can't draft clauses in bullet-point format as suggested in § 7.5). But still, you can avoid dense, "wall of words" legalese — in all likelihood, a series of short, plain statements of the parties' intent will do nicely.

Each paragraph in a contract draft (i) should be short, and (ii) should address a single topic. That's because, other things being equal, short, single-topic paragraphs —

  • are less likely to be summarily rejected by a busy reviewer because she doesn't want to spend the time to decipher long complex sentences;
  • can be saved more easily for re-use, and later snapped in and out of a new contract draft like Lego blocks, without inadvertently messing up some other contract section;
  • are easier to revise if necessary during negotiation;
  • reduce the temptation for the other side's reviewer to tweak more language than necessary — and that's a good thing, because language tweaks take time to negotiate, which in turn causes business people to get impatient and to blame "Legal" for delaying yet another done deal.

So don't be a L.O.A.D. (a Lazy Or Arrogant Drafter): If a sentence or paragraph starts running long, seriously consider breaking it up.

To illustrate the point, consider the following 415-word "wall of words" sentence (!), which is provided as a "don't do this!" example at the estimable WeAgree Website of Netherlands lawyer Willem Wiggers. The sentence covers not one, not two, but five separate topics (and note the abomination of "provided that"):

Exclusivity. The Seller covenants and agrees that for a period of ninety (90) days after the date first written above (the "Effective Date") or such shorter period as set forth below (as the case may be, the "Exclusivity Period"), none of the Seller, its affiliates or subsidiaries will, and they will cause their respective shareholders, directors, officers, managers, employees, agents, advisors or representatives not to, directly or indirectly, solicit offers for, encourage, negotiate, discuss, or enter into any agreement, understanding or commitment regarding, a possible direct or indirect sale, merger, combination, consolidation, joint venture, partnership, recapitalization, restructuring, refinancing or other disposition of all or any material part of the Company or its subsidiaries or any of the Company's or its subsidiaries' assets or issued or unissued capital stock (a "Company Sale") with any party other than Purchaser or provide any information to any party other than Purchaser regarding the Company in that connection; provided that, (i) for the time period commencing on the Effective Date and ending at 11:59 p.m. Central European Time on 7 July 2007 (the "Bid Confirmation Date"), the Parties shall work together in good faith and use commercially reasonable efforts to facilitate due diligence by Purchaser and their advisors to confirm, based on the information made available to Purchaser or their advisors prior to the Bid Confirmation Date, the intent of Purchaser to implement the Transaction pursuant to the terms of this Heads of Agreement and if Purchaser does not deliver notice to Seller of such intent by 11:59 p.m. Central European Time on (or otherwise prior to) the Bid Confirmation Date (such notice, a "Bid Confirmation"), then Seller shall have the right to terminate the Exclusivity Period effective as of (but not prior to) the Bid Confirmation Date by providing written notice to Purchaser by no later than 5 p.m. Central European Time on (but not prior to) the day following the Bid Confirmation Date; and (ii) if Purchaser delivers the Bid Confirmation or if such termination notice set forth in the preceding clause (i) is not given, the Seller shall have the right to terminate the Exclusivity Period effective as of (but not prior to) 11:59 p.m. Central European Time on the sixtieth (60th) day following the Effective Date by delivering written notice of such termination to Purchaser by no later than 5 p.m. Central European Time on (but not prior to) the sixty-first (61st) day following the Effective Date.

(Bold-faced emphasis added.) To repeat: The above paragraph is a single sentence.

7.2 Create defined terms to help shorten sentences

The above L.O.A.D.-bearing wall of words could be simplified by moving many of the substantive terms into definitions, along the following lines:

Exclusivity.

See subdivision (h) for definitions.

(a) During the Exclusivity Period, Seller:

      (i) will not engage in any Off-Limits Activity, and

      (ii) will cause each other member of the Seller Group not to engage in any Off-Limits Activity.

[DCT comment: This subdivision is an example of BLUF — Bottom Line Up Front — as explained at § 7.6.]

(b) During the Exclusivity Period, the Parties will (i) work together in good faith, and (ii) use commercially reasonable efforts, to facilitate due diligence by Purchaser and Purchaser's advisors.

(c) Seller may terminate the Exclusivity Period if Purchaser does not deliver a Bid Confirmation Notice to Seller at or before the end of the Bid Confirmation Period.

[Other provisions omitted]

(h) Definitions:

"Bid Confirmation Notice" refers to written notice from Purchaser to Seller confirming Purchaser's to implement the Transaction pursuant to the terms of this Heads of Agreement, based on the information made available to Purchaser and its advisors.

"Bid Confirmation Period" refers to the period beginning on the Effective Date and ending at exactly 11:59 p.m. Central European Time on 7 July 2007.

[Other provisions omitted]

7.3 Contract length isn't as important as clause length

"Wow, this is a long contract!" Most lawyers have heard this from clients or counterparties.

True, sometimes contracts run too long because of over-lawyering, where the drafter(s) try to cover every conceivable issue.

But focusing too obsessively on contract length will obscure a more-important issue: contract readability.

This isn't just a question of aesthetic taste. The more difficult a draft contract is to read and understand, the more time-consuming the review process, which delays the deal (and increases the legal expense).

Readability has little to do with how many pages a contract runs. Many negotiators would rather read a somewhat-longer contract, consisting of short, understandable sentences and paragraphs, than a shorter contract composed of dense, convoluted clauses.

So the better way to draft a contract is to write as many short sentences and paragraphs as are needed to cover the subject.

Even if the resulting draft happens to take up a few extra pages, your client likely will thank you for it.

7.4 White space is your friend

The author used to hold to the view that it was a good idea to use a "compressed" format for contracts — with narrow margins, long paragraphs, and small print — so as to fit on fewer physical pages. It had been my experience that readers tended to react negatively when they saw a document with "many" pages.

But I've since concluded that if you expect to have to negotiate the contract terms, then larger print, shorter paragraphs, and more white space:

  • will make it easier for the other side to review and redline the draft — always a nice professional courtesy that might just help to earn a bit of trust; and
  • will make it easier for the parties to discuss the points of disagreement during their inevitable mark-up conference call.

A more-readable contract likely will likely get the parties to signature more quickly, and that of course, is the goal.

(At least that's the intermediate goal — ordinarily, the ultimate goal should be to successfully complete a transaction, or to establish a good business relationship, in which each party feels it received the benefit of its bargain and would be willing to do business with the other side again.)

7.5 Bullet-point clauses are a quicker read

Here are two versions of the same contract clause, copied from a 2007 real-estate lease, at https://goo.gl/Qn2e9m (edgar.sec.gov), in which Tesla Motors, Inc., leased a building from Stanford University. Which of these versions would you find easier to review?

Before:

12.5 Indemnity. Tenant shall indemnify, defend (by counsel reasonably acceptable to Landlord), protect and hold Landlord and Landlord’s trustees, directors, officers, agents and employees and their respective successors and assigns (collectively, "Landlord’s Agents"), free and harmless from and against any and all claims, liabilities, penalties, forfeitures, losses or expenses (including reasonable attorneys’ and consultants’ fees and oversight and response costs) to the extent arising from (a) Environmental Activity by Tenant or Tenant’s Agents; or (b) failure of Tenant or Tenant’s Agents to comply with any Environmental Law with respect to Tenant’s Environmental Activity; or (c) Tenant’s failure to remove Tenant’s Hazardous Materials as required in Section 12.4. Tenant’s obligations hereunder shall include, but not be limited to, the burden and expense of defending all claims, suits and administrative proceedings (with counsel reasonably approved by Landlord), even if such claims, suits or proceedings are groundless, false or fraudulent; conducting all negotiations of any description; and promptly paying and discharging when due any and all judgments, penalties, fines or other sums due against or from Landlord or the Premises. Prior to retaining counsel to defend such claims, suits or proceedings, Tenant shall obtain Landlord’s written approval of the identity of such counsel, which approval shall not be unreasonably withheld, conditioned or delayed. In the event Tenant’s failure to surrender the Premises at the expiration or earlier termination of this Lease free of Tenant’s Hazardous Materials prevents Landlord from reletting the Premises, or reduces the fair market and/or rental value of the Premises or any portion thereof, Tenant’s indemnity obligations shall include all losses to Landlord arising therefrom.

After: The above legalese can be made significantly more readable just by breaking up its wall of words into bullet points, with appropriate indentation, highlighting the separate concepts that need review. Here's an example; I've made only minimal stylistic edits, even though a lot more could be done:

12.5 Indemnity.

(a) Tenant shall:

  • indemnify,
  • defend,
    • by counsel reasonably acceptable to Landlord,
  • protect, and hold Landlord,
    • and Landlord’s trustees, directors, officers, agents and employees,
    • and their respective successors and assigns
    • (collectively, "Landlord’s Agents"),
  • free and harmless from and against any and all claims, liabilities, penalties, forfeitures, losses or expenses,
    • including reasonable attorneys’ and consultants’ fees,
    • along with oversight and response costs,
  • to the extent arising:
    • from Environmental Activity by Tenant or Tenant’s Agents,
    • or from failure of Tenant or Tenant’s Agents to comply with any Environmental Law with respect to Tenant’s Environmental Activity,
    • or from Tenant’s failure to remove Tenant’s Hazardous Materials as required in Section 12.4.

(b) Tenant’s obligations hereunder shall include, but not be limited to, the burden and expense of:

  • defending all claims, suits and administrative proceedings,
    • with counsel reasonably approved by Landlord,
    • even if such claims, suits or proceedings are groundless, false or fraudulent;
  • and promptly paying and discharging, when due, any and all judgments, penalties, fines or other sums due against or from Landlord or the Premises.

[remaining text omitted]

More paper — so? To be sure, the "After" version above takes up more space than the "Before" version. But really: Who cares? These days, PDF'd signature pages and electronic signatures are the norm; for busy business people, the number of pages in a contract will usually matter far less than the time they have to wait around for legal review before signing the contract.

Clients prefer bullet points — and counterparties don't object: The author originally developed this bullet-point approach while reviewing and revising other parties' contract drafts for clients:

  • I often encountered wall-of-words provisions like the "Before" version above.
  • To help clients understand what they were agreeing to — and to reduce the chances that I'd miss something — I started breaking up the long paragraphs of dense legalese.

Turning legalese into bullet points has worked out pretty well:

  • My clients have uniformly appreciated the enhanced readability.
  • No counterparty or its counsel has ever objected to the bullet points.
  • The parties have always gone on to sign the bullet-points version, not the other side's original wall-of-words version.

7.6 The BLUF Rule: Bottom Line Up Front

BLUF is an acronym used in the military as a guide for writing emails: Bottom Line Up Front. The same principle is useful in contract drafting.

Before:

If any shareholder of the corporation for any reason ceases to be duly licensed to practice medicine in the state of Alabama, accepts employment that, pursuant to law, places restrictions or limitations upon his continued rendering of professional services as a physician, or upon the death or adjudication of incompetency of a stockholder or upon the severance of a stockholder as an officer, agent, or employee of the corporation, or in the event any shareholder of the corporation, without first obtaining the written consent of all other shareholders of the corporation shall become a shareholder or an officer, director, agent or employee of another professional service corporation authorized to practice medicine in the State of Alabama, or if any shareholder makes an assignment for the benefit of creditors, or files a voluntary petition in bankruptcy or becomes the subject of an involuntary petition in bankruptcy, or attempts to sell, transfer, hypothecate, or pledge any shares of this corporation to any person or in any manner prohibited by law or by the By-Laws of the corporation or if any lien of any kind is imposed upon the shares of any shareholder and such lien is not removed within thirty days after its imposition, or upon the occurrence, with respect to a shareholder, of any other event hereafter provided for by amendment to the Certificates of Incorporation or these By-Laws, [here we finally get to the "bottom line":] then and in any such event, the shares of this [c]orporation of such shareholder shall then and thereafter have no voting rights of any kind, and shall not be entitled to any dividend or rights to purchase shares of any kind which may be declared thereafter by the corporation and shall be forthwith transferred, sold, and purchased or redeemed pursuant to the agreement of the stockholders in [e]ffect at the time of such occurrence. The initial agreement of the stockholders is attached hereto and incorporated herein by reference[;] however, said agreement may from time to time be changed or amended by the stockholders without amendment of these By-Laws. The method provided in said agreement for the valuation of the shares of a deceased, retired or bankrupt stockholder shall be in lieu of the provisions of Title 10, Chapter 4, Section 228 of the Code of Alabama of 1975.

After:

(a)     A shareholder's relationship with the corporation will be terminated, as specified in more detail in subdivision (b), if any of the following Shareholder Termination Events occurs:

      (1) The shareholder, for any reason, ceases to be duly licensed to practice medicine in the state of Alabama.

      (2) The shareholder accepts employment that, pursuant to law, places restrictions or limitations upon his continued rendering of professional services as a physician.

      [remaining subdivisions omitted]

(b)     Immediately upon the occurrence of any event described in subdivision (a), that shareholder's shares:

      (1) will have no voting rights of any kind,

      [Remaining subdivisions omitted]

(Emphasis added.)

7.7 Omit needless words — but remember  your mission

"Omit needless words" is a famous quotation from Strunk & White's The Elements of Style. Here are some examples of possibly-needless words, from the SEC's Plain English Handbook (slightly edited):

  • in order to : to
  • in the event that : if
  • subsequent to : after
  • prior to : before
  • despite the fact that : although
  • because of the fact that : because; since
  • in light of : ditto
  • owing to the fact that : ditto

But remember your mission: To educate, and possibly persuade, readers (see § 5.4). That’s why it can sometimes be helpful to (judiciously) record reasons and explanations in a contract, to educate later readers about why the negotiators agreed to certain things.

Brevity in a contract is a virtue, to be sure. But it's far from the only one — or even the most important one. Sometimes a few words of explanation or clarification (possibly in footnotes) can be cheap insurance.

7.8 Exercises and discussion questions

7.8.1 Discussion: White space and bullet points

QUESTION 1: What's your opinion about lots of white space in a contract?

QUESTION 2: What's your opinion about using bullet points in contract?

7.8.2 Discussion: The BLUF Rule

QUESTION: What does BLUF stand for — and why is it significant? (Hint: See § 7.6.)

7.8.3 Exercise: Rewriting the 415-word L.O.A.D

Using the principles explained above, just break up the 415-word provision at § 7.1.

(For an idea how to get started, see § 7.2.)

7.8.4 Review: When style preferences clash

FACTS:

• Your client MathWhiz asks you to review a draft contract sent by a potential customer of MathWhiz.

• You notice that the draft spells out all kinds of numbers, e.g., "twenty thousand dollars."

• The draft doesn't also include the corresponding numerals in parentheses, i.e., it doesn't say "twenty thousand dollars ($20,000.00)."

QUESTION: When reviewing and revising the draft contract, do you change "twenty thousand dollars" to "$20,000.00"?

No, that's a purely-stylistic revision — it's not a great idea to spend "negotiating chips" on that kind of change.

8 General writing rules

Contract-drafting students should learn — even memorize — the rules in this chapter.

Contents:

8.1 Style guide for numbers

This section sets out some stylistic conventions that lawyers typically follow in drafting contracts.

1.  Spell out the numbers one through ten; use numerals for 11, 12, 13, etc.

2.  Both in the same sentence? Consider using just numbers: The quiz will contain between 8 and 12 questions.

3.  Don’t start a sentence with numerals; either spell out the numerals in words or (preferably) rewrite the sentence.

BEFORE AFTER
42 was Douglas Adams’s answer to The Ultimate Question of Life, the Universe, and Everything. According to the late novelist Douglas Adams, the answer to The Ultimate Question of Life, the Universe, and Everything is … 42.

4.  Spell out million, billion, trillion — but not thousand. Example: More than 300,000,000 300 million people live in the United States. Example: Alice will pay Bob $5 thousand $5,000.

5.  Important: Don’t spell out a number in words and then restate the number in numerals. Example: More than three hundred 300 million (300,000,000) people live in the United States.

6.  Don't say "in United States dollars" if there's no possibility of confusion.

7.  If currency confusion is a possibility, then use ISO 4217 currency abbreviations such as USD, as in: Buyer will pay USD $30 million. (The USD abbreviation goes where indicated, not after the numbers.)

8.  Don't spell out dollar amounts in words. Example: Alice will pay Bob five thousand dollars $5,000.

9.  Omit zero cents unless relevant. Example: Alice will pay Bob $5,000.00 $5,000. But: Alice will pay Bob $3,141.59.

10.  Spell out a percentage if it’s at the beginning of a sentence — or just use numbers and rewrite the sentence to avoid starting with the percentage. Example: 30% Thirty percent of the proceeds will be donated to charity. Better: Of the proceeds, 30% will be donated to charity.

8.2 Parallelism in lists: Be consistent

In lists, you should be able to delete any item in the list and still have the sentence make sense grammatically. Example: The policeman told us to observe the speed limit and we should dim to dim our lights.

8.3 Avoid gobbledygook

From the PlainLanguage.gov Website:

BEFORE AFTER
Consultation from respondents was obtained to determine the estimated burden. We consulted with respondents to estimate the burden.

8.4 Active voice is better — usually

Active voice gets to the point by putting the actor first. Look at the following before-and-after examples:

BEFORE AFTER
A song was sung by her. She sang a song.

But sometimes passive voice is better, for example if the doer or actor of the action is unknown, unimportant, obvious, or better left unnamed:

  • The part is to be shipped on 1 June. (If the actor is unclear or unimportant.)
  • Presidents are elected every four years. (The actors are obvious.)
  • Christmas has been scheduled as a workday. (The actor is better left unsaid.)

And clear, forceful, active-voice language might be inappropriate in diplomacy; in political negotiations — or in contract negotiations. [DCT comment: The original USAF sentence said “… may be inappropriate,” but it’s better to stick with “might be” — use "may" for permission, "might" for possibility.]

8.5 Streamline your sentences

It’s too easy to let a sentence get fat and sloppy. Here are a few examples:

BEFORE AFTER
They made the decision to give their approval. They decided to approve it.
Or: They approved it.
The team held a meeting to give consideration to the issue. The team met to consider the issue.
Or: The team considered the issue.
We will make a distribution of shares. We will distribute shares.
We will provide appropriate information to shareholders. We will inform shareholders.
We will have no stock ownership of the company. We will not own the company’s stock.
There is the possibility of prior Board approval of these investments. The Board might approve these investments in advance.
The settlement of travel claims involves the examination of orders. Settling travel claims involves examining orders.
Use 1.5 line spacing for the preparation of your contract draft. Use 1.5 line spacing to prepare your contract draft.
  Better: Use 1.5 line spacing for your draft contract.

8.6 Word order might matter

Example: “We want only the best” has a slightly-different meaning than “We only want the best.”

Another example, excerpted from StackExchange:

I eat fish only when I'm sick.

I eat only fish when I'm sick.

And another example, also excerpted from StackExchange:

(2) In 1996, only Ford sold a rebadged Mazda 626 GV over here as its rebranded Japanese mid-size stationwagon. (Ford was the only manufacturer)

 * * *

(4) In 1996, Ford sold a rebadged Mazda 626 GV over here as its only rebranded Japanese mid-size stationwagon (there were no others, I assume?)

8.7 "May" and "might" are different

To avoid possible confusion:

  • Use may to indicate permission: ABC may delay payment until December 31.
  • Use might to indicate possibility: It might rain tomorrow.

8.8 Microsoft Word: Crucial things to know

[Students: Items 1-5 are fair game for testing; the remaining items are nice to know but won't be tested.]

1. The safest way to format a paragraph without corrupting the document and crashing the Word program is to format the style of the paragraph, not the individual paragraph itself.

2. To create a heading, use Heading styles: Heading 1, Heading 2, etc.

3. Headings can be automatically numbered by using the Bullets and Numbering feature under Format. The following apply mainly to the formatting of styles, but can be used with caution to format individual paragraphs:

4. On rare occasions, to adjust the line spacing within a specific paragraph, use the menu sequence: Format | Paragraph | Indents and Spacing | Spacing (almost smack in the middle of the dialog box on a Mac).

5. To adjust the spacing between paragraphs, use the menu sequence: Format | Paragraph | Indents and Spacing menu. Don’t use a blank line to separate paragraphs — adjust the spacing instead.

6. To keep one paragraph on the same page with the following paragraph (which is sometimes useful), use the menu sequence Format | Paragraph | Line and Page Breaks | Keep with Next.

Here are some other tips:

7. A table of contents can be useful in a long contract. To create a table of contents, in the References tab, use the Table of Contents dropdown box and select Custom Table of Contents.

8. Tables can sometimes be useful in contracts. To remove the borders from a table (the way Word normally creates them), first use the menu sequence: Table | Select | Table. Then use the menu sequence: Format | Borders & Shading | Borders | None.

9. To copy and paste a short snippet from a Web page into a Microsoft Word document without messing up the formatting of the paragraph into which you’re pasting the snippet, use the menu sequence: Edit | Paste Special | Unformatted text. (Alternatively: Edit | Paste and Match Formatting.)

8.9 Exercises and discussion questions

8.9.1 Discussion: Considering the issue

FACTS: One of the "After" examples in § 8.5 is "They met to consider the issue." A fellow student suggests that this sentence could be streamlined even further, to say simply: They considered the issue.

QUESTION: Would this further simplification be a good idea? What information would be lost, and why might that information be important?

The fact of the meeting might be legally significant; this could be the case, for example, in a court's assessment of whether a corporation's board of directors had given sufficient consideration to an issue to qualify for the business-judgment rule that courts generally will decline to second-guess a board's decision about a business matter if it appears that the board used due care to make an informed decision.

8.9.2 Discussion: Broken parts

TEXT: The part must have been broken by the handlers.

DISCUSS: Any issues here?

This is passive voice, but if it's more important to state by whom the part was broken, it might be OK.

8.9.3 Headings in Word documents

In Microsoft Word, how do you indicate that particular text is a heading?

Use a Heading style.

8.9.4 May and might

Of the words may and might:

  • Which is used to express possibility?
  • Which is used to express permission?

Use may for permission, might for possibility.

9 Drafting workable contracts

9.1 Offer balanced terms (and get to signature sooner)

If you're doing the drafting, you can help speed things up considerably by being reasonable in what you offer to the other side. That's because many busy business people greatly prefer to sign contracts that are reasonably balanced.

The author learned this from personal professional experience. I used to be vice president and general counsel of BindView Corporation, a public network-security software company based in Houston, until we were acquired by Symantec Corporation, the global leader in our field. As outside counsel, I'd helped BindView's founders to start the company.

As soon as I went in-house, I had to handle all our negotiations with customers about our standard contract form. We dramatically speeded up our deal flow by revising the contract form to proactively provide balanced legal terms that our customers typically asked for, in ways that we knew we could support.

In addition to helping us get to signature sooner, the (re)balanced contract form indirectly promoted our product in another way: Customers began to tell me how much they liked our contract, which validated their decision to do business with us.

I started making notes of customers’ favorable comments, and eventually quoted some of the comments (anonymously) on a cover page of our contract form. Here are just a few of those customer comments, which I posted online some years ago; all are from negotiation conference calls except as indicated:

• From an in-house attorney for a multinational health care company: I told our business people that if your software is as good as your contract, we’re getting a great product.

• From an in-house lawyer at a U.S. hospital chain: I giggled when I saw the "movie reviews" on your cover sheet. I’d never seen that before — customers saying this was the greatest contract they’d ever seen. But the comments turned out to be true.

• From a contract specialist at a national wireless-service provider: I told my boss I want to give your contract to all of our software vendors and tell them it’s our standard contract, but I know we can’t do that.

• From an in-house attorney at a global media company: This is a great contract. Most contracts might as well be written in Greek, but our business guys thought this one was very readable.

On a couple of occasions, BindView was the customer. On each of those occasions, instead of taking time to negotiate the other vendor's contract form, we proposed just using our form, with us as the customer instead of as the vendor; each time, the other vendor quickly agreed.

You might wonder whether BindView ever experienced legal- or business problems from having a balanced contract form. I’ll note only that:

  • With the CEO’s permission, I talked about our balanced-contract philosophy in continuing-legal-education ("CLE") seminars, and even included a copy of our standard form in written seminar materials; and
  • In due course we had a successful "exit" when we were approached and acquired by Symantec Corporation, one of the world’s largest software companies and the global leader in our field.

To be sure: Some business people just love to "win" as much as they can in every contract negotiation, often violating Wheaton's Law (warning: crude). If that's you, then the Tango Terms aren't the terms you're looking for.

9.2 You don't want a "wounded tiger" later

Even if your client has a lot of bargaining power, you might well be better off not trying to use it to overreach against the other party. Research indicates that hardball negotiation often lead to worse overall outcomes:

If people[:]

  • start with a high anchor and concede slowly,
  • use aggressive tactics,
  • express some anger,

they end up achieving favorable negotiated deal terms.

But what we’re finding — and this is our central thesis — is that sometimes by being more assertive, by being more aggressive, you might end up with a better negotiated outcome …

but ultimately, through that process, create conflict that causes you to end up with worse value overall.

For example, suppose that you represent a customer company that has a lot of bargaining power. And suppose that your client wants to use that power to force a vendor to make some tough concessions in a contract negotiation.

Your client's negotiators might well regard those concessions as an entitlement: We're the customer, we're the big dog; of course we get what we want.

But the customer's negotiators should also recall that ultimately, all contracts have to be performed by people. And people will almost certainly be influenced, not just by the words of the contract, but by their employer's then-current interests — and by their own personal interests as well.

If the vendor's people feel they've been crushed by the customer, they're unlikely to harbor warm and fuzzy feelings for the customer.

(This is at least doubly true if the contract later proves to be a train wreck for the vendor — most business people know that being associated with a train wreck is seldom good for anyone's professional reputation.)

In that situation, the vendor's people are not likely to be motivated to go out of their way for that customer. They might well be tempted to "work to rule," to use an expression from the labor-relations world — to do just what the contract requires, and no more. That does neither party any favors.

And the reverse can be true when the shoe's on the other foot. Suppose that the customer thinks that it's been taken advantage of by a vendor. When it comes time for renewals, or repeat business, or recommendations to other companies, that vendor probably won't have a lot of brownie points with the customer's people.

For example, in a Sixth Circuit case:

  • A software customer did a corporate reorganization that resulted in the use of the licensed software being technically switched to an affiliate that wasn't covered by the original license grant.
  • The software vendor demanded that the customer re-buy the license; when the customer refused, the vendor took the customer to court, and won.

So: After treating its customer that way, what are the odds that the vendor would ever be able to sell anything again to that customer — let alone convince the customer to be a reference for the vendor's future sales efforts? Talk about pennywise and pound-foolish ….

The lesson for contract drafters and negotiators: Even if you've got the power to impose a killer contract on the other side, think twice before you do so. You could be setting up your client to have to deal later with a wounded tiger.

9.3 Danger: Too-harsh terms could hurt you later

In the Kingston Trio's (somewhat-offensive) 1958 version of the risqué Spanish-language song Coplas, Dave Guard's "translation" of one verse is, Tell your parents not to muddy the water around us — they may have to drink it soon.

Kingston Trio Stereo Concert album cover

Contract drafters will often do well to heed similar advice: Their clients might someday have to live with the hardball provision they force the other side to accept. This section discusses a few examples.

Example: Trump Corporation's lease terms. Trump Corporation ("Trump") has been a real-estate landlord, among other things. According to AmLaw Daily, years ago Trump's lawyers took one of the company's lease agreements, changed the names, and used it for a deal in which Trump was the tenant and not the landlord.

Trump Organization logo

Later, Trump-as-tenant found that its lease-agreement form gave Trump's landlord significant leverage:

"The funny part of it is what one of his internal lawyers must have done years ago," [the landlord's president] says. "Normally Trump is the landlord, not the tenant. So what they did is they took one of their leases and just changed the names. And so it's not a very favorable lease if you're the tenant."

Ouch ….

Example: Tilly's sets the signature bar too high. Tilly's, Inc. and World of Jeans & Tops, Inc. ("Tilly's") had an employee sign an employment agreement (the "2001 employment agreement") containing an arbitration provision.

Tilly's logo
  • The 2001 employment agreement included a carve-out for statutory claims (which thus could be brought in court, not in arbitration).
  • Importantly, the 2001 employment agreement also stated that any modifications to the agreement would need the signatures of three executives: The company's president; senior vice president; and director of human resources.
  • In 2005, the company had its employees sign an acknowledgement of receipt of an employee handbook containing a different arbitration provision — which didn't contain the carve-out for statutory claims.
  • The signed acknowledgement, though, didn't contain the three executive signatures needed to modify the 2001 employment agreement.

So: Because Tilly's set the so bar high for modifying the 2001 employment agreement — requiring three executive signatures — the company found itself facing high-stakes litigation by a class of plaintiffs, whereas it had thought it would be arbitrating low-stakes claims individually.

Example: A one-way NDA later leaves a party unprotected. With a one-way nondisclosure agreement, only the (original) disclosing party's information is protected. This means that any disclosures by the receiving party might be completely unprotected — resulting in the receiving party's losing its trade-secret rights in its information.

That's just what happened to the plaintiff in a Seventh Circuit case: The plaintiff's confidentiality agreement with the defendant protected only the defendant's information; consequently, the plaintiff's afterthought disclosures of its own confidential information were unprotected.

9.4 Try risk‑by‑risk limitations of liability

Limitation-of-liability provisions usually rank at or near the top of the annual surveys done by the International Association for Contract and Commercial Management concerning the most-frequently-negotiated contract terms.

The root of the complaint is often the generic one-size-fits-all limitation of liability clause.

It's true that negotiators do sometimes debate whether particular types of damage (e.g., damages covered by an indemnity obligation) should be carved out entirely from the damages cap. But that's a false dichotomy; it assumes, for no reason, that a given type of damages will be either subject to the 'default' cap, or not subject to any cap at all.

Contract drafters can often speed up discussions of liability limitations by breaking up generic boilerplate language into more-concrete statements of risks that are of particular concern, which the parties can focus on more readily.

One technique that works well is to list specific categories of risk and, for each category, state what if any liability limits are agreed. The categories of risk could include, for example, the following:

  • Personal injury
  • Tangible damage to property (not including erasure, corruption, etc., of information stored in tangible media where the media are not otherwise damaged)
  • Erasure, corruption, etc., of stored information that could have been avoided or mitigated by reasonable back-ups
  • Other erasure, corruption, etc., of stored information
  • Lost profits from any of the above
  • Lost revenue from any of the above
  • Indemnity obligations
  • Infringement of another party's IP rights (including without limitation rights in confidential information)
  • Willful, tortious destruction of property (including without limitation intentional and wrongful erasure or corruption of computer programs or -data)

To be sure, if the non-drafting party won't care much about the limitation of liability anyway, then including such detailed limitation language could actually hinder the overall negotiations.

But remember, by hypothesis we're talking about contract negotiations in which the limitation language is indeed going to be carefully negotiated — in which case this kind of systematic approach will almost always make sense.

9.5 Negotiate variable limitations of liability?

Exclusions of consequential damages and damage-cap amounts don't necessarily have to be carved in stone for all time. The parties could easily agree to vary them, either as time passed or as circumstances changed.

Example: Suppose that:

  • A software vendor is negotiating an enterprise license agreement with a new customer for a mature software package.
  • The customer has successfully completed a pilot project, but it hasn't rolled out the software for enterprise-wide production use.
  • Knowing how tricky a production roll-out can sometimes be, the customer is concerned about the vendor's insistence on excluding all 'consequential' damages, whatever that really means.

Our vendor might try offering to waive the consequential-damages exclusion during, say, the customer's first three months of production use of the software, subject to an agreed dollar cap on the vendor's aggregate liability for all damages — which might be a higher dollar amount than at other times, as discussed below.

This approach could make the customer more comfortable that the vendor is 'standing behind its software' during the roll-out phase.

In theory, certainly, the vendor would be exposed to additional liability risk during those first three months. But the business risk might be eminently worth taking.

Remember, we're assuming that the software is mature, that is, most of its significant bugs have already been corrected. This means that the vendor might be willing to take on the additional theoretical risk — which in any case would go away after three months — in order to help close the sale.

Example: As another illustration, perhaps such a vendor could agree that the damages cap would be, say —

  • 4X for any damages that arise during, say, the first three months of the relationship, or possibly until a stated milestone has been achieved;
  • 3X during the nine months thereafter;
  • 2X thereafter.

In the 4X / 3X / 2X language, X could be defined —

  • as a stated fixed sum;
  • as the amount of the customer's aggregate spend under the contract in the past 12 months, 18 months, etc.;
  • in any other convenient way.

The details in the above examples aren't important. The point is that sometimes 'standard' limitation-of-liability language is too broad to allow the parties to specify what they really need. Negotiators might have more success if they drilled down into the language.

9.6 Drafting for difficult counterparties

It's inevitable: Every contract drafter (and reviewer) comes up against a counterpart for The Other Side who is implacable and maybe even just plain unreasonable. This chapter offers some suggestions for dealing with such folks. There's no guarantee that any of these suggestions will work in a given case, but they might help.

Contents:

9.6.1 Offer the guard dog some "hamburger"

When drafting a contract, it can pay to include a clause that you know the other side will insist on getting, even if you'd really prefer to omit the clause.

EXAMPLE: Suppose that you're drafting a contract under which your client is obligated to pay the other side a percentage of its (your client's) sales. The contract might be an intellectual-property license agreement, or perhaps a real-estate lease agreement.

It might be tempting to omit an audit clause from your draft. Your reasoning could be that the other side's contract reviewers might not think to ask for such a clause, and it's not your job to remind them.

But consider these points:

  • Your notion that the other side's reviewer won't notice the absence of an audit clause omission is likely to be wishful thinking; the other reviewer might be an expert who knows exactly what to look for and what to demand.
  • If the other side's contract reviewer were to see an audit clause in your draft, he or she might well mentally check the box — yup, they've got an audit clause — and move on to other matters, without making significant changes to your wording. That's a win, not least because it's one less thing to negotiate.
  • You might be better off setting the tone with an audit clause that you know your client can live with, and then standing on principle to reject unreasonable change requests.
  • Suppose the other side doesn't really know what they're doing. Chances are you'll get the other side to signature faster — and you'll be laying a foundation for a trusting relationship — if the draft you're proposing seems to address the other side's needs as well as your client's needs.

9.6.2 Be careful about "kicking a sleeping dog"

The scene:

  • You're in a contract negotiation, representing The Good Guys Company.
  • The other side, Nasty Business Partner Inc., insists on requiring The Good Guys to get NBP's consent before assigning the agreement.
  • Nasty Business Partner has all the bargaining power; the Good Guys decide they have no choice but to go along.

Trying to salvage the situation, you ask Nasty Business Partner for some additional language: "Consent to assignment may not be unreasonably withheld, delayed, or conditioned." But Nasty Business Partner refuses. Have you just screwed your client?

In some jurisdictions, The Good Guys might otherwise have benefited from a default rule that Nasty Business Partner Inc. had an implied obligation not to unreasonably withhold consent to an assignment of the contract.

But you asked for an express obligation — only to have Nasty Business Partner reject the request — and The Good Guys signed the contract anyway.

A court might therefore conclude that the parties had agreed that Nasty Business Partner would not be under an obligation not to unreasonably withhold its consent to assignment — that NBP could grant or withhold its consent in its sole discretion.

This is pretty much what happened, on somewhat-different facts, in both the Shoney's LLC and Pacific First Bank cases cited above.

The Team Coco example: You might remember that TV talk-show host Conan O'Brien's stewardship of The Tonight Show proved disappointing to NBC. The network decided to move Jay Leno back into that time slot and bump Conan back to 12:05 a.m. This led Conan to want to leave the show and start over on another network — but if he had, he would arguably have been in breach of his contract with NBC.

Conan's contract apparently did not state that The Tonight Show would always start at 11:35 p.m. Conan's lawyers were roundly criticized for that alleged mistake by ex-Wall Streeter Henry Blodget and some of his readers.

But then wiser heads pointed out that Conan's lawyers might have intentionally not asked for a locked-in start time:

  • The Tonight Show had started at 11:35 p.m. for decades; Conan's lawyers could have plausibly argued that this start time was part of the essence of The Tonight Show, and thus was an implied part of the contract.
  • Suppose that Conan's lawyers had asked for the contract to lock in the 11:35 p.m. start time of The Tonight Show, but that NBC had refused. A court might then have interpreted the contract as providing that NBC had at least some freedom to move the show's start time.
  • Indeed, NBC might have responded by insisting on just the opposite, namely a clause affirmatively stating that NBC was free to choose the start time.
    • Given that NBC had more bargaining power than Conan at that point, Conan might then have had no choice but to agree, given that he wanted NBC to appoint him as the host of the show.
    • And in that case, there'd be no question that NBC had the right to push the start time of the show back to 12:05 p.m.

Ultimately, Conan and NBC settled their dispute; the network bought out Conan's contract for a reported $32.5 million. This seems to suggest that NBC was concerned it might indeed be breaching the contract if it were to push back The Tonight Show to 12:05 a.m. as it wanted to do. As an article in The American Lawyer commented:

… If O'Brien had asked that the 11:35 p.m. time slot be spelled out in any agreement—and had NBC refused—the red pompadoured captain of "Team Coco" would be in a weaker position in the current negotiations.

"If you ask and are refused, or even worse, if you ask and the other side pushes for a 180, such as a time slot not being guaranteed, you can end up with something worse," [attorney Jonathan] Handel adds.

Without having their hands bound by language in the contract on when "The Tonight Show" would air, O'Brien's lawyers are in a better position to negotiate their client's departure from NBC.

Judging by the outcome, it may well be that Conan's lawyers did an A-plus job of playing a comparatively-weak hand during the original contract negotiations with NBC.

The lesson: Be careful what you ask for in a contract negotiation — if the other side rejects your request but you do the deal anyway, that sequence of events might come back to haunt you later.

9.6.3 What if you can't just say "no"?

Your client might not have the bargaining power to get its way in contract negotiations. When that's the case, you have to try to come up with other ways to help protect the client's legal- and business interests.

Imagine, for example, that your client is a customer that is negotiating a master purchasing contract with a vendor.

  • Your customer client would love to flatly prohibit the vendor from raising prices without the customer's consent. But the vendor's negotiators won't go along with such a prohibition.
  • The vendor would love to have the unfettered discretion to raise your customer client's prices whenever the vendor wants. But your client's business people are insisting on having at least some protection on that score.

What to do? In no particular order, here are some approaches that you could try.

9.6.3.1 Non-discrimination language?

A non-discrimination requirement at least brings a bit of overall-market discipline into the picture.

Example: "Vendor will not increase the prices it charges to Customer except as part of a non-targeted, across-the-board pricing increase by Vendor, applicable to its customers generally, for the relevant goods or services."

Comment: Vendor might want to qualify this language, so as to limit how general a price increase must be before it can be applied to Customer.

9.6.3.2 Advance warning or -consultation?

An advance-warning or advance-consultation requirement can buy time for its beneficiary to look around for alternatives (assuming of course that the contract doesn't lock in the beneficiary somehow, for example with a minimum-purchase requirement or a "requirements" provision).

Example: Vendor will give Customer at least X [days | months] advance notice of any increase in the pricing it charges to Customer under this Agreement.

9.6.3.3 Transparency requirement?

Requiring a party to provide information justifying its action, upon request, can force that party to think twice about doing something, even though it technically has the right to do it.

Example: If requested by Customer within X days after notice of a pricing increase, Vendor will seasonably provide Customer with documentation showing, with reasonable completeness and accuracy, a written explanation of the reason for the increase, including reasonable details about Vendor's relevant cost structures relevant to the pricing increase. Customer will maintain all such documentation in confidence any non-public information in such explanation, will not disclose the non-public information to third parties, and will use it only for purposes of making decisions about potential purchases under this Agreement.

Comment: Note the if-requested language, which relieves the vendor from the burden of continually managing this requirement — although a smart vendor would plan ahead and have the required documentation ready to go.

9.6.3.4 Draw the thorn from the lion's paw?

When a party makes tough contract demands, it could be because the party has been burned before. Institutionally, it may still "feel the pain" of a bad experience; its response is to roar at other counterparties.

The counterparty being roared at can try to find out why the lion is roaring. If it can identify the source of the pain, it might be able to figure out another way to make it better, without undertaking burdensome obligations.

9.6.3.5 Cap the financial exposure for the onerous provision?

A party with bargaining power will often demand that its counterparty agree to an onerous provision. In response, the counterparty could ask the first party to agree to a dollar cap on the amount of the counterparty's resulting financial exposure, e.g., capping the amount of money that the counterparty would be required to spend or the liability that it might someday face.

If the first party agrees, the onerous provision might look less dangerous to the counterparty than it would with the prospect of unlimited expense and/or liability.

(This is a variation on the old saying: When in doubt, make it about money.)

9.6.3.6 Impose time limits?

When a party asks its counterparty to agree to an onerous contract provision, the counterparty might try to make its business risk more manageable by imposing time limits on the onerous provision.

For example, if a party demands an oppressive indemnity, the counterparty might counter by asking for a time limit on claims covered by the indemnity.

Or if a party demands a cap on pricing increases, or a most-favored-customer clause, the counterparty could counter with time limits on those as well.

9.6.3.7 Explain why the demanding party loses?

A counterparty can to try to explain to a demanding party why, in the long run, the onerous provision being demanded would ultimately cause problems for the demanding party.

9.6.3.8 Package as part of a premium offering?

Suppose that a smallish supplier is regularly asked by its customers to agree to an onerous contract provision (e.g., an extended warranty). If the supplier plans ahead, it can package the onerous provision as part of a higher-priced premium offering — with the relevant contract language being written in a way the supplier knows it can support.

This approach has a huge advantage: The bargaining over whether to give a customer the premium offering is no longer about legal T&Cs: it becomes a negotiation about price. This means the supplier's legal people might not even have to get involved — which often can be crucial when sales people are working hard to close deals before the shot clock runs down on the fiscal quarter.

Another advantage: The supplier might well score points with customers for anticipating their needs and offering a solution for them.

9.6.3.9 Maybe it's is worth the risk?

The supplier and its lawyer should assess the actual business risk of agreeing to the customer's request — in the real world it might not be as big a problem as the supplier imagines.

9.6.4 How to kill a deal: Insist on using your contract form

For reasons good and bad, big companies usually want to use their contract forms, not yours. Certainly it's important to offer to draft the contract. And if the big company reeaally wants to do a deal with you, then you might get away with insisting on controlling the typewriter.

But bad things can happen, though, if you simply fold your arms and refuse to negotiate the other side's contract paper.

  • Even if the big company's negotiators grudgingly agree to work from your draft contract, they'll start the negotiation thinking your company is less than cooperative (which isn't good for the business relationship). Then later, when you ask for a substantive concession that's important to you, they may be less willing to go along.
  • In any case, their agreement to use your contract form, in their minds, will be a concession on their part, meaning that you now owe them a concession.

For a vendor lawyer, there's another danger in insisting on using your own contract form: Your client's sales people will blame their lack of progress on you.

  • Sales folks are always having to explain to their bosses why they haven't yet closed Deal X.
  • Your insistence on using your contract form gives them a ready-made excuse: They can tell their boss that you're holding up the deal over (what they think is) some sort of petty legal [nonsense].
  • Even if that's not the whole story, it's still not the kind of tale you want circulating among your client's business people.

9.7 Exercises and discussion questions

9.7.1 Discussion: Benefits of balanced terms

DISCUSS: What are some pros and cons of drafting a contract with balanced terms?

9.7.2 Discussion: Chief advantage of short paragraphs

Section  7.1 lists several advantages of drafting contracts with short, single-topic paragraphs. QUESTION: Which do you think are the most important? (This could be based on your own experience at work, for example.)

9.7.3 Exercise: Rewriting Rigel's wall of words

Try just breaking up the following into separate paragraphs. (It's from a Collaborative Research and License Agreement between Pfizer and Rigel Pharmaceuticals.)

9.2.12 PATENTS AND TRADEMARKS. To the best of its knowledge (but without having conducted any special investigation), Rigel owns or possesses sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, and proprietary rights and processes (including technology currently licensed from Stanford University) necessary for its business as now conducted and as proposed to be conducted without any conflict with, or infringement of the rights of, others. Rigel currently licenses certain technology from Stanford University (the "Licensed Technology") on an "as is" basis, with no representation or warranty from Stanford University that such technology does not infringe the proprietary rights of others. To Rigel's knowledge, Rigel has not, as of the date hereof, received any claims from any third party alleging that the use of the Licensed Technology infringes the proprietary rights of such party. Except for agreements with its own employees or consultants and standard end-user license agreements, there are no outstanding options, licenses, or agreements of any kind relating to the foregoing, nor is Rigel bound by or a party to any options, licenses, or agreements of any kind with respect to the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, and proprietary rights and processes of any other person or entity, other than the license agreements with Janssen Pharmaceutica N.V., Stanford University, SUNY, and BASF. Rigel has not received any communications alleging that Rigel has violated or, by conducting its business as proposed, would violate any of the patents, trademarks, service marks, trade names, copyrights, trade secrets, or other proprietary rights or processes of any other person or entity. Rigel is not aware that any of its employees is obligated under any contract (including licenses, covenants, or commitments of any nature) or other agreement, or subject to any judgment, decree, or order of any court or administrative agency, that would interfere with the use of such employee's best efforts to promote the interests of Rigel or that would conflict with Rigel's business as proposed to be conducted. Neither the execution nor delivery of this Agreement, nor the carrying on of Rigel's business by the employees of Rigel, nor the conduct of Rigel's business as proposed, will, to the best of Rigel's knowledge, conflict with or result in a breach of the terms, conditions, or provisions of, or constitute a default under, any contract, covenant, or instrument under which any of such employees is now obligated. Rigel is not aware of any violation by a third party of any of Rigel's patents, licenses, trademarks, service marks, tradenames, copyrights, trade secrets or other proprietary rights.

Here's how I might rewrite the Rigel representations and warranties below, with selected revisions "redlined": [DCT to show on his computer]

Here it is again without the redlines: [DCT to show on his computer]

9.7.4 Exercise: Streamlining a termination clause

Rewrite the following provision from this license agreement, following the guidelines in this section (don't mess with the substance):

12. TERMINATION

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

10 Drafting for possible litigation

Very, very few contracts end up in litigation. But drafting for litigation anyway —

  • signals The Other Side that you're not a clueless newbie; and
  • can come in handy if the parties get into a dispute.

10.1 Draft the preamble to help out trial counsel

See § 2.2, "Drafting the preamble: Front-load useful information."

10.2 Consider contract clauses to promote settlement

Business relationships can be fragile things. When drafting a contract, it can be useful to include specific provisions to reduce the odds that a dispute will cause the parties to drift helplessly into a lawsuit, such as:

Status-review conference calls upon request: Many business-contract disputes could be avoided if the participants would just talk with each other every now and then. See § 24.20.

Consultation in lieu of consent: Sudden, unexpected moves by one party to a contract can make the other party nervous. For example, the business relationship between a service provider and a customer could be damaged if the serv­ice provider were to suddenly replace a key person assigned to the customer's work with­out notice.

The usual, sledge-hammer approach to dealing with this problem is to contractually require the provider to obtain the customer's prior consent before taking such an action.

  • The provider, though, will usually push back against such a consent requirement — the provider will be reluctant to give the customer a veto over how it runs its business.
  • Moreover, it could be a management burden for the provider to have to check every customer's contract to see what internal management decisions required prior customer approval.

As an alternative (and compromise), the provider might be willing to commit to consulting with the customer before taking a specified action that could cause heart­burn for the customer. That way, the customer would at least get notice, perhaps an explanation, and an opportunity to be heard, which could make a big difference in the customer's reaction and to the parties' business relationship.

For example, a software-development contract could say that, for example, "Except in cases of emergency, Service Provider will consult with Customer at least ten business days in advance of replacing the lead software developer assigned to the Project." That would at least get the parties talking to one another, which can help avoid strains in their business relationship.

(Of course, a party must also keep track of its consultation commitments, just as much as its consent obligations.)

Escalation of disputes to higher management: Some lawyers believe that a dispute-escalation requirement can increase the chance of an amicable settlement. Getting different, more-senior people involved in the dispute can sometimes bypass individual animosities, hidden personal agendas, and other foibles; this can help break an impasse. See § 23.16.

Early neutral evaluation: When a legal dispute arises, the parties' lawyers can some­times tell their clients what they think the clients want to hear. (In part this may be because lawyers — especially male lawyers — tend to be overly optimistic about whether they're going to win their cases.) That can hamper getting disputes settled and the parties back to their business (if that's possible). Consequently, if a contract dispute starts to get serious, an early, non-binding "sanity check" from a knowledgeable neutral can help the parties and lawyers get back onto a more-productive track before positions harden and relationships suffer — not to mention before the legal bills start to mount up. See § 23.21.

Mini-trial of disputes to parties' senior management: Mini-trials, in which the parties' lawyers put on a one- to two-hour "trial" to senior executives of the parties (and perhaps a neutral facilitator), are thought to enhance the prospect of settling disputes. (The head of litigation for a global services corporation told me that this was his favorite tool of dispute resolution.) See § 23.23.

10.3 Remember the burden of proof in enforcement

Contract drafters should keep in the back of their minds that contract enforcement might come down to whether a trier of fact will be persuaded by a party's claim:

  • If "Alice" claims that "Bob" breached a contract, then Alice must convince the jury — or the judge, in a non-jury "bench" trial, or arbitration tribunal, if applicable — that Bob in fact did something that was a breach.
  • Conversely: Bob might claim, as an affirmative defense, that even if he did breach, the breach was justified by, say, Alice's own breach, and so he should not be held liable for his own breach. In that situation, it's up to Bob to persuade the jury, etc., that Alice in fact did something that was a breach on her part.

Here's where it can get important: Suppose that — based on the evidence that was admitted at trial — reasonable people could go either way about whether Bob did or didn't do what Alice claimed he did. When that occurs, the jury's or judge's finding on the point is pretty much unassailable (and even more so in arbitration cases).

(The same is true for Bob's affirmative defense: If Bob fails to persuade the trier of fact that Alice did what Bob claims, then Bob loses on that defense.)

The Fifth Circuit illustrated this point in a trade-secret case, where:

  • A company's former employee and his new firm claimed that the company was using a trade secret, owned by the former employee, without authorization.
  • The company denied that it was using the trade secret.
  • In a non-jury trial, the trial judge ruled that the plaintiffs had not proved their case — i.e., had not persuaded the trial judge that the defendant company was in fact using the trade secret.

The appeals court affirmed because the trial judge's finding was not clearly mistaken:

it was unclear to the district court, as it is unclear to us, how a gas and a chemical compound commonly used in lamps and lasers can be a trade secret.

Olstowski and ATOM could have provided expert testimony to show how the use of krypton-chloride is so unique to their device as to make it an integral part of their protected trade secret as opposed to a generic concept of physics, which is unprotected. They did not. The two witnesses they did call merely testified that Petroleum Analyzer’s MultiTek used krypton-chloride, a fact Petroleum Analyzer does not contest.

We conclude that Olstowski and ATOM’s proclaimed legal issue is indeed a factual one, and that they failed to carry their burden of proof at trial. On this record, we cannot say that the district court’s finding of fact was clearly erroneous.

The drafting lesson: Consider trying to phrase contract obligations to put the burden of proof on the other party. Here's a grossly-simplified hypothetical example:

  • Consider the phrase: Bob will bill Alice for his services at $X per hour, but Alice need not pay Bob if it does not rain on Sunday. The "default" position here is that if Alice doesn't want to pay Bob, she must prove that it didn't rain on Sunday.
  • In contrast, consider the phrase: Alice must pay Bob for his services at the rate of $X per hour if it rains on Sunday. This wording suggests that if Bob wants to get paid, it's up to him to prove that it did rain on Sunday.

10.4 Litigation prep: Include "demonstrative exhibits"?

[Note to students: Just skim this section; you won't be tested on it.]

Remember the cliché about a picture being worth a thousand words? Nowhere is that more true than the courtroom. That's why in litigation, lawyers and expert witnesses often use so-called demonstrative exhibits — diagrams, time lines, charts, tables, sketches, etc., on posters or PowerPoint slides — as teaching aids to help them get their points across to the jury during testimony and argument.

In a lawsuit, the jurors might or might not be allowed to refer to the parties' demonstrative aids while they're deliberating. Jurors normally take "real" exhibits — like a copy of the contract in suit — into the jury room with them and refer to them during deliberations. Judges, however, sometimes won't allow the jury to take demonstrative exhibits with them, on the theory that the jurors are supposed to decide the case on the basis of the "real" evidence and not on documents created solely for litigation by the lawyers.

True, in U.S. federal-court cases, Rule 1006 of the Federal Rules of Evidence allows summaries and the like to be admitted into evidence. Trial judges, however, have significant discretion over evidentiary matters; if a judge decides that a particular demonstrative aid should not be given to the jury for use in its deliberations, it's usually the end of that discussion.

If you plan ahead when drafting a contract, your client's trial counsel might later be able to sneak a demonstrative aid or two into the jury room through the back door — no, through the front door, but at the back of the contract — as "real" evidence, not just as a demonstrative exhibit, to help the jurors understand what the parties agreed to.

Ask yourself: Is there anything we'd want the jurors to have tacked up on the wall in the jury room — for example, a time line of a complex set of obligations? If so, think about creating that time line now, and including it as an exhibit to the contract. The exhibit will ordinarily count as part of the "real" evidence; it should normally be allowed back into the jury room without a fuss.

Of course, before the contract is signed the parties would have to agree to include your stealth demonstrative exhibit in the contract document. But their reviewing your exhibit for correctness could be a worthwhile exercise — and if their review makes them realize they don't agree about something, it's usually better if they find that out before they sign.

There's always the risk of unintended consequences: The demonstrative exhibit you create today might not create the impression you want to create in a jury room years from now. But that's always a risk even when you write the contract itself.

Your time line, chart, summary, diagram, etc., doesn't necessarily have to be a separate exhibit: modern word processors make it simple to include such things as insets within the body of the contract. (The author used to do just that when writing patent-invalidity or -noninfringement opinions: I'd prepare the PowerPoint slides that I'd want to use if I were testifying as an expert witness, and then I'd insert those slides as insets in the body of the opinion itself.)

10.5 Note-taking during negotiations: Easy habits your lawyer will love

Chances are that at some point in your career, a lawyer — yours, or someone else's — will want to review notes you took at a meeting or during a phone conversation. With that possibility in mind, whenever you take notes, you should routinely do as many of the following things as you can remember, especially the first three things. This will increase the chances that a later reviewer will get an accurate picture of the event, which in turn can help you stay out of undeserved trouble and save money on legal fees

1.  Indicate who said what you're writing down. Unless you want to risk having someone else's statements mistakenly attributed to you, indicate in your notes just who has said what.

Example: Suppose that John Doe says in a meeting that your company's off­shore oil-well drilling project can skip certain safety checks.

  • Remembering the BP drilling disaster in the Gulf of Mexico, you don't want anyone to think you were the guy who suggested this.
  • So your notes might say, for example, "JD: Let's skip safety checks."
  • If you omitted John Doe's initials, it wouldn't be clear that you weren't the one who made his suggestion.

2.  On every page, write the meeting date and time, the subject, and the page number. The reason: Your lawyer will probably want to build a chronology of events; you can help her put the meeting into the proper context by "time-stamping" your notes. This will also reduce the risk that an unfriendly party might try to quote your notes out of context.

3.  If a lawyer is participating, indicate this. That will help your lawyer separate out documents that might be protected by the attorney-client privilege. EXAMPLE: "Participants: John Doe (CEO); Ron Roe (ABC Consulting, Inc.); Jane Joe (general counsel)."

4.  Start with a clean sheet of paper. When copies of documents are provided to opposing counsel, in a lawsuit or other investigation, it's better if a given page of notes doesn't have unrelated information on it. This goes for people who take notes in bound paper notebooks too: It's best to start notes for each meeting or phone call on a new page, even though this means you'll use up your notebooks more quickly.

5.  Write in pen for easier photocopying and/or scanning, and also because pencil notes might make a reviewer (for example, as an opposing counsel) wonder whether you might have erased anything, and perhaps falsely accuse you of having done so.

6.  Write "CONFIDENTIAL" at the top of each page of confidential notes. That will help preserve any applicable trade-secret rights; it will also help your lawyer segregate such notes for possible special handling in the lawsuit or other investigation.

7.  List the participants. Listing the participants serves as a key to the initials you'll be using, as discussed in item 1 above. It can also refresh your recollection if you ever have to testify about the meeting. If some people are participating by phone, indicate that.

8.  And indicate each participant's role if isn't obvious or well-known – remember, you might know who someone is, but a later reader likely won't know. EXAMPLE: "Participants: John Doe (CEO); Ron Roe (ABC Consulting, Inc.); Chris Coe (marketing)."

9.  Indicate the time someone joins or leaves the meeting, especially if it's you (so that you're not later accused of having still been there if something bad happened after you left).

10.  Write down the stop time of the meeting. This usually isn't a big deal, but it's nice to have for completeness.

10.6 Exercises and discussion questions

10.6.1 Discussion: Burden of proof

Think of a contract-related situation in which careful drafting could make a difference for your client as to who has the burden of proof of a particular fact.

10.6.2 Discussion: Note-taking

Based on your own personal experience — however limited you might think that is — which do you think is the most important tip on note-taking?

10.6.3 Discussion: Terms to promote settlement

Based on your own personal experience — however limited you might think that is — do you think it's actually realistic to include contract terms to try to promote settlement?

11 Getting to signature sooner

11.1 Put "variable" terms in a schedule

You might know from experience that the other side is likely to want to make changes to certain contract terms. For example, a supplier who asks for net-30 payment terms might know that some customers will want net-45 or even net-60 terms.

If that's the case, then consider putting the details of such terms in a "schedule," either at the front of the document or at the beginning of the clause in question. This can speed up review and editing.

(For an example, see the first part of the 2007 real-estate lease between Stanford University (the landlord) and Tesla Motors (the tenant), reproduced at § 2.6.4.)

11.2 Use industry-standard terminology

When you're drafting a contract, you'll want to try to avoid coining your own non-standard words or phrases to express technical or financial concepts. If there's an industry-standard term that fits what you're trying to say, use that term if you can. Why? For two reasons:

• First, someday you might have to litigate the contract. You'll want to make it as easy as possible for the judge (and his- or her law clerk) and the jurors to see the world the way you do. In part, that means making it as easy as possible for them to understand the contract language.

The odds are that the witnesses who testify in deposition or at trial likely will use industry-standard terminology. So the chances are that the judge and jurors will have an easier time if the contract language is consistent with the terminology that the witnesses use—that is, if the contract "speaks" the same language as the witnesses.

• Second — and perhaps equally important — the business people on both sides are likely to be more comfortable with the contract if it uses familiar language, which could help make the negotiation go a bit more smoothly.

11.3 Use charts and tables?

Instead of long, complex narrative language, use charts and tables. Here's an example of the former:

If it rains less than 6 inches on Sunday, then Party A will pay $3.00 per share, provided that, if it it rains at least 6 inches on Sunday, then Party A will pay $4.00 per share, subject to said rainfall not exceeding 12 inches, [etc., etc.]

Here's the same provision, in table form:

Party A will pay the amount stated in the table below, based on how much rain falls on Sunday:

AMT. OF RAIN PAYMENT DUE
Less than 6 inches $3.00 per share
At least 6 inches
but less than 12 inches
$4.00 per share

For an example "in the wild," see § 3.12 of this agreement.

Or even the following, in a bullet-point format:

Party A will pay the amount stated in the table below, based on how much rain falls on Sunday:

  • Amount of rain: Less than 6 inches.
    Payment due: $3.00 per share
  • Amount of rain: At least 6 inches but less than 12 inches.
    Payment due: $4.00 per share

Which one would you rather read if you were reviewing the contract?

11.4 Include examples and sample calculations?

Your contract might contain a complex formula or some other particularly tricky provision. If so, consider including a hypothetical example or sample calculation to "talk through" how the formula or provision is intended to work.

The drafters of $49 million of promissory notes would have been well served to include a sample calculation to illustrate one of their financial-term definitions — it would have saved them a lot of money in attorneys' fees alone, and possibly helped them win a case against the borrowers.

– The case involved a group of borrowers affiliated with franchisees of restaurants such as Burger King and Chili's; these borrowers had negotiated $49 million dollars' worth of corporate promissory notes.

– During the negotiations, the borrowers asked for a change in the lender's standard definition of "Prepayment Penalty." The quoted term ended up being defined in a certain way in all 34 promissory notes.

– But in practice the definition led to an absurd result (the prepayment penalty would always be zero).

The appeals court reversed a summary judgment in favor of the lender and directed the district court to conduct a trial to determine what the parties really meant — watch the lawyers' meters run.

And in the end, the borrowers prevailed because the court adopted their interpretation of the language, not the lender's interpretation, as being closer to the pin as far as what the parties had in mind.

Worth noting: The court specifically mentioned calculations that the lender had submitted with its motion for summary judgment. It's a shame the promissory-note drafters didn't think to include one or two such calculations in the body of the contract itself — by being forced to work through the calculations, the drafters and their client(s) might well have spotted the problem with the language in time to do something about it.

11.5 Add explanatory footnotes?

Suppose that, after intense negotiations, a particular contract clause ends up being written in a very specific way. Consider including a footnote at that point in the contract, explaining the same. Future readers – your client's successor, your client's trial counsel, a judge – might thank you for it.

11.6 Trying to play "hardball" will slow things up

Some say it's best to start a contract negotiation by sending the other side your "hardball" or "killer" contract form that's extremely biased toward your side. By doing so (the theory goes):

  • you set the other side's expectations, and increase the odds that you'll eventually get more of what you want; and
  • you get a batch of potential sleeves-from-your-vest concessions that you can use for horse-trading.

Certainly there are transactions in which it makes at least some sense to do this.

And for some people like to play "the art of the deal"; for those folks, it feels just plain good to come out "on top" when negotiating the legal fine points.

But don't underestimate the immediate price you'll pay for these putative benefits. You'll spend more business-staff time. You'll spend more in legal expenses.

And you'll incur opportunity costs: As the 'shot clock' runs down at the end of the fiscal quarter, you'll be spending time on legal T&Cs instead of on closing additional business.

So when negotiating a deal, you might want to ask yourself whether "hardball" legal negotiation is really what you want to be spending your time doing.

It might make sense instead to lead off with a balanced contract form that represents a fair, reasonable way of doing business — one that ideally the parties could "just sign it" and get on with their business.

Moreover, hardball contract drafts send the wrong message: Everyone wants reliable business associates, but how does someone know the other side is friendly and trustworthy? On that score, offering a fair and balanced contract can help.

11.7 Combat Barbie: Consider using "distractor" terms

Military people learn early that when preparing for inspection, you don't want to make everything perfect. The inspector will keep looking until he (or she) finds something — because if he doesn't find anything, his superior might wonder whether he really did his job.

The trick is instead to make everything pretty squared away — but then [mess] things up just a little bit. That way, the inspector will have something to find and report, and can go away happy.

Illustrating the point: A British lawyer, who had graduated from Sandhurst, the UK equivalent of West Point, once told a story in an online forum:

  • A female first-year cadet did a good job of squaring away her bunk and gear for inspection — and then she put a "Combat Barbie" doll on her bunk.
Combat Barbie
Photo: Pinterest
  • Of course the inspectors immediately noticed Combat Barbie — and they used up their entire alloted time for the cadet's inspection in yelling at her about the unmilitary appearance of the doll. Otherwise, the inspectors might have, shall we say, "found fault with" the cadet's bunk, gear, etc.
  • The inspectors then moved on, without having wreaked the havoc that they might otherwise have done.

This same "distractor" psychology can apply in drafting a contract: Be sure to give the other side's reviewer something to ask to change, if for no other reason than to give the reviewer something to report to her boss or client.

But make it a fairly minor point; otherwise, the reviewer and her client might dismiss you as naïve — and worse, they might start to question whether your client was a suitable business partner.

Example: If you're a supplier, consider specifying payment terms of net-20 days (explained in § 13.12.1), and be prepared to agree immediately to net-30 days if asked. But don't specify net-five days, which in many situations would risk branding you as unrealistic about "how things are done."

11.8 Redline and explain all changes during negotiation

Most contract professionals know that:

  • When revising documents sent over by the other side, all changes should be redlined or otherwise flagged.
  • On a case-by-case basis, it can also be helpful to explain, in comments — for example, in Microsoft Word comment bubbles — the reasoning behind changes, to save time in negotiation conference calls.

Pro tip: As a "canary in the coal mine" clause, consider including, in the general-provisions section, a representation by each party that the party has redlined all changes it has made to the agreement documents (see Clause 24.18). If the other side objects to including such a representation in the contract, you can ask some pointed questions as to why they object.

(The other side might say, in effect, we don't mind re-reading the entire document before we sign it. You can then point out to your client that the other side obviously doesn't mind wasting not only their money, but the client's, on unnecessary legal fees.)

11.9 Exercises and discussion questions

11.9.1 Discussion: Combat Barbie

What do you think about the lesson of the "Combat Barbie" story?

11.9.2 Discussion: Hardball negotiation

Talk about the pros and cons of playing hardball in contract negotiations.

11.9.3 Discussion: Footnotes in contracts

Have you ever seen footnotes in a contract draft? What did you think?

12 Business planning

[Note to the author's law students: You can just skim this chapter; you won't be tested on it, but you might find it useful.]

If you don't know where you're going, you might not get there.
Yogi Berra.

Be Prepared.
Boy Scout motto.

Plans are worthless; planning is everything.
Dwight D. Eisenhower.

[N]o plan of operations extends with any certainty beyond the first contact with the main hostile force.
Helmuth von Moltke the Elder; this is often paraphrased as "no plan survives first contact with the enemy."

Contents:

12.1 "Learn the business!" OK, fine — how?

One of the big complaints clients have about lawyers is that "they just don't understand the business."  But it's singularly unhelpful to just say to a lawyer: Hey, you: Learn the business! The beneficiary of such advice might not know what to do to make that happen.

Neither is it particularly useful to add, Just ask questions! It might not be obvious what questions should be asked.

So, this chapter presents a series of questions, with handy mnemonic acronyms, to help contract professionals and their clients:

  • identify threats and opportunities that might need to be addressed in a contract;
  • develop action plans to prepare for and respond to those threats and opportunities; and
  • flesh out the details of the desired actions;

all with the goal of drafting practical contract clauses.

12.2 T O P   S P I N: Identifying threats and opportunities

The acronym T O P   S P I N can help planners to identify threats and opportunities of potential interest.

(The acronym is inspired by the business concept of SWOT analysis, standing for Strengths, Weaknesses, Opportunities, and Threats.)

The first part of the acronym, T O P, refers to the threats and opportunities that can arise in the course of the different phases of the parties' business relationship. (Those phases can themselves be remembered with the acronym S N O T S: Startup; Normal Operations; Trouble; and Shutdown.)

The second part of the acronym, S P I N, reminds us that various threats and opportunities can be presented by one or more of the following:

• S: The participants in the respective supply chains in which the contracting parties participate, both as suppliers and as customers, direct and indirect. If the parties are "Alice" and "Bob," then we can think of Alice's and Bob's respective supply chains as forming a capital letter H, as illustrated below:

• P: The individual people involved in the supply chains — all of whom have their own personal motivations and interests;

• I: Interveners such as competitors; alliance partners; unions; governmental actors such as elected officials, regulators, taxing authorities, and law enforcement; the press; and acquirers. Don't forget the individual people associated with an intervener, all of whom will have personal desires, motives, and interests;

• N: Nature, which can cause all kinds of threats and opportunities to arise in a contract relationship.

h-diagram

ICE-CREAM EXAMPLE:  Mother Nature might create a threat — and an opportunity for competitors —  if an ice-cream manufacturer's products were to become contaminated with listeria bacteria (as happened in 2015 to famed Texas dairy Blue Bell).

12.3 I N D I A   T I L T: Deciding on responsive actions

Once planners have compiled a list of threats and opportunities of interest, they should think about the specific actions that might be desirable — or perhaps specific actions to be prohibited ­— when a particular threat or opportunity appears to be arising. Many such actions will fall into the following categories:

• I: Information to gather about the situation in question;

• N: Notification of others that the threat or opportunity is (or might be) arising. Refer to the SPIN part of the TOP SPIN acronym above for suggestions about players who might be appropriate to notify.

• D:  Diagnosis, i.e., confirmation that the particular threat or opportunity is real, as opposed to being an example of some other phenomenon (or just a false alarm).

• I: Immediate action, e.g., to mitigate the threat or to seize the opportunity.

• A: Additional actions, e.g., to remediate adverse effects or take advantage of the opportunity.

ICE-CREAM EXAMPLE:  Consumers have been known to become ill, and a few have died, after eating ice cream that, during manufacturing, became contaminated with listeria bacteria. The grocery store's planners might want to use the I N D I A checklist to specify in some detail how the ice-cream manufacturer is to respond to such reports, with requirements for notifying the grocery store; product recalls; and so on.

Some plans are likely to require advance preparation. Planners can use the T I L T part of the acronym to decide whether any of the following might be appropriate:

• T:  Acquisition of tools — such as equipment, information, consumables, etc. — for responding to the threat or opportunity.

• I:  Acquisition of insurance (or other backup sources of funding).

• L: Posting of a lookout, that is, putting in place a monitoring system to detect the threat or opportunity in question.

• T:  Training of the people and organizations who might be called on to respond to the threat or opportunity.

12.4 W H A L E R analysis: Fleshing out the action plans

In specifying actions to be taken, planners will often want to go into more detail than just the traditional 5W + H acronym (standing for Who, What, When, Where, Why, and How). Planners can do this using the acronym W H A L E R:

• W:  Who is to take (or might take, or must not take) the action.

• H:  How the action is to be taken, e.g., in accordance with a specified industry standard.

• A:  Autonomy of the actor in deciding whether to take or not take the action.  Depending on the circumstances, this might be:

  • No autonomy:  The action in question is either mandatory or prohibited, with nothing in between.
  • Total autonomy:  For the action in question, the specified actor has sole and unfettered discretion as to whether to take the action.
  • Partial autonomy:  The decision to take (or not take) the action must meet one or more requirements such as:
    • Reasonableness — be careful: that can be complicated and expensive to litigate;
    • Good faith — ditto;
    • Notification of some other player, before the fact and/or after the fact;
    • Consultation with some other player before the fact; or
    • Consent of some other player (but is consent not to be unreasonably withheld?  A claim of unreasonable withholding of consent could itself be one more thing to litigate.)

• L:  Limitations on the action — for example, minimums or maximums as to one or more of time; place; manner; money; and people.

• E:  Economics of the action, such as required payment actions (each of which can get its own W H A L E R analysis), and backup funding sources.

• R:  Recordkeeping concerning the action in question (with its own W H A L E R analysis).

12.5 The "bow tie method": A diagrammatic approach

A more-complicated approach to identifying and planning for risks is the so-called "bow tie" method, developed by oil-and-gas giant Shell and later adopted in other industries.

12.6 Finally, ask the investigator's all-round favorite question

When I was a baby lawyer at Arnold, White & Durkee, I worked a lot with partner Mike Sutton. One of the many things Mike taught me was that when interviewing or deposing a witness, a useful, all-purpose question consists of just two words:  Anything else?

That same question can likewise help contract planners get some comfort that they've covered the possibilities that should be addressed in a draft agreement.

12.7 Stephen Colbert proves the benefits of thinking ahead

Stephen Colbert and his agent showed that there's more to contract drafting than just putting words on the page:

  • They planned ahead, setting up Colbert's contracts with Comedy Central so that the contracts would expire at the same time as David Letterman's contracts with CBS.
  • That way, if Letterman ever decided to retire, Colbert would be able to leave the Comedy Central show that made him famous, The Colbert Report, and throw his hat in the ring to take over Letterman's The Late Show on CBS
Stephen Colbert

This worked out well for both Colbert and CBS — in 2019, they agreed to a three-year contract extension through 2023; a New York Times article commented that "The move was a no-brainer for CBS. Mr. Colbert is, by far, the most-watched late-night host."

12.8 Danger: Hope is not a plan

Wishful thinking can be dangerous, but some people are prone to it — including business people. Contract negotiators should keep this in mind in brainstorming scenarios and action plans.

Example: Where will the money come from? When drafting a critical contract obligation for the other side — for example, an indemnity obligation — consider imposing additional requirements to be sure that there's money somewhere to fund the obligation, such as:

  • an insurance policy;
  • a third-party guaranty;
  • a letter of credit from a bank or other financial institution;
  • or even taking a security interest in collateral that could be seized and sold to raise funds.

Apropos of wishful thinking, there's an old joke about economists that seems to have been first published in 1970:

  • A physicist, a chemist, and an economist are shipwrecked on a desert island with nothing to eat.
  • A pallet full of cans of food washes up on the beach, but the castaways have no tools with which to open the food cans.
  • The physicist and the chemist each propose ingenious but complicated mechanisms to open the cans, using the materials at hand.
  • The economist has a simpler solution: "We'll assume we have a can opener."

13 Payments

13.1 Deposits

13.1.1 How are deposits to be applied?

Any deposits and other advance payments provided under the Contract — if any —

  • are to be applied to amounts due under invoices issued in connection with the Contract.

13.1.2 What is to be done with any remaining balance?

Any remaining balance of a deposit

  • is to be promptly refunded
  • upon the conclusion of the parties' dealings under the Contract,
  • or as otherwise stated in the Contract.

13.1.3 Will deposits bear interest?

No.

13.2 Drawbacks

  1. This Clause will govern whenever an order for deliverables is submitted by a party ("Customer") and accepted by another party ("Supplier"),
    • if some or all the deliverables are eligible for one or more "Special Benefits,"
    • namely the following:
      • special status under a free trade agreement;
      • drawbacks; and/or
      • any similar industrial benefit from a governmental authority.
  2. At no extra charge, Supplier is to provide Customer with:
    • all paperwork reasonably requested by Customer,
      • such as certificates of origin and the like,
      • to help Customer to claim the Special Benefit,
      • where Supplier can provide the paperwork without undue burden or expense; and
    • all cooperation that Customer reasonably requests in connection with Customer's efforts to obtain the Special Benefit.
Commentary

This Clause draws on ideas seen in § 2.4 of a Honeywell purchase-order form archived at https://perma.cc/CUV6-NKTY.

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).

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13.3 Expense Reimbursement Protocol

13.3.1 Terminology: Paying party; incurring party

This Clause will govern when, under the Contract, a party (the "paying party") is to reimburse another party (the "incurring party") for specified expenses.

13.3.2 Must either party reimburse the other's expenses?

  1. 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.
  2. The incurring party may seek reimbursement for a particular expense only if:
    • the expense is of a type eligible for reimbursement under the Contract;
    • the incurring party actually incurred the expense; and
    • the expense is reasonable in amount.

13.3.3 May reimbursable expenses be marked up?

An incurring party may not mark up expenses for reimbursement,

  • unless the paying party has clearly agreed otherwise in writing.
Commentary

Many contracts prohibit marking up of expenses, but some contracts are "cost-plus."

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13.3.4 Must expense receipts be submitted?

Yes: The incurring party must provide the paying party

  • with complete and accurate copies of receipts to support each requested reimbursement,
  • unless the paying party clearly says otherwise in writing (e.g., for small expenses).

13.3.5 May a paying party require compliance with a reimbursement policy?

Yes: All requests for reimbursement must comply

  • with any commercially reasonable (as defined in Clause 25.14) written reimbursement policy,
  • that the paying party provides to the incurring party from time to time,
  • as long as the paying party provides each such policy:
  1. in a manner reasonably calculated to let the incurring party know about the policy's requirements; and
  2. a reasonable time before the incurring party —
    • incurs an expense that is subject to the reimbursement policy,
    • or otherwise become obligated to pay that expense.
Commentary

Customers' various expense-reimbursement policies are sometimes an administrative pain for providers, but they're often a practical necessity, especially for large corporate customers that by law must comply with internal-controls requirements.

A customer might or might not want to impose a specific written-reimbursement policy at the time of contracting, but it definitely might that flexibility for the future without having to renegotiate the Contract.

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13.3.6 Option: Direct Billing of Expenses

  1. If this Clause is agreed to,
    • it applies if the Contract clearly states that an incurring party may — or must — arrange for specified individual expenses to be billed directly to the paying party.
  2. The paying party must timely pay any such direct-billed expense.
  3. Otherwise, the incurring party is not to have expenses billed directly to the paying party.
Commentary

Direct billing might be appropriate if, as a matter of prudent cash-flow management, a service provider or other contract party would like for its customer to "front" significant reimbursable expenses.

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13.3.7 Option: Preclearance Requirement

An incurring party will not be eligible for reimbursement of any individual expense of more than FILL IN AMOUNT unless the incurring party consults with the paying party about the expense before the incurring party commits to incurring the expense.

13.3.8 Option: Expense-Flagging Requirement

In each invoice for reimbursement, the incurring party must suitably flag any submitted expense as to which the paying party might reasonably disagree that the expense is eligible for reimbursement.

Commentary

This section is modeled on a clause that the present author saw in a contract form reviewed on behalf of a client.

Caution: A party incurring expenses probably wouldn't want to agree to this option. A paying party could easily claim that the incurring party failed to give the paying party a "heads up" about a particular expense; that could give the paying party an excuse to withhold reimbursement.

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13.4 Factoring (commentary to come)

Please check back later …

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

13.5 Guaranties

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract (which may be a standalone guaranty agreement),

  • a party ("Guarantor")
  • guarantees a payment obligation (a "Guaranteed Payment Obligation")
    • that is owed to another party ("Creditor")
    • by a third party ("Payer")
  • under an agreement (the "Guaranteed Agreement").

The Guarantor's obligation is referred to as the "Guaranty."

Discussion checklist:

Commentary

This Clause covers only payment obligations, because guaranties of performance of other types of obligation (for example, an obligation to perform consulting services, repair work, building construction, etc.) might well require considerably-more negotiation and customized language.

Spelling: In U.S. law, the terms "guaranty" and "guarantee" are usually associated with a third party's commitment to make good on a party's failure to comply with an obligation. Traditionally, "guaranty" is the noun, while "guarantee" is the verb.

Guaranteed Payment Obligation: Drafters will want to be careful to define whose payment obligations are being guaranteed; a creditor's aggressive position on this issue can lead to litigation.

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13.5.1 What is guaranteed: Payment? Or collection?

Payment is guaranteed unless the Guaranty clearly says otherwise, as follows:

  1. Each Guarantor guarantees, to each Creditor,
    • to the extent of that Creditor's rights under the Guaranteed Payment Obligation.
    • the full payment, by each Payer, when due, of the Guaranteed Payment Obligation.
  2. For this purpose, it does not matter:
    • how or when the Guaranteed Payment Obligation in question previously came to exist, is coming to exist now, or comes to exist in the future,
      • including, without limitation, by acceleration or otherwise;
    • nor whether the Guaranteed Payment Obligation is direct or indirect, absolute or contingent.
Commentary

Some of this language is informed by the terms of the guaranty in suit in a Seventh Circuit case.

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13.5.2 What Creditor efforts are required if payment is guaranteed?

If the Guaranty is of payment, then Creditor's only obligation is to demand payment, as follows:

  1. Each Guarantor must honor its Guaranty obligations:
    • within five business days after any Creditor asks — in writing — that the Guarantor do so,
    • following a failure by the Payer to comply with the relevant Guaranteed Payment Obligation,
    • and after expiration of any relevant cure period for that failure.
  2. The Creditor is not required to first attempt to collect a judgment against the Payer or the Guarantor,
    • nor need the Creditor first attempt to foreclose on any lien, security interest, or other collateral securing the Guaranteed Payment Obligation.
Commentary

Many guaranties are guaranties of payment, of the kind set out in subdivision a.

NOTE: Under Texas law, the guarantor 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 c, however, presumably would waive that guarantor protection.

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13.5.3 What Creditor efforts are required if collection is guaranteed?

If the Guaranty is of collection, then the Guaranty may not be enforced,

  • against any Guarantor,
  • as to any Guaranteed Payment Obligation,
  • until the Creditor has obtained,
    • in a court or other forum of competent jurisdiction,
  • a final judgment against the Payer,
    • from which no further appeal is taken or possible,
  • that enforces — in whole or in part — that Guaranteed Payment Obligation,
  • and the Creditor has been unable to collect the judgment from the Payer,
    • after diligently making reasonable efforts to do so.
Commentary

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.

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13.5.4 What if Creditor is partially successful in collecting?

The Creditor may not double-dip: If the Creditor is able to collect part of the Guaranteed Payment Obligation,

  • then the amount of the Guaranty will be automatically reduced to that extent.

13.5.5 Are Guarantors jointly and severally liable?

Yes: Multiple Guarantors of a Guaranteed Payment Obligation are jointly and severally liable for any unpaid amounts of that obligation.

Commentary

It's a really good idea for drafters (and reviewers) to be clear about the extent to which multiple guarantors are to be jointly and severally liable for different Guaranteed Payment Obligation(s).

In a given transaction, for example, Alice might guarantee the obligations of Alan, and Bob might guarantee the obligations of Betty, but not vice versa — that is, Alice does not guarantee Betty's obligations nor does Bob guarantee Alan's obligations.

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13.5.6 Will obligation-modification negate the Guaranty?

Yes: If the Guaranteed Payment Obligation is modified in any material respect,

  • then Guarantor will no longer be obligated under the Guaranty,
  • unless Guarantor has given its written consent to the modification.
Commentary

The general rule — which typically is strictly applied by courts — is that "a guarantor is discharged if, without his or her consent, the contract of guaranty is materially altered."

Alternative: "An amendment to or modification of a Guaranteed Payment Obligation does not discharge or otherwise affect Guarantor's obligation under the Guaranty for that Guaranteed Payment Obligation." Comment: For an example of clause language like this, see 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).

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13.5.7 Is Guarantor's liability capped?

No: Each Guarantor's liability for a Guaranteed Payment Obligation is limited only by the amount of that obligation

  • unless the Contract clearly states otherwise.
Commentary

This is a placeholder and reminder — drafters would presumably go into more detail to cap a guarantor's liability.

In some transactions, a cap on guarantor liability might be a possible negotiation point.

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13.5.8 What law will govern the 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 23.15 (Governing Law)),
  • or if none, by the law that governs the interpretation and enforceability of the Contract.
Commentary

In a complex- or sophisticated transaction, a guaranty 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.

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13.5.9 Where may a Guaranty be enforced?

  1. If it becomes necessary for any Creditor to enforce the Guaranty against any Guarantor
    • in respect of that Creditor's rights under the Guaranteed Payment Obligation,
    • then that Creditor may do so,
    • in any forum having jurisdiction over that Guarantor,
    • without regard to where that Guarantor happens to be domiciled or otherwise located.
  2. In case of doubt, a Guarantor's agreement to a particular forum
    • is not intended as that Guarantor's submission to the general jurisdiction of the forum.
Commentary

Subdivision a allows any Creditor to enforce the Guaranty. This language is included because loans are often packaged and sold to different parties that collect payments (sometimes being "sliced and diced" in the process); the language allows a guaranty to be transferred to the original lender's successors and assigns as part of the "collateral" for the loan.

A specific, permissive forum-selection provision much like this one, allowing a guaranty to be enforced in the courts of Indiana, was readily upheld by the Seventh Circuit in the Knauf Insulation case, even though the guarantors purportedly did not have "minimum contacts" with the state of Indiana; the appeals court remarked that because of the forum-selection clause, the guarantors "didn't have to have any contacts" with that forum.

But if a Guarantor had bargaining power, it might insist that it could be sued under the Guaranty only in a particular jurisdiction, e.g., the Guarantor's home jurisdiction.

Many corporate-finance instruments specify that a guarantor can be sued in New York City, so that successive assignees of the right to payment will know that they can bring suit in that city (probably using their regular law firm(s)), no matter where the guarantor happens to be located.

Subdivision b: Disclaiming submission to general jurisdiction of a forum might be important to some parties.

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13.5.10 Must Creditors sign or accept the Guaranty?

No: In case of doubt, each Guarantor WAIVES (as defined in Clause 24.26):

  1. acceptance of the Guaranty by the Creditor(s);
  2. notice of such acceptance; and
  3. signature of the Guaranty by the Creditor(s).
Commentary

Many guaranties include waiver-of-acceptance and waiver-of-signature language. True, such language might very well merely duplicate applicable law. But it can't hurt to be explicit and thus try to avoid the issue.

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13.5.11 Are Guarantors liable for deficiency after foreclosure?

Yes: In case of doubt: if foreclosure on collateral (if any) does not produce enough money to pay the Guaranteed Payment Obligation or other obligations under the Guaranty,

  • then Guarantor will be liable for any remaining amount to the fullest extent permitted by applicable law,
  • even if the Payer's own liability for such a deficiency were to be wholly- or partly discharged by the foreclosure under a statute or judicial decision.
Commentary

This collateral-deficiency language is relatively common — and makes intuitive sense: Suppose that:

  • a creditor forecloses on collateral but the proceeds aren't enough to pay the debt; and
  • the creditor is not allowed to demand that a guarantor make up the shortfall.

In that situation, the guaranty might not be worth much, if anything.

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13.5.12 Who must pay enforcement expenses?

If a Creditor must take action to enforce the Guaranty against any Guarantor,

  • then that Guarantor must pay or reimburse that Creditor
  • for any court costs and other reasonable expenses —
  • including but not limited to attorney fees —
  • that the Creditor incurs in enforcing the Creditor's rights against Guarantor under the Guaranty.
    • and/or the Guaranteed Payment Obligation in question against the Payer.
Commentary

Expense-shifting language similar to that of this section was used in the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 305 (Ala. 2012).

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13.5.13 What is the consideration for the Guaranty?

Each Guarantor is undertaking its obligations under the Guaranty in consideration of each Creditor's entry into the Guaranteed Agreement.

Commentary

The recital of consideration is included because without such a recital (and possibly even with one), a court might hold a guaranty to be unenforceable. EXAMPLE: In a Massachusetts case:

  • A company's bookkeeper signed an order for ad space in a Yellow Pages phone book.
  • 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.

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13.5.14 Must Guarantors reimburse bankruptcy refunds?

Yes —

  1. This section applies if a Creditor:
    1. makes a refund (as defined below) of a payment made by a Payer on a Guaranteed Payment Obligation,
    2. because of a requirement of bankruptcy law; fraudulent-transfer law; or comparable law; or
    3. makes a partial refund of such a payment in settlement of a claim for a larger refund.
  2. In any such case, Guarantor must reimburse the Creditor for:
    1. the amount of the refund or partial refund; and
    2. the Creditor's attorney fees associated with the refund or partial refund, if any.
  3. For purposes of this provision, the term refund includes without limitation any payments made by the Creditor to third parties, for example to a trustee in bankruptcy, a debtor-in-possession, or a receiver.
Commentary

If a principal of a Guaranteed Payment Obligation were to file for bankruptcy protection (under U.S. law), then creditors might be forced to return any payments that were made by the principal within the 90 days preceding the bankruptcy filing date. Such payments are known as "avoidable preferences."

"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."

A creditor in bankruptcy does have the right to contest its obligation to refund an avoidable preference. That can be difficult, though, because the creditor must successfully jump through some hoops to prove that it was entitled to the payment.

As a practical matter, many avoidable-preference cases are settled, with the creditor making a partial refund in lieu of incurring the expense of jumping through those proof hoops. In such a situation, if the original obligation had been guaranteed, then the creditor likely would want to try to recoup the partial refund from the guarantor.

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13.5.15 Do Guarantors certify their financial information?

Yes: Each Guarantor represents and warrants,

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

This certification would provide creditors with at least some anti-fraud assurance, to supplement their own financial due diligence on guarantors.

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13.5.16 May Creditor's successors take advantage of the Guaranty?

Yes: Creditor's successors and assigns are intended third-party beneficiaries of the Guaranty

  • unless the Guaranty itself clearly says otherwise.
Commentary

See generally Clause 21.3 (Third-Party Beneficiary Disclaimer).

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13.5.17 Option: Financial Statement Updates

  1. No later than 45 days after the end of each calendar quarter,
    • each, a calendar period unless otherwise specified,
    • each Guarantor will provide each Creditor with a copy of Guarantor's financial statement for that period (the "updated financial statement").
  2. Guarantor will be deemed to have represented and warranted the accuracy of the updated financial statement,
    • to the same extent and in the same manner as the financial information originally provided by Guarantor.
Commentary

Financial-statement updates would give Creditors at least some ongoing comfort that Guarantor(s) continue to have the wherewithal to back up their Guaranty commitments.

Drafters should consider what "Plan B" provisions to include in a guaranty in case a Guarantor's financial position slips below acceptable levels. [TO DO: Research Plan B provisions]

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13.5.18 Option: Standard for Guarantor Financial Statements

Each set of financial statements that Guarantor provides to Creditors

  • must be prepared in accordance with the disclosure requirements applicable to guarantors of guaranteed debt under the U.S. securities laws.
Commentary

Concerning standards for guarantor financial statements, see generally, e.g., Michael H. Friedman, Public Offerings of Guaranteed Debt and the SEC's Proposed Rule Changes (PepperLaw.com 2018), which discusses Rule 3-10(a)(1) of Regulation S-X.

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13.5.19 Option: Audit Requirement for Guarantor Financials

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

Subdivision b — wording choice: In the author's view, requiring the copy of the auditor's report to be complete and accurate is far better than the pretentious legalese phrase true and correct; the latter:

  • is arguably redundant, and
  • arguably doesn't go far enough.

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13.5.20 Option: Guarantor Waiver of Defenses

Guarantor's obligations under the Guaranty are absolute, unconditional, direct and primary —

  1. any claim or defense that Guarantor's obligations under the Guaranty are allegedly illegal, invalid, void, or otherwise unenforceable;
  2. any claim or defense pertaining to any 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 may be available to the Payer or any other person who might be liable in respect of any Guaranteed Payment Obligation;
  3. any setoff available to the Payer 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 25.23), a nonjudicial foreclosure with respect to security for a Guaranteed Payment Obligation,
    • even if that election of remedies resulted in impairment or destruction of Guarantor's rights of subrogation and/or reimbursement against the Payer; and
  5. any other circumstance that might otherwise give rise to a defense available to, or a discharge of, either the Payer or Guarantor.
Commentary

The "absolute, unconditional" language makes for a strong guaranty; at least in some jurisdictions, such a guaranty is likely to be enforced even in what might seem like unfair circumstances — such as collusion between the Creditor and the Payer.

The waiver-of-defenses language is in part adapted from California Civil Code § 2856(c) and (d).

The use of all-caps type for WAIVES is for conspicuousness; see generally the discussion at Clause 26.2 (Conspicuousness (commentary)).

Subdivisions 2-4: Some of the listed items are based on those of the respective guaranties in two litigated cases.

Subdivision 3: In guaranties, "setoff" language like this is not uncommon; see, e.g., the guaranty in suit in a Texas case.

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13.6 Hollywood accounting (commentary)

[TO DO]

13.7 Income Tax Responsibility

As between the parties to the Contract,

  • each party is solely responsible for all taxes on that party's income arising from or relating to the Contract.

13.8 Interest Charges

  1. A payee may invoice Payer for, and Payer must pay, interest on any past-due amount,
    • at the specified rate, or the maximum rate allowed by law, if less,
    • beginning on the first day after the due date,
    • and continuing (on remaining unpaid amounts only) until the past-due amount is paid in full.
  2. Clause 13.20 (Usury Savings) is incorporated by reference.
Commentary

Caution: Vendors sometimes add interest charges to invoices; doing so without the customer's prior agreement can result in the charge being usurious.

Note that even invoicing for excess interest might constitute usury — and, in some circumstances and jurisdictions, that could result in forfeiture of the entire amount owed; see the commentary to Clause 13.20 (Usury Savings).

Pro tip: Is it worth arguing over an interest clause? Whether a payee will actually charge and try to collect interest is a real question. For example, suppliers sometimes hesitate to charge interest to their customers, even if their contracts permit them to do. Some large customers have been known to announce, imperiously: We don't pay interest, period.

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

So, when a drafter's client will be the payee of interest payments, it's worth considering whether it's even worthwhile to push for an interest provision.

Interest start date: The usury laws in some jurisdictions might prohibit charging interest before a specified time.

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Review: Interest rate

QUESTION (with Zoom poll): What if anything is wrong with this provision? (Assume that the payment terms are adequately specified elsewhere.)

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

13.9 Invoicing

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

  • a specified party (a "payee")
  • wants to be paid one or more specified amounts
  • by another party (a "Payer").

Discussion checklist:

13.9.1 Are invoices required for payment?

Probably: A party desiring to be paid payee must send Payer an invoice for the amount(s) due,

Commentary

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.)

Pro tip: a party submitting an invoice might want to confirm the current address to which the invoice should be sent. Otherwise, the invoice be lost in the other party's internal correspondence routing system. (With the rise of electronic invoicing- and payment systems, this provision might become less relevant.)

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13.9.2 What information must be included in invoices?

To aid Payer's compliance with its internal financial controls obligations,

  • each invoice must include such information as Payer reasonably requests in writing.

(See also the sales-tax itemization requirement in Clause 13.16 (Sales Tax Responsibility).)

Commentary

Invoices should be detailed enough to permit the paying party to exercise any audit rights it might have under an agreement. Some companies 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 very-detailed invoicing requirements, see section 13 of a Honeywell purchase order at https://perma.cc/84BS-KYXB.

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13.9.3 What language are invoices to be written in?

Each invoice must be written:

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

13.9.4 Must any particular invoice charges be itemized?

In each invoice, separate itemization is required for any charges for:

  • shipping and/or delivery,
  • insurance,
  • and any taxes that the Contract requires or allows to be billed to the Payer.
Commentary

See also Clause 13.16 (Sales Tax Responsibility).

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13.9.5 When must invoices be sent?

  1. If the payee and Payer have agreed in writing to a schedule for invoices to be sent,
    • for example, in the Contract or a statement of work,
    • then that agreement will control.
  2. Otherwise, the payee is to send invoices only when the payee's applicable performance being invoiced has been completed
    • for example, upon delivery of goods or completion of services.
  3. If a payee and Payer agree in writing to an invoicing deadline,
    • and Payer receives an invoice from the payee after that deadline,
    • then it will be up to Payer's sole discretion (as defined in Clause 25.19) to decide when — and whether — to pay the invoice.
Commentary

Invoicing schedules are often a subject covered in construction- and other services agreements, where the service provider wants to be paid as work is done, as opposed to waiting to be paid until the work is 100% complete.

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13.10 Payment Disputes

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a paying party ("Payer") believes that an invoice (or other request for payment) contains errors.

Discussion checklist:

See also Clause 13.9 (Invoicing).

13.10.1 What must Payer do to dispute an amount due, and when?

  1. Payer must advise the payee in writing that it is disputing the amount due,
    • specifying in reasonable detail why Payer believes the request for payment is in error,
    • no later than five business days before the putative payment due date.
  2. If the payee so requests,
    • Payer must provide the payee with reasonable written documentation to support Payer's position.
  3. Payer must pay any undisputed amounts on or before the original putative payment due date;
    • this subdivision, however, does not in itself excuse Payer's obligation to timely pay the disputed amount(s).
  4. If the payee provides Payer with information satisfactorily demonstrating
    • that some or all of the disputed charge(s) are in fact correct,
    • then Payer must pay those correct charges on or before the original putative due date.
Commentary

Paying parties should timely challenge incorrect invoices, because in some jurisdictions, if a party pays an incorrect invoice without protest, the paying party might not be able to recover its overpayment.

As one court in New York explained:

The common-law voluntary payment doctrine bars recovery of payments made with full knowledge of the facts, and in the absence of fraud or mistake of material fact or law. Where a party pays overcharges without protest or inquiry, was not acting under a mistake of fact, and the overpayment was the result of the party's lack of diligence, the payments are deemed voluntary and cannot be recovered.

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13.10.2 What must the payee do if Payer disputes an amount due?

If Payer so requests in writing,

  • the payee must promptly issue Payer:
  • a refundable credit for any amount
  • that both Payer and the payee agree was incorrectly charged,
  • and, if so requested, one or more appropriate replacement invoices for any remaining balance(s).

13.10.3 What if the parties can't agree about the disputed amount?

If the parties are unable to resolve the payment disagreement at the working level,

  • then the disagreement must be addressed in accordance with Clause 23.9 (Dispute Management Protocol).

13.11 Payment Security

Commentary

This Clause draws on ideas seen in § 2.2 of a General Electric terms-of-sale document archived at https://perma.cc/8LRL-PFL3.

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13.11.1 Is there a deadline for setting up payment security?

  1. Payer must establish,
    • and must keep in force as set forth in this Clause,
    • payment security that meets any and all requirements that are:
      • stated in this Clause, and/or
      • otherwise agreed to in writing,
  2. Payer must provide Supplier
    • with confirmation that the payment security has been established
    • no later than five business days
    • after the parties' agreement to the order that requires payment security.

13.11.2 How long must payment security be kept in place?

Payer must 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. Supplier's receipt of the final payment required under the order.

13.11.3 Who will pay the costs of payment security?

Payer must bear all costs and expenses associated with establishing and maintaining the payment security.

13.11.4 Must Payer ever modify its payment security?

  1. Payer must modify the payment security, upon written request by Supplier, if:
    • in Supplier's reasonable judgment, modification of the payment security is appropriate in view of the circumstances,
    • including, without limitation,
      • Payer's payment history, and
      • other facts that Supplier reasonably deems relevant to Payer's ability and/or willingness to pay.
  2. A modification required under subdivision a could include, without limitation, one or more of the following:
    • an increase in the amount of the payment security;
    • an extension of the term of the payment security;
    • changing to another Bank; and/or
    • any other appropriate modifications to the payment security reasonably requested by Supplier.
  3. Payer must make the requested modification(s) no later than ten business days after receiving (or refusing) Supplier's written request.

13.11.5 Must Supplier perform without acceptable payment security?

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

13.11.6 What forms of payment security are acceptable?

All payment security under this Clause:

  1. must be in the form of:
    • an irrevocable, unconditional, sight letter of credit or bank guarantee,
    • on terms reasonably acceptable to Supplier; and
  2. must be issued (or confirmed) by a financial institution
    • that is reasonably acceptable to Supplier (the "Bank").
Commentary

"A sight letter of credit is a document that verifies the payment of goods or services, payable once it is presented along with the necessary documents. An organization offering a sight letter of credit commits itself to paying the agreed amount of funds provided the provisions of the letter of credit are met."

13.11.7 What payment types must payment security cover?

The payment security must provide for payments by the Bank to 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 due from Payer in connection with the order.

13.11.8 Will failure to keep payment security in place be a material breach?

Any failure by Customer to timely provide, maintain, and/or update, the required fully effective payment security,

13.12 Payment Terms

13.12.1 When are payments due?

Payer must pay each amount due net 30 days

  • after the date of Payer's receipt of the invoice (or other request for payment).
Commentary
"Net 30 days"

"Net X days" means that payment in full is to be received by the payee no later than X days after the stated date.

Comment: It's not unheard of for customers to want to wait a long time before paying their suppliers. Net 45 and even net 60 are generally considered within the band of reasonableness. But some customers demand net 90 and even net 120 days.

Other due dates

Alternative: "Invoice payments are due net 30 days from the date of the invoice." Payees sometimes want this alternative, but paying parties generally push back because they need (or want) more time to process invoices.

Alternative: "Invoice payments are due 2% 10 days, net 30 days …" 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.

13.12.2 What payment methods are acceptable?

  1. Payments under the Contract may be made by any reasonable means.
  2. A payment method is to be conclusively deemed acceptable
    • if the payee does not reasonably and seasonably (as defined in Clause 25.49) object to the payment method
    • after being advised of the proposed form of payment
    • or after receiving a payment using the payment method.
Commentary

Some widely-used payment methods include the following:

• Check: See Investopedia at https://goo.gl/19C7Rv . The check could be required to be drawn on a U.S. bank, or on a specified bank, or on any bank to which the payee does not reasonably object in writing.

Importantly, 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. (These days this is almost always done electronically if the payee uses a different bank.)

Caution: 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 [XXX].

• Automated clearing house ("ACH") electronic debit transaction in lieu of a check: See Investopedia at https://goo.gl/1P9EQa;

Certified check: See Investopedia at https://goo.gl/aVLbsE: a certified check (see above) is written by the payer and drawn on the payer's account, but the bank guarantees to the payee that the bank has put a hold on the payer's account for the amount of the check, meaning that the check should not bounce.

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 payee cashes the check, the payee might have to refund the money.

Cashier's check: See Investopedia at https://goo.gl/EZ7Vec. 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 Contract might specify what bank, or what type of bank, is to be used.

Caution: Cashier's checks can be counterfeited.

• Wire transfer (Investopedia at https://goo.gl/t6kisl) to give the payee "immediately-available funds" that can be immediately withdrawn and spent (Investopedia at https://goo.gl/51Ai5A).

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13.12.3 May Payer offset amounts owed to it?

  1. If Payer owes money to a payee under the Contract,
    • and the payee also owes money to Payer, whether under the Contract or otherwise,
    • then Payer may not reduce its payment to the payee
    • unless the Contract clearly states otherwise.
  2. If Payer does offset against a payment obligation as permitted by the Contract, then:
    • 1. Payer must not reduce the payment by more than the amount that the payee owes to Payer; and
    • 2. no later than the due date of Payer's payment, Payer must:
      • advise the payee in writing that Payer is taking an offset; and
      • provide the payee with a reasonable written explanation of each offset, together with reasonable supporting documentation.
Commentary

A payee might be reluctant to agree to allow payment offsets, because the payee might be depending on Payer's timely payment for the cash flow that the payee needs to run its business. Moreover, offsets could lead to difficulties in tracking invoice payments.

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

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13.12.4 In what order are payments to be applied to obligations?

The payee may apply Payer's payments:

  • first to accrued interest (if any),
  • then to unpaid principal,

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

Commentary

Provisions of this kind are often seen in promissory notes. This language is adapted from a suggestion in David Cook, The Interest Tail Wags the Profit Dog, in Business Law News Issue No. 3, 2014 (State Bar of California Business Law Section; available on-line to Section members).

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13.12.5 Will payment diminish Payer's other rights?

  1. If Payer pays some or all of an amount invoiced (or otherwise charged) under the Contract,
    • that fact will not diminish any rights that Payer might have concerning the subject matter of the payment,
    • whether under the Contract or by law,
    • unless Payer expressly agrees otherwise in writing.
  2. Payer's rights referred to in subdivision a include, without limitation, any warranty rights concerning goods delivered and/or services performed.

13.12.6 Option: Pay If Paid / When Paid

13.12.6.1 When would this Option be relevant?

If this Option is agreed to, it will apply if:

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

Example: Suppose that a contractor enters into a contract with a homeowner, under which the contractor will remodel the homeowner's kitchen. The contractor enters into a subcontract with a painter, under which the painter will do the necessary painting in the kitchen. In this example, pay if paid means that the contractor need not pay the painter unless the homeowner pays the contractor.

In some jurisdictions, a pay-when-paid clause implicitly means within a reasonable time. For example, if an end-customer does not pay a prime contractor within a reasonable time, then the prime contractor — or more likely, the insurance carrier that wrote the prime contractor's payment bond — must pay the subcontractor anyway.

A pay-if-paid clause makes the end-customer's payment a condition precedent to the subcontractor's right to payment; in other words, if the end-customer doesn't pay the prime contractor, then the subcontractor isn't entitled to payment even from the prime contractor's performance bond.

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13.12.6.2 When must a contingent payment be made?

Payer must immediately make the contingent payment

  • after Payer has received,
  • on an unconditional basis,
  • and accepted,
  • the specified third-party payment(s).
13.12.6.3 What Payer collection efforts are required for pay-when-paid?

If Payer owes money under a pay-when-paid obligation,

13.12.6.4 What Payer collection efforts are required for pay-if-paid?

If Payer owes money under a pay-if-paid obligation,

  • then Payer need not make any particular efforts to collect any associated third-party payment,
  • and if Payer does make such efforts, they will be:
  • 1. in Payer's sole discretion (as defined in Clause 25.19); and
  • 2. solely for Payer's benefit.
13.12.6.5 What risk does the payee assume for a pay-if-paid obligation?

If a payee will be owed money under the Contract for an agreed pay-if-paid obligation;

  • then the payee certifies —
  • with the intent that Payer rely on the payee's certification —
  • 1. that the payee has taken into account the risk that the paying party might not get paid by the relevant third party or ‑parties, and therefore that the payee might not get paid;
  • 2. that the payee is relying on the credit and willingness and ability to pay of those third parties, and not on that of the paying party, for the payee to be paid that amount; and
  • 3. The payee KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY ASSUMES AND ACCEPTS THE RISK that one or more of those third parties might not be able or willing to pay the paying party,
  • in which case the payee might not get paid (or might not be paid in full).
Commentary

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.

• 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.

• In New Jersey, the courts are split about pay-if-paid clauses, according to Michelle Fiorito, The Consequences of "Pay-If-Paid" and "Pay-When-Paid" Construction Contracts Clauses (ZDLaw.com 2012).

• Still another court — in passing, and arguably in a dictum — seems to have implicitly treated a pay-if-paid clause as a pay-when-paid provision.

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

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13.12.7 Option: COD Terms may be imposed

In case of:

  • multiple late payments,
  • or one or more significant late payments,
  • by a party,
  • the other party may require cash-on-delivery (COD) terms
  • for any subsequent transactions.
Commentary

Applicable law might well implicitly permit a payee to demand COD terms after late payment if the late payment constituted a material breach (as defined in Clause 25.33.2) of the Contract.

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13.12.8 Option: Payment Failure is Not Infringement

If a party does not timely pay another party (the "payee") one or more amounts required by the Contract

  • for goods furnished by the payee,
    • including, for this purpose, without limitation, computer software,
  • and the first party's use of the goods would infringe the payee's intellectual-property rights if unlicensed;
  • then the payee's remedies (if any) will NOT include remedies for such infringement.
Commentary

A customer purchasing and using (or reselling) goods, or acquiring a license to use software, might be interested in this clause, because nonpayment of a software license fee might means that the non-paying user was infringing the copyright in the software.

In one case, the Ninth Circuit observed (in a dictum) that "[a] licensee arguably may commit copyright infringement by continuing to use the licensed work while failing to make required payments …."

And the damage award for such infringement might be significantly more than simply having to pay the required license fee. For example:

  • The MGM Grand Hotel's casino floor show was found to infringe the copyright in the Broadway musical Kismet.
  • The resulting damage award included 2% of MGM's profits from the hotel operations as a whole, including the casino itself.

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…."

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13.12.9 Exercises and discussion questions

13.12.9.1 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

13.12.9.2 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 § 23.20.2.)

13.13 Payments Rider

If this Payments Rider is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How will deposits and down payments be handled? See Clause 13.1 (Deposits).
  2. How must amounts due be invoiced? See Clause 13.9 (Invoicing).
  3. When are payments due? See Clause 13.12 (Payment Terms).
  4. How will (allowable) expenses be reimbursed? See Clause 13.3 (Expense Reimbursement Protocol).
  5. How are payment disputes to be handled? See Clause 13.10 (Payment Disputes).
  6. Who is responsible for personnel compensation? Each party, for its own personnel; see Clause 13.14 (Personnel Compensation Responsibility).
  7. Who is responsible for paying sales taxes? Normally, the vendor or supplier; see Clause 13.16 (Sales Tax Responsibility).

.

Commentary

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

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13.14 Personnel Compensation Responsibility

13.14.1 Who is responsible for compensating the parties' personnel?

As between the parties, each party is solely responsible for administering and paying the following:

  1. all salary and employment benefits (if any) of that party's employees and other personnel; and
  2. all employment-related taxes and/or fees (if any) that are required, in any jurisdiction, for those personnel.

13.14.2 Will party personnel be entitled to other parties' benefits?

No: Unless the Contract unmistakably states otherwise,

  • no party "ABC" intends for the Contract to confer, on any other party's personnel,
  • any entitlement to the employment benefits (if any) or other benefits (if any)
  • that ABC provides to ABC's own employees or other personnel.

13.14.3 What if someone claims otherwise?

As between any party, referred to as "ABC," and any other party "XYZ,"

13.15 Sales Tax Definition

The term "sales tax," whether or not capitalized, includes (without limitation) all of the following:

  • sales taxes;
  • use taxes;
  • value-added taxes;
  • excise taxes;
  • other forms of ad valorem tax and consumption tax;
  • and equivalent taxes.

13.16 Sales Tax Responsibility

  1. This Clause applies whenever:
    • under the Contract, any party sends an invoice (see § 13.9) to another party
    • for goods, services, or other things potentially subject to sales taxes (as defined in Clause 13.15).
  2. The invoicing party must do the following — at its own expense:
    1. determine what if any sales taxes must be paid to an applicable jurisdiction in connection with the transaction;
    2. separately list all sales taxes in the relevant invoice (see also § 13.9 concerning invoices); and
    3. timely report and remit all sales taxes
      • to all relevant taxing authorities
      • anywhere in the world,

unless the parties clearly agree otherwise in writing in connection with a particular transaction.

13.17 Tax-Indemnity Plan

Each party must defend (as defined in Clause 21.4) each other party's Protected Group (as defined in Clause 25.40)

  • against any claim by a third party,
  • that the first party failed to pay any tax (as defined in Clause 13.18) for which the first party is legally responsible,
    • whether the first party's responsibility arises under the Contract or otherwise.

13.18 Tax Definition

  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.
Commentary

This definition draws on the following:

  • the contract language quoted by the Court of Appeals of New York in upholding a summary judgment that a $20 million-plus water usage charge, levied by a Mexican government entity, was a "tax" within the meaning of the contract's laundry-list definition; and

13.19 Taxing Authority Definition

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.

13.20 Usury Savings

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Payer and the payee intend for all charges and payments under the Contract to comply with law; this Usury Savings will therefore apply—
    • if any charge by the payee, or any payment by Payer, under the Contract is properly characterized as interest,
    • and the charge or payment is determined to have exceeded the maximum interest permitted by law,
    • after taking all permitted steps to spread such payments over time.
  3. In any such case, the excess interest is to be considered the result of an inadvertent error,
    • even if the payee or Payer intended to take the action(s) that resulted in the excess interest being charged or paid.
  4. If Payer has not yet paid the excess interest, then the payee will cancel the excess-interest charge.
  5. If Payer has paid excess interest, then the payee will promptly refund the excess interest to Payer, and/or credit the excess interest to any balance still owed by Payer,
    • together with interest on the excess interest at the maximum rate permitted by law.
Commentary

Caution: Usury savings clauses might or might not be effective in a given jurisdiction. For example:

• Texas law permits usury-savings clauses.

• 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.

Subdivision b: "Properly characterized as interest": Not all so-called "interest" charges will be subject to usury laws. For example, in Texas, interest is defined by statute as "compensation for the use, forbearance, or detention of money. The term does not include time price differential, regardless of how it is denominated. …"

What is this "time price differential" of which the Texas statute speaks? One article explains the quoted term in relation to Texas law:

If certain requirements are met and a transaction is not designed to circumvent the usury laws, a merchant may sell merchandise at a higher price for credit than for cash and the price difference is not usurious. The new statute codifies the common law time-price doctrine.

In order to apply the time-price doctrine, it must be shown that the seller clearly offered to sell goods for both a cash price and a credit or time price, that the purchaser was aware of the two offers, and that the purchaser knowingly chose the higher time or credit price.

If an agreement fails to qualify as a time-price differential contract, then the finance charges may be found to constitute usurious interest.

See generally, e.g.:

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14 Operations: Services, sales, etc.

Beginning with this chapter, this manual is arranged chiefly in a clause-plus-commentary format.

Most clauses beginning with an issues checklist for reviewers and drafters (cleverly disguised as a table of contents).

Contents:

14.1 Orders for Goods & Services

14.1.1 Terminology: Customer; Supplier; Order

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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.
  2. Each such agreement for a transaction is referred to as an "Order."
  3. 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.

14.1.2 How must Supplier submit orders?

Supplier may decide, from time to time, how orders are to be submitted,

  • for example via hard copy, 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]."

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14.1.3 What information must Customer provide in 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."

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14.1.4 A Supplier quotation constitutes an "offer"

  1. 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.
  2. 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 24.7 (Entire Agreement) concerning the effect of additional terms in purchase orders, etc.

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14.1.5 Supplier's catalogs and price lists are not "offers"

No: 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.

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14.1.6 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.

14.1.7 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.

14.1.8 Must Orders be in writing? What about change orders?

  1. 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.
  2. 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 25.13).
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 the Amendments & Waivers Rule and its commentary.

Subdivision b – corroboration requirement: See Clause 23.8 (Corroboration Requirement) and its commentary.

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14.1.9 Which party must agree to an Order? A change order?

  1. An Order must be agreed to by both Supplier and Customer.
  2. A change order must be agreed to by (at least) the party against which the change order is sought to be enforced.
Commentary

Subdivision b – agreed to by the party to be bound: This borrows from the approach of UCC § 2-201.

Alternative: "A change order must be agreed to by both parties."

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14.1.10 Who may agree to an Order? A change order?

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 § 24.2.3.

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."

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14.1.11 Customer's affiliates may submit orders

  1. Customer's affiliates (as defined in Clause 25.2)
    • may submit one or more proposed Orders for transactions with Supplier under the Contract
    • unless the Contract clearly specifies otherwise.
  2. 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.
  3. 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.

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.

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14.1.12 Customer is not responsible for its affiliates' Orders

Customer is not responsible for its affiliates' obligations under their Orders (if any),

  • unless the Contract clearly states otherwise,
  • or 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."

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14.1.13 What packaging and labeled are required?

  1. 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,
  2. 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.

14.1.14 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.)

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14.1.15 May Customer specify delivery to a third party?

Possibly:

  1. Customer may designate, in writing, a third party to which deliverables are to be shipped,
    • unless the Contract clearly specifies otherwise.
  2. Customer's designation of the third party must take place a reasonable time before shipment.
  3. Customer must respond promptly
    • to any reasonable requests by Supplier
    • about the third party,
    • for example (as defined in Clause 25.23), to determine whether Supplier may legally ship the deliverables to the third party
      • because of export-control restrictions or other legal factors.
  4. Supplier is to cause the deliverables to be shipped to the third party,
    • absent reasonable objection on Supplier's part,.
  5. Customer is to pay any additional costs arising from Customer's designation,
    • e.g., additional shipping, additional insurance, etc.
Commentary

Subdivision c: 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.

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14.1.16 When will title and risk of loss pass to Customer?

Title and risk of loss will pass to Customer as specified in INCOTERMS 2020 EXW - Ex Works Supplier's facility.

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.

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14.1.17 What if an Order is delivered late — or early?

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 § 25.47.)

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14.1.18 Orders are separate agreements

Each Order is to be considered a separate agreement

  • that incorporates the Contract by reference,
  • including but not limited to this Clause,
  • whether or not the incorporation is explicit,
  • unless the Order clearly says otherwise.
Commentary

Alternative: "Each Order is to be considered an addition to this Agreement and not as a separate agreement."

Comment: Language along the lines of the above alternative is seen in some contracts where "netting out" of multiple transactions is desired, such as, e.g., the ISDA Master Agreement.

For standalone commercial transactions, the above alternative would be unwise to use, in the author's view, 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 Supplier's liability for damages were to be capped at "the amounts paid or payable under the Parties' Agreement," then that amount would grow over time as more statements of work were completed; Customer might like that, but Supplier wouldn't be wild about it.

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14.1.19 Exercises and discussion questions

14.1.19.1 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?)

14.2 Orders: Optional clauses

14.2.1 Option: Stocking Point Delivery

  1. An Order may specify that ordered deliverables are to be delivered to a warehouse (or other stocking point) until called for Customer.
  2. 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.

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14.2.2 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.

14.2.3 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.

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14.2.4 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 19.6 (Force Majeure Protocol).

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14.2.5 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.

14.2.6 Option: Shipping-Document Consolidation

Supplier is encouraged to consolidate shipping documents wherever practicable.

14.2.7 Option: Shipment Advice

  1. Supplier will advise Customer in writing when deliverables specified in an Order have been shipped.
  2. Supplier will provide any specific details reasonably requested by Customer,
    • such as tracking information for the shipment.

14.2.8 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.

14.2.9 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.)

14.2.10 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.

14.2.11 Option: Customer Handling of Rejected Deliverables

  1. Customer may direct that rejected deliverables be returned to Supplier (at whatever address Supplier specifies) at Supplier's expense.
  2. Customer may store rejected deliverables, at Supplier's risk, pending Customer's receipt of Supplier's return shipping instructions.
  3. Supplier must pay, or reimburse Customer for, all charges for storage, insurance, and return shipping of rejected deliverables.
  4. 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.
  5. 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.

14.2.12 Option: Supplier Orphaned Deliverables

  1. 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.
  2. 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 25.23), a freight forwarder).
  3. Both title and risk of loss for stored deliverables will immediately pass to Customer (if that has not already happened).
  4. 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).
  5. Customer will reimburse Supplier for all expenses incurred by Supplier in connection with putting the relevant deliverables into storage,
    • in accordance with Clause 13.3 (Expense Reimbursement Protocol).
  6. 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.

14.2.13 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).

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14.2.14 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].

14.2.15 Option: Terms for Customer cancelation 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].

14.2.16 Option: Advance Payment Requirement

Supplier reserves the right, in its sole discretion (as defined in Clause 25.19),

  • 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.

14.3 Services Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

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

Discussion checklist:

Commentary

Consider also the following:

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14.3.1 Written statements of work are required

  1. 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.
  2. 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 § 24.19.1.

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14.3.2 Statements of work can be changed

  1. 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.
  2. 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.
  3. 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.
  4. The parties may agree orally to a change in a statement of work,
Commentary

See generally Clause 24.2 (Amendments Procedure) and its commentary.

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14.3.3 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,
  • unless the Contract clearly says otherwise.
Commentary

This checklist item is intended as a roadblock to "creative" contractor claims to the contrary, as seen in, e.g.:

  • 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 found in favor of the contractor and awarded lost profits, but the Fifth Circuit held that the contract unambiguously did not require Dow to assign the contractor work during the termination-notice period; and
  • a Chicago lawsuit in which 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;

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14.3.4 Who is to obtain licenses & permits for the work itself?

  1. 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.
  2. 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: The law might disregard contract provisions in order to protect other societal interests. 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.

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14.3.5 Who is to obtain authorizations for use of deliverables?

Customer must timely obtain any licenses or permits needed

  • for use of deliverables,
  • by Customer or others authorized by Customer,
  • for example, any necessary patent licenses,
  • unless the Contract clearly says otherwise.
Commentary

Even if Provider warrants that deliverables per se do not infringe third-party IP rights, that might not provide Customer with much comfort about third-party infringement claims arising from Customer's use of the deliverables.

And in the U.S., see UCC § 2-312, which provides in part that:

(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.)

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

  1. This section will apply if Provider and Customer disagree about the need for a particular third-party authorization.
  2. Provider will not be in breach of the Contract if, with prompt notice (as defined in Clause 24.17) to Customer, Provider suspends the relevant work until the parties resolve the disagreement.
  3. The parties are to attempt to resolve their disagreement in accordance with Clause 23.9 (Dispute Management Protocol).
  4. If the parties are unable to resolve their disagreement themselves, then Clause 23.4 (Baseball-Style Dispute Resolution) will apply.
Commentary

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 to:

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.

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14.3.7 Who is responsible if authorizations are not obtained?

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 —
    • this could include, without limitation, something like a building inspector ordering Customer to move out of a building because Provider failed to get an occupancy permit —
  • then the first party must defend and indemnify the other party and its Protected Group (as defined in Clause 25.40) against all foreseeable damages and losses arising from the third party's claim.

14.3.8 What personnel must Provider assign to do the work?

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.

14.3.9 Will background checks be required for anyone?

Possibly: If the statement of work clearly so states, then:

  • Provider is to cause background checks to be performed,
  • in accordance with Clause 15.2 (Background Checks),
  • 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.

14.3.10 What quality of service performance is required?

  1. 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.
  2. If the Contract uses the term workmanlike, the term has the same meaning as professional as defined above.
Commentary
"Professional" = "workmanlike"

The term professional is used here instead of workmanlike because the former term sounds more, well, professional, but the definition of professional 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 in connection with the repair of tangible goods.

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

A covenant, not a representation or warranty

This performance-requirement language 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).

Implied warranties of workmanlike performance

Drafters should be aware that in some states the law might automatically impose a warranty of workmanlike performance, or something close to it. See, e.g., Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 291-94 (Tenn. 2011) (citing numerous authorities but not defining workmanlike).

Implied warranties of workmanlike performance come into play especially in connection with the sale of a new residence. The imposed warranty might even be non-waivable and/or non-disclaimable. For example:

  • Home construction: Forty-three states provide an implied warranty of habitability for new residences, according to the Utah supreme court, while three others provide a warranty of workmanlike manner.
  • 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 20.7 (Implied Warranty Disclaimer) and its associated commentary.

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 25.7).)
Performance standards: Further reading

See generally, e.g.:

14.3.11 What specific tasks is Provider responsible for?

Provider is to see to 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.
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.

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14.3.12 What materials, etc., must Provider furnish?

Provider is to see to the furnishing —

  • of all materials, equipment, supplies,
  • computer hardware and -software,
  • work locations,
  • electrical power,
  • Internet- and other communications capabilities,
  • and other items needed to meet Provider's performance responsibilities;
  • this obligation includes any necessary acquisition, installation, and maintenance of all such items.
Commentary

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.

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14.3.13 Who is to furnish safety equipment?

Provider is to see to the furnishing,

  • as necessary,
  • of prudent, properly-functioning safety equipment
  • for Provider's personnel
    • and for the personnel of Provider's contractors;
  • this includes, without limitation, any necessary personal protective equipment (PPE).
Commentary

Depending on the situation, it might make more sense for Customer to furnish (some or all) PPE.

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14.3.14 Who is to supervise the individuals doing the work?

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

14.3.15 Who 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.

14.3.16 What must Customer do to support Provider?

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

14.3.17 What must Provider do about defects?

Provider is to proceed in accordance with Clause 14.5 (Defect Correction Protocol) in any case of defective performance of services and/or delivery of defective deliverables.

14.3.18 When are payments for services due?

  1. Provider is to invoice Customer, and Customer is to pay Provider, for services, in accordance with the applicable statement of work and Clause 13.13 (Payments Rider).
  2. 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.

14.3.19 Must Customer reimburse Provider for expenses?

Customer need not reimburse Provider for expenses incurred in performing services unless the Contract clearly says so — in which case Clause 13.3 (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.

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14.3.20 May Provider 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.

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

  1. 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 must keep records in accordance with Clause 15.4 (Recordkeeping Protocol),
    • and Customer may audit those records in accordance with Clause 15.1 (Audit Protocol).
  2. Otherwise, Provider need not allow Customer to audit Provider's records concerning the services unless the Contract clearly says otherwise.

14.3.22 Do any confidentiality obligations apply here?

Unless the Contract clearly states otherwise, neither party has any confidentiality obligations relating to the services.

 Provider must preserve in confidence the Confidential Information of Customer in confidence per Clause 16.1 (Confidential Information).

 Each party must preserve in confidence the Confidential Information of the other party per Clause 16.1 (Confidential Information).

14.3.23 Customer need not pay Provider more to use deliverables

  1. This section applies if Provider has any legal right to restrict Customer's use of deliverables,
    • for example under a patent or copyright.
  2. 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..

14.3.24 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.

14.3.25 Provider need not support further development by others

No: Provider may, in its sole discretion (as defined in Clause 25.19), 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.

14.3.26 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.

14.3.27 May Customer terminate a statement of work "at will"?

Yes: 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."

Pro tip: If Customer wants the right to terminate a statement of work "at will" (or "for convenience"), Provider might want to impose limits, or perhaps require an early-termination fee, so that Provider will have a chance —

  • to recoup at least some of the the investment that Provider makes in tooling, materials, training, etc., to perform the statement of work; and/or
  • to find replacement revenue to support Provider's personnel who are assigned to Customer's account.

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14.3.28 Either party may terminate for material breach

Any specified party may terminate a statement of work for material breach (as defined in Clause 25.33.2) 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 24.17) 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.

14.3.29 Some Provider breaches are automatically "material"

Yes: Except as otherwise agreed, 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).

14.3.30 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).

14.3.31 What must Provider do after termination?

Promptly after any termination of a statement of work:

  1. 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.
  2. Provider is to send Customer one or more final invoices for the statement of work,

14.3.32 What must 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.

14.3.33 Confidentiality obligations (if any) will continue

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

14.3.34 What if one party goes on another's premises?

Clause 19.16 (Site Visits Protocol) will apply if either party's personnel visit physical premises of another party

14.3.35 What if one party accesses another's computers?

Clause 19.3 (Computer System Access Prococol) will apply if either party's personnel access another party's computer system(s) and/or network(s)

14.3.36 Exercises and discussion questions

14.3.36.1 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?
14.3.36.2 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?

14.3.36.3 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?

14.3.36.4 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.

14.4 Services terms (optional)

14.4.1 Option: Mitigation of Schedule Slips

  1. 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.
  2. If that milestone is not completed by the specified date,
    • then Provider must 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.

14.4.2 Option: Prohibited Use of Deliverables by Others

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.

14.4.3 Option: Customer Ownership of IP Rights

  1. 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).
  2. Provider is to seasonably (as defined in Clause 25.49) 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.

14.4.4 Option: Loss of Rights for Nonpayment

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.

14.4.5 Option: Post-Termination Deliveries Delay

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.

14.4.6 Option: Customer Post-Termination Payment Delay

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.

14.4.7 Option: Adjustment of Final Payment for Material Breach

If a statement of work is terminated for material breach (as defined in Clause 25.33.2) by Provider,

  • then Customer's final payment obligation is to be adjusted appropriately,
  • preferably as agreed by the parties in accordance with [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider),
  • but if not, as determined by a tribunal of competent jurisdiction
  • in accordance with Clause 23.4 (Baseball-Style Dispute Resolution).

14.4.8 Option: Expiration as Termination

Unless clearly agreed otherwise in writing,

  • an expiration of a statement of work is to be considered a form of termination.

14.5 Defect Correction Protocol

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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."
  2. 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 25.23), if a third-party service provider is to deal with defects as stated in this Clause.

Discussion checklist:

Commentary

This Clause represents a fairly-standard protocol for correction of software defects; it should also be useful in other contexts.

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14.5.1 What is Customer's deadline for reporting defects?

Provider's obligations under this Clause apply only to defects —

  • that Customer reports in writing to Provider (or Provider's designee),
  • on or before 90 days 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.

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14.5.2 What must Provider do about reported defects?

Provider is to address defects as specified in Plan A and Plan B below.

14.5.2.1 Plan A: Repair, replacement, or workaround

For any defect that is timely reported under § 14.5.1,

  • 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 30 days 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.

This language should not be interpreted as creating a long-term warranty of deliverables' future performance. Indiana's supreme court held that "we 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."

The supreme court did note that "parties could agree that the limitations period will stop running while a seller attempts to repair defective goods and resume when repairs are completed."

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14.5.2.2 Plan B: Refund

If Provider does not timely take the action or actions required by this Clause 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:

  • Consider: 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."
  • 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.

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14.5.3 Does Customer have any other legal remedies for defects?

No: Provider's defect-correction obligations stated in this Clause

  • are Provider's only obligations,
  • and the EXCLUSIVE REMEDIES available to Customer
    • (or any individual or organization claiming through Customer),
  • 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. 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.

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.

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14.5.4 Terminology: What is a "defect"?

For purposes of this Clause, 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 25.23), 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.

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14.6 Referrals Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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").

Discussion checklist:

14.6.1 How much will each commission be?

Commissions will be 0.001% of eligible sales as specifed in more detail in this Clause.

(This is a placeholder that will apply only if the Contract does not specify otherwise.)

14.6.2 What offerings are eligible for commissions?

All "Company offerings" are eligible for commissions; this refers to Company products and/or services that are —

  • offered for sale by Company,
  • in the Territory,
  • during the Referral Term.

14.6.3 Referrals for what "Territory" are commission-eligible?

The term "Territory" refers to:

  • anywhere in the world,
  • in all market segments.

14.6.4 Referrals during what time period are eligible?

  1. The "Referrals Term":
    • begins upon the effective date of the Contract,
    • and ends at the end of the day (as defined in Clause 25.16) on the date two years after that.
  2. In case of doubt: Only otherwise-eligible referrals made during the Referrals Term are eligible for commission payments.

14.6.5 Could a given referral "go stale?

Yes: 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 date one year after Associate's initial referral of that customer to Company.

14.6.6 When will a Company sale be considered "made"?

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.

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14.6.7 How long will commissions be paid for a referral?

Company need not pay commissions

  • for an otherwise-eligible sale to a customer,
  • if that sale is "made" (see Clause 14.6.6)
  • after the end of one year after Company's first sale to that customer.
Commentary

Note that under Clause 14.6.11, the due date for a commission payment might be after the end of this period.

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14.6.8 Will the Referrals Term be automatically extended?

No: If the Contract does provide for automatic extension of the Referrals Term (defined in Clause 14.6.4),

14.6.9 Are Associate's referral rights exclusive?

Not unless the Contract clearly says so.

If the Contract does provide for any type of exclusivity,

14.6.10 Must Associate meet any performance requirements?

Not unless the Contract clearly says so.

The Contract, however, may provide, for example (as defined in Clause 25.23) for one or more of the following:

  • minimum referrals by Associate,
  • and/or minimum sales by Company,
  • in a specified time period,
  • failing which (for example) Company may terminate Associate's right to receive commissions.

14.6.11 When are commission payments due?

A: 30 days after the end of the fiscal quarter in which which Company collects the associated invoiced price.

Payments are to be in accordance with Clause 13.12 (Payment Terms).

14.6.12 Does anyone have confidentiality obligations?

Yes, as follows:

  1. Clause 16.1 (Confidential Information) will apply,
    • but only as to Company's Confidential Information.
  2. The terms of the parties' commission arrangement are Company's Confidential Information.

14.6.13 How will Company report the 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.

14.6.14 What supporting records must Company keep?

Company must keep records to support commission amounts due

14.6.15 May Associate verify Company's reports?

Yes: Associate may have Company's commission records audited;

14.6.16 In general, which sales are eligible for commission?

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.

14.6.17 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.

14.6.18 May Associate hold itself out as Company's agent?

No.

See also Clause 24.11 (Independent Contractors).

14.6.19 Who will control customer sales negotiations?

  1. 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 25.19).
  2. Associate must follow Company's lawful directions in that regard.
  3. Associate must not attempt to insert itself into any such negotiation without Company's prior approval.

14.6.20 Who will be responsible for warranty claims?

If a customer or other third party makes a claim (as defined in Clause 25.12) 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 21.4) Associate's Protected Group (as defined in Clause 25.40) against the claim.

14.6.21 Who will be responsible for alleged Associate faults?

If a third party makes a claim (as defined in Clause 25.12) against Company

14.6.22 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?

14.7 Resale Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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 14.7.4);
  • this arrangement is sometimes referred to as the "Reseller Relationship."

Discussion checklist:

[Note to drafters: See also the optional terms in Clause 14.8.]

14.7.1 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").

14.7.2 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.

14.7.3 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.

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14.7.4 How long may Reseller engage in resales?

  1. 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.
  2. If and when the Resale Term ends, Reseller must permanently cease:
    1. advertising, marketing, or otherwise promote Resale Offerings; and
    2. identifying itself as a channel associate of Supplier.

14.7.5 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 24.8 (Evergreen Extensions).

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14.7.6 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 25.24 (Exclusivity Definition) will apply.

14.7.7 May Reseller engage subresellers?

  1. Reseller may not appoint a subreseller without first obtaining Supplier's written consent.
  2. Supplier may grant, withhold, or condition its consent to appointment of a subreseller in Supplier's sole discretion (as defined in Clause 25.19).
  3. 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.
  4. 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 Clause 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.
  5. Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40) against any claim by a third party
    • if the claim arises out of acts or omissions of a subreseller relating to a Subreseller Agreement.

14.7.8 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;

14.7.9 Who will support Reseller's customers?

  1. Level 1 support (defined in Clause 14.11.4) for Reseller's customers for Resale Offerings will be provided by Reseller;
    • Level 2 and Level 3 will be provided by Supplier
  2. 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.
  3. Reseller will promptly notify Supplier if Reseller finds that it is unable to respond effectively to a request for support from a Reseller customer.

14.7.10 What performance requirements must Reseller meet?

During the Resale Term, Reseller must use commercially-reasonable efforts (defined in Clause 25.14) in promoting sales of the Resale Offerings within the Territory.

Commentary

Drafters could come up with a variety of performance-standard terms, such as, for example:

  • dollar revenue to Supplier in a stated period
  • sales penetration in the Territory in a stated period
  • as time goes on, more-stringent standards (to give Reseller a "break-in period")
  • rewards for over-achieving the targets

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14.7.11 What if Reseller fails to perform as agreed?

If Reseller does not meet the performance standard set forth in Clause 14.7.10,

  1. invoke Clause 19.15 (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 19.15.
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.

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14.7.12 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 16.1 (Confidential Information).

14.7.13 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 16.1 (Confidential Information).

14.7.14 Reseller will not be Supplier's "agent"

Unless the Contract clearly states otherwise, Reseller is not Supplier's agent,

  • and must conduct itself accordingly at all times.

14.7.15 How may the Reseller Relationship be publicized?

  1. The authorizations in this section are effective only during the Resale Term (as defined in Clause 14.7.4).
  2. 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.
  3. A Publicizing Party's identification of itself as a channel associate under this Clause may include commercially-reasonable use (as defined in Clause 25.14) 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.
  4. A Publicizing Party's use of another party's Marks must conform to Clause 18.6 (Trademark Use).
  5. A Publicizing Party must promptly stop using another party's Marks upon any termination of the Reseller Relationship.
  6. Nothing in this Clause gives either party any right in, nor any right to use, any Mark of another party except as expressly stated in this Clause.

14.7.16 Reseller customers will get Supplier warranties

  1. 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).
  2. Supplier will defend (as defined in Clause 21.4) Reseller's Protected Group (as defined in Clause 25.40) 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.
  3. 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 25.23), 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.

14.7.17 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 must make it clear to its customers that Supplier is not liable for Reseller's commitments; and
  3. Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40)
    • against any third-party claim
    • arising from or relating to
    • any such additional warranty or other commitment offered by Reseller.

14.7.18 May Reseller modify Resale Offerings?

  1. 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 25.19).
  2. For example (as defined in Clause 25.23), 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.

14.7.19 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. verti- cal price fixing) under antitrust laws.

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14.7.20 Supplier may change its Resale Offerings

  1. 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.
  2. 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.
  3. As a matter of commercial practice, Supplier may elect,
    • in its sole discretion (as defined in Clause 25.19),
    • 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.

14.7.21 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:

14.7.21.1 Supplier will provide for customer provisioning
  1. 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.
  2. Reseller is to refer all of its customers to such a Supplier-provided provisioning system.
14.7.21.2 Reseller's customers must agree to Supplier's terms
  1. Supplier may require Reseller's customers to agree to Supplier's then-current terms and conditions
  2. 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.
  3. Reseller must advise each of its customers in writing,
    • for example (as defined in Clause 25.23), in a written quote form,
    • that the customer will be required to agree to Supplier's terms and conditions.
14.7.21.3 Reseller must "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 must 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.
14.7.21.4 Reseller may make limited use of the Software
  1. 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.
  2. All such use of the Software by Reseller must comply with Supplier's applicable terms and conditions (see Clause 14.7.21.2).
  3. 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.
  4. Otherwise, Reseller must 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.

14.7.22 What must Reseller do in case of piracy, etc.?

  1. 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.
  2. 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.
  3. Reseller must not make any Policing Efforts of its own without Supplier's prior written approval.

14.7.23 What must Reseller do with customer feedback?

  1. 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.
  2. 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.
  3. Supplier may use or disclose feedback as Supplier sees fit in its sole discretion (as defined in Clause 25.19).
  4. 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.
  5. For purposes of this section, "feedback" refers to any and all suggestions, comments, opinions, ideas, or other input.

14.7.24 What must Reseller do if Supplier issues any recalls?

  1. Reseller must provide reasonable cooperation with Supplier and its designees in connection with any recall of Resale Offerings.
  2. 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 13.3 (Expense Reimbursement Protocol).
  3. Reseller must 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 24.26) reimbursement of that expense.

14.7.25 What rules apply to Reseller's repairs, etc.?

  1. 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.)
  2. Reseller must use parts of equal or better quality than the original parts in the Resale Offering.
  3. Reseller may not offer or provide as "new" any Resale Offering that Reseller has repaired after return by a customer.

14.7.26 Reseller may not rebrand any Resale Offerings

Reseller must 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.

14.7.27 Reseller is responsible for its business dealings

Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40) from and against any and all claims by any third party arising out of Reseller's activities under an agreement.

14.7.28 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.

14.7.29 This is not a franchise or business opportunity

  1. This section applies unless the Contract clearly and unmistakably provides otherwise.
  2. No party intends, by entering into the Contract, to create a relationship that would be subject to laws governing franchises and/or business opportunities.
  3. Each party WAIVES (as defined in Clause 24.26),
    • 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.

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14.7.30 Supplier is not responsible for Reseller's finances

Reseller agrees that Supplier has no responsibility for —

  • any dependence that Reseller might have on its ability to resell Resale Offerings for Reseller's revenues,
  • nor for any harm that might come to Reseller from the Resale Term's coming to an end.

14.7.31 May either party 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 24.23.8."

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.

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14.7.32 Termination will not cut of 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

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.)

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14.7.33 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 14.10 (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 Clause might be a negotiation point.

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14.7.34 Other terms to consider

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

14.8 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.]

14.8.1 Data About Reseller Customers

  1. 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.
  2. 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.

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14.8.2 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].

14.8.3 Marketing consultation

To reduce the chances of mutual interference between Supplier's and Reseller's marketing activities, Reseller must consult Supplier in advance about Reseller's own proposed marketing activities concerning Resale Offerings.

14.8.4 No customers outside the Territory

Reseller must not solicit or support any customer for Resale Offerings if the customer has significant operations outside the Territory.

14.8.5 No Reseller facilities outside the Territory

Reseller must not establish or maintain facilities specifically for supporting customers' use of Resale Offerings if such use is reasonably likely to occur outside the Territory.

14.8.6 No extra-Territorial availability

Reseller must 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.

14.8.7 No competition

During the Resale Term and for one year thereafter, Reseller must 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.

14.8.8 Minimum inventory

Reseller must keep a minimum quantity of Resale Offerings in inventory as follows: [DESCRIBE].

14.8.9 Maximum inventory

Reseller must not keep more than [AMOUNT] of Resale Offerings in inventory without Supplier's prior written consent.

14.8.10 Reseller retail sale

Reseller may offer or sell Resale Offerings from physical premises (for example, in stores).

14.8.11 Reseller retail sale

Reseller must not offer or sell Resale Offerings from physical premises (for example, in stores) without Supplier's prior written consent

14.8.12 No other Resale Offering sources

Reseller must not acquire Resale Offerings from sources other than Supplier.

14.8.13 No Resale Offerings to non-end-customers

Reseller must not provide Resale Offerings to others for resale or redistribution.

14.8.14 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.

14.9 Marketing Plan [to come]

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

14.10 Wrap-Up Protocol

14.10.1 When does this Clause apply?

When this Clause is agreed to, it applies whenever both of the following are true:

  1. a specified relationship, authorization, or grant of rights, governed by the Contract (referred to generically as the "Relationship"), comes to an end,
    • whether by expiration or termination; and
  2. the Contract states that a party will have time after the end of the Relationship in which to wrap up any pending business (the "Wrap-Up Period").

14.10.2 How long can a party wrap up pending business?

The Wrap-Up Period —

  • will begin on the date that the Relationship comes to an end; and
  • will end, at the end of the day, ten business days thereafter,
    • or such other time as specified in the Contract .

14.10.3 What if the party is in material breach?

A party will not have a Wrap-Up Period if that party is in material breach (as defined in Clause 25.33.2) of the Contract when the Relationship ends.

14.10.4 What wrap-up activities are allowed?

A party entitled to a Wrap-Up Period may attempt to complete any then-pending transactions that would have been authorized by the Contract before the end of the Relationship,

  • on the same terms as before the end of the Relationship,
  • except as otherwise stated in this Clause.

14.10.5 Must wrap-up transactions be pre-cleared?

If a party wishes to take advantage of the Wrap-Up Period,

  • then, not later than two business days after the date that the Relationship ends,
  • that party must furnish the other party
  • with a complete written list of pending transactions expected to be completed during the Wrap-Up Period.

14.10.6 Must wrap-up eligibility be confirmed?

If a party asserts the right to complete a particular transaction during a Wrap-Up Period,

  • then the other party may ask the asserting party to furnish evidence,
  • reasonably satisfactory to the other party,
  • that the asserting party had in fact been actively engaged in negotiating that transaction before the end of the Relationship.

14.11 Template clauses for software

14.11.1 Terminology: Software; Licensor; Customer

The clauses in this Chapter 14.11 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."

14.11.2 Software License Protocol

14.11.2.1 Terminology: Software; Customer; License

Clause 14.11.1 (Terminology: Software; Licensor; Customer) is incorporated into this Clause by reference.

14.11.2.2 How is a "Software License" granted?
  1. A "Software License" must be granted by a written document,
    • which is referred to for convenience as a "License Granting Document."
  2. In case of doubt: In some circumstances, the Software License might be granted
    • via a reseller or other intermediary
    • and not directly by Licensor.
14.11.2.3 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").
  1. 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.
  2. The Contract may specify that the License Granting Document is an Order for purposes of Clause 14.1 (Orders for Goods & Services).
14.11.2.4 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.
14.11.2.5 What must 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.

14.11.2.6 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.

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14.11.2.7 What may Customer do with the Software?
  1. 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.
  2. 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.
  3. 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.

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14.11.2.8 What could happen if Customer doesn't pay?
  1. 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.
  2. 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

Customer might want to negotiate to include a provision such as Clause 13.12.8 so that continued use of Software after nonpayment of fees does not constitute copyright infringement — which could lead to an award of serious damages such as Customer's profits arising "indirectly" from the infringement; see the discussion of the Frank Music Corp. v. MGM case in the commentary to Clause 13.12.8.

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14.11.2.9 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.
14.11.2.10 Is service-bureau use 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 clearly provided otherwise
  • in the applicable License Granting Document.
14.11.2.11 Who 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.
14.11.2.12 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.
14.11.2.13 Reverse engineering, etc., is prohibited
  1. Customer may not decompile, disassemble, or reverse engineer any part of the Software,
    • nor permit or assist others to do so.
  2. If applicable law permits Customer to engage in such activity notwithstanding the Contract,
    • then Customer must provide Licensor with advance notice and reasonably detailed information concerning Customer's intended activities.
14.11.2.14 May Customer sublicense or transfer the Software?

No: 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 the applicable agreed usage plan.
14.11.2.15 New versions will not increase usage limits
  1. 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.
  2. Customer may not use both the New Version and another version if such use would exceed the use permitted by the License Granting Document.
  3. 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.
14.11.2.16 Customer does not acquire ownership of the Software
  1. 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.
  2. Customer has no rights in the Software other than those expressly granted by the License Granting Document.
14.11.2.17 May copies be provided to others?
  1. The Software (and its documentation, if any) remain the confidential property of Licensor or its suppliers, as applicable.
  2. 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.
14.11.2.18 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.

14.11.2.19 Licensor may audit Customer's Software usage
  1. 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.
  2. Licensor will give Customer at least ten business days to respond to any such request for a Customer usage report.
  3. Customer must timely comply with any such Licensor request.
  4. Licensor may audit Customer's usage reports,
    • upon reasonable notice to Customer,
    • in accordance with Clause 15.1 (Audit Protocol).
  5. 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.
14.11.2.20 How long will Licensor support "old" versions?
  1. 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.
  2. Licensor might offer longer support for outdated versions, but:
    • whether to do so is in Licensor's sole discretion (as defined in Clause 25.19); and
    • such longer support might require a separate contract and/or additional fees.
14.11.2.21 Customer represents that it is not legally barred from using the Software

Customer represents that, to the best of Customer's knowledge, applicable law does not prohibit Customer from using the Software.

Commentary

See the discussion of export controls in the commentary at § 26.4.

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14.11.2.22 U.S. Government customers: The Software is "commercial"
  1. 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.
  2. 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.

14.11.3 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 14.11.1.

14.11.3.1 Option: Catch-Up Licenses After Overusage
  1. When agreed to, this Option applies if Customer uses the Software beyond the scope of the Software License.
  2. The parties prefer to resolve the overusage on a business basis, and not as a matter of possible copyright infringement.
  3. Toward that end: Customer must 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.
  4. If Customer intentionally used the Software beyond the scope of the Software License,
    • then Customer must 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 25.2) (if any).
  5. Pricing for catch-up license purchases under this Option will be Licensor's then-applicable list price.
  6. 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 must 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 25.19).
  7. 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 § 13.12.8.
  • 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.

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14.11.4 Level X Support Definition

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. 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.
  3. 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.
  4. 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.:

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14.11.5 Software Limited Warranty

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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:

14.11.5.1 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:
  1. 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.
  2. 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.

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14.11.5.2 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:

  1. 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.
  2. 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.
  3. 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.
  4. 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 Clause 25.7.)

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14.11.5.3 How long is the Software's performance warranted?
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.
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.
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 25.23), under a software-as-a-service ("SaaS") subscription,
  • then the performance warranty period will be the entire period of the subscription.
Performance remedies

If, during the specified performance warranty period, the Software does not perform as stated in Clause Applicability; performance warranty,

  • then Provider is to:
  • provide Customer with a repair, replacement, or commercially-reasonable workaround for the defective Software in accordance with Clause 14.5 (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.
  1. Provider's obligations in subdivision b are Customer's EXCLUSIVE REMEDY for any failure of performance by the Software.
14.11.5.4 Is the Software warranted against third-party IP infringement?
  1. Provider warrants that the Software as delivered complies with Clause 20.6 (Infringement Warranty),
    • subject to the limitations of that warranty,
    • including but not limited to the remedy limitations,
    • during the entire period of Customer's use.
  2. Customer's EXCLUSIVE REMEDIES for any claim of infringement by the Software are as stated in Clause 20.6 (Infringement Warranty).
14.11.5.5 What must Customer do for warranty service?

For Customer to be entitled to the remedies of this Clause, Customer must, at its own expense:

  1. report a potential breach of this Clause 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.
14.11.5.6 Are there any general limitations to these warranties?
  1. Provider DOES NOT WARRANT that the Software:—
    1. will be error free;
    2. will meet Customer's need; or
    3. will operate without interruption.
  2. 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.

15 Verifications: Audits, inspections, etc.

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

Contents:

Comment: See also the following:

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15.1 Audit Protocol

Commentary

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

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15.1.1 What records are auditable?

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

  • labor and/or materials billed to the auditing party;
  • other items billed to the auditing party;
  • compliance with specific requirements; and
  • any other clearly-agreed auditable matters;
  • unless the Contract clearly provides otherwise,

15.1.2 How often may audits be conducted?

An auditing party may request an audit only up to once per 12 months

  • and once per period audited,
  • whichever is more restrictive,
  • unless good reason (as defined in Clause 15.3.10) 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.

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15.1.3 How much advance notice is required for an audit?

An auditing party must give the recordkeeping party

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.

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15.1.4 When is the audit-request deadline for a record?

  1. 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. three years
      • after the end of the calendar quarter,
      • in which the substantive content of the record was most-recently revised.
  2. 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 25.13),
    • of good reason (defined in Clause 15.3.10).
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.

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15.1.5 What interest rate will be charged on 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 13.8 (Interest Charges).

15.1.6 When must audit expenses be reimbursed?

  1. 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 § 25.33.2) of the Contract,
    • by the recordkeeping party,
      • or for which the recordkeeping party is responsible,
      • either by law or as stated in the Contract.
  2. 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 15.1.17 (Option: Recordkeeping Party Expense Reimbursement).

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15.1.7 In what form are records to be provided?

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.

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15.1.8 What cooperation with auditors is required?

Except as otherwise provided in this Clause, 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.

15.1.9 Who may serve as auditors?

  1. An auditing party may engage any of the following to conduct an audit:
    1. any Big Four accounting- or consulting 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 24.26) any conflict of interest in that regard.
  2. 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 24.17) 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.

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15.1.10 During what hours, and where, may audits take place?

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.

15.1.11 Is any information off-limits to auditors?

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.

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15.1.12 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.

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15.1.13 What are the auditors' confidentiality obligations?

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

15.1.14 May auditors retain copies of audited records?

  1. The auditors may make and keep copies of auditable records,
    • subject to the confidentiality- and return-or-destruction provisions of this Clause.
  2. 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.

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15.1.15 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.

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15.1.16 What corrective action is required after an audit?

  1. 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.
  2. No invoice need be sent for a payment required under § 15.1.16,
    • other than the audit report and a written request for payment.

15.1.17 Option: Recordkeeping Party Expense Reimbursement

  1. 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.
  2. 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 § 15.1.6 (audit expenses).

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15.1.18 Option: True-Up as Exclusive Audit Remedy

  1. 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 Clause
      • within ten business days
      • after the recordkeeping party receives a copy of the auditor's report.
  2. 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.
  3. The exclusive-remedy limitation of subdivision b will not apply, however, if the audit revealed or confirmed—
    1. fraud (see § 23.13); or
    2. a material breach (see § 25.33.2) 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 § 13.12.8.

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.

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15.1.19 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.
Commentary

See the discussion of flowdown requirements.

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15.1.20 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?

15.1.21 Audits exercise

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).

15.2 Background Checks

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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:

Commentary

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

A customer might especially want (or need) for a supplier to have background checks run on the supplier's personnel, for example, if the customer is a government contractor; if the supplier will have access to the customer's confidential- or sensitive information; if the supplier's personnel will "face" the customer's own customers or clients, that is, be seen or heard by them.

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

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 employee might be tempted to sue the customer, not just the provider. (In that situation, § 15.2.8 would require the provider to protect the customer from the cost of defending and/or paying damages for such claims.)

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15.2.1 What specific background checks are required?

Criminal History Checks are required,

  • if not otherwise specified in the Contract.
Commentary

See the definitions in Clause 15.2.9 (and consider other possible background checks).

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15.2.2 Whose backgrounds must be checked?

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

Commentary

See the definitions in Clause 15.2.9 (and consider other possible background checks).

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15.2.3 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.

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15.2.4 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.
Commentary

This section requires the checking party only to consult with the requesting party, as opposed to obtaining the requesting party's consent.

(Consent requirements seem more common in background-checks provisions, but they could lead to legal issues, as discussed below.)

Criminal records checks in basic form seem to be available from any number of Web sites at low cost. (The author has never personally used any such site and can't recommend any particular one; your company's or client's HR people might be able to recommend one.)

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 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 …."

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 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.

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15.2.5 What if possible drug misuse is revealed?

  1. 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.
  2. 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.
Commentary

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.

For obvious reasons, if a background check indicates that a person might have a drug-misuse problem, then tighter restrictions are imposed on using the person for Critical Activities than for other Restricted Activities.

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.

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15.2.6 What standards must background checks meet?

  1. 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.
  2. 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.

The present author's impression is that few checking parties will actually conduct their own background checks: Even if they're capable of doing so, they're likely to want to "outsource" that responsibility to an outside party that can do such things more cost-effectively, and at which the finger can be pointed if something goes wrong.

Credit checks have special consent requirements

Credit checks, if not done correctly, can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act ("FCRA"). One particular procedural requirement comes up in class-action lawsuits: Section 1681b(b)(2)(A) of the FCRA, which states that, with certain very-limited exceptions:

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

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

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

(Emphasis added.) Hat tip: Ken Remson, Employers Hit With Background Check Lawsuits, May 20, 2014.

Noncompliance has hit some well-known companies with sizable settlement costs; for example:

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15.2.7 What 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.
Commentary

This section requires independently-obtained contact information for former employers, etc. (other than purely-personal references). This helps to guard against the possibility that an applicant might provide a checking party with fake contact information for such references — so that when the checking party contacts the "references," the checking party ends up talking to one of the applicant's friends who is in on the scam.

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15.2.8 Who will take care of any third-party claims?

  1. 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 25.40), 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.
  2. In such an event, the checking party must Protect,
    • as defined in Clause 21.4.2,
    • the Protected Group member against the claim.
  3. 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.
Commentary

This section makes the checking party responsible for any third-party claims arising out of background checks; the obligation is worded carefully to focus on just what breaches of this Clause are covered.

As with any indemnity obligation, drafters should:

  • consider pairing the indemnity obligation with an insurance requirement; and
  • consider whether the indemnifying party might be liable for unforeseeable damages as well as foreseeable damages, and decide whether to be specific about that in the indemnity obligation.

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15.2.9 Definitions for Background Checks

  1. Applicable Background Checks refers to the specific background check(s) that are to be performed under the Contract (see § 15.2.1).
  2. Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question.
  3. 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.
  4. 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.
  5. 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.
  6. 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).
  7. Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals.
  8. Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.
  9. Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years.
  10. Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings.
  11. 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.
  12. Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years.
  13. 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.

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15.2.10 Option: Checks by Requesting Party

  1. If this Option is agreed to, the requesting party may cause its own background checks to be conducted on any or all checked individuals.
  2. 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 21.4.2) the checking party's Protected Group (as defined in Clause 25.40) against any claims arising out of noncompliance,

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

  1. The requesting party must bear its own expenses associated with any background checks that it conducts.
  2. The checking party is to provide reasonable cooperation with the requesting party in attempting to obtain any necessary consent for checks from checked individuals.
  3. The requesting party must provide the same defense and indemnity to the checking party and its Protected Group (as defined in Clause 25.40) (if any) as the checking party must provide under this Option (that is, the parties' roles for this purpose will be deemed reversed).

15.3 Inspections

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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").

Discussion checklist:

15.3.1 How much advance notice of an inspection is required?

The inspecting party must give the host

15.3.2 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 15.3.10).
Commentary

The author can attest (from long-ago personal experience in the U.S. Navy's nuclear-propulsion program) that having inspectors hanging around for a long time can be a pain.)

15.3.3 What may be included in an inspection report?

Inspectors may report their findings to the inspecting party,

  • subject only to any applicable confidentiality restrictions.
Commentary

Alternative: "Inspectors must disclose to the inspecting party only: (i) whether the inspection revealed a reportable discrepancy, and if so, (ii) the size and general nature of the discrepancy."

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15.3.4 Who may conduct inspections?

Inspections (if any) must be performed by one or more of the following, to be engaged by the inspecting party:

  • any Big Four accounting- or consulting firm; and/or
  • any other inspector 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.

15.3.5 What hours may inspections be conducted?

The host — in consultation with the inspecting party —

  • may make reasonable decisions about just when the 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.

15.3.6 What workspace must the host provide for inspectors?

  1. The host must provide the inspector(s) with appropriate facilities and equipment,
    • of the type customarily used by knowledge-based professionals,
    • unless the Contract clearly states otherwise.
  2. Such facilities and equipment would normally include, for example (as defined in Clause 25.23),
    • furniture; lighting; air conditioning; electrical power; and Internet access.

15.3.7 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 Clause.

15.3.8 What may inspectors do with confidential information?

  1. The inspecting party must take prudent measures to keep confidential any non-public information that it learns via the inspection.
  2. The inspecting party must not use non-public information learned through the inspection, except:—
    • for correcting discrepancies identified in the inspection,
    • or for enforcing the inspecting party's rights under the Contract.
  3. 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.
  4. 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.
  5. The inspecting party must ensure that its inspectors have agreed in writing to comply with the confidentiality obligations of this Clause.

15.3.9 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.

15.3.10 What constitutes "good reason"?

For purposes of this Clause,

  • 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:

15.3.11 Will inspection rights survive termination?

The inspection-related provisions of the Contract,

  • including but not limited to those of this Clause:
  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.
Commentary

Caution: Not specifying that inspection rights survive termination of an agreement might result in the inspection right ending when an agreement does. That happened in a case in which a union benefits fund tried to audit an employer's contributions to the fund, as permitted by its agreement with the employer — but this was after the employer had terminated its agreement to participate in the fund. The court held that the union's audit right had died with the agreement.

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15.4 Recordkeeping Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract, a party (a "Recordkeeping Party") must keep records.

Discussion checklist:

Commentary

Consider also Clause 15.1 (Audit Protocol).

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15.4.1 During what time period must records be kept?

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

  • as stated in this Clause,
  • at all times during the term of the Contract.

15.4.2 What records must be kept?

  1. The Recordkeeping Party must cause records (the "Required Records") to be made and kept as stated in this section.
  2. 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 payee, 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.
Commentary

The records required to be kept might include, for example: Sales journals; purchase-order journals; cash-receipts journals; general ledgers; and inventory records.

This list of record categories is adapted from the contract in suit in an Eleventh Circuit case.

A sample clause published by the Association of Certified Fraud Examiners contains a laundry list of specific types of documents that a vendor might want to require a contractor to maintain. #+endaside

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15.4.3 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 25.14) standards of recordkeeping; and
  3. to comply with any stricter recordkeeping standards specified in the Contract.
Commentary

Subdivision 1 — accurate and materially complete: Some drafters use the term true and correct, but that seems both redundant and incomplete. Perhaps in an archaic sense the term true might be interpreted broadly to mean materially complete and accurate, but there seems to be little reason to take a chance that a judge would see it that way.

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15.4.4 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 § 15.1) 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.
Commentary

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When services are involved, retaining records for two- to four years after final payment seems to be a not-uncommon requirement; this can be found, for example, in the [U.S.] Federal Acquisition Regulations.

Some industries or professions might require specific record-retention periods.

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15.4.5 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.)

16 Confidentiality- and privacy

16.1 Confidential Information

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:—

Discussion checklist:

Note to drafters: See also the optional terms at § 16.2, which are not incorporated by reference into the Contract unless it clearly says so.

Commentary
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.

It's also quite common for other types of agreement to include confidentiality provisions, 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.

Other Tango reference clauses to consider

Drafters might wish to use Clause 16.3 (Confidentiality of Parties' Dealings).

Privacy law

Drafters should also applicable personal-privacy law, e.g., the California Consumer Privacy Act (CCPA) and the European Union's General Data Protection Regulation. See the commentary at § 16.4.

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.

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16.1.1 Whose information is protected?

Each party will be "Discloser" with respect to its own Confidential Information (as defined in Clause 16.1.2);

  • each other party will be "Recipient" as to Discloser's Confidential Information.
Commentary: Whose information should an NDA protect?

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 disclosing 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 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.

(Beware, though: even if an agreement is nominally a two-way agreement, it still can be drafted so as subtly to favor the drafter's client.)

Moreover, a two-way agreement can avoid the danger of future, "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.

That's just what happened to the plaintiff in the Fail-Safe case: The plaintiff's confidentiality agreement with the defendant protected only the defendant's information. Consequently, said the Seventh Circuit, 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.

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.

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16.1.2 What types of information are potentially protectable?

Confidential Information refers to information as to which:

  • Discloser has taken, and is still taking, reasonable measures to keep the information secret; and
  • the information meets the other eligibility requirements in the Contract.

(Note: As an aid to readers, Confidential Information is sometimes referred to as "Discloser's Confidential Information.")

Commentary

Reasonable secrecy measures 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."

The author has long used a three-part rule of thumb:

  • 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.
  • 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.)
  • "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 such as this Clause.

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16.1.3 What are some examples of Confidential Information?

Recipient's confidentiality obligations under this Clause apply, without limitation, to the following categories of information when the information otherwise qualifies as Confidential Information:

  • analyses; compilations; forecasts; interpretations; notes; reports; studies; summaries; and similar materials, prepared by or for Recipient or on Recipient's behalf;
  • "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
  • the fact that Discloser is using particular nonconfidential information — but only if that fact itself otherwise qualifies as Confidential Information.
Commentary

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. See, for example:

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 in New York put it:

Second, 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.

Zirvi v. Flatley, No. 18-cv-7003 (S.D.N.Y. Jan. 14, 2020) (dismissing complaint with prejudice) (cleaned up; citations omitted).

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16.1.4 Can third-party information be Confidential Information?

Yes — when otherwise eligible, information of third parties

  • that Discloser provides to Recipient
  • can be protectable under this Clause
  • to the same extent as Discloser's own Confidential Information.

BUT: If Discloser does provide Recipient with confidential information of a third party,

  1. then 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

16.1.5 What about protected health information ("PHI")?

If Discloser makes protected health information available to Recipient, then Clause 16.8 (Protected Health Information) will also apply.

Commentary

See the commentary to § 16.8.

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16.1.6 What can qualify as a "trade secret?"

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 16.1.9.)

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).

A key feature of that statutory definition is that, for Discloser to establish that particular Confidential Information is also a trade secret, Discloser must show that knowledge of the Confidential Information provides an economic advantage to those who know it.

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.

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 …."
What constitutes "improper means"?

"Improper means" 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[.]"

Will breach of a confidentiality obligation 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 had 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 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 Hoover Panel holding "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.

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16.1.7 What is excluded from Confidential Information status?

This Clause does not impose any confidentiality obligations on Recipient for particular Discloser information

  • if Recipient shows that,
  • at the relevant time or times,
  • the particular information fell into 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 Clause; 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 23.8)
    • 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 Clause.
Commentary
Caution: These exclusions might be preempted by law

Just because this Clause does not protect particular excluded information 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 § 16.4.

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 such disclosures are explicitly authorized as provided in Clause 16.1.21.2.

Subdivision 1: Exclusion of "generally known" information

The phrase "generally known to people within the circles …" phrase is a mashup of section 1(4)(i) of the U.S. Uniform Trade Secret Act, https://perma.cc/XK9G-CLJA at 5, as well as 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.

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."

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.

Subdivision 2: Exclusion of "readily ascercertainable" information

As noted in the [BROKEN LINK: trade-secret-defn] the Defend Trade Secrets Act defines improper means as: "(A) [including] theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means; and (B) [not including] reverse engineering, independent derivation, or any other lawful means of acquisition …."

Subdivision 4: Exclusion of already-known information

The prior-knowledge exception is one of those where a corroboration requirement (as defined in Clause 23.8) comes into play. 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 a bald assertion to that effect, in the absence of corroborating evidence.

(See § 23.8 for more discussion of the policy underpinnings and supporting precedent concerning corroboration requirements.)

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.

Subdivision 5: Exclusion of independently-developed information

As a practical matter, an accused misappropriator of confidential information might have a hard time convincing a judge or jury that it independently developed the allegedly-misappropriated information on its own. 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.

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16.1.8 Are pre-agreement disclosures protected?

No: Discloser's disclosures of Confidential Information before the parties' entry into the Contract will be protected only to the extent that the Contract clearly says so.

Commentary

In some cases drafters might want to specify that information disclosed before the parties signed the Contract will qualify as Confidential Information — this might be appropriate, for example, if the parties are entering into a written confidentiality agreement to confirm a previous oral agreement.

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16.1.9 When — if ever — will confidentiality obligations expire?

Some confidentiality obligations will expire in time, but others will not, as stated below.

16.1.9.1 Confidentiality obligations will end if an exclusion applies

Recipient's confidentiality obligations under the Contract will automatically expire, as to particular Discloser information, if and when the information becomes subject to one or more of the exclusions in Clause 16.1.7.

16.1.9.2 Confidentiality obligations for non-trade-secrets will expire

For Discloser's Confidential Information that does not qualify as a trade secret,

  • Recipient's confidentiality obligations under the Contract will expire
  • at the end of three years after the effective date of the Contract,
  • if not otherwise provided in the Contract.
Commentary

Whether confidentiality obligations should ever expire 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. (For those types of information, see the separate provision above concerning trade secrets.)

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.

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16.1.9.3 Trade-secret confidentiality obligations will not expire

If Discloser discloses trade-secret information (as defined in Clause 16.1.6) to Recipient;

  • and Discloser complies with the requirement to assert trade-secret status in writing,
  • then as to that information, Recipient's confidentiality obligations under the Contract will not expire,
  • unless and until the information becomes subject
    • to one or more of the exclusions from Confidential-Information status
    • in Clause 16.1.7.

16.1.10 Will confidentiality expiration affect other legal restrictions?

No: Even if Recipient's confidentiality obligations under the Contract were to expire,

  • Discloser could still enforce its copyrights, patents, and other rights (if any) against Recipient,
  • unless Discloser had expressly agreed otherwise in writing.

16.1.11 Is confidential information of affiliates protected?

  1. Confidential Information of Discloser's affiliates (as defined in Clause 25.2)
    • is not protected under this Clause
    • unless the Contract clearly states otherwise
  2. If the Contract does state otherwise,
    • then Discloser must treat the information of Discloser's affiliates as Confidential Information,
    • in the same manner as if the information were Discloser's Confidential Information,
    • if the following requirements are met:—
      • 1. The affiliate's information in question must otherwise qualify as Confidential Information; and
      • 2. The affiliate information must be clearly marked as being subject to the Contract,
        • whether or not Discloser's own information would need to be marked as Confidential Information (see § 16.1.12),
      • so that Recipient and its personnel will have fair warning
      • about their obligations concerning confidential information of Discloser's affiliates.
Commentary

When it comes to affiliate information, Discloser and Recipient have conflicting concerns:

  • 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 Recipient someday for breach of contract and/or misappropriation of trade secrets.

So as a compromise, this language, when agreed to:

  • allows affiliate information to be protected,
  • while reducing 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.

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16.1.12 Must Confidential Information be marked as such?

Yes, with certain exceptions, as follows:

16.1.12.1 Information is presumed to be confidential if so marked

If Discloser marks its information as Confidential Information in accordance with this Clause,

  • then Recipient must treat the information as Confidential Information,
  • unless the information is excluded from Confidential Information status under § 16.1.7.
16.1.12.2 Marking must be prominent and human-readable

For information to qualify as Confidential Information,

  • Discloser must make sure that the information — as initially disclosed to Recipient —
  • is marked as confidential in a reasonably-prominent, human-readable form,
  • with certain exceptions as stated below.
Commentary
Marking requirements: A compromise

The marking requirements and its exceptions represent a compromise between the legitimate operational interests of Discloser and Recipient. The basic objectives of requiring Confidential Information to be marked as such are usually the following:

  • to alert Recipient's personnel that particular information is subject to confidentiality obligations;
  • conversely, to let Recipient's personnel know what particular information is not subject to confidentiality obligations and therefore is free for use (at least as far as Discloser is concerned); and
  • perhaps most importantly (at least from a litigation perspective), to help courts and arbitrators sift through claims that particular information was or was not subject to confidentiality obligations.
Courts pay attention to the absence of marking.

In assessing whether Discloser in fact maintained particular information in confidence, a court very likely will give significant weight to whether 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 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: Some unmarked information might be confidential by law

Some categories of information might be confidential by law even without marking — 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.

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16.1.12.3 Obviously-confidential information need not be marked

Discloser's information can qualify as Confidential Information,

  • even if the information is not marked as such,
  • if Discloser shows that the information is clearly of a type
  • that reasonable people in the business
  • would readily recognize
  • as likely to be confidential.
Commentary

Some disclosing parties might not want to be bothered with having to mark their confidential information as such. This section accommodates that preference at least somewhat.

A receiving party, though, might well object to this provision because it's necessarily vague, which could later lead to disputes about whether particular information qualified as "clearly" confidential.

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16.1.12.4 Discloser's internal files need not be marked

Discloser's information can qualify as Confidential Information, even if the information is not marked as such,

  • if Discloser shows that it made the information available to Recipient
  • only by allowing Recipient to have access to Discloser's internal files (hard copy, electronic, etc.),
  • without giving Recipient permission to make and/or take away copies of the information.
Commentary

This section addresses the slightly-tricky situation when Recipient's people are allowed to look at Discloser's internal files but not to make notes, take away copies, etc.

In such a situation, it might well be burdensome for 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.)

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16.1.13 Is catch-up marking allowed?

Yes, within limits: Discloser's information can still qualify as Confidential Information,

  • even if the information was not marked as confidential
  • when Discloser initially made it available to Recipient —
    • for example, if Discloser initially disclosed the information to Recipient orally,
    • or in a demonstration, or in an unmarked written disclosure —

if Discloser shows that:

  1. Within ten business days after that initial, unmarked disclosure,
    • Discloser followed up by sending Recipient
    • a reasonably-detailed written summary of the information;
  2. the follow-up summary was marked as confidential as prescribed in this Clause; and
  3. Discloser gave Recipient notice (as defined in Clause 24.17)
    • that Discloser had sent the follow-up summary,
    • so as to make a record of the follow-up.
Commentary

In the real world, parties sometimes have play catch-up on their contract paperwork. This section tries to accommodate that reality.

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16.1.14 Must trade secrets be specifically labeled? How?

  1. Even in cases where the Contract would not require other Confidential Information to be marked,
    • Discloser must do as prescribed in this section for particular Confidential Information
    • if Discloser wants the information to be considered a trade secret (as defined in Clause 16.1.6).
  2. Discloser must clearly assert to Recipient, in writing, that the Confidential Information is a trade secret.
  3. Discloser's written assertion of trade-secret status:
    • must be reasonably prominent; and
    • must contain reasonable identifying details about the information in question.
  4. As one (non-exclusive) "safe harbor" example,
    • Discloser's 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 § 16.1.9, 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.

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 does not require marking for garden-variety confidential information that does not 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. See, e.g.:

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16.1.15 When must trade secrets be identified as such?

Discloser's written assertion of trade-secret status under [BROKEN LINK: conf-info-ts-mark-rqmt][BROKEN LINK: conf-info-ts-mark-rqmt]

  • must be received by Recipient
  • before Recipient's confidential obligations would otherwise have ended as to the information in question under § 16.1.9.
Commentary

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16.1.16 What secrecy measures must Recipient take?

  1. This section applies for the entire term of Recipient's confidentiality obligations under this Clause as stated in Clause 16.1.9.
  2. Recipient must take, at a minimum, the specified measures to keep Discloser's Confidential Information secret,
    • and those measures must include, without limitation, at least the same secrecy measures that Recipient takes with respect to Recipient's 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. This happened 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 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." (Emphasis added.)

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."

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16.1.17 How may Recipient use Confidential Information?

  1. Recipient may use Confidential Information only —
    1. as authorized by the Contract, and/or
    2. as otherwise agreed in writing by Discloser.
  2. During the term of the Contract, and only then, Recipient 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 Recipient's obligations under the Contract;
    2. exercising Recipient's 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.
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.

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16.1.18 What copies of Confidential Information may Recipient make?

Recipient may reproduce Discloser's Confidential Information only to the extent reasonably necessary:

  • for a use or disclosure that is authorized by this Clause, or that Discloser has otherwise agreed to in writing; and/or
  • for Recipient's 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.

16.1.19 Is translation of Confidential Information allowed?

Recipient may 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.

16.1.20 Is reverse-engineering of Confidential Information allowed?

No — Recipient may not engage in reverse-engineering,

  • or 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

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 not considered "improper means" for discovering a trade secret (see § 16.1.2);
  • but if Recipient bargains away (i.e., waives) its right to engage in reverse engineering, courts will enforce that bargain.

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16.1.21 When may Recipient disclose Confidential Information to others?

Recipient may not make Discloser's Confidential Information available to others —

  • including but not limited to by confirming others' guesses or conjectures —
  • except as provided in this section.
16.1.21.1 Authorized disclosure to certain Recipient personnel
  1. During the term of the Contract, and only then, Recipient may disclose Discloser's Confidential Information — to the extent not prohibited by law — to Recipient's own employees, officers, and directors, BUT ONLY to the extent that those individuals:
    1. have a legitimate "need to know" in connection with an authorized use of the information, and
    2. are bound by obligations of confidence comparable to those of the Contract.
  2. Before Recipient discloses Confidential Information under this section, Recipient must first:
    1. confirm that each intended recipient is bound by the confidentiality obligations of the Contract; and
    2. cause each recipient to be specifically instructed and/or reminded that he or she is obliged to abide by those confidentiality obligations.
Commentary

Drafters should consider the extent — if any — to which 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.

Subdivision a.1: Limiting Recipient's disclosures to a need-to-know basis is pretty standard in confidentiality provisions.

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16.1.21.2 Disclosure in response to subpoena, etc.

Recipient will not breach its obligations under this Clause if it discloses Discloser's Confidential Information to the minimum extent required by law in response to subpoenas and other compulsory legal demands — IF Recipient satisfies the following prerequisites:

  1. Recipient must try to give Discloser as much advance notice of the impending disclosure as is allowed by law — but Recipient may use reasonable discretion on that score if a government authority asks Recipient not to notify Discloser.
  2. Recipient must provide reasonable cooperation with any effort by Discloser to limit the disclosure in response to the demand.
  3. Recipient must disclose only so much Confidential Information as, in the written opinion of Recipient's counsel to Recipient, is required by the demand.

(In case of doubt, subdivision 3 does not require Recipient or its counsel to disclose counsel's written opinion to Discloser or anyone else.)

Commentary

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 Clause.

(If the parties want to allow for disclosures in public filings, they can consider Clause 16.2.9 (Option: Disclosure in Public Filings Authorization).)

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16.1.21.3 Legally-immune disclosures
  1. Recipient will not breach its obligations under this Clause if it discloses 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.
  2. In any such event, Recipient is strongly encouraged, but it is not required, to advise Discloser in advance of any such disclosure.
Commentary

U.S. 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 this; the contractor agreed to the entry of a cease-and-desist order and to pay $130,000 settlement. [SEC press release] [SEC order] [Houston Chronicle article]

See also the commentary in the next section, concerning how the [U.S.] National Labor Relations Board has taken a similar view about employees' discussing salary- and working-conditions with each other.

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16.1.21.4 Disclosures for labor-law purposes
  1. Recipient will not breach its obligations under this Clause if it discloses Discloser's Confidential Information to the minimum extent affirmatively authorized by law or regulation, for example the (U.S.) National Labor Relations Act or other applicable labor- or employment law.
  2. In any such event, Recipient is strongly encouraged, but it is not required, to advise Discloser in advance of any such disclosure.
Commentary

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 this "it's not a violation" carve-out as insufficiently explaining to employees their right to engage in concerted action under the NLRA.

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16.1.22 May Discloser seek a restraining order?

Yes —

  1. This section applies in any case in which:
    • Confidential Information is (i) disclosed, or (ii) used,
    • other than as provided in the Contract,
    • by Recipient, or by an individual or organization to which Recipient disclosed the information.
  2. This section will also apply if it appears that such unauthorized disclosure or use is about to happen.
  3. 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,
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 23.10 (Equitable Relief).

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16.1.23 Must Confidential Information be returned or destroyed?

  1. Confidential Information need not be returned or destroyed unless the Contract clearly says so.
  2. If the Contract does clearly say so,
    • then if Discloser so requests in writing,
    • Recipient must return or destroy copies of Discloser's Confidential Information,
    • in accordance with Clause 19.8 (Information Purge Protocol),
      • including but not limited to its general exceptions and deadlines,
    • except as provided below in this section.

Contents:

Commentary

An obligation to return or destroy Confidential Information might not be practical 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 16.2.6 — or Recipient could elect to segregate Confidential Information on its own initiative, even without a contractual requirement — for easier compliance with this section.

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16.1.23.1 Exception: Archive copies need not be purged
  1. Recipient may keep archive copies of Discloser's Confidential Information in accordance with the Archive Copies — but see subdivision b for an exception to this exception.
  2. If Recipient is an employee or individual contractor of Discloser,
    • then Recipient must not retain copies of Confidential Information,
    • except solely for the purpose of imminent disclosure under one of the exceptions in this Clause (response to subpoenas, legally-immune disclosures, and disclosures under labor- or employment law).
16.1.23.2 Confidentiality obligations continue for remaining copies

Recipient's confidentiality obligations under the Contract will continue in effect for all copies of Discloser's Confidential Information that are not returned or destroyed.

16.1.24 Will confidentiality provisions end with termination?

No — even if the Contract itself were to come to an end, for example, by being terminated or by expiring,

  • that would not release Recipient from its confidentiality obligations concerning Discloser's Confidential Information,
  • and this would be true no matter what other provisions of the Contract might also deal with survival of the terms of the Contract.
Commentary

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See also the Survival of Terms and Conditions

16.1.25 Other terms to consider adopting

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

16.1.26 Review questions

16.1.26.1 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?
16.1.26.2 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.
16.1.26.3 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"?

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)

16.2 Confidential information - optional terms

16.2.1 Option: Disclosure to Prospective Acquirer

16.2.1.1 Only certain M&A prospects are eligible
  1. Prospect may be a prospective acquirer of substantially all assets of Recipient's business specifically associated with the Contract.
  2. 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 25.2) 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.)

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16.2.1.2 The Prospect must agree to secrecy obligations
  1. Prospect must agree in writing with Recipient to abide by Recipient's obligations concerning Discloser's Confidential Information.
  2. Discloser will be an intended third-party beneficiary of Prospect's agreement with Recipient.
  3. 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.
16.2.1.3 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.

16.2.1.4 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.
16.2.1.5 Prospect may not take copies without Recipient's consent

Recipient must 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.)

16.2.2 Option: Recipient Indemnity Obligation

Recipient must defend (as defined in Clause 21.4) Discloser's Protected Group (as defined in Clause 25.40) 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].

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16.2.3 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).

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16.2.4 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 24.5 (Assignment Consent).

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16.2.5 Option: Copies of Confidentiality Agreements

  1. If Discloser so requests, Recipient must 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.
  2. 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.
  3. 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.

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16.2.6 Option: Required Segregation of Confidential Information

Recipient must 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 § 16.1.23).
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.

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16.2.7 Option: Inspections of Recipient's Compliance

  1. 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.
  2. 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.
  3. Any such inspection must be upon written notice, far enough in advance to be reasonable under the circumstances.
  4. Any such inspection must comply with Clause 15.3 (Inspections).
Commentary

Some Recipients are likely to balk at this Option; in some circumstances, though, Discloser might feel it was necessary.

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16.2.8 Option: Required Cooperation Against Misappropriators

If Discloser so requests, Recipient must 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.

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16.2.9 Option: Disclosure in Public Filings Authorization

  1. 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.
  2. 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 16.1.21.2.
  3. 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.
  4. Recipient must disclose only so much Confidential Information as is required to comply with the law.
  5. 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.
Commentary

A receiving party whose shares are (or are to be) publicly traded might justifiably 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. See generally the Investopedia article.

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16.2.10 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."

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16.2.11 Option: Residuals-Rights Exclusion

  1. Recipient may use "residuals," defined below, as Recipient sees fit, without obligation to Discloser.
  2. 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.
  3. This Option does not negate any restriction of the Contract on Recipient's disclosure of Discloser's Confidential Information to third parties.
  4. 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.

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16.2.12 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.

16.3 Confidentiality of Parties' Dealings

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract requires that the parties' dealings be kept confidential.

Discussion checklist:

16.3.1 What information must the parties keep confidential?

In addition to any general requirements of the Contract concerning confidential information, if any,

each party must 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 also Clause 16.1 (Confidential Information).

Business context

Parties often want the mere fact that they are in discussions to remain confidential, let alone the  details of their business dealings. That can present some tricky issues, though, especially in an employment-related agreement. 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.
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 25.33.2).

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 § 16.1.21.3 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.

Be careful what you do or don't prohibit

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.

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16.3.2 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 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 obligation;
  • or as would be authorized for disclosure under Clause 16.1 (Confidential Information),
Commentary

See the commentary to Clause 16.1 (Confidential Information).

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16.3.3 Does the Contract establish a fiduciary relationship?

No; this Clause is not intended as evidence of, nor as establishing, a "confidential relationship" or "fiduciary relationship."

Drafters should be careful to avoid implying that the parties' relationship is confidential, as opposed to the fact and terms of their dealings. If it were otherwise — that is, if an agreement said that the parties' relationship was confidential — then the confidentiality provision might be (mis)interpreted as a declaration of a "confidential relationship"; that in turn might imply unwanted fiduciary obligations. See also [BROKEN LINK: indep-k-agency][BROKEN LINK: indep-k-agency] and its commentary.

16.4 Data privacy (commentary)

This commentary section doesn't pretend to cover the subject of data privacy in any detail, but only to alert the reader to its importance. Data privacy law is most definitely "a thing" — and in many jurisdictions, especially California and Europe, a thing with big, sharp teeth. As just a sample, see:

16.5 Data Privacy - Customer Commitment

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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").

Discussion checklist:

16.5.1 Does Customer have authorization to manage personal data?

Customer warrants (as defined in Clause 20.4),

  • to Provider's Protected Group (as defined in Clause 25.40),
  • that Customer has been authorized by each such individual to manage that individual's personal data,
  • to the extent required by applicable law.

16.5.2 What privacy laws must Customer comply with?

Customer must comply at all times with all applicable Privacy Laws (as defined in Clause 16.7).

Commentary

Caution: Data-privacy law is a big, important topic; see the resources cited at § 16.4.

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16.5.3 Must Customer do any "external" privacy paperwork?

Customer acknowledges that applicable Privacy Law (as defined in Clause 16.7) 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.

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16.6 Data Use Authorization

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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.
  2. 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 § 16.4.

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16.7 Privacy Law Definition

  1. "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.
  2. 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.

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16.8 Protected Health Information

Commentary

For speedier legal review (and acceptance), this Clause 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.

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16.8.1 Catch-all definitions from HIPAA Rules

The following terms used in this Clause have the same meanings as stated in the HIPAA Rules (defined below):—

In addition:

16.8.2 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.

16.8.3 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.

16.8.4 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.

16.8.5 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.

16.8.6 What PHI must Provider make available to Customer?

Provider must make protected health information available to Customer,

16.8.7 What if PHI must be revised?

  1. 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.
  2. 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.

16.8.8 What are Provider's PHI recordkeeping obligations?

  1. 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.
  2. 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.
  3. Provider must make its internal practices, books, and records available to the Secretary
    • for purposes of determining compliance with the HIPAA Rules.

16.8.9 How may Provider use or disclose PHI?

  1. Provider may disclose protected health information to persons whom Customer has authorized to access Customer's records stored in Provider's file servers.
  2. Provider may use or disclose protected health information as required by law.
  3. 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.
  4. 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.
  5. 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.

16.8.10 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.

16.8.11 How must Provider respond to government PHI requests?

  1. 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.
  2. Provider must provide reasonable cooperation with Customer in any attempt by Customer to contest or limit such disclosure.

16.8.12 What is the Term of the parties' business associate agreement?

The Term of the parties business associate agreement is that of the Contract.

16.8.13 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 Clause, and
  • has not promptly cured the breach or ended the violation.

16.8.14 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.

17 Pricing

17.1 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). 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.

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17.2 Pricing adjustment options

17.2.1 Option: Pricing Adjustment Discretion

Supplier is not restricted

17.2.2 Option: Pricing Cost Pass-Through

  1. During the term of the Contract,
    • if Supplier's relevant costs increase,
    • then Supplier may pass the increase on,
      • without markup,
    • to Customer.
  2. If Customer so requests, Supplier will provide Customer with reasonable supporting documentation
    • that fairly evidences the increase in Supplier's relevant costs.

17.2.3 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.

17.2.4 Option: Pricing Increase Notice

During the term of the Contract, Supplier must give Customer at least 30 days advance written notice of any pricing changes.

17.2.5 Option: Pricing Lock-In

During the term of the Contract, all pricing for transactions under the Contract will be as stated in the Contract.

17.2.6 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 —

17.3 Most favored customer (commentary)

17.3.1 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 23.7.]

[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."

17.3.2 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.

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.

17.3.3 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.

17.3.4 Additional reading about MFC clauses

See generally:

17.3.5 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?

17.3.6 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?

17.4 Price fixing (commentary)

17.4.1 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.

17.4.2 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. …

18 Intellectual property

18.1 Intellectual Property Definition

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. 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.

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18.2 Intellectual Property Right Definition

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. 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 18.1),
    • 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.
  3. The term includes, for example (as defined in Clause 25.23):
    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

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18.3 License (IP) Definition

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. 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 25.23), the making, using, selling, copying, distributing, or importing of something,
    • on grounds that such Licensee activities,
  3. In the same context, the term "license" (noun) refers to Owner's commitment described in subdivision b.
  4. 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.

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18.4 IP Creation Ownership

18.4.1 Definition: Ownership (of IP)

In respect of particular intellectual property (as defined in Clause 18.1) ("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

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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.

18.4.2 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).

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18.4.3 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 § 18.4.4)."

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 Clause.

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.

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18.4.4 Will ownership of Toolkit Items change hands?

No — unless the Contract clearly states otherwise:

  1. 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."
  2. 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.
  3. In case of doubt, however,
    • the term Toolkit Item does not encompass Confidential Information,
    • as defined in Clause 16.1 (Confidential Information),
    • 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.

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18.4.5 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.

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18.4.6 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.

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18.4.7 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.

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18.4.8 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

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18.4.9 Future to-be-owned IP rights are transferred now

  1. 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.
  2. 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.

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18.4.10 Who must make arrangements with parties' employees, etc.?

  1. This section applies as to any particular IP that, under the Contract, is to be owned by an Owner (as defined in Clause 18.4.9).
  2. 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 Clause.
  3. 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.

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18.4.11 What documents must a party sign if required to "assign" IP?

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. In case of doubt: The former owner will not be entitled to additional compensation
    • for doing the things required by this Clause 18.4.11,
    • 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.

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18.4.12 Additional commentary

18.4.12.1 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.

18.4.12.2 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.

18.4.12.3 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:

18.5 Challenges to IP Rights

Commentary

This Clause 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 18.6 (Trademark Use).

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18.5.1 What types of "Challenge" are covered by this Clause?

  1. This Clause 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 18.2) (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.
  2. 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.

18.5.2 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.

18.5.3 Who will make decisions in the Challenge?

It will be entirely up to Owner,

  • in Owner's sole discretion (as defined in Clause 25.19),
  • 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.

18.5.4 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 16.1 (Confidential Information) will govern.

18.5.5 Who will pay costs of the Challenge?

  1. 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.
  2. Other Party is not obligated to fund or reimburse any Owner expense in respect of the Challenge
    • unless the Contract clearly says otherwise.

18.5.6 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 25.23), damages, profits, costs, and/or attorney fees,
  • made against a third party in any proceeding concerning the Challenge to Owner's IP Rights.

18.6 Trademark Use

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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 Clause 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."

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18.6.1 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 25.24 (Exclusivity Definition).)
8. Is Owner approval of specific proposed uses required?
No.
Other: [Describe in detail in the Contract]. (See § 18.6.10.)
9. Will approval of specific uses be deemed granted after X days (absent objection)?
No.
Yes, after ten business days, per § 18.6.10.
10. Are sublicenses authorized?
No.
Other: [Describe in detail in the Contract].

18.6.2 The Trademark License is granted by the Contract

  1. When Owner and User enter into the Contract, Owner, by doing so, grants User the Trademark License.
  2. The Contract does not grant User any other right, title, or interest in any Licensed Mark unless the Contract expressly says so.

18.6.3 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.

18.6.4 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.

18.6.5 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.

18.6.6 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.

18.6.7 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 Clause;

  • Clause 15.3 (Inspections) will apply to any such inspections.

18.6.8 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.

18.6.9 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.

18.6.10 When must User obtain Owner approvals?

  1. This section applies only if and to the extent so specified in the Contract (if any; see § 18.6.1).
  2. User must not use any Licensed Mark, in advertising materials or otherwise, without Owner's specific approval of the proposed use.
  3. 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.)

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18.6.11 What if a third party challenges the Licensed Marks?

Clause 18.5 (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.

18.6.12 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.

18.6.13 User is responsible for its business liabilities.

User must defend (as defined in Clause 21.4) Owner's Protected Group (as defined in Clause 25.40) 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.

18.6.14 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.)

18.6.15 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;

18.6.16 User assigns to Owner any Licensed-Mark legal rights

  1. This section applies in any jurisdiction where, by law, User acquires or otherwise owns any rights or other interest in a Licensed Mark.
  2. 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.
  3. User will comply with the ownership-transfer and -confirmation provisions of Clause 18.4 (IP Creation Ownership).
Commentary

For the reasoning behind using the term "hereby assigns," see Clause 18.4.9 and its commentary.

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18.6.17 User may not do certain things concerning the Licensed Marks

  1. Without limiting User's other obligations under this Clause, User must not, anywhere, without Owner's discretionary consent (as defined in Clause 25.19):—
    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.
  2. 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 25.19), and
    2. will be effective immediately upon notice (see § 24.17).

18.6.18 What steps must User take to protect Owner's goodwill?

  1. 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;
  2. 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.
  3. User must stop any particular use of a Licensed Mark immediately upon notice (as defined in Clause 24.17) 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

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18.6.19 What are some other rules that User must follow?

18.6.19.1 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 25.19).

18.6.19.2 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.
18.6.19.3 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.
18.6.19.4 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.

18.6.20 What steps must User take after termination?

This section applies if the Trademark License expires or is otherwise terminated in any manner.

18.6.20.1 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.
18.6.20.2 User must transfer all related Web address(es) to Owner
  1. 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.
  2. This section does not authorize User to register any such Web address;
18.6.20.3 Delivery of tangible Licensed Items could be required
  1. This section applies only if the Contract clearly so states.
  2. User, at its own expense, must immediately deliver to Owner all tangible Licensed Items bearing any Licensed Mark.
  3. Alternatively, User may remove all Licensed Mark(s) from such Licensed Items and certify the same in writing to Owner.
  4. 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 24.17) to User.

18.6.21 Option: User must destroy improper specimens

  1. If this Option is agreed to, it applies:
    • if, by notice (as defined in Clause 24.17) 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 18.6.18.
  2. 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.

19 Other supporting operations

19.1 Archive Copies

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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:

19.1.1 Who may (or must) keep archive copies?

As a safe harbor, one possible (and non-exclusive) way for Retainer to comply with § 19.1.5 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.

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19.1.2 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]."

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19.1.3 A reasonable number of archive copies are allowed

Retainer may cause the specified number of archive copies to be maintained.

19.1.4 Archive copies may be retained indefinitely

All such retention is subject to the requirements of this Clause.

19.1.5 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.

19.1.6 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].

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19.1.7 What confidentiality obligations apply to archive copies?

Retainer must comply with Clause 16.1 (Confidential Information) for any information in archive copies that qualifies as Confidential Information or trade secrets of Owner (see § 16.1.2).

Commentary

Alternative: Retainer need not maintain the archive copies or their contents in secrecy.

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19.1.8 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 16.1.21.2.

19.1.9 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.

19.2 Code of Conduct Limitation

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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.

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19.2.1 What may Customer do if Supplier breaches the code of conduct?

  1. If Supplier fails to follow the code of conduct,
    • then Customer's EXCLUSIVE REMEDY will be to terminate the Contract,
    • in accordance with Clause 24.23.1 (Either party may terminate for material breach),
    • except as provided in subdivision b.
  2. This Clause, 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 Clause gives customers what they often really want — namely, the opportunity to publicly throw a vendor under the bus if the customer perceives that the vendor is not complying with the customer's code of conduct — while reducing the operational- and liability burden for the vendor.

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19.3 Computer System Access Prococol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, in connection with the Contract:

  • an individual (the "User"),
  • employed by (or otherwise under the control of) a party to the Contract (the "Accessing Party"),
  • gains access to one or more computers; workstations; networks; email systems; telephone systems; or other similar systems,
  • each of which is referred to generically as "a System" or as "the System,"
  • of another party (the "Host").

Discussion checklist:

19.3.1 The Host may require compliance with usage policies

The User must follow any policies governing System access and-usage that the Host timely (as defined in Clause 25.49) communicates to the User and/or to the Accessing Party.

19.3.2 The User must not provide false sign-up information

  1. IF: The System requires a user to go through a sign-up process for access; THEN: The User must:
    1. provide complete and accurate information in response to requests made in the sign-up process; and
    2. timely update the information if it changes.
  2. IF: The System or the Host asks the User to furnish evidence of identity; THEN: The evidence furnished must be authentic.
  3. In determining whether to grant access to the System to the User, the Host is entitled to rely on:
    1. the completeness and accuracy of the User's sign-up information; and
    2. the authenticity of the User's evidence of identity.

19.3.3 The Users must employ commercially-reasonable malware protection

The User must:

  1. maintain commercially-reasonable (as defined in Clause 25.14) protection against malware (as defined in Clause 14.11.5.2) for any computer or other device by which the User accesses the System; and
  2. take commercially-reasonable measures to prevent malware from being introduced into the System as a result of User's accessing of the System.

19.3.4 What if the User suspects password compromise?

  1. This section applies if the User or Accessing Party suspects
    • that anyone has improperly obtained System login credentials,
    • whether of the User or of any other user of the System.
  2. The User must immediately change the User's password if that User's login credentials are suspected to have been compromised.
  3. The User and/or the Accessing Party must promptly notify the Host
    • of the suspected improper obtaining of System login credentials.
  4. If the Host asks the User and/or the Accessing Party to help the Host investigate and/or remediate the situation,
    • then the User and the Accessing Party
    • must provide reasonable cooperation in that respect.

19.3.5 Certain types of content are prohibited

Without limiting the User's other obligations under this Clause,

  • the User must not use the System to transmit or store any of the following:
  1. viruses,Trojan horses, bots, crawlers, keystroke recorders, or other malware of any kind;
  2. information or other content owned by someone else without the owner's permission;
  3. information used or intended to be used:
    • (i) in any unlawful manner,
    • (ii) in connection with any unlawful purpose, or
    • (iii) in any manner that in the Host's judgment could expose the Host or any other user of the System to a risk of liability;
  4. content that is unlawful, obscene, or offensive,
    • according to the standards in the geographic community where the User uses the System;
  5. content that violates any other acceptable-usage policy that the Host might publish from time to time;
    • the Host must give the User and/or the Accessing Party reasonable notice if it does publish such a policy.

19.3.6 Certain other System uses are prohibited

Without limiting the User's other obligations under this Clause,

  • the User must not use the System in any manner:—
  1. that, in the Host's judgment, unreasonably burdens the System, any network associated with it, or any other network associated with the Host —
    • this could include, for example (but not as a limitation),
    • bandwidth usage that the Host judges to be excessive;
  2. that the Host judges to be a nuisance;
  3. that violates the law;
  4. that the User and/or Accessing Party knows (or should know)
    • contributes to violation of the law; or
  5. that the Host judges to be otherwise unreasonable.

19.3.7 Certain general prohibitions apply

Without limiting the User's other obligations under this Clause, the User must not:

  1. allow anyone else to access or use the System using the User's access credentials;
  2. use someone else's credentials to access the System;
  3. otherwise impersonate anyone else in connection with the System;
  4. establish multiple user accounts to engage in one or more actions that would be prohibited by this section —
    • without limiting this restriction, if the User's account is temporarily- or permanently suspended,
    • the User must not create another account to access the System;
  5. falsely pretend to represent another individual or entity in connection with the System;
  6. access anyone else's information stored on the System without proper authorization;
  7. trace any information about, or owned by, any other user of the System —
    • this prohibition applies, but is not limited to,
    • personal identifying information and financial information of other users;
  8. engaging "doxxing," that is, publishing or otherwise disseminating
    • information or images (personal or otherwise)
    • about any other user of the System
    • without that other user’s specific authorization;
  9. engage in spoofing,
    • for example, disguising the origin of any transmission
    • that the User sends via the System or any network associated with it;
  10. interfere with anyone else's use of the System;
  11. probe or attempt to defeat or bypass any of the following:
    • (i) security measures of the System or any network associated with the System;
    • (ii) access-control filters or -blocks imposed by the Host
      • and/or by another User, if any; and/or
    • (iii) any other mechanism that may be built into the System
      • to enforce limitations such as (for example) time, geography, etc.;
  12. make, distribute copies of, or create derivative works based on, any content provided via the System, other than:
    • (i) the Accessing Party's own content, or
    • (ii) as expressly authorized in writing by the Host or other owner of the content;
  13. otherwise infringe anyone else’s copyright, trademark, trade secret, or other intellectual property right in the course of using the System;
  14. disassemble, decompile, or otherwise reverse-engineer any aspect of the System;
  15. use a bot, screen scraper, Web crawler, or similar method
    • to access the System
    • or any content stored at the System; nor
  16. otherwise access the System using any method other than the user interface provided by the Host.

19.3.8 Prohibitions also apply to attempts and assistance

Without limiting the User's other obligations under this Clause,

  • the User and the Accessing Party:
  1. must not attempt to do something prohibited by this Clause,
    • whether or not the attempt is successful; and
  2. induce, solicit, allow, or knowingly help anyone else
    • to do something prohibited by this Clause,
    • whether for the User's or Accessing Party's benefit or otherwise.

19.3.9 What responsibility does the Accessing Party have?

The Accessing Party, if any, is jointly responsible with the User for any harm caused by the User's noncompliance with this Clause.

19.3.10 There is no expectation of privacy on the System

  1. The User acknowledges (as defined in Clause 25.1) that the User has no expectation of privacy
    • for the User's communications or information on the System
    • unless applicable law clearly requires otherwise
    • or the Contract clearly specifies otherwise.
  2. The Accessing Party, if any, makes the same acknowledgement
    • that neither does it have any such expectation of privacy.

19.3.11 The Host may monitor and/or suspend the User

  1. The Host may, in the Host's sole discretion (as defined in Clause 25.19), at any time,
    1. monitor the User's access to, and activities on, the System; and
    2. suspend the User's access to the System at any time, for reasonable cause,

unless the Contract clearly says otherwise.

  1. Any suspension of access by the Host under subdivision a will be final and binding —

19.3.12 What if a User is with the U.S. Government?

  1. This section applies if the Accessing Party is any department, agency, or other subdivision of the U.S. Government.
  2. The System is provided to the Accessing Party as a "commercial item," "commercial computer software," "commercial computer software documentation," and "technical data," as applicable,
    • as defined in the Federal Acquisition Regulations (FARs) and the Defense Federal Acquisition Regulations (DFARs).
  3. If the Contract does not meet the U.S. Government’s needs,
    • or if the User or the Accessing Party regards the Contract as being inconsistent in any respect with federal law,
    • then both the User and the Accessing Party must immediately discontinue its use of the System.
Commentary

This section is modeled on a concept shown in Amazon's AWS agreement at https://aws.amazon.com/agreement/.

See also the clause at § 14.11.2.22 concerning licensing software to the Government.

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19.4 Deceptive Practices Prohibition

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

19.4.1 Each party is bound by this Prohibition

Each party so bound is referred to as an "Obligated Party."

Commentary

The "each party" configuration of this provision is canary-in-the-coal-mine language: If a prospective obligated party were to balk at it, that might be a red flag.

Some parties might balk at an indemnity obligation, which could be another canary-in-the-coal-mine event.

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19.4.2 What must an Obligated Party not do?

Each Obligated Party, in its dealings with third parties relating to the Contract,

  • must refrain from engaging in any deceptive, misleading, or unethical practice.

19.4.3 What responsibility must an Obligated Party undertake?

Each Obligated Party must defend (as defined in Clause 21.4) each other party's Protected Group (as defined in Clause 25.40)

  • against any third-party claim
  • arising out of any alleged violation of this Prohibition
  • by the Obligated Party.

19.5 Disparagement Prohibition

19.5.1 Each party is bound by this Prohibition

Each party so bound is referred to as an "Obligated Party."

19.5.2 What must an Obligated Party not do?

Each Obligated Party must refrain from making,

  • to any third party,
  • any disparaging statement —
    • about any other party to the Contract ,
    • and/or about the products or services of that other party.
Commentary

Sellers sometimes ask for disparagement prohibitions in their contracts, with the idea that they can prohibit their distributors, resellers, and customers from making negative comments to others.

A buyer of a private company might well ask for a nondisparagement provision in the purchase agreement. This was the case when InfoGroup founder Vinod Gupta sold his company and later was found to have violated a nondisparagement clause in his buyout agreement when he said to a reporter that the company "[has] no leadership, no brains and their product is obsolete."

See also the additional comments at Clause 19.5.5.

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19.5.3 Accurate, factual disparagement is prohibited

Unless the Contract clearly provides otherwise,

  • all disparaging statements are prohibited,
  • not merely false- or misleading ones,
  • and disparaging statements of fact, as well as of opinion, are prohibited.

19.5.4 "Second-person" disparagement is not prohibited

For purposes of this Prohibition,

  • the term "third party" does not include the other party's affiliates (as defined in Clause 25.2),
  • nor the officers, employees, distributors, resellers, and agents of the other party or any of its affiliates.

19.5.5 Cautions and other additional commentary

19.5.5.1 State law might limit disparagement-clause enforcement

Some jurisdictions might limit a party's ability to enforce a disparagement prohibition; for example, in 2014, California enacted Cal. Civ. Code 1670.8 prohibiting such provisions in consumer contracts, with civil penalties for violation.

19.5.5.2 The NLRB doesn't like anti-disparagement clauses

The (U.S.) National Labor Relations Board has taken the position that a lawsuit by an employer to enforce a contractual non-disparagement provision would be partly preempted by the National Labor Relations Act, and that the employer's continued prosecution of the lawsuit after receiving a warning letter from the NLRB would violate the Act.

19.5.5.3 The FTC might claim a "gag order" clause was illegal

In a Florida case, the Federal Trade Commission obtained summary judgment that a "gag clause" binding customers of the defendants' weight-loss products was an unfair practice in violation of Section 5 of the FTC Act — and later ordered the defendants to pay $25 million to the FTC "as equitable monetary relief, including consumer redress and disgorgement of ill-gotten gains" for false advertising.

19.5.5.4 Pro tip: Consider "the Streisand effect"

A disparagement prohibition could lead to bad publicity. Consider the so-called Streisand effect: When the legendary singer-actress tried to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her purpose.

19.5.5.5 What about disparagement in the course of litigation?

The litigation privilege might trump a contractual non-disparagement provision.

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19.6 Force Majeure Protocol

19.6.1 Either party may invoke force majeure

  1. In response to the actual- or imminent occurrence of one or more force majeure events,
    • any specified party may invoke force majeure,
    • by advising another affected party by any reasonable means.
  2. A party that invokes force majeure as permitted by the Contract,
    • at a reasonable time —
      • which might be before or after the relevant force majeure event or -events,
    • will not be liable under the Contract,
      • for any loss, injury, delay, damages, or other harm, suffered or incurred by another affected party,
    • due to failure of timely performance, by the invoking party, resulting from the force majeure,
    • except as otherwise agreed in writing.
Commentary

Subdivision a: The "actual or imminent occurrence" language contemplates that a party might invoke force majeure before the fact — for example, if a hurricane were approaching or a pandemic were erupting — as well as after the fact.

Subdivision b: See the exception in Clause 19.6.3 (payment failure limitation).

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19.6.2 Either party may terminate for force majeure after 60 days

Any specified party may terminate all going-forward obligations under the Contract,

  • if the aggregate effect of the relevant force majeure:
    1. is material in view of the Contract as a whole; and
    2. lasts longer than the specified period of time
      • after that force majeure was duly invoked.
Commentary

The termination right is limited to force-majeure events that are material in view of the Contract as a whole; this restriction is adapted from a master services agreement, between IBM and the State of Indiana, that was the subject of extended litigation.

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19.6.3 When can nonpayment be excused by force majeure?

Force majeure will not excuse failure to pay an amount due under the Contract

  • unless the failure is due to generalized failure,
  • beyond the invoking party's control,
  • in all reasonably-available payment systems,
  • such as, for example (as defined in Clause 25.23) —
  1. banks are closed by government edict; or
  2. all of the invoking party's assets that could be used for payment are trapped or stranded in a failed bank or other deposit system.
Commentary

This section says, in effect, that an invoking party can't escape a payment obligation unless, for example, the banks are closed, as happened in 1933 during the Great Depression.

This, though, is an issue that parties might want to think about — especially in situations like the COVID-19 pandemic of 2020, in which countless businesses experienced crippling cash-flow problems as a result of government stay-at-home orders.

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19.6.4 Must an invoking party report its status?

  1. If requested by another affected party, AND the Contract so provides,
    • then a party invoking force majeure must provide reasonable information
    • to other parties to the Contract,
    • from time to time,
    • about the invoking party's efforts, if any,
    • to remedy and/or mitigate the effect of the force majeure.
  2. Any party receiving any force-majeure status information from an invoking party must treat that information as the invoking party's Confidential Information under Clause 16.1 (Confidential Information),
    • including but not limited to the exclusions from confidentiality in Clause 16.1.7.

19.6.5 What types of event can count as force majeure?

  1. The term "force majeure" refers generally to any single event or series of events as to which:
    • a prudent person in the position of the party invoking force majeure,
      • did not actually anticipate,
      • could not reasonably have been able to foresee,
      • and could not have been able to take reasonable measures to avoid,
    • a failure of timely performance,
    • resulting (directly or indirectly) from the event or series of events.
  2. The Contract may optionally adopt a "laundry list" of specific types of event that would qualify as force majeure.
Commentary

This definition of force majeure largely restates the common-law defense of impossibility; as New York's highest court summarized in its oft-cited Kel Kim case.

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19.6.6 Additional commentary and cautions

Contents:

CAUTION: Will a force-majeure "laundry list" be needed?

In New York and possibly in some other jurisdictions, it might be necessary to include a "laundry list" of specific types of event that the parties intend to qualify as force majeure. The Court of Appeals's Kel Kim case went on to hold:

… Ordinarily, only if the force majeure clause specifically includes the event that actually prevents a party's performance will that party be excused. Here, of course, the contractual provision does not specifically include plaintiff's inability to procure and maintain insurance.

Nor does this inability fall within the catchall "or other similar causes beyond the control of such party." The principle of interpretation applicable to such clauses [i.e., ejusdem generis] is that the general words are not to be given expansive meaning; they are confined to things of the same kind or nature as the particular matters mentioned.

Some drafters might want to specify that the term force majeure includes, without limitation, any event that (i) is not excluded by the Contract and (ii) falls within one or more of the following categories; some of these categories are typographically flagged to indicate that a party might want to exclude them.

  • act of a public enemy;
  • act of any government or regulatory body, whether civil or military, domestic or foreign, not resulting from violation of law by the invoking party;
  • act of war, whether declared or undeclared, including for example civil war;
  • act or omission of the other party, other than a material breach (as defined in Clause 25.33.2) of the Contract;
  • act or threat of terrorism;
  • blockade;
  • boycott;
  • civil disturbance;
  • court order;
  • drought;
  • earthquake;
  • economic condition changes generally;
  • electrical-power outage;
  • embargo imposed by a government authority;
  • epidemic or pandemic;
  • explosion;
  • fire;
  • flood;
  • hurricane;
  • insurrection;
  • internet outage;
  • invasion;
  • labor dispute, including for example strikes, lockouts, work slowdowns, and similar labor unrest or strife;
  • law change, including any change in constitution, statute, regulation, or binding interpretation;
  • legal impediment such as an inability to obtain or retain a necessary authorization, license, or permit from a government authority;
  • nationalization;
  • payment failure resulting from failure of or interruption in one or more third-party payment systems;
  • public health emergency;
  • quarantine;
  • riot;
  • sabotage;
  • solar flare;
  • storm;
  • supplier default;
  • telecommunications service failure;
  • tariff imposition;
  • transportation service unavailability;
  • tornado;
  • weather in general.

This list does not include the so-called "act of God" because of the vagueness of that term.

As to epidemic: See generally, e.g., Mark Duedall, Coronavirus and Distress …. (JDSupra 2020).

CAUTION: Will economic- and market changes count?

As to economic changes generally: See Kevin Jacobs and Benjamin Sweet, ‘Force Majeure' In the Wake of the Financial Crisis, Corp. Counsel, Jan. 16, 2014.

As to market fluctuations, a Texas court of appeals held that :

… Because fluctuations in the oil and gas market are foreseeable as a matter of law, it [sic] cannot be considered a force majeure event unless specifically listed as such in the contract.

To dispense with the unforeseeability requirement in the context of a general "catch-all" provision would, in our opinion, render the clause meaningless because any event outside the control of the non-performing party could excuse performance, even if it were an event that the parties were aware of and took into consideration in drafting the contract.

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19.7 Force majeure – 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 19.6.

19.7.1 Option: Supplier allocation

If the Contract requires an invoking party to supply goods or services,

and the invoking party experiences shipping delays as a result of one or more force-majeure events,

then:

  • the invoking party may allocate its available goods or services to its customers in its discretion.
  • the invoking party must allocate its available goods and/or services so that the customer under the Contract will receive at least the same proportion of those goods and/or services as the customer would have received in the absence of the force-majeure event.

19.7.2 Option: No Required Mitigation or -Remediation

Neither party is obligated to make any efforts to mitigate and/or remediate the effects of the invoked force majeure.

Commentary

Should mitigation, remediation, or both, be required? Note that there are two distinct options presented here: One for mitigation, one for remediation, which are two different things. In a supply- or services agreement, the customer might not want to be bound by any obligation to respond to force majeure events. Of course, a drafter should be careful not to commit a client to either mitigation or remediation efforts if such efforts are not part of the client's business model.

Caution: "Best efforts" to mitigate / remediate?

  • Some customers might want suppliers to commit to using "best efforts" to mitigate or remediate the effects of force majeure; see, e.g., section 4 of a set of Honeywell purchase-order terms and conditions, apparently from February 2014.
  • A supplier, however, might be reluctant to agree to a best-efforts commitment because different courts might define that term in different ways (see the commentary in Clause 25.7 (Best Efforts Definition)).

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19.7.3 Option: Extension of Expiring Right

If one or more properly invoked events of force majeure make it impracticable or impossible for an invoking party to timely exercise a right under an agreement,

  • then the time for exercising that right will be deemed extended for the duration of the resulting delay.
Commentary

This Option addresses a  gap (depending on one's perspective) in many force-majeure clauses: In one case, New York's highest court held that the force-majeure clause in question "does not modify the habendum clause and, therefore, the leases terminated at the conclusion of their primary terms."

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19.7.4 Option: Economic Out

An invoking party is considered not to be reasonably able (or not to have been reasonably able, as applicable) to avoid a failure of timely performance resulting from one or more force-majeure events if avoidance is (or was) not possible at a commercially reasonable cost.

19.7.5 Option: Mandatory Alerting

FILL IN PARTY NAME must promptly alert FILL IN PARTY NAME if the former concludes that a substantial risk exists that it might have to invoke force majeure.

19.7.6 Option: Subcontractor Failure

If a party invoking force majeure fails to timely perform its obligations (or exercise its rights) under the Contract;

  • and the invoking party's failure was due to a failure of a subcontractor or supplier;

then the invoking party's failure will be excused only if both of the following are true:

  1. The failure by the subcontractor or supplier otherwise qualifies as one or more force-majeure events; and
  2. It was not reasonably possible for the invoking party to timely obtain, from one or more other sources, the relevant goods or services that were to have been provided by the subcontractor or supplier.

19.8 Information Purge Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

  • a specified party ("Recipient")
  • must return or destroy particular information ("Specified Information")
  • of another party ("Discloser").

Discussion checklist:

Commentary

Recipient will want to consider pushing back against a blanket obligation to return or destroy copies of Discloser's information. There are several reasons for concern, discussed in the commentary below; in addition:

1. Sometimes both parties forget about the return-or-destruction obligation, which could harm not just Recipient but Discloser as well:

  • If Recipient were to forget to comply with the return-or-destruction obligations, then Discloser might use that fact to bash Recipient as a scofflaw in front of a judge or jury.
  • On the other hand, if Discloser failed to follow up to confirm Recipient's return or destruction of Confidential Information (e.g., by asking for [BROKEN LINK: conf-info-rtn-certif]), then later a third party, learning about that failure, might try to use the failure to support an argument that Discloser had failed to take reasonable precautions to preserve the secrecy of its information.

2. In many situations, Recipient will want a set of archive copies of what it actually received from Discloser, to guard against an unscrupulous Discloser's later claiming that it had provided more documents or information to Recipient than it actually did.

This is addressed in Clause 19.8 by allowing Recipient to retain archive copies in accordance with Clause 19.1 (Archive Copies).

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19.8.1 What does "Purge" mean?

The term "Purge" refers to returning or destroying

  • all copies and other tangible embodiments ("Copies") of the Specified Information
  • that are in Recipient's possession, custody, or control.

19.8.2 What will trigger a Purge obligation?

Recipient need Purge the Specified Information

  • only if Discloser asks Recipient to do so,
  • in writing,
  • with Recipient receiving the request no later than 30 days after termination or expiration of the Contract;
  • otherwise, Recipient need not Purge the Specified Information.

19.8.3 What if an electronic Purge would be burdensome or costly?

  1. Recipient need not return or destroy electronic Copies,
    • to the extent that it would be unduly burdensome or costly to do so.
  2. For example (without limitation),
    • Specified Information in email attachments and system-backup media
    • need not be returned or destroyed.
Commentary

In many situations, an obligation to return or destroy documents might not be practical, especially where electronic information is concerned.

Consider litigation discovery of electronically-stored information, or "ESI":

  • Anyone who has gone through that process can attest to the burden and expense of even just identifying the information that might need to be returned or destroyed.
  • The inconvenience and expense of purging that information from Recipient's electronic data systems would be even worse.

This section addresses these problems by providing an exception.

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19.8.4 Recipient must check first before destroying Copies

Yes:

  1. Before Recipient destroys its Copies of Specified Information,
    • Recipient must send Discloser a written destruction alert,
    • by any reasonable means (including without limitation email),
    • in case Discloser does not have its own copies of particular Specified Information.
  2. Recipient must not destroy its Copies unless Discloser either—
    1. indicates in writing that Discloser does not need copies of the Specified Information; or
    2. fails to respond to Recipient's destruction alert
      • on or before the date five business days after Discloser receives or refuses the alert.
Commentary

This section takes into account that sometimes Recipient's copies might be the only ones that exist.

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19.8.5 Recipient must turn over Copies if requested

  1. This section applies if Discloser, in writing,
    • asks Recipient to return its Copies, instead of destroying them,
    • pursuant to § 19.8.4.
  2. In such a case: Instead of destroying Recipient's Copies,
    • Recipient must turn over those Copies to Discloser,
    • or to another party that Discloser designates in writing.
  3. If the Copies are electronic, however,
    • then Recipient may make new copies and give those new copies to Discloser.
    • This might be the case, for example, if Recipient was planning to delete electronic copies from its computer system.

19.8.6 Recipient must provide a written certificate of compliance

  1. This section applies if Discloser so requests, in writing,
    • within a reasonable time after the purge requirement of this Clause becomes applicable (see § 19.8.2).
  2. Recipient must promptly provide Discloser with a written certificate of Recipient's compliance with the requirements of this Clause.
  3. The certificate must:
    1. be signed by someone having authority to make a binding commitment on Recipient's behalf (or by Recipient him- or herself if an individual);
    2. note any known compliance exceptions; and
    3. for each exception, note whether and how the exception is authorized by the Contract
      • (unless doing so is prohibited by applicable law, for example because Recipient has provided Copies to law-enforcement authorities).
Commentary

This section requires Recipient to certify compliance with the return-or-destruction requirements and to specify any areas of noncompliance. That has several benefits:

  • It makes it easier for Discloser to manage its contract rights;
  • It gives Recipient an incentive to do a good job in complying with the return-or-destruction requirement;
  • It help the parties identify specific areas that might need attention before a dispute arose, and thus possibly help to avoid the dispute in the first place.

BUT: This certification requirement would also give Discloser ammunition to blast Recipient with a "they lied!" accusation, if it turned out that Recipient had overlooked some specimens of Discloser's Confidential Information.

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19.9 Insurance-Requirement Policy [TO DO]

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19.9.1 Attorney malpractice insurance: What type?

QUESTION: Attorney malpractice insurance is an example of a type of coverage that, in the business-insurance context, is normally referred to by this name:

A.  Client liability coverage

B.  Professional liability coverage

C:  Commercial General Liability coverage

D.  Umbrella coverage

19.9.2 Insurance questions (commentary)

For this week's homework, as MathWhiz's counsel, do a review and markup of this insurance provision, which is from an actual contract form used by a Gigunda-type company.

IMPORTANT: Be sure to break up the provisions into single-subject paragraphs.

QUESTIONS for small-group discussion today — do any lookups you want:

1.  What's the main difference between an "excess liability" policy and an "umbrella" policy? (Hint)

2.  From a 10,000-foot level, is there any difference between a "self-insured retention" and a deductible"? (Hint)

3.  TEXT from the first paragraph of subdivision A: "Upon request MathWhiz shall immediately provide certified copies of policies."

QUESTION: Any issues here for MathWhiz?

QUESTION: Any issues here from Gigunda's perspective?

4.  TEXT from the second paragraph of subdivision A: "In addition to any other insurance obligations or requirements set forth in this Agreement, and without limiting the indemnity obligations of MathWhiz or its insurers, at any and all times during the term of this Contract, MathWhiz shall, at MathWhiz’s sole cost and expense, procure and maintain in full force and effect, and shall require its MathWhiz Agents to procure and maintain, at all times during the term of this Agreement, sufficient insurance or Gigunda-approved self-insurance (i) as may be required by law, and (ii) to protect MathWhiz and Gigunda from third-party claims arising out of or connected with the performance of Services hereunder."

QUESTION: Any issues here for MathWhiz?

5.  TEXT from subdivision B: "Insurers and underwriters shall be satisfactory to Gigunda …."

QUESTION: Any issues here for MathWhiz?

6.  TEXT from subdivision B: "… A.M. Best rating of at least A- and financial rating of at least VII."

QUESTION: What is an A.M. Best rating? (Hint) What is a financial size of VII? (Hint)

7.  TEXT from subdivision C: "… all insurance policies and coverage acquired by MathWhiz shall extend to and protect Gigunda to the fullest extent." (Emphasis added.)

QUESTION: Any issues here for either party?

8.  TEXT from subdivision C: "… The amount of such coverage, including excess and umbrella insurance, shall be primary to, and receive no contribution from, any other insurance or self-insurance programs maintained by or on behalf of or benefiting Gigunda." (Emphasis added.)

QUESTION: What does the italicized text mean? (Hint)

9.  TEXT from subdivision C: "… MathWhiz shall delete, strike, or remove any language in any provision or endorsement limiting or excluding coverage, including but not limited to any endorsements addressing sole negligence. "

QUESTION: Any issues here for MathWhiz?

10.  TEXT from subdivision D: "… Endorsement shall be on a form substantially equivalent to ISO Form “20 10 11 85” covering both ongoing operations and products / completed operations and covering the sole, joint, concurrent, or contributory negligence of Gigunda."

QUESTION: Any issues here for MathWhiz in the italicized portion? (Hint)

11.  TEXT from subdivision E: "All of MathWhiz’s insurance policies, whether or not coverage is required by the Agreement, and excluding Technology Errors and Omissions Insurance shall be endorsed to contain a waiver on the part of the insurer, by subrogation or otherwise, of all rights against Gigunda."

QUESTION: What is a waiver of subrogation? (Hint)

12.  TEXT from subdivision F: "All of MathWhiz’s insurance policies, whether or not coverage is required by this Agreement, shall be endorsed to provide that they may not be materially altered or cancelled without at least thirty (30) days prior written notice to Gigunda."

COMMENT: This might be tricky for MathWhiz to make happen; see here and here.

  1. TEXT from subdivision I: "Occurrence form …."

    QUESTION: What is an "occurrence form" and how does it differ from the alternative?

14.  QUESTION: Nowadays, is professional-liability coverage ("E&O") normally available on an occurrence basis? (Hint)

19.10 Language Capability Requirement

19.10.1 What is the "Contract Language"?

The term "Contract Language" refers to the language in which the body of the Contract is principally written.

19.10.2 What must the Contract Language be used for?

  1. The Contract Language must be used for the following:
    1. all any notices under the Contract; and
    2. all service of legal process,
      • in any dispute arising out of or relating to the Contract or any transaction or relationship resulting from it,
      • except as provided in subdivision b.
  2. If applicable law requires that service of process be made in another language,
    • then a translation into the Contract Language of each other-language document served is to be served with the other-language document.
  3. The Contract Language may be used for any other written communication in connection with the Contract.
Commentary
Business context

In a LinkedIn discussion (membership required), the following points were suggested:

• English is the global lingua franca.

• The choice of language for drafting a contract should take into account the jurisdiction (or jurisdictions) in which the contract is likely to be enforced — even with translations, it can be expensive, burdensome, and risky to ask a court to interpret and apply a contract written in a language not its own.

• It might be possible to "write around" legal requirements that contracts be written in a local language by requiring binding arbitration in the desired language. (It would make sense to include, in the contract, a translation of the arbitration provision into the local language.)

• A party acting in bad faith might try to claim that it misunderstood a term in a foreign language.

• In some cases, the body of the Contract might be written in multiple languages, or the Contract might have attachments in different languages.

Caution: Drafters of transnational contracts will want to check local law (and possibly engage local counsel) to see whether the law in a potentially-relevant jurisdiction requires contracts to be in the local language. EXAMPLE: • IndonesiaQuébecChina.

Subdivision a.1: Language for notices

Requiring notices and service of process to be in the Contract Language could be important: A U.S. retailer found itself losing an arbitration in China — and having a sizable damages award entered against it — because the notice of arbitration was written in Chinese, and the U.S. retailer did not get the notice translated in time to avoid adverse consequences under the arbitration rules.

(The U.S. retailer in that case managed to dodge the bullet: A U.S. court refused to enforce the arbitration award against the retailer, on grounds that a different agreement controlled, under which the arbitration notice was required to be in English, not Chinese.)

As a former student of the author's once said: That's a conversation we don't want to have.

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19.10.3 Must the parties use the Contract Language orally?

  1. Each party is to maintain the capability of conducting routine business orally in the Contract Language,
    • for example (as defined in Clause 25.23), in person or by telephone,
    • whether through party personnel who can speak the Contract Language,
    • or via translators engaged at the party's expense.
  2. Subdivision a does not limit any party's right to communicate orally in any other language,
    • when agreed to by the individuals involved,
    • and not a hindrance to the purpose of the Contract.
Commentary

This provision tries to balance:

  • the parties' interest in making sure they can communicate orally, against
  • the possible threat of legal action from employees claiming discrimination on the basis of national origin.

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19.10.4 Which language version of the Contract will control?

  1. Any translation of the Contract or any related document is for convenient reference only and not binding on any party.
  2. The version of the Contract or related document in the Contract Language is to take precedence in case of discrepancy.
Commentary

Drafters dealing with multi-lingual appendixes, exhibits, etc., will want to consider this provision carefully.

In a LinkedIn discussion (membership required), the following points were suggested:

  • Translations can be iffy, because specialized words and phrases, such as fraud and gross negligence, conceivably might be translated into other languages in ways that have subtly different meanings than the original.
  • An expensive but sometimes-worthwhile approach is to negotiate a contract in one language; have the final draft translated into another desired language; and then have the translation retranslated back into the original language.

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19.11 Lead Representatives Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:

  • one or more parties (each, a "designating party"),
  • may (or must) designate a lead representative (each, a "Lead Rep") for purposes of the Contract,
  • either as an absolute requirement or when requested by another party.

Discussion checklist:

19.11.1 Any party may designate one or more Lead Reps

  1. Any party that wishes to designate a Lead Rep for purposes of this Clause may do so in a written communication to each other relevant party.
  2. A designating party may designate multiple Lead Reps:
    • for the same purpose,
      • possibly for different time periods,
    • and/or for different purposes.
  3. Neither party is required to designate a Lead Rep unless the Contract clearly says otherwise.
Commentary

Subdivision b – different Lead Reps: A designating party ABC Corp. might designate:

  • Alice as its Lead Rep for the day shift;
  • Allen for overnight;
  • Amy for weekends;

etc. Or, ABC Corp. might designate:

  • Alice as its Lead Rep for engineering matters;
  • Allen for personnel matters;
  • Amy for financial matters;

etc.

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19.11.2 A party may change its Lead-Rep designations

Yes —

  1. At any time, a designating party may "un-designate" one or more of its Lead Reps,
    • in any manner that the designating party is allowed or required to make such a designation.
  2. A designating party's un-designation of a Lead Rep will not change the effect of that Lead Rep's prior communications in that role.
  3. If un-designating a Lead Rep means that the designating party no longer has a Lead Rep that the Contract requires the designating party have,
    • then the designating party must promptly designate a replacement in the manner prescribed above.

19.11.3 A party may limit its Lead Reps' authority

Yes —

  1. A designating party may place written limits on a Lead Rep's authority:—
    • in the designating party's initial designation of that Lead Rep,
    • and/or in a subsequent notice (as defined in Clause 24.17) to the other party.
  2. A communication by a Lead Rep outside the stated limits of that Lead Rep's authority will not be binding on the designating party,
    • and the other party will not be entitled to rely on it.
Commentary

As an example, suppose that ABC Corp. designates Alice as its Lead Rep. The designation might state that Alice is not authorized to make commitments on behalf of ABC Corp. that would cost more than X dollars, in much the same way that some organizations, when spending money, require two authorized signatures on checks for amounts exceeding X dollars.

Subdivision b uses the phrase "the other party will not be entitled to rely on" on a particular communication, because the phrase "the other party may not rely on" the communication could be misinterpreted as "the other party might not rely on" the communication. See also Clause 25.34 (May and May Not Definition).

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19.11.4 Communications from Lead Reps will be binding

Yes: The other party is entitled to rely on any communication from a Lead Rep

  • as being authorized by, and binding on, the designating party,
  • regardless whether the communication is oral, written, or in some other manner,
  • unless the Contract clearly provides otherwise,

19.11.5 Other party communications will not be binding

  1. This section applies if:
    • another representative of a party that has designated a Lead Rep —
      • makes a request of another party,
      • or issues an instruction or update to another party;
    • but that other representative has not been designated as a Lead Rep of the designating party
      • (in the relevant area, if applicable).
  2. When subdivision a applies:—
    • no other party is entitled to rely on the request, instruction, or update from the other representative of the designating party
      • as purportedly being from the designating party;
    • no other party need comply with the request or instruction;
    • and if another party does elect to comply with the request or instruction,
      • then that other party does so at its own risk and expense.
Commentary

Subdivision b – nonbinding communications from other representatives: This provision addresses one of the major causes of "troubled" contracts, which is that is unauthorized people can make change requests that can lead to cost overruns and delays.

BUT: In some cases, a party might want to be free to rely on any communication by any representative of the other party, under apparent-authority principles, instead of being obligated to pay attention only to Lead-Rep communications.

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19.11.6 A Lead-Rep communication can be nonbinding

If a communication from a Lead Rep clearly states

  • that the communication is not binding on the designating party in one or more respects,
  • then to that extent, no other party is entitled to rely on that communication.

19.11.7 Oral Lead-Rep communications should be summarized in writing

Except as provided in Clause 19.11.9,

  • an oral communication from a Lead Rep will not be binding on the designating party,
  • and the other party may not rely on the oral communication,
  • unless the oral communication is promptly followed up with a written summary —
    • by either the designating party or the other party —
  • that contains reasonable detail,
  • and that is successfully transmitted to the other party or the designating party (as applicable) by any means,
    • including but not limited to email and text message.
Commentary

This section is intended to encourage written communications in the interest of trying to forestall future "he said, she said" disputes.

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19.11.8 A written summary might be binding

A written summary,

  • by any Party A,
  • of an oral communication from any party's Lead Rep,
  • will be binding on any other Party B,
  • if Party B does not object to the the summary
  • within a reasonable time after receiving the summary.

19.11.9 An unsummarized oral communication might not be binding

An oral communication,

  • from a Lead Rep,
  • that is not summarized in writing
  • will not be binding on the party that designated the Lead Rep,
  • and no other party may rely on that communication,
  • unless the other party can prove both the fact and the content of the communication
Commentary

This section bows to the reality that parties likely will not always reduce their important oral communications to writing, but it tries to give some structure to the parties' dealings when that happens.

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19.12.1 Each party is bound by this Clause

  1. Each specified party must defend (as defined in Clause 21.4) each other party's Protected Group (as defined in Clause 25.40)
    • from any third-party claim
    • arising from any violation of law by the first party
    • in connection with the first party's activities under the Contract.
  2. This Clause does not require a party to completely indemnify (as defined in Clause 21.1) other parties from losses arising from the first party's legal violations,
    • but only to defend against third-party claims,
    • and pay any resulting monetary awards,
    • as stated in Clause 21.4.

19.13 Noncompetition clauses (notes only)

From mondaq: "The California Supreme Court just addressed this very question in Ixchel Pharma v. Biogen , holding that most B2B agreements are governed by the common law rule of reason, instead of the flat prohibition on noncompetes applicable to the employment context."

19.14 Other Necessary Actions Requirement

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

19.14.1 What must each party do?

Each specified party is to sign and deliver any other commercially-reasonable documents (as defined in Clause 25.14),

  • and take any other commercially-reasonable actions,
  • as may be reasonably requested by the other party,
  • if necessary to further the clear purpose of the Contract.
Commentary

This Clause and language like it are sometimes seen in merger- and acquisition agreements, but rarely in everyday commercial agreements.

Subdivision b: The use of several instances of "reasonably" is intentional:

  • Suppose that Party 1 requests that Party 2 take a particular Action A.
  • In the abstract, Action A might be commercially reasonable; in context, however, Party 1's request might not be reasonable under the circumstances.

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19.14.2 What if the parties disagree about what's "reasonable"?

If the parties disagree about what constitutes reasonable action for purposes of this Clause,

  • they are to manage that disagreement in accordance with Clause 23.9 (Dispute Management Protocol),
  • including but not limited to Clause 23.4 (Baseball-Style Dispute Resolution) to encourage each party to be reasonable in its position.
Commentary

Chances are that a disagreement of this nature will never go very far into a dispute-management process.

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19.15 Performance Improvement Plans

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a specified party,

  • referred to for convenience as "Performer,"
    • whether an individual or an organization,
  • is not meeting performance requirements that were agreed to with another party ("Observer").

Discussion checklist:

Commentary

For general information about performance improvement plans in the workplace — which can have issues that might not appear in a B2B context — see generally Society for Human Resource Management, How to Establish a Performance Improvement Plan (SHRM.org, undated).

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19.15.1 What must Observer do to trigger this Clause?

  1. To trigger this Clause, Observer must give Performer notice (as defined in Clause 24.17) to that effect;
  2. Observer's Notice must specify,
    • in reasonable detail,
    • in what respects Performer has failed to meet the agreed performance requirements.

19.15.2 What plan must Performer propose, and by when?

  1. Performer will have five business days,
  2. after the effective date of Observer's notice under § 19.15.1,
    • to propose to Observer, by notice,
    • a written plan,
    • reasonably acceptable to Observer,
    • to improve Performer's performance to acceptable levels,
    • including but not limited to appropriate milestones and deadlines.
  3. Performer's proposed plan should preferably include provisions for scheduled "catch-up" calls with Observer; see generally Clause 24.20 (Status Conferences).

19.15.3 By when must Observer state objections to Performer's plan?

Observer will be deemed to have accepted Performer's proposed improvement plan,

  • if Observer does not object, in reasonable detail, by notice to Performer,
  • on or before five business days after the effective date of Performer's notice to Observer that proposes the plan.

19.15.4 Then what?

If Performer fails to propose a reasonably acceptable improvement plan as provided above,

  • or if Performer fails to meet an approved plan's requirements
    • in one or more material respects,
  • then Observer may take such action as specified in the Contract.

19.16 Site Visits Protocol

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when one or more individuals under the control of a party is to access a "Site" of another party (the "Host"), namely:
    1. any physical premises of the Host; and/or
    2. any computer system or network of the Host.
  2. Each such individual is referred to as a "Visitor";
    • the party controlling the Visitor is referred to as the "Accessing Party";
    • the Accessing Party might be the Visitor him- or herself, or it might be the Visitor's employer or other controlling person.
  3. Any such access is referred to as a "Site Visit" — which could take the form of:
    1. a Visitor's in-person presence at the Host's physical premises; and/or
    2. a Visitor's access to a computer system or network of the Host — in which case Clause 19.3 (Computer System Access Prococol) will also govern.

Discussion checklist:

Commentary

Customers' contract forms for providers of goods and services often include provisions along the lines of this Clause.

These definitions recognize that "site visits" are sometimes virtual.

In many services-type agreements, the Host will be the customer, while the Accessing Party will be the services provider coming onto the customer's site or accessing the customer's computer network. (The same could be true of providers of goods if the provider's personnel will be, e.g., making deliveries at the customer's site, or if sales people will be making in-person calls at the customer's premises.)

In other types of agreement, it might be the other way around, e.g., with a customer's people coming onto a service provider's site for training, to have work done on vehicles or equipment, etc.

Some drafters might want to make this a one-way provision so that only one party is a Host and the other an Accessing Party.

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19.16.1 What site rules must Visitors follow?

At all times during a Site Visit, each Visitor must comply with:

  1. this Clause;
  2. Clause 19.3 (Computer System Access Prococol), where applicable; and
  3. such other reasonable Site rules and policies
    • as the Host timely (as defined in Clause 25.49) communicates
    • to the Visitor and/or to the Accessing Party.
Commentary

Subdivision 2 doesn't require site rules to be communicated in writing, but obviously that might be advisable for proof purposes.

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19.16.2 What must the Host not do during a Site visit?

  1. The Host, and personnel subject to the Host's control, must not engage in "unlawful conduct," which for this purpose means any and all of the following:
    1. denying access to the Site to a Visitor,
      • or otherwise discriminating against a Visitor,
      • for any reason prohibited by applicable law; and/or
    2. other unlawful conduct against the Visitor — which includes, without limitation,
      • tortious conduct, and/or
      • conduct prohibited by anti-harassment or anti-retaliation law.
  2. If any personnel of the Host engage in unlawful conduct, as defined in subdivision a,

19.16.3 The Accessing Party is responsible for its Visitors' conduct

  1. If a Visitor fails to comply with the applicable Site rules (see § 19.16.1),
  2. If a Visitor engages in unlawful conduct (as defined in Clause 19.16.2),

19.16.4 The Host may require evidence of Visitor employability

If the Host timely asks the Accessing Party in writing,

  • then the Accessing Party must provide the Host
  • with reasonable evidence
  • that the Accessing Party's Visitors
  • who will access any physical premises of the Host
  • are legally employable where those premises are located.
Commentary

A given company might feel compelled to verify employability of any individual that comes on its premises. (That's especially possible if a company had previously entered into a non-prosecution agreement after being caught employing aliens not having the legal right to work.)

This provision shouldn't be too contentious, given that U.S. law already requires most if not all employers to verify that their employees have the right to work in this country.

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19.16.5 How much room must the parties give each other on-site?

  1. Visitors and Host personnel are to make reasonable efforts to avoid interfering with each other at any site where both are present.
  2. The Host and the Accessing Party are to instruct their respective personnel to comply with subdivision a.
Commentary

Some customers might want this to be a one-way clause, where it's only the on-site service provider that must make an effort to avoid interference with the customer, and not vice versa.

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19.17 Training Program

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a party, referred to as "Provider," will provide training to personnel of another party, referred to as "Customer."

Discussion checklist:

19.17.1 What training must be provided?

The Contract may (and should) set forth specific details about the training, including but not limited to:

  1. contact information for lead representatives for each party;
  2. specific courses to be offered;
  3. physical location(s) of training, if any;
  4. minimum- and maximum class size;
  5. scheduling;
  6. required trainee qualifications (prerequisites);
  7. logistical support to be provided by Customer;
  8. registration deadline;
  9. cancellation- and refund policy;
  10. any fee(s) that Provider will charge,including but not limited to:
    • any minimum fee (and how many attenders does that cover);
    • any per-person fee;
    • materials charges, if any;
  11. reimbursement of Provider expenses — see § 13.3;
  12. payment deadline(s) — see § 13.12.

19.17.2 Customer is responsible for its trainees' expenses?

As between Customer and Provider, the specified party is responsible for:

  1. all salary and benefits of Customer personnel attending training; and
  2. all expenses of those personnel in connection with attending training, including without limitation:
    • expenses for travel, lodging, and meals, if any; and
    • expenses for video conferencing and other Internet access, if applicable.

19.17.3 What rules must trainees and other visitors follow?

Each party is to comply with the provisions of specific Tango clauses as follows:

  • When accessing the other party's computers or network: Clause 19.3 (Computer System Access Prococol)
  • When on-site at the other party's physical premises: Clause 19.16 (Site Visits Protocol)

19.17.4 Who is responsible for any trainee- or instructor misconduct?

Each party will indemnify (as defined in Clause 21.1)

20 Representations and warranties

20.1 Introduction to reps and warranties (commentary)

Many contracts contain various representations and warranties. Each one 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.

20.1.1 What's the difference?

Representations and warranties are similar but in significant ways different in U.S. law. (See § 20.1.3 for a (crude) drawing summarizing the differences.)

Perhaps most notably, a claim of misrepresentation requires the claimant to show:

  • that the claimant in fact relied on the representation — although that usually won’t be a heavy burden if the representation is explicitly stated in the contract;
  • that the claimant’s reliance was reasonable under the circumstances; reasonableness of reliance would likely be presumed, but reliance could be /un/{}reasonable if the representation was obviously false or misleading when made; and
  • that the party that made the representation had acted negligently, or recklessly, or even intentionally (i.e., fraudulently), in making the (mis)representation.

In contrast, none of the above showings is required for a claim of breach of warranty.

Moreover, a proven claim of misrepresentation could entitle the claimant to tort-style remedies such as punitive damages and/or rescission of the contract; in contrast, neither of these remedies is normally available for breach of warranty.

20.1.2 "They lied!" is a go-to phrase for trial counsel

When a big contract fails, trial counsel will pretty much always try hard to find opportunities to accuse the other side of having misrepresented facts. Why? Because it can work, sometimes spectacularly well. Jurors and even judges might not understand the nuances of the dispute, but they will definitely undertand the accusation that "they lied!"

Consequently, every contract drafter should be mindful of the possibility that if a serious dispute were ever to arise concerning the contract, the other side might claim that the drafter's client engaged in fraudulent behavior. We see this in the civil complaint filed by the state of Oregon against Oracle, in which the second paragraph said, in its entirety (with extra paragraphing added for readability):

Oracle lied to the State about the “Oracle Solution.”

Oracle lied when it said the “Oracle Solution” could meet both of the State’s needs with Oracle products that worked “out-of-the-box.”

Oracle lied when it said its products were “flexible,” “integrated,” worked “easily” with other programs, required little customization and could be set up quickly.

Oracle lied when it claimed it had “the most comprehensive and secure solution with regards to the total functionality necessary for Oregon.”

As another example, consider Sky Broadcasting's lawsuit against EDS (founded by the late H. Ross Perot), in which:

  • British Sky Broadcasting ("Sky") contracted with EDS to develop a customer relationship management (CRM) software system.
  • Things didn't go as planned, and Sky eventually filed suit.
  • In the (non-jury) trial, the judge concluded that EDS had made fraudulent misrepresentations when one of EDS's senior UK executives, wanting very much to get Sky's business, lied to Sky about EDS's analysis of the amount of elapsed time needed to complete the initial delivery and go-live of the system.
  • 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.
  • 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.

One of the most interesting aspect of the judge's opinion, it seems to me, is its detailed exposition of the facts, which illustrate the ‘sausage factory' by which technology deals sometimes get made — and how even just one vendor representative can make a deal go terribly wrong for his employer.

In early June 2010, EDS reportedly agreed to pay Sky some US$460 million — more than four times the value of the original contract — to settle the case.

In another example, in 2019 a natural-gas provider was hit with a judgment for some $9 million for fraudulent inducement and negligent misrepresentation for recklessly representing 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 …." (at ¶ 54).

20.1.3 Contract Ninja Warrior: An evidentiary "Hill of Proof"

As noted above:

  • a claim for breach of warranty has a shorter proof checklist than a claim for fraudulent inducement or negligent misrepresentation,
  • but the former also has a more-limited set of remedies available.

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?)

Suppose that in our Alice-and-Bob case, 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: (i) warrant, but not represent, that the car was in good working order, and (ii) 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) 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) Alice’s statement was false — her car, as delivered to Bob, turned out to need some significant work; and

(3) Bob incurred damages as a result, i.e., repair costs.

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

New facts: 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:

(4) 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;

(5) Bob's reliance was reasonable — ditto, although Alice could try to prove that Bob's reliance was not reasonable under the circumstances; and

(6) Alice intended for Bob to rely on Alice’s representation — ditto; and

(7) 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 make it to 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.

More new facts: Now let’s change up the hypothetical — 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.

20.1.4 (Skim:) State laws vary somewhat about misrepresentation

As to negligent misrepresentation, “under New York law, the plaintiff must allege that (1) the defendant had a duty, as a result of a special relationship [such as privity of contract–DCT], to give correct information; (2) the defendant made a false representation that he or she should have known was incorrect; (3) the information supplied in the representation was known by the defendant to be desired by the plaintiff for a serious purpose; (4) the plaintiff intended to rely and act upon it; and (5) the plaintiff reasonably relied on it to his or her detriment.”

Somewhat similarly, in Texas as in many other states, the courts follow Restatement (Second) of Torts § 552 (1977) in defining negligent misrepresentation as “(1) the representation is made by a defendant in the course of his business, or in a transaction in which he has a pecuniary interest; (2) the defendant supplies ‘false information’ for the guidance of others in their business; (3) the defendant did not exercise reasonable care or competence in obtaining or communicating the information; and (4) the plaintiff suffers pecuniary loss by justifiably relying on the representation.”

It bears noting that “California courts have expressly rejected that requirement [of privity of contract or other a special relationship], holding that negligent misrepresentation claims may be brought against any person who negligently supplies false information for the guidance of others in their business transactions and intends to supply the information for the benefit of one or more third parties.”

As to fraud, New York law is fairly typical: “The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages.”

Similarly, under Texas law, “[t]he elements of fraud are: (1) that a material representation was made; (2) the representation was false; (3) when the representation was made, the speaker knew it was false or made it recklessly without any knowledge of the truth and as a positive assertion; (4) the speaker made the representation with the intent that the other party should act upon it; (5) the party acted in reliance on the representation; and (6) the party thereby suffered injury.”

20.1.5 Which do I want: A rep, or a warranty?

Here's a rule of thumb:

• A party who 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 case the represented- or warranted thing turns out to be false.

20.1.6 Gouge: Key takeaways about reps and warranties

("Gouge" is a Navy term that refers to "what you really need to know.")

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. Example: Alice represents that her car has never been in an accident [past fact] and is in good working order [present fact].

3. A representation might be paraphrased as: So far as I know, X is true, but I’m not making any promises about it.

4. When qualifying a representation as in #3 above, use a term such as, so far as I know, and not the term to my knowledge: In a lawsuit, an aggressive trial counsel might claim that the latter term amounts to an implicit representation that the representing party did indeed have knowledge.

5. A representation can include the disclaimer without any particular investigation; this could be paraphrased as: I represent that X is true, but I’m not saying that I’ve done any particular investigation into the question.

6. The term warranty is a shorthand label for a kind of conditional covenant, a promise that if the warranted fact(s) are shown to be untrue, then the warranting party will make good on any resulting losses suffered by the party to whom the warranty was made.

Example: Consider the simple warranty, Alice warrants to Bob that Alice’s car will run normally for at least 30 days. This is tantamount to a promise by Alice that, if Alice’s car fails to run normally for at least 30 days, then Alice will pay for repairs, a rent car, and any other foreseeable damages resulting from the failure.

7. A warranty might be paraphrased as: I’m not going to say 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 14.5.2.1.)

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.

11. Don’t use the term represents to indicate that a party will take or abstain from action — commitments to future action should instead be written as promises (covenants).

Before: Bob represents that he will pay Alice ….

After: Bob will pay Alice …

Caution: In the “Before” example above, if Bob failed to pay Alice, he might try to claim that he should not be liable for nonpayment because when he made the representation, he had no reason to believe that he would not make the payment. A court might treat such a “representation” as a simple promise, but the drafter would do all concerned a disservice by not making the obligation explicit and unconditional.

20.1.7 Drafting lessons

– If your client is being asked to represent and warrant some fact, 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 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, 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.

20.1.8 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."

Author's note: The economic loss doctrine should 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 have shared that view.

20.2 Representation Definition

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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.

Discussion checklist:

Commentary

The term statement of past‑ or present fact is suggested by Professor Tina Stark in her highly-regarded Drafting Contracts textbook.

The term transaction or relationship term is modeled on the arbitration provision that was litigated in both the Fifth and Eleventh Circuits.

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20.2.1 What exactly does a representing party assert to be true?

By making the representation, a representing party asserts that,

  • so far as representing party knows (as defined in Clause 25.32):
  • at the time the representing party makes the representation,
  • the stated fact is true.
Commentary

"So far as Representing Party knows": 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.

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20.2.2 Must a party have a reasonable basis for a representation?

  1. 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. 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: "So far as I know, the car is in good working order." By using this phrasing,
      • Alice is implicitly making an ancillary representaiton
      • that she has a reasonable basis for her main representation about the car's condition
      • perhaps because she has recently driven it or had it checked out by a mechanic.
    • Phrasing 2: "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."
      • By adding the "but" part, Alice disclaims any ancillary representation about the basis for her main representation about the car's condition.
Commentary

Note that the burden is on the representing party to disclaim having a reasonable basis for the main representation.

In the context of disclaiming reliance to preclude later fraud claims (discussed at Clause 20.3), noted corporate practitioner Glenn West suggests that "when there is a requested representation that is not verifiable, but is nonetheless requested as a risk allocation subject to the indemnification regime, consider inserting a clause that says just that and disclaiming that the representation is intended to be an assertion of known truth."

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20.2.3 May the other party rely on the representation?

By making a representation to another party,

  • the representing party states its intent
  • that the other party rely
    • on both the main representation
    • and the ancillary representation about reasonable basis (see § 20.2.2),
  • 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.

20.2.4 What law is to govern claims of misrepresentation?

In any Agreement-Related Dispute (as defined in Clause 25.3),

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

New York law is chosen for uniformity; see the commentary to § 24.2.5 (amendments) concerning the notion of choosing a law to govern a specific section of a contract.

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20.2.5 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.

20.2.6 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?

20.3 Reliance Disclaimer

Commentary

Reliance disclaimers are used to try to defeat claims of misrepresentation.

This disclaimer draws on one that was successfully invoked by a bank.

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20.3.1 Each party is disclaiming reliance

Each specified party (each, a "Disclaiming Party") DISCLAIMS reliance,

  • as stated in this Clause,
  • on any representation or other statement
  • outside the four corners of:
    • the Contract, and
    • any document attached to, or incorporated by reference in, the Contract.

20.3.2 Why is reliance being disclaimed?

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

Commentary

Why use a reliance disclaimer? Because:

  • in some jurisdictions such as Texas, an entire-agreement provision (as defined in Clause 24.7) in a contract, standing alone, generally won't preclude XYZ from claiming that ABC should be liable for "fraud in the inducement" in getting XYZ to enter into the contract in the first place;
  • but if the contract states that XYZ has not relied and will not rely on any representation by ABC outside the four corners of the contract, that might do the trick.

Reliance disclaimers are often used in situations such as M&A deals 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.

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."

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20.3.3 What does the Disclaiming Party warrant, and to whom?

By entering into the Contract, the Disclaiming Party both represents (as defined in Clause 20.2) and warrants (as defined in Clause 20.4),

  • 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.

20.3.4 The Disclaiming Party releases future claims

  1. 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.
  2. The Disclaiming Party WAIVES (as defined in Clause 24.26) 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."
Commentary

This release language is based on an online comment. Caution: The author has not researched the extent to which advance releases are enforceable or not.

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20.3.5 This disclaimer can be limited

The Contract may limit the scope or effect of this Clause, for example (as defined in Clause 25.23), by stating that Disclaiming Party is disclaiming reliance only on specified categories of statement.

20.4 Warranty Definition

20.4.1 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.

20.4.2 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
What is being warranted, exactly?

Warranties should be carefully phrased to be clear just what is being 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.

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.

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.

Ordinary-course economic losses

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 22.2.3.

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20.4.3 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.

20.4.4 Who may assert warranty rights?

  1. A warranty will benefit only the specific individuals and organizations clearly identified as such,
    • in the warranty itself,
    • or otherwise in the Contract.
  2. 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 …."

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20.4.5 Reliance on a warranty need not be proved

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.

Commentary

A leading case on this point is CBS v. Ziff-Davis, from the Court of Appeals of New York (that state's highest court).

Likewise, the Seventh Circuit, applying Illinois law, held that: "The warranty sued on here was part of the parties' agreement, so the plaintiff did not need to prove further reliance."

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.

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20.4.6 Review questions

20.4.6.1 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.

20.4.6.2 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?

20.4.7 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? [1]

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

20.4.8 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.)

20.4.9 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.

20.4.10 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?

20.4.11 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.)

20.5 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 2020B (beta) warranties to XYZ: [List shorthand terms].

(END)

20.6 Infringement Warranty

20.6.1 When does this Clause apply?

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, 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 Clause.
  2. 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.

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20.6.2 What does this Clause 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 Clause.
Commentary

See the commentary to § 20.6.3 for a discussion of why the copyright- and trade-secret warranty has a different scope than the patent- and industrial-design warranty.

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20.6.3 What does this Clause cover for patents and industrial designs?

In making an Infringement Warranty about a Covered Item,

Supplier only represents (as defined in Clause 20.2) —

  • 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 Clause.

20.6.3.1 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 20.6.9.

20.6.4 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 25.23) 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 20.6.9.)

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.

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20.6.5 Compliance with a furnished specification is not covered

  1. 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 25.2) of a Beneficiary (to avoid possible collusion);
      • or by a third party on behalf of a Beneficiary or affiliate of a Beneficiary.
  2. 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.)

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20.6.6 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.

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20.6.7 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 Clause.

20.6.7.1 What must happen to trigger Supplier's obligations?

The "Infringement Remedies" defined in this Clause 20.6.7 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.
20.6.7.2 What must Supplier do in case of a Triggering Event?
  1. If a Triggering Event (as defined in Clause 20.6.7.1) 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 25.19), 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 20.6.7.3 below.
  2. 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.
20.6.7.3 Any refund will reflect amortization over 36 months

If Supplier proceeds under Plan C in Clause 20.6.7.2,

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.

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20.6.8 EXCLUSIVE WARRANTY & REMEDIES

Unless the Contract expressly states otherwise — specifically mentioning and overriding the Infringement Warranty:

  1. This Clause 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 Clause 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.

20.6.9 Additional commentary: Patent infringement basics

20.6.9.1 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.

20.6.9.2 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.
20.6.9.3 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.)
20.6.9.4 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.
20.6.9.5 "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.

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20.7 Implied Warranty Disclaimer

20.7.1 Each party is a "disclaiming party"

The Contract may clearly states otherwise.

20.7.2 Express warranties are not affected

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

  • that are clearly stated in the Contract.
Commentary

This exclusion of express warranties from the disclaimer is just a reminder to reassure contract reviewers who might be unsettled by the breadth of the implied-warranty disclaimer. (The author has seen that happen on more than one occasion.)

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20.7.3 This implied-warranty disclaimer is broad

  1. 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."
  2. 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.
  3. No party will assert that the disclaiming party is liable for breach of any implied factual commitment of a type listed in this section.
Commentary

Subdivision a: 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. In one UK case, an oil seller failed to do so and learned that its disclaimer of implied warranties didn't preclude liability for implied conditions, which were not disclaimed.

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20.7.4 Examples are listed here

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.

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20.7.5 Discussion topics

20.7.5.1 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?

21 Indemnity and defense

21.1 Indemnity Protocol

Commentary

Indemnity- and defense obligations in contracts can become especially important if a catastrophic event occurs, such as an oil-well blowout — and if the relevant contract has been assigned, things can get even more … interesting.

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21.1.1 Definitions: Indemnify; hold harmless; Event

The verb indemnify, and its synonym hold harmless,

  • relate to losses and/or expenses resulting
  • from one or more specified categories of event,
  • each referred to as an "Event."
Commentary

This definition reflects what seems to be a consensus by legal-writing experts: The term hold harmless is the second part of the doublet indemnify and hold harmless. "The evidence is overwhelming that indemnify and hold harmless are perfectly synonymous. The first is Latinate, the second Anglo-Saxon. And it would be possible to multiply 20th- and 21st-century authorities to this effect."

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21.1.2 Indemnity obligations are "strict liability" for reimbursement

  1. If a party ("Payer") is required, by the Contract or by law,
    • to indemnify another party ("Beneficiary") upon the occurrence of an Event,
    • then if the Event were to occur,
    • Payer must promptly pay, or reimburse Beneficiary for,
      • any foreseeable loss or expense
      • that Beneficiary incurs as a result of the Event,
    • upon written request from Beneficiary,
    • unless the Contract clearly provides otherwise.
  2. In case of doubt, Beneficiary need not prove that Payer was negligent, or otherwise at fault,
    • to be entitled to have Payer pay for Beneficiary's losses and/or expenses from the Event,
    • unless the indemnity obligation itself, by its clear terms,
    • extends only to Payer's negligence or other fault.
Commentary

For citations of cases holding that a Beneficiary need not prove that the indemnifying party was liable, see the Montana supreme court's A.M. Welles, Inc. opinion.

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21.1.3 Whether to get indemnity insurance is up to Payer

It is up to Payer's sole discretion (as defined in Clause 25.19) to decide whether to carry insurance to cover Payer's indemnity obligation(s) under the Contract

  • unless the Contract clearly specifies otherwise.

21.1.4 Indemnity payments must be made promptly

  1. Payer must pay or reimburse Beneficiary for covered losses and expenses as stated in this section.
  2. If Beneficiary has not already paid for a covered loss or expense itself,
    • then Payer must reimburse Beneficiary for the loss, or pay the expense,
    • promptly after Beneficiary presents Payer with a written request for payment or reimbursement.
  3. If Beneficiary has already paid for a covered loss or expense itself,
    • then Payer must reimburse Beneficiary for the payment in the same manner as stated in subdivision b.
  4. In either case, Payer may require Beneficiary to provide Payer with reasonable supporting evidence of the loss or expense.

21.1.5 Beneficiary's own indemnity obligations are not covered

In case of doubt, Payer need not indemnify Beneficiary against any claim, loss, or expense

  • that arises only because Beneficiary is contractually obligated
  • to indemnify and/or defend a third party.
Commentary

This section is inspired by the contract in suit in a Fifth Circuit case.

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21.1.6 Beneficiary's consequential damages are not covered

Payer need not indemnify the Beneficiary for consequential damages (as defined in Clause 22.2) arising from or relating to the Event

  • unless the Contract expressly specifies otherwise.
Commentary

This exclusion is designed to avoid positioning a reimbursing party as an insurer for another party's unusual losses, etc., unless the parties have affirmatively specified otherwise.

By way of background, in Anglo-American jurisprudence:

  • Damages for breach of contract are generally limited to those that are not only foreseeable, but within the contemplation of both parties as possibly occurring within the usual course. See generally the definition of consequential damages and its commentary.
  • If a party A breaches a contract and causes B to incur damages, B generally must make reasonable effort to mitigate the damages.

But liability for indemnity might not be subject to such limitations, nor to a duty to mitigate (although the case law is unclear on this point).

See also the commentary to § 21.1.6 (exclusion of liability for consequential damages).

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21.1.7 Damages that could have been avoided are not covered

Payer will not be liable for indemnity to Beneficiary,

21.1.8 The "express negligence rule" applies

Payer need not indemnify Beneficiary for losses and/or expenses that result from the Beneficiary's own negligence or gross negligence, unless:

  • the Contract expressly and conspicuously so states; and
  • applicable law does not prohibit that kind of indemnity obligation.
Commentary

This exclusion adopts the express-negligence doctrine that applies in some states such as California and Texas.

Caution: In some places, an indemnity obligation (other than in an insurance policy) might be unenforceable to the extent it purports to protect a party from its own negligence.

See also the commentary on conspicuousness in § 26.2.

NOTE: In Texas, advance releases of negligent conduct must also be both express and conspicuous: "[W]e hold that the fair notice requirements of conspicuousness and the express negligence doctrine apply to both indemnity agreements and to releases in the circumstances before us …."

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21.1.9 Beneficiary's willful misconduct is not covered

Payer need not indemnify Beneficiary for losses or expenses that result from willful misconduct (as defined in Clause 25.52) by Beneficiary

Commentary

This exclusion would probably be the law in most U.S. jurisdictions, on the basis that allowing a party to shuck off liability for its own willful misconduct would create "moral hazard" and be against public policy.

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21.1.10 Indemnity liability is otherwise presumptively unlimited

  1. Payer's liability to Beneficiary for indemnifiable losses and expenses resulting from an Event
    • is not limited unless the Contract clearly states otherwise.
  2. A general damages cap in the Contract does not count for purposes of subdivision a,
    • unless that cap expressly limits liability for indemnity specifically.

21.1.11 Beneficiary's own claims are covered unless clearly stated

Payer's indemnity obligations to Beneficiary are not limited to third-party claims against Beneficiary,

  • but instead extend as well to Beneficiary's own claims against Payer,
  • unless the particular indemnity- or defense language clearly specifies otherwise.
Commentary

This section is intended to "write around" a split in the case law as to whether an indemnity obligation must be "unmistakably clear" that it does or does not cover claims between the parties themselves.

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21.1.12 Exercises and questions

21.1.12.1 Exercise: Atari indemnification provision

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

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

(Emphasis added.)

QUESTIONS:

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

Discuss these from your perspective as MathWhiz's counsel — but keep in mind what Gigunda's reaction might be (because MathWhiz wants to get to signature).

  1. "Beneficiary must request Payer to defend an applicable claim in writing on or before 10 days after Beneficiary learns, by any means, of the claim. If the Beneficiary fails to follow this provision, then Payer is released from their [sic] indemnity obligation." (Emphasis added.) QUESTION: What might Beneficiary propose as a counteroffer?
  2. "The Payer will maintain indemnity insurance in the amount of $1,000,000." QUESTION: What exactly is "indemnity insurance"? (Is there even such a thing?)
  3. "Provider agrees to indemnify, defend, and hold harmless Customer and its directors, officers, agents, and employees from and against any and all losses, settlements, damages, judgments, expenses and costs (including reasonable attorneys’ fees and court costs) resulting from any third-party claim, action or suit arising from Customer’s performance of the services in accordance with this Agreement …." QUESTION: Does this cover damage done to Customer by Provider's errors in performing services?
  4. "In cases of a breach of a warranty listed in Article 4, the Payer is obligated to reimburse the Beneficiary for direct losses and expenses that occur. The Payer must pay the Beneficiary for covered losses and expenses as follows: …."
  5. "a. Each party agrees to indemnify, defend, and hold harmless the other party from and against any loss, cost, or damage of any kind to the extent arising out of its breach of this Agreement, and/or its negligence or willful misconduct. [¶] b. Each party agrees to indemnity [sic], defend, and hold harmless up to the amount of the applicable insurance policy. If the party does not have an insurance policy, the party agrees to indemnity the other party for the full amount of any loss, cost, or damage." QUESTION: Does subdivision b limit the obligation of subdivision a?
  6. "The Provider shall be liable hereunder only for its own gross negligence, willful misconduct or bad faith. The Company agrees to indemnify the Provider and save it harmless against any and all liabilities, including judgments, costs and reasonable counsel fees, for anything done or omitted by the Provider in the execution of this Agreement, except as a result of the Provider's gross negligence, willful misconduct or bad faith." QUESTION: How might the Company respond to this clause if it were proposed by the Provider?
  7. "The Company’s pay-for obligations are not limited to third-party claims against the Provider, and do not exclude the Provider’s own claims against the Company." QUESTION: How might Gigunda — which presumably has greater power than MathWhiz — respond to this clause if MathWhiz were to propose it?
  8. "If Payor chooses to take control of Beneficiary’s defense, they [sic] may not relinquish control of the defense without written consent of Beneficiary." COMMENT: While choice-of-pronouns is "a thing" in some settings, you probably don't want to go there in a contract.
  9. "Company may retain its own counsel to defend or assist in defending any claim, action or proceeding involving potential liability of $5,000,000 or more, and Contractor shall pay the reasonable fees and disbursement of such counsel." DISCUSS.
  10. "It is expressly understood that Company shall not have any obligation to defend, indemnify and hold harmless Contractor or its Agents with respect to any Contractor Indemnified Claims except to the extent that the aggregate Indemnified Claims exceed $1,000,000.00. Company will not have any such indemnity and hold harmless obligation for the first $1,000,000.00 of the aggregate Indemnified Claims." QUESTION: What's the legal-jargon term for this kind of provision?
  11. "§ 7.2 The aggregate liability of each Party arising out of this Agreement will not exceed $100.000." QUESTION: Is this a limitation on just the indemnity obligation, or on all liability?
  12. "5.1 To the fullest extent of any applicable laws, Gigunda will pay for, defend, and hold harmless Math-Whiz, its officers, employees, agents, representatives, and contractors from and against any and all loss, costs, penalties, fines, damages, claims, expenses (including attorney’s fees) or liabilities arising out of, resulting from, or in connection with the services of this Agreement, notwithstanding subsection 5.1 through 5.5." QUESTION 1: How broad is this obligation? QUESTION 2: What effect does the "notwithstanding …" language have?
  13. "7.2 Buyer will indemnify and hold harmless the Seller, its officers, directors, employees, shareholders, agents, representatives and other advisors (“Seller Indemnitees”) against all actions, proceedings, claims or demands made by any third party for losses, costs, damages and expenses which may be brought against or suffered by the Seller or which it may sustain, pay or incur by reason of anything arising out of or in any way attributable to the Services carried on or to be carried on by the Seller Indemnitees, except when and to the extent that losses, costs, damages or expenses are a result of the gross negligence or willful misconduct of the Seller Indemnitees. QUESTION: How broad is this?
  14. From the same student as the preceding paragraph: "7.3 Buyer will defend and indemnify Seller Indemnitees against any claim or action brought by a third party against Seller Indemnitees, alleging that Services infringes [sic] a patent, copyright, trademark, trade secret, trade name, trade dress, mask work or other intellectual property right."
  15. The student in the previous two paragraphs put a border around the entire Indemnities § 7. DISCUSS.
  16. "Service Provider will indemnify, defend, and hold harmless the client and its officers, directors, employees, agents, and representatives, and their respective successors and assigns (“Service Provider Recipient Indemnitees”) in connection with any (i) losses, (ii) claims, (iii) damages, and (iv) liabilities and expenses, including reasonable attorneys’ fees incurred by Client as a result of any act or omission by the Service Provider in connection with the performance of the services contemplated by the Agreement." DISCUSS.
  17. "[Indemnity obligation for monetary awards] in a final judgment arising out of or resulting from any third-party claim, suit, action, or proceeding arising out of or resulting from: (a) bodily injury, death of any person, or damage to real or tangible, personal property resulting from the willful, fraudulent, or negligent acts or omissions of Service Provider or Service Provider Personnel; and (b) Service Provider’s material breach of any representation, warranty, or obligation of Service Provider set forth in this Agreement."
  18. "Both Gigunda and Math-Whiz will be indemnified against Errors and Omissions done by the other party." DISCUSS.
  19. "(e) Gigunda will indemnified against any employee claims"
  20. "(f) Gigunda will indemnify Math-Whiz at a cap of $1,000,000"
  21. "Both parties will ensure insurance coverage is available in the event of dispute."
  22. "If any of the parties got sued by a third party, the payer will pay for the defense."
  23. "The Payer will reimburse the Beneficiary in net 30 days …."
  24. "Each party indemnifies the other against …."
  25. "… arising out of a party’s breach of its obligations, representations, warranties, or covenants under this Agreement."
  26. "[The protected party must] deliver to the indemnifying party all documents reasonably necessary to indemnify the proceeding."
  27. "… already payed for …."
  28. "An indemnifying party’s obligations are limited to the amount covered by its insurance policy."
  29. "If either Party’s representation(s) under this agreement are defective, inaccurate, or false, that party will defend the other party against any and all claims (subject to exclusions set forth below) and assume all costs and liabilities for the injury."
  30. "Percentages of fault will be determined by agreement of the parties. Should an agreement fail, a neutral mediator will make the decision."
21.1.12.3 Topics for group discussion: Indemnities
  1. What exactly does an indemnity obligation commit a party to actually do?
  2. True or false: The following is an acceptable conventional phrasing: Alice hereby indemnifies Bob against any damage Bob might incur if it rains tomorrow.
  3. Are indemnity obligations limited to third-party claims, as opposed to first-party claims?
  4. Is a "hold harmless" obligation any different?
  5. How does an indemnity relate to a warranty?
  6. True or false: IF: Alice agrees to indemnify Bob against damage arising from occurrence of Event X; THEN: This reduces the risk to the parties associated with the (possible) occurrence of Event X.
  7. Must a protected party prove negligence or other fault by the indemnifying party?
  8. FACTS: A. Big company ABC is hiring small company XYZ to do some work in Alice's factory. B . Alice’s draft of the contract requires XYZ to indemnify ABC for any harm that might occur to any of XYZ's employees while at ABC's factory. FILL IN THE BLANK: ABC should also consider inserting a provision requiring XYZ to enter into and maintain this type of ancillary contract to make sure there is a pot of money available if necessary to support XYZ's indemnity obligation.
  9. Does an indemnity obligation extend to the protected party’s own negligence?
  10. Do indemnity obligations extend beyond foreseeable, ordinary-course losses (etc.)?
  11. Will a contractual indemnity be excluded from the indemnifying party's insurance coverage?
  12. Is an indemnity obligation even a good idea?
  13. Should consequential damages, etc., be indemnified?
  14. Must an indemnifying party carry insurance to cover the indemnity?
  15. Can liability for an indemnity obligation be limited?
  16. Must an indemnifying party provide a defense against third-party claims?
  17. How can a protected party invoke a defense obligation?
  18. What if the protected party doesn't timely ask for defense?
  19. What must an indemnifying party do to defend against a claim?
  20. How much must an indemnifying party do to defend against a claim?
  21. What if a protected person never asks for a claim defense?
  22. What must a protected person do in its own defense?
  23. Who pays for a protected person's cooperation in a claim defense?
  24. Should an indemnifying party allow the protected party to conduct its own defense?
  25. May a protected person engage its own counsel?
  26. When may a protected person take over control of its defense?
  27. Who should call the shots in settlement talks?
  28. Can an indemnifying party agree to a consent judgment?
  29. What may a protected party admit or waive in the case?
  30. May a protected person settle a defended claim?
  31. Can liability for a defense obligation be limited?

21.2 Hold Harmless Definition

Hold harmless has the same meaning as indemnify.

Commentary

The above definition reflects what seems to be a consensus by legal writing experts. Some courts have held otherwise — treating hold harmless as amounting to an advance waiver, release, or exculpation, of stated claims against the person held harmless — but famed lexicographer Bryan Garner marshals an impressive body of evidence that indemnify and hold harmless should be treated as synonyms, asserting that the former is Latinate in origin, while the latter is the English counterpart. (This, even though courts ordinarily construe contracts so as to give effect to each provision.)

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21.3 Third-Party Beneficiary Disclaimer

The parties do not intend for the Contract to create any right or benefit for any party except themselves,

  • except to the extent — if any — that the Contract clearly states otherwise.
Commentary

See generally, e.g., Third-Party Beneficiary (Wikipedia.org).

A 2016 lawsuit is fairly typical of the genre:

  • A manufacturer of industrial lubricants and additives, together with one of the manufacturer's distributors, jointly persuaded a business customer, a manufacturer of tow boats, to buy the additive manufacturer's products from the distributor.
  • At some point, the additive manufacturer fired the distributor because the manufacturer suspected that the distributor had engaged in unethical conduct.
  • The additive manufacturer didn't notify the tow-boat manufacturer that it had fired the distributor.
  • The distributor, now unable to procure the manufacturer's products for the tow-boat manufacturer, substituted an allegedly-inferior product from another company.
  • The tow-boat manufacturer sued the distributor and, probably hoping for a larger judgment, also sued the additive manufacturer — in part on a third-party beneficiary theory.

In an opinion by Judge Posner, the Seventh Circuit affirmed summary judgment in favor of the additive manufacturer, holding that the tow-boat manufacturer was not a third-party beneficiary of the contract between the additive manufacturer and the distributor:

Although as the ultimate consumer ACL could expect to benefit from Lubrizol’s sale of the additive to its distributor, that expectation did not make ACL a third‐party beneficiary of the contract between VCS and Lubrizol. More was re‐ quired. Otherwise a consumer would be a third‐party beneficiary of any sales contract between a supplier of a good and a distributor of the good to the consumer.

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21.4 Defense Protocol for Third-Party Claims

Commentary

Indemnity- and defense obligations in contracts can become especially important if a catastrophic event occurs, such as an oil-well blowout — and if the relevant contract has been assigned, things can get even more … interesting.

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21.4.1 Beneficiary must timely alert Defender to the claim

  1. Beneficiary must advise Defender, in writing, of the claim,
    • on or before ten business days after Beneficiary first learns, by any means, of the claim.
  2. If Beneficiary is late in advising Defender of a claim, then:
    • Defender need not reimburse Beneficiary against any harm resulting from the delay in notification,
    • but Defender must still provide Beneficiary with a defense against the claim.
Commentary

In some, harsh indemnity- and defense provisions — in some insurance policies, for example — Beneficiary loses any right to defense or indemnity if Beneficiary does not advise Defender of the claim within a specified time period. This section takes a more-balanced approach.

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21.4.2 A competent defense is required, at Defender's cost

  1. Defender must provide Beneficiary with a timely, competent, diligent defense against the claim,
    • by suitably-experienced and reputable defense counsel
    • reasonably acceptable to Beneficiary.
  2. Defender must pay for all fees and expenses charged by the defense counsel whom Defender engages to defend Beneficiary against the claim.
Commentary

This section's substantive standards are really no more than the general requirements of legal-ethics rules for lawyers. The "suitably-experienced and reputable defense counsel" language is necessarily vague, but it should serve as a warning that, say, a traffic-ticket lawyer would not necessarily be a sound choice to defend against, say, a bet-the-product-line patent infringement claim.

The "reputable" requirement for defense counsel recognizes that when you propose a specific choice of defense counsel, Beneficiary might not have any way of assessing whether the proposed defense counsel actually know what they're doing; the requirement that the defense counsel be reputable is intended to give Beneficiary some assurance on that point.

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21.4.3 Defender is to control the defense

For as long as you are providing the Beneficiary with a defense against the claim in accordance with this Clause, you are entitled to control the defense — albeit with some exceptions as stated below.

Commentary

If Defender fails to "step up" to provide Beneficiary with a defense against the claim, then Beneficiary should be able to control the Beneficiary's own defense.

But if Defender does provide a defense, then Defender should be able to control the defense — otherwise, the Beneficiary-hired counsel will know it will be Defender, not Beneficiary, that will eventually be paying the bills. That could tempt Beneficiary's counsel to put on an expensive, gold-plated defense that it might not have done otherwise.

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21.4.4 Defender must pay any resulting monetary award

If any monetary award is entered against Beneficiary,

  • in a final judgment from which no further appeal is possible,
  • then Defender must pay that monetary award.

21.4.5 Defender may defend even if defense not desired

  1. This section applies if Beneficiary does not ask Defender to defend against the claim,
    • and even if Beneficiary does not want a defense against the claim.
  2. Defender may elect, in Defender's sole discretion (as defined in Clause 25.19), to defend Beneficiary against a claim anyway,
    • under the same terms as if Beneficiary had asked for such a defense.
  3. Defender need not reimburse Beneficiary for losses or expenses, of any kind, arising from or relating to the claim,
    • even if Defender does elect to defend Beneficiary against the claim,
    • and even if the Contract would have otherwise required reimbursement.
Commentary

Defender might find it desirable to defend Beneficiary against a claim even if Beneficiary itself is uninterested in the claim or its result. For example:

  • Suppose that a third party sues Customer for using Supplier's products, on grounds that the products supposedly infringe the third party's patent rights.
  • In that case, Supplier might want to defend the claim, even if Customer doesn't care, because a judgment in favor of the third party might have adverse consequences for Supplier.

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21.4.6 Beneficiary must provide reasonable cooperation, at Defender's expense

  1. Beneficiary must provide Defender and Defender's counsel with reasonable cooperation in defending against the claim;
    • such cooperation must include, without limitation,
    • providing Defender and/or Defender's counsel with all information reasonably requested for the defense.
  2. Beneficiary's cooperation obligation under this section applies whether or not Beneficiary asked for a defense against the claim.
  3. Defender must pay directly, or reimburse Beneficiary for,
    • all reasonable, out-of-pocket expenses that Beneficiary pays to third parties  —
    • specifically not including, without limitation, any compensation to Beneficiary's own employees —
    • in providing the required cooperation,
    • if Beneficiary so requests in writing;
    • Defender may require Beneficiary to provide Defender with reasonable supporting documentation for such expenses.
Commentary

The "reasonably request" language allows some flexibility, which might be appropriate if requested information is subject to, e.g., the attorney-client privilege and the Beneficiary has other reasons for not risking waiver of the privilege by providing the information to Defender's counsel.

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21.4.7 Beneficiary may use monitoring counsel

  1. Beneficiary may engage separate counsel to monitor the defense,
    • at Beneficiary's own expense and risk.
  2. Defender and Beneficiary must each instruct their respective counsel
    • to provide reasonable cooperation with each other in the defense.
Commentary

In many cases where Defender must defend Beneficiary, Defender is likely to want to have its own regular legal counsel be the ones to represent Beneficiary and run the defense.

But Beneficiary might reasonably want Beneficiary's own counsel to keep an eye on what Defender's lawyers are doing — even though, under legal ethics in the U.S. (and probably in other jurisdictions as well), an attorney's loyalty is to the client, not to a third party that's paying the bills, meaning that Defender's regular legal counsel will owe loyalty to Beneficiary.

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21.4.8 When may Beneficiary assume control of the defense?

  1. If reasonable minds could conclude that Defender's counsel had a conflict of interest,
    • and under applicable ethics rules, that conflict would preclude Defender's counsel from representing Beneficiary in the defense against the claim,
    • then Beneficiary may, in its sole discretion (as defined in Clause 25.19):
      • assume control of the defense; and
      • and engage separate counsel for the defense.
  2. Defender must reimburse Beneficiary for any reasonable attorney fees (as defined in Clause 23.3) that Beneficiary incurs in conducting the defense
    • if Beneficiary assumes control of the defense under subdivision a.
Commentary

Subdivision a is based on standard legal-ethics rules: A lawyer for Party A probably cannot also represent Party B in the same matter if the two parties have conflicting interests.

The language, "If reasonable minds could conclude" (emphasis added) is intended to make sure that close calls go in favor of separate counsel.

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21.4.9 Beneficiary's admissions and waivers are restricted

  1. Whenever Defender is entitled to control Beneficiary's defense,
    • Beneficiary must not make any non-factual admission or stipulation concerning the claim —
    • for example, an admission that a third party's patent was valid and enforceable —
    • and Beneficiary must not waive any defense against the claim,
    • without Defender's prior written consent.
  2. If Beneficiary does anything prohibited by subdivision a,
    • then Defender will have no further obligation to Beneficiary,
    • in respect of the claim,
    • by way of either defense or reimbursement.
Commentary

Admissions and stipulations to factual matters can greatly streamline litigation (and arbitration). Factual admissions should be made as required. EXAMPLE: Suppose that a claimant asked the Beneficiary to admit that, in calendar year 20XX, the Beneficiary sold Y units of the Beneficiary's Model ABC widget; if that were true, then it would make sense for the Beneficiary to simply make the admission.

But if the Beneficiary were to admit, let's say, that the claimant's patent claims were valid and infringed, then that could seriously screw up Defender's defense of the Beneficiary.

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21.4.10 Defender will control settlement when providing a defense

Defender may settle the claim against Beneficiary,

  • at any time that Defender is providing a defense as required by the Contract,
  • but Defender's right to control the settlement is limited by § 21.4.11.
Commentary

This control-of-settlement provision is a detailed example of a type of clause that is often found in reimbursement- and defense obligations.

As a particular example, some categories of insurance contract give the insurance carrier essentially complete control over the settlement of third-party claims. That could cause problems for the protected person if the insurance carrier were to settle a claim but then try to recoup the settlement amount from the protected person. This could happen, for example, if a contractor's surety-bond carrier decided to settle a claim and then sued the contractor to recoup the settlement payment.

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21.4.11 Defender's settlement authority is restricted

Unless Beneficiary gives its prior written consent,

  • Defender may not settle the claim, and Beneficiary will not be bound by any purported settlement,
  • if the settlement would include any of the following:
  1. restrict or place conditions on the Beneficiary's otherwise-lawful activities;
  2. or require Beneficiary to take any action,
    • other than making one or more payments of money to one or more third parties,
    • where Defender fully funds each such payment in advance,
    • with no recourse against Beneficiary;
  3. or encumber any of Beneficiary's assets;
  4. or include or require any admission or public statement by Beneficiary;
  5. or call for the entry of a consent judgment inconsistent with any of subdivisions 1 through 4 above;
  6. or not include a complete, unconditional release of Beneficiary and its Protected Group from all Claims.

21.4.13 May Beneficiary settle on its own?

Yes, but: If Defender is defending the against the claim as provided in this Clause,

  • and Beneficiary settles with the claimant without Defender's prior written
  • then Beneficiary will be deemed to have released Defender from any further defense- or reimbursement obligation as to the claim,
  • unless Defender unreasonably withheld consent to the Beneficiary's settlement,
  • in which case Defender's defense- and reimbursement obligations will remain in place.

21.4.14 An indemnity obligation includes claim defense

If the Contract requires Defender to indemnify Beneficiary for losses and expenses resulting from specified third-party claims,

  • but The Contract is silent about whether Defender must defend Beneficiary against such claims,
  • then Defender must provide Beneficiary with a defense against any such claim,
  • as provided in this Clause.
Commentary

If a contract requires A to indemnify B against a third-party claim, then the law, especially in California, might require A also to defend B against the claim — even if the agreement didn't expressly include such a requirement.

But A's duty to defend B might not apply if A "can conclusively show by undisputed facts that plaintiff's action is not covered by the agreement."

On the other hand, as Dentons partner Stafford Matthews pointed out in a 2014 LinkedIn discussion thread (membership required): "Under the common law of most states, including New York and Illinois for example, an indemnitor generally has no duty to defend unless the contract specifically requires such defense. See, e.g., Bellefleur v. Newark Beth Israel Med. Ctr., 66 A.D.3d 807, 809 (N.Y. App. Div. 2d Dep't 2009); CSX Transp. v. Chicago & N. W. Transp. Co., 62 F.3d 185, 191-192 (7th Cir. 1995)." (Emphasis added;. Matthews was responding to one of the present author's comments.)

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21.4.15 Indemnity terms apply to defense obligations

Defender's obligations under this Clause

  • are to be considered a type of indemnity obligation under Clause 21.1 (Indemnity Protocol),
  • meaning (without limitation) that the exclusions and limitations of that provision
  • will apply equally to this Clause.

22 Limitations of liability

22.1 Limitations of Liability Usage

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when if the Contract limits the liability of one or more parties,

  • including without limitation by one or more of the following:
  1. a disclaimer of one or more warranties; and/or
  2. an exclusion of, and/or a cap on, one or more forms of monetary relief,

Discussion checklist:

22.1.1 What types of claim are subject to liability limitations?

Each limitation of liability set forth in the Contract is to apply to all claims for damages or other monetary relief,

  • whether alleged to arise:
    • in contract;
    • tort — including, without limitation, negligence, gross negligence, and/or willful misconduct;
    • or otherwise.

22.1.2 But what if all of the Contract's stated remedies fail?

Even if the Contract says that a harmed party is entitled only to certain specific types of remedy,

  • and perhaps even to just one type of remedy,
  • but those remedies did not solve the problem —
    • in legalese, those remedies "failed of their essential purpose" —
  • then any limitation(s) of liability in the Contract will remain in effect nonetheless.
Commentary

This section simply states how the law applies in many — but not all — U.S. jurisdictions.

To illustrate the point with a made-up example, suppose that a customer signs a purchase agreement calling for the customer to buy a car from a dealer, and —

  • Under the purchase agreement, the customer's only recourse, if the car has a problem while it's still under warranty, is for the dealer to fix the problem. (This is known as an "exclusive remedy.")
  • The purchase agreement also says that the dealer will not be liable for consequential damages (as defined in Clause 22.2).
  • The customer's specific car has a problem that the dealer is simply unable to fix.

Result: In that situation, the agreement's exclusive remedy is said to have failed — but under this Clause, the purchase agreement's exclusion of consequential damages will remain in effect anyway.

Caution: In some states, this won't be the case; for example, in a Minnesota federal-court case:

  • A contract for installation of complicated computer software went badly awry.
  • The contract said that the vendor would not be liable for consequential damages in case of breach.
  • The customer sued the vendor; it sought consequential damages despite the contract's exclusion.
  • The vendor moved to dismiss the claim for consequential damages.
  • The trial court found that the customer had adequately pleaded that the contract's exclusive remedies had failed of their esssential purpose, and so the court denied the motion to dismiss the claim for consequential damages.

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22.1.3 But what if the liable party was clearly at fault?

A limitation of liability in the Contract will apply

  • even if the harm resulting in the liability was clearly the fault of the liable party,
  • for example because the liable party:
    • failed to perform its obligations; or
    • was negligent or even grossly negligent.
Commentary

This section is inspired by a partial failure of a limitation of liability in Facebook's terms of service: A court described that limitation as a "showstopper" for a user's claims that Facebook had breached a contract following a data breach, but the limitation did not apply as to the user's claims for negligence because the limitation did not even mention negligence, "let alone unequivocally preclude liability for negligence."

Incidentally, the court (Judge Alsup) noted that:

An agreement which seeks to limit generally without mentioning negligence is construed to shield a party only for passive negligence, not for active negligence.

Whereas passive negligence involves mere nonfeasance, such as the failure to discover a dangerous condition or to perform a duty imposed by law,

active negligence involves an affirmative act, knowledge of or acquiescence in negligent conduct, or failure to perform specific duties.

In other words, Facebook's mere failure to discover the vulnerability might be barred by the clause, but if it had acquiesced to, or known of the vulnerability, the [negligence] claim would certainly be allowed through.

The terms negligence and gross negligence are in bold to make them conspicuous, in case the express-negligence rule in Texas and some other jurisdictions were to be held to apply.

(Concerning the express-negligence rule, see the commentary to § 21.1.8.)

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22.1.4 But what if the liable party knew of a special vulnerability?

A limitation of liability in the Contract will apply,

  • even if the liable party and/or its agents knew (or had reason to know),
    • at any time,
  • that the harmed party had some special, out-of-the-ordinary vulnerability to being harmed.
Commentary

This section is a shout-out to the English court decision in Hadley v. Baxendale, discussed in Clause 22.2.3.

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22.1.5 What if a liability limitation is legally unenforceable?

A limitation of liability in the Contract will not apply if,

  • and only to the extent that,
  • under applicable law the limitation would be unenforceable in the circumstances.
Commentary

As one example: The law might provide that a limitation of liability is unenforceable when it comes to personal injury or death.

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22.1.6 Why are the parties agreeing to limit liability?

The limitation(s) of liability in the Contract are a fundamental part of the basis of the bargain between the parties;

  • without such limitations, one or more parties would not have entered into the Contract
  • on the economic terms stated in it.
Commentary

Drafters can be well-served by explaining, in the contract itself, why the parties are agreeing to limit liability. Such a payoff occurred for a defendant in a case where the contract in suit excluded recovery of lost profits but the jury awarded lost profits anyway. Vacating and remanding, the appeals court took specific note of a clause in the contract that said the following:

8.4 Effect of Limitation. The parties acknowledge that the limitations [of liability] set forth in this Section are integral to the amount of fees specified within this Agreement, and recognize that were Jeppesen to assume any further liability beyond that set forth herein, such fees could be substantially higher.

In a subsequent appeal after remaind, the Tenth Circuit explained:

Under Colorado law, sophisticated parties allocate risk for themselves. [It is a] fundamental principle of contract law that parties must be able to confidently allocate risks and costs during their bargaining without fear that unanticipated liability may arise in the future. This is precisely what SOLIDFX did when negotiating its License Agreement with Jeppesen, albeit to its eventual detriment.

SOLIDFX acceded to the risk of agreeing to the damages limitation, and in return it received the sizeable benefit of Jeppesen waiving its licensing fee.

Both parties agreed to bear the risk of lost profits and forego other damages.

As a general rule, courts will uphold an exculpatory provision in a contract between two established and sophisticated business entities that have negotiated their agreement at arm’s length.

This court further noted in SOLIDFX I that the parties’ bargain would not have left SOLIDFX without a remedy. …

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22.2 Consequential Damages Exclusion

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract excludes or otherwise limits "consequential damages" (which are defined in this Clause).

Discussion checklist:

Commentary

See the extended commentary at § 22.2.3.

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22.2.1 Who is protected by this Clause?

No member of any party's Protected Group (as defined in Clause 25.40) (each, a "Protected Party")

  • will be liable for consequential damages, defined below,
  • even if the Protected Party was in fact advised, or had other reason to know or foresee, of the possibility or even the high probability of such damages,
  • and regardless of the label given to the conseqential damages such as, for example (as defined in Clause 25.23), "special damages,"
  • except as otherwise provided in this Clause or as otherwise agreed in writing.

22.2.2 Definition: What are "consequential damages"?

The term consequential damages refers to (what could be thought of as) "uncommon" harm arising from a breach of the Contract or other cause, namely:

  • the harm was not of a type:
    • that reasonable people,
    • in the relevant business,
    • would have expected to occur,
    • in the usual course of things,
    • as a result of the breach or other cause;
  • but under the particular circumstances,
    • at the time that the liable party entered into the Contract,
    • the liable party nevertheless should have foreseen the possibility of such harm,
    • because, for example (as defined in Clause 25.23), the liable party was specifically advised of the possibility of such harm.
Commentary

Some drafters might want to list specific types of damages that are not recoverable; see § 22.2.3.4 for a list compiled from various sources.

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22.2.3 Additional commentary

22.2.3.1 How are consequential damages different from general damages?

The definition of consequential damages in Clause 22.2 (Consequential Damages Exclusion) is based on:

  • the landmark English case of Hadley v. Baxendale (the "corn mill crankshaft case") and its progeny;
  • the Restatement of Contracts (Second); and
  • the Uniform Commercial Code.

The difference between consequential damages and "general" damages can sometimes be unclear. The commentary to the Restatement (Second) of Contracts contrasts the two terms. On the one hand are general damages:

Loss that results from a breach in the ordinary course of events is foreseeable as the probable result of the breach. Such loss is sometimes said to be the "natural" result of the breach, in the sense that its occurrence accords with the common experience of ordinary persons. … The damages recoverable for such loss that results in the ordinary course of events are sometimes called "general" damages.

On the other hand are consequential damages, i.e., uncommon damages:

If loss results other than in the ordinary course of events, there can be no recovery for it unless it was foreseeable by the party in breach because of special circumstances that he had reason to know when he made the contract. … The damages recoverable for loss that results other than in the ordinary course of events are sometimes called "special" or "consequential" damages.

These terms are often misleading, however, and it is not necessary to distinguish between "general" and "special" or "consequential" damages for the purpose of the rule stated in this Section.

The above-quoted Restatement excerpt exemplifies what seems to be a modern trend of collapsing the traditional two-prong formulation of Hadley v. Baxendale into a single test: Should the claimed damages have been foreseen by the breaching party. Under that test, a way for the non-breaching party to establish that its particular damages were foreseeable by the breaching party is for the non-breaching party to clearly inform the breaching party, at the time the breaching party became bound by the obligation, of the non-breaching party's particular requirements or circumstances.

In the Uniform Commercial Code, section 2-715(2) defines consequential damages as follows:

Consequential damages resulting from the seller's breach include[:] (a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise ….

(Emphasis added.)

The UK court of appeals phrased the foreseeability test more plainly: "In essence, D is liable for damage resulting from his breach if, at the time of making the contract, a reasonable person in D's position would have had damage of that kind in mind as not unlikely to result from a breach[.]"

A different and arguably-stricter approach has been taken by the Supreme Court of Texas, which observed that:

Direct damages are the necessary and usual result of the defendant's wrongful act; they flow naturally and necessarily from the wrong…. Consequential damages, on the other hand, result naturally, but not necessarily.

22.2.3.2 Consequential damages can be big

Noted practitioner-commentator Glenn D. West observes:

In 1984, an Atlantic City casino entered into a contract with a construction manager respecting the casino’s renovation. The construction manager was to be paid a $600,000 fee for its construction management services. In breach of the agreement, completion of construction was delayed by several months. As a result, the casino was unable to open on time and lost profits, ultimately determined by an arbitration panel to be in the amount of $14,500,000. There was no consequential damages waiver in the contract at issue in this case.

As another example, a Dr. Kitchen, an Australian opthmalmologist, wrongfully terminated his service agreement with an eye clinic. The service agreement did not include an exclusion of consequential damages. The Supreme Court of Queensland held him held liable for the clinic's lost profits and other amounts, in the total sum of AUD $10,845,476.

22.2.3.3 Consequential damages can be tough to identify

Classifying specific damages as consequential or direct might be very subjective exercise. See, e.g., Indiana v. IBM, where in a second trial (on remand) over a failed computer-system acquisition:

  • The trial judge held that IBM had to pay for a replacement computer system that the state acquired after IBM was fired, known as the "Hybrid" system, even though the Hybrid system was an upgrade from the system that IBM had agreed to build.
  • The trial judge held that the additional cost of the upgrade was properly classified as direct damages resulting from IBM's breach — and thus was subject to an agreed cap of $125 million — and not as consequential damages, which would have been subject to a much-lower cap of $3 million.
  • The trial judge's decision was affirmed on appeal.

Dissenting on that issue, a state supreme court judge argued that "it was not IBM's breach but the State's decision to switch to the different, more expensive Hybrid system that caused the State to incur these additional expenses. The State's additional, Hybrid-related costs are at most consequential damages, not direct damages."

22.2.3.4 Consequential damages — other specific examples

Some drafters like to enumerate specific categories of risk for which damages cannot be recovered, and cross their fingers that a court will enforce the enumeration congenially to them. The following categories have been compiled from various agreement forms but should be reviewed carefully, as some could be a bad idea:

  • breach of statutory duty;
  • business interruption;
  • loss of business or of business opportunity;
  • loss of competitive advantage;
  • loss of data;
  • loss of privacy;
  • loss of confidentiality [Editorial comment: This would normally be a really bad idea, at least from the perspective of a party disclosing confidential information.]
  • loss of goodwill;
  • loss of investment;
  • loss of product;
  • loss of production;
  • loss of profits from collateral business arrangements;
  • loss of cost savings;
  • loss of use;
  • loss of revenue.
22.2.3.5 "Lost profits" will often be direct damages, not consequential damages

The laundry list of excluded damages should not be drafted, though, so as to be overly broad for the situation. That's why the lost-profits exclusion in this clause is phrased as lost profits from collateral business arrangements. New York's highest court, reviewing case law held that, on the facts of a particular case, "lost profits were the direct and probable result of a breach of the parties' agreement and thus constitute general damages" and thus were not barred by limitation-of-liability clause.

22.2.3.6 Other definitions of consequential damages

A different definition of consequential damages, one that might possibly be more tractable in litigation, is found in North Carolina law: "Consequential or special damages for breach of contract are those claimed to result as a secondary consequence of the defendant's non-performance. They are distinguished from general damages, which are based on the value of the performance itself, not on the value of some consequence that performance may produce."

For a stricter definition than that of Hadley, see the Texas supreme court's El Paso Marketing case, where the court (quoting from an earlier opinion) said that: "Direct damages are the necessary and usual result of the defendant's wrongful act; they flow naturally and necessarily from the wrong. Consequential damages, on the other hand, result naturally, but not necessarily." This Texas test replaces Hadley's "usual course of things" with "necessary and usual."

22.2.3.7 The Fourth Circuit's lecture to negotiators

The Fourth Circuit 'splained things to customers that negotiate services contracts containing consequential-damages exclusions:

Companies faced with consequential damages limitations in contracts have two ways to protect themselves.

First, they may purchase outside insurance to cover the consequential risks of a contractual breach, and second, they may attempt to bargain for greater protection against breach from their contractual partner.

Severn apparently did take the former precaution – it has recovered over $19 million in insurance proceeds from a company whose own business involves the contractual allocation of risk.

But it did not take the latter one, and there is no inequity in our declining to rewrite its contractual bargain now.

22.2.3.8 Caution: Unconscionability?

Courts will sometimes hold that exclusions of consequential damages are "unconscionable." Indeed, UCC § 2-719(3) specifically says:

Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable.

Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not.

(Extra paragraphing added.)

Example: In a Minnesota case about a failed software-installation project, a federal court refused to give effect (at least initially) to a consequential-damages exclusion benefiting the vendor, because the court deemed the exclusion to be unconscionable.

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22.3 Damages Cap Usage

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract limits the amount of ("imposes a cap on") damages recoverable in case of a specified event.

22.3.1 Who is protected by a damages cap?

A damages cap in the Contract will limit the liability of each party to the Contract.

22.3.2 What is the effect of a damages cap?

When the Contract imposes a damages cap, it means

  • that the maximum amount recoverable in damages
  • is the amount specified in the damages cap.

(See also the "Defined terms" shorthand possibilities in Clause 22.3.6 below.)

22.3.3 How would a damages cap apply to different claims?

The damages cap limits the aggregate monetary amount recoverable,

  • including but not limited to attorney fees and ‑expenses,
  • from any and all liable parties,
  • in respect of the same claim (or group of related claims).

22.3.4 To what types of claim will a damages cap apply?

A damages cap in the Contract will apply to to all claims for:

  • damages of any kind;
  • attorney fees;
  • and other monetary recoveries;
  • that arise out of, or relate to, breach of the Contract.

22.3.5 Can different damages caps apply in different circumstances?

Yes: The Contract may provide for different damages caps for —

  • different breaches or types of breach;
  • different time periods;
    • for example (as defined in Clause 25.23), different damages caps for before and after X months after the effective date of the Contract;
  • different geographical areas;
  • and the like.

22.3.6 Defined terms: Can the Contract use damages-cap shorthand?

Yes: The following hypothetical examples are provided to illustrate the meanings of terms that could be used in the Contract:

ABC's liability for breach is capped at 2X: This means that ABC will not be liable for,

  • and no other party will seek,
  • more than two times the amount paid or payable to ABC.

ABC's liability for breach is capped at 3X on a 12-month lookback: This means that ABC will not be liable,

  • and no other party will seek,
  • more than three times the amount that ABC was paid (or was owed),
    • in the 12-month period just before the date that any claimant against ABC knew,
    • or reasonably should have known,
    • of the circumstances giving rise to the claim against ABC.

Damages cap: 2X the total contract value: This means that neither party will be liable,

  • and no other party will seek,
  • more than two times the total amount to be paid under the Contract,
  • for example (as defined in Clause 25.23), in fees for services or payment for goods.
Commentary

The shorthand terminology in this section can be used in the Contract, e.g., "3X on a 12-month lookback."

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22.4 No Individual Liability

Commentary

See the extended commentary at § 22.4.6.

The language of this Clause draws on ideas in language proposed by a noted corporate-law practitioner.

In an email exchange with the present author on August 8, 2012, Mr. West commented that "I find general acceptance of some version of my clause as long as it's mutual. Both sides of the transaction have the same general interest in protecting the integrity of the entity-specific nature of the contract; and if they don't, this clause smokes that out and there is a real discussion about guarantors."

This clause is akin to the so-called Himalaya clause, which has its origins in maritime practice.

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22.4.1 Which organizations' personnel are covered?

  1. The parties intend for this Clause to benefit each of the following "Protected Individuals,"
    • when serving in any of the following capacities,
    • for any party to the Contract (each, a "Contracting Party"),
    • and/or any affiliate (as defined in Clause 25.2) of any Contracting Party:
      • directors; officers; employees; incorporators;
      • partners; members; managers;
      • stockholders and other investors;
      • agents; attorneys; accountants;
      • representatives; financial advisors; and lenders;
      • in each case whether past, present, or future,
  2. The term Protected Individual, however, does not include
    • any individual who is expressly identified,
    • in the preamble of the Contract,
    • as being a party to the Contract.

22.4.2 What are the parties agreeing not to do?

  1. Each party agrees not to assert any Contract-Related Claim (as defined in Clause 25.15)
    • against any Protecterd individual,
    • unless the Contract expressly states otherwise.
  2. Each party that makes the agreement stated in subdivision a,
    • for itself and any individual or organization claiming through or under the party,
    • WAIVES (as defined in Clause 24.26) AND RELEASES all such Contract-Related Claims
    • this waiver and release applies, without limitation,
      • to all claims of entitlement to avoid,
        • or to disregard the entity form,
      • of a Contracting Party,
      • or otherwise to impose the liability of a Contracting Party
      • on a Protected Individual.

22.4.3 What types of claim are covered?

This Clause applies, without limitation, to claims based on theories of equity; agency; control; instrumentality; alter ego; domination; sham; single business enterprise; piercing the veil; unfairness; undercapitalization; or otherwise.

22.4.4 Is reliance on Protected Individuals' personal representations OK?

No: Unless the Contract clearly says otherwise,

  • each party KNOWINGLY DISCLAIMS, AND AGREES NOT TO ASSERT,
    • ANY RELIANCE UPON any action or omission,
      • including for example any statement or silence,
    • by any Protected Individual,
    • with respect to:
      • the performance of the Contract; or
      • any representation or warranty made in,
        • or in connection with,
        • or as an inducement to enter into,
        • the Contract.
Commentary

See the commentary to Clause 20.3 (Reliance Disclaimer).

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22.4.5 Which party's personnel are protected?

This Clause is intended to protect the personnel of each party.

22.4.6 Additional commentary

When embarking on a contract that could result in claims for big dollars being thrown around, parties might want to think about including some protection for their employees.

Consider this illustration:

  • In August 2014, the state of Oregon filed a $3 billion lawsuit against Oracle Corporation and six Oracle employees personally, in the wake of the failed attempt to develop Oregon's health-insurance exchange under the Affordable Care Act a.k.a. Obamacare.
  • The six employees included five executivies at the vice-president level and higher, as well as a technical manager who was accused of having conducted a fraudulent demo of the new system's capabilities.
  • The state is seeking "only" some $45 million from the technical manager, as well as amounts ranging from $87 million to $267 million from various Oracle executives.

In high-dollar and high-profile cases like this, plaintiffs sometimes bring claims against company employees personally. The author's guess is that the underlying reason often is to try to rattle the employees and encourage them to cooperate as witnesses against their employers (sort of like the way criminal prosecutors bring charges against low-level employees).

Against that possibility, it's not unheard-of for vendor companies to include, in their contract forms, language protecting employees from being sued in their personal capacities; Clause 22.4 (No Individual Liability) is one such effort.

High-profile lawsuits like this typically settle before trial. Not least, this is because the elected officials who bring or authorize the lawsuits would prefer to trumpet a "victory" instead of rolling the dice with the court.

But such cases don't always settle; see, for example, the state of Indiana's lawsuit against IBM for allegedly botching the building of a new system for administering the state's welfare programs; that lawsuit dragged on for nearly ten years years and ended (more or less) with a judgment against IBM for some $78 million.

A court, especially a hometown court, might not give effect to such protection in cases of alleged fraud.

But such protective language for individual employees, etc., would be better than nothing.

23 Dispute management

23.1 Arbitration Agreement

Commentary
Arbitration is a (usually) binding form of private dispute resolution

Arbitration is, in essence, a form of private dispute resolution in which, by agreement of the parties, an arbitrator (or a panel of three arbitrators) decides the dispute instead of a court's doing so. In the U.S. and many other jurisdictions, contracts can agree in advance that some or all disputes between the parties are to be arbitrated.

Note that arbitration is not the same as mediation, in which a neutral mediator has no authority to decide the dispute, but does attempt to broker an agreed settlement between the disputing parties, often using "shuttle diplomacy."

Arbitration by agreement is usually binding: By law and treaty in the U.S. and many other countries:

  • If the parties to a dispute agree to arbitration, and the arbitrator renders an award, then the party that wins the arbitration can go to court to have the arbitrator's award "confirmed," that is, entered into the court records as though it were a judgment of the court itself; and
  • if the award requires the losing party to pay money to the winning party, but the losing party doesn't pay up, then the winning party can have the confirmed award "executed," e.g., by getting a writ of execution from the court, which commands the sheriff (or other law-enforcement authority) to seize the losing party's bank funds and deliver them to the winning party (or by seizing non-monetary assets, selling them, and delivering the proceeds to the winning party).
What are some pros and cons of arbitration instead of litigation?

Properly managed, arbitration can serve as a faster, less-expensive way of resolving business disputes.

But it has been said that:

  • arbitration has been "captured" by litigation counsel who, for reasons of their own, prefer to agree with their counterparts to run arbitration proceedings in the same expensive way as they're familiar with in court; and
  • arbitrators — desirous of getting future business from counsel — can be reluctant to anger counsel by overruling them, even though that would help to keep costs down.

For arbitration-management suggestions, see this streamlining article by the author as well as the author's arbitration procedures.

A one-way arbitration requirement could be dangerous

A one-way arbitration clause — requiring one party to arbitrate its claims while allowing the other party to litigate its claims in court — might be held unenforceable as unconscionable. [TO DO: Cite needed]

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23.1.1 What disputes must be arbitrated? Essentially, all

To the extent not affirmatively prohibited by law, the parties must arbitrate any Agreement-Related Dispute (as defined in Clause 25.3) in accordance with this Clause. This includes, without limitation, the following:

  1. any claim under a statute or a common-law doctrine; and
  2. any claim that a party was induced to enter into the Contract by another party's fraud or negligent misrepresentation.
Commentary
Subdivision a: Statute-based claims can be arbitrable — if agreed

American courts have held that statute-based claims can be arbitrated, but only if the parties agree. Here are some examples.

An employer tried to force an employment-discrimination case to be heard in arbitration under the employer's collective-bargaining agreement ("CBA") with a union. The employer managed to convince the district court to rule in its favor. But the Fifth Circuit disagreed; the appeals court said that the arbitration provision in the CBA didn't cover discrimination claims because the provision didn't include a clear and unmistakable statement that statutory claims were to be arbitrated.

In contrast, another employer's collective-bargaining agreement did include what the [U.S.] Supreme Court described as "a provision … that clearly and unmistakably requires union members to arbitrate claims arising under the Age Discrimination in Employment Act of 1967 (ADEA)"; the Court held that that arbitration provision was enforceable.

Not all claims will be forced into arbitration

Not all arbitration provisions will be readily enforced by U.S. courts. For example:

• Drafters working in the financial-services arena should check the Dodd-Frank Act's prohibition of mandatory arbitration of Sarbanes-Oxley Act "whistleblower" claims.

• In the Truth in Lending regulations, Regulation Z now prohibits pre-dispute arbitration clauses in mortgages secured by dwellings. See 12 C.F.R. § 1026.36(h).

• Government contractors and subcontractors should check restrictions on arbitration clauses in employment agreements relating to certain government contracts.

• Moreover, in July 2014, President Obama signed an executive order stating that in federal government contracts for more than $1 million, "contractors [must] agree that the decision to arbitrate claims arising under Title VII of the Civil Rights Act of 1964 or any tort related to or arising out of sexual assault or harassment may only be made with the voluntary consent of employees or independent contractors after such disputes arise"; the order includes a flowdown requirement for subcontracts for more than $1 million. (The order sets out exceptions for (i) the acquisition of commercial items or commercially available off-the-shelf items; (ii) collective bargaining agreements; and (iii) some but not all arbitration agreements that were in place before the employer placed its bid for the government contract in question.)

• Federal law provides that in franchise agreements between automobile manufacturers and their dealers, pre-dispute arbitration agreements are unenforceable.

• The regulations implementing the Military Lending Act render unenforceable any agreement to arbitrate consumer credit disputes between lenders and active-duty military personnel or their eligible dependents; the regulations do not distinguish between pre-dispute and post-dispute agreements to arbitrate, even though the statute appears to make just such a distinction.

• Federal regulations governing livestock and poultry production require that certain contracts mandating the use of arbitration must include, on the signature page, a specifically-worded notice, in conspicuous bold-faced type, allowing the producer or grower to decline arbitration; in addition, the Secretary of Agriculture seems to have the power to review agreements to determine "whether the arbitration process provided in a production contract provides a meaningful opportunity for the poultry grower, livestock producer, or swine production contract grower to participate fully in the arbitration process."

Arbitration of employee claims at NLRB, etc.

Anyone drafting an arbitration provision for an employment agreement should consider this: The (U.S.) National Labor Relations Board has held that a mandatory arbitration provision, in a company's sales-commission agreement, unlawfully interfered with employees' right of access to the Board's processes, in violation of section 8(a)(12) of the National Labor Relations Act. The Board distinguished the arbitration provision from another arbitration provision that contained an adequate exception for Board charges.

Pro tip: Be clear that arbitration is mandatory

An arbitration clause should be very clear that arbitration is mandatory; feel-good language making it seem that arbitration is optional can kill an arbitration requirement.

In one case, the arbitration clause said that "[i]f the dispute is not resolved through mediation, the parties may submit the controversy or claim to Arbitration. If the parties agree to arbitration, the following will apply: …." Both the trial court and appellate court concluded that under this clause, arbitration was not required and that the appellant's motion to compel arbitration must be denied.

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23.1.2 Must even "small claims" be arbitrated? No

  1. Either party may opt out of arbitrating a claim, and instead take the claim to a court of competent jurisdiction, if (but only if), all told, the aggregate amount being sought under the claim is no more than USD $10,000.
  2. If the Contract includes a forum-selection provision (see § 23.11), then the claim must be brought in a court permitted by that provision.
  3. In case of doubt, this small-claims exception to arbitration does not itself authorize class- or collective-action arbitration (see below).
  4. If either party asserts that the claim must be arbitrated despite this small-claims exception, then that assertion is to be decided by the court; the arbitral tribunal will have no power to do so. (This is an exception to the delegation of arbitrability disputes, below.)
Commentary

Arbitration is not cost-free, because arbitrators and arbitration administrators charge for their services. If a particular dispute doesn't have a lot of money at stake, it probably would be more cost-effective for the parties to take the dispute to small-claims court instead.

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23.1.3 Arbitration rules: AAA Commercial (U.S.) or ICDR (other)

  1. For this purpose, a "U.S." arbitration is one in which all parties to the arbitration are citizens and/or residents of the United States.
  2. The applicable rules are those in effect at the time of the demand for arbitration.
  3. In case of doubt, the parties' agreement to the arbitration rules is intended as a choice of rules and not of forum.
Commentary

Many arbitration rules are sufficiently well-developed that they could be thought of as the arbitral version of the Federal Rules of Civil Procedure: Once you agree to such rules, you've agreed, in great detail, how any arbitration proceeding would be conducted.

Drafters have considerable choice in their selection of arbitration rules, such as, for example:

  • For U.S. arbitrations, this Clause specifies the Commercial Arbitration Rules of the American Arbitration Association, which are a typical "default" standard in the U.S. The AAA also has expedited rules that can be used if desired, as well as rules for appeal of arbitration awards to an appellate panel of arbitrators. (Disclosure: The author is a member of the AAA's commercial arbitration panel.)
  • For non-U.S. arbitrations, this Clause specifies the International Arbitration Rules of the International Centre for Dispute Resolution ("ICDR"), the international division of the AAA; those rules are said to be based on the UNCITRAL Rules (mentioned below) but with administration features included.

For a brief comparison of various rules, see an article by Mark Anderson on the IP Draughts blog at http://goo.gl/ZX1iy.

For a more-detailed comparison of arbitration rules in the U.S. (AAA, JAMS, and CPR), see Liz Kramer, ArbitrationNation Roadmap: When Should You Choose JAMS, AAA or CPR Rules?

For international arbitration, see this October 2014 chart (CorporateCounsel.com), by Kiera Gans and Amy Billing, of selected key aspects of different rules.

Subdivision c: Choice of rules, not of forum

This subdivision provides that the choice of arbitration rules is a choice of rules, not of forum. This is to try to avoid the result in the Second Circuit's 1995 Salomon securities class-action case, where:

  • The arbitration agreement stated that the rules of the New York Stock Exchange (NYSE) would control; those rules provided for arbitration proceedings to be heard by the NYSE.
  • But the NYSE declined to accept the case for hearing — and the court held that this action by the NYSE negated the agreement to arbitrate.

Other courts, however, have reached the opposite result, holding that, just because the designated arbitral body isn't available, that won't negate the agreement to arbitrate unless that designation was material to the agreement.

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23.1.4 Arbitral tribunal: One arbitrator

  1. Number of arbitrators: The arbitral tribunal is to consist of the specified number of arbitrators, selected:—
    1. as provided in the arbitration rules or,
    2. failing that, as provided by law.
  2. Arbitrator qualifications: The Contract may specify particular arbitrator qualifications, but if an arbitrator lack those particular qualifications, it will not affect the validity or enforceability of any award by the tribunal unless either party objects to the member's participation:
    1. within the time provided by the arbitration rules; or
    2. if the arbitration rules do not provide a time limit for objection, within ten business days after being informed in writing, by any means, of the tribunal member's appointment.
Commentary
Subdivision a: Why just one arbitrator?

At least in theory, three arbitrators are more likely than a single arbitrator to consider everything that needs to be considered and not overlook significant issues or evidence. It's also possible that a reviewing court might be more inclined to confirm an arbitration award rendered by three arbitrators instead of just one.

BUT: Many arbitrators and counsel agree that three arbitrators will cost more than three times the cost of a single arbitrator, because three arbitrators will spend time conferring with each other and negotiating the language of the award.

Contract negotiators therefore might want to specify appointing a single arbitrator in cases of comparatively low value, perhaps using three arbitrators for "big" cases.

Under Rule R-16 of the AAA's Commercial Arbitration Rules, the AAA can in its discretion decide to appoint three arbitrators, but otherwise a single arbitrator is used unless the arbitration agreement specifies otherwise.

"The arbitral tribunal is to consist of three arbitrators."

Subdivision a.2: Judicial backup selection of arbitrator

The arbitrator selection method prescribed by the arbitration rules might not succeed in picking a tribunal. In that circumstance, a court might refuse to compel arbitration; at this writing, this is the subject of a circuit split among U.S. federal courts. For that reasons, this section says that a court can serve as a backup selector.

Subdivision b: Arbitrator qualifications

Some contracts specify different arbitrator qualifications for different types of dispute. One such case involved the sale of certain oil and gas properties for $1.75 billion; the contract called for title disputes to be arbitrated by consultants familiar with the energy industry, but for accounting disputes to be arbitrated by an accounting referee.

A very few contracts get extremely explicit about who may serve as an arbitrator, e.g., "ten years practicing law in the computer-software field and five years' experience as an arbitrator." Doing that, though, might seriously limit the pool of available arbitrators.

Caution: Letting one party choose — or be — the arbitrator could be problematic

Some arbitration agreements, especially in sports, provide for a senior authority figure in one of the parties to serve as arbitrator. Consider, for example, the famous "Deflategate" case, which centered on legendary (U.S.) National Football League quarterback Tom Brady:

  • NFL commissioner Roger Goodell approved a recommendation that Brady be suspended for four games for using slightly-deflated footballs. Brady requested arbitration.
  • Goodell appointed himself as arbitrator, as permitted by the NFL's collective bargaining agreement (the "CBA") with the NFL Players Association (the "Union").
  • Brady requested that Goodell recuse himself, but Goodell declined (even though Goodell had previously recused himself in other cases).

A federal judge in the Southern District of New York vacated the arbitration award — albeit not because of Goodell's declining to recuse himself. The Second Circuit reversed and remanded with instructions to confirm the award; in the process, the appeals court dismissed the Union's argument that Goodell should have recused himself, holding that:

Here, the parties contracted in the CBA to specifically allow the Commissioner to sit as the arbitrator in all disputes …. They did so knowing full well that the Commissioner had the sole power of determining what constitutes "conduct detrimental," and thus knowing that the Commissioner would have a stake both in the underlying discipline and in every arbitration …. Had the parties wished to restrict the Commissioner's authority, they could have fashioned a different agreement.

On the other hand, the First Circuit held that, under the applicable Puerto Rican law, the arbitration provision in the World Boxing Organization's agreement with boxers was unconscionable because it gave the WBO the power to select the arbitrator.

And in an earlier California case, an appeals court held that a "review committee" procedure in an employer's "Employee Guide" did not constitute an agreement to arbitrate because "a third party decision maker and some decree of impartiality must exist for a dispute resolution mechanism to constitute arbitration."

23.1.5 Arbitral law: FAA and Texas (U.S.) or law of the seat (other)

For this purpose:

  1. A "U.S." arbitration is one in which all parties to the arbitration are citizens and/or residents of the United States.
  2. "Seat" refers to the law of the seat of the arbitration (usually determined by the arbitration rules; see § 23.1.3).
Commentary

Texas arbitration law is adopted here (for U.S. arbitrations) because Texas law lays out a sensible process that allows:

  • compulsory depositions of adverse witnesses — but outside of Texas, of course, that provision might well be unenforceable against non-party witnesses; and
  • an expanded right of appeal if desired (discussed in more detail at § 23.1.20), which is not available under the Federal Arbitration Act per se.

In the U.S., the Federal Arbitration Act will generally apply in cases involving or affecting interstate commerce "absent clear and unambiguous contractual language to the contrary" in which the contract "expressly references state arbitration law."

This Clause doesn't try to specify a particular governing law for non-U.S. arbitrations, because that would be subject to too much variation.

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23.1.6 Arbitration administrator: AAA (U.S.) or ICDR (other)

The arbitration is to be administered by:

  1. the American Arbitration Association, if all parties to the arbitration are citizens and/or residents of the United States; or
  2. the International Center for Dispute Resolution, for all other arbitrations; or
  3. the arbitral tribunal, if no agreed-to administrator is willing or able to serve in that role.
Commentary
Why use an administrator for arbitration?

As far as "administration" of arbitration goes, it comes in two flavors: Administered, and ad hoc. Among the reasons to prefer administered arbitration: Arbitration requires doing a number of chores such as scheduling, invoicing, etc. It's usually more cost-effective to have those chores handled by the AAA, the ICC, or other arbitral institution, than it would be to pay the arbitrator's hourly rate.

Moreover, an experienced arbitrator points out that:

  • "AAA's vetting process formalizes disclosures of potential conflicts/biases and thus minimizes [sic; reduces] the likelihood of a flawed proceeding."
  • In addition, a party might have a complaint about an arbitrator, for example a perception that the arbitrator is biased toward another party. It will usually be better if the complaining party can take its complaint to an arbitral institution, than to risk angering the arbitrator by raising the complaint with the arbitrator himself.
  • And "a competent administrator will goad an arbitrator who is not moving the proceeding apace."

Another commentator says that "the conventional wisdom is that it is easier to enforce an award given by an arbitral institution than one given by an ad hoc arbitrator."

What institutional administrators are available?

The arbitration administrator could be, for example:

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23.1.7 Arbitration location: Per arbitration rules

The arbitration hearing is to be conducted in the specified location,

  • which is to be considered the "seat" of the arbitration.
Commentary

The choice of arbitral location — sometimes referred to as the "seat" of the arbitration — can have significant procedural implications, such as in determining the arbitral law. (The arbitration rules might specify the arbitral location to be applied in the absence of the parties' agreement otherwise.)

EXAMPLE: Suppose that the parties' agreement specifies that the arbitral location will be (say) London, but the agreement does not specify an arbitral law. In that case, procedurally the arbitration proceedings might well be governed by English arbitration law — even if the agreement's governing-law provision specified another law to govern the interpretation and enforcement of the Agreement.

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23.1.8 Arbitral language: English

The specified arbitral language is to be used for all proceedings, notices, and decisions in the arbitration.

Commentary

In transnational contracts, the parties might well be fine with using English, the global lingua franca of business, as the arbitral language.

But drafters should also consider where an arbitration award might have to be enforced, with an eye to reducing the expense (and time delay) of providing a sworn translation, which might be necessary under Article IV.2 of the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention).

Requiring notices to be in the arbitral language could be important: a U.S. retailer found itself losing an arbitration in China, and having a sizable damages award entered against it, because the notice of arbitration was written in Chinese, and the U.S. retailer did not get the notice translated in time to avoid adverse consequences under the arbitration rules. (Fortunately for the U.S. retailer, a U.S. court refused to enforce the award, on grounds that a different agreement controlled, under which the arbitration notice was required to be in English, not Chinese.)

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23.1.9 Is class arbitration allowed? No

  1. Unless the Contract clearly and unmistakably states otherwise, a claimant must arbitrate only its own dispute —
    1. without consolidation with claims of other parties, and
    2. without purporting to be (i) a plaintiff or representative class member in a purported class action, collective action, or representative proceeding, nor (ii) a private attorney general under laws such as (for example) California's Private Attorneys General Act.
  2. The arbitral tribunal will have no power to decide whether arbitration is allowed in any manner other than as stated in this Clause
    • unless the Contract expressly and unmistakably allows class arbitration.
Commentary
Why no class arbitration?

A majority of the (U.S.) Supreme Court is of the view that arbitration is so different from litigation — with very different procedures and, crucially, very little right of appeal — that the "default" rule, at least for arbitrations under the Federal Arbitration Act, is that class-action arbitration is not allowed unless the parties expressly agree to it. In Stolt-Nielsen, the Court reversed a ruling by the Second Circuit that class-action arbitration was implicitly permitted if not prohibited by the arbitration agreement or applicable law. The Court held that "class-action arbitration changes the nature of arbitration to such a degree that it cannot be presumed the parties consented to it by simply agreeing to submit their disputes to an arbitrator"; the Court listed several examples of these changes, for example the significant raising of the stakes with little prospect of appellate review.

In other cases, the Court has similarly held that:

  • The Act preempts state law barring enforcement of a class-arbitration waiver; and

+ A contractual waiver of class arbitration is enforceable under the Act even if the plaintiff's cost of individually arbitrating a federal statutory claim exceeds the potential recovery.

Caution: Drafters should be extremely explicit that class arbitration is not allowed; otherwise, a court might well find that the court had no power to overrule the arbitrator's conclusion that class arbitration was allowed.

Subdivision b: Why bar the arbitral tribunal from deciding class-arbitration allowability?

The Supreme Court has held that if an arbitration agreement delegates to the arbitrator the decision whether class arbitration is allowed, then the arbitrator's decision about class-action arbitrability cannot be overruled by a court except on very-limited grounds. See Oxford Health Plans LLC v. Sutter, 569 U.S. 564 (2013) (affirming denial of motion to vacate arbitrator's approval of class action).

Caution: Be careful what you wish for in ruling out class arbitration

The food-delivery service DoorDash used a contract with delivery drivers that included an arbitration clause that prohibited class arbitrations — so thousands of drivers flooded DoorDash with demands for arbitration, and the company was ordered to pay $9.5 million in arbitrator fees as required by the contract.

Likewise, more than 5,000 food-delivery drivers for Postmates, Inc., submitted arbitration demands, but Postmates refused to tender its share of the arbitration costs, claiming that "the demands are tantamount to a de facto class action in violation of the class action waiver." The court granted the drivers' motion to compel arbitration so that the arbitrator could take up Postmates's claim, as required by the arbitration provision's delegation clause. The court said: "… the possibility that Postmates may now be required to submit a sizeable arbitration fee in response to each individual arbitration demand is a direct result of the mandatory arbitration clause and class action waiver that Postmates has imposed upon each of its couriers." (The court later ordered that Postmates show cause why it should not be held in civil contempt for violating the order compelling arbitration, and still later refused to grant a stay to allow Postmates to appeal.)

Alternative: Allow class arbitration?

Parties wishing to allow class arbitration could consider using the following in the Contract: "Class arbitrations are permitted in accordance with the Supplementary Rules for Class Arbitrations of the American Arbitration Association; this overrides the class-arbitration prohibition in Clause 23.1.1."

Parties agreeing to class arbitration might also want to agree to an enhanced right of appeal, as stated in Clause 23.1.20 (Option: Enhanced Right of Appeal).

Allow opt-out of a class-arbitration prohibition?

Some companies include opt-out provisions in their arbitration agreements, especially in employment agremeents and customer agreements. Opting out of arbitration would preserve an employee's or customer's right to bring class-action litigation.

Many people might not actually bother to opt out; this happened in a Ninth Circuit case, where an employee didn't timely opt out and so was held to have waived the right to go to court.

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23.1.10 Where can an award be enforced? Anywhere with jurisdiction

  1. An arbitration award may be confirmed or otherwise enforced in any forum having jurisdiction.
  2. The Contract may specify that a particular forum is the only permissible forum for enforcement.
Commentary

Parties could specify an agreed forum — possibly an exclusive one — for confirmation of arbitration awards.

See also Clause 23.11 (Forum Selection).

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23.1.11 May a party seek preliminary relief? Yes

A party may seek temporary, interim, or preliminary injunctive relief, in accordance with applicable law, from one or more of (i) a court or other tribunal of competent jurisdiction; and/or (ii) the arbitral tribunal.

  1. A party's seeking of such relief in court (or other forum), instead of from the arbitral tribunal,
    • will not in itself waive that party's right to arbitrate.
  2. If a party seeks such relief in a court,
    • then the arbitrability of that request for relief is to be decided by that court.
Commentary

This section leaves it up to the relevant tribunal to decide whether a party's request for preliminary relief must be arbitrated, to try to avoid the extra expense and uncertainty that in one case required a trip to the (U.S.) Supreme Court. In that case, on remand, the appeals court noted that:

… the arbitration clause [requiring arbitration under AAA rules] creates a carve-out for "actions seeking injunctive relief." It does not limit the exclusion to "actions seeking only injunctive relief," nor "actions for injunction in aid of an arbitrator's award." Nor does it limit the carve-out to claims for injunctive relief.

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23.1.12 Who will decide arbitrability disputes? The arbitral tribunal

The parties delegate to the arbitral tribunal

  • the authority to decide any claim whether — for any reason — a particular dispute between the parties is not to be arbitrated,
  • unless the dispute manifestly and indisputably does not fall within the scope of the parties' agreement to arbitrate.
Commentary

When a dispute arises, one party might claim that it doesn't need to arbitrate, but can instead go to court. Such a claim might arise about (for example) the following questions:

  • whether the parties in fact entered into an agreement to arbitrate that covers the particular dispute in question;
  • whether the agreement to arbitrate (if any) is binding; is enforceable; and/or is in conflict with a non-waivable legal right; and
  • whether a party seeking arbitration has waived arbitration.

Delegating such arbitrability disputes to the arbitrator, instead of having a court decide, helps to avoid piecemeal litigation. That's because under U.S. law, it's the court, not the arbitrator, that normally must determine whether the parties have agreed to arbitrate — but the arbitration agreement itself can clearly and unmistakably delegate that power to the arbitrator, in which case the arbitrator will decide that question.

Of course, even then, any challenge specifically to the "delegation agreement" itself will be heard by the court.

BUT: If the parties never agreed to an arbitration clause in the first place, then the arbitration clause's adoption of arbitration rules containing a delegation provision (such as the American Arbitration Association's Commercial Arbitration Rules) won't be enough to delegate the arbitrability dispute.

For a useful survey of the law in this area, see Paul T. Milligan, Who Decides the Arbitrability of Construction Contracts? in The Construction Lawyer, Vol. 31, No. 2, Spring 2011.

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23.1.13 What confidentiality obligations will apply, and to whom?

  1. The obligated parties described in subdivision b below must, at all times:
    1. maintain in confidence all non-public information disclosed, in the course of the arbitration proceedings, by any party to the arbitration;
    2. use any such information only for purposes of the arbitration and any related court proceedings; and
    3. not disclose any such information to any third party, except to the minimum extent authorized or required by: (i) the arbitration rules; (ii) the disclosing party; or (iii) applicable law.
  2. The confidentiality obligations of this Clause are intended to be binding on:
    1. each party to the dispute;
    2. each member of the arbitral tribunal; and
    3. each other participant in the arbitration proceedings.
  3. To the extent that any other persons listed in this section
    • are subject to a party's control,
      • for example, party employees, contractors, etc.,
    • that party is to ensure that the person:
      • (i) agrees in writing to comply with the confidentiality obligations of this Clause, and
      • (ii) if the person is an organization: causes its own employees, and others under its direction, to do the same.
  4. But if someone breaches the confidentiality obligations of this Clause,
    • that will not affect the enforceability of any arbitration award.
Commentary

A primary reason parties opt to arbitrate their disputes is to try to avoid having their business affairs made public in court proceedings. Arbitration proceedings might not be confidential, however, unless the parties expressly so agreed — or unless the agreed arbitration rules include confidentiality provisions, as is the case, for example, in some rules:

  • Rule R-23(a) of the Commercial Arbitration Rules of the American Arbitration Association allows the arbitrator to impose secrecy requirements in connection with the pre-hearing exchange of confidential information and the admission of confidential evidence at the hearing.
  • The rules of the London Court of Interntional Arbitration automatically provide for secrecy of arbitration proceedings.

A survey of some relevant holdings in various countries, and of various arbitration rules that do or do not contain confidentiality provisions, can be found in a 2007 article (paywalled).

In addition, the law might independently require confidentiality. For example, apparently English law implies a duty of confidentiality in arbitration proceedings; a failure to maintain confidentiality where required may result in the imposition of severe sanctions or the institution of legal proceedings against the discloser by other parties to the arbitration. See Veleron Holding, supra, at part II.

And of course the substantive law (e.g., privacy law) might independently impose a duty of confidentiality because of the nature of the dispute.

Drafters could also use more-detailed confidentiality provisions if desired, such as Clause 16.1 (Confidential Information).

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23.1.14 How broad is the arbitral tribunal's power?

  1. Introduction: Under this Clause, the arbitral tribunal has no power to award relief in contravention of this section.
  2. Award must conform to law: The arbitral tribunal will have no power to award relief of a kind that a court could not award if the dispute were being litigated instead of being arbitrated,
    • taking into account the applicable law —
    • including, without limitation, any applicable statute of limitation or of repose.
  3. Award must conform to contract: The arbitral tribunal will have no power to award relief inconsistent with the Contract, including, without limitation:
    1. any agreed limitation of liability — and that term includes, without limitation, exclusions of remedies; and
    2. any shortened limitation period stated in the Contract.
Commentary

Subdivision a: The language, "has the power only to award such relief," has in mind that, under the (U.S.) Federal Arbitration Act, one of the very few grounds allowing a federal court to vacate an arbitration award is that "the arbitrators exceeded their powers …."

This power-limitation language might be important because under the law and the agreed arbitration rules, an arbitrator might have the power to decide a case as she sees fit, in accordance with her own notions of fairness, and the arbitrator might not need to stay within the strict bounds of either the agreement or the law.

The legalese names for this arbitrator freedom to go beyond the law and the contract are:

  • amiable compositeur, which refers to the arbitrator's varying what would otherwise be the effect of the law and the parties' agreement; and
  • ex aequo et bono, which refers to the arbitrator's deciding the case "according to the equitable and good."

This expansive arbitrator freedom sometimes causes parties to fear that an arbitrator might "go rogue," imposing an award that no one could have foreseen, acting on his or her own individual sense of justice. And depending on the applicable law and the arbitration rules, such fear might not be unwarranted: while most arbitrators seem to stick to the law and the contract, it's not unheard of for arbitrators to "get creative" in fashioning awards.

For example, some thought the arbitrators ran amok in a software-copyright dispute between competitors IBM and Fujitsu. In that case, the arbitrators ultimately:

  • ordered IBM to provide its operating-system source code and other secret information to Fujitsu; and
  • ordered Fujitsu to pay significant money to IBM.

Subdivision b: An arbitrator might even be able to ignore a relevant statute of limitations that would otherwise bar a claim.

Compounding the concern, arbitration awards cannot be appealed except on very-limited grounds (in some jurisdictions the parties can agree otherwise), as discussed here.

Optional language: Prohibition of punitive sanctions

The following optional language could be copied and pasted into the Contract: "The arbitral tribunal will have no power to order punitive sanctions against a party, in respect of an issue (or multiple issues), in the form of (i) preclusion of evidence or defense concerning the issue or (ii) entry of judgment concerning the issue."

This optional language seeks to avoid the result in a case where a disk-drive manafacturer sued a defecting employee and his new employer for theft of trade secrets. The arbitrator found:

  • that the defecting employee had fabricated evidence by altering a PowerPoint slide deck to make it appear that the employee, while employed by the disk-drive manufacturer, had publicly presented particular trade-secret material at a conference — if true, this would have meant that that the information in question did not qualify as a trade secret (see the discussion at § 16.1.2); and
  • that the new employer was complicit in the fabrication of evidence because it knew that the defecting employee had altered the PowerPoint slide deck yet submitted the altered slide deck into evidence.

As a punitive sanction for fabrication of evidence, the arbitrator (i) barred the defecting employee and the new employer from contesting the manufacturer's position about the validity and misappropriation of the trade secrets in question, and (ii) based on the former employer's evidence, awarded the disk-drive manufacturer more than $600 million.

A district court vacated the arbitration award and ordered a rehearing before a new arbitrator, but both the court of appeals and the Minnesota supreme court upheld the arbitrator's award. The supreme court noted:

Some courts have held that punitive sanctions in arbitrations are not allowed based on public policy reasons.

Other courts have concluded that punitive sanctions are not incorporated into a broad arbitration agreement without specific language granting the authority.

But other courts have held that arbitrators do have the power to impose punitive sanctions.

  • Some courts have based this power on a concept of inherent authority.
  • Other courts have grounded the arbitrator authority to issue sanctions in broad language in the arbitration agreement.
Optional language: Prohibition of punitive damages

The following optional language could be copied and pasted into the Contract: "The arbitral tribunal will have no power to award punitive damages, exemplary damages, multiple (e.g., treble) damages, or similar relief."

This prohibition is phrased without the qualifier, "to the maximum extent permitted by law"; otherwise, the prohibition might be disregarded, as happened in an Eighth Circuit case.

Portions of this prohibition are adapted from a provision at issue in another Eighth Circuit case.

If more detail is desired in spelling out remedies that the arbitral tribunal is not permitted to award, see the examples in Charles M. Sink, Negotiating Dispute Clauses That Affect Damage Recovery in Arbitration, The Construction Lawyer, vol. 22, no. 3, summer 2002.

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23.1.15 What happens if a party fails in an arbitration challenge?

  1. If a party goes to court
    • to try to get out of arbitration,
    • or to set aside an arbitration award,
    • then that party must reimburse the other party for its attorney fees (as defined in Clause 23.3) incurred in connection with the arbitrability challenge, in both trial- and appellate courts.
  2. The court, not the arbitral tribunal, is to determine the amount of the reimbursement. (This is an exception to the delegation of arbitrability decisions to the arbitral tribunal in Clause 23.1.1.)
Commentary

At almost any point in an arbitration, a party might use court proceedings to challenge the propriety of arbitration. For example:

  • A plaintiff, instead of initiating arbitration proceedings, might instead file a lawsuit in court and then oppose a motion by the defendant to compel arbitration;
  • A party that is served with a demand for arbitration might ask a court to grant a restraining order against continuing with the arbitration;
  • During the arbitration proceedings, the arbitral tribunal might express preliminary views that are unfavorable to a party — this is permitted by some rules and might be permitted by agreement — in which case the disfavored party might run to court to try to shut down the arbitration, claiming (for example) that the arbitral tribunal was biased.
  • When the arbitration is over and an award has been issued, the losing party might refuse to comply with the award, which typically would involve the loser being ordered to pay money to the winner; that would force the winner to spend time and money going to court to "confirm" the award (so that the award would be enforceable in essentially the same way as if the award were a judgment of the court itself, e.g., by seizure of assets).

This section tries to discourage such stalling tactics by imposing attorney-fee sanctions for unsuccessfull stalling attempts; this approach is based on a suggestion by an experienced arbitrator.

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23.1.16 Are the parties giving up their right to jury trial?

YES: By agreeing to arbitration, each party WAIVES (as defined in Clause 24.26) any right it might have to trial by jury for any dispute that the Contract requires to be arbitrated.

Commentary

This waiver of the right to a jury trial is probably overkill for most jurisdictions, but it's one of those instances where a few extra words could be cheap insurance against future disputes raised by "creative" litigation counsel.

Generally, advance waivers of jury trials are unenforceable in California and Georgia — but those laws likely would be preempted in cases where the Federal Arbitration Act applied.

Contra: The New Jersey supreme court held that an arbitration provision was unenforceable because the provision did not expressly waive jury trial; to the surprise of many observers, the Supreme Court declined to hear the losing side's appeal.

On the other hand, the Nevada supreme court held that a state statute imposing requirements on arbitration agreements was indeed preempted.

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23.1.17 Will the arbitration requirement survive termination?

Yes: Even if the Contract comes to an end in some way (whether by termination or expiration), the provisions of the Contract relating to arbitration will still remain in effect.

23.1.18 What notice of an enforcement action is required?

If a party files an action, in any forum,

  • seeking to confirm or enforce an arbitration award, or
  • to vacate an award in whole or in part,
  • then that party must promptly cause notice to be given to the other party,
  • in the arbitral language (as defined in Clause 23.1.8),
  • that the action has been filed.

(An actually-received or ‑refused written notification, in the arbitral language, from an arbitration administrator (as defined in Clause 23.1.6), will suffice for this purpose.)

23.1.19 What could happen if a party ignores an award?

If a party is required to take action under an arbitration award,

  • but that party does not timely comply with the requirement on its own,
  • and another party successfully goes to court or other forum to confirm and/or enforce the requirement,
  • then the noncompliant party must pay or reimburse the other party's reasonable attorney fees for those confirmation and/or enforcement proceedings —
    • at all stages of the confirmation- and/or enforcement proceedings, at both trial- and appellate levels; and
    • in addition to any other relief granted to the successful party, either in the confirmation / enforcement proceedings or in the arbitration.
Commentary

This section seeks to avoid what likely would happen under American law. Consider the following scenario:

  • [BROKEN LINK: Alice] (as defined in [BROKEN LINK: Alice][BROKEN LINK: Alice]) wins an arbitration case against Bob; the arbitrator's award requires Bob to pay Alice money.
  • Bob refuses to comply with the award, so Alice must go to court to confirm and enforce the award.
  • The court rules in Alice's favor — but applying the [BROKEN LINK: atty-fees-american-rule] about attorney fees, the court declines to order Bob to pay Alice's attorney fees for the enforcement proceedings.

This happened, for example, in a Texas case where an appeals court affirmed a trial court's refusal to award attorney fees incurred in post-arbitration confirmation proceedings.

On a related note: Also invoking the [BROKEN LINK: atty-fees-american-rule], the Second Circuit held that, when the parties' contract provides only for awarding attorney fees for breach of the contract, such fees cannot be awarded to a respondent that successfully defends against a claim of breach in arbitration and then successfully defends against the claimant's attempt to vacate the award in court. (This ruling is of a piece with the "[BROKEN LINK: AttyFeesTexasRule] (as defined in [BROKEN LINK: AttyFeesTexasRule][BROKEN LINK: AttyFeesTexasRule])" concerning attorney fees which is to the same effect.)

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23.1.20 Option: Enhanced Right of Appeal

  1. Under this Option, the arbitral tribunal's powers do not include the power to render an award that:
    1. is based on errors of law or legal reasoning that would be grounds for reversal if made by a judge in a civil trial to the court (sometimes known as a "bench trial"); or
    2. is based on evidence that would not satisfy the requirements of law in such a trial; or
    3. grants relief prohibited by the Contract or not available under applicable law.
  2. If a court of competent jurisdiction finds that an arbitration award is based,
    • in whole or in part,
    • on one or more of the factors enumerated in subdivision 1 of this Option;
    • then the parties desire that, upon application of either party,
    • the award is to be vacated,
    • on grounds that (without limitation) the arbitral tribunal thereby exceeded its agreed powers.
  3. The interpretation and enforcement of this Option is to be governed by the law of the State of California applicable to contracts made and performed entirely in, by residents of, that state.
  4. (Opt-in required) If this Option is found to be unenforceable, the parties' agreement to arbitrate may be rescinded as provided in the Option: Jettison of Arbitration Agreement.
Commentary
Hall Street: The Supreme Court leaves the door open for enhanced judicial review

In its Hall Street case, the (U.S.) Supreme Court held that, when the sole authority for an arbitration proceeding is the Federal Arbitration Act, the courts may not entertain an appeal of the award except on the limited, misconduct-based grounds provided in section 10 of that statute.

In a later case, the Court later explained:

Because the parties bargained for the arbitrator's construction of their agreement, an arbitral decision even arguably construing or applying the contract must stand, regardless of a court's view of its (de)merits.

Only if the arbitrator acts outside the scope of his contractually delegated authority — issuing an award that simply reflects his own notions of economic justice rather than drawing its essence from the contract — may a court overturn his determination.

So the sole question for us is whether the arbitrator (even arguably) interpreted the parties' contract, not whether he got its meaning right or wrong.

Enhanced judicial review under state law?

Drafters can keep in mind another possibility for enhanced appellate review: In its Hall Street decision, the  Court expressly left open the possibility that enhanced review might be available under some other authority, such as state law or (in the case of court-annexed arbitrations) a court's inherent power to manage its docket.

• Subsequently, both the California and Texas supreme courts ruled that, in proceedings under the arbitration acts of their respective states, the parties were free to agree to enhanced judicial review.

• In contrast, the Tennessee supreme court reached the opposite conclusion; the court held that the arbitration agreement's expansion of the scope of judicial review was invalid.

• The New Jersey arbitration statute provides that "nothing in this act shall preclude the parties from expanding the scope of judicial review of an [arbitration] award by expressly providing for such expansion in a record."

Enhanced review might require an express reference to a congenial arbitral law

Parties desiring enhanced review should seriously consider specifying that the arbitral law is that of a jurisdiction that permits such review. In one Fifth Circuit case, a party lost an arbitration, and on appeal the losing party cleimed that the arbitration panel had "completely botched" certain issues. The appellate court held that under the Supreme Court's Oxford Health Plans decision, the losing party was stuck with the arbitration panel's interpretation of the relevant contract, even if that interpretation was arguably incorrect. The court explained:

In Hall [Street], the Supreme Court noted that parties may obtain more searching review of arbitration decisions by stipulating in the arbitration agreement that state statutes or common law rules apply. Action is consistent with Hall. Action simply states that the FAA provides the default standard of review, and that parties must unambiguously express their agreement to non-FAA standards to obtain more searching review.

Because the Agreement does not refer to the TAA, IAA, or any other body of law offering a competing standard of review, we hold that the FAA's standard of review controls.

BNSF R.R. Co. v. Alston Transp., Inc., 777 F. 3d 785, 790-91 (5th Cir. 2015) (vacating district court's vacatur of arbitration award and remanding with instructions to reinstate award; citations omitted, emphasis and extra paragraphing added), citing Action Indus., Inc. v. U.S. Fid. & Guar. Co., 358 F.3d 337, 341 (5th Cir. 2004).

Jettison of arbitration absent enhanced judicial review?

When drafting an arbitration provision with an agreement to enhanced judicial review, consider whether to state that the arbitration provision is to be jettisoned if a reviewing court declines to provide an enhanced review.

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23.1.21 Option: Jettison of Arbitration Agreement

  1. This Option applies if the following prerequisites are satisfied:
    1. the Contract clearly states — including, but not limited to, by incorporation of a Tango Terms provision — that a particular provision of the parties' agreement to arbitrate is subject to this Option; and
    2. A court of competent jurisdiction holds that the particular provision is unenforceable; such a holding must be in a final judgment from which no further appeal is taken or possible (a "Final-Final" judgment).
  2. Either party may, by notice to the other party and to the court, unilaterally rescind the parties' arbitration agreement and thereby automatically vacate any arbitration award.
  3. The notice of rescission must be effective no later than five court days (i.e., days on which the court is open for routine business) after the judgment becomes Final-Final, as defined above.
  4. If a party exercises this rescission right, then any applicable statute of limitation or ‑repose is to be deemed to have been retroactively tolled beginning with the date on which the demand for arbitration was made and ending [five court days] after the effective date of the notice of rescission.
Commentary

In some cases, "[BROKEN LINK: Alice] (as defined in [BROKEN LINK: Alice][BROKEN LINK: Alice])" might regard a particular agreed feature of arbitration — for example, an enhanced right of appeal — as so important that she isn't willing to agree to arbitration without that feature. For that case, Clause 23.1.21 (Option: Jettison of Arbitration Agreement) can be included in the Contract.

That Option is informed by a case in which Tennessee's supreme court held that an agreement to arbitrate in a contract must be rescinded for mutual mistake in view of that court's holding that the parties' agreement to expanded judicial review was invalid.

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23.1.22 Option: Severability of Arbitration Provisions

  1. This Option will apply automatically — except as provided in the Option: Jettison of Arbitration Agreement — if:
    1. the Contract clearly states, in substance, that some or all of the parties' agreement to arbitrate is severable; and
    2. a court of competent jurisdiction determines, in a decision from which no further appeal is taken or possible, that one or more provisions of the parties' agreement to arbitrate is void, invalid, or otherwise unenforceable for any reason.
  2. In such a case, the parties desire that the unenforceable provision be severed from the remainder of the agreement to arbitrate, while the remainder of the agreement to arbitrate is to be enforced.

23.1.23 Review question: A sad story

DCT to recount an arbitration case:

  • "Alice" signs a contract with "Bob LLC" to provide marketing for a new, Web-based store.
  • Contract is signed electronically for Bob LLC by "Billy, authorized agent."
  • Contract calls for Alice to pay Bob LLC $25K up front, AND 30% commission on sales.
  • Contract says that if Alice's Web store doesn't make "reasonable sales" within 90 days, then Alice gets her money back.
  • Unbeknownst to Alice: Bob LLC engages a third party, "Carol," to do the actual work and (supposedly) pays the $25K to Carol.
  • No sales at all for a year — "Carol" hasn't been heard from.
  • In text messages, Billy (Bob LLC's "authorized agent") agrees that Alice should get her money back, says he's working on getting it back from Carol — then, silence.
  • Alice brings an arbitration claim.
  • AAA duly "serves" Bob LLC, but Bob LLC never appears in the case.
  • In due course, arbitrator (DCT) finds in favor of Alice, awards her the full $25K.

QUESTIONS:

  1. With the arbitration award in hand, what's Alice's next step — can she take the award to Bob LLC's bank and get the bank to give her the $25K?
  2. Can Bob LLC appeal the arbitration award on grounds that the arbitrator screwed up the law?
  3. What could Alice have done to help her recover her money?

23.1.24 Arbitration exercise

FACTS: Gigunda wants MathWhiz to agree to arbitrate any dispute arising out of or relating to their agreement.

QUESTION: As counsel for MathWhiz, what are some pros and cons you might want to discuss with MathWhiz about this Gigunda request? Feel free to use the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ).

23.2 Attorney fees (commentary)

Contents:

23.2.1 Introduction: The "American Rule"

Attorney fees are a major expense (perhaps the major expense) of contract disputes. In U.S. jurisdictions the so-called "American Rule" is that each party must bear its own attorney fees.

In most non-U.S. jurisdictions, on the other hand, under the so-called prevailing-party rule — sometimes called the "loser pays" rule or the "everywhere but America" rule — a prevailing party is entitled to recover its attorney fees from the losing party.

23.2.2 The "Texas rule" says some contract claimants can recover fees

If a party negotiating a contract thinks it might be more likely to be the defendant in a dispute than the plaintiff, AND Texas law will apply, then that party it might want to affirmatively include the American Rule option in subdivision g. That's because under Texas law, absent an agreement otherwise, a party is entitled to recover its attorney fees if:

  • it successfully enforces a claim
  • against an individual or corporation
  • on an oral or written contract. 

Importantly: A party that successfully defends against an enforcement action is not entitled to recover attorney fees under that Texas statute. "Chapter 38 does not provide for recovery of attorneys' fees by defendants who only defend against a plaintiff's contract claim and do not present their own contract claim."

23.2.3 Statutes might entitle particular classes of parties to attorney fees

By statute, legislatures have allowed or even required awards of attorney fees to specified classes of parties. For example:

• U.S. antitrust law requires "a reasonable attorney's fee"to be awarded to "any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws …." As one example, a federal district court in California awarded more than $40 million in attorney fees to a group of current and former student athletes who sued the NCAA over the college sports rule that prohibited student athletes from being paid for use of their names and likenesses in advertising and video games.

•  Under one California statute: "In any action to recover damages to personal or real property resulting from trespassing on lands either under cultivation or intended or used for the raising of livestock, the prevailing plaintiff shall be entitled to reasonable attorney’s fees in addition to other costs, and in addition to any liability for damages imposed by law." As explained in a  court case: "The statute is intended to ensure that farmers are able to protect their land from trespassers through civil litigation."

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

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

Likewise in Oregon: Or. Rev. Stat. § 20.096 (2017)

23.2.5 One-sided attorney-fee clauses might well be enforced

Some contracts contain unilateral attorneys' fee clauses; for example, a real-estate lease agreement might state that the landlord can recover its attorney fees if it has to sue the tenant, while remaining silent as to whether the tenant can ever recover its attorney fees. Such unilateral clauses might well be enforceable.

(Under the 'American rule,' that would normally mean that the tenant could not recover, even if it were the prevailing party in a suit brought by the landlord — unless a statute provides otherwise, as in the Texas and California examples mentioned above.)

23.2.6 Apostrophe, or not?

The term "attorney fees" is most-often rendered as attorneys' fees or attorney's fees, following the usage in, e.g., some statutes.

The Tango Terms generally omit the apostrophe, following something of a trend noted by preeminent legal lexicographer Bryan Garner.

23.3 Attorney Fees

Commentary

Like many contracts, this Clause adopts the prevailing-party rule; the American Rule is available as an opt-in provision. Both are discussed in more detail in the additional commentary at § 23.2.

The language of this Clause is informed in part by the attorneys-fees clause in the contract in suit in a Delaware case.

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23.3.1 Definition: What counts as "attorney fees"?

  1. The term attorney fees (whether or not capitalized) refers to any and all of the following:
    1. reasonable fees billed by —
      • attorneys,
      • law clerks, paralegals, and others acting under attorney supervision,
      • and expert witnesses;
    2. reasonable expenses incurred in connection with the proceeding,
      • such as (without limitation) printing, photocopying, duplicating, and shipping; and
    3. costs of court and/or arbitration,
      • including without limitation arbitration administration fees and arbitrator fees and expenses.
  2. "Proceeding": For purposes of this Clause:
    1. The term "proceeding" refers, without limitation,
      • to pre-hearing and hearing proceedings,
      • in a court- or contested-administrative action or arbitration;
      • an appeal at any level;
      • or other contested proceeding in the action or arbitration.
    2. The term includes but is not limited to interim proceedings such as —
      • motion- and petition practice,
      • and appeals from decisions in such interim proceedings.

23.3.2 Who can recover attorney fees?

  1. Prevailing party recovery: In any proceeding (as defined in Clause 23.3.1), the prevailing party is entitled to recover its attorney fees (ditto),
    • in addition to any other interim- and/or final relief to which the prevailing party shows itself to be entitled.
  2. Nonappealability of denial of interim awards: To reduce the chance of satellite litigation
    • over attorney-fee demands in motion practice and other interim proceedings,
    • each party WAIVES (as defined in Clause 24.26) any right
    • to appeal a decision by a tribunal not to award attorney fees for an interim proceeding.
  3. No recapture of interim awards: If a party is required to pay or reimburse attorney fees for an interim proceeding,
    • that party WAIVES (as defined in Clause 24.26)
    • any right it might have to recapture the payment or reimbursement
    • if that party is later awarded damages, or its own attorney fees, or any other monetary amount.
Commentary

It's probably not important to a contract drafter, but: Just what constitutes a "prevailing" party can be very fact-specific; Some courts have held that, if the putatively winning side did not receive any monetary damages or equitable relief, then it will not be considered the prevailing party for purposes of an attorney fee award.

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23.3.3 How is the "prevailing party" to be determined?

In determining which is the "prevailing" party, the tribunal is requested (if a court) or directed (if an arbitral tribunal) to take into account:

  1. the claims asserted;
  2. the amount(s) of money sought versus the amount(s) awarded; and
  3. offsets and counterclaims asserted (successfully or otherwise) by the other party.
Commentary

This language is adapted from a slide in a June 2020 CLE Webinar on "Commercial Contract Pitfalls" by Locke Lord attorneys Janet E. Militello and Brandon F. Renken.

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23.3.4 Option: Waiver for ADR Nonparticipation

  1. If this Option is agreed to, it applies if a party:
    1. fails to participate in efforts or proceedings required by a dispute-resolution provision of the Contract; and/or
    2. unsuccessfully challenges the enforceability of such a dispute resolution provision.
  2. The nonparticipating party will not be entitled to recover attorney fees (as defined in Clause 23.3.1) or other dispute-related expenses, of any kind, and that party hereby WAIVES (as defined in Clause 24.26) any such claim; this will be true even if:
    1. the nonparticipating party would otherwise have been entitled to such a recovery,
      • whether under the Contract or under applicable law; and/or
    2. the nonparticipating party prevails in the dispute in question or in the challenge against the validity or enforceability of the dispute-resolution provision in question.
Commentary

Subdivision a is modeled on a mediation provision, which has been enforced by courts, in a standard California residential real-estate purchase agreement.

Subdivision b is modeled on a provision in a real-estate sale contract, which stated that "if a party does not agree first to go to mediation, then that party will be liable for the other party's legal fees in any subsequent litigation in which the party who refused to go to mediation loses …."

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23.3.5 Option: Attorney Fees for Serious Accusations

  1. If this Option is agreed to, it applies if:
    1. a party (the "accuser") makes a "Serious Accusation" as defined below, against another party; but
    2. in the final judgment or arbitration award, as the case may be,
      • from which no further appeal is possible,
      • the tribunal does not find that the accusation was proved by:
      • (i) the proof required by law, or
      • (ii) if greater, the proof required by the Contract.
  2. When this section applies, the accuser must reimburse the other party for all of the other party's attorney fees incurred in the entire case,
    • not merely in defending against the unproved Serious Accusation,
    • unless the tribunal determines otherwise for good reason.
  3. In addition, the accuser may not recover any of its own attorney fees or other expenses or costs of the litigation or arbitration,
    • and the accuser hereby WAIVES (as defined in Clause 24.26) any such recovery,
    • regardless whether the accuser would have been otherwise entitled to such a recovery under the Contract and/or applicable law.
  4. Finally: The accuser must pay the other party USD $10,000 as liquidated damages,
    • representing the parties' best guess of what the other party would suffer in the way of additional expense, burden, and inconvenience for defending against the unproved Serious Accusation(s) in the case,
    • unless the tribunal determines otherwise for good reason.
    • (This is over and above the accuser's attorney-fee obligation under subdivision b.)
  5. The term "Serious Accusation" refers to any assertion that one or more other individuals and/or organizations (each, an "accused") engaged or is engaged in one or more of:—
    1. conduct punishable as a felony under applicable law; and/or
    2. fraud.
  6. Any and all parts of this section are severable from the Contract if found to be unenforceable for any reason.
Commentary

This section is intended to discourage parties' trial counsel from making baseless accusations against another party in the hope of prejudicing the jury, judge, or arbitrator.

This is a concern because many litigation counsel like to load up their pleadings with accusations of fraud, gross negligence, bad faith, breach of fiduciary duty, and the like — whether or not such accusations are really warranted by the facts.

The strategic thinking often seems to be something like this: What the hell, we might as well go ahead and make these accusations — there's no downside to us for doing so, and the jury might believe us. That will raise the stakes for the other side; this in turn will give us more leverage to force the other side to settle the case on our terms.

Unfortunately, even when Serious Accusations are baseless, they can pose major problems for their targets, because:

  • such accusations can unfairly influence jurors;
  • in themselves such accusations can damage a defendant's reputation — because third parties can tend to think, where there's smoke, there's fire — even if the defendant is ultimately vindicated;
  • such accusations are almost always expensive and time-consuming both to prosecute and to defend against, because wide-ranging discovery and expert testimony will usually ensue; and
  • such accusations can be tough to get rid of quickly, either on the pleadings or on summary judgment, because judges and arbitrators will often find that a full trial (usually a jury trial in the U.S.) or arbitration is required to decide the truth of the matter.

With these factors in mind, the expense-shifting and liquidated-damages features of this provision are intended to encourage parties to think long and hard before making a Serious Accusation, by giving them a significant financial downside if they make such an accusation but then fail to prove it.

Credit where it's due: This concept was inspired by a remark some years ago by the author's then-law partner (and longtime friend and mentor), über-patent-litigator John F. Lynch. Back then, accused patent infringers would routinely accuse patent owners and their patent attorneys of "fraud on the Patent Office," which is now known as inequitable conduct before the U.S. Patent and Trademark Office. John mused that perhaps there should be a rule, which I paraphrase from memory: If Lawyer A accuses Lawyer B of fraud on the Patent Office, then perhaps at the end of the case, one of the two lawyers should be suspended from practice. To be sure, this Option doesn't (and can't) go quite that far; it does, though, give parties an incentive to be cautious about making a Serious Accusation.

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23.3.6 Option: Attorney Fees American Rule

If this Option is agreed to, then each party is to bear its own attorney fees in all litigation, arbitrations, or other Agreement-Related Disputes.

Commentary

See the introductory commentary to § 23.3.

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23.3.7 Review questions

23.3.7.1 Attorney fees: The American Rule

QUESTION: Under the so-called "American rule," this party can recover its attorney fees if it prevails in contract-related litigation if the contract does not say otherwise:

23.3.7.2 Review — attorney fees in Texas: Who d'ya gotta be?

QUESTION: Under Texas law, when a plaintiff successfully asserts a contract claim against a  defendant, if the plaintiff wishes to recover its attorney fees under Tex. Civ. Prac. & Rem. Code sec. 38.001, the defendant must be a[n] [BLANK] or a[n] [BLANK].

23.4 Baseball-Style Dispute Resolution

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the parties engage in any Agreement-Related Dispute (as defined in Clause 25.3) about:

1. which is the correct number, e.g., an amount owed; or

2. what proposed action would comply with an agreed standard or requirement —

for example, what would constitute "commercially-reasonable efforts" if the Contract required a party to make such efforts.

Discussion checklist:

Commentary
A hypothetical example

Suppose that, in a contract between Supplier and Customer,

  • the parties disagree whether Customer owes a particular amount to Supplier,
  • and the parties are unable to resolve the disagreement under [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).

In that situation, Supplier and Customer would submit final offers,

  • and the tribunal would choose one of those final offers as the amount that Customer must pay,
  • in accordance with this Clause.
Baseball arbitration strongly motivates settlement

Final-offer or last-offer arbitration, a.k.a. "baseball arbitration" or "pendulum arbitration," promotes settlement by forcing the decision maker to choose between the parties' competing proposals. That constraint forces each party, in submitting its proposal(s), to think hard about whether the decision maker might regard the other party's proposal as being closer to the "correct" one, and thus whether the decision maker will be forced to adopt the other party's proposal.

As one commentator put it, baseball arbitration is "designed to produce a settlement, not a verdict."

And in Major League Baseball, last-offer arbitration does seem to work as a settlement incentive:

  • In 2018, fully 179 out of 201 arbitration-eligible players reached a settlement with their teams without having to go to hearing;
  • in 2019, it was 12 settlements out of 14 arbitration-eligible players;
  • and in 2020, it was 11 settlements out of 14 players.

See also Edna Sussman and Erin Gleason, Everyone Can Be a Winner in Baseball Arbitration: History and Practical Guidance (sussmanadr.com), in N.Y. State Bar Association, New York Dispute Resolution Lawyer, Spring 2019, at 28, archived at https://perma.cc/QW76-C7BB.

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23.4.1 How are the parties to exchange settlement proposals?

  1. The parties are to exchange, in succession, two written proposals to resolve the dispute.
  2. Each party is to provide the tribunal with a copy of each of that party's settlement proposals.
  3. Each party may include, in any proposal, a brief explanation why it believes the tribunal should select that proposal.
Commentary

Doing two successive rounds of settlement proposals should help nudge each party into assessing whether the other party's proposal might look better to the tribunal, which can promote reasonable positions and thus improve the odds of settlement. This borrows from a set of final-offer arbitration rules published by the International Centre for Dispute Resolution (the international division of the American Arbitration Association).

A variation of this is "night baseball," in which the tribunal is not given copies of the parties' respective proposals, but instead, after the hearing or trial, indicates which party wins; that party's settlement proposal then goes into effect.

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23.4.2 May the tribunal suggest that the parties try again?

Yes, as follows:

  1. The tribunal, in its sole discretion (as defined in Clause 25.19),
    • but no more than once,
    • may advise the parties that in the tribunal's view,
    • none of the parties' current proposals should be selected
    • (preferably, explaining why).
  2. If the tribunal does advise the parties of its views,
    • it should allow the parties a reasonable time to submit and confer about revised proposals if they so choose.
Commentary

Disclosure of the tribunal's impressions can likely help the parties reassess their settlement positions and thus formulate their next proposals for resolution of the dispute.

Some might be concerned that an arbitrator could give the impression of bias by commenting on the parties' proposals. But the ABA/AAA code of ethics for arbitration expressly contemplates that arbitrators will "comment on the law or evidence …. These activities are integral parts of an arbitration."

Certainly arbitrators must be vigilant against creating an appearance of bias. But neither should arbitrators be overly fearful of being attacked for bias:

  • Arbitrators and judges and jurors routinely and unavoidably form one or more initial impressions of the merits after the parties' opening statements. What is expected of them (nay, demanded) is that they they withhold judgment until all the evidence is in.
  • An arbitrator's disclosure of her initial impressions will help to increase the overall transparency of the arbitration proceeding, in the same vein as her disclosure of any past- or present relationships with the parties, counsel, witnesses, etc. If the arbitrator really does have a genuine bias, her disclosure of her impressions might help counsel to identify that bias.

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23.4.3 How is the tribunal to decide the dispute?

  1. If the parties' exchange of proposed resolutions does not lead to settlement,
    • then the tribunal is to select, as the resolution of the dispute —
      • without modification —
    • the one, party-proposed resolution
    • that the tribunal regards
    • as most-closely matching the resolution
    • that the tribunal would award in the absence of this Clause.
  2. The tribunal's selection of a party proposal will be binding unless otherwise agreed.
  3. In case of doubt: This Clause does not grant the tribunal any other power to decide the parties' dispute.
Commentary

One of the perceived advantages of baseball-style decision-making is that, because the tribunal must choose between the parties' last offers, the tribunal is not allowed to "go rogue," as is sometimes a concern about arbitrators (see § 23.1.14), nor may the tribunal "split the baby," as some think that arbitrators are prone to do (the author sometimes serves as an arbitrator and disagrees with this view).

Subdivision a: This section says that the arbitral tribunal "is to select" one of the parties' competing proposals, as opposed to stating that the tribunal "must select" one of the proposals. That's in deference to the fact that the tribunal might be a court, not an arbitration panel; a court would not be bound by the Contract, and a judge might take umbrage at contract language purporting to tell the court otherwise.

Subdivision c: The no-other-power language has in mind the case in which the arbitral tribunal does something other than choose between the two alternatives; the language should trigger one of the (very few) grounds under which a U.S. court will ordinarily set aside an arbitration award under the Federal Arbitration Act, namely that the arbitrators "exceeded their powers …."

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23.4.4 Baseball arbitration

FACTS: Gigunda wants MathWhiz to agree to "baseball" (last-offer) arbitration.

QUESTION: As counsel for MathWhiz, what are some pros and cons of this approach?

23.5 Blue Pencil Request

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a tribunal (as defined in Clause 23.26) of competent jurisdiction holds
    • that a provision of the Contract is invalid, void, unenforceable, or otherwise defective.
  2. In any such situation, the parties desire the following:
    1. All other provisions of the Contract are to remain enforceable.
    2. The holding of defectiveness is to apply:—
      • only in the jurisdiction of the tribunal issuing the holding,
      • and only for so long as the holding remains in effect.
    3. The tribunal is respectfully requested (if a court or other governmental body),
      • or directed (if an arbitral tribunal),
      • to reform the defective provision, if practicable,
      • to the minimum extent necessary to cure the defect,
      • while still given effect to the intent of the defective provision.
Commentary

A "blue-pencil" request — seen most often in connection with overly-restrictive noncompetition covenants— could in theory lead to unpredictable results.

New York courts can engage in blue-penciling of restrictive covenants, as authorized by a landmark Court of Appeals decision, if a standard is met:

… if the employer demonstrates an absence of overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct, but has in good faith sought to protect a legitimate business interest, consistent with reasonable standards of fair dealing, partial enforcement may be justified.

But in some other jurisdictions, courts will refuse to engage in blue-penciling of a contract even if contract specifically authorizes it. For example, the Indiana supreme court vacated a preliminary injunction that enforced a nonsolicitation covenant as modified, in part on grounds that in Indiana, the blue-pencil doctrine permits only deleting language, not adding limitations to a non-competition covenant: "Indiana courts employ the 'blue pencil doctrine' to revise unreasonable noncompetition agreements. This doctrine, though, is really an eraser."

For a possibly-dated survey of the doctrine, see Kenneth J. Vanko, A Quick State-By-State Guide on the Blue-Pencil Rule (2009), archived at https://perma.cc/CMF7-LHJB.

For commentary about a UK supreme court decision addressing blue-penciling, see Seyfarth Shaw LLP, First UK Supreme Court Decision on Restrictive Covenants for 100 years (JDSupra 2019), discussing Tillman v. Egon Zehnder Ltd., [2019] UKSC 32 at ¶¶ 54 et seq.

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23.6 Bond Waiver

If a party to the Contract sues another party (or demands arbitration),

  • to get an injunction, restraining order, specific performance, or other equitable relief against the other party,
  • on grounds that the other party is (or imminently will be) violating the Contract;

then the other party WAIVES (as defined in Clause 24.26) any requirement that the seeking party must post a bond as a prerequisite to such relief.

Commentary

Under U.S. procedural rules, when a party seeks a "restraining order" (i.e., preliminary injunctive relief), the court will often, and possibly must, require that party to post a bond to guarantee that at least some money will be available to compensate the defendant for any damage it might have suffered from an improvidently-granted preliminary injunction.

Caution: Agreeing to a bond waiver in a contract might be a really bad idea for a party that might be hit with a motion for preliminary injunction. That's because it might turn out:

  1. that the injunction should not have been granted, but
  2. the claimant, which obtained the wrongfully-granted injunction, doesn't have the money to compensate the respondent for the harm that the claimant caused.

In that situation, without a bond to serve as a backup pot of money, the respondent might never be able to recover damages for its wrongful harm.

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23.7 Contra Proferentem Disclaimer

  1. Each party:
    • acknowledges (as defined in Clause 25.1) that the parties were equally responsible for drafting the precise language of the Contract in its final form; and
    • agrees that any ambiguity in particular language of the Contract is not to be interpreted against the party that happened to draft the language solely on that basis —
    • that is, the contra proferentem ("against the profferor") principle of contract interpretation is not to be applied.
  2. This Clause, however, is not intended to rule out having the language interpreted against the drafting party for other reasons.
Commentary
Introduction: What is "contra proferentem"?

The contra proferentem principle of contract interpretation holds that if an ambiguity in particular contract language cannot be resolved by other conventional methods — e.g., by consulting other language in the contract and/or by considering extrinsic evidence such as course of dealing and usage in the trade — then the ambiguity should be resolved against the party that drafted the ambiguous language and thus is "to blame" for the problem. (If a contract provision is not ambiguous, then contra proferentem won't come into play in the first place.)

The (U.S.) Supreme Court explained the concept: "Respondents drafted an ambiguous document, and they cannot now claim the benefit of the doubt. The reason for this rule is to protect the party who did not choose the language from an unintended or unfair result." Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62-63 (1995) (reversing 7th Circuit) (citations and footnotes omitted).

Contra proferentem is roughly analogous to the baseball rule, tie goes to the runner. It gives drafters an incentive to draft clearly, because as between the drafter of ambiguous language, on the one hand, and the "innocent" other party, it's the drafter that must bear the consequences of the ambiguity.

See generally:

Language choice: Disclaimer, not prohibition

This provision is phrased as a disclaimer, and not as a prohibition forbidding a court from applying contra proferentem. That's because parties to a contract generally can't prohibit a court from applying a particular legal doctrine; they can only request that the court not apply the doctrine.

Caution: Disclaiming contra proferentem can cause problems

Suppose that a court or arbitrator concluded that there was no way to resolve an ambiguity in a contract, other than by applying the contra proferentem principle — but the parties had agreed that contra proferentem was not to be used. The results in that situation might be unpredictable:

  • The tribunal might disregard the contra proferentem prohibition and apply the principle to resolve the ambiguity; or
  • The tribunal might rule that the ambiguous provision could not be enforced — which in some circumstaces might jeopardize the enforceability of the entire contract.

(Hat tip: Jonathan Ely, in a comment in a LinkedIn group discussion (group membership required).)

Exercise: Contra proferentem and a CPI clause

FACTS:

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

QUESTION: On these facts, how might a court rule on Buyer's claim that Seller's price increases must be limited to the increase in CPI-U and not to the increase in the special CPI? [3]

(See also Clause 17.1 (Consumer Price Index / CPI Definition).)

Exercise: Re-using an old contract form

FACTS:

  1. A partner in your law firm gives you an assignment to draft a contract, and suggests that you start with a particular prior agreement, which she gives you. You change the parties' names and the business terms in the prior agreement to reflect the current deal.
  2. The parties sign the agreement, but unfortunately the relationship quickly goes south.
  3. Your client claims that the other party has breached a particular clause in the contract.
  4. The other party claims that the clause in question is too hard to understand — a sentiment with which you privately agree — and that your client had told him that the clause meant something entirely different from what your client is claiming now.
  5. The contract does not include an entire-agreement ("integration") clause.
  6. The General Provisions section says, among other things, that "Each party acknowledges (as defined in Clause 25.1) that it has been represented by counsel in negotiating this transaction."
  7. Your client confirms, though, that the other side actually wasn't represented by counsel.

QUESTION: How might a court analyze this situation? [4]

23.8 Corroboration Requirement

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract calls for a factual assertion to be supported by corroborating evidence.
  2. The question whether sufficient corroboration has been provided is to be governed by a rule of reason.
  3. Corroborating evidence can include, without limitation, documents and testimonial evidence.
  4. Each case requiring corroboration is to be decided on its own facts; hard and fast rules will not necessarily apply.
  5. Not every detail need necessarily be independently and conclusively supported by corroborating evidence.
Commentary

The requirements in this Clause are adapted from the Federal Circuit's TransWeb case.

A corroboration requirement takes into account that witnesses might "describe [their] actions in an unjustifiably self-serving manner …. The purpose of corroboration [is] to prevent fraud, by providing independent confirmation of the [witness's] testimony."

The U.S. Supreme Court explained the need for corroboration of self-interested statements in a famous 19th-century case concerning a patent for a type of barbed wire. In that case:

  • an accused patent infringer claimed that someone else was actually the first inventor of the patented barbed wire; BUT
  • the accused infringer relied solely on oral testimony to support the claim of prior invention.

The Court was not persuaded that the uncorroborated testimony rose to the level needed to invalidate the patent in suit:

We have now to deal with certain unpatented devices, claimed to be complete anticipations of this patent, the existence and use of which are proven only by oral testimony.

In view of the unsatisfactory character of such testimony, arising from the forgetfulness of witnesses, their liability to mistakes, their proneness to recollect things as the party calling them would have them recollect them, aside from the temptation to actual perjury, courts have not only imposed upon defendants the burden of proving such devices, but have required that the proof shall be clear, satisfactory and beyond a reasonable doubt. [In modern U.S. patent law, such claims must be established by clear and convincing evidence.]

Witnesses whose memories are prodded by the eagerness of interested parties to elicit testimony favorable to themselves are not usually to be depended upon for accurate information.

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23.9 Dispute Management Protocol

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. To promote amicable resolutions of disputes, in any case of an Agreement-Related Dispute (as defined in Clause 25.3), the parties are to proceed in accordance with the following Tango provisions, in the order listed unless the cited provision indicates otherwise, or as otherwise agreed:
    1. Clause 23.16 (Internal Escalation)
    2. Clause 23.18 (Lawyer Involvement)
    3. Clause 23.21 (Neutral Evaluation)
    4. Clause 23.23 (Senior Management Mini-Trial) (may be combined with #3)
    5. Clause 23.4 (Baseball-Style Dispute Resolution) (for disputes coming within its scope)
  3. Toward the same goal, the following will apply unless otherwise agreed:
    1. Clause 23.24 (Settlement Confidentiality)
    2. Clause 23.25 (Settlement Rejection Consequences)

23.10 Equitable Relief

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Any party,
    • referred to here as a "claimant,"
    • upon proper proof,
    • may seek injunctive relief,
    • against actual- or imminent breach of the Contract,
    • in accordance with the four-factor test restated by the (U.S.) Supreme Court in eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388, 391 (2006).
  3. Each other party,
    • referred to here as a "respondent,"
    • acknowledges (as defined in Clause 25.1)
    • that some types of breach of the Contract,
    • by the respondent,
    • could result in irreparable harm to the claimant,
    • that would not be adequately compensable by monetary damages or other remedies at law.
Commentary

Caution: Reviewers being asked to agree to language like this should pay careful attention to it, because it could end up significantly disadvantaging the party against which injunctive relief is someday sought.

Contents:

Legal background: The four-factor proof requirement for injunctive relief

In U.S. jurisdictions, a party seeking an injunction or similar equitable relief must show, not merely allege, that (among other things) it has suffered or is likely to suffer irreparable harm that could not be adequately compensated by remedies available at law, such as monetary damages.

As explained by the Supreme Court of the United States:

According to well-established principles of equity, a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief.

A plaintiff must demonstrate:

(1) that it has suffered an irreparable injury;

(2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury;

(3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and

(4) that the public interest would not be disserved by a permanent injunction.

The decision to grant or deny permanent injunctive relief is an act of equitable discretion by the district court, reviewable on appeal for abuse of discretion.

eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388, 391 (2006) (describing traditional four-factor test in context of patent-infringement injunctions) (citations omitted, emphasis and extra paragraphing added).

Caution: Stipulating to irreparable harm might be a significant concession

A potential future Respondent might not want to stipulate to irreparable harm, because doing so would absolve the Claimant from what might be a significant burden of proof, as discussed below.

On the other hand, in some cases — e.g., misappropriation of crucial trade secrets — the existence of irreparable harm might be pretty obvious. In such a case, it might not be much of a concession for a potential Respondent to stipulate in advance to the existence of irreparable harm.

Stipulations to irreparable harm have been enforced

In a 2012 opinion, then-chancellor Strine of the Delaware chancery court (now chief justice of the state's supreme court) relied in part on a similar clause in granting a four-month injunction against one company's hostile takeover bid targeting another company:

In Delaware, parties can agree contractually on the existence of requisite elements of a compulsory remedy, such as the existence of irreparable harm in the event of a party's breach, and, in keeping with the contractarian nature of Delaware corporate law, this court has held that such a stipulation is typically sufficient to demonstrate irreparable harm.

Martin Marietta Materials, Inc v. Vulcan Materials Co., 56 A.3d 1072, 1144-45 (Del. Ch.), aff'd, 45 A.3d 148 (Del. 2012) (en banc) (footnotes with extensive citations omitted).

But a contract can't force a court to issue an injunction

Even if a contract stipulates that a party will suffer irreparable harm from breach, a court might not give effect to the stipulation. "We hold that the terms of a contract alone cannot require a court to grant equitable relief. In doing so, we adopt the accepted rule of our sister circuits that have addressed the question."

And the Delaware chancery court disregarded a contractual stipulation of irreparable harm in one case:

Parties sometimes, as Renco and M&F did here, agree that contractual failures are to be deemed to impose the risk of irreparable harm. Such an understanding can be helpful when the question of irreparable harm is a close one.

Parties, however, cannot in advance agree to assure themselves (and thereby impair the Court’s exercise of its well-established discretionary role in the context of assessing the reasonableness of interim injunctive relief) the benefit of expedited judicial review through the use of a simple contractual stipulation that a breach of that contract would constitute irreparable harm.

[In footnote 20 the court added:] In part, this is simply a matter that allocation of scarce judicial resources is a judicial function, not a demand option for litigants.

AM General Holdings LLC v. The Renco Group, Inc., No. 7639-VCN, slip op. at 10, text accompanying nn.19-20 (Del. Ch. Dec. 29, 2015) (denying request for preliminary injunction) (footnotes omitted, extra paragraphing added).

For a useful catalog of things that might qualify as irreparable harm, see the cases cited in Paige Bartholomew, Commercial Division Judge Reaffirms "Most Critical" Element for Injunctive Relief: Irreparable Harm (JDSupra 2020) (scroll down to the list of bullet points).

Subdivision c: Language choice

Claimants usually want a stronger version of this acknowledgement (as defined in Clause 25.1), in which the respondent concedes that the breach would result in irreparable harm to the claimant. That might well be a major concession by the respondent, absolving the claimant from what could be a significant burden of proof in litigation, as discussed above. In some cases, of course — for example, cases involving misappropriation of crucial trade secrets — the existence of irreparable harm might be obvious. In such a case, it might not be much of a concession for a potential respondent to stipulate in advance to the existence of irreparable harm.

See also

See also the commentary to the Bond Waiver, which likewise can be dangerous to a party that might have to defend against a motion for preliminary injunction or similar equitable relief.

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23.11 Forum Selection

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract states that specified disputes may — or must — be brought in a particular court or jurisdiction (each, an "Agreed Forum").

Discussion checklist:

23.11.1 What location(s) are permissible for litigation?

Any such specified dispute,

  • if not required to be resolved by other means,
  • may be heard in any Agreed Forum,
    • regardless where the defendant is geographically located.
Commentary : Forum selection
Legal background

In the U.S., federal courts routinely enforce forum-selection clauses "unless extraordinary circumstances unrelated to the case clearly disfavor a transfer."

"[A] forum selection clause should be enforced unless the resisting party can show[:] [i] that enforcement would be unreasonable and unjust, or [ii] that the clause was invalid for such reasons as fraud or overreaching or [iii] that enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision."

Likewise, state courts in the U.S. generally honor forum-selection provisions "unless the party challenging enforcement establishes that such provisions are unfair or unreasonable, or are affected by fraud or unequal bargaining power."

Language choices

This Clause does not say that disputes must be litigated in an Agreed Forum, but only that disputes may be heard there — and even that language is non-exclusive, so as not to rule out:—

  • filing a lawsuit in another venue, nor
  • seeking a transfer of a case to another forum after its filing.

The "regardless where the defendant is geographically located" language is adapted from a forum-selection provision that was successfully asserted on appeal by the plaintiff.

"Arising out of," but not "relating to," the agreement

Drafters should be careful about specifying a forum for proceedings "relating to" the parties' agreement, as opposed to the narrower "arising out of" the agreement.

Here's a hypothetical example of why that might be a concern – suppose that:

  • Provider licenses its software to Customer.
  • The license agreement requires any litigation arising from the agreement to be brought in the city of Customer's principal place of business; let's assume that's Atlanta.
  • One day, though, a different division of Customer, located in, say, Zion (Illinois), rolls out a new product that:
    • performs some of the functions of Provider's software, and
    • bears a trademark that's confusingly similar to Provider's trademark.

In that situation, if Provider wanted to sue Customer for trademark infringement, then:

  • Provider might well want to bring the lawsuit in Zion because of the better availability of witnesses and documents,
  • but Provider might not be able to do so if the license agreement required all disputes relating to the license agreement to be brought in Atlanta.
Caution: Saying "the courts of a jurisdiction could be dangerous

This Clause does not say that the parties agree to have suits heard "in the courts of" the specified forum location. A U.S. court might find that such language precluded the defendant from removing the suit to federal court. That happened in a Ninth Circuit case, where the appeals court also held that the forum-selection clause was unenforceable.

Caution: The term "shall be subject to" might confer exclusive jurisdiction

In an English case, a Hong Kong freight forwarder used its standard bill-of-lading form in accepting cargo for shipment from China to Venezuela. The form provided in part that "[t]his Bill of Lading and any claim or dispute arising hereunder shall be subject to English law and the jurisdiction of the English High Court of Justice in London." The UK Court of Appeal, after reviewing case law concerning similar language, held that the bill of lading's wording conferred exclusive jurisdiction on the English courts.

A court might not honor the parties' agreement to an improper forum

In many American states, a statute specifies the location where a lawsuit must be brought. Typically, this will be either the county where the plaintiff resides or the county where the defendant resides.

If a contract's forum-selection clause specifies a county that does not meet the statutory requirement, a court might refuse to enforce the forum selection. This happened in a North Carolina case — although the court did note that "a forum selection clause which favored a court in another State was enforceable …."

And forum-selection clauses might be disregarded for policy reasons

Courts will sometimes refuse to honor a contract's forum-selection clause if the clause offends a strong public policy of the forum location. Here are a couple of examples.

A group of users of the America OnLine (AOL) service sued AOL in California and sought class-action status.

  • The AOL user agreement required all disputes to be litigated in Virginia.
  • Citing the forum-selection clause, a federal district court in California dismissed the case but said it could be re-filed in Virginia state courts as required by the user agreement.
  • The federal appeals court disagreed. It held that California had a strong public policy favoring class-action relief, and noted that such relief was not available in Virginia state courts. Therefore, said the appeals court, "the forum selection clause in the instant member agreement is unenforceable as to California resident plaintiffs bringing class action claims under California consumer law."

A Texas case had a very different outcome:

  • AutoNation, a Florida-based car dealer, filed suit, in Florida, against a former employee who lived in Texas and had worked for the car dealer there.
  • The former employee's employment agreement contained a choice-of-law clause calling for Florida law to apply, together with a forum-selection clause requiring any litigation to take place in Florida.
  • Before learning of the Florida action, the former employee sued the car dealer in Texas, seeking a declaratory judgment that the non-competition covenant of the employment agreement was unenforceable under prior Texas supreme court precedent.
  • Granting a writ of mandamus, the Texas supreme court ruled that while it was not questioning the validity of its prior precedent, it would still enforce the "freely negotiated" [sic] forum-selection clause to allow the first-filed suit in Florida to proceed.

QUESTION: On the AutoNation facts, what are the odds that the Florida court would have applied Texas law, given that the contract included a Florida choice-of-law clause?

For additional discussion and case citations, see generally Paulo B. McKeeby, Solving the Multi-State Non-Compete Puzzle Through Choice of Law and Venue (2012).

Caution: China could be a special case

Anyone drafting a contract with a Chinese counterparty should consider:

  • whether the contract meets the language- and governing-law requirements of Chinese law to make the contract enforceable by a Chinese court; and
  • if not, whether the counterparty has sufficient reachable assets in a more-friendly jurisdiction (because Chinese courts purportedly won't enforce foreign judgments or arbitration awards).
Caution: A Massachusetts forum could be dangerous for defendants

If a contract specifies Massachusetts as the forum state for litigating disputes, the defendant might find that its bank account and other assets have been "attached" even before trial if the plaintiff can show a likelihood of success on the merits.

Territory-specific choice of forum?

Some companies’ boilerplate terms include territory-specific choices of forum (and law). For example, here’s a territory-specific forum provision from Carson Wagonlit Travel, at https://perma.cc/6RJK-57EM:

18.1 This Agreement shall be exclusively governed by the exclusive laws of [sic] and all disputes relating to this Agreement shall be resolved exclusively in[:]

(i) England and Wales and governed by English law if the Seller’s registered office is located in the Europe, Middle East, Africa (EMEA) region;

(ii) Singapore if the Seller’s registered office is located in Asia Pacific (APAC) region; or

(iii) the State of New York, USA if the Seller’s registered office is located the Americas region.

(Emphasis and extra paragraphing added.)

Failing to advise a client in writing about forum selection could get a lawyer in trouble

In a UK case:

  • An English sports executive was approached about signing on as CEO of an Indian company in the sports business.
  • A Web page of a UK legal-malpractice law firm says that the executive's longtime London law firm had only three hours to draft the employment agreement.
  • The court found that the law firm had failed to advise the executive to include a forum-selection clause in the draft to require litigation to be in England because of the notorious slowness of Indian courts.
  • After much litigation, the end result was a £40,000 judgment against the law firm for the executive's wasted costs of trying to collect the judgment.

The lesson: If the law-firm partner had advised the executive in writing about the desirability of including an English forum-selection clause, the case might never have gotten as far as it did.

Additional terms to consider

Consider also:

23.11.2 Is the selected forum exclusive? No

An Agreed Forum is not exclusive unless the Contract clearly says so.

23.11.3 May a case be transferred from an exclusive forum? No

If the Contract clearly says that an Agreed Forum is exclusive,

  • then no party will seek to transfer a dispute that is brought there.

23.11.4 Discussion questions

1.  When might a court not give effect to a forum selection provision?

2.  How might an exclusive forum-selection provision affect an arbitration provision?

3.  Any issues with saying that the exclusive forum is to be "the courts of Houston, Texas"?

4.  When might it make a difference if the forum-selection clause applies to actions:

  • arising out of the agreement, versus
  • arising out of or relating to the agreement?

5.  What's a really broad "arising out of …" expression you could use in a forum-selection provision?

23.12 Franchise-Law WAIVER

The parties do not intend for anything in the Contract to be construed as making any party a franchisee of the other party,

  • and each party WAIVES (as defined in Clause 24.26) the benefit of any state or federal statutes dealing with the establishment and regulation of franchises.
Commentary

In some jurisdictions, this waiver 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 is still sometimes seen in contracts

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23.13 Fraud Proof Requirement

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Any assertion that a person committed or engaged in fraud must be established by showing — in addition to any other required elements — one or both of the following:
    1. that the person made an untrue statement of a material fact,
      • with knowledge of the statement's untruth;
    2. or that the person omitted a material fact,
      • with knowledge that the material fact was necessary in order to make the statements made,
      • in the light of the circumstances under which they were made,
      • not misleading.
  3. Each element of proof of fraud must be supported by clear and convincing evidence (as defined in Clause 25.13),
  4. The fraud-proof requirements of this section apply, without limitation:
    • to any claim of fraud made in any Agreement-Related Dispute (as defined in Clause 25.3),
    • whether the claim purports to arise under contract law, tort law, strict liability law, statutory law, or otherwise.
  5. In case of doubt: each party WAIVES (as defined in Clause 24.26) any claim of fraud that is not proved in accordance with the fraud-proof requirements of this section.
Commentary

Subdivision b: These specific fraud-proof requirements are adapted from the definition in Rule 10b-5 of the U.S. Securities and Exchange Commission; see generally the Wikipedia article "Rule 10b-5."

Subdivision c – clear and convincing evidence: This proof requirement is based on the widely-applied (but not universally-followed) standard in U.S. law.

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23.13.0.1 Review: Can liability for fraud be disclaimed?

QUESTION: An entire-agreement provision, by itself, won't preclude an aggrieved party from claiming misrepresentation unless the entire-agreement provision includes a disclaimer of this thing: [one word]

23.14 Fraudulent inducement (commentary)

23.15 Governing Law

  1. This Clause applies if the Contract specifies a governing law or a "choice of law" (which is intended to mean the same thing),
    • referred to as the "Governing Law."
  2. Unless the parties expressly agree otherwise in writing, the Governing Law is to apply in any Agreement-Related Dispute (as defined in Clause 25.3).
  3. The Governing Law is to be applied without regard to conflicts-of-law rules that might otherwise result in the application of the law of some other jurisdiction.
  4. If the Contract requires arbitration (as defined in Clause 23.1) of some or all disputes,
    • then any such arbitration is to be governed by the Governing Law,
    • unless the arbitration agreement expressly provides for a different arbitral law,
    • in which case the specified arbitral law will govern.
  5. The Contract may exclude one or more laws, to the extent not prohibited by law.
Commentary
A court might disregard a problematic choice of law

A court might not give effect to a governing-law clause in a contract if doing so would lead to a result that contravened a fundamental public policy of the law of the jurisdiction in which the court sits. Here are some examples:

EXAMPLE: In New York, a non-solicitation provision in an employment agreement (as in, no soliciting our customers after you leave), purporting to bind an employee in that state, is judged by New York law, not the governing law stated in the employment agreement.

EXAMPLE: A medical-device sales representative quit his job in Arizona and started working for a direct competitor of his former company. So, the former company filed a lawsuit in federal court in Arizona. The former company wanted to enforce a non-competition covenant in the sale rep's employment agreement; it asked the court for an immediate temporary restraining order (TRO) to prohibit the sales rep from working for the competitor.

The Arizona federal court refused to grant the requested restraining order:

  • The court recognized that the employment agreement's governing-law clause specified that the law of Washington state would apply.
  • But, said the Arizona court, in this area the laws of Arizona gave more weight to employees' right to earn a living than did Washington law, and this was an area of fundamental public policy for Arizona law.
  • Consequently, the court refused to give effect to the agreement's choice of Washington law — and the court held that under Arizona law, the sales rep's non-competition covenant was unenforceable.

EXAMPLE: A California truck driver sued the Texas-based trucking company for which he worked for violating California employment law. The driver's contract with the company specified that Texas law would apply and said that the driver was an independent contractor, not an employee.

A California federal district court granted summary judgment in favor of the employer: The court reasoned that Texas law governed, as required by the contract. Applying Texas law to the facts of the case, the court concluded that the driver was indeed an independent contractor and therefore could not sue the company for violating California employment law.

The federal appeals court, though, reversed:

  • The court held that California courts would not give effect to the contract's choice of Texas law, but instead would apply California law.
  • Under California law, said the appeals court, the driver was really an employee, not an independent contractor, and therefore could properly sue the trucking company for violating California employment law.

EXAMPLE: A Maine-based sales representative was employed by a California company. The sales rep's employment agreement included a California choice-of-law clause. The company failed to pay commissions on certain sales.

The First Circuit held that Maine law governed — and therefore the sales rep was entitled, not only to back commissions, but also to treble damages and attorney fees under a Maine statute.

But a court might give effect to a problematic choice of law

Contrary to the above examples, a court might give effect to a contract's choice of law even if a party claimed that the choice contravenes a fundamental public policy.

For example, the  Supreme Court of Texas held that it was permissible for ExxonMobil to choose New York law for its employee stock-option and restricted-stock programs, because multi-national companies should be able to choose the laws they want to follow, in the interest of uniformity.

(OK, the "choose the laws they want to follow" part does overstate the court's holding just a bit, but not by much; the court arguably opened the door wide for corporations to purport to impose onerous terms and conditions on their employees while using a choice-of-law clause to strip the employees of their legal protections.)

Which governing law to choose?

Drafters wondering which governing law to choose should give some thought to the specifics of the laws being considered.

• Several years ago the author started a choiceof-law cheat sheet for U.S. states (still a work in progress) that might be helpful.

• In international transactions, a party from a jurisdiction with a civil code (e.g., continental Europe; Latin America) might be reluctant to agree to the law of a common-law country (e.g., England and its former colonies), or vice versa. In that situation, the UN CISG (discussed below) might be an acceptable "neutral" choice.

• English law is often chosen for multi-national transactions.

• Different laws might be suited for different industry categories.

Choose the law of the agreed forum?

If the parties are also going to agree to a choice of forum — about which see the Forum Selection — then they might want to choose the law of the agreed forum as their governing law. That could increase the chances of having their choice of law enforced in a dispute.

For example: the parties might agree to New York law, in part to take advantage of the statutory provision validating clauses requiring amendments to be in writing in certain contracts (see the [BROKEN LINK: amend-apx]] and its commentary). A New York court would seem to be more likely to give effect to that provision, and thus to an amendments-in-writing clause, than might a court in another jurisdiction.

Territory-specific choice of law?

Some companies’ boilerplate terms include territory-specific choices of law (and forum selections). For example, here’s a territory-specific governing law provision from Carson Wagonlit Travel, at https://perma.cc/6RJK-57EM:

18.1 This Agreement shall be exclusively governed by the exclusive laws of [sic] and all disputes relating to this Agreement shall be resolved exclusively in[:]

(i) England and Wales and governed by English law if the Seller’s registered office is located in the Europe, Middle East, Africa (EMEA) region;

(ii) Singapore if the Seller’s registered office is located in Asia Pacific (APAC) region; or

(iii) the State of New York, USA if the Seller’s registered office is located the Americas region.

(Emphasis and extra paragraphing added.)

Caution: China could present issues for choice-of-law provisions

At the China Law Blog, Dan Harris asserts that as a practical matter, Chinese courts:

  • will not enforce a contract unless the contract is written in Chinese and the governing law is Chinese;
  • will not enforce judgments of other nations' courts in contract lawsuits; and
  • are unlikely to enforce arbitration awards from non-Chinese jurisdictions.
Subdivision c: No renvoi

The legalese term for a ping-pong application of a choice of law is "renvoi." An analogous issue came up in an Idaho case, where the state's supreme court held that the agreement's choice of Texas law required arbitration in Idaho, not in Dallas — even though the contract expressly required arbitration in Dallas.

Subdivision d: Law for arbitration

Suppose that the Contract specified Texas law for general purposes, but New York law for arbitration. Then, any arbitration pursuant to that provision would be governed by New York law — and, if applicable, the U.S. Federal Arbitration Act. See also § 23.1.5 (arbitral law).

Subdivision e: Excluded laws

It's not uncommon for parties to exclude, e.g., the United Nations Convention on Contracts for the International Sale of Goods ("UN CISG" or "Vienna Convention"). That convention, in some ways, amounts to an international version of the U.S. Uniform Commercial Code, with nontrivial differences.

Another possible exclusion is the Uniform Computer Information Transactions Act ("UCITA"), which is (was?) a controversial proposed uniform law that was enacted only in Maryland and Virginia, and and otherwise appears to be essentially dead.

Section 104 of UCITA allows parties to a contract to "opt out" of the Act's applicability. Going even farther, a few states have enacted so-called "bomb-shelter" legislation voiding any contractual choice of law that would result in UCITA being applied.

Different jurisdictions' laws for different purposes?

It might seem strange to specify a choice of law to govern just one particular provision in a contract. But it’s not unheard of; for example:

• The 1988 update to the Restatement (Second) of Conflicts of Laws states that "the parties may choose to have different issues involving their contract governed by the local law of different states." The comment cites a Maryland case in which loan documents for a real-estate project adopted local Maryland law for interest- and usury issues but New York law for others.

• In its famous Akorn v. Fresenius decision, the Delaware chancery court observed: "The parties … chose Delaware law to govern the Merger Agreement (excluding internal affairs matters governed by Louisiana law) ….."

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

• An international contract might specify that it is to be governed by the laws of, say, Brazil, but that any arbitration is to be "[BROKEN LINK: arb-loc]" in England, which might well mean that the arbitration proceedings would be governed by English law. That was precisely the holding of an English court.

A governing-law clause might backfire

Specifying the law that you want to govern your contract, or your contractual relationship, might lead to unexpected (and undesired) results. Here are some real-world examples:

• A group of couriers, working in New York as couriers for a Massachusetts-based company, sued the company in Massachusetts for unpaid overtime. These New-York based couriers claimed to be entitled to the protection of Massachusetts statutes governing independent contractors, wages, and overtime.

Normally, people who file employment-type lawsuits against their companies tend to do so in their own home jurisdictions. That’s understandable; the home-court advantage is not to be sneezed at – and it’s also why companies like for their contracts to specify their home court for any lawsuits.

Well, that’s just what had happened here: the courier company had used a standard form for its contracts with its New York courier personnel. The contract form stated that Massachusetts law would apply and that all disputes would be litigated in Massachusetts.

When confronted by an actual employee lawsuit in the forum it had specified, the company moved to dismiss the case — and the Massachusetts trial court granted the motion — on theory that the employment laws of Massachusetts did not apply to people who worked in New York.

The Massachusetts supreme court disagreed; it reversed the trial court’s decision, giving an interim win to the New York-based courier personnel. The supreme court held that it would not be unfair to enforce the courier company’s own forumselection and governing-law clauses against the company.

Moreover, said the supreme court, enforcement of those clauses would not contravene a fundamental policy of the state of New York, where the couriers actually worked. The supreme court said that the trial court would need to conduct an evidentiary hearing to determine whether, on the facts of the case, the forum-selection and governing-law clauses should be enforced. The court remanded the case to the trial court for further proceedings.

• A Florida-based, remote-working employee of a failed Massachusetts company successfully sued the company's CEO — personally — for more than $100,000 in unpaid wages and expense reimbursements, among other amounts. The employee did so under a Massachusetts statute that created the right of action, in part because the Florida-based employee's employment agreement stated that Massachusetts law applied.

But a federal district court in Oklahoma, considering the same Massachusetts statute, distinguished the Dow opinion and dismissed the class-action claims filed by two remote employees; in that case, unlike Dow, the employment agreement did not include a choice-of-law provision.

• In a Canadian franchise-dispute case, an appeals court held that Ontario law — which gave franchisees specific rights — applied even to franchisees outside Ontario because the franchise agreement specified that Ontario law would apply.

• BUT: A federal district court in San Francisco held that Uber drivers working outside California could not sue the company for violation of a California wage-and-hour statute, even though the drivers’ contract with Uber included a California choice-of-law clause, on grounes that the relevant statutes did not apply extraterritorially.

Too-narrow a governing-law clause can be problematic

Drafters and reviewers should pay attention to the scope of the governing-law clause. Here are a couple of examples where that proved to be an issue.

EXAMPLE: A Canadian software company had too narrow a choice of Canadian law in its end user license agreement ("EULA") and, as a result, found itself forced to defend a class-action lawsuit in Chicago instead of in Victoria, B.C. The court noted that the EULA’s governing-law provision applied only to the EULA per se and did not encompass the plaintiff’s Illinois-law claims; this, said the court, tipped the balance in favor of keeping the case in Chicago.

EXAMPLE: A married couple brought an arbitration claim against its investment firm.

  • The parties' contract contained a choice of Massachusetts law, but that choice of law applied only to the interpretation and enforcement of the contract, not to related claims.
  • The client’s claims against the investment firm included not only contract claims, but also claims under a Pennsylvania unfair-trade-practices statute.
  • The arbitrator held that, because the contract's choice-of-law provision did not apply to noncontract claims, the Pennsylvania statute was available to the client; the arbitrator awarded treble damages under the Pennsylvania statute.
  • The court upheld the (sizeable) arbitration award.
Further reading

See generally (the extremely-useful) John F. Coyle, The Canons of Construction for Choice of Law Clauses, 92 Wash. L. Rev. 631, 648-55 (2017).

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23.16 Internal Escalation

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

Discussion checklist:

23.16.1 When does this Clause apply?

This Clause will apply if:

  • the parties disagree about a matter relating to the Contract,
  • and are unable to resolve the disagreement at the working level.
Commentary
Why escalate disputes?

Disputes can often be nipped in the bud if the parties would just talk to each other regularly, as provided in Clause 24.20 (Status Conferences). But in case that doesn't happen, this Clause sets up a process to try to resolve disputes before the parties dig their heels in — and you'll be in breach of contract if you refuse to escalate when asked.

Escalation can be effective in resolving disputes at the working level because, as one article puts it, "the threat to line managers of having to explain to senior executives of both companies the failure to effectively cooperate likely carried more weight than the threat of legal action." The authors continue: "Superiors are unlikely to look with favor on subordinates who send problems up the line for resolution. The subordinates' job is to resolve problems, not escalate them."

For another example of escalation-clause language, see the CPR International Model Multi-Step Dispute Resolution Clause (scroll down to "(A) Negotiation").

Mechanics of escalation

If a party asks for escalation, each party should advise the other party in writing of the name and contact information of a representative at the next-up management level (each, a "Senior Representative").

Each Senior Representative should have authority to discuss — and, preferably, the authority to settle — the dispute on behalf of the party represented.

Senior Representatives should meet at least once by video conference (or by phone or in person if they agree) and try to settle the dispute.

Arrangements for Senior Representatives' meetings would typically be initiated and coordinated by the party making the request for escalation.

It can be helpful for each party to provide the other party, in advance of each Senior Representative meeting, with a reasonably-detailed written statement of the providing party's then-current position in the dispute.

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23.16.2 Two levels of internal escalation are required

If either party so requests in writing,

  • then each party must internally escalate a pending disagreement,
  • at least two levels "up" in succession if necessary.
Commentary

Some escalation provisions require issues to be referred all the way up to "executive-level management." Apart from the vagueness of that term, a giant multinational corporation isn't likely to want to be forced to escalate a small-dollar issue all the way to its executive suite.

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23.16.3 Internal escalation is a prerequisite to litigation or arbitration

The parties must finish escalating under this Clause before commencing litigation or arbitration, EXCEPT:

  1. to the minimum extent necessary:
    • to prevent irreparable harm, and/or
    • to meet a deadline for taking action under an applicable statute of limitations or statute of repose —
      • in which case each party must offer to escalate in accordance with this Clause immediately after commencing litigation or arbitration; or
  2. if the other party refuses to cooperate in escalating as set forth in this Clause.
Commentary

This section seeks to forestall a non-aggrieved party from racing to the courthouse (or to arbitration) to get a home-court advantage.

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23.17 Jury Trial WAIVER

23.17.1 Each party is waiving jury trial for all disputes

Each party VOLUNTARILY waives the right to trial by jury for all Agreement-Related Disputes (as defined in Clause 25.3).

Commentary

Waiver of jury trial are more likely to be enforced if the waiver is by each party, not by just one party.

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23.17.2 The jury-trial waiver is to apply as broadly as the law allows

This Clause applies to the greatest extent not prohibited by law.

Commentary

Pre-dispute waivers of jury trial are unenforceable in some jurisdictions:

Arkansas: See Tilley v. Malvern Nat'l Bank, 2017 Ark. 343, 532 S.W.3d 570 (state constitution prohibits pre-dispute jury waivers unless authorized by law), overturned in part by Ark. Code § 16-30-104 (new statutory exception for contracts to borrow or lend money), discussed in Tilley v. Malvern Nat'l Bank, 2019 Ark. 376 (holding that supreme court's mandate remanding for jury trial was not affected by intervening enactment of statutory exception).

California: See Grafton Partners, L.P. v. Superior Court, 36 Cal. 4th 944, 32 Cal. Rptr. 3d 5, 116 P.3d 479 (2005) (state constitution prohibits advance waivers of jury trial); Rincon EV Realty LLC v. CP III Rincon Towers, Inc., 8 Cal. App. 5th 1, 213 Cal. Rptr. 3d 410 (2017) (California prohibition of pre-dispute jury trial waiver overrode parties' contractual choice of New York law); accord, In re County of Orange (v. Tata Consultancy Services Ltd.), 784 F.3d 520 (9th Cir. 2015) (adopting Grafton Partners rule for federal diversity cases).

Georgia: See Bank South, N.A. v. Howard, 264 Ga. 339, 444 S.E.2d 799 (1994).

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23.17.3 No one has represented that the waiver won't be enforced

  1. When a party waives jury trial, that party automatically certifies —
    • that no representative, agent or attorney of any other party
    • has represented, expressly or otherwise, that the other party would not seek to enforce the waiver,
    • and that the waiving party is not relying and will not rely on any such representation if made.
  2. The waiving party also acknowledges —
    • that each other party will rely on the waiving party's certification in subdivision a
      • when the other party decides whether or not to enter into the Contract
      • on the economic- and other terms stated in it,
    • and that such reliance by the other party will be reasonable.
Commentary

Concerning the no-reliance certification in subdivision a: See the commentary to § 20.3.

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23.17.4 Review

:PROPERTIES: :CUSTOMID: jury-waiver-q :HTMLCONTAINERCLASS: CMT

FACTS: Gigunda's proposed contract states that the parties waive the right to trial by jury.

QUESTION: As MathWhiz's counsel, what are some factors that you should take into account in making a recommendation to the client about this proposal?

23.17.5 Drafting exercise: Jury trial waiver

FACTS:

  1. You represent MathWhiz.
  2. You've sent Gigunda a draft master services agreement.
  3. On a "page-turn" negotiation call, Gigunda's lawyer says that they'd like for MathWhiz to waive its right to jury trial.
  4. Mary, the CEO of MathWhiz, responds — to all on the call — that MathWhiz will agree to that.

EXERCISE: Draft a short, "minimum-viable provision" (MVP).

QUESTION: What do you think about the one-sided waiver?

QUESTION: Do you think the jury waiver would be enforceable?

23.18 Lawyer Involvement

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

Discussion checklist:

23.18.1 Parties must get their lawyers involved if requested

  1. If Party A asks Party B for contact information for B's legal counsel,
    • in connection with a particular disagreement relating to the Contract,
    • then B must provide A with current contact information for B's legal counsel (if any) who represents B in respect of the disagreement.
  2. If Party B has in-house counsel,
    • it is not acceptable for B to respond to Party A that B's counsel are not involved,
    • nor that B does not want to get its counsel involved.
Commentary

Sometimes parties' business people can get stuck in a disagreement that might be resolved quickly or even immediately by getting the parties' counsel involved.

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23.18.2 Lawyers may copy other parties' business people

In the interest of speeding up discussions and enhancing settlement possibilities,

  • whenever Party A's legal counsel sends emails or other correspondence
    • to Party B's legal counsel
    • concerning a disagreement,
  • Party A's legal counsel may also copy any of Party B's non-lawyer personnel
    • whom Party A's legal counsel reasonably believes could contribute to settlement progress.
Commentary

Under an American legal-ethics rule, if Party A's lawyer knows that Party B is represented by a lawyer in a particular matter, then A's lawyer is not allowed to deal directly with B's business people, but instead must deal with B's lawyer, unless B's lawyer gives consent.

It's possible that Party A's lawyer might violate this ethical rule merely by copying Party B's business people on emails, etc., to Party B's lawyer. Against that possibility, this section is intended to require Party B's counsel to give such consent.

In emails to other parties' counsel, the author frequently uses text along the following lines to both give and request such consent; in the example below, "ABC" represents my client and "Jane" is the other party's legal counsel:

Jane, to speed things up, please copy ABC's business people on any emails you send me; unless you tell me otherwise, I plan to do the same with your business people on any emails or other correspondence that I send to you, on the assumption that this would not violate any applicable legal-ethics rules about dealing directly with a represented party without the consent of the other party's counsel.

23.19 Limitation Period Usage

  1. When this Clause is agreed to, it applies if the Contract expressly states, in effect,
    • that a party, referred to here as a "claimant,"
    • has only a limited period of time (a "limitation period")
    • in which to bring a claim against another party.
  2. A limitation period in the Contract applies to all Agreement-Related Disputes (as defined in Clause 25.3).
  3. A claimant's failure to bring a claim before the end of an agreed limitation period WAIVES (as defined in Clause 24.26) the claim.
  4. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
Commentary

This Clause is based on California law: For purposes of the filing deadline under a statute of limitations, an action normally "accrues" at the time of the injury; California recognizes "the discovery rule," which holds that, in certain circumstances, a claim accrues, and thus the limitation period starts to run, when the plaintiff first had, or reasonably should have had, a suspicion of wrongdoing.

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23.20 Liquidated damages (commentary)

23.20.1 Introduction: Liquidated damages are like a partial settlement in advance

A liquidated-damages clause is, in essence, a partial settlement agreement, entered into in advance, about how much money a party must pay in damages if it breaches the parties' contract, when that amount is uncertain and would be difficult to compute.

Relying on freedom-of-contract principles, courts in the U.S. will enforce a liquidated-damages clause if the clause genuinely represents a reasonable estimate of agreement — but not if the clause is actually a penalty (in contract law, penalties are unenforceable), disguised as an agreement to settle uncertain damages claims.

In theory, a liquidated-damages clause spares the parties from having to engage in expensive battles of expert witnesses about the amount of damages owed.

In practice, however, parties in a contract dispute will often litigate whether a liquidated-damages clause is enforceable; that battle might eat up any savings from not having to try a damages case.

An Indiana supreme court opinion summarizes the workings of liquidated-damages law in many jurisdictions:

"Liquidated damages" refers to a specific sum of money

  • that has been stipulated by parties to a contract as the amount of damages to be recovered by one party for a breach by the other,
  • whether it exceeds or falls short of actual damages.

A typical liquidated damages provision provides

  • for the forfeiture of a stated sum of money upon breach
  • without proof of damages.

Reasonable liquidated damages provisions are permitted.

While liquidated damages clauses are ordinarily enforceable,

  • contractual provisions that constitute penalties are not.

Whether a contract provision providing for liquidated damages is an unenforceable penalty is a question of law for the court to decide.

23.20.2 "Penalties" are unenforceable …

Ohio's supreme court explained the difference between liquidated damages and penalties:

[A penalty is] a sum inserted in a contract, not as the measure of compensation for its breach, but rather as a punishment for default, or by way of security for actual damages which may be sustained by reason of nonperformance, and it involves the idea of punishment.

A penalty is an agreement to pay a stipulated sum on breach of contract, irrespective of the damage sustained. Its essence is a payment of money stipulated as in terrorem of the offending party,

  • while the essence of liquidated damages is a genuine covenanted pre-estimate of damages.

The amount is fixed and is not subject to change;

  • however, if the stipulated sum is deemed to be a penalty, it is not enforceable
  • and the nondefaulting party is left to the recovery of such actual damages as he can prove.

23.20.3 … but just saying "it's not a penalty!" probably won't work

Some liquidated-damages provisions say that the breaching party will pay, as liquidated damages and not as a penalty, a stated (or computable) amount. Many courts tend to ignore such self-serving exculpatory language.

23.20.4 There must be a reasonable correlation with actual damages

In an Indiana case, the supreme court affirmed striking down the liquidated-damages clauses in question; the court summarized those clauses:

Defendants Marlin Knowles, Jonathan Day and David Lancet were all previously employed by Plaintiff, American Structurepoint, Inc. ("ASI"). Knowles served as ASI's Vice President of Sales,

  • and as a condition of his employment, he executed a contract that contained covenants restricting him from both customer and employee solicitation should he leave his employment with ASI.
  • That is, Knowles agreed that for two years after his employment, he would not sell, provide, try to sell or provide or assist any person or entity in the sale or provision of any competing products or services to ASI's customers with whom Knowles had any business contact with on behalf of ASI during the two years prior to separation.

He agreed that if he breached this agreement and such a breach resulted in termination, withdrawal or reduction of a client's business with ASI, he would pay liquidated damages in an amount equal to 45% of all fees and other amounts that ASI billed to the customer during the twelve months prior to the breach.

The contract further precluded Knowles from causing an employee to end their employment with ASI, and if he breached this provision, he agreed to pay liquidated damages equal to 50% of the employee's pay from ASI during the twelve months prior to the breach.

Day and Lancet, who were both resident project representatives at ASI, also executed agreements that precluded them from hiring or employing ASI employees.

They agreed that if they breached their agreements, they would pay liquidated damages in an amount equal to 100% of that employee's pay from ASI during the twelve months prior to breach.

The state supreme court did not see much correlation between the liquidated damages and the actual damages that the non-breaching party was likely to have suffered:

While ASI is correct that the damages in this case are difficult to ascertain and this Court has previously noted its unwillingness to interfere in the freely negotiated contracts of the parties (see Time Warner, 802 N.E.2d at 886), this alone is not enough to enforce a liquidated damages provision.

The liquidated damages provisions related to employee recruitment in this case are facially problematic for several reasons.

First, it is not clear how an employee's salary for the prior year correlates to the loss to the company

as salary alone is not reflective of revenue to ASI.

  • While the salary of an employee factors into revenue to some extent, it is not the only variable that determines revenue, and ASI could hire other employees.
  • It is also not clear why Knowles, who held a higher rank and made more money than Day or Lancet, is responsible for 50% of a recruited employee's salary while Day and Lancet are responsible for 100% of it.
  • Additionally, as Judge Riley aptly noted in her dissent in the Court of Appeals below, because several employees were recruited in violation of all three agreements at issue, ASI was seeking 250% of their respective salaries. Even if we were to assume that the lost employee's salary was an appropriate measure of damages, it is highly unlikely it would cost ASI 250% of a recruited employee's salary to replace them.

The court distinguished other Indiana cases where liquidated-damages clauses had been enforced:

[O]ur courts enforced liquidated damages in two cases where doctors breached their employment contracts.

  • In each of those cases, the doctors were subject to liquidated damages clauses that set forth a specific sum for the breach, both $25,000,
  • which represented a portion of the revenue each doctor earned prior to the breach.

Unlike those cases, the liquidated damages clauses in the present case:

1) do not provide for payment of a specific sum, but rather, provide for a percentage of a yet to be ascertained sum;

2) the percentages provided for in the provisions are not tied to ASI's actual lost revenue from losing its employees; and

3) the liquidated damages are not a portion of Defendant's salaries; they far exceed the salaries of the Defendants.

The court pounded one last nail in the coffin of the reasonable-correlation assertion:

Here, Knowles' contract provides that he must pay liquidated damages if he solicits or recruits, or assists anyone else in soliciting or recruiting, ASI employees.

It also punishes him whether he hires or merely attempts to hire an ASI employee. …

As for Knowles' agreement to not solicit ASI's clients, the penalty of 45% of the prior year's revenue from that client to ASI is in no way tied to ASI's actual losses.

As discussed by Judge Riley in her dissent, ASI is seeking damages for contracts it was ineligible for ….

Thus, this liquidated damages provision is a penalty meant to secure performance and one that is not proportional to ASI's actual losses.

23.20.5 Caution: Don't be ridiculous — in hindsight

Continuing the theme explored above: It can be dangerous to establish a liquidated-damages amount that — in hindsight — ends up being ridiculously disproportionate to the "real" damages. In 2014 the Supreme Court of Texas held that:

  • actual damages must be difficult to estimate, and the agreed liquidated damages must be a reasonable forecast of the actual damage; but also:
  • if in practice the actual damages and the agreed liquidated damages end up being too far apart, then the liquidated-damages provision will be struck down as a penalty.

The supreme court noted that the highest actual damages supported by the evidence was $6 million, but the liquidated-damages amount assessed by the court below was $29 million.

The Texas court said that this was an unacceptable disparity: "When the liquidated damages provisions operate with no rational relationship to actual damages, thus rendering the provisions unreasonable in light of actual damages, they are unenforceable."

To like effect, the Seventh Circuit rejected a claim for liquidated damages for breach of a confidentiality provision in a settlement agreement.

  • The liquidated-damages provision required a payment of $10,000 for each unauthorized disclosure of the terms of the settlement agreement.
  • The party accused of breaching the confidentiality provision had included detailed information about the settlement in a franchise disclosure document that was distributed to about 2,000 people, not all of whom were required by law to be given a copy.
  • The plaintiff sued for liquidated damages of 2,000 times $10,000, or $20 million.
  • Applying Texas law, the trial court held that this was unreasonable, because the plaintiff had not proven that she had suffered any harm at all, let alone $20 million worth.

The Seventh Circuit affirmed; Judge Posner said that, "when there is an unbridgeable discrepancy between liquidated damages provisions as written and the unfortunate reality in application, we cannot enforce such provisions."

23.20.6 But some judges argue: No Monday-morning quarterbacking

In contrast to the holdings discussed above, some courts discourage the use of hindsight in assessing liquidated-damages provisions in public-works contract. For example, the Ohio supreme court explained:

{¶ 35} We reaffirm that Ohio law requires a court, when considering a liquidated-damages provision, to examine it in light of what the parties knew at the time the contract was formed.

If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.

{¶ 36} This prospective or "front end" analysis of a liquidated-damages provision focuses on the reasonableness of the clause at the time the contract was executed rather than looking at the provision retrospectively, i.e., ascertaining the reasonableness of the damages with the benefit of hindsight after a breach.

The prospective approach properly focuses on whether[:]

(1) the parties evaluated, at the time of contract formation, the probable loss resulting from delay in completing the construction,

(2) the parties clearly intended to use liquidated damages in case of a delay because actual damages would be difficult to ascertain, and

(3) [in per-diem cases,] the parties reached an agreement as to a per diem amount for delays.

[P]rospective analysis resolves disputes efficiently by making it unnecessary to wait until actual damages from a breach are proved and eliminates uncertainty and tends to prevent costly future litigation.

The reasonableness of the forecast or estimate in a liquidated-damages provision is usually determined in view of the facts known at the time of contracting, and not at the time of the breach or delayed completion.

Legendary Seventh Circuit judge Richard Posner once mused:

Indeed, even if damages wouldn't be difficult to determine after the fact, it is hard to see why the parties shouldn't be allowed to substitute their own ex ante determination for the ex post determination of a court. Damages would be just another contract provision that parties would be permitted to negotiate under the general rubric of freedom of contract.

One could even think of a liquidated damages clause as a partial settlement, as in cases in which damages are stipulated and trial confined to liability issues. And of course settlements are favored.

Judge Posner's view was quoted in a dissent by an Indiana supreme court justice, who argued that:

Rather than condemning such [liquidated] damages when judges conclude they are facially problematic, courts should get out of the business of deciding whether the parties' estimate of the harm underlying liquidated damages is reasonable. … This approach to liquidated damages here would have the virtue of honoring the parties' freedom of contract, including their settlement of a disputed issue it has taken our Court more than a year to resolve.

23.20.7 Pro tip: Provide an alternative performance standard instead?

Drafters might want to consider setting up an alternative-performance structure instead of liquidated damages. For example:

  • What amounts to an early-termination fee was upheld in a First Circuit case where the court of appeals affirmed a summary judgment that Alasko, a Canadian food distributor, owed Foodmark, a U.S. marketing firm, a fee for electing not to renew the parties' "evergreen" agreement.
  • A California appeals court reversed and remanded a summary adjudication that certain payment provisions in a contract were an unenforceable penalty; the court held that "the trial court erred because More-Gas's motion for summary adjudication failed to eliminate the possibility that the contractual provisions in question were instead valid provisions for alternative performance."
  • Washington state's supreme court ruled that an early termination fee in a cell-phone service agreement was "an alternative performance provision and not a liquidated damages clause."
  • But a California court ruled that Sprint that "Plaintiffs introduced contemporaneous Sprint internal documents referring to the ETF as a '$150 contract penalty fee,' and as a 'Penalty or Contract Cancellation Fee.'"

23.20.8 Other ways to compute liquidated damages

For language setting forth liquidated damages calculated per day of delay, see Federal Acquisition Regulations § 52.211.11.

Liquidated damages based on revenue, not profit, might be enforceable.

23.20.9 Exercises and discussion questions

A student wrote: "If Math-whiz fails to provide the Invoice on the tenth day of any particular month, Gigunda will penalize Math-Whiz up to USD$200.00 per day until the Invoice is received. This provision may be altered by written agreement, acknowledged by both parties."

1.  QUESTION: Is the "penalize" language the best choice? QUESTION: What's an alternative way to express this?

2.  QUESTION: What exactly does the second sentence mean?

23.21 Neutral Evaluation

23.21.1 Neutral evaluation is required one time

Either party may submit a dispute to neutral evaluation,

  • no more than the specified number of times if not otherwise agreed,
  • at any time before the main adversarial hearing in a lawsuit,
    • or other proceeding, including but not limited to arbitration,
  • in accordance with the then-effective early neutral evaluation procedures of the U.S. District Court for the Northern District of California.
Commentary

At this writing, the Northern District's ENE procedures can be found at https://www.cand.uscourts.gov/about/court-programs/alternative-dispute-resolution-adr/early-neutral-evaluation-ene/.

This section mandates only one neutral evaluation. That's because it would be undesirable for a wealthy party to keep forcing a poorer party to incur the expenses associated with neutral evaluation.

Of course, parties are always free to agree to additional neutral evaluations — perhaps as the case gets further along, e.g., after discovery has been completed.

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23.21.2 Neutral evaluation is nonbinding

In case of doubt, a neutral evaluation under this Clause, in itself, will have no binding effect,

  • but any resulting agreed settlement could well be binding under applicable law.

23.21.3 Private disclosures to the evaluator are to be confidential

If a party privately discloses confidential information to the neutral evaluator;

  • then the evaluator is not to reveal that information to the other party, nor to anyone else, except:
    • with the disclosing party's consent,
    • or as required or permitted by law.

23.21.4 The neutral evaluation results are confidential

The results of the neutral's evaluation are confidential —

  • neither party may disclose those results, in whole or in part, to anyone else except:
    • on a need-to-know basis, to:
      • the party's employees
      • and the party's attorneys, accountants, and other advisors,
      • in each case only under appropriate confidentiality obligations;
    • or if the neutral and the other party each specifically agrees otherwise in writing;
    • or as required or permitted by law.

23.22 Past Dealings Disclaimer

When this Clause is agreed to, the parties do not intend, and neither party is to assert, that the parties' past dealings will have the effect of modifying or supplementing the Contract.

Commentary

Language like this is sometimes seen in companies' "canned" standard forms, e.g., in customers' purchase-order terms and conditions and sellers' terms of sale.

Caution: Agreeing to this Clause could later put a party at a disadvantage in possibly-unpredictable ways.

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23.23 Senior Management Mini-Trial

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. This Clause will apply only if an Agreement-Related Dispute (as defined in Clause 25.3) appears clearly likely to lead to litigation or arbitration.
  3. Either party may submit the dispute — only one time if not otherwise agreed — to a non-binding mini-trial in accordance with the then-current mini-trial procedures of the International Institute for Conflict Prevention and Resolution (the "Mini-Trial Rules").
  4. In the event of such a submission, each party will provide a senior management representative to participate personally in the mini-trial proceedings as called for by the Mini-Trial Rules.
Commentary
Overview of mini-trial procedure

As summarized in the CPR's mini-trial procedures [at https://tinyurl.com/CPR-MiniTrial (cpradr.org)], a mini-trial typically consists of an abbreviated "closing argument" presentation, by each party's counsel, to a panel consisting of:

  • A senior-management representative of each party; and
  • A neutral presiding officer.

After the presentations, the senior-management representatives confer privately, together with the neutral presiding officer, to see if they can work out a resolution to the dispute.

An acquaintance of the author is the head of litigation for a global Fortune 500 company. Speaking at a continuing legal education (CLE) seminar, the acquaintance said that in his view, mini-trials were the most-effective approach to resolving disputes between companies.

Motivation for mini-trial

In mid-size and large organizations, senior-management representatives will typically have:

  • greater authority in their organizations than do more-junior personnel, as well as
  • more experience and a broader perspective on their businesses. (Sometimes, junior personnel have more in-depth knowledge of the relevant aspects of the business, so their presence might be needed as well.)

For those reasons, it's not unusual for senior-management representatives to able to reach an agreed settlement of a dispute, where more-junior personnel might not be able to do so.

Two Australian lawyers point out that "[b]ringing in senior management will focus the minds of the parties on the bottom line, and allows senior decision makers who are not caught up in the underlying dispute to approach the situation taking commercial reality into account."

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23.24 Settlement Confidentiality

  1. The parties' communications made in the course of any escalation, neutral evaluation, or other settlement-related discussions under this Clause,
    • as well as the results of any evaluation by a neutral under § 23.21,
    • are to be treated as having been made in compromise negotiations,
    • with the effect stated in Rule 408 of the [U.S.] Federal Rules of Evidence.
  2. In case of doubt, subdivision a will apply regardless whether Rule 408 would apply in a court proceeding or arbitration.

23.25 Settlement Rejection Consequences

23.25.1 When does this Clause apply?

This Clause will apply, in the interest of promoting the settlement of disputes, in any dispute arising out of or relating to the Contract or any transaction or relationship resulting from the Contract.

23.25.2 Definition: Covered Settlement Offer

The term "Covered Settlement Offer" refers to a written offer that:

  1. expressly states that it (the offer) is subject to this Clause; and
  2. makes a proposal to settle a dispute.
Commentary

Subdivision 1: The "expressly states" requirement is intended to prevent a party from being ambushed by another party's claim that (for example) a vague settlement proposal from the other party constituted a Covered Settlement Offer.

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23.25.3 Expenses will shift if the offer is not beaten by 20%

If a party rejects a Covered Settlement Offer,

  • but then fails to obtain a final result in the dispute that is at least 20% more favorable than the Covered Settlement Offer,
  • then the rejecting party must pay or reimburse the offeror's attorney fees (as defined in Clause 23.3) that the offeror incurred in the dispute after making the Covered Settlement Offer.
Commentary

This Clause is modeled roughly on the offer-of-judgment provisions in Rule 68 of the Federal Rules of Civil Procedure. Unfortunately, Rule 68 is largely toothless, because it only shifts subsequently-incurred court costs, which usually don't amount to a lot of money in the scheme of things; moreover, Rule 68 doesn't shift the burden of attorney fees, which can be huge. As a result, most litigators don't regard Rule 68 as providing much of an incentive to settle.

A somewhat-better approach is New Jersey Court Rule 4:58, which shifts not just court costs but also attorney fees. (The New Jersey rule, however, applies only when exclusively-monetary relief is sought; the provision above doesn't contain such a restriction.)

Some empirical research by two law professors, of Northwestern University and (now) the University of Pennsylvania respectively, suggests that the New Jersey rule seems to encourage early settlement and to reduce attorneys' fee expenses, without affecting the size of the damage award for cases that do go to trial.

Georgia and Florida have fee-shifting statutes similar to New Jersey's — see Ga. Code Ann. § 9-11-68 and Fla. Stat. § 768.79. Texas likewise has a similar expense-shifting statute; see Tex. Civ. Prac. & Rem. Code ch. 42.

In 2011, the Texas Legislature tightened the limits on the amount of fees and expenses that could be recovered, which is now capped at the amount of the jury verdict, as explained in this article.

A related concept is implemented in Arizona's compulsory-arbitration program for small-dollar disputes: In any civil case where the amount in controversy is less than an amount set by court rule (not more than $65,000), the court is normally required to send the case to arbitration. Relevant here: A party that 'loses' the arbitration can still demand a trial de novo in court. If the result of the trial de novo, however, is not at least 23% (??) better than the arbitration award, then the party demanding the trial must pay (i) the arbitrators' fee, and (ii) the other side's costs and attorney fees and expenses for the trial de novo.

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23.25.4 Federal Rule 68's procedure is to be followed

Matters of timing and other procedural issues concerning the Covered Settlement offer are to be governed in the general manner provided for an offer of judgment under Rule 68 of the [U.S.] Federal Rules of Civil Procedure (with any necessary change being made) to the extent the parties do not agree otherwise in writing.

Commentary

The general procedures of Federal Rule 68 are adopted here because:

  • they cover the required ground reasonably well, and
  • they're familiar to (U.S.) counsel.

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23.25.5 Settlement discussions are confidential

Absent consent of the other party, each party shall preserve in strict confidence:

  1. the existence and details of any Covered Settlement Offer made by the other party; and
  2. any communications between the parties regarding any Covered Settlement Offer.
Commentary

Confidentiality of settlement offers would normally be required by standard American rules such as Rule 408 of the Federal Rules of Evidence; this subdivision makes that requirement explicit.

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23.26 Tribunal Definition

The term tribunal refers to a panel of one or more neutral officials,

  • including but not limited to courts; arbitration tribunals; administrative agencies; and legislative bodies,

where:

  1. one or more parties presents evidence or legal argument or both to the panel; and
  2. thereafter, the panel renders a binding legal judgment that directly affects the interests of one or more parties in the matter in question.
Commentary

This definition of tribunal is adapted from proposed amendments to Rule 1.00(u) of the 2010 proposed amendments to the Texas Disciplinary Rules of Professional Conduct [for lawyers]. (The proposed amendments were rejected in a referendum for unrelated reasons.)

24 Contract administration

24.1 Adoption of Tango Terms

24.1.1 What if "the Tango Terms" are adopted as a whole?

If the Contract adopts "the Tango Terms" without being more specific, then [BROKEN LINK: tango-always][BROKEN LINK: tango-always] (Tango Terms General-Purpose Rider) will apply.

24.1.2 What if only specific Tango Terms are adopted?

  1. If the Contract adopts one or more Tango checklists (e.g., by incorporating them by reference), then those checklists and their stated "default" terms will apply in the Contract as though they had been copied and pasted there.
  2. Contract drafters can consider adopting particular Tango agreements, riders, or clauses using language such as the following: "The Tango [TITLE] is incorporated by reference." (Abbreviated versions of the title have the same meaning if it is clear which Tango terms are being referenced.)
  3. Contract drafters are free (and encouraged) to specify that some of the provisions cited below will not apply in the Contract and/or that other provisions will also apply.

24.1.3 What about cross-referenced and linked Tango Terms?

  1. All Tango clauses that are adopted in the Contract are deemed incorporated by reference into the Contract as though fully set forth there.
  2. Suppose that a Tango clause is incorporated by reference into the Contract,
    • and that Tango clause in turn references another Tango clause —
    • including (but not limited to) by hyperlinking to the other clause.

In that situation, the other Tango clause is likewise itself incorporated by reference into the Contract.

Example: The Tango Clause 14.3 (Services Protocol) contains payment provisions (§ 14.3.18) that link to Clause 13.13 (Payments Rider). This means that the Payments Rider will apply in any agreement that adopts the Services Protocol.

24.1.4 What about "option" provisions?

  1. A Tango provision whose heading includes the word "Option," or that includes a blank ballot box , does not apply unless the Contract clearly says so.
  2. A Tango provision that includes a checked ballot box is part of the Contract unless the Contract clearly says otherwise.

24.1.5 What effect does the Tango commentary have?

No.

Many Tango clauses are annotated to include or refer to commentary, variously labeled as "Commentary" or "Comment." Such commentary is intended for educational purposes and is not binding as part of the Contract.

Commentary

Author's note: I've long used this guide and its predecessors, especially the commentary portions, in the advanced business contracts course that I teach as an adjunct professor at the University of Houston Law Center.

See also the commentary at Clause 1 (Introduction: MathWhiz & Gigunda).

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24.1.6 Which Tango Terms version will apply?

The most-recent version (at the effective date) applies: The Tango Terms version posted at https://www.tangoterms.org on the effective date of the Contract (see § 25.21 for the standard effective date) will apply unless the Contract clearly says otherwise.

Archived versions can be used instead: Some drafters might prefer to use an earlier version of the Tango Terms manual; each publicly-released version is archived in two places:

  • The perma.cc site, built by Harvard University's Library Innovation Lab and supported by a consortium of law libraries; and
  • the Wayback Machine of the nonprofit Internet Archive, founded in 1996 and currently hosting materials from, among many others, the Library of Congress; NASA; and the Smithsonian Libraries.

All versions archived at the Internet Archive are at [LINK]; see the table below for the perma.cc archives.

2020A
LINK

24.1.7 Which terms take precedence?

Normally, a Tango provision will take precedence over any inconsistent terms in the Contract — with three exceptions:

  1. Some terms in the Tango clauses are specially formatted like this to signal that the parties are free to specify some other agreed term. (In computer-software terms, these are "variables.")
  2. Some Tango clauses includes both  standard ("default") language and  alternative "override" language. The standard language can be overriden by copying and pasting the override language into the Contract.
  3. If the Contract clearly states that its own terms take precedence, specifically mentioning the Tango Terms, then that statement will control.

24.2 Amendments Procedure

Commentary

As parties operate under an agreement, one or both parties will sometimes propose changes. If the parties don't put an agreed change in writing, they could end up disagreeing later about just what change was agreed to. So, this Clause sets out prerequisites for such a change to be binding.

The writing requirement of this Clause tries to strike a balance between:

  • the need for parties to have at least some flexibility in their dealings, without being unduly hamstrung by what might be a long-forgotten contract;
  • the concern that a party might claim that a "stray remark" in an email, etc., had the effect of modifying an existing agreement; and
  • the legitimate concern that an unscrupulous party might try to get another party's personnel to sign a form (a purchase order, an order confirmation, etc.) that would have the effect of modifying a previously-negotiated agreement.

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24.2.1 When does this Clause apply?

  1. This Clause sets out requirements for amending or otherwise modifying (referred to generically as "amending") the Contract or any related document.
    • The document to be amended is referred to as a "Modified Document."

24.2.2 Must amendments be in writing?

Yes: To be effective, a purported amendment must be:

  1. in writing;
  2. clearly labeled as an amendment —
    • the labeling must be reasonably prominent, for example by including the word "Amendment" as part of the title of the amending document; and
  3. signed by at least the other party to the Contract.
Commentary
Subdivision 1: Writing requirement

It's quite common for contracts to state that amendments will not be effective unless in writing — but such a requirement might be effectively meaningless in some jurisdictions, as discussed in the commentary to § 24.2.7.

Subdivision 2: Labeling requirement

Requiring an amendment to be clearly labeled as such should help reduce the chances that parties will dispute whether a particular communication constituted an amendment. That was an issue in a Fourth Circuit case in which a tenant of an office building signed an estoppel certificate — the court held that the estoppel certificate did not modify the tenant's lease, in part because "the Estoppel Certificate does not label itself as an amendment to the Lease."

Pro tip: Identify which amendment it is

To reduce the chance of possible future confusion, it might be helpful to give an amendment a series number and date in its title, and perhaps even include a (brief) mention of its purpose. Example: "First Amendment, Dated December 25, 20X7, to Asset Purchase Agreement (Increase of Purchase Price)."

Pro tip: Consider an "amended and restated agreement"

An amendment can be done as a complete "amended and restated agreement"; for example, as of March 22, 2020, the title of the Enterprise Products Partners limited-partnership agreement is "Sixth Amended and Restated Agreement of Limited Partnership of Enterprise Products Partners L.P." (emphasis added).

Subdivision 3: One-party signature requirement

This one-party-signature requirement is inspired by the (U.S.) Uniform Commercial Code's statute of frauds provision, which provision requires only that a written contract must be signed "by the party against whom enforcement is sought …." UCC § 2‑201.

This one-party signature requirement also comports with a Seventh Circuit holding that "[t]he critical signature [on an amendment] is that of the party against whom the contract is being enforced, and that signature was present."

Optional language: Both parties' signatures required

The following optional language could be copied and pasted into the Contract: "An amendment must be signed by each party to the Contract."

In some jurisdictions, the signature of both parties might be required — especially if the contract itself says so.

And consider this hypothetical example: Suppose that you are an apartment dweller. You and the landlord agree to amend your lease: The landlord agrees to reduce your monthly rent in exchange for your agreeing to extend the lease by one year. Each of you is being bound by the amendment, so each of you must sign it.

Pro tip: It's a good practice to have amendments signed by all parties, but it's also better not to require signatures by all parties, in case for some reason one party's signature is not obtained.

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24.2.3 What authority must an amendment signer have?

An amendment will be binding on an organization if signed by any individual who has at least apparent authority to do so on.

Override language: "An amendment will not be binding on an organization unless it is signed on behalf of the organization by an individual at the vice-president level or higher, or in a comparable position in an organization not having a vice-president."

Commentary

When an amendment is being signed on behalf of an organization, the human signer need only be an individual with so-called apparent authority.

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24.2.4 What terms will be affected by an amendment?

In case of doubt, an amendment will affect only the specific provision(s) of the Modified Document that are clearly identified in the amendment document —

  • all other terms of the Modified Document will remain in effect as before the amendment.
Commentary

This kind of language — expressly leaving in place any unamended provisions — is often used to try to roadblock aggressive arguments from opposing counsel that other provisions were implicitly amended.

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24.2.5 What law will govern amendment procedure?

  1. If the parties disagree about how this Clause is to apply,
    • then New York's General Obligations Law 15-301(1) is to control,
    • along with that statutory provision's interpretation by state- and federal courts having jurisdiction in New York,
    • no matter what law would otherwise apply.
  2. The parties are agreeing to this provision-specific choice of law:
    1. in the interest of uniformity, and
    2. to reduce uncertainty about how a court or other tribunal might interpret this Clause.
Commentary

New York's General Obligations Law 15-301(1) provides that:

A written agreement … which contains a provision to the effect that it cannot be changed orally,

cannot be changed by an executory agreement

unless such executory agreement is in writing

and signed[:]

  • by the party against whom enforcement of the change is sought
  • or by his agent.

(Extra paragraphing and bullets added.)

It might seem strange to specify a choice of law to govern one particular provision in a contract. But it's not unprecedented; the 1988 update to the Restatement states in part that "the parties may choose to have different issues involving their contract governed by the local law of different states," citing a Maryland supreme court case in which a financial instrument did just that.

Domestic contracts often specify that the substantive law of a particular jurisdiction will apply — which implicitly leaves in place the procedural law of the forum state — or they might specify a jurisdiction to provide both substantive and procedural law, although a court might not honor a choice of procedural law. When as here a contract provision requires amendments and waivers to be in writing, it amounts to a choice of procedural rules.

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24.2.6 Exercise: Amending a contract by substituting new text

QUESTION: An agreement can be amended by setting out the entire agreement anew, as modified; this is referred to as a|an [BLANK] agreement.

An amended and restated agreement

24.2.7 What if the law allows nonwritten amendments anyway?

24.2.7.1 Background

In some jurisdictions, a court (or other tribunal of competent jurisdiction) might hold that the parties were free to amend the Contract without doing so in writing, for example orally —

  • even though the parties had agreed to this Clause,
  • which could lead to undesirable uncertainty.
24.2.7.2 Proof requirement

If, notwithstanding this Clause, a court allows a party (the "asserting party") to assert that a Modified Document was amended without doing so in writing,

then:

  1. The asserting party must show, by clear and convincing evidence (as defined in Clause 25.13), that each other relevant party agreed to each of the alleged nonwritten amendments;
  2. The evidence on that point will not be considered clear and convincing unless it includes (without limitation) reasonable corroboration (as defined in Clause 23.8) of any self-interested statements, for example, self-interested witness testimony; and
  3. If another party so requests,
    • then the asserting party must promptly produce all related (unprivileged) evidence in its possession, custody, or control about the alleged nonwritten amendment,
    • in accordance with the initial-disclosure and discovery procedures of the (U.S.) Federal Rules of Civil Procedure
    • (whether or not those Rules govern).
24.2.7.3 Waiver

If a party asserting a nonwritten amendment does not comply with § 24.2.7.2,

Commentary

Under a century-old New York precedent (which this author refers to as the "Cardozo Rule," after its author, later a Supreme Court justice), parties are free to orally waive a contractual requirement that amendments and waivers must be in writing, subject to any possible impact of the statute of frauds.

And California still allows oral waiver of an amendments-in-writing provision. This rule came into play, for example, in a case involving profits from the TV series Home Improvement:

  • The plaintiffs, who were writers and producers of the show, sued the Walt Disney company for failing to properly account for and pay amounts allegedly owed to the plaintiffs under their profit-participation agreement.
  • The agreement required Disney to periodically provide accounting statements to the plaintiffs; the agreement also provided that any given accounting statement would become incontestable after 24 months if the plaintiffs did not request an audit.
  • Disney asserted that the accounting statements in question had become incontestable because of the time that had elapsed.
  • A trial court granted summary judgment in favor of Disney, but the appeals court reversed, holding that a jury must decide whether Disney orally waived or agreed to modify the 24-month incontestability provision.

On the other hand:

• In some jurisdictions, courts will uphold requirements that amendments and waivers must be in writing. See, e.g., a Seventh Circuit case in which the appeals court, looking to Michigan precedents, upheld summary judgment giving effect to an "anti-waiver" clause in Ford's dealership agreement.

• The United Kingdom's Supreme Court expressly rejected the Cardozo Rule, concluding that "the law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation."

A statute might expressly validate amendments-in-writing and waivers-in-writing provisions, such as New York's General Obligations Law 15-301(1), discussed above, as well as UCC § 2-209(2) for amendments to agreements for the sale of goods.

On the other hand, a California statute has been relied on by courts to allow oral waiver of provisions requiring amendments amendments to be in writing: "Nothing in this section precludes in an appropriate case the application of rules of law concerning estoppel, … [or] waiver of a provision of a written contract…."

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24.2.8 Discussion questions

1.  Which party or parties should sign an amendment? Why that choice?

2.  Will courts typically enforce a provision requiring amendments and waivers to be in writing? When might a court not do so?

3.  When might a provision for unilateral amendment be handy? [DCT to relate a client story from today]

4.  What are some dangers of a badly-drafted unilateral-amendment provision?

24.3 Amendments (Unilateral)

24.3.1 When will this Clause apply?

When agreed to, this Clause will apply if the Contract allows a party, referred to as an "Amending Party,"

  • to unilaterally amend the Contract or a related document,
  • or some portion of if, e.g., an annex, schedule, etc.,
  • without first getting the express agreement of another party.
Commentary

Unilateral-amendment provisions are fairly common in, e.g., Web sites' terms of service, cable- and telephone-service contracts, and the like.

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24.3.2 How much advance notice of amendment is required?

The Amending Party must give the other party at least 30 days' advance written notice of any unilateral amendment that it wishes to make.

Commentary

It's pretty conventional for unilateral-amendment provisions to give the non-amending party the right to opt out of the agreement if it doesn't want to accede to a unilateral amendment.

In a mass-market form contract, a unilateral-amendment provision might instead allow (or require) a non-amending party simply to terminate its account with the amending party or to cease utilizing the amending party's services, as opposed to giving notice of termination.

Advance notice of unilateral amendment might be required to save an arbitration provision. For example: a company's employment handbook contained an agreement to binding arbitration. The handbook also stated that "Any change to this Agreement will only be effective upon notice to Applicant/Employee and shall only apply prospectively." According to the Fifth Circuit, that wasn't enough to save the arbitration agreement from being illusory and therefore unenforceable, because the agreement didn't include the advance notice required for the so-called Halliburton exception.

Caution: For agreements that are posted to a Website, just changing the agreement at the Website likely won't be enough notice of a unilateral amendment. That was the result in a case involving Talk America Inc., a long-distance telephone service provider, which changed its service agreement to require arbitration and a waiver of class actions.

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24.3.3 What must an amendment notice look like?

  1. A notice of unilateral amendment must conspicuously (as defined in Clause 26.2) state that an amendment is being proposed.
  2. A notice of unilateral amendment must also clearly state:
    1. the details of the proposed amendment;
    2. when the proposed amendment would go into effect;
    3. one or more actions that the user may take — and by when — to reject the proposed amendment (for example, giving notice of termination of the Contract, or terminating a user account); and
    4. what action on the other party's part would constitute affirmative acceptance of the proposed amendment (for example, continuing to use an online service after the effective date of the proposed amendment).

24.3.4 Will a unilateral amendment have retroactive effect?

No: Any unilateral amendment will be prospective only; that is, the amendment will not substantively expand or limit either party's rights or liabilities under the Contract that had already come into effect as of the effective date of the unilateral amendment.

(Of course, the parties can jointly agree to amend with retroactive effect; see the Amendments Procedure.)

Commentary

If a unilateral-amendment provision might have retroactive effect, then that provision might cause some or all of a contract — for example, an arbitration provision with a [BROKEN LINK: arb-class-no] — to be unenforceable, on grounds that the contract was illusory. That, in turn might strip a provider of legal protection that the contract might otherwise have provided, in the form of, e.g., an arbitration clause with class-action waiver; a forum-selection or governing-law clause; and so forth.

That's essentially what happened in the Harris v. Blockbuster, Inc. case: a Blockbuster customer sued the company for allegedly violating her privacy rights and sought class-action status. Blockbuster sought to parry the suit by moving to compel individual, case-by-case arbitration, as required in the Blockbuster on-line terms of service. The customer opposed this, because it would be much less economically attractive for her lawyers. The court denied Blockbuster's motion to compel arbitration, on grounds that the customer agreement was illusory and therefore was unenforceable under the relevant state law.

Much the same result occurred in Carey v. 24 Hour Fitness USA, Inc.: A former employee filed a lawsuit against 24 Hour Fitness. The company moved to compel arbitration, citing an arbitration provision in the company's employee handbook. The court held that the arbitration provision was unenforceable because the company reserved the right to change the employee handbook at will. That meant that the former employee's case would be tried in court instead of being heard privately by an arbitrator.

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24.3.5 Will a unilateral amendment apply to existing disputes?

  1. If an Amending Party proposes a change to a dispute-resolution procedure in the Contract,
    • for example, a binding-arbitration provision,
    • then the other party may reject the proposed change,
    • by giving the Amending Party notice to that effect,
    • but only if the notice of rejection is effective within 30 days after the effective date of the Amending Party's notice of unilateral amendment.
  2. If the other party does reject the proposed unilateral amendment to the dispute-resolution procedure,
    • then the Agreement's then-existing dispute resolution provisions (if any) will remain in effect,
    • for any disputes that were pending at (what would otherwise have been) the effective date of the proposed amendment.
  3. If the other party does not timely reject the proposed dispute-resolution amendment
    • then the proposed amendment will go into effect as to all disputes,
    • including but not limited to any dispute that was pending at the time of the notice of unilateral amendment.
Commentary

This provision is modeled on a comparable one at the end of section 6 of the Uber ride-sharing terms of service (last visited December 13, 2015).

A somewhat-similar provision was responsible for saving an arbitration clause from invalidation: An arbitration agreement was terminable by the employer, but it expressly stated that the termination would be prospective only and would not be effective until the employer had given the employee ten days' notice.

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24.4 Assignment Succession-Agreement Requirement

  1. Any assignee of the Contract must agree in writing to abide by the assigning party's obligations the Contract,
    • including but not limited to
    • any covenants concerning confidentiality
    • and/or noncompetition.
  2. In case of doubt: This Clause neither authorizes nor prohibits assignment of the Contract.
Commentary

This policy seeks to avoid the result in a Florida federal case: A franchisor terminated a franchise agreement but was unable to enforce a contractual noncompetition covenant against the franchisee, because:

  • the franchisee was the successor in interest to the original franchisee;
  • the successor franchisee had not signed the franchise agreement that contained the noncompetition covenant; and
  • a Florida statute prohibits enforcing a noncompetition covenant against a party that did not sign the writing containing the covenant.
Commentary

Normally, in U.S. law, most contracts (but not all) can be freely "assigned" — that is, transferred to a third party, with the assigning party's duties delegated to the third party — without the consent of the other party. This general rule is thought to promote economic efficiency.

Notably, though, two categories of contract are exceptions to the general rule of free assignability:

  • Intellectual-property license agreements are not assignable by the licensee without the consent of the owner of the intellectual property in question. See, e.g.:
  • Agreements where the assigning party's performance is considered special or unique — for example, if rapper Kanye West were under contract to perform at a hip-hop festival, he probably couldn't assign the contract to hard-rocker Ted Nugent without the consent of the festival.

Caution: In a long-term contractual relationship, a party's desire to require consent to assignment by the other party can be strategically dangerous for the other party.

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24.5.1 When is Reviewer's deadline for objection to assignment?

  1. Within ten business days after receiving Assignor's written request for Reviewer's consent to a proposed assignment,
    • Reviewer must advise Assignor in writing whether Reviewer consents to the proposed assignment.
  2. If Reviewer does not object to the request for consent within the specified time, then Reviewer will be deemed to have consented to the request.

24.5.2 Can Reviewer ask for more information?

Yes: If Reviewer reasonably requests more information about the proposed successor,

  • then the clock will be stopped on Reviewer's time to respond
  • until the requested information is provided.

24.5.3 What must Reviewer do to refuse consent?

  1. If Reviewer refuses consent to the assignment,
    • then Reviewer must also,
    • no later than one business day later,
    • provide Assignor with a written explanation, in reasonable detail,
    • of all of Reviewer's then-existing reasons for withholding consent.
  2. Reviewer's providing of a statement of reasons
    • for withholding consent to assignment
    • does not preclude Reviewer from later citing later-discovered facts
    • to support Reviewer's withholding of consent.

24.5.4 How much withholding autonomy does Reviewer have?

None of the following options will apply unless the Contract clearly says so, as indicated by the blank ballot boxes :

  1. Reviewer may withhold consent to assignment in its sole discretion (as defined in Clause 25.19).
  2. Reviewer may not arbitrarily or capriciously withhold, delay, or condition consent to assignment.
  3. Reviewer may not unreasonably withhold, delay, or condition consent to assignment.
  4. The Contract may identify specific factors that would permit Reviewer to withhold consent to assignment.
  5. Reviewer must take into account any evidence that Assignor timely provides concerning the relevant qualifications, capabilities, and financial position of Assignor's proposed successor.
  6.  Reviewer may not unreasonably withhold or condition consent to assignment.
  7.  A requirement that Assignor pay a fee (no matter how named) in addition to any fee or other payment that may be due under this Agreement, as a prerequisite to consent to assignment, is to be considered an unreasonable and arbitrary condition to consent.
Commentary

This section imposes limits on Reviewer's ability to withhold consent to assignment, but it also lays out factors that Reviewer may — or must — consider, as suggested in an article by two noted scholars.

As one example of such factors: "A more aggressive landlord will expressly condition its consent [to a tenant's assignment of a lease] on the presence or absence of certain circumstances, such as: (1) the tenant not being in default under the lease …."

Of course, in some jurisidictions the law might require that consent to assignment of the agreement must not be unreasonably withheld. For example:

Section 1995.260 of the California Civil Code provides that: "If a restriction on transfer of the tenant's interest in a lease requires the landlord's consent for transfer but provides no standard for giving or withholding consent, the restriction on transfer shall be construed to include an implied standard that the landlord's consent may not be unreasonably withheld. … "

Apropos of that statutory provision, a California appeals court held in 2008 that a contract provision allowing the landlord to withhold consent "for any reason or no reason" was not to be construed as including an unreasonably-withheld standard, saying that "the parties' express agreement to a ‘sole discretion' standard is permitted under legal standards existing before and after enactment of section 1995.260, as long as the provision is freely negotiated and not illegal."

• In the Pacific First Bank case, in a lease agreement prohibited the tenant from assigning the agreement, including by operation of law, without the landlord's consent. The lease agreement also stated that the landlord would not unreasonably withhold its consent to an assignment of the lease to a subtenant that met certain qualifications. Notably, though, the lease agreement did not include a similar statement for other assignments. The Oregon supreme court held that ordinarily, the state's law would have required the landlord to act in good faith in deciding whether or not to consent to an assignment. But, the court said, the parties had implicitly agreed otherwise; therefore, the landlord did not have such a duty of good faith.

• In a factually-messy Eleventh Circuit case, the court upheld a trial court's finding that the owner of a patent, which had exclusively licensed the patent to another party, had not acted unreasonably when it refused consent to an assignment by the licensee to a party that wanted to acquire the licensee's relevant product line.

• The Tennessee supreme court held that "where the parties have contracted to allow assignment of an agreement with the consent of the non-assigning party, and the agreement is silent regarding the anticipated standard of conduct in withholding consent, an implied covenant of good faith and fair dealing applies and requires the nonassigning party to act with good faith and in a commercially reasonable manner in deciding whether to consent to the assignment."

• Likewise, the Alabama supreme court alluded to such a possibility: The contract in suit specifically gave the Shoney's restauraunt chain the right, in its sole discretion, to consent to any proposed assignment or sublease of a ground lease by a real-estate developer that had acquired the ground lease from Shoney's. The supreme court held that this express language trumped a rule that had been laid down in prior case law, namely that a refusal to consent is to be judged by a reasonableness standard under an implied covenant of good faith:

Succinctly stated, under Alabama law "sole discretion" means an absolute reservation of a right. It is not mitigated by an implied covenant of good faith and fair dealing in contracts because an unqualified reservation of a right in the sole discretion of one of the parties to a contract expresses the intent of the parties to be subject to terms that are inconsistent with any such implied covenant.

• State law also might impose a reasonableness requirement if a commercial- or residential lease agreement requires the landlord's consent before the tenant can assign the lease.

BUT: The reviewing party might be willing to "play chicken" with the assigning party by (metaphorically) folding its arms and saying, in effect: We think we're being reasonable in withholding our consent unless you pay us big bucks. If you don't agree, then sue us — and watch your deal disappear while you wait months or years for the court proceedings to end.

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24.5.5 Option: Consent Exception for certain business-asset transfers

Assignor need not obtain Reviewer's consent to an assignment of the Contract that occurs in conjunction with a sale or other transfer of substantially all of the assets of Assignor's business to which the Contract relates.

Commentary

Contracts are frequently assigned in connection with corporate mergers, acquisitions, and spin-offs. The legal implications of an assignment can be important, particularly concerning provisions such as indemnity- and defense obligations if a catastrophic event occurs, such as an oil-well blowout.

Alternative: Assignor need not obtain Reviewer's consent to an assignment of the Contract that occurs in conjunction with a sale or other transfer of substantially all of the assets of Assignor's business.

Alternative: Reviewer's consent is required even for an assignment of the Contract in conjunction with a sale or other transfer of Assignor business assets

Business context: Suppose that Alice and Bob are negotiating a contract between them. It'd be fairly standard for Bob to want to be able to assign the contract without Alice's consent if Bob were to do an asset disposition such as the sale of an unincorporated division or a specific product line. This could be crucial to Bob's company if the company wanted to retain control over its own strategic destiny.

Moreover, if Bob were to sell a line of business, an assignment-consent exception for asset sales also could save Bob's assignee ("Betty") from having to re-buy and pay again for an IP license that Bob already paid for once for the line of business.

Something close to this happened in a Sixth Circuit case in which a software customer found itself having to pay copyright-infringement damages to the software vendor, in an amount equal to the licensee fee that the customer had already paid, because the customer switched the use of the software to an unauthorized affiliate.

So in Alice and Bob's contract negotiation, Bob might argue for one or more consent carve-outs along the following lines:

We need to keep control of our strategic destiny. If we ever wanted to sell a product line or a division (or even the whole company) in an asset sale, we'd need to be able to assign this agreement as part of the deal. We don't want to have to worry about whether somebody at your company was going to get greedy and try to hold us up for a consent fee.

Alice, though, might respond in the negotiation with something like this:

Wait — what if you decided to sell a product line or a division to one of our competitors? We need to retain control over that possibility. The only way for us to do that is to retain the absolute right to consent to any assignment you might make.

That will usually be a matter for negotiation.

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24.5.6 Is consent needed for a pledge of rights under the Contract?

  1. Except as stated in this section, Assignor need not obtain Reviewer's consent to a "Pledge," namely:
    1. an assignment- or pledge of one or more of Assignor's rights under the Contract, and/or
    2. a grant of a security interest in any such right.
  2. This Pledge exception applies regardless whether the Pledge is absolute or collateral.
  3. Consent is required, however, for a Pledge that:
    1. purports to delegate any of Assignor's material obligations under the Contract, and/or
    2. has such an effect as a matter of law.
Commentary

Even without the carve-out of this section, courts have distinguished between assigning an agreement in its entirety and assigning certain rights and benefits under the agreement.

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24.5.8 What if Reviewer assigns the Contract?

If Reviewer assigns the Contract, then Assignor need no longer obtain consent to assignment from Reviewer or any direct or indirect assignee of Reviewer.

Commentary

A basic premise underlies the requirement that Assignor must obtain Reviewer's consent to assignment: Reviewer bargained for the right to choose its counterparty and thus to consent to any assignment by Assignor. The other side of that coin, though, is that when Assignor agreed to give Reviewer the power to veto Assignor's future strategic transactions, Assignor implicitly bargained for that veto to be exercised by Reviewer, not by some unknown future successor to Reviewer.

Accordingly, this section says that if Reviewer assigns the Contract, then Reviewer relinquishes its veto.

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24.5.9 Option: Assignment as Material Breach

If Assignor assign the Contract without a consent required by the Contract, Assignor will be materially breaching the Contract.

Commentary
Cue the distracted-boyfriend meme…

If a contract states that assignment without consent is a material breach, that could give a non-assigning party an incentive:

  • to claim that the other party had "assigned" the agreement, in material breach of the agreement; and
  • to use that alleged material breach as an excuse to scrap that contract relationship — and take up with another, more-lucrative party.

Such a desire to ditch an existing contract relationship seems to have been at work in a case involving Hess Energy, where:

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

The appeals court expressed considerable doubt that Statoil had indeed assigned the contract to its new parent company, Amerada Hess. And even if Statoil had in fact assigned the contract, the resulting breach of the agreement would not have been a material breach, and therefore the vendor did not have the right to terminate the contract:

[T]here is no provision in the agreement making such an assignment an automatic ground for immediate termination of either the Master Agreement or of the confirmation contracts under it. To the contrary, an assignment under certain circumstances is authorized, and any assignment could be made with Lightning's consent, which could not be unreasonably withheld.

Accordingly, even if Lightning could establish that there was an improper assignment, termination would be justified only if the assignment resulted in a breach that was material.

Danger of an own-goal termination for breach

If the Contract doesn't include a material-breach clause in the assignment-consent provision, then:

  • A non-assigning party might not be able to terminate the contract merely because the other party assigned the agreement without consent.
  • That in turn could mean that the non-assigning party would be stuck with a new contract partner.
  • The non-assigning party's only remedy against the assigning party for assigning without consent would presumably be money damages — and it might be difficult and expensive to establish, with evidence, the fact and amount of her damages.

See § Caution: Improper termination for breach could be an "own goal" breach for additional discussion.

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24.5.10 Option: Assignment Void Without Consent

  1. Except as provided in subdivision b, if Assignor assign the Contract without Reviewer's consent, then the assignment will be void ab initio ("from the beginning").
  2. Exception: An assignment without consent might occur automatically by operation of law as part of a merger or other transaction; such an assignment is not void unless the Contract expressly requires Assignor to obtain Reviewer's consent to such a merger or other transaction.
Commentary

Absent agreement otherwise:

  • A court applying the so-called classical approach might hold that an assignment was void if made without a required consent.
  • In contrast, a court applying the so-called modern approach (or one of its variants) might hold that an unconsented assignment was a breach of the contract — for which damages might be available — but that the assignment per se was not void unless the contract said so, perhaps with requisite "magic words."

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24.5.11 Option: Consent Requirement for Mergers

  1. A "Merger Transaction" on Assignor's part requires Reviewer's consent to the same extent, if any, as an assignment of the Contract outside of such a transaction.
  2. For this purpose, the term "Merger Transaction" refers to a merger, consolidation, amalgamation, or other similar transaction or series of transactions, involving Assignor, in which Assignor is not the surviving entity; this definition will apply whether or not an assignment occurs by operation of law.
Commentary

Contracts are frequently assigned in connection with corporate mergers, acquisitions, and spin-offs. The legal implications of an assignment can be important, particularly concerning provisions such as indemnity- and defense obligations if a catastrophic event occurs, such as an oil-well blowout.

The law seems to vary as to whether a merger or similar transaction effects an assignment of contracts by operation of law. The Delaware chancery court once ruled, on summary judgment, that "mergers do not result in an assignment by operation of law of assets that began as property of the surviving entity and continued to be such after the merger."

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24.5.12 Option: Reviewer Deems Itself Insecure

  1. When agreed to, this Option applies if Assignor assigns the Contract in a manner that delegates some or all of Assignor's performance under the Contract.
  2. The non-assigning party may (by giving notice (as defined in Clause 24.17)) demand commercially reasonable assurance that Assignor's obligations under the Contract will be duly performed.
  3. The non-assigning party's right to demand assurance under subdivision b does not affect any other right or remedy that the non-assigning party might have against Assignor and/or the assignee.
  4. IF: The non-assigning party does not receive such assurance within a reasonable time (not to exceed 30 days) after the effective date of the non-assigning party's notice demanding assurance; THEN: Assignor and the assignee will be deemed to have repudiated the Contract.
Commentary

This Option is modeled on a similar provision in the [U.S.] Uniform Commercial Code, namely UCC § 2-210(5) (which applies by its terms only to sales of goods). That provision states that "[t]he other party may treat any assignment which delegates performance as creating reasonable grounds for insecurity and may without prejudice to his rights against the assignor demand assurances from the assignee" under UCC § 2-609.

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24.5.13 Drafting exercise: Assignment provision

The following comes from a software-development agreement in an arbitration case in which I was engaged to be the arbitrator (the case was settled before the hearing):

9.7 Assignment. No Party may sell, transfer, assign, assume or subcontract any right nor obligation set forth in this Agreement by contract, operation of law or otherwise, except as expressly provided herein, without the prior written consent of the other Party; provided, however, upon providing the other Party written notice, any Party may without the consent of the other Party: (a) (i) assign any or all of its rights and interests hereunder to one or more of its Affiliates or (ii) designate one or more of its Affiliates to perform its obligations hereunder, in each case, so long as the assigning Party is not relieved of any liability hereunder and so long as any such Affiliate remains such Party's Affiliate; provided, however, that such Affiliate assignee(s) provide the other Party with written acknowledgement of and agreement to the assigning Party's obligations under the Agreement that were assigned to it; or (b) assign or transfer this Agreement as a whole to any Person that succeeds to all or substantially all of the business or assets of such Party related to the subject matter of this Agreement.

EXERCISE: Break this up into shorter, one-subject paragraphs. Do this in your groups. In virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section )

24.5.14 Discussion exercise: Assignment

FACTS: Your client MathWhiz has grown considerably and expanded into other lines of business. They're negotiating a contract to provide commodity data-processing services for BigWhale Corporation.

BigWhale wants the contract to state that MathWhiz won't assign the contract without BigWhale's consent.

QUESTION: How might MathWhiz respond?

24.5.15 Assignment of contracts: Oil futures below zero (first time)

See this Bloomberg story — here's an excerpt:

The price on the futures contract for West Texas crude that is due to expire Tuesday fell into negative territory – minus $37.63 a barrel.

That’s right, sellers were actually paying buyers to take the stuff off their hands.

The reason: with the pandemic bringing the economy to a standstill, there is so much unused oil sloshing around that American energy companies have run out of room to store it.

And if there’s no place to put the oil, no one wants a crude contract that is about to come due.

(Emphasis and extra paragraphing added.)

HYPOTHETICAL: Suppose that:

  1. Alice buys a May oil futures contract.
  2. Alice later sells the contract to Bob.
  3. Bob defaults on the contract, i.e., he refuses to take delivery.

QUESTION: Under ordinary contract-assignment rules, would Alice be liable for Bob's default?

24.5.16 Assignment of Mickey-Dee franchise agreement

FACTS:

  • You represent Smith, LLC, a family business that operates three Mickey-Dee franchised restaurants in Houston.
  • Smith, LLC owns the land and buildings of the restaurants, which are built to specifications developed by the global franchising firm Mickey-Dee Incorporated.
  • The restaurants all use trademarks owned by Mickey-Dee Incorporated, including the signage, logos, the name "Mickey-Dee," uniform styles etc.
  • The franchise agreement is silent about assignability of the agreement.
  • Smith, LLC wants to sell its three franchised restaurants to Jones, Inc., another family business.

QUESTIONS:

  1. What if anything could Mickey-Dee Incorporated do if your client Smith, LLC were to assign the franchise agreement to Jones, Inc.?
  2. What changes might you request in the franchise agreement as Smith LLC's lawyer?

24.6 Binding Agreement

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. In entering into the Contract, each party voluntarily acknowledges (as defined in Clause 25.1) the following:
    1. The acknowledging party had an opportunity to read and understand the Contract in its entirety,
      • including without limitation the Tango Terms provisions incorporated by reference into the Contract;
    2. The acknowledging party had an opportunity to seek clarification of any provision that it did not understand;
    3. The acknowledging party had an opportunity to consult licensed legal counsel of its choosing,
      • in deciding whether to enter into the Contract on the terms stated in it;
    4. If the acknowledging party did not consult counsel, it made an informed, voluntary decision not to do so;
    5. The acknowledging party is not relying on advice from counsel for any other party;
    6. The acknowledging party intends to be bound by the Contract,
      • except for provisions, if any, that the Contract clearly identifies as nonbinding;
    7. The acknowledging party intends for each other party to rely on its acknowledgements in this Clause; and
    8. It is reasonable for such other party (or parties) to rely on those acknowledgements.
  3. The acknowledging party also agree that the Contract will bind not just the acknowledging party itself,
    • but also the acknowledging party's heirs and legal representatives,
    • if the acknowledging party is an individual,
    • and the acknowledging parties successors and (if any) permitted assigns.
Commentary

This is a roadblock provision, intended to forestall a later claim by a party that, "I didn't know this was supposed to be a binding agreement — I thought we were just writing down ideas!" (If the parties want that, they can use the Letter of Intent Addendum.)

Subdivision b.3: This acknowledgement states that the parties have had the opportunity to consult counsel; it does not say that the parties have been represented, because one or both parties might not have been represented. This acknowledgement also refers to consultation with counsel when the parties were entering into their agreement, not to when they were negotiating the agreement (because there might not have been any negotiation).

Subdivision b.5: This disclaimer of reliance on other parties' counsel can help shield each party's attorneys against later claims, by a disgruntled counterparty, to the effect of, wait, I thought you were my lawyer; you had a conflict of interest and didn't disclose it. It can be tempting for disgruntled counterparties to make such accusations: In malpractice lawsuits against attorneys, a standard tactic by plaintiffs' lawyers is to claim that the attorney accused of malpractice had an undisclosed conflict of interest — and that's a claim that's easy for nonlawyer jurors to understand, akin to They lied!

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24.7 Entire Agreement

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. The Contract,
    • including but not limited to the adopted Tango Terms provisions,
    • and any other materials attached or incorporated into the Contract,
    • is the parties' complete, final, and exclusive agreement,
    • concerning the matters addressed in it,
    • unless the Contract clearly says otherwise.
  3. All prior discussions, of any kind in any medium, concerning those matters,
    • including but not limited to representations,
    • are to be treated as having been merged into and replaced by the Contract.
  4. Additional- or different terms,
    • in a purchase order, order confirmation, invoice, or similar document,
    • will be of no effect,
    • even if one or more parties takes action consistent with those terms, unless the document:
      • expressly and specifically identifies the Contract —
        • a generic precedence provision is not sufficient for this purpose; and
      • is signed by the party sought to be bound by the additional or different terms.
Commentary

This is a roadblock provision, intended to forestall later claims that the parties also agreed to side letters, oral agreements, and the like.

Subdivision c: Merger of prior discussions

Caution: In some states, merely stating, in essence, that there are no representations other than in the four corners of this Agreement would not be enough to avoid a claim that one party fraudulently induced another party to enter into the contract; see the extended discussion concerning Clause 20.3 (Reliance Disclaimer).

Subdivision d: Additional or different terms

Even when parties have agreed in writing about the terms on which they do business, their procurement- or sales people might reflexively issue purchase orders, sales confirmations, and similar documents. Such party-issued documents typically include terms and conditions that might be significantly different than what the parties agreed to (read: heavily biased in favor of the issuing party).

Allowing such additional‑ or different terms to take precedence would give a party a blank check to "re-trade the deal" by including such terms in a purchase order, an order confirmation, an invoice, etc.

(See also the Battle of the Forms commentary.)

Subdivision d: Actions consistent with additional terms

Example: Suppose that:—

  • Provider and Customer sign an agreement that contains this Clause;
  • Under the Contract, Provider is supposed to, say, provide services for Customer;
  • But then Customer sends Provider a purchase order for the services;
  • The purchase order contains additional or different terms that purportedly supersede the terms of the Contract;
  • Provider performs the services, thinking "everything's cool, we've got a contract";
  • Customer then claims that the services are governed by the additional- or different terms in Customer's purchase order — according to Customer, Provider implicitly accepted those additional- or different terms by performing the services.

does what it's supposed to do under ships  party might claim that another party had implicitly accepted additional- or different terms by taking action that conformed to some of those terms. (In fact, some customers' purchase-order forms state that the supplier is deemed to have accepted the purchase-order terms if the supplier starts work in any manner.) This language tries to forestall such an interpretation.

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24.7.1 Exercise and discussion questions

24.7.1.1 Discussion questions

1.  What happens if parties negotiate sign a master sales agreement — but then one party sends a purchase order with additional, more-onerous terms?

2.  FACTS: In a contract, an entire-agreement provision states that there are no representations other than those set forth in the agreement. QUESTION: In Texas, will that provision preclude a party's claim that the other party fraudulently induced the claimant to enter into the contract?

24.7.1.2 Drafting exercise

FACTS:

1.  You represent MathWhiz.

2.  Gigunda's lawyer has sent over a draft services agreement for your review.

3.  You notice that Gigunda's draft agreement doesn't include an entire-agreement provision.

4.  Gigunda's draft otherwise looks OK.

EXERCISE: Draft a short, "minimum-viable provision" (MVP).

24.8 Evergreen Extensions

Commentary

Caution: By law, some states restrict automatic extension or renewal of certain contracts unless specific notice requirements are met.

Some examples of states that restrict automatic renewal include the following:

• California: Cal. Bus. & Prof. Code § 17600-17606 (consumer contracts)

• Illinois: 815 ILCS § 601 (consumer contracts)

• New York: N.Y. Gen. Oblig. L. § 5-903 (contracts for services, maintenance or repair)

• North Carolina: N.C. Gen. Stat. § 75-41 (consumer contracts)

• Wisconsin: Wis. Stat. § 134.49 (business equipment leases and business services).

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24.8.1 Applicability; definitions

This Clause will apply if the Contract, in substance:

  • sets forth a time period; a right; or an obligation —
    • each referred to generically here as an "Evergreen Period" —
  • that by its terms is to expire at a particular time; and
  • clearly indicates that the Evergreen Period is to be automatically renewed or extended,
    • for one or more specified periods.
Commentary

Language choice: The term "extension" is used because the term "renewal" (which seems to be the common term) might require a party to renegotiate as a condition of being able to exercise an option to renew.

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24.8.2 Which party or parties may opt out of an extension?

  1. {{{Any party}}} party may opt out of an automatic extension of the Evergreen Period,
  2. If an eligible party does opt out,
    • then the Evergreen Period will come to an end at its then-current expiration date.
  3. If no (eligible) party opts out of automatic extension as provided above,
    • then the Evergreen Period will be extended,
    • at its then-current expiration date,
    • and on the same terms,
    • for successive extension periods, without a break,
    • except as otherwise stated in this Clause.
Commentary

Subdivision a: The "sole discretion" language is intended to forestall any claim that a decision to opt out is subject to some sort of duty of good faith and/or fair dealing. In its Bhasin case, the Supreme Court of Canada, citing U.S. cases, noted that:

… even in jurisdictions that embrace a broader role for the duty of good faith, plaintiffs have met with only mixed success in alleging bad faith failure to renew a contract.

Some cases have treated non-renewal as equivalent to termination and thus subject to a duty of good faith: Shell Oil Co. v. Marinello, 294 A.2d 253 (N.J. Super. Ct. 1972), aff’d 307 A.2d 598 (N.J. 1973); Atlantic Richfield Co. v. Razumic, 390 A.2d 736 (Pa. 1978), at pp. 741-42.

Other courts have seen non-renewal as fundamentally different, especially where the express terms of the contract contemplate the expiry of contractual obligations and leave no room for any sort of duty to renew: J.H. Westerbeke Corp. v. Onan Corp., 580 F. Supp. 1173 (D. Mass. 1984), at p. 1184; Pitney-Bowes, Inc. v. Mestre, 517 F. Supp. 52 (S.D. Fla. 1981), cert. denied, 464 U.S. 893 (1983).

Caution: In a Canadian case, the agreement in suit involved the software giant Oracle Corporation and a member of Oracle's partner network.

  • The agreement gave Oracle the sole discretion to accept the partner's application to renew the agreement.
  • For 20 years the agreement was renewed each year.
  • In 2014, though, Oracle invited the partner to renew the agreement, but then rejected the partner's renewal application.
  • The partner filed suit.

The trial court denied Oracle's motion to dismiss, holding that a dictum in Bhasin "does not stand for the (extreme) proposition that under no circumstances does a 'sole discretion' contract renewal power have to be exercised reasonably."

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24.8.3 When is the opt-out deadline?

Any opt-out notice under § 24.8.2

  • must be effective no later than 30 days before,
  • or, if so stated in the Contract, after,
  • the expiration of the Evergreen Period.

24.8.4 Is there a maximum number of automatic extensions?

The Evergreen Period will continue to be extended indefinitely,

  • with no maximum number of extensions,
  • until such time (if any) as an eligible party opts out,
  • unless the Contract clearly specifies otherwise.

24.8.5 What is the maximum duration of an automatic extension?

Each successive evergreen-extension period will be of the same duration as the original duration of the Evergreen Period —

  • but only up to a maximum of the specified duration per extension period,
  • unless clearly agreed otherwise in writing for a specific extension.
Commentary
Maximum extension duration

This section puts an upper limit on the duration of an automatic extension (the parties are of course free to affirmatively agree to any extension they want).

  • Example 1: A six-month Evergreen Period would be automatically extended for successive six-month terms.
  • Example 2: A three-year Evergreen Period would be automatically extended for successive one-year terms.

Caution: Too-long an automatic-extension period can be problematic. Here's an example that the author once saw with a client:

  • The client, a software provider once gave a steep pricing discount to a particular high-profile customer; the provider agreed that the steep discount would last for five years. (The author was not involved in that transaction.)
  • The agreement provided that the discount would be automatically extended for another five years if the software provider didn't opt out when the first five-year period was expiring.
  • No one in the software provider's organization noticed that the five-year discount period was ending.

As a result, the software provider didn't remember send the customer a notice that the client was opting out of the pricing commitment — and so the provider had to honor the steeply-discounted pricing for that customer for another five years --- even though the provider had raised its prices significantly for the rest of its customer base.

Pro tip: Longer durations for subsequent extension periods?

Evergreen extension periods could be of different lengths; for example, in some contractual relationships:

  • a first extension period might be relatively short, to give the parties a chance to find out what it's like working together;
  • Then, if neither party opts out, subsequent extension periods could be of longer duration.

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24.8.6 Option: Mandatory Reminder of Upcoming Expiration

24.8.6.1 Applicability

This § 24.8.6 applies if —

  • the Contract allows only one party,
    • referred to generically here as "Customer,"
    • to opt out of automatic extension,
  • and does not allow the other party,
    • referred to generically here as "Provider,"
    • to opt out of automatic extension of the Evergreen Period.

Note: These placeholder names are used here because automatic extensions are often seen in provider-customer agreements; this Clause is not limited to such agreements.

24.8.6.2 Written-reminder requirements
  1. For the Evergreen Period to be automatically extended,
    • Provider must send Customer a written reminder of the upcoming expiration date of the Evergreen Period.
  2. For the expiration reminder to be effective,
    • Customer must receive or refuse the reminder,
    • or the reminder must be undeliverable after reasonable efforts,
    • no earlier than 60 days,
    • and no later than 30 days,
    • before the upcoming expiration date.
  3. If Provider does not timely send Customer the expiration reminder,
    • then Customer may affirmatively elect to extend the Evergreen Period,
      • for the same length of time as would otherwise have happened automatically,
      • by giving Provider notice of its election to extend;
    • BUT: For Customer's election to extend to be effective,
      • the notice of election must be effective on or before:
        • 30 days after Customer receives a belated reminder from XYZ, if any,
        • or if earlier, 90 days after what would otherwise have been the expiration date of the Evergreen Period.
  4. In case of doubt: If the Contract allows each party to opt out of automatic extension, then no reminder is necessary.
Commentary

This mandatory-reminder option is intended to prevent a party that doesn't want to extend an Evergreen Period (e.g., a provider) from allowing the Evergreen Period to expire silently without first reminding the party eligible extension (e.g., a customer) that the opt-out deadline is coming up.

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24.8.7 Option: Extension Opt-Out Fee

  1. If a party opts out of an extension under this Clause before [specify date],
    • then that party must pay the other party an early opt-out fee of [FILL IN AMOUNT, no later than 12 midnight UTC at the end of the day on the then-current expiration date of the Extendable Period;
    • otherwise, the extension will go into effect,
    • and the right to opt out of the extention will expire,
    • with no further action by any party.
  2. In case of doubt, the early opt-out fee of this section is intended as a form of alternative performance and not as liquidated damages.
Commentary

This provision was inspired by an analogous provision in a Ninth Circuit case where the court of appeals affirmed a summary judgment that a Canadian food distributor owed a U.S. marketing firm a fee for electing not to renew the parties' "evergreen" agreement.

The intent of the early opt-out fee is to give the other party a specified minimum time in which, say, to recoup the investments it makes in supporting the parties' contractual relationship.

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24.9 Freedom of Action

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Neither party will assert, and each party WAIVES (as defined in Clause 24.26) any claim or other assertion, that the Contract:
    • obligates any party to enter into any other agreement, relationship, or transaction — see also Clause 24.14 (Letter of Intent Addendum),
      • or precludes any party from doing any kind of business with anyone else — see also Clause 25.24 (Exclusivity Definition),
      • or requires any party to restrict the assignment of employees or other personnel,
    • unless the Contract clearly states otherwise.
Commentary

This is a roadblock provision, intended to forestall claims by a party that another party implicitly agreed to restrict its activities.

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24.10 Government Subcontract Representation

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

Discussion checklist:

Commentary

This Clause is a "no surprises" provision: Subcontracts to government contracts might include mandatory "flowdown" obligations (as defined in Clause 26.5) as a matter of law; neither party wants to be surprised to learn that the Contract includes such flowdown obligations.

Of course, entire books have been written about government contracting and subcontracting; this Clause is intended merely to "smoke out" any need to address issues that could arise in such contracts.

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24.10.1 Is the Contract a government subcontract?

Each specified party represents (as defined in Clause 20.2) and warrants (as defined in Clause 20.4),

  • to each other party,

that the Contract is not a subcontract,

except to the extent (if any) that the Contract itself expressly discloses otherwise.

24.10.2 May a party make governmental commitments for another?

  1. No party may purport to obligate any other party,
    • as a subcontractor or otherwise,
    • to any government authority,
    • nor to the terms of any government contract,
    • through flowdown provisions or otherwise,
    • without the other party's express, prior, written consent.
  2. No party may make any representation, warranty, or certification,
    • purportedly on behalf of the other party,
    • concerning the other party' business practices, work force, or other status,
    • in any report to a government authority,

for example (as defined in Clause 25.23), an equal-opportunity compliance report.

24.11 Independent Contractors

24.11.1 The parties intend to be independent contractors

  1. Each party is entering into the Contract with the intent that all parties will be independent contractors.
  2. No party has any intention of entering into (for example):
    • an employment relationship;
    • a joint venture;
    • or a partnership.
  3. No party is authorized to act as an agent for any other party.
  4. The parties do not intend for the Contract
    • to establish, nor to evidence,
    • a fiduciary relationship between the parties.

24.11.2 Certain specific inconsistent actions are prohibited

No party may purport to do,

  • nor attempt to do,
  • any of the following things,

except to the minimum extent (if any)

  • that the Contract clearly states otherwise,
  • or as otherwise clearly agreed in writing:
  1. make any promise, representation, or warranty,
    • on behalf of any other party,
    • concerning the subject matter of the Contract;
  2. hold itself out as an employee, agent, partner, joint venturer, division, subsidiary, branch, or other representative of another party:
  3. hire any individual to be an employee of another party;
  4. determine working hours or working conditions of another party's employees;
  5. select or assign any employee of another party to perform a task;
  6. direct or control the manner
    • in which any employee of another party performs his or her work,
    • as distinct from the result to be accomplished;
  7. remove any employee of another party from a work assignment;
  8. discharge or otherwise discipline any employee of another party;
  9. incur any debt or liability on behalf of another party;
  10. bind another party to any other type of obligation, commitment, or waiver.

24.11.3 Each party must defend against resulting third-party claims

Each party,

  • upon request by another party,

must defend (as defined in Clause 21.4) that other party's Protected Group (as defined in Clause 25.40)

against any third-party claim

  • that arises from the first party's alleged noncompliance with this Clause.
Commentary
Calling parties "independent contractors" won't make them so

Contracts often contain independent-contractor declarations, but as discussed in the commentary below, (U.S.) Supreme Court precedent makes it clear that "there is no shorthand formula or magic phrase" for independent‑contractor status.

Other courts have held that such declarations won't necessarily carry the day. For example, in 2014 a three-judge panel of the Ninth Circuit held that the plaintiffs in a class-action suit, who were drivers for FedEx, were not independent contractors but employees; the panel reversed summary judgment in favor of FedEx and remanded to the trial court with instructions to enter summary judgment for the drivers on the question of their employment status. The court's opinion began:

As a central part of its business, FedEx Ground Package System, Inc. ("FedEx"), contracts with drivers to deliver packages to its customers. The drivers must wear FedEx uniforms, drive FedEx-approved vehicles, and groom themselves according to FedEx's appearance standards. FedEx tells its drivers what packages to deliver, on what days, and at what times. Although drivers may operate multiple delivery routes and hire third parties to help perform their work, they may do so only with FedEx's consent.

FedEx contends its drivers are independent contractors under California law. Plaintiffs, a class of FedEx drivers in California, contend they are employees. We agree with plaintiffs.

A concurring opinion noted, somewhat harshly:

Abraham Lincoln reportedly asked, "If you call a dog's tail a leg, how many legs does a dog have?" His answer was, "Four. Calling a dog's tail a leg does not make it a leg." …

The California Supreme Court echoed this wisdom in Borello, saying that the "label placed by the parties on their relationship is not dispositive, and subterfuges are not countenanced." …

Although our decision substantially unravels FedEx's business model, FedEx was not entitled to "write around" the principles and mandates of California Labor Law by constructing a contract which, after a contested trial, the California trial court in Estrada called: "a brilliantly drafted contract creating the constraints of an employment arrangement with the drivers in the guise of an independent contractor model—because FedEx not only has the right to control, but has close to absolute control over the drivers based upon interpretation and obfuscation."

The Court of Appeal in that case appropriately called the trial court's observation an application of the looks like, walks like, swims like, and quacks like a duck test.

IRS guidance about independent contractors vs. employer-employee

The [U.S.] Internal Revenue Service's Web site offers easy-to-read guidance about what the Service considers in determining whether someone is an employee (for whom the employer must pay certain taxes) or an independent contractor.

California's statutory response defining "employee" status

In 2019, the California legislature enacted a statute, known as AB 5, which added a new section 2750.3 to California Labor Code, setting out a three-part initial test for whether someone is an independent contractor instead of an employee. The statute, however, goes on to set forth carve-outs for certain occupations that are worth a careful review.

No agency- or fiduciary relationship

Subdivisions c and d are a roadblock provisions: Routine contract disputes can be made more complicated if an aggressive lawyer tries to claim that the lawyer's client was an agent of another party, or that another party owed a fiduciary duty to the client.

This section will also usefully alert any party that might be expecting another party to act as a fiduciary.

BUT: Once again, merely saying "there's no agency relationship here" won't make it so. In a Seventh Circuit case, "a district judge concluded that DISH Network and its agents committed more than 65 million violations of telemarketing statutes and regulations. The penalty: $280 million." In mostly affirming the judgment, the appeals court noted that "[t]he contract [between DISH and its representatives] asserts that it does not create an agency relation, but parties cannot by ukase negate agency if the relation the contract creates is substantively one of agency."

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24.11.4 Independent contractors — topics for discussion

  1. Will courts generally honor a contractual statement that the parties are independent contractors? When might they not, and why?
  2. If courts won't always honor a contractual statement that the parties are independent contractors, why bother including the statement?

24.12 Labor-Law Rights

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. The parties do not intend for anything in the Contract to restrict the ability of a party to exercise any legally protected and non-waivable right:
    1. to engage in collective action, for example under the U.S. National Labor Relations Act ("NLRA"); or
    2. to file a charge or other claim with a governmental authority,
      • for example, the U.S. National Labor Relations Board ("NLRB")
      • or the U.S. Equal Employment Opportunity Commission ("EEOC").
  3. To be clear, though: Neither do the parties intend for this Clause to constitute evidence of any of the following —
    1. that an employment relationship exists between the parties; nor
    2. that the NLRA or other legislation applies; nor
    3. that the NLRB, EEOC, or other authority, has jurisdiction.
Commentary

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.

More recently, however, Trump appointees to the NLRB appear to be more open to employer-employee agreements that favor the employer.

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24.14 Letter of Intent Addendum

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

24.14.1 Why are the parties agreeing to this Clause?

  1. When this Clause is agreed to, it indicates that the Contract is to be a "letter of intent", also referred to here as an "LOI."
  2. The parties intend to discuss, or to continue discussing, a potential business arrangement (a potential "Arrangement");
    • they anticipate that they might eventually enter into a final, definitive written agreement (a "Final Agreement"):
      • that sets forth all final, material terms of the Arrangement,
      • and is signed and delivered by all relevant parties.
  3. The parties are entering into the LOI with the following intent:
    1. to make it clear that the parties have not yet agreed to all material terms of the potential Arrangement,
      • and that they do not yet agree to be bound except as provided in the LOI;
    2. to provide the parties with a convenient outline of the potential Arrangement as they are then currently contemplating it;
    3. and to set out agreed ground rules for the parties' anticipated discussions about the potential Arrangement.
Commentary

The consequences of parties’ entering into what they think is a "nonbinding" letter of intent can be significant if a court later finds that the parties in fact intended to enter into a binding contract.

A canonical example of this danger is the Texaco-Pennzoil litigation: Texaco was hit with a damage award of some $10.5 billion — or more than $27 billion in 2019 dollars — for tortiously interfering with (what the jury and the courts found to be) Getty Oil's binding written agreement with Pennzoil, under which Pennzoil was to acquire a minority interest in Getty Oil.

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24.14.2 Are the parties' discussions exclusive?

Except to the extent (if any) that the LOI expressly states otherwise,

  • each party remains free,
  • in that party's sole discretion (as defined in Clause 25.19),
  • to seek, discuss, negotiate, and/or enter into other arrangements, of any kind, with other parties —
  • even if, as a result of such other discussions, etc., it would no longer be possible for one or more of the parties to enter into a Final Agreement.
Commentary

Drafters can also consider:

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24.14.3 Are the parties free to withdraw from discussions?

Yes: Any party may withdraw from discussion of the potential Arrangement and negotiation (if any) of a Final Agreement,

  • in the withdrawing party's sole discretion (as defined in Clause 25.19),
  • without obligation or liability of any kind, under any legal- or equitable theory, to any other party,
  • until the Final Agreement is signed and delivered by all parties,
  • except to the extent (if any) that the LOI expressly states otherwise.
Commentary

See generally Clause 25.19 (Discretion Definition) and its commentary.

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24.14.4 What LOI obligations are binding?

The parties intend for only the following terms in the LOI to be binding:

  1. this Clause; and
  2. any other terms in the LOI that the parties have clearly agreed in writing are to be binding, such as, if applicable:
    • confidentiality;
    • exclusivity; and/or
    • no-shop.
Commentary

Drafters can consider also the following:

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24.14.5 Why is this Clause important to the parties?

Each party acknowledges that without that party's agreement to this Clause, the other party would not go forward with discussions about the potential Arrangement.

24.14.6 When might other terms become binding?

  1. Neither party will be bound by any obligation or liability,
    • nor entitled to any right,
    • relating to the potential Arrangement,
    • unless and until the parties sign and deliver a Final Agreement,
    • except to the extent (if any) that the LOI clearly states otherwise.
  2. Without limiting subdivision a: No party intends to be bound by any of that party's communications or actions concerning the potential Arrangement,
    • in any form or medium,
    • before the parties' formal entry into the Final Agreement,
    • no matter how long a discussion and/or an exchange of messages continues concerning the potential Arrangement;
    • no matter how many different discussions and/or message exchanges occur about the potential Arrangement; and
    • regardless whether an alleged obligation, liability, or right purportedly arises in contract; tort; strict liability; quantum meruit; quasi-contract; unjust enrichment; or otherwise.
Commentary

In at least some jurisdictions, the express requirement of a Final Agreement, and the disclaimer of binding effect of other communications, should be enough to keep prior written exchanges from being binding.

For example, the Texas supreme court held that a trial court had correctly granted summary judgment that, as a matter of law, a particular email exchange did not create a binding agreement in view of a confidentiality agreement that contained a "No Obligation" clause.

And in the famous Pennzoil v. Texaco case, a Texas court of appeals court held that "[a]ny intent of [Getty Oil and Pennzoil] not to be bound before signing a formal document is not so clearly expressed in [their] press release to establish, as a matter of law, that there was no contract at that time."

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24.14.7 Will an early start by a party be binding?

  1. This section applies if a party begins taking action concerning the potential Arrangement before a Final Agreement has been fully signed and delivered.
  2. The party taking action does so entirely at its own expense and risk,
    • including but not limited to legal risk.
  3. No party will assert that such action constitutes or evidences:—
    • agreement to the Final Agreement,
    • nor the formation of a partnership, joint venture, or similar type of relationship.
Commentary

This section tries to forestall a particular type of finding: That a contract — or a partnership or other relationship — was formed, not by negotiation as contemplated in a letter of intent, but instead by the parties' actions.

Moreover, under state law a partnership can arise even without a contract; and according to a Texas jury — whose $550‑million verdict was subsequently overturned on appeal — two parties formed a de facto partnership, even though they had signed a letter agreement disclaiming any such intent, because (said the plaintiff and the jury) the parties had behaved as though they were partners. Fortunately for the defendant, the court of appeals and the state supreme court later held that the parties' freedom of contract allowed them to agree that they would not be subject to partnership obligations unless and until the prerequisites in their agreement had been met.

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24.14.8 Other terms to consider adopting

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

Letter of intent exercise

FACTS: Gigunda is proposing to acquire MathWhiz. Mary, the CEO of MathWhiz, asks you to draft a letter of intent ("LOI").

EXERCISE: In virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ) in your breakout rooms, draft a list of bullet points that should be covered in the LOI.

24.15 No-Material-Conflicts Representation

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

Discussion checklist:

Commentary

Some strategically-important types of agreement routinely include more-detailed "reps and warranties" of this kind; see, for example, the merger agreement between United Airlines and Continental Airlines, at the SEC's EDGAR Website, https://www.sec.gov/Archives/edgar/data/100517/000095015710000587/ex2-1.htm.

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24.15.1 Do any known third-party conflicts exist?

Each party represents (as defined in Clause 20.2)

that the representing party:

  • (i) is not a party to any agreement, and
  • (ii) is not involved in any pending litigation or other claim,

that, in either case, could reasonably be regarded

  • as posing a risk of materially interfering
  • with any party's performance under the Contract.

24.15.2 Could others sue for tortious interference?

Each party represents (as defined in Clause 20.2)

  • that the parties' entry into,
  • and performance of,
  • the Contract
  • will not constitute tortious interference,
  • by a party to the Contract other than the representing party,
  • with a contract between the representing party and any third party,
  • nor with the prospective economic advantage of any third party.
Commentary

See generally the Wikipedia discussion of tortious interference with contractual relationship or prospective economic advantage.

This no-tortious-interference representation tries to avoid the catastrophic results of a lawsuit in which oil giant Texaco was hit with a damage award of some $10.5 billion, or more than $27 billion in 2019 dollars, for tortiously interfering with what the jury and the courts found to be a binding memorandum of understanding between Pennzoil and Getty Oil.

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24.15.3 Option: No-Conflicts Commitment

If this Option is agreed to,

  • then during the term of the Contract,
  • neither party will enter into any agreement
  • that would interfere with the Contract.
Commentary

This Clause seems unnecessary: In a contract between "Alice" and "Bob," it's arguably none of Alice's business if Bob wants to enter into a contract with a third party "Carol"; Alice's only legitimate concern is whether Bob will timely perform his obligations under his contract with Alice.

A stronger version of this Clause would be to prohibit entering into any agreement that has a substantial likelihood of interfering with the Contract.

Variations on this general concept might include:

  • Most-favored-customer clauses (see § 17.3)
  • Non-competition clauses [TO DO: Link]
  • Exclusivity clauses (see § 25.24)

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24.16 No-Shop Obligation

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

Discussion checklist:

24.16.1 Terminology: "Shop the Deal," etc.

  1. This Clause:
    1. imposes restrictions on a party to the Contract ("Seller"),
    2. for the benefit of another party to the Contract ("Buyer"),
    3. in connection with a transaction agreed to in the Contract (the "Transaction")
    4. subject to a limited fiduciary-out exception in Clause 24.16.3.
  2. "Competing Transaction" refers to any transaction,
    • or series of related transactions,
    • similar in nature to the Transaction —
    • including but not limited to the following if the Transaction relates to a merger or acquisition involving Seller:
    • 1. any merger, consolidation, share exchange, or other business combination involving Seller;
    • 2. any disposition of a substantial portion of Seller's assets,
      • whether by sale, lease, license, pledge, mortgage, exchange, or otherwise; and
    • 3. any sale, exchange, or issuance of shares of stock (or, if applicable, of convertible securities)
      • that, in the aggregate, represent a substantial portion of the Voting Power of Seller.
  3. "Participating Seller Representative" refers to any Seller Representative (defined below) who is actively involved in the parties' discussions concerning the Transaction.
  4. "Seller Representative" refers to:
    • any accountant, agent, attorney, director, employee, financial advisor, investment banker, officer, or other representative —
    • of Seller or any Seller affiliate (as defined in Clause 25.2).
  5. "Shop the Deal," and corresponding terms such as Shopping the Deal, refer to the taking of any action that could reasonably be interpreted
    • as having the purpose or effect of exploring, setting up, furthering, or finalizing a Competing Transaction.
    • The term includes, without limitation:
      • 1. initiating or soliciting discussion about a potential Competing Transaction; and
      • 2. furnishing information (public or nonpublic) to a prospective party to a potential Competing Transaction.
Commentary

This Clause draws ideas from — but tries to simplify and streamline — various no-shop clauses found at the Lawinsider.com Website, at https://www.lawinsider.com/clause/no-shop.

See generally also No-Shop Clause (Investopedia.com).

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24.16.2 May Seller "Shop the Deal"?

No: Apart from the fiduciary-out exception of § 24.16.3, Seller:

  1. must not Shop the Deal before termination of the Contract;
  2. must promptly advise Buyer in writing of any inquiries and proposals received concerning possible Competing Transactions;
  3. must neither authorize nor direct any Seller Representative or any other party to take any action inconsistent with Seller's obligations under this Clause; and
  4. must, in writing, timely (as defined in Clause 25.49) direct each Participating Seller Representative not to take any action inconsistent with Seller's obligations under this Clause.

24.16.3 Does Seller have a "fiduciary out"?

Yes, with restrictions, as follows:

  1. Nothing in the Contract is intended to preclude Seller from Shopping the Deal if Seller's board of directors, acting on advice of counsel and, if applicable, Seller's financial advisors, concludes:
    1. that a potential Competing Transaction proposed by a third party,
      • if consummated,
      • would be more favorable to holders of Seller's stock than the Transaction,
    2. or that Shopping the Deal is necessary or advisable for the board of directors to comply with its fiduciary duties under applicable law.
  2. Seller must advise Buyer in writing, at least 48 hours beforehand, that it intends to take action under subdivision a.
  3. Seller must advise Buyer in writing promptly upon receiving any communication (written or otherwise) from a third party,
    • if the communication could reasonably be interpreted
    • as suggesting or inquiring about a potential Competing Transaction.
  4. Seller need not furnish Buyer with the advice of its counsel or its financial advisors.
Commentary

A fiduciary-out clause will typically also allow a seller not only to shop the deal but to terminate an existing acquisition agreement, e.g., if a better offer comes along.

Merger- and acquisition ("M&A") agreements typically provide for a seller to pay the buyer a breakup fee if the seller exercises its fiduciary-out option.

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24.17 Notices Protocol

24.17.1 Definition: Notices

  1. This Clause will govern any communication,
    • each referred to as a "Notice,"
    • that could reasonably be interpreted
    • as being intended to have some significant effect under the Contract;
    • parties are urged to err in favor of complying with this Clause.
  2. Without limiting subdivision a: The term Notice is intended to cover any communication that:
    • 1. advises a party that the party has allegedly breached its obligations under the Contract;
    • 2. advises a party that the advising party is terminating:
      • the Contract,
      • or some aspect of the parties' business relationship or engagement;
    • 3. demands defense and/or indemnification; and/or
    • 4. formally invokes any other right or obligation, whether under the Contract or otherwise.
Commentary

In subdivision a, the "some significant effect" language seeks to avoid the confusion that might arise if a party were to claim that all communications must comply with the formalities required for significant notices.

The Seventh Circuit was forced to confront such an argument in a case where the contract said, "Any notice or communication required or permitted hereunder … shall be in writing and shall be sent by registered mail, return receipt requested, postage prepaid." (Emphasis added.) The court ruled that "[t]o require the companies to send every communication via registered mail is commercially unreasonable, if not absurd in the twenty‐first century."

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24.17.2 How must Notices be given?

All Notices under the Contract must be in writing.

24.17.3 When will a Notice take effect?

  1. Except as expressly stated otherwise in the Contract, Notices are effective only per "the Three Rs," as follows:
    1. upon receipt by,
    2. upon refusal by, or
    3. after reasonable but unsuccessful efforts at delivery to —
  • the addressee him- or herself, if an individual;
  • or someone who is the addressee's agent for purposes of receiving communications of the general type sent (for example (as defined in Clause 25.23), a mailroom clerk).
  1. Proof of facts to establish the effectiveness of Notice must be by independent evidence;
    • such evidence can include, without limitation, a response from the addressee.

24.17.4 What contact info must be used for email or FAX Notices?

Any Notice may be sent by email or FAX,

  • but such a Notice will not be effective unless one or more of the following is true:
  1. the party being notified has expressly designated the specific email address or FAX number, in writing, as one to which Notices may be sent;
    • in case of doubt, the inclusion of a FAX number or email address in contact information for an individual or for a party does not in itself satisfy this express-designation requirement; or
  2. the Notice has been expressly or implicitly acknowledged in writing by the actual human to whose attention the Notice was addressed;
    • in case of doubt, a response from an automatic responder does not count for this purpose; or
  3. the Notice has been otherwise shown to have been actually received,
    • or actually refused,
    • by a human agent of the party to whom the Notice was addressed.
Commentary

Some contracts make the categorical statement that notices by email (and/or FAX) are ineffective. That seems too extreme. This provision offers a compromise that should accommodate most concerns.

Subdivision 2: Absent agreement, a notice received by email might well be effective even if no human recipient ever saw it. This could occur, for example, under § 15(e) of the Uniform Electronic Transactions Act.

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24.17.5 Is an "attention" line required?

Yes, for organizations:

  • to reduce the chances of Notices to organizations going astray,
  • any such Notice must be addressed
  • to the attention of a specific position of responsibility in the organization.

(Hypothetical example: "Attention, vice president of sales.")

Commentary

Suppose that:

  • A contract requires notices to be sent to the attention of a specific individual, e.g., "Attention: Jane Doe."
  • But after the contract is signed Jane Doe leaves her position — she might be promoted, she might leave the company, she might go on leave, she might even die.
  • In that situation, a notice marked "Attention: Jane Doe" might not timely get to Jane's successor.

For that reason, this section requires notices to be sent to the attention of a specific position, e.g., "Attention: vice president of sales."

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24.17.6 Must additional copies of Notices be sent?

Possibly: If so specified in a party's address for notice,

  • a copy of any Notice must be separately sent to the attention of the individual or position so specified in the address —
  • for example, "With a copy to the attention of the Legal Department" —
  • in a manner prescribed or permitted by this Clause.
Commentary

When sending a Notice of a serious situation, it can be helpful to involve the addressee's Legal Department sooner rather than later.

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24.17.7 Are the stated addresses for Notice the only ones?

No: A Notice may be addressed (without limitation) to the address or addresses for notice stated in the Contract, if any.

Commentary

Many notices clauses specify mandatory addresses for notice, but such provisions are often cumbersome (for example, requiring formal notice of a change of address for notice). Given that notices are effective only in specified circumstances (see below), the permissive approach of this clause likely will be easier for the parties to manage

If a notice was actually received, a court is likely to consider the notice to have been effective, even if the contractual notice requirements were not strictly followed.

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24.17.8 Must a change of address be by Notice?

No: A party may change its address for Notice by communicating the new address in any reasonable written manner —

  • preferably by Notice with a copy of the Notice to the other party's legal counsel.
Commentary

Requiring formal notice of a change of address can create unnecessary burdens for parties.

On the other hand, formal notice of a change of address can be advantageous if the formality helps to get the attention of the notified party. One commercial real-estate tenant learned, to its sorrow, that its administration procedures were deficient in this regard:

  • The landlord sent the tenant a notice of change of address; the tenant began sending rent checks to the landlord's new address.
  • The tenant later decided to terminate the lease, but it sent the notice of termination to the landlord's old address; the notice was returned as undeliverable.
  • The tenant re-sent the notice of termination to the landlord's "new" address — but by then the lease had been automatically extended under an "evergreen" provision (see Clause 24.3 (Amendments (Unilateral))).

The result was that the tenant ended up stuck paying rent for a full additional year on space it had stopped using.

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24.17.9 Should a Notice be copied to legal counsel?

To promote prompt scrutiny of potential disputes:

If a Notice relates to a possible dispute,

  • or to a change of address for Notice,
  • then the notifying party is strongly encouraged,
    • but is not required,
  • to provide a copy of the Notice to the notified party's legal counsel (if known),
    • using any reasonable means to do so.

24.17.10 May Notices be sent by regular mail?

  1. Notices sent by regular mail will be effective only if the Contract clearly says so.
  2. In any such case, the "mailbox rule" will apply for such notices;
    • that is, a properly addressed Notice
    • is rebuttably presumed to have been received
    • three business days after being deposited
    • in the official mail of the jurisdiction where the Notice is sent,
    • either with first-class postage or its equivalent affixed —
      • certified- or registered mail or its equivalent is not necessary —
    • or in compliance with applicable bulk-mail regulations
      • to reduce mailing expense.
Commentary
The mailbox rule: A rebuttable presumption

Notices by regular mail can benefit from a so-called mailbox rule that applies in many jurisdictions. "When a letter, properly addressed and postage prepaid, is mailed, there exists a presumption the notice was duly received by the addressee. This presumption may be rebutted by proof of non-receipt. In the absence of proof to the contrary, the presumption has the force of a rule of law."

The presumption of receipt might even be statutory.

But "unsupported, second-hand accounts [of mailing] cannot invoke the mailbox rule's presumption."

Notices by regular mail: Unsuitable for B2B contracts?

In business-to-business ("B2B") contracts, the better practice is not to allow notices to be automatically effective a certain number of days after being mailed. As the Third Circuit said:

In this age of computerized communications and handheld devices, it is certainly not expecting too much to require businesses that wish to avoid a material dispute about the receipt of a letter to use some form of mailing that includes verifiable receipt when mailing something as important as a legally mandated notice. The negligible cost and inconvenience of doing so is dwarfed by the practical consequences and potential unfairness of simply relying on business practices in the sender's mailroom.

For B2B contracts, when it comes to the question whether a particular notice has in fact been received, "that's a conversation I don't want to have" (to quote one of the author's former students in another context).

How many days after mailing until effective?

Pro tip: Drafters might want to adjust the time at which notice by mail becomes effective, so as to match the expected postal delivery time.

24.17.11 Exercises and questions: Notices clauses

24.17.11.1 Discussion questions

The following have been harvested from various notices clauses.

  1. Keep in mind that for simpler contracts the notices provision can be succinct.
  2. Remember that a notice might be undeliverable — or might be refused.
  3. "A copy of any notice required under this Agreement shall also be sent to the law firm representing the party to be noticed." COMMENT: This is a good idea in general, but the specific implementation assumes facts not in evidence. QUESTION: How else could this be approached?
  4. "Notice will be effective … after two reasonable attempts at serving notice." COMMENTS: (A) Good idea to put a number on it. (B) I wouldn't call it "serving" notice, because that creates an impression of litigation and thus of hostility. Try instead "after two reasonable attempts at delivery"; this would be softer-sounding.
  5. "An email notice under this Agreement will be deemed received when sent." DISCUSS.
  6. "Notices are effective when (a) sent via certified mail and (b) upon receipt, refusal, or reasonable efforts at delivery." QUESTION: Would notice by FedEx, with confirmed receipt, be effective under this provision?
  7. "12.02. Mechanics. To be effective, notice must be: (i) in writing; (ii) addressed to the attention of the receiving party; (iii) accompanied by a copy to the legal department; and (iv) sent by Certified Mail." DISCUSS.
  8. "Notices may be sent to either party's registered agent." QUESTION: Is this a good balancing of the risk of nondelivery versus the time it takes for notice to reach the right person? (Remember: By law in essentially all states, any corporation that does business in a state must have a registered agent in that state so that a plaintiff in that state will have a definite person or organization upon whom to effect service of process, e.g., a summons and complaint.)
  9. "If either party changes their address during the duration of this Agreement, they shall promptly notify the other party of the address change via certified mail." COMMENT: Should be "it shall promptly notify the other party …." (Pronoun choice hasn't made its way to the business-contract-drafting world yet.)
  10. "If a Notice regards a possible dispute, the notifying party must provide a copy of the Notice to the notified party’s legal counsel." (Emphasis added.) DISCUSS.
  11. A notice will be effective "five business days after the date it is sent by domestic registered or certified mail, with postage and charges prepaid, …." QUESTION: I'm really not a fan of saying that notices are effective X days after transmission, even if it's by registered- or certified mail.
  12. "All notices required under this Agreement must be in writing and sent by any method with written verification of receipt. [¶] To reduce the chances of Notices going astray, any Notice to an organization must be addressed to the attention of the position of responsibility in the organization." COMMENT: This is commendably succinct — although it would help to state what happens in case of an undeliverable notice.
  13. "If a party changes its address for Notice, then such party/ must provide written notice to the other party of its new address /within 15 calendar days." (Emphasis added.) QUESTION 1: So what would happen if this requirement were not met? QUESTION 2: Is there a better way to approach this?
  14. Notices by FAX / email are effective upon confirmaion of receipt — but what if the confirmation is automatic from the addressee's email system or FAX machine? Does that mean that a responsible human actually received the notice?
  15. What do you think about having notices be effective three business days after mailing?
  16. What do you think about allowing notices by email?
  17. Consider the email address specified for notices: Does what email address is used make any difference?
  18. Should a change of address for notice require a formal notice?
  19. Should formal notice be used for all communications?
24.17.11.2 Exercise: Ambiguity & notice of pricing term extension

FACTS:

1.  A supply contract between Provider and Customer includes a price schedule that is to be effective for one year, expiring December 1 (the "Pricing Term"), but Customer can extend the Pricing Term once, for one more year.

2.  The extension provision says: Written notice of extension of the Pricing Term must be given no later than 30 days before its then-current expiration date. The contract does not contain any other relevant notice provision.

3.  On October 31, Customer mails Provider a written notice of extension by certified mail, return receipt requested. A week later, Customer receives back the "green card" from the U.S. Postal Service confirming receipt by Provider on November 2.

4.  Provider later tells Customer that the Pricing Term expired and that Provider's prices will increase to Provider's published list prices.

QUESTION: Has Customer effectively extended the Pricing Term? Why or why not? [5]

EXERCISE: Rewrite the Pricing Term extension provision to clarify it.

One possibility: To extend the Pricing Term, Customer must give Provider written notice of extension, which must be effective no later than 30 days before its then-current expiration date.

(The same issues can come up with terms such as, for example, the term "submit for bids" — is a bid "submitted" when sent, or when received?)

24.18 Redlining

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when

24.18.1 Why are the parties agreeing to this Clause?

The parties are agreeing to this Clause

  • so that each party may sign the final draft of the Contract, and any related documents,
  • without having to take the time (and spend the money) to re-read the final document in its entirety before signing,
  • merely to confirm that the other party did not surreptitiously make any unagreed changes.

24.18.2 What exactly are the parties representing?

Each party's signing and delivery of the Contract or any related document

  • constitutes that party's representation of its good-faith belief
  • that the signing party or its counsel
  • has "redlined" or otherwise called attention to all changes that it made and sent to the other party
  • in drafts previously seen by the other party,
  • including but not limited to drafts of any attachments, schedules, exhibits, addenda, etc.
Commentary
Surreptitious changes do happen

The overwhelming majority of lawyers would never try to pull something so underhanded as to make surreptitious changes to signature versions of a document. Doing so could severely damage the lawyer's reputation and possibly even lead to disciplinary action.

But in a Sixth Circuit case, a party did just that, surreptitiously altering a release before signature.

And a court might not come to the rescue; for example, a Russian court reportedly enforced a "contract" created by a man who changed a bank's credit-card agreement, then successfully sued the bank when it didn't comply with the altered terms.

This type of sneaky behavior can happen even in what should be a relationship of trust and confidence: The author once served as an expert witness in a case in which a corporate officer surreptitiously altered his employment agreement, changing a two-year noncompetition provision to a two-month period.

And in a Delaware case, the court refused to declare that a $3.5 million payment obligation was unenforceable on grounds that it allegedly had been "quietly" inserted into settlement agreement.

This landlord could have used a redlining representation in its lease form: As a prank, a prospective tenant, reviewing the Word document of the lease form, inserted a requirement that the landlord must provide birthday cake on the weekend nearest the tenant's birthday. Understandably, the landlord didn't notice the insertion.

Not a warranty — good faith belief only

This certification is merely a representation of good-faith belief, not a warranty. But it still gives each side an indisputably-reasonable basis for assuming that the other side isn't playing dirty in trying to slip in surreptitious changes. Each side therefore shouldn't have to worry that it must re-read the hard-copy document in its entirety before signing it. (It might still make sense to re-read the hard copy anyway, just to make sure it says what the parties really want it to say.)

The specific wording is informed by the following thinking.

  • At the end of a fiscal quarter, when a lot of sales contracts are in negotiation at once, negotiator time is a scarce resource that has to be used economically. A vendor's negotiator wants to provide as much legal protection for the vendor as practicable, but as the clock runs down on the quarter, the negotiator also want to try to timely get the customer's ink on the signature line — because there are other negotiations that also need attention.
  • The customer's contract negotiator similarly has limited time, and might not be a lawyer. The last thing the vendor's sales people want is for the customer's negotiator to get nervous about the redlining language and, taking the path of least resistance, to put the deal aside until next quarter.
  • In the author's experience, a representation clause comes across as "softer" than a warranty clause, and is less likely to trigger a visceral objection from the other side.
  • True, a representation has different legal consequences than a warranty. (See XXX.) But in many vendor-customer situations — particularly longer-term, high-dollar relationships such as some software license agreements — the differences likely will be academic:
    • High-dollar vendors are keenly interested in preserving their customer relationships if at all possible — they generally don't want to file a lawsuit against a customer except as a last resort.
    • If a customer were unintentionally to make a material change in the contract without marking it, the odds are high that the vendor and customer would try to work things out amicably. In that situation, the mere existence of the representation clause would bestow a fair degree of moral- and bargaining leverage on the vendor. (It's something I could go to my counterpart with and ask, "can't we do something about this?")
    • Whether the change in the contract was truly unintentional might well come down to the credibility of the customer's witnesses — not a comfortable situation for the customer to be in. If a jury were to conclude that a customer had deliberately sneaked in a material unmarked change in the contract, that likely would be fraud under this representation clause, giving rise among other things to the possibility of punitive damages. That likely would give the vendor even more bargaining power in negotiations to fix the contract wording.

So, on balance, for high-volume, high-dollar, long-term agreements, the author prefers a simple representation that the customer is likely to accept readily, over a more-complete warranty-and-reformation clause that might require more time for customer legal review. That won't be the case in for all situations — and for an important, M&A-type deal, a tougher clause could well be superior — but the softer approach seems to work well in a lot of cases.

What if a party balks?

If a party (or, more likely, its lawyers) were to balk at agreeing to this certification, that could be a red flag that the party might not be a good business partner.

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24.19 Signatures

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

Commentary

See also § 2 for suggestions on how to draft signature blocks, with examples.

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24.19.1 Definition: Signed

  1. The term "signed" and like terms such as sign, signing, and signature,
    • with respect to a writing or other record (collectively, "record"),
    • refer to executing or adopting a symbol,
    • or carrying out a process,
    • attached to or logically associated with the record,
    • with the intent to adopt, accept, or authenticate the record.
  2. The defined terms referred to in subdivision a
    • include digital signatures, electronic signatures, and facsimiles of signatures,
    • which will have the same effect as a "wet ink" signature
    • unless the context or the Contract clearly require otherwise.
  3. A writing has been signed by a person when the writing includes, bears, or incorporates the person's signature.
  4. A transmission or reproduction of a writing signed by a person is considered signed by that person for purposes of the Contract.
Commentary
Language origins

This definition is adapted largely from:

Acceptability of increasingly-popular electronic signatures

U.S. law explicitly law supports the use of electronic signatures, which are becoming increasingly popular in business:

  • See generally the federal Electronic Signatures in Global and National Commerce Act (E-SIGN Act), 15 U.S.C. § 7001 et seq., which provides in part (subject to certain stated exceptions) that, for transactions "in or affecting interstate or foreign commerce," electronic contracts and electronic signatures may not be denied legal effect solely because they are in electronic form.
  • At the U.S. state level, 47 states, the District of Columbia, and Puerto Rico, and the U.S. Virgin Islands have adopted the Uniform Electronic Transactions Act (UETA).
  • The remaining three states — Illinois, New York, and Washington — have adopted their own statutes validating electronic signatures.

U.S. courts now routinely honor electronic "signatures.

Electronic signatures are now common in England and Wales as well.

Caution: Under California law, a car dealer apparently must still obtain a manual contract signature from a car buyer. See Cal. Civ. Code § 1633.3(c) (various carve-outs from authorization of electronic signatures) and Cal. Veh. Code § 11736(a) (requiring signed agreement with car-buying consumer).

Pro tip: Be able to prove up electronic signatures

A California appeals court affirmed denial of an employer's petition to compel arbitration of a wage-and-hour claim by one of its employees. The arbitration agreement had an electronic signature, but according to the court, the employer had not sufficiently proved that the purported electronic signature on the arbitration agreement was in fact that of the employee.

The California court seems to have offered a road map for contract professionals about what would suffice to prove up an electronic signature in litigation:

[The employer's business manager] Main never explained how Ruiz's printed electronic signature, or the date and time printed next to the signature, came to be placed on the 2011 agreement.

More specifically, Main did not explain how she ascertained that the electronic signature on the 2011 agreement was "the act of" Ruiz. This left a critical gap in the evidence supporting the petition.

Indeed, Main did not explain[:]

• that an electronic signature in the name of "Ernesto Zamora Ruiz" could only have been placed on the 2011 agreement (i.e., on the Employee Acknowledgement form) by a person using Ruiz's "unique login ID and password";

• that the date and time printed next to the electronic signature indicated the date and time the electronic signature was made;

• that all Moss Bros. employees were required to use their unique login ID and password when they logged into the HR system and signed electronic forms and agreements;

• and the electronic signature on the 2011 agreement was, therefore, apparently made by Ruiz on September 21, 2011, at 11:47 a.m.

Rather than offer this or any other explanation of how she inferred the electronic signature on the 2011 agreement was the act of Ruiz, Main only offered her unsupported assertion that Ruiz was the person who electronically signed the 2011 agreement.

Contracts by email can be binding

See the discussion at [BROKEN LINK: elec-k-email][BROKEN LINK: elec-k-email].

Caution: DON'T sign agreement drafts to acknowledge receipt

If a party were to sign a contract that still says "Draft," or if schedules or appendixes are missing, then that party might end up having to engage in expensive litigation about whether or not it actually intended to be bound by the draft. Exactly this happened in a long-running Delaware case between (most-relevantly) an entrepreneur and an investor, concerning a company formed to develop and market software to aggregate medical information about patients to help physicians determine appropriate medications to prescribe.

  • The entrepreneur "did not merely initial or put his first name on the front or last page of the document, as he testified he sometimes did."
  • Rather the investor "put his entire signature on the signature lines of the Contribution and LLC Agreements, and hand-wrote his title, 'CEO' and/or hand-printed his name on them."

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24.19.2 Must all parties sign the same copies?

No: If a document is to be signed by more than one party, then the parties may sign and exchange separate physical copies, each of which is considered part of the same instrument.

Commentary

When contracts are wet-ink signed on paper, it's a practically-universal practice for each party to sign two copies and to keep one fully-signed copy.

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24.19.3 May just signed signature pages be delivered?

Yes —

  1. A party may deliver a signed document to another party
    • by transmitting just an image of a signed signature page,
      • by email, FAX, or other electronic transmission means,
    • in which case the delivery will have the same effect as delivering the entire signed document,
      • as long as subdivision b below is complied with.
  2. If a party delivers a signed signature page electronically,
    • it must be clear, from all the circumstances,
    • that the signed signature page is from the document in question,
      • and not from some other document (or draft thereof).
Commentary

It's very common for parties in separate locations to manually sign separate copies of a paper contracts and then to email a PDF image (or to FAX) just their signed signature pages to each other. If this is to happen, it might turn out to be critical to establish clearly that each party agreed to the same draft of the document.

Not doing this proved fatal to a party's case in Delaware:

  • The evidence indicated that a company and an outside sales representative had exchanged signature pages from two different drafts of an equity-grant agreement.
  • Only one of the drafts included a non-competition/non-solicitation covenant and forfeiture clause that the company had insisted on but the sales rep had rejected.
  • The Delaware chancery court held that there had been no meeting of the minds, because "given the haphazard manner in which drafts were exchanged, the parties were not signing the same draft of the agreement and the key non-compete language was never agreed to;" the court therefore held that "Plaintiff has not proven the existence of a valid contract."

For that reason, a signature page should preferably be tied to a specific version of the Contract by including, on each page of the Contract, a running header or -footer that identifies the document and its version.

Example: In a draft confidentiality agreement between ABC Corporation and XYZ LLC, a running header could read "ABC-XYZ Confid. Agrmt. ver. 2019-03-01 15:00 CST" — where the date and time at the end are hand-typed, and not in an automatically-updating "field." (Including such a running header can also help avoid confusion when the parties are discussing a draft of the agreement, by allowing the parties to make sure that everyone is looking at the same draft.)

Pro tip: It's a good idea to combine the PDF of the unsigned agreement and the PDFs of the signed signature pages into a single "record copy" PDF, then email the record-copy PDF to all concerned. The email will then serve as a paper trail to help establish the authenticity of the record copy.

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24.20 Status Conferences

24.20.1 Why are status conferences required?

This Clause requires the parties to confer, from time to time,

  • about the transaction(s) and/or relationship(s) contemplated or evidenced by the Contract,
  • to help the parties maintain a productive working relationship
  • and to try to nip disputes in the bud.
Commentary

This status-conference requirement recognizes that many business disputes could be mitigated, or even avoided entirely, if the parties would just talk with each other once in a while. This is basically "Management 101," but making it a contractual requirement also gives each party an incentive not to ignore or brush off the other party.

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24.20.2 How often are status conferences required?

Status conferences are to take place:

  • as provided in the Contract, if it does so,
  • or whenever reasonably requested from time to time by either party
Commentary

It's often extremely helpful to hold status conferences immediately after (better yet, before) a missed deadline or other potential breach.

In some situations, the parties might want to specify quarterly‑, monthly‑, or even weekly calls.

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24.20.3 How are status conferences to be held?

Status conferences will preferably but not necessarily be by video conference,

  • or by phone or in person if so agreed.
Commentary

Zoom video conferencing became quite familiar to business people during the lockdowns and self-quarantines of the COVID-19 global pandemic that began in 2020.

Video conferences, as opposed to old-fashioned phone conferences, can be quite useful to help build interpersonal relationships. Screen sharing during video conferences can be especially effective for status updates.

Other video-conference providers include Microsoft Teams; Amazon Chime; and GoToMeeting.

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24.20.4 Who is to make arrangements for status conferences?

The party requesting a status conference is to make any necessary arrangements,

  • for example by providing a link for video conferencing or a dial-in number.

24.20.5 What will the agenda be?

The parties can of course discuss whatever they want,

  • but each status conference should ordinarily include discussion of some or all of the following "G-PP-AA" items:
  • G - goals of the parties in respect of the Contract;
  • P - progress to date in achieving those goals;
  • P - problems encountered or anticipated;
  • A - action plans for the future,
    • including for example action plans for addressing existing or anticipated problems and opportunities; and
  • A - assumptions being made,
    • especially assumptions that might turn out to be unwarranted.
Commentary

The above "G-PP-AA" agenda items are pretty generic but should be serviceable as a template.

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24.20.6 Who must pay the expenses of status conferences?

Each party is to be responsible for its own expenses of status conferences.

Commentary

Expenses for video- and phone conferences should be minimal.

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24.21 Survival of Terms and Conditions

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. All provisions of the Contract in the categories listed in this Clause will continue in effect beyond any termination or expiration of the Contract.
  3. 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.
  4. 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.

24.22 Tango Disclaimer

24.22.1 NO WARRANTIES

Each party acknowledges (as defined in Clause 25.1) that the Tango Terms are made available AS IS, WITH ALL FAULTS, with no warranties, representations, conditions, or terms of quality.

24.22.2 No attorney-client relationship

Each party acknowledges that it does not have an attorney-client relationship with any author, editor, or publisher of the Tango Terms solely because the party uses the Tango Terms in some fashion.

24.22.3 Not a substitute for legal advice

Each party agrees not to rely on the Tango Terms (including but not limited to their commentary) as a substitute for licensed legal advice about the party's specific situation.

24.22.4 Waiver of contrary assertions

Each party WAIVES (as defined in Clause 24.26) any claim or defense inconsistent with this section.

24.23 Termination Protocol

Commentary

Drafters can also consider incorporating one or more of Clause 24.25 (Termination: Other terms) (which are not part of the Contract unless clearly so stated there).

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24.23.1 Either party may terminate for material breach

  1. Either party may terminate (i) the Contract, and/or (ii) an order under the Contract,
    • for the specified type(s) breach, by the other party, of the other party's obligations under the Contract,
    • in accordance with this Clause.
  2. See § 25.33.2 for the definition of material breach.
Commentary
Termination for material breach might be available as a matter of law

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 25.33.2 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.

Caution: Improper termination for breach could be an "own goal" breach

Imagine this:

  • You want to get out of a contract.
  • You conclude that the other side has materially breached the contract and failed to cure it, 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.

Here's an example: You terminate a contract because of the other side's supposedly-"incurable" breach — but then a court says that the breach wasn't incurable after all, and thus the breach didn't justify your termination.

Much the same thing happened in the Hess case, discussed at § Cue the distracted-boyfriend meme…: 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, 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.

24.23.2 Termination for breach usually requires two notices

  1. To terminate for breach, the terminating party must do the following:
    1. give the breaching party notice of breach, stating at least:
      • (i) the circumstances of the breach, in reasonable detail; and
      • (ii) the duration of the specific cure period that the terminating party believes to be applicable, if any, as set forth below;
    2. wait for the cure period, if any (see below), to end; and
    3. give the breaching party notice of termination if the (curable) breach has not been cured by the end of the cure period;
  2. The notice of termination must describe, with reasonable specificity:
    1. the basis for termination, and
    2. the putative effective date of termination.
  3. If the breach is incapable of cure, then the notice of breach and notice of termination may be the same notice.
Commentary
Caution: Don't do an own-goal

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.

Notice of termination should be clear about that

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.

Language choice: "Terminating party"

This provision uses the term "terminating party" instead of the more-common "non-breaching party." That's because in one case, a supposedly non-breaching party was itself in breach of a different contract provision. 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.

See Powertech Tech., Inc. v. Tessera, Inc., No. C 11-6121 CW, slip op. at part I.A (N.D. Cal. Jan. 15, 2014) (on summary judgment).

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24.23.3 Cure periods vary with the type of breach

The cure period for a breach will be as follows, beginning upon the effective date of the other party's notice of breach:

  1. Nonpayment of an amount due under the the Contract: Five business days.
  2. Missed deadline for which the Contract expressly states, in effect, that time is of the essence (as defined in Clause 25.47): No cure period.
  3. Other, curable missed deadline stated in the Contract: Five business days.
  4. Other, curable breach: Ten business days.
  5. Breach that clearly is not capable of being cured: No cure period; immediate termination is allowed.

24.23.4 A transaction, etc., may be terminated instead

In lieu of terminating the Contract, a party authorized to terminate the Contract may instead terminate one or more of the following specific items,

  • to the extent that such items exist under the the Contract:
  1. transactions, for example, a purchase order or a statement of work for services;
  2. grants, for example, a lease or license;
  3. relationships, for example, a distributorship; and/or
  4. exclusivity of a grant.
Commentary

Drafters should think about whether termination of the Contract is what they have in mind. People routinely refer to termination of an agreement, but what they really might mean (and sometimes should mean) is the termination of specific rights and obligations under the agreement.

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24.23.5 Other termination grounds may be relied on later

If a party terminates the Contract (or a transaction or relationship under the Contract) for a stated reason,

but the stated reason later is found not to have been applicable,

then the termination will be deemed to have been made for any other reason

  • that would have warranted or allowed termination under the Contract.
Commentary

This language provides a terminating party with a backup position in case its original reason for termination doesn't pan out. That might be handy to keep the original termination from being held to have been itself a breach of contract, as happened in Southland Metals, Inc. v. American Castings, LLC, 800 F.3d 452 (8th Cir. 2015) (affirming judgment on jury verdict).

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24.23.6 Termination is not the exclusive remedy for breach

Termination is not the terminating party's exclusive remedy for breach unless expressly agreed otherwise in writing.

24.23.7 Post-termination performance may be required

The Contract may require one or more parties to take certain actions, or to have other rights or obligations, upon a termination.

Commentary

This section is included as a reminder to drafters. Different types of agreement might require different post-termination obligations; drafters could consider, for example:

  • final deliveries;
  • issuance of final invoices and payment of outstanding amounts;
  • return of confidential information;
  • preparation and signing of intellectual-property assignment documents;
  • a provider's obligation to help a customer transition to another provider.

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24.23.8 Termination at will may be restricted

  1. This section does not in itself authorize, nor prohibit, termination at will.
    • (For this purpose, the terms termination at will and termination for convenience are considered synonyms.)
  2. The Contract may include agreed restrictions on a party's right to terminate at will, including without limitation one or more of the following:
    1. imposing a minimum advance notice requirement;
    2. allowing termination at will only:
      • (i) after a certain amount of time has elapsed;
      • (ii) after one or another party has achieved specified performance targets;
      • (iii) if the terminating party pays a specified buyout fee; and/or
      • (iv) for good reason (preferably but not necessarily specified in the Contract).
  3. Absent a clear restriction in the Contract, a party entitled to terminate at will may do so:
Commentary : U.S. law might allow termination at will

Under the law in the U.S., an ongoing contract that does not include its own end date will usually be considered terminable at will "upon reasonable notice to the other party after a reasonable time has passed"; moreover, "In general, contracts of perpetual duration are disfavored as a matter of public policy; thus, while we will enforce a contract that unambiguously expresses an intent to be of perpetual duration, we construe ambiguous language regarding duration against perpetual duration."

Caution: A party that will be making a significant investment of time or money in the Contract might want to try to negotiate restrictions on the other party's right to terminate at will, so as to allow the investing party at least some minimum time in which to try to recoup at least some part of that investment.

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24.23.9 Termination will have the usual effects

To the extent not manifestly inconsistent with mandatory applicable law, any termination would:

  1. cancel the parties' relevant, respective, post-termination rights and obligations, except to the extent (if any) that the Contract provides otherwise — for example in a survival provision;
  2. cancel any right a party has to continue performance of its relevant pre-termination obligations;
  3. not affect any claim, by any party, for pre-termination breach by another party; and
  4. be without prejudice to any party's other rights or remedies except to the extent, if any, that the Contract clearly provides otherwise.
Commentary

Subdivision 1 – cancelation of right to perform: This sub­div­i­sion is inspired by a Michigan case in which the state supreme court's recitation of facts noted that "Miller-Davis gave Ahrens notice of default, terminated Ahrens's right to perform the contract, and demanded the bonding company perform under the bond."

In other words, in that case the contractor was fired and presumably was replaced by another contractor hired by the bonding company — presumably at the original contractor's expense, which almost surely cost the original contractor more than just finishing the job would have cost it.

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24.23.10 Termination itself will (normally) not lead to liability

  1. Neither party will owe another party money,
    • solely because of termination of the Contract in accordance with its termination provisions,
    • unless the Contract clearly specifies otherwise,
    • for example (as defined in Clause 25.23), in a provision for an early-termination fee.
  2. This section, however, does not mean that a party might not owe money:
    • under other provisions of the Contract,
    • or for breach of an obligation under the Contract,
    • or for wrongfully terminating the Contract when the terminating party was not entitled to do so.

24.23.11 Expiration counts as a type of termination

  1. Any expiration of the term of the Contract,
    • or, if applicable, expiration of a transaction, grant, or relationship under the Contract),
    • will have the same effect as a termination,
    • unless otherwise clear from the context.
  2. For this purpose, the term expiration includes, without limitation, expiration due to a party's exercising a right to opt out of an automatic-extension provision.
  3. A notice of an upcoming expiration is not needed for the expiration to be effective unless the Contract clearly requires otherwise.

24.24 Discussion questions: Termination

1.  "If (1) either Party breaches this Agreement, and (2) the breaching party fails to cure the breach within 5 business days after receiving written notice of the breach from the non-breaching party …." DISCUSS.

See the commentary following Clause 24.23.2.

2.  "'Good Reason' [for termination] means (i) a transfer of all, or substantially all of Client’s business assets to another entity, and (ii) a contraction of Client’s business eliminating Client’s need for Service Provider’s data analytic services." (Emphasis added.) QUESTION: Are both (i) and (ii) required to establish "Good Reason," or with either one suffice?

3.  "The solvent Party may Terminate upon the filing by the other Party (the insolvent party) …." DISCUSS. (Hint: See question 1.)

4.  "If the Termination at will is for a material breach, …." QUESTION: Does this even make sense?

A termination at will and a termination for material breach are two different things.

5.  "Except for material breach or legal violation, Client may terminate this Agreement at-will where Client gives written notice: …." DISCUSS.

6.  "However, if the Terminating Party and the Nonterminating Party fail to cooperate, in a professional manner, both the Terminating Party and Nonterminating Party may agree to a shorter effective termination date." QUESTION: What are the odds that there'd be such an agreement if, by hypothesis, the parties failed to cooperate in a professional manner?

7.  QUESTION: If termination is at-will, would the notice of termination need to state a basis for termination?

8.  "This Agreement may be terminated by either party upon no less than 30 calendar days written notice, without cause, unless a lesser time is mutually agreed upon by both parties. Said notice shall be delivered by certified mail, return receipt requested, or in person with proof of delivery." QUESTION: Any issues about the italicized part?

1.  It's better to just say "notice in accordance with the notices provisions of this Agreement" (or just cross-reference to the section number of that provision).

2.  In-person notice of breach could give rise to challenges later — better to do it by certified mail or overnight courier.

See also Clause 24.17 (Notices Protocol) and its commentary.

9.  "Either Buyer or Seller may terminate the Agreement if the other party commits any act or omission that: a. is material to the other party’s rights or responsibilities under the Agreement, and b. violates any applicable law where the violation is likely to materially and adversely affect the other party." QUESTION: Does this allow termination for breach?

Termination for material uncurable breach is probably available by law in any case.

But this language might be argued to be the exclusive option to terminate for breach.

10.  "11.1 Any termination of the agreement does the following: [¶] 11.1.1 cancels any right that a party has to continue its performance [¶] 11.1.2 cancels any relevant post-termination rights of the parties …." COMMENT: Use (1), (2), etc., or romanettes — not "11.1.1," etc. — for subdivisions that aren't complete sentences.

11.  "X.1. Each party may, at its sole discretion and with at least 30 days written notice, terminate this Agreement at-will. All amounts due must be paid within 30 days of termination." QUESTION: Any thoughts about the italicized part?

Does this mean no sooner than 30 days before termination? Or is it no later than 30 days afterwards?

6.  "Upon the occurrence of a material breach, as that term is defined in this Agreement and as it is defined under the laws of the State of Texas, the party not responsible for said material breach may, at its option, terminate this Agreement." QUESTION: Would that work for you if your client might someday be a breaching party?

This doesn't include a notice-and-cure provision.

7.  "This provision will apply if the Agreement, or applicable law, provides for termination at will." QUESTION: So is termination-at-will allowed, or not?

If a contract is silent on the subject, ttermination at will is generally allowed by law only in cases of contracts of indefinite duration.

8.  "Should either party desire to terminate the Agreement, that party will provide a minimum of thirty-days’ written notice to the other before doing so." QUESTION: Any thoughts about the drafting style of the italicized part?

The phrasing, "thirty-days" is unusual.

9.  "… any termination of the Agreement has the effect of releasing both parties of all obligations and rights – except for those regarding confidentiality – that exist under the Agreement." COMMENT: Whoa!

10.  "For a termination to be effective, the terminating party must give the non-terminating party 30 days notice of termination (separate from notice of breach, if any)." QUESTION: Would this work for you if your client was the terminating party?

11.  Timing: Conventionally, you'd give notice with X days opportunity to cure, then notice of termination — and the latter would take effect immediately.

24.25 Termination: Other terms

24.25.1 Option: Termination After Certain Personnel Changes

  1. A party specified in the Contract (a "terminating party") may terminate the Contract,
    • or a related transaction or relationship, e.g., a statement of work for services,
    • following any change, of a type expressly specified in the Contract,
    • among the personnel of the other party.
  2. If not sooner exercised, this right to terminate will expire at the earlier of:
    1. 90 days after the date that the terminating party first learns, via any source, of the most-recent personnel change in question; or
    2. six months after the most-recent personnel change in question.
Commentary

This provision might be used in a contract with a small company or startup company whose ability to continue to perform might be called into question if too many senior- or key people were to leave.

Subdivision b ­– expiration of termination right: This provision follows the maxim that rights and obligations should generally have a "sunset," so as not to be indefinitely hanging over other parties' heads.

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24.25.2 Option: Termination Change of Control

  1. Any party (each, a "terminating party") may terminate the Contract following a change of ownership of the power to vote more than 50% of the voting power entitled to vote for members of the other party's board of directors (or equivalent body in a non-corporate organization).
  2. If not sooner exercised, the right to terminate under this Option will expire at the earlier of:
    1. 90 days after the date that the terminating party first learns, via any source, of the change; or
    2. six months after the effective date of the change of control.
24.25.2.1 Commentary

This Option has in mind that a party might not want to continue doing business with a counterparty if, say, the counterparty was acquired by one of the first party's competitors. (For this purpose, the parties might want to specify a different definition of control.)

Commentary

Subdivision b ­– expiration of termination right: This provision follows the maxim that rights and obligations should generally have a "sunset," so as not to be indefinitely hanging over other parties' heads.

• The 90-day termination period forces the terminating party to make up its mind; the termination period starts when the terminating party first learns of the change of control, as opposed to when the other party gives notice of the change of control. The terminating party might prefer it to be the other way around, but that might be too burdensome for the other party to manage.

• The six-month limit has in mind that if the terminating party hasn't seen fit to terminate within that time — for example, because it hasn't noticed any ill effects from a change of control — then the right to terminate should lapse, so that the other party won't continue to have the threat of termination hanging over its head for what has become old news.

24.25.3 Option: Termination Damages WAIVER

For the avoidance of doubt:

  1. Upon any termination of the Contract, whether or not the termination was allegedly wrongful, the non-terminating party will not have, and may not assert or maintain, any claim for the termination per se against the terminating party, nor against any member of the terminating party's Protected Group (as defined in Clause 25.40).
  2. Upon any expiration of the Contract, no party will have, and no party may assert or maintain, any claim for the termination per se against any other party, nor against any member of that other party's Protected Group.
24.25.3.1 Commentary

The author once read, but now cannot locate, a case in which a party had allowed the term of an agreement to expire. In the ensuing lawsuit, the other party tried (unsuccessfully, if memory serves) to recover damages that it claimed to have suffered as a result of the expiration. This Option attempts to forestall such a claim.

24.25.4 Option: Termination Insolvency

  1. When this Option is agreed to, a party specified in the Contract (a "terminating party") may terminate the Contract (or a related transaction or relationship, e.g., a statement of work) for insolvency if another party to the Contract:
    1. ceases to do business in the normal course;
    2. becomes insolvent;
    3. admits in writing its inability to meet its debts or other obligations as they become due;
    4. makes a general assignment for the benefit of creditors;
    5. files a voluntary petition for protection under the bankruptcy laws or similar laws of the relevant jurisdiction, or to effect a plan or other arrangement with creditors;
    6. has a receiver, administrative receiver, administrator, liquidator, trustee in bankruptcy, or similar functionary in the relevant jurisdiction, appointed for its business or assets; or
    7. becomes the subject of an involuntary petition under the bankruptcy laws, or a similar petition or other filing under the laws of the relevant jurisdiction, and the same is not vacated, released, dismissed, stayed, reversed or otherwise overturned, or bonded off before the end of 60 days after the date of the petition or other filing.
  2. A terminating party's right to terminate for insolvency under this Option will expire at the end of 90 days after the date that the terminating party first learns, via any source, of the most-recent event listed in this Option.
24.25.4.1 Commentary

Caution: In the U.S., some of these provisions will be unenforceable as so-called "ipso facto" clauses if the non-terminating party has filed a petition for protection under the bankruptcy laws. In fact, under the Bankruptcy Code, the filing of such a petition creates an automatic stay against many forms of contract termination or other action that could jeopardize the orderly reorganization or liquidation of the party seeking protection (known as the "debtor"). See Robert L. Eisenbach III, Are "Termination On Bankruptcy" Contract Clauses Enforceable? (Cooley.com 2007), https://perma.cc/PV6N-VFTC.

As an "in the wild" example of such a provision, see a Honeywell purchase-order form at http://perma.cc/CUV6-NKTY:

The solvent party may terminate this Purchase Order upon written notice if the other party becomes insolvent or if any petition is filed or proceedings commenced by or against that party relating to bankruptcy, receivership, reorganization, or assignment for the benefit of creditors.

Subdivision b — deadline for termination: This "sunset" provision will force the terminating party to fish or cut bait, and thus avoid leaving the threat of termination hanging over the other party's head.

24.25.5.1 Commentary

Subdivision c is a "sunset" provision will force the terminating party to fish or cut bait, and thus avoid leaving the threat of termination hanging over the other party's head.

24.25.6 Option: Termination Right is Not Waivable

IF: Following any termination or expiration of the Contract, one or both parties engages in conduct contemplated by the Contract — for example, if the parties continue to do business with each other in accordance with the terms of the Contract; THEN: Such conduct by one or both parties is not to be construed:

  1. as a waiver of the termination or expiration of the Contract (as applicable), nor
  2. as an extension or continuation of the term of the Contract beyond the period specified in a notice of termination, if applicable.

24.25.7 Option: Termination for Reputation Risk

  1. When this Option is agreed to, any party, referred to for this purpose as "ABC," may terminate the Contract if ABC reasonably determines that: • one or more Reputation Risk Actions, defined in subdivision 5 below, • when taken by (i) another signatory party to the Contract, referred to for this purpose as "XYZ," or (ii) an affiliate of XYZ, • are likely to create a not-insubstantial risk to the business reputation of ABC or any affiliate of ABC.
  2. ABC's right to terminate for reputation risk will expire (if not sooner exercised) at 12 midnight at the end of the day on the date 90 days after the date that ABC first learned, via any source, of the most-recent Reputation Risk Action.
  3. This Option establishes only a conditional right to terminate the Contract; in itself it does not obligate any party in any way.
  4. XYZ will not be liable, in damages or otherwise, for any Reputation Risk Action that does not otherwise breach the Contract.
  5. For this purpose, "Reputation Risk Action" refers to any action (for this purpose including omissions) or series of actions, whether related or unrelated, where the action is (i) intended by the actor, or (ii) reasonably likely, to do one or more of the following:
    1. libel or slander another person;
    2. put another person in a false light;
    3. threaten, embarrass, harass, or invade the privacy of another;
    4. impersonate another or promote, encourage, or assist in, such impersonation;
    5. offend a reasonable person on racial- or ethnic grounds;
    6. engage in conduct prohibited by law, including for example the U.S. Foreign Corrupt Practices Act;
    7. encourage activities prohibited by law, including (for example) bribery; identity theft; child pornography; and terrorism;
    8. engage in tortious conduct; and/or
    9. mistreat a person, or promote, assist in, or encourage such mistreatment.
24.25.7.1 Commentary

In today's global economy, "offshore" companies do a great deal of manufacturing for U.S. and European firms. Those companies might not always comply with First-World standards of safety, employee treatment, and the like, which could result in adverse publicity for the offshore companies' customers.

For example:

• Apple and HP were forced to deal with news stories about worker suicides in factories owned by the giant Chinese electronics contract manufacturer Foxconn.

• Walmart and other retailers were confronted with a similar problem when a clothing factory in Bangladesh burned, killing over 100 people.

• Walgreens ended its relationship with troubled blood-testing company Theranos (NYTimes.com).

• In 2015, the Twin Peaks restaurant organization terminated the franchise of a restaurant in Waco, Texas, after a shootout between rival motorcycle gangs left nine dead. See, e.g., this news story. Car manufacturer Hyundai terminated one of its dealerships because the New York attorney general had obtained a court judgment against the dealership for having engaged in fraudulent and illegal business practices. Giuffre Hyundai, Ltd. v. Hyundai Motor America, 756 F.3d 204 (2d Cir. 2014).

• Longtime Subway sandwich shop pitchman Jared Fogle agreed to plead guilty to child-pornography charges, among others. Subway had previously suspended its relationship with Fogle. The case, along with the attendant bad publicity for the already-troubled Subway, is a sad reminder of the value of including an appropriate "termination for business-reputation risk" clause in a contract of that nature.

Subdivision 2: This "sunset" period forces the terminating party to make up its mind – to fish or cut bait (or fill in your own metaphor).

Subdivision 5: This "laundry list" of actions that could lead to termination is adapted from language used in a number of on-line terms of service collected by Zachary West in his blog posting, Morality clauses in domain registration (zacwe.st 2011).

24.25.8 Termination options: Other drop-in language

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.]

Any party entitled to terminate one transaction, grant, or relationship for material breach (as defined in Clause 25.33.2) by the other party may in its discretion terminate some or all other uncompleted transactions, grants, or relationships between the parties.

No party may terminate or rescind the Contract, no matter what the circumstances, except as expressly provided in the Contract.

No party may terminate or rescind the Contract, no matter what the circumstances; in case of breach of the Contract by the other party, that party's sole remedy will be an action at law for damages, and any purported termination will be of no effect.

24.26 Waivers

24.26.1 Must waivers be in writing?

Yes —

  1. This section applies if you waive (i) a right under the Contract, or (ii) another party's performance of an obligation under the Contract.
  2. Your waiver is to be deemed as having been made knowingly; voluntarily; intentionally; permanently; and irrevocably,
    • unless your waiver clearly says otherwise in writing;
    • this will be true even if your waiver is (and is allowed to be) non-written.

24.26.2 What must waivers look like?

  1. A party cannot validly assert that another party waived a provision of the Contract, nor of any related document, unless the waiver is:
    1. in writing;
    2. labeled, with reasonable prominence, as an amendment or waiver; and
    3. signed by the other party (or, if the other party is an organization, by an authorized representative of the other party).
  2. An individual signing a waiver on behalf of an organization must have at least apparent authority to do so.
24.26.2.1 Commentary

This writing requirement tries to reconcile:

  • the legitimate concern that an unscrupulous party might try to get another party's personnel to sign a form (a purchase order, an order confirmation, etc.) that would have the effect of waiving a right or obligation;
  • the concern that a party might claim that a "stray remark" in an email, etc., had the effect of being a waiver; and
  • the need for parties to have at least some flexibility in their dealings, without being unduly hamstrung by what might be a long-forgotten contract.

Subdivision a.2 – labeled with reasonable prominence: This is to reduce the chances that parties will dispute whether a particular communication constituted a waiver.

Subdivision b – apparent authority: See generally https://en.wikipedia.org/wiki/Apparent_authority. For an example, see aTenth Circuit case where a company was held to be bound by a contract even though its executive vice president who signed the contract did not have internal authority to do so.

Alternative: "No waiver will be binding on a party that is an organization unless signed on behalf of the organization by an individual at the vice-president level or higher (or in a comparable position in an organization not having a vice-president)." This alternative would help to preclude a party from claiming to have relied on the "apparent authority" of other would-be signers.

Under a New York statute, a waiver of a statute of limitations defense must be in writing.

24.26.3 How broad an effect will a waiver have?

  1. A waiver will affect only the specific provision(s) of the Contract Document
    • that are clearly identified in the waiver document;
    • all other terms of the document will remain in effect as before the amendment or waiver.
  2. A waiver is effective only for the specific provision or breach being waived,
    • on a one-time basis only.
Commentary

Limited-effect language along these lines is often seen in waiver provisions; this section makes that automatic. See generally, e.g., Title Guaranty Escrow Services, Inc., v. Wailea Resort Co., 456 P.3d 107, 109 (Haw. 2019), where an amendment to the contract in suit contained similar language (which was not relevant to the lawsuit).

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24.26.4 What law is to govern assertions of waiver?

  1. New York's General Obligations Law 15-301(1) is to control in any dispute arising out of or relating to this Clause,
    • regardless of what law would otherwise govern the Contract;
    • in that New York statutory provision, the parties intend for the term "change" to be interpreted as encompassing waivers.
  2. The parties are agreeing to this provision-specific choice of law:
    1. in the interest of uniformity; and
    2. to reduce uncertainty about how a court or other tribunal might interpret this Clause.
Commentary

New York's General Obligations Law 15-301(1) provides that "[a] written agreement … which contains a provision to the effect that it cannot be changed orally, cannot be changed by an executory agreement unless such executory agreement is in writing and signed by the party against whom enforcement of the change is sought or by his agent."

It might seem strange to specify a choice of law to gov­ern one particular provision in a contract. But it's not unprecedented; in the 1988 update to the Restatement (Second) of Conflicts of Laws, comment i to § 187 states in part that "the parties may choose to have different issues involving their con­tract governed by the local law of dif­fer­ent states," citing Kronovet v. Lipchin, 288 Md. 30, 415 A.2d 1096 (1980), in which a financial instrument did just that.

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24.26.5 What if a court rules that waivers need not be written?

  1. As a fallback rule, this section applies if:
    1. a party asserts that a provision in the Contract was orally waived; and
    2. a court or other tribunal of competent jurisdiction holds that the applicable law allows oral modification despite the parties' agreement to this Clause.
  2. In such a case, the asserting party WAIVES its assertion of that oral modification if the asserting party does not do the following:
    1. The asserting party must show, by clear and convincing evidence (as defined in Clause 25.13), that the other party agreed to each such alleged oral waiver; and
    2. If asked, the asserting party must promptly produce all related (unprivileged) evidence in the asserting party's possession, custody, or control in accordance with the initial-disclosure and discovery procedures of the (U.S.) Federal Rules of Civil Procedure.
Commentary

See the commentary to the Amendments Procedure.

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25 General Definitions & Usages

Contents:

25.1 Acknowledgement Definition

If the Contract includes language in which a party acknowledges something,

  • then the acknowledging party PERMANENTLY and IRREVOCABLY WAIVES (as defined in Clause 24.26) —
  • any right to contest the truth of the thing being acknowledged; and
  • any right to require another party to the Contract to prove the acknowledged thing.
Commentary

This definition concerns about acknowledgements made within the body of a contract. For acknowledgements in notary-public certificates, see the reading at § 3.4.

Contents:

A hypothetical example

Imagine this: You are negotiating a patent-license agreement with a patent owner. In the license agreement, you "acknowledge" that one of your company's products is covered by the other party's patent, which means that you must pay royalties to the patent owner for your sales of that particular product.

But later you conclude that your product in question actually isn't covered by the patent after all. You decide that you needn't pay those particular royalties to the patent owner after all.

You might be out of luck: Your acknowledgement of patent coverage in the license agreement might well block you from taking a different position later. That's essentially what happened in a Tenth Circuit case.

An acknowledgement is like an admission in court

An acknowledgement is tantamount to an admission under the (U.S.) Federal Rules of Civil Procedure, Fed. R. Civ. P. 36(b).

Apropos of this subject, California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added.)

Don't be a jerk about asking for acknowledgements

Acknowledgements can be useful to establish facts for future litigation … but don't be a jerk about it. Some inexperienced drafters include statements in which another party "acknowledges" a supposed fact that would be against that party's interest.

Here's an overreaching example that's sometimes seen in confidentiality agreements: "Recipient acknowledges that Discloser would be irreparably harmed by a breach or threatened breach of Recipient's confidentiality obligations under this Agreement." (The intent here is presumably for Recipient to waive Discloser's burden of proof in seeking a preliminary injunction or comparable relief; see the Equitable Relief and its commentary.) Most Recipient counsel would reflexively:

  • delete this equitable-relief acknowledgement entirely, or
  • change "would be …" to "could be irreparably harmed"; and
  • be irritated at Discloser's counsel for the obnoxious drafting.
Acknowledgements: Study guide
  1. What does it mean to "acknowledge" something, and why might it be dangerous?
  2. Cite (or make up) an example of how acknowledging something in a contract might be dangerous (other than the example in the reading above).

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25.2 Affiliate Definition

25.2.1 Does affiliate status come from a "control" relationship?

  1. For purposes of the Contract, two persons A and B are "affiliates" (or "affiliated") if one or more of the following things is true:
    1. B "controls" A, as defined in this Clause,
    2. or A controls B,
    3. or B and A are each under common control of a third person,
    4. or the Contract clearly identifies A and B as being affiliates.
  2. For this purpose, control can be direct,
    • or it can be indirect through one or more intermediaries.
    • Example: If A controls B, and B controls C, then A controls C indirectly.
Commentary
Purpose of definition

In some cases, the Contract might give rights to "affiliates" of one or another party, for example the right to acquire goods or services on the same terms as in the Contract. In such a case, it could be important to define just who qualifies as an affiliate of the relevant party.

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

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

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

Language origins

This basic definition is adapted from (a portion of) the definition promulgated by the U.S. Securities and Exchange Commission ("SEC") in Rule 405, which is also found in other sources.

The definition provides parties with two separate "proof paths" for establishing affiliate status:

  • By showing a direct- or indirect control relationship between two persons (including common control by a third person); or
  • By specifically agreeing that two named persons (each, an individual or organizations) are affiliates for purposes of the Contract, regardless whether a control relationship exists between them. If it's not possible to determine in advance who all the named affiliate groups will be, the parties could consider:
    • letting one party unilaterally name additional affiliates with the other party's consent, not to be unreasonably withheld; and/or
    • designating specific "open enrollment" periods in which affiliates can be named.

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Caution: Don't make affiliates "parties" to the Contract

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

The much-better practice is to state the specific rights and obligations that affiliates have under the contract. This is sometimes done in "master" agreements that are available to the affiliates of one or more parties.

Caution: An affiliate of a contracting party might be bound by the contract if the contracting party — or its signatory — controls the affiliate and the contract states that the contract is to benefit the affiliate. That was the result in one case the contract (i) stated that it was creating a strategic alliance for the contracting party and its affiliates, and (ii) was signed by the president of the contracting party, who was also the sole managing member of the affiliate. The court held that the affiliate was bound by, and violated, certain restrictions in the contract.

Pro tip: Plan for changes in affiliate status

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

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

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

• New York's highest court held that: "Absent explicit language demonstrating the parties' intent to bind future affiliates of the contracting parties, the term 'affiliate' includes only those affiliates in existence at the time that the contract was executed."

• The First Circuit held that Cellexis had breached a settlement agreement not to sue GTE or its affiliates when it sued a company that, at the time of the settlement agreement, had not been a GTE affiliate, but that later became an affiliate. Reversing a summary judgment, the appeals court reasoned that when read as a whole, the contract language clearly contemplated that future affiliates would also be shielded by the covenant not to sue.

(Hat tip: Ken Adams.)

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25.2.2 How much voting power is needed for "control"?

If B is a corporation or other organization, then A is considered to control B if A has the power to vote —

  • more than 50%
  • of the voting power entitled to vote for members
  • of the organization's board of directors,
  • or equivalent body in a non-corporate organization.
Commentary
Where to set the voting percentage

A minimum voting percentage of 50% seems to be pretty typical. Drafters, though, should think about why they're defining the term affiliate, because the answer might warrant changing the percentage — and it doesn't necessarily have to be the same percentage for every situation or condition. [TO DO: Examples]

Voting power by contract

A voting trust or voting agreement might give Shareholder A the power to vote Shareholder B's shares. See generally, e.g.,

Other possible approaches to voting control

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

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

See also the Voting Power Definition and its commentary.

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25.2.3 Control by "management power" must be by contract

A is also considered to control B if a contract clearly and unmistakably gives A the power to direct B's relevant management and policies.

Commentary

This definition does not subscribe to the notion that affiliate status can arise through non-contractual forms of management power, even though that concept can be found in U.S. securities regulations such as SEC Rule 405, 17 C.F.R. § 230.405. That's because the vagueness of the quoted term could lead to expensive litigation. See, for example:

  • UBS Securities LLC v. Red Zone LLC, where the parties litigated whether UBS was entitled to a $10 million fee for a corporate acquisition deal — and in the aftermath, a blue-chip NYC law firm was hit with a $17.2 million judgment for malpractice for not nailing down an agreed definition of control to govern when the deal fee would be earned.

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Commentary

This "laundry list" of what constitutes an Agreement-Related Dispute borrows concepts from the second of two arbitration agreements in a lawsuit; some of the language is adapted from a suggestion by a noted corporate practitioner.

Subdivision 3: the transaction or relationship … term is modeled on an arbitration provision that has been litigated at least twice.

Subdivision 8: The inducement reference has in mind claims of fraudulent inducement; it borrows from model language by another noted corporate practitioner.

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25.4 And/Or Definition

When the term "and/or" is used in a list, such as "A, B, C, and/or D," it refers to one or more (or, some or all) of the listed items, not to just one of them.

Hypothetical example: The parties expect to meet on Tuesday, Wednesday, and/or Thursday. This means that the parties expect to meet on one or more of those days, not just on one and only one of them.

Commentary

Some people loathe the term and/or. Used properly, however, the term can be a serviceable shorthand; it's equivalent to the inclusive-or, as opposed to the exclusive-or (which is expressed mathematically as XOR).

One state-court judge excoriated the use of and/or as "indolent"; the judge, evidently not a slave to brevity, proclaimed that a drafter could instead "express a series of items as, A, B, C, and D together, or any combination together, or any one of them alone."

More sensibly: Ken Adams, author of A Manual of Style for Contract Drafting, suggests that, when dealing with a list of three or more items, use "one or more of A, B, and C."

Granted, it's possible to use and/or inappropriately. See, e.g., the examples collected by Wayne Scheiss, director of the legal-writing program at the University of Texas School of Law, in In the Land of Andorians (Jan. 2013).

But trying to ban and/or is likely a bootless errand, because many drafters will use the term anyway. So the better practice is just to define the term and be done with it. (W.I.D.D. — When In Doubt, Define!)

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25.5 As-Is Definition

  1. For purposes of this Clause, the term "Factual Commitment" refers to any of:
  2. The term as-is operates as a disclaimer of all Factual Commitments concerning performance and noninfringement.
  3. An as-is disclaimer negates, without limitation, any implied Factual Commitment that might otherwise apply concerning merchantability or fitness for a particular purpose.
  4. An as-is disclaimer does not negate:
    • any express Factual Commitment; nor
    • any Factual Commitment that might be implied under applicable law concerning title to goods.
  5. An as-is disclaimer may be expressed in variations such as "as is, where is, with all faults," which will have the same meaning as stated in this Definition.
Commentary

This definition is modeled on § 2-316 of the (U.S.) Uniform Commercial Code, which covers disclaimer of implied warranties in sales of goods. It's included here in case the UCC doesn't apply (for example, if this Agreement is not for the sale of goods or if the transaction is governed by a law that doesn't include some version of the UCC).

One common formulation for disclaiming warranties is "AS IS, [and sometimes: WHERE IS,] WITH ALL FAULTS," in all-cap, bold-faced type, or other conspicuous manner.

Caution: Drafters should check for any applicable legal requirement of conspicuousness for warranty disclaimers.

The definition does not exclude implied warranties of title. This carve-out is modeled on UCC § 2-312, which requires that a disclaimer of an implied warranty of title must be expressly stated. 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.

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25.6 Associated Individual Definition

Associated Individual, as to an organization, refers to any individual who, at the time in question, falls into one or more of the following categories:

  1. an employee of the organization;
  2. an officer or director of the organization, if it is a corporation;
  3. a holder of a comparable position, if the organization is of another type, such as a limited liability company; and/or
  4. any other individuals expressly specified in an agreement, if any.
Commentary

This is a convenience definition, used in various Tango sections; you can use the search function in your browser to find examples.

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25.7 Best Efforts Definition

  1. Best efforts refers to the diligent making of reasonable efforts to achieve an objective.
  2. 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.
Commentary

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 the Tango Terms version can at least reduce some of the associated legal uncertainty. (W.I.D.D.: When In Doubt, Define!)

See also Clause 25.14 (Commercially Reasonable Definition) and Clause 25.41 (Reasonable Efforts Definition).

Contents:

Language choices

This definition frames the concept of best efforts in terms of the diligent making of reasonable efforts. This approach comes from Restatement (Second) of Agency.

Subdivision 2.b intentionally rules out contentions that best efforts requires the taking of every conceivable reasonable action. This responds to an unfortunate reality: An opposing party's litigation counsel and expert witness —

  • will be motivated to point fingers at alleged failures by a party accused of not using its best efforts; and
  • with 20-20 hindsight, can almost always come up with something reasonable that the accused party conceivably could have done, but in fact didn't do.

Subdivision 2.c attempts to resolve a division of opinion among various courts, discussed below.

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, reasonable efforts will cover a range of possibilities, while best efforts refers to somewhere near the top of that range. The author has no formal research to support this view, but I've negotiated more than a few contracts with best-efforts clauses in them, so I'd like to think I have at least some sense of what many business people are after.

A sports analogy: Bring your "A" game

By analogy, to many business people:

  • "C" is a passing grade in (U.S.) schools, and is equivalent to reasonable efforts.
  • In contrast, best efforts means an "A" effort — or in basketball slang, bring your "A" game, buddy, not your "C" game.

Another analogy:

  • On major U.S. highways, the speed-limit signs often include both maximum and minimum speeds of (say) 60 mph and 45 mph. Those two speeds establish the upper- and lower bounds of reasonableness.
  • Now, suppose that a trucking company were to agree that its driver would use her "best efforts" to drive a shipment of goods from Point a to Point B on such a highway, where drivers must drive between 45 mph and 60 mph.
  • In good weather with light traffic, driving at 45 mph might qualify as reasonable efforts. But driving at that speed likely wouldn't cut it as best efforts.
Diligence might be the touchstone of "best efforts"

The "diligence" term comes from the Restatement (Second) of Agency: "Best efforts is a standard that has diligence at its essence."

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 …."

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]

"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."

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.

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.
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.

Further reading about best efforts

See also:

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25.8 Board of Directors Definition

Board of directors refers to the principal governing body of an organization, such as (without limitation) the board of directors of an American corporation.

Commentary

This is a convenience definition, allowing drafters to refer generically to a "board of directors" without having to spell out different variations for, e.g., limited liability companies, foreign organizations, and the like.

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25.9 Business Day Definition

Business day refers to a day other than a Saturday; a Sunday; or a holiday on which banks in New York City are generally closed.

(See also the definition of day in Clause 25.16.)

Commentary

Depending on the country chosen for bank closings, this definition could eliminate a lot of what Americans might think of as work days.

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25.10 Calendar Year Definition

  1. Calendar year refers to a year according to the Gregorian calendar,
    • beginning at midnight at the beginning of January 1,
    • and ending at midnight at the end of the following December 31.
  2. An interval of a calendar year,
    • beginning at a specified time on a particular date or following a particular date,
    • ends at exactly 12:00:00 midnight at the beginning of the same date one year afterwards.
    • EXAMPLE: A period of one calendar year following January 2, 20x5 ends at 12:00:00 midnight at the beginning of January 2, 20x6.
Commentary

Subdivision a – Gregorian calendar: Many parties entering into contracts, even in non-Western countries, will likely operate on the West's conventional calendar; that might not be the case, however, e.g., in Muslim countries.

Subdivision b – midnight: Note the use of "12:00:00 midnight at the beginning of the same date …" to remove ambiguity about whether a calendar-year interval ends at the beginning, or at the end, of the anniversary date.

See also the definition of midnight.

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25.11 Certify Definition

When a party "certifies" an assertion relating to the Contract (in a "certification" or "certificate"), the certifying party does the following:

  1. represents (as defined in Clause 20.2) that the assertion is true;
  2. represents that, within a reasonable time before certifying the assertion, the certifying party made a reasonable investigation to confirm that the assertion was true;
  3. acknowledges (as defined in Clause 25.1) that the certifying party intends for another party to the Contract to rely on the certification; and
  4. acknowledges that it is reasonable for the other party to rely on the certification for purposes relating to the Contract.

25.12 Claim Definition

  1. The term claim refers to any request or demand for damages or other relief by an individual or organization, including without limitation a government authority.
  2. A claim might be set forth, without limitation:
    1. in a written communication such as, for example, a letter or email; and/or
    2. in a filing with (or submission to) a tribunal of competent jurisdiction.
Commentary

This definition draws on ideas set out in an article by D. Hull Youngblood, Jr. and Peter N. Flocos, Drafting And Enforcing Complex Indemnification Provisions, The Practical Lawyer, Aug. 2010, p. 21, at 27.

When appropriate, drafters should consider specifying written claims, to avoid putting a hair trigger on provisions that depend on claims being made, e.g., defense requirements.

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25.13 Clear and Convincing Evidence Definition

  1. Clear and convincing evidence of an assertion refers to evidence that is sufficient to produce, in the mind of the factfinder, an abiding conviction that the assertion's truth is highly probable.
  2. Oral testimony by an interested party, on its own, will not suffice as clear and convincing evidence is not met by statements of individuals and organizations having an interest unless supported by reasonable corroboration (as defined in Clause 23.8).
Commentary

The clear and convincing evidence standard is most often required by law for important matters. For example, in many jurisdictions, fraud must be proved by clear and convincing evidence, as compared to the lower, "preponderance of the evidence" standard that normally applies. But it's not unheard-of for contracts to require specific facts to be established by clear and convincing evidence.

This definition restates, in somewhat-plainer language, the standard set out by the Supreme Court of the United States.

Subdivision b is paraphrased from a Federal Circuit case concerning the need for corroboration of interested testimony about certain patent-related issues, where the court cited a famous 19th-century Supreme Court decision on the subject.

See also the commentary to the Corroboration Requirement.

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25.14 Commercially Reasonable Definition

  1. Defining by example: 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.
  2. 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.
Commentary

See also the  Clause 25.41 (Reasonable Efforts Definition) and Clause 25.7 (Best Efforts Definition).

Contract drafters are often tempted to use the term commercially reasonable when they don't want to be more specific — or when at that point the parties simply don't know what they'd want in an actual case. This section discusses some of the pros and cons of doing so, along with how courts have interpreted the term.

Contents:

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!)

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."

Are all reasonable efforts required?

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.

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. The project ended up being in essence a train wreck, after which the parties sued each other. The trial court rendered judgment in favor of IBM, but a state appellate court reversed in part and remanded, holding that while IBM was entitled to be paid for its work, that payment would be subject to offset (to be determined on remand), on grounds that IBM had materially breached the contract. 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."

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.

"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 decision process? When the parties don't know what outcome they want, perhaps they can agree instead to a reasonable process for deciding 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.

See the provisions at [TO DO: Link] for more details on these options.

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25.15 Contract-Related Claim Definition

  1. The term "Contract-Related Claim" refers to any claim, obligation, liability, or cause of action (each, a "Claim") arising out of or relating to any of the following:
    1. the Contract;
    2. the negotiation, execution, performance, or breach of the Contract;
    3. any representation or warranty made in, in connection with, or as an inducement to, the Contract; and
    4. any transaction or relationship resulting from the Contract.
  2. For the avoidance of doubt, the term Contract-Related Claim encompasses all Claims whether, for example —
    1. in contract or in tort,
    2. in law or in equity, or
    3. created or granted by a constitution, statute, regulation, order precedent, or other governmentally-enforceable policy.
Commentary

This defined term is used in the No Individual Liability.

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25.16 Day Definition

  1. Day refers to a calendar day, as opposed to a business day (as defined in Clause 25.9).
  2. A period of X days:
    • begins on the specified date,
    • and ends at exactly 12 midnight at the end of the day on the date X days later.
    • Example: If a five-day period begins on January 1,
      • then that period ends at exactly 12 midnight at the end of January 6.
  3. For purposes of subdivision b, 12 midnight refers:
    • to local time if only one time zone is relevant,
    • otherwise, to the latest occurrence of 12 midnight on the date in question.
    • Example: If both California time and Tokyo time are relevant,
      • then 12 midnight at the end of the day on January 1
      • refers to 12 midnight at the end of the day on January 1 in California (when it would be 4:00 p.m. on January 2 in Tokyo).

25.17 Deadline Definition

  1. If the Contract states a deadline date marking the end of a specified period,
    • but it does not clearly indicate a time at which the period ends,
    • then the period ends at exactly 12 midnight at the end of the stated deadline date.
  2. The Contract may specify a time zone, as well as a time, for the deadline.
Commentary

This definition simply provides a benchmark reference point; using this definition, drafters can precisely specify deadlines as desired.

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25.18 Deliverable Definition

  1. The term "deliverable" refers to:
    • any tangible goods,
    • and any intangible information, no matter how transmitted or stored,
    • in either case to be delivered to a party ("Customer") under the Contract.
  2. For purposes of subdivision a, a deliverable could take the form of Customer's own goods or information,
    • transformed and/or otherwise processed under the Contract.
Commentary

The meaning of deliverable was one of many issues litigated in Walmart, Inc., v. Cuker Interactive, LLC, No. 18-1959, slip op. at 10-11 (8th Cir. Feb. 12, 2020), in which the court affirmed judgment on a jury verdict that Walmart had stolen trade secrets of a software developer.

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25.19 Discretion Definition

  1. This Definition applies any time that the Contract provides that a party, referred to as "ABC," may act in its discretion.
  2. Whenever the Contract uses the term discretion without modifier or qualification (or, equivalently, in ABC's reasonable discretion):—
    1. ABC must act both reasonably and in good faith; and
    2. ABC is to be strongly presumed to have complied with subdivision 1,
  3. Whenever the Contract provides that ABC may act in its "sole discretion" (or "unfettered discretion" or "absolute discretion" or similar terms), it means that:—
    1. ABC may act as its sees fit,
      • with regard solely to ABC's own interests and desires as ABC then perceives them,
      • and without the need to show any justification; and
    2. ABC is to be conclusively deemed to have satisfied any applicable standard of good faith or fair dealing.
  4. The term discretionary consent refers to consent that may be granted or withheld in the grantor's sole discretion (see subdivision c).
  5. In case of doubt: For purposes of the definition of discretion, not acting is considered an action.
Commentary

Subdivision b: in some U.S. jurisdictions, a party's discretion might be constrained by an implied obligation of reasonableness, or perhaps of good faith.

And in the UK, there is case law indicating that discretion must be exercised in good faith and not arbitrarily, capriciously, or irrationally.

Subdivision c: This "strong presumption of good faith" language borrows from the business-judgment rule that is applied to directors of a corporation, albeit without the other duties that bind directors, most notably the duties of loyalty and care.

Subdivision d: If the Contract gives a party sole, absolute, and/or unfettered discretion as to a particular matter, then the party shouldn't be second-guessed later about its action. Unlike the UK cases cited above, this definition does not impose a good-faith requirement on exercises of sole discretion, because doing so can complicate litigation.

BUT: This subdivision might not be enforced in some jurisdictions. For example, a New York appeals court refused to honor a "sole and absolute discretion" clause in an agreement, noting that:

[E]ven where one has an apparently unlimited right under a contract, that right may not be exercised solely for personal gain in such a way as to deprive the other party of the fruits of the contract. Thus, even an explicitly discretionary contract right may not be exercised in bad faith so as to frustrate the other party's right to the benefit under the agreement.

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25.20 Discretionary Consent Definition

See § 25.19.

25.21 Effective Date Definition

  1. The effective date of the Contract is the date signed by the last party necessary to make the Contract a legally-binding contract,
    • unless the Contract clearly states otherwise.
  2. A handwritten date of signature in a signature block of the Contract is to be deemed conclusive on that point,

Commentary

Business context

Parties sometimes want agreements to go into effect at some time after signature, or to have retroactive effect. This Definition states a "default" provision.

The author strongly prefers to state that the effective date is the last date signed; this helps to reduce the temptation for signers to backdate a contract for deceptive purposes, which has landed people in jail as discussed in the commentary at § 2.2.8.

Avoid these alternatives

Some contract drafts use less-good forms, such as:

  • "This Agreement is made December 31, 20XX, between …."
  • "This Agreement is dated December 31, 20XX, between …."

Either of these latter forms can be problematic because the stated date might turn out to be inaccurate (depending on when the parties actually sign the contract) and could help an unscrupulous signer to fraudulently backdate the contract.

Almost as bad is to leave a blank space for the effective date: This creates the risk that the parties and their counsel will neglect to fill in the date. (R.O.O.F.: Root Out Opportunities for [Foul]-ups!)

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25.22 Ending Time Definition

If the Contract states:

  • that a time period, a right, an obligation, etc.,
  • is to end or expire on a specified day,
  • but the Contract does not clearly indicate the time of day for ending or expiration;

then:

  • the end or expiration will be at exactly 12 midnight at the end of the specified date;
  • and the time zone to be used is the time zone:—
    • where the relevant actor,
    • or the action to be taken,
    • is located,
    • or, if applicable, is required to be located,
    • at that time,
    • if not otherwise agreed in writing.

Commentary

Another time-zone possibility would be to use Coordinated Universal Time, which is basically Greenwich Mean Time with a few technical differences; see generally the Wikipedia article Universal Time.

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25.23 Examples Definition

  1. Examples are for purposes of illustration and not limitation.
  2. When examples of a term are given,
    • the parties do not intend for the principle of ejusdem generis ("of the same kind") to limit the term's meaning,
    • unless clearly stated otherwise.
  3. The Contract might sometimes use longer expressions such as "by way of example and not of limitation";
    • such expressions do not mean that the parties intend for shorter expressions such as "for example" to function as limitations,
    • unless expressly stated otherwise.

Commentary

Including this definition in a contract will let drafters safely say, e.g., "including, for example," which is somewhat less stilted than "including, by way of example and not of limitation."

Ejusdem generis: As the Third Circuit pointed out: "By using the phrase ‘including, but not limited to,' the parties unambiguously stated that the list was not exhaustive. … [S]ince the phrase ‘including, but not limited to' plainly expresses a contrary intent, the doctrine of ejusdem generis is inapplicable."

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25.24 Exclusivity Definition

  1. This Clause will govern when, under the Contract:
    • one party, referred to as "Grantor,"
    • grants (explicitly or implicitly) to another party,
      • referred to as "Recipient,"
    • the right to engage in one or more activities,
      • referred to for this purpose as "Activities";
    • this grant is referred to as the "Grant."
  2. The Grant is not exclusive unless the Grant explicitly says so in writing. This means, without limitation, that:
    • Grantor is free — in its sole discretion (as defined in Clause 25.19) — to enter into similar- or identical arrangements with others;
      • this is true even if one or more of those others are competitors of Recipient; and
    • in case of doubt, Recipient is likewise free, in its sole discretion, to enter into similar arrangements with others.
  3. Even if the Grant is exclusive, that exclusivity does not preclude Grantor from engaging the same Activities,
    • anywhere in the world in any market segment,
    • even if Grantor would be competing with Recipient,
    • unless the Grant expressly states otherwise.
  4. If the Grant is exclusive,
    • Grantor need not account to Recipient,
    • nor compensate Recipient,
    • if Grantor engages in one or more of the Activities.

Commentary

Subdivision d: No accounting required

U.S. copyright law requires that co-owners of a copyright in a work of authorship, unless they agree otherwise, must "account" to one another for their uses of the work — basically, this means sharing profits / royalties. See the commentary to [BROKEN LINK: joint-ip-acctg][BROKEN LINK: joint-ip-acctg].

Amazon learns that breach of exclusivity can have consequences

Violating an exclusivity clause can lead to serious consequences. For example: Online giant Amazon and the owner of a commercial building in New York City on the Avenue of the Americas (the "Avenue building") entered into a nonbinding letter of intent ("LOI").

  • Under the LOI, the parties were to negotiate for Amazon to lease ten floors in the Avenue building.
  • Importantly, the LOI included an exclusivity clause prohibiting Amazon from negotiating with any other landlord during a stated period.
  • But while the parties were negotiating the formal lease for the Avenue building, Amazon secretly shopped for other space without telling the Avenue building owner — while insisting that the  owner proceed with renovations that would need to be completed before Amazon moved in.
  • Amazon eventually jilted the Avenue building owner, signing a lease for space in another Manhattan building. This left the Avenue building owner stuck with the extensive costs of the renovations it had done at Amazon's insistence.

The jilted Avenue building owner sued Amazon for breach of the exclusivity provision of the LOI (and also for fraud); the trial court granted the building owner's motion for summary judgment of breach.

(It surely did not help Amazon's image in the case that not even a year before, the company had backed out on its selection of the borough of Queens as the location of its planned second headquarters, following intense community backlash after the selection was announced. See, e.g., J. David Goodman, Amazon Pulls Out of Planned New York City Headquarters, N.Y. Times, Feb. 14, 2019.)

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25.25 Gender Usage Definition

When necessary, any gender-specific or gender-neutral term in the Contract or any associated document,

  • for example (as defined in Clause 25.23), he, she, it, etc.,
  • is to be read as referring to any other gender,
  • or to no gender,
  • as appropriate,
  • unless the context clearly requires otherwise.

Commentary

Caution: This Clause is representative of provisions used "back in the day" but that nowadays could be read by some as being implicitly offensive.

Drafters might want instead to use gender-neutral language throughout — certainly when drafting a form for repeated use with parties who are individuals, such as standard-form employment agreements.

Before: Employee will keep his personal protective equipment (PPE) properly stored in his locker when he is not at work.

AFTER (alternatives):

  1. Employee will keep Employee's personal protective equipment (PPE) properly stored in Employee's locker when Employee is not at work.
  2. You must keep your personal protective equipment (PPE) properly stored in your locker when you are not at work.
  3. Keep your personal protective equipment (PPE) properly stored in your locker when you're not at work. (This might need extra language to be clear that imperative sentences are intended to be binding.)

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25.26 Good Faith Definition

  1. Good faith refers to conduct that both:
    1. is honest in fact, and
    2. comports with reasonable commercial standards of fair dealing in the trade.
  2. This definition does not in itself impose any duty of good faith on any party.

Commentary

This definition is a blend of:

  • Restatement of Contracts (Second) § 205, which states: "Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement"; and
  • Uniform Commercial Code § 1‑304, which imposes a duty of good faith on all contracts and duties within the UCC, and § 2-103(b), which defines good faith (in the case of a merchant) as "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade."

The term good faith is defined here because, as the U.S. Supreme Court has observed, "it does not appear that there is any uniform understanding of the doctrine's precise meaning. … [W]hile some States are said to use the doctrine to effectuate the intentions of parties or to protect their reasonable expectations, other States clearly employ the doctrine to ensure that a party does not violate community standards of decency, fairness, or reasonableness."

Caution: Unlike the law many other states, Texas law does not impose a general duty of good faith and fair dealing in contractual relationships. As explained by the Fifth Circuit, such a duty arises only in specific, limited circumstances.

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25.27 Government Authority Definition

  1. The terms government authority and governmental authority refer to any individual or group,
    • anywhere in the world,
    • that exercises de jure or de facto governmental- or regulatory power of any kind.
  2. The terms should normally be read as including, as applicable and without limitation:
    • any agency; authority; board; bureau; commission; court; department; executive; executive body; judicial body; legislative body; or quasi-governmental authority,
    • at any level, for example, state, federal or local.
  3. The governmental- and regulatory power referred to here is intended to include, without limitation, administrative; executive; judicial; legislative; policy; regulatory; and/or taxing power.

25.28 Gross Negligence Definition

  1. Gross negligence refers to conduct that evinces a reckless disregard for or indifference to the rights of others,
    • tantamount to intentional wrongdoing;
    • it differs in kind, not only in degree, from ordinary negligence.
  2. An assertion of gross negligence must be proved by clear and convincing evidence (as defined in Clause 25.13).
Commentary

This definition adopts a middle-ground standard set out by the Court of Appeals of New York (that state's highest court).

In contrast: A Texas statute sets the bar for gross negligence quite high, for purposes of liability for punitive damages:

(11) "Gross negligence" means an act or omission:

(A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and

(B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

Tex. Civ. Prac. & Rem. Code 41.001(11). The definition is used in § 41.003 of the Code, which conditions any award of punitive damages on a showing, by clear and convincing evidence, of fraud, malice, or gross negligence.

More vaguely, the California supreme court noted that gross negligence "long has been defined in California and other jurisdictions as either a want of even scant care or an extreme departure from the ordinary standard of conduct."

In the litigation over the notorious "BP oil spill" in the Gulf of Mexico, a federal district court wrote at length about the definition of gross negligence in the context of a federal statute; the court held that gross negligence was less than reckless conduct (much as in the California definition discussed above).

Subdivision b: clear and convincing evidence (as defined in Clause 25.13) is the same standard as is required in many jurisdictions for proof of fraud.

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25.29 If Definition

The term if, when used in granting a right or imposing an obligation that would not otherwise apply, means if and only if unless the context clearly indicates otherwise.

Commentary

This definition might seem to be overkill — but consider a Seventh Circuit case:

  • The principal owner of a cardboard-box manufacturer entered into a letter of intent (LOI) to sell the company. The LOI stated that: "IF the Seller … provides to Customer written notice that negotiations toward a definitive asset purchase agreement are terminated, THEN Seller shall pay Customer a breakup fee of two hundred thousand dollars ($200,000)."
  • The seller never provided written notice of termination, as stated in the breakup-fee obligation — but the buyer claimed that the seller was obligated to pay the breakup fee anyway.

The above definition of if might have helped establish that the seller was not required to pay the breakup fee unless it sent the buyer a written notice of termination before the sunset date.

Postscript: On remand, the trial court found that the seller did not have to pay the breakup fee; the appeals court affirmed.

An English case reached a somewhat-contrary result: Under a real estate seller's contract with an agent, the agent was entitled to a "success fee" if the property was sold for a stated price — but the sale was for a lower price. The court of appeal held that in context, the term if did not mean if and only if, and so the agent was awarded a (reduced) success fee under an unjust-enrichment theory — even though normally unjust enrichment is not available when the parties have a contract — on grounds that the Parties' Agreement did not address what would happen if the sale was at a lower price, and so recovery for unjust enrichment was not precluded.

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25.30 Including Definition

  1. The term including is not to be taken as limiting —
    • instead, the term is to be read as though it had been written as, including but not limited to,
    • unless the context clearly indicates otherwise.
  2. The same is true for like terms such as include, includes, and included.
    • (In legalese: The parties do not wish for the principle of ejusdem generis to call for a different result.)
  3. In some places a document might use expressions such as including but not limited to or including without limitation.
    • If that is the case, it does not mean that the parties intended for shorter expressions —
    • such as, simply, including, by itself —
    • to serve as limitations,
    • unless the document expressly states otherwise.
    • (In legalese: The parties do not wish for the principle of expressio unius est exclusio alterius to call for a different result.)
Commentary

This definition eliminates (or at least reduces) the need to repeatedly write (and read), for example, "including without limitation." It's not uncommon in contracts, and generally uncontroversial.

Subdivision b – ejusdem generis: As the Third Circuit pointed out: "By using the phrase ‘including, but not limited to,' the parties unambiguously stated that the list was not exhaustive. … [S]ince the phrase ‘including, but not limited to' plainly expresses a contrary intent, the doctrine of ejusdem generis is inapplicable."

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25.31 Incorporation by Reference Usage Definition

Incorporation by reference into a document has the same force and effect as though the incorporated text or other material had been fully set forth in the body of the document itself.

Commentary
Caution: Incorporated material should be readily available

If an incorporation by reference of external terms is not clear and unmistakable, a court might hold that the external terms are not part of the contract. For example: The Oklahoma supreme court ruled that a form contract for the sale of hardwood flooring, which referenced "Terms of Sale" but gave no indication where to find them, did not incorporate the external terms. The court held that: "a contract must make clear reference to the extrinsic document to be incorporated, describe it in such terms that its identity and location may be ascertained beyond doubt, and the parties to the agreement had knowledge of and assented to the incorporated provisions. … BuildDirect's attempt at incorporation was nothing more than a vague allusion."

Pro tip: At the very least, provide a Web link — preferably a short, memorable one — where the additional incorporated terms can be found.

Attachment "for general reference" might not incorporate by reference

A Nebraska case reinforces the lesson that incorporation-by-reference language must be clear: An architectural-services contract stated that "[t]he Architect’s Response to the District’s Request for Proposal is attached to this Agreement for general reference purposes including overviews of projects and services." But the architect firm's response to the RFP wasn't attached to the contract — for that matter, it wasn't even titled as stated in the contract provision. Agreeing with the trial court, the state's supreme court held that "[t]he expression 'for general reference purposes,' interesting though it may be, contrasts with a provision, common in contract law, which incorporates another document by reference. … [The contract language] simply does not incorporate [the architect firm's] responses into the contract."

Caution: It's not hard to see how another court might have held that the contract did incorporate the architecture firm's guaranteed-maximum-price response.

Still, the contract's drafters, who presumably worked for the school district, might have been more clear about their client's intent.

But a clear intent to incorporate might suffice

In a 2014 case, the Fifth Circuit held that a supplier's price quotation sufficiently incorporated by reference a standard-terms-and-conditions document published by the European Engineering Industries Association (the "ORGALIME"), which contained an arbitration provision. The supplier's price quotation didn't expressly incorporate the ORGALIME by reference; instead it stated, "Terms and conditions are based on the general conditions stated in the enclosed ORGALIME S2000." (Emphasis added.)

The Fifth Circuit reviewed Texas law on the point, summarizing that "when the reference to the other document is clear and the circumstances indicate that the intent of the parties was incorporation, courts have held that a document may be incorporated, even in the absence of specific language of incorporation." The appeals court concluded that "the district court erred in holding there was no agreement to arbitrate."

Caution: A purchase order might be read as incorporating any document mentioned

In a California case:

  • A prime contractor issued a purchase order to a subcontractor. The purchase order mentioned, but did not expressly incorporate by reference, a sales quotation that the subcontractor had previously sent to the prime contractor.
  • Further down in the purchase order, though, the P.O. language referred to "the contract documents described above or otherwise incorporated herein …." (Emphasis added.)
  • Applying the contra proferentem rule of contract interpretation (without using that Latin phrase) — and therefore construing the quoted term against the prime contractor — the court held that the "described above or otherwise incorporated" term had the effect of incorporating the subcontractor's sales quotation by reference into the purchase order.
Mentioning one provision of a document won't necessarily incorporate the whole thing

Drafters should pay attention to just what portion or portions of another document are being incorporated by reference. That issue made a difference in a Second Circuit case, where:

… Addendum 5 [to the contract in question] refers only to a single specific provision in [another agreement] – the non-compete clause. Where, as here, the parties to an agreement choose to cite in the operative contract only a specific portion of another agreement, we apply the well-established rule that a reference by the contracting parties to an extraneous writing for a particular purpose makes it part of their agreement only for the purpose specified.

A party might deny having received referenced documents

In one Eighth Circuit case, a buyer's purchase-order form referred to an external document with additional terms and conditions, and said the document would be provided on request. In a subsequent lawsuit, however, the seller denied having ever received the additional document. That led to (what had to have been) an expensive court fight over whether an arbitration provision and an indemnification provision were part of the contract. The case presents a nice illustration of the Battle of the Forms; the Eighth Circuit ruled that the district court should have conducted a bench trial (there having been no jury demand) to make findings of fact about just who had received what contract documents, and therefore just what terms were or were not part of the parties' contract under UCC § 2-207.

Lesson: It's understandable that the buyer didn't want the hassle and expense of having to provide a hard copy of its Form F-027 with every purchase order. Merely offering to provide a copy of the form, though, might well have been insufficient to bind the seller to its terms. The buyer could have put itself in a stronger position in court if it had posted the Form F-027 on its Web site and then included a link to the form in its printed purchase order.

Provisions following the signature blocks should be clearly incorporated by reference

In a Kentucky case, a for-profit school used a one-page contract. The basic terms and signature blocks were on the front of the page; additional terms and conditions — including an arbitration provision — were on the back of the page, as part of what the state supreme court described as "a sea of plain-type provisions dealing with tuition refunds, curriculum changes, … and arbitration." (Emphasis in original.)

Citing a state statute requiring signatures to be at the end of an agreement, the supreme court said that the arbitration clause was not part of the school's agreement.

Incorporation by reference is consistent with an entire-agreement clause

The Seventh Circuit rejected an argument that incorporation by reference negated a contract's entire-agreement clause:

In an effort to overcome this unambiguous text, Druckzentrum argues that because the contract incorporates extrinsic materials by reference, it cannot reasonably be understood to be an exclusive statement of the parties’ agreement despite the presence of an apparently conclusive integration clause. This argument backfires. When a contract expressly incorporates specific extrinsic materials by reference, the proper inference is that other, unmentioned extrinsic agreements are not part of the contract.

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25.32 Knowledge Definition

  1. Knowledge refers to actual knowledge; related words such as knows, knowingly, and like words have corresponding meanings.
  2. An organization is not considered to have knowledge of something,
    • unless the thing in question is shown to have been known, at the relevant time,
    • by an individual who, at that time, had management responsibility concerning the associated subject matter.
  3. When a representation (as defined in Clause 20.2) or other statement about a particular matter is qualified by a term such as "to our knowledge" or "so far as we know,"
    • or words of similar effect,
    • then the statement is not to interpreted as implying
      • that the party making the statement made any particular inquiry about the matter,
    • unless the statement makes it clear otherwise.
Commentary

Subdivision a is adapted almost verbatim from subdivision b of UCC 1-202.

Other subdivisions of UCC 1-202 are not incorporated into this definition; some of those other subdivisions define "notice" and specify default rules for when an organization has knowledge or notice of a fact, but those default rules might conflict with the notice provisions of a contract.

Merger- and acquisition (M&A) agreements often contain definitions of knowledge that are much more elaborate than this one. Such definitions seem to be less common in contracts for commercial transactions.

Subdivision b (organizational knowledge) is intended to avoid imputing knowledge to an organization just because, let's say, a janitor knows it.

Subdivision c – "to our knowledge" qualifier: In contrast to UCC 1-202, this subdivision refrains from imposing a duty of inquiry; a party desiring to do so should specify it explicitly.

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25.33 Material & Material Breach Definition

25.33.1 Material definition

A thing is material (for example, material information) if a substantial likelihood exists that a reasonable person would consider the thing important in making a relevant decision.

Commentary

This definition is adapted from the opinion of the Supreme Court of the United States in a securities-law case.

Material might be defined differently in other contexts. For example, Hawaii law contains a hair-trigger statutory definition of material in the context of residential-real-estate disclosures:

"Material fact" means any fact, defect, or condition, past or present, that would be expected to measurably affect the value to a reasonable person of the residential real property being offered for sale.

Caution: A summary judgment on the issue of materiality (i.e., a court ruling without a trial) might be difficult to get. As the Texas supreme court explained: "Like other issues of fact, materiality may be decided as a matter of law only if reasonable jurors could reach only one verdict. If the evidence at trial would enable reasonable and fair-minded people to differ in their conclusions, then jurors must be allowed to do so."

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25.33.2 Material breach definition

  1. If the Contract states (in effect) that a certain type of breach will be material, then that statement is to be considered conclusive.
  2. Otherwise, any determination whether a breach of the Contract was (or would be) material is to take into account the factors listed in the Restatement (Second) of Contracts § 241 (1981),
    • considering the Contract as a whole,
    • with no single factor necessarily being decisive.
  3. A history of multiple non-material breaches could collectively constitute a material breach of the Contract when considering that agreement as a whole;
    • this is true whether the individual breaches are related or unrelated,
    • and whether or not one or more of the individual breaches is cured.
Commentary
Breaches expressly labeled as material

Subdivision a: As an example, a real-estate lease might state that a failure to pay rent, after notice and an opportunity to cure, is a material breach. This is not an uncommon practice; for example, in a major litigation over a computer-software development contract, the Indiana supreme court held that the contract's specific identification of standards of materiality took precedence over a Restatement of Contracts analysis: "when a contract sets forth a  standard for assessing the materiality of a breach, that standard governs. Only in the absence of such a contract provision does the common law, including the Restatement, apply."

Considering the agreement as a whole

Subdivision b is modeled on section 16.3.1(1)(A) of the master service agreement in the Indiana v. IBM case, cited above.

Caution: The "Agreement as a whole" language might well reduce the likelihood of getting summary judgment about the materiality or immateriality of a breach.

Multiple non-material breaches can add up to material breach

Subdivision c: At some point, a party might respond to a series of non-material breach by (figuratively) slapping the table and saying, "Enough is enough!" Language like this is found in some contracts.

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25.33.3 Review: Material breach – calling it out

TRUE OR FALSE: For a contract provision to be considered "material," the contract normally must so state.

25.34 May and May Not Definition

  1. The term may is permissive; if the Contract states that a party may take (or omit) an action, it means that the party has the right, but not the obligation, to do so, in its sole discretion, unless the Contract clearly states otherwise.
  2. If the Contract states that a party may not take (or omit) an action, it means that the party is prohibited from doing so.
Commentary

This definition is intended to preclude a party from arguing that another party that "may" do X must exercise good faith, or be reasonable, or anything like that.

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25.35 Midnight Definition

References to midnight on a stated day are to exactly midnight at the end of that day unless clearly specified otherwise.

Commentary

This definition of midnight and 12 a.m. is included because the terms are ambiguous — as pointed out by the (U.S.) National Institute of Standards and Technology in a frequently-asked-questions (FAQ) document:

12 a.m. and 12 p.m. are ambiguous and should not be used. … ‘a.m.' and ‘p.m.' are abbreviations for ‘ante meridiem' and ‘post meridiem,' which mean ‘before noon' and ‘after noon,' respectively. Since noon is neither before noon nor after noon, a designation of either a.m. or p.m. is incorrect. Also, midnight is both twelve hours before noon and twelve hours after noon."

The NIST FAQ document points out that drafters could use 24-hour time, where 0000 refers to midnight at the beginning of the day and 2400 to midnight at the end of the day.

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25.36 Month Definition

  1. Month refers to the Gregorian calendar.
  2. A period of N months, where N is a number,
    • when beginning on a specified date,
    • ends at exactly midnight,
    • in the relevant time zone,
    • at the end of the same day of the month N months later,
    • or at the end of the last day of that later month, if earlier.
  3. Hypothetical examples:
    1. A one-month period beginning on November 15 ends at exactly midnight at the end of December 15.
    2. A two-month period beginning on December 31, 2023 ends at exactly midnight at the end of February 29, 2024 (a Leap Day).
Commentary

This definition could be useful for the avoidance of doubt in contracts involving companies in Muslim countries, and possibly in Israel, where a lunar calendar might be used.

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25.37 Need Not Definition

  1. A statement in the Contract that a party need not take a particular action means that the Contract does not obligate the party to take that action.
  2. If for any reason or no reason the party does not take the action in question,
    • then unless the Contract clearly states otherwise, the party:
      • is to be conclusively deemed to have complied with any applicable standard of good faith, fair dealing, or reasonableness,
      • and will not be liable for not taking the action,
        • under any legal- or equitable theory arising from or relating to the Contract,
      • and no party is to assert the contrary.
Commentary

This is a roadblock clause to try to forestall claims that a party failed to comply with some implied obligation of good faith and fair dealing.

Subdivision b – deemed to comply with good-faith standards: This borrows from UCC 1-302(b) (which applies only to contracts that come within the scope of the UCC), which reads as follows: "The parties, by agreement, may determine the standards by which the performance of those obligations [of good faith, etc.] is to be measured if those standards are not manifestly unreasonable."

25.38 Organization Definition

Organization refers to any of the following: • a corporation; • a business trust; • estate; • a trust; • a general- or limited partnership; • a limited liability company; • an association; • a joint venture; • a joint stock company; • a government; • a governmental subdivision, agency, or instrumentality; • a public corporation; and • any other legal or commercial entity that has a legal identity apart from its members or owners.

Commentary

This "laundry list" is adapted from:

25.39 Prompt (adjective) Definition

Prompt, along with corresponding terms such as promptly, refer to taking specified action within a reasonable time and with a high priority, but not necessarily immediately nor with necessarily the highest priority.

Commentary

This term is of course vague, but it can be useful in requiring reasonably-fast action — but not necessarily immediate action — when the parties don't necessarily know (or perhaps can't agree on) a specific time frame for the action.

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25.40 Protected Group Definition

  1. The term Protected Group relates to an individual or organization (a "Protected Party")
    • that is identified by name in an agreement
    • as being the beneficiary of a defense and/or indemnity obligation
    • or of a limitation of liability.
  2. The term refers to the following:
    1. the Protected Party itself;
    2. the Protected Party's affiliates (as defined in Clause 25.2), if any;
    3. any other individuals or organizations specified in an agreement; and
    4. for the individuals and organizations within the scope of subdivisions 1 through 3: their respective employees, officers, directors, shareholders (in that capacity), general- and limited partners, members, managers, and other persons occupying comparable positions, all as applicable.
  3. As a hypothetical illustration, suppose that ABC Corporation is referred to by the shorthand term "ABC."
    • In that situation, the term "ABC Protected Group" would refer to ABC's Protected Group, as defined above.
Commentary

This is a convenience definition — the term Protected Group is used throughout the Tango Terms.

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25.41 Reasonable Efforts Definition

  1. 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.
  2. A requirement to make reasonable efforts does not necessarily require taking every conceivable reasonable action.
  3. 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.
  4. 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

"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.)

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.)

One UK decision held 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 …." Rhodia UK Ltd. v Huntsman Int'l LLC, 2007 EWHC 292 (Comm) para. 33.

Some commenters take the view that anything less than all reasonable efforts would be, by definition, unreasonable. Many people would disagree, though: Reasonable efforts can encompass a range of efforts; it doesn't have to be a binary, yes-no dichotomy.

Consider Scenario 1, in which Alice's contract with Bob requires Alice to make reasonable efforts to advise Bob in writing if some (non-emergency) Event X occurs.

  • If Event X were to occur, then Alice might send Bob an email to that effect, using the email address that Bob has consistently used in his dealings with Alice.
  • In that scenario, many business people would think that Alice had complied with her contractual obligation to advise Bob, even if for some reason Bob never got the email.

But now consider Scenario 2, in which the contract requires Alice to make all reasonable efforts to advise Bob in writing that Event X has occurred. In that scenario, if Event X were to occur, then Alice might have to try every available means of written communication — email, FAX, certified mail, FedEx, UPS, showing up at Bob's house, etc. — until she received positive confirmation that Bob had in fact received the message.

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 (Nov. 30, 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 friend of the author's, now retired).

25.42 Reckless Definition

  1. A person (the "actor") acts recklessly when the actor:
    • consciously disregards
    • a substantial and unjustifiable risk
    • that harm will result
    • from the actor's conduct.
  2. The risk of harm must be of such a nature and degree that —
    • considering the nature and purpose of the actor's conduct,
    • and the circumstances known to the actor —
    • the disregard of the risk involves a gross deviation
    • from the standard of conduct
    • that a reasonable person would comply with
    • in the actor's situation.
Commentary

This definition is based on Model Penal Code 2.02(c), as implemented in, e.g., Tex. Pen. Code 6.03(c).

Some of the terms used, such as substantial and unjustifiable risk and gross deviation, are of course vague and likely to be the subject of debate.

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25.43 Record (noun) Definition

Record, in the context of documents and the like, refers to books, documents, and other data that are stored in any tangible- or intangible medium regardless of type, without regard to whether such items are in written, graphic, audio, video, or other form.

Commentary

This definition is adapted from the (U.S.) Federal Acquisition Regulations, Contractor Records Retention, 48 C.F.R. § 4.703(a).

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25.44 Responsible Definition

  1. Responsible, in the sense of taking responsibility, refers to action that is both reasonable and conscientious.
  2. As an illustrative example, to make responsible efforts to achieve an objective (whether or not the term is capitalized) means to make at least such efforts as a reasonable person would make in a conscientious attempt to achieve that objective.
Commentary

The term responsible is perhaps vague, but it's not unknown in the law. For example, the Delaware chancery court, in describing the duration of a preliminary injunction, referred to it as a "responsible period," albeit shorter than the period to which the claimant arguably would have been entitled.

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25.45 Shall Definition

Unless the context clearly and unmistakably requires otherwise, terms such as "Party A shall take Action X" mean that Party A is required to take Action X; likewise, terms such as "Party B shall not take Action Z" means that Party B is prohibited from taking Action Z.

Commentary

A plain-language drafting guide published by a coalition of (U.S.) federal employees says: "Besides being outdated, ‘shall' is imprecise. It can indicate either an obligation or a prediction." Federal Plain Language Guidelines at 25 (PlainLanguage.gov 2011) (emphasis added).

The same is true in some other English-speaking countries, where the term shall might be construed as tentative or optional, not as mandatory. See, e.g., a New Zealand legislative drafting guide at A3.33 and an Australian legislative-drafting guide, at page 20.

Even in the United States, shall might not be mandatory; for a U.S. Supreme Court dispute on that point, in the context of a particular federal statute, see Gutierrez de Martinez v. Lamagno 515 U.S. 417, 433 n.9 & accompanying text (1995); id. at 439 & n.1 (Souter, J., dissenting). (Author's note: From a strictly lexical perspective, it seems to me that Justice Souter's dissent had the better of the argument.)

And here's another illustration of the Court's non-mandatory use of shall, from Florida v. Georgia, 585 U.S. __, 138 S. Ct. 2502 (2018) (Breyer, J.): "As we shall discuss in more detail, …." Id., 135 S. Ct. at 2508. "As we shall explain, …. Id. at 2511. "At this stage, we shall do the same." Id. at 2520.

On the other hand, the D.C. Circuit has held that shall was mandatory in a contract's forum-selection clause saying that a Saudi grievance council "shall be assigned for settlement of any disputes or claims arising from" the contract.

The contrary argument isn't frivolous; as the D.C. Circuit noted: "To be sure, one way to make a clause mandatory is to specifically refer to the designated forum as 'exclusive' of other fora."

The author generally prefers will or is to, not shall, for contract obligations for business reasons:

  • The term will seems to have a more-collaborative feel to it, and less of a master/servant tone, than shall. That can provide just a smidgen of help in establishing a cooperative attitude among the parties, which can be important to a successful long-term relationship or even to just a one-shot transaction.
  • From a sales-psychology perspective, in a contract drafted by a supplier, the term will seems softer and more deferential; it pays the customer the respect of implicitly acknowledging that the customer can walk away before signature.

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25.46 Subject to Contract Definition

If a document states that particular discussions are "subject to contract," the document thereby incorporates the Letter of Intent Addendum by reference.

25.47 Time is of the essence (commentary)

When a contract states that time is of the essence, it generally means that if a party misses a deadline, then the other party will have the right to cancel the contract.

But a court might look past a time-of-the-essence provision if it appeared that the provision was included as a mere "stock phrase" as opposed to being genuinely negotiated and agreed to.

As one example: a California appeals court held that "a provision in the parties' contract making time of the essence does not automatically make Rugger's untimely performance a breach of contract because there are triable issues regarding the scope of that provision and whether its enforcement would result in a forfeiture to Rugger and a windfall to MCR."

25.48 Time of Day Definition

A time of day refers to the exact time (in the relevant time zone if not otherwise specified).

Hypothetical example: The term "The deadline for submitting a bid is 5 p.m." means that a bid will be untimely unless submitted before exactly 5:00:00.00 p.m.

Commentary

Why bother defining time of day? Because the issue came up in two Canadian cases where this issue arose in the context of disputes whether contract bids had been timely submitted; the two courts reached opposite results:

(1) Smith Bros. & Wilson (B.C.) Ltd. v. B.C. Hydro, 30 BCLR (3d) 334, 33 CLR (2d) 64 (1997): a company's bid for a construction contract was time-stamped as having been submitted at 11:01 a.m.; the deadline was 11:00 a.m. Technical analysis indicated that the time clock was fast, and that the actual time of the bid submission was sometime between 11:00 a.m. and 11:01 a.m.. The British Colombia supreme court held that the bid was untimely.

(2) In contrast was Bradscot (MCL) Ltd. v. Hamilton-Wentworth Catholic District School Board, 42 O.R. (3d) 723, [1999] O.J. No. 69. In that case, the contract bids were due no later than 1 p.m. The winning bid was submitted at 1 p.m. and 30 seconds. The Ontario court of appeals held that the bid was timely submitted because the clock had not yet reached 1:01 p.m.

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25.49 Timely Definition

An action is timely (or "seasonable") if the action is taken at or within the time agreed or, if no time is agreed, at or within a reasonable time.

Commentary

"Timely" is a useful but vague term, so this definition borrows from the definition of of seasonably in UCC 1-205. (Many modern readers seem not to be familiar with the term seasonably.)

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25.50 Voting Power Definition

  1. Defining by example: Consider a corporation, having:
    1. articles of incorporation; and
    2. a board of directors whose members are elected by holders of voting shares.
  2. For that corporation, 50% of the "Voting Power" of the corporation refers to one or more of the following legally-enforceable rights (see subdivision c):
    1. the right to vote at least 50% of such voting shares; and/or
    2. the right to select at least 50% of the members of the board of directors.
  3. The rights referred to in subdivision c can arise:
    1. by ownership of shares;
    2. by contract, for example, a voting trust or voting agreement; and/or
    3. by a provision in the articles of incorporation.
  4. This Definition will apply in similar fashion to organizations of any other type (including without limitation not-for-profit organizations).
Commentary

Concerning voting agreements, see generally, e.g.,

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25.51 Will Definition

Unless the context clearly and unmistakably requires otherwise, terms such as "Party A will take Action X" mean that Party A is required to take Action X; likewise, "Party B will not take Action Z" means that Party B is prohibited from taking Action Z.

Commentary

See the commentary to the definition of shall.

Caution: Bad things could happen if a court were to read the term will in the "wrong" way. For example: In a 2014 opinion, the Supreme Court of Texas ruled in a Lubbock County case that the term will, in context, did not establish a contractual obligation, but merely stated the intent of one of the parties.

Similar disputes might be avoided if the term will is defined as meaning must. In many cases that will (pardon the expression) be overkill, but it also might be one of those situations where a few extra words can sometimes be cheap insurance against a creative trial counsel. Conceivably, the result in the Lubbock County case might have been avoided by using shall instead of will in the contract language.

Professor Tina Stark (a friend and mentor to the author) thinks that contract obligations should always be signaled by shall, not by will.

So too does Ken Adams, author of A Manual of Style for Contract Drafting; a Google search will help the reader to find Ken's various on-line postings about shall versus will.

25.52 Willful Definition

Willful and its variant spelling wilful, in the context of action or conduct (for example, willful act or willful action or willful conduct or willful misconduct or willful neglect), refer to action or conduct that would be tortious if engaged in outside the context of a contract.

Commentary

This definition is based on that of New York law. If the definition were ever to become relevant, it might well be in connection with a carve-out to a limitation of liability, as in a New York case in which that state's highest court looked to the doctrine of ejusdem generis in holding that, in context, the contractual term willful acts referred to tortious conduct, not merely to mere intentional nonperformance of the contract..

The meaning of willful also came under review in a U.S. Supreme Court's decision that arose because section 523(a)(6) of the Bankruptcy Code provides that debts from "willful and malicious injury" are not dischargeable in bankruptcy. The Court held that, in context, the term willful requires a showing of intent to cause injury, not merely of intent to take the action that resulted in the injury.

The better practice, of course, is not to rely on guesses about how a court will view the meaning of a term; this practice is summarized in the acronym W.I.D.D.: When In Doubt, Define!

25.53 Writing (noun) Definition

Writing refers to a tangible or electronic record of a communication or representation; written has a corresponding meaning. The terms writing and written encompass, without limitation:

  1. handwriting, typewriting, printing, photocopying, photography, audio or video recording, and e-mail; and
  2. words, pictures, and diagrams.
Commentary

Portions of this definition are adapted from proposed amendments to Rule 1.00(v) of the 2010 proposed amendments to the Texas Disciplinary Rules of Professional Conduct [for lawyers]. (The proposed amendments were rejected in a referendum for unrelated reasons.)

26 Additional commentary

26.1 Checklists (commentary)

Why use these planning checklists? Because even the most-competent professional will sometimes miss things — and such a lapse, if not caught in time, could have grave consequences. This was catastrophically illustrated in a 1935 prototype test flight of the legendary B-17 "Flying Fortress" bomber:

  • Before takeoff, the crew neglected to remove locking devices from certain control surfaces.
  • In the resulting crash, both the U.S. Army's chief of flight testing and Boeing's chief test pilot were killed.

See Atul Gawande, The Checklist (NewYorker.com 2007) (archive.org copy).

B-17 Flying Fortress crash
Photo: National Archives

Those and other bitter lessons led to aviation's emphasis on checklists as a crucial backup to fallible human memory: Pilots are trained to complete a checklist before every flight (and at other important times too).

Preflight checklist
Photo: U.S. Air Force

As a U.S. Air Force officer once wrote: "The majority of the notes, warnings, and cautions [in these checklists] have been written in blood." Gary S. Rudman, Checklist mentality … it’s a good thing (safety.af.mil 2012).

26.2 Conspicuousness (commentary)

26.2.1 Overview

In some jurisdictions, certain types of clauses might not be enforceable unless they are "conspicuous." For clauses in this category, courts typically want extra assurance that the signers knowingly and voluntarily assented to the relevant terms and conditions.

(Spoiler alert: A long provision in all-capital letters ("all-caps") won't necessarily be deemed conspicuous; it's just less readable — and might be dangerous.)

26.2.2 All-caps ≠ "conspicuous" – and might be dangerous?

Contract drafters sometimes put entire paragraphs into all-capital letters in the hope of making them "conspicuous." The reader has probably seen examples of this particular disorder in warranty disclaimers and limitations of liability.

But keeping the all-caps going for line, after line, after line, can be self-defeating, as the Georgia supreme court observed (arguably in dicta):

No one should make the mistake of thinking, however, that capitalization always and necessarily renders the capitalized language conspicuous and prominent.

In this case, the entirety of the fine print appears in capital letters, all in a relatively small font, rendering it difficult for the author of this opinion, among others, to read it.

Moreover, the capitalized disclaimers are mixed with a hodgepodge of other seemingly unrelated, boilerplate contractual provisions — provisions about, for instance, a daily storage fee and a restocking charge for returned vehicles — all of which are capitalized and in the same small font.

Even worse, drafting a long block of text in all-caps might actually hurt the drafter's own client. Here's a tweet by Boston-area tech lawyer turned entrepreneur Luis Villa: "Love to see an ALL CAPS AND BOLD section of a contract that is so typographically painful to read that the company’s lawyers didn’t actually proof it, and made a substantive error in my favor as a result." (Emphasis added.)

The drafting tips here, of course, are:

  1. Be judicious about what you put in all-caps.
  2. Don't use too-small a font for language that you want to be conspicuous.

If you want an example of what NOT to do to make something conspicuous, just glance at (don't even try to read) the following abomination, which is near the very front of a real-estate purchase agreement for a Dallas-area "gentlemen's club":

Section 1.02. Disclaimer and Indemnity. THE PROPERTY SHALL BE CONVEYED AND TRANSFERRED TO PURCHASER “AS IS, WHERE IS AND WITH ALL FAULTS”. EXCEPT FOR THE REPRESENTATIONS, WARRANTIES AND COVENANTS OF SELLER SET FORTH IN ARTICLE V OF THIS AGREEMENT, SELLER DOES NOT WARRANT OR MAKE ANY REPRESENTATIONS, EXPRESS OR IMPLIED, AS TO FITNESS FOR A PARTICULAR PURPOSE, MERCHANTABILITY, DESIGN, QUANTITY, QUALITY, LAYOUT, FOOTAGE, PHYSICAL CONDITION, PERATION, COMPLIANCE WITH SPECIFICATIONS, ABSENCE OR LATENT DEFECTS OR COMPLIANCE WITH LAWS AND REGULATIONS (INCLUDING, WITHOUT LIMITATION, THOSE RELATING TO HEALTH, SAFETY AND THE ENVIRONMENT) OR ANY OTHER MATTER AFFECTING THE PROPERTY AND SELLER SHALL BE UNDER NO OBLIGATION WHATSOEVER TO UNDERTAKE ANY REPAIRS, ALTERATIONS OR OTHER WORK OF ANY KIND WITH RESPECT TO ANY PORTION OF THE PROPERTY. FURTHER, PURCHASER SHALL INDEMNIFY, DEFEND AND HOLD HARMLESS SELLER AND SELLER’S REPRESENTATIVES FROM AND AGAINST ANY CLAIMS OR CAUSES OF ACTION ARISING OUT OF THE CONDITION OF THE PROPERTY BROUGHT BY ANY OF PURCHASER’S SUCCESSORS OR ASSIGNS, OR ANY THIRD PARTY, AGAINST SELLER OR SELLER’S REPRESENTATIVES. INFORMATION PROVIDED OR TO BE PROVIDED BY SELLER IN RESPECT OF THE PROPERTY WAS OBTAINED FROM A VARIETY OF SOURCES. SELLER HAS NOT MADE AN INDEPENDENT INVESTIGATION OF SUCH INFORMATION AND MAKES NO REPRESENTATIONS AS TO THE ASSURACY OR COMPLETENESS THEREOF. PURCHASER HEREBY ASSUMES ALL RISK AND LIABILITY RESULTING FROM THE OWNERSHIP, USE, CONDITION, LOCATION, MAINTENANCE, REPAIR OR OPERATION OF THE PROPERTY, WHICH PURCHASER WILL INSPECT AND ACCEPT “AS IS”. IN THIS REGARD, PURCHASER ACKNOWLEDGES THAT (a) PURCHASER HAS NOT ENTERED INTO THIS AGREEMENT IN RELIANCE UPON ANY INFORMATION GIVEN TO PURCHAWSER PRIOR TO THE DATE OF THIS AGREEMENT, INCLUDING, BUT NOT LIMITED TO, PROMOTIONAL MATERIALS OR FINANCIAL DATA , (b) PURCHASER WILL MAKE ITS DECISION TO PURCHASE THE PROPERTY BASED UPON PURCHASER’S OWN DUE DILIGENCE AND INVESTIGATIONS, (c) PURCHASER HAS SUCH KNOWLEDGE AND EXPERIENCE IN REAL ESTATE INVESTIGATION TO EVALUATE THE MERITS AND RISKS OF THE TRANSACTIONS PROVIDED IN THIS AGREEMENT, AND (d) PURCHASER IS FINANCIALLY ABLE TO BEAR THE ECONOMIC RISK OF THE LOSS OF SUCH INVESTMENT AND THE COST OF THE DUE DILIGENCE AND INVESTIGATIONS UNDER THIS AGREEMENT. IT IS UNDERSTOOD AND AGREED THAT THE PURCHASE PRICE HAS BEEN ADJUSTED BY PRIOR NEGOTIATION TO REFLECT THAT THE PROPERTY IS SOLD BY SELLER AND PURCHASED BY PURCHASER SUBJECT TO THE FOREGOING. Disclaimers similar to the foregoing in form satisfactory to Seller as well as Seller’s reservation of the mineral estate shall be inserted in any and all documents to be delivered by Seller to Purchaser at Closing.

26.2.3 The UCC definition of conspicuousness

The [U.S.] Uniform Commercial Code doesn't apply to all types of transaction, nor in jurisdictions where it has not been enacted. Still, its definition of "conspicuous," such as in section UCC § 1-201(10) (Texas version) nevertheless provides useful guidance:

"Conspicuous," with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it.

Whether a term is "conspicuous" or not is a decision for the court.

Conspicuous terms include the following:

(A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and

(B) language in the body of a record or display in larger type than the surrounding text,

or in contrasting type, font, or color to the surrounding text of the same size,

or set off from surrounding text of the same size by symbols or other marks that call attention to the language.

Tex. Bus. & Com. Code § 1.201(10) (emphasis and extra paragraphing added).

Courts often adopt the UCC standard for conspicuousness, as explained in the next section.

26.2.4 In judging conspicuousness, courts tend to focus on "fair notice"

In a non-UCC context, the Supreme Court of Texas held that — with a possibly-significant exception — an indemnity provision protecting the indemnitee from its own negligence must be sufficiently conspicuous to provide "fair notice." The supreme court adopted the conspicuousness test stated in the UCC, quoted above; the court explained:

This standard for conspicuousness in [Uniform Commercial] Code cases is familiar to the courts of this state and conforms to our objectives of commercial certainty and uniformity. We thus adopt the standard for conspicuousness contained in the Code for indemnity agreements and releases like those in this case that relieve a party in advance of responsibility for its own negligence.

When a reasonable person against whom a clause is to operate ought to have noticed it, the clause is conspicuous.

For example, language in capital headings, language in contrasting type or color, and language in an extremely short document, such as a telegram, is conspicuous.

Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (citations omitted, emphasis and extra paragraphing added).

The court also pointed out that the fair-notice requirement did not apply to settlement releases: "Today's opinion applies the fair notice requirements to indemnity agreements and releases only when such exculpatory agreements are utilized to relieve a party of liability for its own negligence in advance." Id., 853 S.W.2d at 508 n.1 (emphasis added).

26.2.5 Fair notice will often depend on the circumstances

What counts as "conspicuous" will sometimes depend on the circumstances. In still another express-negligence case, the Texas supreme court said that the indemnity provision in question did indeed provide fair notice because:

The entire contract between Enserch and Christie consists of one page; the indemnity language is on the front side of the contract and is not hidden under a separate heading.

The exculpatory language and the indemnity language, although contained in separate sentences, appear together in the same paragraph and the indemnity language is not surrounded by completely unrelated terms.

Consequently, the indemnity language is sufficiently conspicuous to afford "fair notice" of its existence.

Enserch Corp. v. Parker, 794 S.W.2d 2, 8-9 (Tex. 1990) (extra paragraphing added).

26.2.6 Proven actual knowledge might substitute for conspicuousness

Texas's Dresser court noted an exception to the conspicuousness requirement: "The fair notice requirements are not applicable when the indemnitee establishes that the indemnitor possessed actual notice or knowledge of the indemnity agreement." Dresser, 853 S.W.2d at 508 n.2 (emphasis added, citation omitted).

Note especially the italicized portion of the quotation, which implies that the burden of proof of actual notice or knowledge is on the party claiming indemnification from its own negligence.

In contrast, a federal district judge in Houston granted Enron's motion to dismiss Hewitt Associates' claim for indemnity, on grounds that the contract in question did not comply with the conspicuousness requirement of the [BROKEN LINK: indem-def-exclusions]; the judge surveyed prior cases in which actual knowledge (of an indemnity clause) had been sufficiently established, including by ways such as:

  • evidence of specific negotiation, such as prior drafts;
  • through prior dealings of the parties, for example, evidence of similar contracts over a number of years with a similar provision;
  • proof that the provision had been brought to the affected party's attention, e.g., by a prior claim.

See Enron Corp. Sav. Plan v. Hewitt Associates, LLC, 611 F.Supp.2d 654, 673-75 (S.D. Tex. 2008) (Harmon, J.).

26.3 Employee protection (commentary)

Companies negotiating contracts that might prove contentious should consider building in some protection for their employees and other personnel.

Contents:

26.3.1 Exonerating individuals in advance

Clause 22.4 (No Individual Liability) tries to protect individuals and others associated with organization parties from liability relating to the Contract. The clause is adapted from language proposed by a noted corporate-law practitioner. See Glenn D. West & Natalie A. Smeltzer, Protecting the Integrity of the Entity-Specifc Contract: the "No Recourse Against Others" Clause-Missing or Ineffective Boilerplate?, 67 Bus. Law. 39, 71-72 (2011). In an email exchange with this author on August 8, 2012, Mr. West commented that "I find general acceptance of some version of my clause as long as it's mutual. Both sides of the transaction have the same general interest in protecting the integrity of the entity-specific nature of the contract; and if they don't, this clause smokes that out and there is a real discussion about guarantors."

This clause could be useful if a dissatisfied contracting party were to sue another party's employees, etc., to pressure them to be cooperative in the hope of being dismissed from the lawsuit. This might have been part of the strategy of the (U.S.) stsate of Oregon in its bitter lawsuit against Oracle Corporation: The state named various Oracle managers and executives 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 (!). (The lawsuit was later settled: Oracle agreed to pay Oregon $25 million in cash and provide another $75 million in technology.)

The clause is a variation of the classic Himalaya clause, which has its origins in maritime practice.

26.3.2 Specifying the "universe" of protected individuals and organizations

Clause 25.6 (Associated Individual Definition) is used to extend the Contract's limitations of liability and indemnity protection to specified individuals and organizations associated with the parties.

From the liability-limitation perspective, that definition can be useful if an aggrieved plaintiff were to decide to sue, not just the company that is another party to the contract, but also various individuals associated with that company. This might occur:

  • if the plaintiff felt that the defendant company had few assets that could be seized to satisfy a judgment, but that the individual co-defendants personally owned substantial assets; and/or
  • to pressure individual employees of the defendant to be cooperative, as might well have happened in the Oregon v. Oracle case

(discussed here).

Likewise, the term is used in the Defense Protocol for Third-Party Claims to extend that Clause's protection to individuals associated with the indemnified party.

26.4 Export controls (commentary)

The export-controls laws in the U.S. are a bit complicated, but it’s extremely important for companies and counsel to get a handle on them.

Here are a couple of examples of "exports" that might be surprising:

  • Disclosure of controlled technical data to a foreign national in the U.S. can constitute an "export" that requires either a license or a license exception.
  • Emailing controlled technical data to a U.S. citizen located in a foreign country could constitute an export of the data.

Want to do ten years in prison? Just do an "export" of technical data witout the required export license (or license exception). Even without prison, you could be heavily fined and/or denied export privileges.

EXAMPLE: A 71-year old emeritus university professor was sentenced to four years in prison for export-controls violations.

  • The professor had been doing research, under an Air Force contract, relating to plasma technology designed to be deployed on the wings of remotely piloted drone aircraft.
  • Apparently, his crime was to use, as part of the project staff, two graduate students who were Iranian and Chinese nationals respectively.
  • It probably didn’t help that the professor was found to have concealed those graduate students’ involvement from the government.

EXAMPLE: In a related vein, in late 2019 a cryptocurrency expert was arrested for having traveled to North Korea to present at a Pyongyang blockchain and cryptocurrency conference, despite having been warned by the State Department that doing so was prohibited by sanctions legislation.

For additional information, see, e.g.:

26.5 Flowdown requirements (commentary)

The term flowdown can be relevant when a contract is between a customer and a so-called "prime" contractor that is expected to use subcontractors. The prime contract might require the prime contractor:

  • to comply with various requirements concerning confidentiality, safety, and the like; and
  • to include some or all of those requirements in subcontracts — these are referred as "flowdown" clauses.

For government contracts, depending on the law, a subcontractor could be subject to specific requirements imposed by statute or regulation, for example:

  • equal-opportunity reporting requirements;
  • affirmative-action obligations;
  • prohibitions of various employment practices;
  • restrictions of various kinds, e.g., on assignments;
  • failure to keep required records.

Flowdown requirements are often seen in U.S. Government contracts under the Federal Acquisition Regulations (FARs) and Defense Federal Acquisition Regulations (DFARs).

In U.S. Government contracts, under the so-called Christian doctrine from 1963, a flowdown clause required by federal regulations might — as a matter of law — be deemed included in a subcontract, even if the subcontract itself didn't actually include the flowdown clause. The Federal Circuit explained in 2018: "For a court to incorporate a clause into a contract under the Christian doctrine, it generally must find (1) that the clause is mandatory; and (2) that it expresses a significant or deeply ingrained strand of public procurement policy."

To help parties avoid being ambushed by undisclosed flowdown requirements, Clause 24.10 (Government Subcontract Representation) is included in [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).

26.6 Foreign Corrupt Practices Act (commentary)

Bribing foreign "officials" can lead to prison time. See generally the 2020 resource guide issued by the Criminal Division of the U.S. Department of Justice and the Enforcement Division of the U.S. Securities and Exchange Commission, at https://www.justice.gov/criminal-fraud/file/1292051/download.

26.7 Subcontracts (commentary)

26.7.1 Basics: What is a "subcontractor"?

Let's illustrate the subcontractor concept with a simple example. Suppose that a would-be homeowner buys an old house (a "tear-down") in a desirable neighborhood and wants to put up a new house on the site. After obtaining architectural plans:

  • The owner will typically hire a prime contractor, which is commonly referred to as the general contractor, or "GC," to actually get the house built.
  • The general contractor will in turn engage various other companies such as: • a demo company to demolish the old house and clear the site; • a foundation company to pour a new foundation; • a framing company to erect the frame of the house; • a roofing company; etc.
  • Each of these other companies is referred to as a subcontractor or "sub"; the subs will normally deal only with the general contractor and not with the owner.

26.7.2 Should subcontracting be allowed?

That will depend on the parties and the situation. Sometimes one party might want —

  • to prohibit the other party from using subcontractors at all, or
  • to require the other party:
    • to obtain the first party's prior written consent to any use of subcontractors, or
    • to get the first party's approval of the specific subcontractor(s) to be used, or
    • to notify the first party before using subcontractors, or
    • to impose specific obligations (e.g., confidentiality obligations) on any subcontractor(s), e.g., in the form of specific terms in a written subcontract;
    • to provide the first party with a copy of each written subcontract (possibly redacted to black out confidential information).

26.8 Subrogation (commentary)

Author's note: In Carter v. Pulte Home Corp., No. A154747 (Cal. App. Jul. 23, 2020), the court summarized the law of subrogation in that state; an extensive excerpt from the court's opinion follows, lightly edited and with citations omitted.

Pulte Home Corporation (Pulte), a residential developer and general contractor, was sued for construction defects by the owners of 38 homes in two housing developments.

Many subcontractors worked on the projects, under contracts requiring each subcontractor to indemnify Pulte and to name it as an additional insured on the subcontractor’s commercial general liability insurance.

These contracts required each subcontractor to indemnify Pulte against "all liability, claims, judgments, suits, or demands for damages to persons or property arising out of, resulting from, or relating to Contractor’s performance of work under the Agreement (‘Claims’) unless such Claims have been specifically determined by the trier of fact to be the sole negligence of Pulte . . . ."

Pulte cross-complained against the subcontractors who worked on some or all of the homes at issue, alleging it was entitled to a defense and indemnity, and tendered its defense of the homeowners’ suit to the subcontractors and their insurers.

Travelers, the insurer for four of the subcontractors, accepted the tender and provided a defense.

The "Blanket Additional Insured Endorsements" to Travelers’s named insureds’ policies stated that the "person or organization is only an additional insured with respect to liability caused by ‘your work’ for that additional insured."

Respondents are seven subcontractors who did not respond to the tender of Pulte’s defense and whose insurance carriers denied that the additional insured endorsements to their policies required the insurers to provide a defense.

Travelers filed a complaint in intervention against respondents and other subcontractors no longer involved in the litigation. …

Pulte eventually settled the homeowners’ claims and its claims against all the subcontractors. Travelers ultimately paid $320,491.82 for Pulte’s defense.

At trial, [Travelers] sought to recover $156,091.82 from respondents, having recovered $164,400 from other subcontractors. Travelers’s position at trial was that respondents were each jointly and severally liable for the remainder of its costs for defending Pulte, as each respondent had a contractual obligation to defend Pulte.

* * * 

Subrogation is the substitution of another person in place of the creditor or claimant to whose rights he or she succeeds in relation to the debt or claim.

In the case of insurance, subrogation takes the form of an insurer’s right to be put in the position of the insured in order to pursue recovery from third parties legally responsible to the insured for a loss which the insurer has both insured and paid.

The subrogated insurer is said to "stand in the shoes" of its insured, because it has no greater rights than the insured and is subject to the same defenses assertable against the insured.

Thus, an insurer cannot acquire by subrogation anything to which the insured has no rights, and may claim no rights which the insured does not have.

As now applied the doctrine of equitable subrogation is broad enough to include every instance in which one person, not acting as a mere volunteer or intruder, pays a debt for which another is primarily liable, and which in equity and good conscience should have been discharged by the latter.

The essential elements of an insurer’s cause of action for equitable subrogation are as follows:

1. the insured suffered a loss for which the defendant is liable, either as the wrongdoer whose act or omission caused the loss or because the defendant is legally responsible to the insured for the loss caused by the wrongdoer;

2. the claimed loss was one for which the insurer was not primarily liable;

3. the insurer has compensated the insured in whole or in part for the same loss for which the defendant is primarily liable;

4. the insurer has paid the claim of its insured to protect its own interest and not as a volunteer;

5. the insured has an existing, assignable cause of action against the defendant which the insured could have asserted for its own benefit had it not been compensated for its loss by the insurer;

6. the insurer has suffered damages caused by the act or omission upon which the liability of the defendant depends;

7. justice requires that the loss be entirely shifted from the insurer to the defendant, whose equitable position is inferior to that of the insurer; and

8. the insurer’s damages are in a liquidated sum, generally the amount paid to the insured.

Author's note: The court affirmed the trial court's ruling that Travelers had failed to prove its entitlement to equitable subrogation.

26.9 Term sheet drafting tips (commentary)

Here are some basic tips for drafting a term sheet to accompany a Tango email agreement.

  • Short sentences are best.
  • One (short) sentence per paragraph is best.
  • Be very clear who is responsible for doing what, when. As the business cliché puts it: Whose throat gets choked?
  • Specify any relevant time frames such as:
    • deadlines;
    • earliest- and latest start dates; and/or
    • maximum- or minimum time periods.
  • Fences: Spell out any relevant restrictions or limitations. For example: If payments must be made by wire transfer, then say so.
  • If a party is or will be relying on information provided by another party, then say so.
  • Bullet points are fine as long as they're clear.
  • Hypothetical examples can be really useful to illustrate points and educate future readers, such as:
    • business people who need to get up to speed;
    • judges and jurors.
  • Diagrams? Tables? Flow charts? Footnotes? Why not — when in doubt, serve the reader.

27 Faster contracts by email

Because emails and even text messages can form binding contracts (as discussed in § 4.2), companies could opt to skip long, legalese contracts, and instead agree by email to business terms plus one of the Tango Terms email agreements in this chapter.

Contents:

27.1 Example: A two-sentence NDA — just "the Tango Terms"

The parties: ABC Corporation, whose CEO is "Alice," and XYZ Inc., whose CEO is "Xavier."

The situation: Alice and Xavier want to exchange some confidential information so that they can each assess whether it would make sense for their companies to do business together.

The business need: Alice and Xavier want to have their companies enter into a confidentiality agreement, a.k.a. a nondisclosure agreement or "NDA."

A solution: After checking with their respective legal counsel, ABC Corporation and XYZ Inc. could quickly enter into an NDA by Alice sending Xavier an email along the following lines:

To: Xavier
From: Alice
Subj: Confidentiality agreement - please confirm agreement

Hi Xavier — it was great talking to you the other day. So that we can continue our discussions, let's enter into a confidentiality agreement; if it's OK with you, we can just use the Tango Terms. If that works, please reply to this email, saying that you agree.

Alice
CEO, ABC Corporation

(Emphasis added.) See § 24.1 for an explanation of which Tango Terms provisions would apply in Alice's proposed NDA, given that she cited just "the Tango Terms" and not a specific Tango agreement.

Alternatively, Alice could propose using Clause 27.5 (Confidentiality Agreement ("NDA")) to be more specific about which terms they wanted to adopt in their email agreement.

Now suppose that Xavier emails Alice back, as follows:

To: Alice
From: Xavier
Subj: Re: Confidentiality agreement - please confirm agreement

Sounds good, Alice; we agree.

Xavier
CEO, XYZ Inc.

(Emphasis added.)

In U.S. jurisdictions and probably in many others as well, the above email exchange would almost certainly create a legally-binding NDA between ABC Corporation and XYZ Inc. (This is explained in more detail in [BROKEN LINK: elec-k-email][BROKEN LINK: elec-k-email].)

Author's note: For years I've used this basic agreement-by-email approach in my law practice: My clients and I enter into written engagement agreements in pretty much just this way, by email. (For lawyer readers: My engagement-agreement form is at https://www.oncontracts.com/engage/; I've made it available for other lawyers to use if they wish. At some point I'll add that agreement form to the Tango Terms corpus.)

At the risk of belaboring the point: Your reading or using the Tango Terms doesn't make me your lawyer; also, you shouldn't rely on the Tango Terms as a substitute for legal advice about your specific situation from an attorney licensed in the relevant jurisdiction.

Pro tip: Both Alice and Xavier would want to make sure to keep this email exchange for future reference and, ideally, to log it into whatever systems their companies use for contract management.

27.2 Example: A consulting agreement by email

The situation: At Xavier's company XYZ Inc., one of the key IT people, "Betty," recently left the company. Now XYZ is facing an emergency: Things are going wrong with XYZ's computer system, and no one knows how to fix the problem — except its former employee Betty.

The business need: XYZ very much wants to rehire Betty, its former IT employee, as a temporary outside consultant, and to do so as quickly as possible without spending a lot of time negotiating terms and conditions.

A solution: An easy way for XYZ Inc. to enter into a consulting agreement with Betty (after checking with legal counsel) would be for Xerxes, XYZ's director of IT, to send Betty an email along the following lines:

To: Betty
From: Xerxes
Subj: Consulting agreement - please confirm agreement

Hi Betty — thanks so much for agreeing to help us out. Confirming our discussions: This month you'll spend up to 20 hours a week helping us with our computer system, when and as requested by our supervisor Xena, for $XXX per hour plus any reasonable expenses. The Tango Terms will apply.

If this is agreeable, please reply to this email to that effect.

Thanks again!

Regards,

Xerxes
Vice president-IT, XYZ Inc.

(Emphasis added.)

If Betty was agreeable, she could respond:

To: Xerxes
From: Betty
Subj: Confidentiality agreement - please confirm agreement

That's fine — I look forward to working with you again; thanks!

Betty

(Emphasis added.)

Just as in Example 1, in U.S. jurisdictions and probably in many others as well, the above email exchange would almost certainly create a legally-binding consulting agreement between Betty and XYZ Inc.

(See § 24.1 for a description of which Tango Terms provisions would apply in this consulting agreement.)

Alternatively, Xerxes and Betty could agree to use Clause 27.6 (Consulting-Services Agreement) to be more specific about which terms they wanted to adopt in their email agreement.

27.2.1 Example: A referral agreement by emailed term sheet

The situation: Alice and Xavier want their companies to enter into a written agreement that Alice's company, ABC Corporation, will pay Xavier's company, XYZ Inc. a commission for certain customer referrals.

The business need: Alice and Xavier want a referral agreement to document their companies' arrangement.

A solution: With advice of counsel, Alice and Xavier could do the following as an email exchange, with an agreed term sheet attached.

To: Xavier
From: Alice
Subj: Referral agreement - please confirm agreement

Hi Xavier — glad we've got the referral agreement worked out. A term sheet is attached, and we'll use the Tango Terms Referral Agreement. If that's agreeable to XYZ, please reply to this email to that effect. We look forward to working with you!

Alice
CEO, ABC Corporation

(Emphasis added; the Tango Referral Agreement is in Clause 27.7. Alternatively, Alice's email could just refer to "the Tango Terms" as in the first two examples.)

Xavier responds to Alice as follows:

To: Alice
From: Xavier
Subj: Re: Referral agreement - please confirm agreement

Thanks, Alice — love it! Done!

Xavier
CEO, XYZ Inc.

(Emphasis added.)

Once again, in U.S. jurisdictions and probably in many others as well, the above email exchange would normally create a legally-binding contract.

Repeating the pro tip: Alice and Xavier would want to be sure to have their new referral agreement installed into their companies' contract-management systems.

27.3 Example: Saving time in negotiating a bespoke contract

:PROPERTIES: :CUSTOMID: intro-pack

The situation: Alice and Xavier and their lawyers have been drafting and negotiating a "bespoke" contract.

The business need: The companies' lawyers want to plug some "standard" terms and conditions into the draft bespoke contract.

A solution: The lawyers could save some time in drafting the bespoke contract by incorporating one or more Tango riders (or specific Tango protocols, definitions, or other clauses) by reference into the contract, such as:

  • [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider)
  • Clause 13.13 (Payments Rider)
  • [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider)
  • Clause 25 (General Definitions & Usages)

27.4 Business Associate Agreement (HIPAA)

If this Business Associate Agreement (HIPAA) is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How must "protected health information" be handled? See Clause 16.8 (Protected Health Information).
  2. If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  3. What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).

27.5 Confidentiality Agreement ("NDA")

(This Clause may also be referred to as "the Tango NDA.")

If this Confidentiality Agreement ("NDA") is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How must confidential information be handled? See Clause 16.1 (Confidential Information).
  2. Whose information is protectable? Each party's information is potentially eligible for protection under this Clause.
  3. If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  4. What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).
Commentary

For more-detailed commentary, see Clause 16.1 (Confidential Information).

Drafters can also including the following in the Contract:

Hide all commentary

27.6 Consulting-Services Agreement

If this Consulting-Services Agreement is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  • How are services to be provided? Any services called for under the Contract are to be provided as stated in (i) one or more written statements of work, and (ii) Clause 14.3 (Services Protocol).
  • What rules will govern computer-system access? Any access by one party to a computer system or network of another party must comply with Clause 19.3 (Computer System Access Prococol).
  • What rules will govern site visits? Any party whose personnel visit physical premises of another party must cause those personnel to comply with Clause 19.16 (Site Visits Protocol).
  • How must confidential information be handled? See Clause 16.1 (Confidential Information) — but only the customer's information is eligible to be Confidential Information unless the Contract clearly says otherwise.
  • How must "protected health information" be handled? See Clause 16.8 (Protected Health Information).
  • Who will own any newly-created IP? See Clause 18.4 (IP Creation Ownership).
  • How will payments under the Contract be made? See Clause 13.13 (Payments Rider).
  • If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  • What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).
Commentary

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

Hide all commentary

27.7 Referral Agreement

If this Referral Agreement is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How are referrals to be handled? See Clause 14.6 (Referrals Protocol).
  2. How will payments under the Contract be made? See Clause 13.13 (Payments Rider).
  3. If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  4. What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).
Commentary

Drafters can also consider including the following in the Contract:

Hide all commentary

27.8 Reseller Agreement

If this Reseller Agreement is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. Clause 14.7 (Resale Protocol)
  2. Clause 13.13 (Payments Rider)
  • If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  • What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).

27.9 Services Agreement

If this Services Agreement is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How are services to be provided? Any services called for under the Contract are to be provided as stated in (i) one or more written statements of work, and (ii) Clause 14.3 (Services Protocol)
  2. How will payments under the Contract be made? See Clause 13.13 (Payments Rider)
  3. If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  4. What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).
Commentary

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

  • Clause 15.4 (Recordkeeping Protocol)
  • Clause 15.1 (Audit Protocol)
  • Clause 19.3 (Computer System Access Prococol)
  • Clause 19.16 (Site Visits Protocol)
  • Clause 16.1 (Confidential Information) — possibly only one party's information should be is eligible to be Confidential Information
  • Clause 18.4 (IP Creation Ownership) — if the services might create new "intellectual property" such as (for example) new software; new data compilations; new trademarks; etc.

Hide all commentary

27.10 Software License Agreement

If this Software License Agreement is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. Clause 14.11.2 (Software License Protocol), which references:
    • a License Granting Document such as a purchase order
    • Clause 15.1 (Audit Protocol)
  2. Clause 14.11.5 (Software Limited Warranty), which references:
  3. Clause 19.17 (Training Program) (only if Provider is to provide any training for Customer personnel), which references:
    • Clause 19.3 (Computer System Access Prococol) — if either party is to access the other party's computers or network; and
    • Clause 19.16 (Site Visits Protocol) — if either party is to go on-site to the other party's physical premises
  4. Clause 13.13 (Payments Rider)
  5. Clause 22.2 (Consequential Damages Exclusion) — Provider will not be liable for consequential damages
  6. Clause 22.3 (Damages Cap Usage) — Customer's damages are capped at two times the aggregate amounts paid by Customer in the 12 months immediately preceding the first event giving rise to the claim
  7. Clause 22.1 (Limitations of Liability Usage)
  8. If a dispute arises, how will the parties manage it? See [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider).
  9. What "general" provisions will apply? Amendments, formal notices, and other topics will be governed by [BROKEN LINK: gen-prov][BROKEN LINK: gen-prov] (General Provisions Rider).

28 Appendix: General exercises

28.1 Even more ambiguity exercises

28.1.1 Redrafting an ambiguity in the "B.C." comic strip

See the strip of July 17, 2017].

EXERCISE: Rewrite.

28.1.2 Ambiguity: How life will turn out when you're young

See this Pearls Before Swine cartoon. (The author, Stephan Pastis, is a non-praticing lawyer.)

QUESTION: How could the first panel's wording be "improved"?

28.1.3 Ambiguity and the impeachment trial

TEXT: From a tweet: "Republicans are seemingly days away from voting to assert that presidents have dictatorial power to cheat in their own elections (if they're Republican presidents) and there needs to be a mass uprising about it."

QUESTION: There needs to be a mass uprising about what, exactly?

28.1.4 Ambiguity exercise: A man's success

From a Facebook posting: "A man's success has a lot to do with the kind of woman he chooses to have in his life. (Pass this on to all great women.)"

QUESTION: What's another, grossly-sexist interpretation of this quote? (Please don't be offended by this example; we're learning here to spot — and fix — unintentional ambiguities that can be subject to intentional, motivated misinterpretation.)

28.1.5 Ambiguity: "… was clearly executed" vs. "clearly was executed"

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

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

28.1.6 Ambiguity and vagueness

  1. Consider the following sentence: "Alice says that Bob is cold." Is this more likely to be considered vague, ambiguous, or both?
  2. Consider the following sentence: "Alice says that Bob's forehead feels warm." Is this more likely to be considered vague, ambiguous, or both?
  3. What's a principal danger of an ambiguous contract term?
  4. FACTS: In a contract draft prepared by The Other Side, you see a term that's vague — it says that your client must pay The Other Side a certain amount by a certain date, but doesn't specify the time of day for that deadline.

    QUESTION: Is this worth asking The Other Side to fix? Discuss your reasoning.

  5. MORE FACTS: In this contract, your client is located in Vancouver, Canada and The Other Side (which drafted the contract) is located in Houston. The contract states that the amount your client must pay is $1 million.

    QUESTION: Is this an issue? If so, is it worth burning up negotiation time by asking The Other Side to fix it? Discuss your reasoning.

  6. MORE FACTS: In the above situation, your client really wants to get the contract to signature as soon as possible, like yesterday. You've tentatively concluded that it's not worth raising either of the above points (time of day and amount due) with The Other Side.

    QUESTION: To be on the safe side and keep your malpractice-insurance carrier happy, what might you want to do about these points before sending your markup to The Other Side?

  7. QUESTION: If all else fails in trying to interpret a contract provision, what Latin maxim will courts often follow, and what does it mean?

28.1.7 Ambiguity: Julia Louis-Dreyfus's early career

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

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

(Emphasis added.)

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

28.1.8 Ambiguity alert: Kellyanne Conway

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

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

28.1.9 Ambiguity: Iowa caucuses

TEXT: From Ezra Klein on Monday morning: "Iowa Democrats want to be fair to candidates but also have a clear winner of the #IowaCaucuses." (The caucuses are tonight.)

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

28.1.10 Ambiguity exercise: Hillary's email server

Since this keeps coming sort-of back in the news ….

SOURCE: A Politico piece titled FBI could leak Clinton email investigation, Grassley warns.

TEXT: "A hypothetical leak could occur, he said, if officials believed Clinton was not being prosecuted for political reasons." (Emphasis added.)

EXERCISE: There are two possible meanings of the italicized portion of the above sentence. Discuss.

28.1.11 Ambiguity exercise: Prime rate plus 2%

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

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

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

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

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

28.1.12 Redrafting an ambiguity from President Trump

From a presidential tweet of April 3, 2017: "Such amazing reporting on unmasking and the crooked scheme against us by @foxandfriends. …" (Hat tip: Chris Richardson.)

QUESTION:

28.1.13 Redrafting an ambiguity in the Amazon

From Smithsonian.com: "Researchers Discover the Tallest Known Tree in the Amazon"

Discuss.

28.1.14 Ambiguity rewriting exercise: Nestle and Starbucks

From this BBC.com article: "Nestle has announced that it will pay Starbucks $7.1bn (£5.2bn) to sell the company's coffee products."

QUESTION: Which company will sell which company's coffee —

  • Will Nestle sell Starbucks coffee? or
  • Will Starbucks sell Nestle coffee?

(Which do you think is more likely?)

EXERCISE: In your breakout rooms and the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), rewrite twice — once for each possible interpretation.

28.1.15 Ambiguity in an obituary

From the obituary of Inez Neill Winton, who died at age 97:

In early 1942, when American's [sic] of Japanese ancestry were taken from their homes and relocated to internment camps, Inez went to the camp at Amache, Colorado to teach the children and open a library. She still received Christmas cards from several of the children she taught well into the 1960s including two who fought in the 442nd Infantry Regiment Brigade [sic].

QUESTION: What are two possible interpretations of the italicized portion? How could this be rewritten to clarify?

28.1.16 Ambiguity rewriting exercise: Lemley's pants

From a Facebook post by Stanford law professor Mark Lemley:

Things I appear to like more than my Facebook friends:

1. Pants

EXERCISE: What are the two possible meanings here?

28.1.17 Ambiguity and Jewish grandmothers

In honor of the first night of Passover tonight, from Joshua Rothman in The New Yorker: "My grandmother is ninety-three and, to my knowledge, has never kept kosher."

DISCUSS.

28.1.18 Ambiguity rewrite: Swearing to defend the Constitution 11 times

Here's a tweet I saw retweeted: "I’ve sworn to defend and uphold our Constitution 11 times."

QUESTION: What exactly does "11 times" refer to — defending and upholding the Constitution 11 times, or swearing to do so?

EXERCISE: Rewrite to clarify.

28.1.19 Ambiguity: Euthanasia

TEXT: From a BBC News tweet: "Belgium court clears three doctors accused of unlawfully poisoning a woman whose life they helped to end in landmark trial."

QUESTION: What exactly happened at the "landmark trial"?

28.1.20 Ambiguity: Chris Tomlinson column

From Chris Tomlinson, Facebook could learn better practices from newspapers, Houston Chronicle: "Here’s what everyone needs to know about the First Amendment: It only protects people from government interference and does not apply to private people or companies. No media organization has an obligation to publish anything and is legally liable for what they do publish." QUESTION: Is that really what he meant to say?

28.1.21 Ambiguity and the Easter service booklet

FACTS: This is adapted from my church's Easter Sunday service booklet of a few years ago (with the family's name changed):

Easter flowers and decorations are given
to the glory of God
and in memory of their grandmother Jane Doe
In honor of all Christians,
Especially those persecuted
By the Doe family

QUESTION: How could this be fixed with just one additional character?

28.1.22 A Memorial Day tweet: Remembering those who served ….

This tweet: "We remember all who have served hot breakfast"

28.1.23 Ambiguity exercise: Ambassador Taylor's Vietnam service

From the Washington Post: "Rep. Sean Patrick Maloney (D-N.Y.) walked [acting ambassador to Ukraine William] Taylor through his U.S. Military Academy and military career, including that he was No. 5 in a class of 800 and took a tough infantry assignment in Vietnam, in an apparent effort to embarrass Republicans."

QUESTION: Who, exactly, did what, "in an apparent effort to embarrass Republicans"? How could the ambiguituy be fixed?

28.1.24 Ambiguity exercise: What's a "living properties executive"?

From Katherine Ellison, Getting his tattoo took less than 20 minutes. Regret set in within hours (WashingtonPost.com 2020): "Slavin, a former senior living properties executive, … argued that Zapatat has performed far more [tattoo-removal] treatments than most dermatologists …." QUESTION: What is a "living properties executive"? QUESTION: How could this be clarified?

28.1.25 Ambiguity exercise: Masks and signs on cars

From a tweet encouraging attendance at an anti-lockdown protest in Maine: "[T]here will be a caravan around the Capitol … Monday. … Remain in your vehicles but masks, bandanas, flags and signs on cars are encouraged."

QUESTION: In your view, why are caravaners being encouraged to put masks and bandanas on cars?

EXERCISE: Using the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), rewrite to clarify.

28.1.26 Ambiguity: Arenas awash in pleasure

TEXT: From a Maureen Dowd column in the NY Times, March 5, 2016: "Like Bill Clinton, Trump talks and talks to crowds. They feed his narcissism, and in turn, he creates an intimacy even in an arena that leaves both sides awash in pleasure." (Emphasis added.)

DISCUSSION: The italicized part of this quotation arguably has two meanings: Both sides are left awash in pleasure by —

  1. An arena.
  2. The intimacy that Trump creates even in an arena.

EXERCISE: Rewrite the italicized portion of the Dowd quote to be clear that she intended the second meaning.

28.1.27 Ambiguity: Professor Goodenough's prospects

From the Houston Chronicle:

Feeling behind in school wasn't new for Goodenough when he started his physics Ph.D. at the University of Chicago. As a child, his dyslexia went undiagnosed. But it still stung when, after serving in World War II, an administrator told him he wouldn't make it as a physicist because he had started too late. He was in his 20s.

QUESTION (discuss in your groups): What's wrong with the italicized portion?

28.1.28 Ambiguity: Rodney Dangerfield

Here's the "Quotation of the day" from the NY Times morning-briefing email of August 2, 2017:

“His mother convinced him to open a savings account one summer so he could save up for a football uniform. Then she stole his money.”
Joan Dangerfield, the widow of the comedian Rodney Dangerfield, who was honored with a plaque in Kew Gardens, Queens, 13 years after his death. His childhood in the neighborhood prepared him for a lifetime of getting no respect.

QUESTION: Who was honored — Joan Dangerfield, or Rodney?

EXERCISE: Rewrite the sentence that begins, "Joan Dangerfield" to clarify it.

28.2 Plain-language exercises

28.2.1 Streamlining the sentence: The team meeting

In your small groups, discuss how to trim out the "fat" from the following sentence:—

Before:  
The team held a meeting to give consideration to the issue.

After: ???

28.2.2 Drafting fail: Smokin' in the building

TEXT: "From a commercial lease: 'Tenant’s Occupants will be required to smoke outside the Building in compliance with the Utah Indoor Clean Air Act.' [Cut to view of bewildered occupants corralled outside the building and forced to smoke.]" (From Ken Adams.)

SUGGESTED REVISION (from Neil Brown): "Tenant's Occupants may not smoke inside the Building. If they wish to smoke outside the Building, they must [insert rules]. The Tenant is responsible for enforcing this." (Notice how this uses shorter, crisper sentences.]

28.2.3 "Flow" exercise: Carbolic acid and Queen Victoria

From this NPR piece:

[Joseph] Lister was the closest surgeon to [Queen Victoria's] residence in Scotland, Fitzharris says, so she directed Lister to come drain a large abscess growing under her armpit. Before the surgery, Lister's assistant sprayed carbolic acid with a machine Lister invented called the donkey engine all over the operation area, sterilizing it but also accidentally spraying the queen in the face.

QUESTION: How could the italicized text be rewritten to "flow" better? (Hint: Consider rewriting it so that it would sound more-natural if read aloud — which isn't bad advice for any writing.)

28.2.4 Drafting fail: American Girl

28.2.5 The case of LeBron's tattoos

FACTS: Here's a quote from this S.D.N.Y. opinion:

Familiarity with the facts underlying this case, which have been detailed in prior decisions of the Court, including the August 2, 2016, Memorandum Opinion and Order, the May 16, 2017, Memorandum Order, and the March 30, 2018, Memorandum Opinion and Order, is presumed.

(In the lawsuit, the owner of the copyrights in various NBA players' tattoos filed a lawsuit against the maker of an NBA-licensed video game that showed animated images of the players. The court granted the video-game maker's motion for summary judgment dismissing the case.)

EXERCISE: Right here, right now, each student "chat" me a rewrite of the above quote to make it more readable.

Hints:

  • Could the sentence be broken up into, say, two sentences?
  • Why so much verbiage between the start of the sentence and the "punch line"?

Then we'll discuss.

28.2.6 Rewriting exercise: "Provided that …"

A contract contains the following provision: "Alice will pay Bob USD $100 no later than December 25; provided, however, that if Alice pays Bob no later than December 21, the amount to be paid will be $75."

TRUE OR FALSE: Professor Toedt regards the "provided …" as an acceptable form.

Answer: False. The term "provided that …." is commonly used in wall-of-text provisions but should be avoided in favor of breaking up the sentence and possibly even the paragraph. (This clause could be turned into a table, but it's short enough not to be worth bothering.)

EXERCISE: In the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), rewrite this. (Hint: Consider using romanettes.)

Another approach would be to rewrite the sentence with numbers or romanettes "Alice will pay Bob as follows: (1) If no later than December 21: USD $75. (2) If no later than December 25: $100."

28.2.7 It's vs. its

Know the difference — "it's never a good thing to assume that a party will always act in its own best interest."

28.2.8 Clause phrasing

FACTS:

  1. You are drafting a contract between your client Alice, and Bob, who owns a sole-proprietorship yard maintenance company that employs a number of workers.
  2. Under the contract, Bob's workers are to replace the sod in Alice's front yard.
  3. Bob won't be personally doing any of that work — and the contract will be between Alice and Bob, not Alice and Bob's workers.

QUESTION: How can you phrase this obligation so that it's clear that Bob is responsible for making this happen, without making it a false imperative?

28.2.9 Nickname for a "this is acceptable" provision

A lease states that

1.  Tenant must pay the rent by a means reasonably acceptable to Landlord, and

2.  Venmo is to be conclusively deemed an acceptable means of payment.

QUESTION: Subdivision (2) is an example of a xxxx-yyyyyy provision.

28.2.10 "Provided that …"

A contract contains the following provision: "Alice will pay Bob USD $100 no later than December 25; provided, however, that if Alice pays Bob no later than December 21, the amount to be paid will be $75."

TRUE OR FALSE: Professor Toedt regards the "provided …" as an acceptable form.

28.2.11 Use of other contract provisions in interpretation

TRUE OR FALSE: Parol evidence for interpreting Provision A of a contract can include the text of Provision B of the same contract.

28.2.12 Review: Parol evidence — when is it relevant?

QUESTION: In the U.S., courts generally will look to parol evidence to interpret a contract provision only if the provision is [BLANK]:

28.2.13 Employment agreement salary frequency

FACTS: You're drafting an employment agreement for a salaried employee. The parties have agreed on the starting salary, and you've been instructed to put that starting salary into the agreement.

QUESTION: You'll want to state that the salary will be paid:

A.  Monthly

B.  Biweekly

C:  Per the company's standard payroll procedures

29 Afterword

29.1 Benefits of using the Tango Terms

Get contracts signed sooner with balanced terms

The Tango Terms "bake in" many common party requests, in a balanced way. This helps parties avoid wasting time in reinventing the wheel and "art of the deal" game-playing (and likely ending up in more-or-less the same place anyway).

See the commentary at § 9.1 for a more-detailed discussion of the benefits of the balanced-terms approach.

Enhanced readability via bullet-point clauses

In the Tango Terms, many sentences are broken up into bullet points, which greatly enhances their readability. If you need convincing, see the before-and-after example in § 7.5.

Guard against disaster with checklists

Even if you're not adopting any Tango clauses in your draft contract, the Tango planning checklists can help you review what is in your draft — before it's too late — for things such as:

  • terms missing from the draft contract; and/or
  • terms present in the draft that could lead to problems later for one or more parties.

Why use these planning checklists? Because even the most-competent professional will sometimes miss things — and such a lapse, if not caught in time, could have grave consequences, as discussed in more detail in the commentary at § 26.1.

The commentary explains context and precedent

The Tango commentary will help readers understand how particular contract language could affect the parties' dealings. The included annotations often include brief "case studies," that is, recaps (with links) of court cases where the outcome, in many instances, turned on the nuances of contract language. Here are just a few examples of some of the topics covered:

  • the litigated meanings of "commercially reasonable" and "material breach" in a long-running lawsuit by the State of Indiana against IBM for an allegedly-botched welfare-management system installation (§ 25.14 and § 25.33)
  • a $3 billion lawsuit against Oracle Corporation and six Oracle employees personally, in the wake of the failed attempt to develop Oregon's health-insurance exchange under the Affordable Care Act a.k.a. Obamacare (§ 22.4)
  • a biotech company's "visitor's confidentiality agreement," signed by a visiting Stanford University scientist, which to Stanford's chagrin was held to have given the company part-ownership of a significant Stanford patent (§ 18.4.3)
  • an arbitration case in which a U.S. company didn't realize that a Chinese-language notice of arbitration had started a deadline clock running (§ 23.1.8)
  • a memorandum of understanding that brought oil-and-gas giant Texaco to its knees (§ 24.14.1)
  • an incomplete limitation-of-liability provision in Facebook's terms of service that helped a Facebook user prolong his lawsuit against the company (§ 22.1.3)
  • a release agreement that was surreptitiously altered, without redlining, before signature (§ 24.18)
  • a lawsuit in which 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; (§ 14.3.3)
  • a case in which a company and an outside sales representative exchanged signature pages from two different drafts of an equity-grant agreement (§ 24.19.3)

An analogy: Cake mixes take less time and taste fine

A few years ago, my daughter and I took a cooking class in which we baked a cake from scratch, starting with making dough from flour and ending with turning powdered sugar into frosting. We enjoyed the experience, but it also gave me a new appreciation for the uniform quality, convenience, and time savings that you get with prepackaged mixes and store-bought frosting.

A cake mix
Photo: Andy Melton (Creative Commons)

True, you might not want to use a prepackaged mix for, say, a wedding cake. But for everyday baking, a cake from a mix and a can of frosting will usually serve the purpose — and, importantly, a cake from a mix can be made and served pretty quickly.

By the same token, not every contract needs to be "made from scratch" — for many routine uses, one of the Tango riders (see [BROKEN LINK: tango-riders][BROKEN LINK: tango-riders]) might well be good enough and can be agreed to quickly.

Even with a cake mix, you can still customize the end-product by adding flavorings, bits of fruit, and the like. Similarly, with many of the Tango riders, the parties could customize their contract by adding other clauses or perhaps overriding some of the standard Tango terms.

Another analogy: Off-the-rack clothing costs less

Suppose that you needed some business-casual clothes — say, shirts or blouses and slacks.

  • You could go to Savile Row in London and order hand-cut, hand-sewn "bespoke" garments for all your needs. But you'd almost certainly have to pay a lot of money, and you'd likely have to wait for your garments to be delivered to you.
  • For everyday wear, though, you might be just as well-served — much sooner and at lower cost — by ordering online (off the rack, so to speak) from, say, Brooks Brothers or Nordstrom or Land's End. What you'd get would be "standard" garments, but they might be enough for what you need; if any of the standard garments needed alterations for a better fit, you could have a local tailoring shop do that work.

To be sure, there might well be times when you really do want — and are willing to pay for and wait for — a Savile Row suit. But that won't always be the case.

Likewise with contracts: There will probably be times when you need a "bespoke" contract; your lawyer can advise you about that. For everyday needs, off-the-rack terms and conditions could serve your purpose just as well.

29.2 Surgeons' tools are standardized …

For some time now, I've used the Tango Terms as reading material in the advanced business-contracts courses that I teach at the University of Houston Law Center. That experience has made me wonder about the big contrast with medical schools and teaching hospitals: From what I gather, unlike law schools, those institutions generally don't teach their trainees to design and manufacture their own surgical instruments — scalpels, retractors, clamps, etc.

Trying to teach surgical trainees those skills of design and manufacturing would be a considerable extra burden, not just on the trainees but on the instructors as well. Instead, budding surgeons, nurses, etc., are expected to learn to use standard surgical instruments, of the exact kind that they will almost certainly use routinely in their practices.

Surgery team
Photo: U.S. Navy (public domain)

In fact, the International Organization for Standards (ISO) publishes standards for various types of surgical instrument.

And this standardization gives surgeons a big advantage: In developed countries, a surgeon trained can travel to perform a procedure in an unfamiliar hospital, without having to bring her own personal set of standard instruments with her; the surgeon can safely assume that the hospital will provide her with standard scalpels, retractors, etc.

To be sure, improved surgical instruments are sometimes invented by surgeons, nurses, and others. But those medical professionals generally were first taught first how to use standard instruments.

Back to the contracts world: The public would be better served, I submit, if contract drafters and reviewers were trained to use standardized contract-term "instruments" for routine matters, customizing the language only when clearly necessary. This would help drafters' clients to do productive things, more quickly — not least because there'd be less time spent on review and revision of drafters' randomly-idiosyncratic language — and at lower cost.

I hope that as the Tango Terms evolve and grow, they can serve as a step in that direction.

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30 About the author

I'm an AV-rated business lawyer and neutral arbitrator in Houston, as well as a part-time law professor teaching contract drafting. I'm licensed in Texas and California and am registered to practice in the U.S. Patent and Trademark Office. (My last name is pronounced "Tate"; because of my Roman numeral my parents called me "D.C.," which stands for Dell Charles.)

I'm a member of the bar in Texas and California, as well as registered to practice in the U.S. Patent and Trademark Office.

I'm an adjunct professor at the University of Houston Law Center, teaching contract drafting. I maintain a limited solo practice advising tech companies, both established and startups.

I was formerly a partner and member of the management committee at Arnold, White & Durkee, one of the largest IP-only law firms in the United States, with some 150 lawyers in six offices.

I left AW&D to become vice president and general counsel of BindView Corporation, a publicly-traded software company with some 500 employees in six countries. As outside IP counsel, I'd helped the founders to start the company and later to go public; I served in-house until our successful "exit," when we were acquired by Symantec Corporation, the world leader in our field.

My law degree is from the University of Texas at Austin, where I was on law review; that's also where I received my undergraduate degree, in mathematics.

In between college and law school, I did my ROTC scholarship pay­back time as a U.S. Navy nuclear engineering officer (the Rickover program) and surface warfare officer, including three years of sea duty in the aircraft carrier USS ENTERPRISE. I was in charge of a 150-man engineering division; I also served as officer of the deck underway (in charge of the ship and its 5,000-man crew while on watch) and qualified as [chief] engineer officer of a naval nuclear powered ship.

My wife, Maretta Comfort Toedt, and I have two adult children who live and work in Houston (and, says Maretta, don't call us enough).

Any views I might express here are my own, of course, and not necessarily those of clients, former employers, etc., etc.

Footnotes:

[1]

Possibly not, because the warranty is to Gigunda USA. In any case, that's a conversation you don't want to have.

[2]

One possibility, with two steps: (1) Define a term such as Buyer (or perhaps Purchaser) as, whichever entity is making purchases under the master agreement; and (2) Rewrite the warranty provision to read, "Widgets warrants to Buyer" instead of "Widgets warrants to Gigunda USA …."

[3]

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

[4]

A court might analyze the situation along something like the following lines:

  • The court might conclude that the allegedly-breached (and hard-to-understand) clause is indeed ambiguous, that is, capable of two or more plausible meanings.
  • The court, resorting to parol evidence to resolve the ambiguity — especially given the absence of an entire-agreement provision — might credit the other side's testimony about what your client allegedly said the breach clause means.
  • True, the other side acknowledged that it had been represented by counsel. But given that the contract was drafted by your firm, the court might apply the contra proferentem rule and construe it against your client. In doing so, the court might be influenced by the fact that the General Provisions section included a demonstrable falsehood, namely that each side had been represented by counsel.

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[5]

Arguably not; it depends on whether notice is "given" when mailed or when received.