A working notebook of contract terms and ‑takeaways (being reorganized; please pardon the mess).
Copyright © 2013-2016 D. C. Toedt III. Version CD1611, last modified Tuesday May 03, 2016 17:33 Houston time.
This dictionary-style notebook organizes contract provisions and reference material that I've written or encountered over the years; I use them both in my law practice and in the law-school contract drafting course that I teach at the University of Houston Law Center. (See the summary table of contents at left.)
- Pre-configured term sheets are accompanied by, and incorporate by reference, detailed terms and conditions; the terms represent (what I view as) sensible, collaborative ways of doing business, without unduly favoring either side.
- A drafter can consider creating a "short form" contract by copying and editing the desired term sheets into a signable document and using that document as the contract. [a]
- Plug-in provisions can be used as additional terms and conditions.
- Clause-specific notes and extended notes provide context and food for thought.
[a] In an attempt to be sure that the Common Draft notebook will always be available for reference in the future, the notebook is being submitted for permanent archiving at the Harvard Law Library's Perma.cc project at [LINK TBD] and at the Internet Archive at [LINK TBD].
Please email me with suggestions for additions or revisions at firstname.lastname@example.org. Unless you say otherwise, I'll credit you in these materials for any suggestions that I incorporate. Please sign up to be notified of updates.
Of course, you shouldn't rely on these materials as a substitute for legal advice about your particular situation.
Table of Contents
- Accelerated litigation per New York rules
- Acknowledgements in contract language
- Acknowledgement in a notary certificate
- Affiliate status
- "Agreement"-related definitions
- Agreements to agree; agreements to negotiate in good faith
- Ambiguity and vagueness
- Arising out of
- Arms-Length Negotiation Pattern Acknowledgement
- Assignment-consent requirements
- Associated Individuals Definition Clause
- Association membership rules not necessarily binding
- Assumption of the risk
- Attorney fees
- "Avoid" versus "reduce the chance"
Accelerated litigation per New York rules
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(a) The parties hereby jointly request that, in any litigation arising out of or relating to this Agreement or any transaction or relationship resulting from it, the court follow the procedures set out in the then-current rules the Commercial Division of the New York State Supreme Court, including without limitation the accelerated procedures of those rules.
(b) In any such litigation, either party may file a motion with the court making the request set forth in subdivision (a), representing that it is a joint motion.
- Concerning the any transaction or relationship term, see the arbitration-clause commentary.
- A court is more likely to pay attention to a motion that is labeled as a joint motion.
Running a lawsuit in accordance with the New York Commercial Division's accelerated rules could significantly streamline the proceedings. The streamlined procedures of Rule 9 include, for example:
- trial in nine months;
- waiver of the right to jury trial — note that in some jurisdictions an advance waiver like this might be unenforceable;
- significant limitations on discovery, especially electronic discovery;
- waiver of punitive damages;
- no interlocutory appeals.
For further reading, see generally:
- Hon. Timothy S. Driscoll, The New York State Supreme Court Commercial Division: Past, Present, and Future (AmericanBar.org 2014) (an overview of those rules by a trial judge of that court);
- Hon. Timothy S. Driscoll, Recent Developments in the Commercial Division of the New York State Supreme Court (Part Two) (AmericanBar.org 2015);
- Eric Fishman, Andrew C. Smith, and Shriram Harid, New York Creates Rocket-Docket for Commercial Disputes—But Accelerated Adjudication Comes With Trade-Offs (PillsburyLaw.com 2014).
- Economic Litigation Agreement.
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This definition is adapted from the Oxford English Dictionary, as quoted in Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016, 1022 (10th Cir. 2014) (discussed here).
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A contract reviewer should be extremely careful about statements in a draft agreement in which the parties “acknowledge” something or another. Such language might preclude the reviewer's client from later disputing what was acknowleged in the contract.
As an illustration, consider Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016, 1022 (10th Cir. 2014) (reversing and remanding trial-court judgment in part). In that case:
- A license agreement between a manufacturer of cell-phone docking stations and a patent owner required the manufacturer to pay royalties on its products that were covered by the patent.
- The license agreement included a statement in which the manufacturer "acknowledged" that certain specific docking stations were indeed covered by the patent.
- The manufacturer later denied that some of those specific docking stations were covered by the patent.
- The court, though, held that the acknowledgement language in the contract precluded the manufacturer from making that denial.
Acknowledgements are an opportunity for drafters — but don't be a jerk about it
Contract drafters should give some thought to judiciously including one or more factual acknowledgements in a draft. Doing so could help to reduce the cost and burden of any future disputes, as well as make it easier for the client's future trial counsel to do their jobs.
On the other hand, nobody likes a drafter who asks the other side to “acknowledge” something that clearly is or would be in dispute.
- EXAMPLE: Suppose that a customer's purchase-order form includes printed boilerplate language stating that "Supplier acknowledges that any failure by Supplier to deliver the goods or services required by this purchase order at the stated delivery date will cause Customer significant long-term harm." In a particular case that might be true, but in a standard form it's just obnoxious.
- EXAMPLE: Suppose that a supplier's standard terms of sale recite that "Customer acknowledges that Supplier's products have a reputation for exceptionally-high quality and value for the money." Come on, now; few if any customers would willingly agree to such a statement.
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- "Notarizing" a document with an acknowledgement certificate makes the document self‑authenticating
- Other, non-notary officials might also be authorized to certify signature authenticity
- A notary public can't certify a signature if s/he has a conflict of interest
- A flawed signature-acknowledgement certificate can lead to serious problems in court
- A lawyer who certifies a client's signature acknowledgement might have to testify about it
(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 the notary or other official certifies that the signer of the document personally declared, under penalty of perjury, that the document's contents were true.)
A document such as a deed to real property might include, after the signature blocks, a space for a notary to sign a certificate that the signer appeared before the notary, presented sufficient identification, and acknowledged that the signer indeed signed the document. In many jurisdictions, the notary's signed certificate and official seal serve as legally-acceptable evidence that the document isn't a forgery — that is, that the document is authentic. (This is sometimes referred to as making the document self-authenticating or self-proving.)
The law likely requires a notary's certificate of acknowledgement if the document is to be recorded in the public records so as to put the public on notice of the document's contents. Let's illustrate the process with a hypothetical example.
- Suppose that "Alice" is selling her house. To do so, she will ordinarily sign a deed and give it to "Bob," the buyer.
- Bob will normally want to take (or send) the deed to the appropriate government office to have the deed officially recorded. That way, under state law, the world will be on notice that Bob now owns Alice's house.
But how can a later reader know for sure that the signature on the deed is in fact Alice's signature and not a forgery?
The answer is that under the laws of most states, for Alice's deed to Bob even to be eligible for recording in the official records, the deed must include an acknowledgement certificate, signed by a notary public or other authorized official. The notary's certificate must state that Alice:
- personally appeared before the notary (usually on a stated date);
- produced sufficient identification to prove that she was indeed Alice; and
- acknowledged to the notary that she had signed the deed.
If Alice signed the deed in a special capacity (e.g., as trustee of a trust or executor of her father's estate), then the notary's certificate will usually say that, too.
Once Alice has done this, the notary will sign the certificate and imprint a seal on the deed. The notary might do this with a handheld "scruncher" that embosses the paper of the deed, or instead with an ink stamp (this depends on the jurisdiction).
Typically, the notary is also required to make an entry in a journal to serve as a permanent record.
This acknowledgement procedure allows the civil servants who must record Alice's deed to look at the deed and have at least some confidence that the signature on it isn't a forgery.
Incidentally, state law usually determines just what wording must appear in an acknowledgement.
In some jurisdictions, Alice need not actually sign the deed in the presence of the notary; she need only acknowledge to the notary that yes, she signed the deed.
Other, non-notary officials might also be authorized to certify signature authenticity
By statute, certain officials other than notaries public (note the plural form) are authorized to certify the authenticity of signatures in certain circumstances. See, e.g., Tex. Civ. Prac. & Rem. Code § 121.001, which gives the power to certify signature acknowledgements to district-court and county-court clerks and, in certain cases, to commissioned officers of the U.S. armed forces, among others.
A notary public can't certify a signature if s/he has a conflict of interest
See generally, e.g., American Society of Notaries, Conflicts of Interest (2008).
See also Tex. Civ. Prac. & Rem. Code § 121.002: That statute specifically allows a corporate employee (who is a notary public) to certify the acknowledgement of a signature on a document in which the corporation has an interest unless the employee is a shareholder who owns more than a specified percentage of the stock.
Parties will want to double-check that the notary "does the needful" (it's an archaic expression, but I like it) to comply with any statutory requirements.
In a New York case, a married couple's prenuptial agreement was voided because the notary certificate for the husband's signature didn't recite that the notary had confirmed his identity. See Galetta v. Galetta, 21 N.Y.3d 186, 191-92, 991 N.E.2d 684, 969 N.Y.S.2d 826 (2013) (affirming summary judgment that prenup was invalid).
- It was undisputed that the couple's signatures on the agreement were authentic, and there was no accusation of fraud or duress. See id., 21 N.Y.3d at 189-90.
- Even so, said the state's highest court, the notarization requirement was important because it "necessarily imposes on the signer a measure of deliberation in the act of executing the document." Id. at 191-92.
In many states it's easy to become a notary public. Some lawyers themselves become notaries so that they can certify the authenticity of clients' signatures on wills, deeds, and the like.
But that might lead to the lawyer's being called someday to testify in a court proceeding about a signed document.
- For example, the notary might have to explain how he or she confirmed the signer's identity if that information isn't stated in the lawyer's notary records.
- That in turn might disqualify the lawyer from being able to represent the client whose signature was certified.
(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.)
- 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.
- QUESTION: Why might the tenant's lawyer want the lease agreement to be notarized? Would that be in your client Landlord's best interest? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: J. Allen Smith & Michael R. Steinmark, Tenants' Rights Under Unrecorded Leases, at http://goo.gl/S2prC (2010); Tex. Prop. Code §§ 12.001, 13.001, 13.002.
- QUESTION: If the notary public can't find her notary seal, may she sign the notary certificate and skip applying the seal? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Gov. Code § 406.013; Tex. Civ. Prac. & Rem. Code § 121.004.
- QUESTION: What must the notary public do before signing the notary certificate to confirm that the signers are who they claim to be? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.005(a).
- QUESTION: Must the notary's certificate say anything in particular about the identity of the signer? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.005(b).
- QUESTION: What must the notary do after notarizing the signature(s)? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.012; Tex. Gov. Code § 406.014.
- QUESTION: If no notary is around, can you notarize the signatures as an attorney? Should you? Explain, citing relevant statutory- and regulatory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.001; Tex. Discipl. R. Prof. Conduct 3.08 ("Lawyer as Witness").
- QUESTION: Surprise! The person who will sign the lease for the tenant has gone on a business trip to Kuwait and will FAX her signed signature page to you. Can your secretary, who is here in Houston and is a notary public, notarize that signature page? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.004(a).
- QUESTION: Another document in the transaction must be signed and notarized by an individual who's in California. Is anything special required for the notary certificate? What downside risk does the notary have if the notary is asked to sign the certificate in the absence of the individual who's going to sign the document? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Cal. Civ. Code § 1189(a).
- QUESTION: Who in Kuwait could "notarize" the signature? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any. Suggested reading: Tex. Civ. Prac. & Rem. Code § 121.001.
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This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- 1. To have control of an organization via the power to vote the organization's shares or other ownership interests, the Minimum Voting Percentage required is:
- 2. The following Named Affiliate Groups are considered affiliates of each other, whether or not a control relationship exists between them:
- 3. Can affiliate status arise through other forms of power to direct the management of an organization?
- A minimum voting power of 50% seems to be pretty typical.
- Drafters should think about why they're defining the term affiliate, because the answer might warrant changing the percentage.
- In some circumstances, a drafter might want to consider alternative definitions of voting power.
- By listing specifically-named affiliate groups, drafters can expand the definition of affiliate on a case-by-case basis, without reducing the minimum voting percentage.
- The "power to direct management" option for affiliate status appears in U.S. securities laws, and is sometimes also seen in contracts, but could give rise to significant problems in the future.
(b) For purposes of subdivision (a), control refers to the right to exercise at least the Minimum Voting Percentage of the other organization's aggregate right to vote to select the members of the board of directors or comparable primary governing body of the organization; this right-to-exercise can arise via, for example, (1) legal, beneficial or equitable ownership of voting securities; or (2) a voting agreement.
(c) For purposes of this Agreement, affiliate status exists only as provided in subdivision (a) unless this Agreement expressly states otherwise.
The "control" language in subdivision (a) generally tracks terminology found in U.S. securities laws such as SEC Rule 405, 17 C.F.R. § 230.405, as well as in other sources. See, e.g., UBS Securities LLC v. Red Zone LLC, 77 A.D.3d 575, 578 (N.Y. App. Div. 1st Dept. 2010) (quoting Black's Law Dictionary and citing New York and Delaware statutes).
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Affiliate status can be important in a contract because the contract might give rights to — and/or (purport to) impose obligations on — the "affiliates" of one or both of the parties.
For example, a software license agreement might grant the right to use the software not only to the named licensee company, but also to affiliates of the licensee company. Such an agreement will almost certainly impose corresponding obligations on any affiliate that exercises the right to use the software.
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:
• "Absent explicit language demonstrating the parties' intent to bind future affiliates of the contracting parties, the term 'affiliate' includes only those affiliates in existence at the time that the contract was executed." Ellington v. EMI Music Inc., 24 N.Y.3d 239, 246, 21 N.E.3d 1000, 997 N.Y.S.2d 339, 2014 NY Slip Op 07197 (affirming dismissal of complaint).
• In GTE Wireless, Inc. v. Cellexis Intern., Inc., 341 F.3d 1 (1st Cir. 2003), the appeals court held that Cellexis breached a settlement agreement not to sue GTE or its affiliates when it sued a company that, at the time of the settlement agreement, had not been a GTE affiliate, but that later became an affiliate. Reversing a summary judgment, the appeals court reasoned that the contract language as a whole clearly contemplated that future affiliates would be shielded by the covenant not to sue. See id. at 5.
(Hat tip: Ken Adams.)
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.)
Some contracts start out by identifying one of the parties as (for example), "ABC Corporation and its Affiliates." This is normally a bad idea, because it can lead to confusion about which organizations have which rights and which responsibilities. See also the notes to Preamble.
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Tying affiliate status to "management power" could be problematic, as discussed below — if a contract really needs to define Affiliate without being limited by a certain percentage of voting control, one better approach is for the contract to list specific Named Affiliate Groups.
In some circumstances, allowing affiliate status to arise through "management power" could lead to expensive litigation because of the vagueness of the term. Drafters should therefore be cautious in taking such an approach, even though:
- some contracts include language like it;
- some parties insist on it; and
- business people might argue that the business risk is low.
For regulatory purposes — as in various securities-law definitions — management-power language may be all well and good.
And it might be that in a contract, the definition of affiliate is relevant only to determine, say, which affiliates of a customer are entitled to the negotiated pricing, or are entitled to use licensed software. In that situation, the downside risk of a management-power definition of affiliate might be manageable.
But it's not hard to imagine how, in later litigation, the parties might have to engage in extensive – and expensive – discovery for trial of a fact-intensive dispute about who had what management power at the relevant time(s).
Consider the Offshore Drilling Co. case: the parties in the lawsuit hotly disputed who had had "control" of a vessel destroyed by fire, and thus which party or parties should be liable for damages. The specific facts and outcome of the case aren't important here — what matters is that the parties almost-certainly had to spend a lot of time and money fact-intensive litigation over the control issue. See Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., 604 F.3d 221 (5th Cir. 2010) (affirming summary judgment in relevant part). That's the last thing parties to a contract should want.
in the UBS v. Red Zone case, the UBS investment bank and Red Zone LLC, a private equity firm (whose managing member was Dan Snyder, owner of the Washington Redskins) entered into a contract which stated, in part, that Red Zone would pay UBS a $10 million fee if Red Zone succeeded in acquiring — or in acquiring "control" of — the amusement-park company Six Flags. Apparently Red Zone never did acquire more than 50% of Six Flags's stock, but because of other circumstances the appellate court held that:
… Red Zone clearly controlled Six Flags once its insiders and nominees constituted the majority of the board and took over the company's management.
It cannot be disputed that Red Zone had seized the power to direct Six Flags' management and policies.
We reject Red Zone's argument that it did not control Six Flags simply because it did not obtain ownership of the majority of its voting shares. The argument is at odds with the inclusive definition of "control" ….
UBS Securities LLC v. Red Zone LLC, 77 A.D.3d 575, 578, 910 N.Y.S.2d 55 (N.Y. App. Div. 1st Dept. 2010) (reversing denial of UBS's motion for summary judgment).
After losing its case with UBS, Red Zone successfully sued its law firm for malpractice in contract drafting, winning a $17.2 million judgment. See Red Zone LLC v. Cadwalader, Wickersham & Taft LLP, 45 Misc.3d 672, 994 N.Y.S.2d 764 (N.Y. Sup. Ct. 2013), aff'd, 2014 NY Slip Op 4570, 118 A.D.3d 581 988 N.Y.S.2d 588 (App. Div. 1st Dept. 2014). (Hat tip: Ken Adams.)
This Agreement and the Agreement refer, collectively, to the following:
(1) the agreement document signed by the parties;
(2) any exhibit, schedule, appendix, or addendum attached to or forming part of the document referred to in subdivision (1); and
(3) any document, or portion thereof, that is expressly incorporated by reference in any document referred to in one or more of subdivisions (1) and (2).
Agreement-Related Dispute refers to any claim, controversy, or other dispute between the parties — whether based on the law of contract; tort; strict liability; statute; or otherwise — that: (i) is brought before any Tribunal; and (ii) is based upon, arises out of, or relates to any of the following:
(1) a document executed in conjunction with this Agreement;
(2) a transaction or relationship memorialized by, or resulting from, this Agreement (each, a "Transaction" or "Relationship", respectively);
(3) a service provided pursuant to, or incidentally to, this Agreement or a Transaction or Relationship;
(4) insurance coverage for, or relating to, this Agreement or a Transaction or Relationship;
(5) a document that documents or otherwise contains information about any of the items listed in subdivisions (1) through (4);
(6) an application for, or an advertisement, solicitation, processing, closing, or servicing of, a Transaction or Relationship; and
(7) any representation or warranty made: (A) in or in connection with any document listed in subdivisions (5) or (6); or (B) to induce anyone to enter into, agree to, or accept any such document.
- Concerning the any transaction or relationship term, see the arbitration-clause commentary.
- The enumerated "laundry list" in this provision borrows concepts from the second of two arbitration agreements in suit in Porter Capital Corp. v. Roberts, 101 So. 1209, 1218-19 (Ala. App. 2012) (affirming denial of plaintiffs' motions to compel arbitration of defendant's counterclaims).
- Some of the language in this provision is adapted from a suggestion in Glenn D. West & W. Benton Lewis, Jr., Contracting to Avoid Extra-Contractual Liability — Can Your Contractual Deal Ever Really Be the "Entire" Deal?, 64 Bus. Law. 999, 1036, text accompanying n.232.
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Extended notes (and caution)
Agreements to agree are generally not enforceable (in the U.S.)
In U.S. jurisdictions, an agreement to agree is generally unenforceable. See generally, e.g., Daniel P. Graham and Tyler E. Robinson, Enforceable Contract or Unenforceable Agreement to Agree? The Importance of Specificity in Teaming Agreements (WileyRein.com 2013).
In contrast, an agreement to negotiate in good faith is likely to be enforceable, and breaching that agreement could end up being expensive for the breacher. Consider, for example, SIGA Technologies, Inc. v. PharmaThene, Inc., No. 2627-VCP (Del. Dec. 23, 2015), in which breach of an agreement to negotiate in good faith resulted in a $113 million damage award:
- SIGA was the financially-troubled developer of an experimental smallpox drug. It had a serious need for cash.
- The drug developer approached a potential rescuer, PharmAthene, about merging. The two companies had unsuccessfully discussed merger before.
- The parties signed a detailed, non-binding term sheet in which the drug developer and its rescuer would enter into a "partnership"; in that partnership, the drug developer would eventually merge with the rescuer — but not before first licensing the smallpox drug to the rescuer (because of the parties' history).
- To provide the drug developer with some much-needed immediate cash, the parties also signed a separate bridge-loan agreement. Among other things, that agreement included a "Plan B" obligation under which the parties would negotiate in good faith a license agreement, in accordance with the detailed economic provisions set forth in the term sheet, if the merger agreement were to fail to go through.
- The parties then turned their attention to the merger agreement itself; they eventually negotiated and signed the formal merger agreement, which likewise included a "Plan B" obligation to negotiate a license agreement in good faith as "Plan B" if the merger agreement were to be terminated.
- After that, though, the drug developer got several items of good news: It was awarded a substantial financial grant from the National Institute of Allergy and Infectious Disease; its initial clinical trials of its new smallpox drug went very well; and it received a sizable contract from the National Institutes of Health, one rich enough to fund future development of the smallpox drug.
- The drug developer, now concluding that it no longer needed to be rescued after all, terminated the merger agreement with its would-be rescuer. (The merger agreement gave the drug developer a termination right because the merger had not been completed on or before a drop-dead date, due to the SEC's delay in approving a proxy statement.)
- The jilted rescuer, resorting to the previously-agreed "Plan B," informed the drug developer that the rescuer was ready to sign a license agreement for the new smallpox drug in accordance with the economic provisions of the now-abandoned term sheet. The drug developer, though, insisted on drastically re-trading the economics of the deal. So, the rescuer sued the drug developer for breach of its contractual commitment to negotiate, in good faith, a license agreement for the new smallpox drug.
The Delaware supreme court affirmed the Chancery Court's award of $113 million against the drug developer for breach of its obligation to negotiate the license agreement in good faith
Caution: Agreeing to negotiate "in good faith" could lead to a litigation tar pit
Sometimes when parties can't agree about a specific point, they might be tempted to agree that they'll negotiate that point later in good faith. That, though, could really complicate the parties' lives if they can't reach agreement.
As a hypothetical example, suppose that:
- Alice and Bob sign a non-binding letter of intent that includes a binding commitment to negotiate certain points in good faith.
- The parties aren't able to reach a final agreement on those points.
- Angered, Alice claims that Bob breached his binding commitment to negotiate in good faith. Bob responds that the deal blew up because of honest differences of opinion, not bad faith.
- Alice files a lawsuit against Bob, along the lines of the SIGA Technologies case discussed above.
Most litigators would agree that, in this hypothetical scenario, Bob is unlikely to be able to get Alice's case thrown out without first having to go through a lot of expensive discovery and motion practice. Drafters should keep this in mind when contemplating agreeing to negotiate in good faith.
FACTS: Alice and Bob are negotiating a contract for Alice to provide services for Bob, but they can't agree on just what services Alice will be obligated to provide. QUESTION: What are some of the pros and cons of having the contract say simply that they'll agree to agree later on that issue?
FACTS: Same facts as above. QUESTION: What are some of the pros and cons of having the contract state that Alice and Bob will negotiate the scope of Alice's services in good faith?
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Ambiguity vs. vagueness
A contract term is ambiguous if it is susceptible to two or more plausible interpretations. (In contrast, is vague if its precise meaning is uncertain.) See, e.g., Ambiguity (Wikipedia.org); Ambiguity (law) (Wikipedia.org); Ken Adams, Sources of Uncertainty in Contract Language (AdamsDraft.com 2008).
As a silly example, consider this provision in a contract for a home caregiver: Nurse will visit Patient's house each day, check her vital signs, and give her cat food.
- The italicized sentence above is ambiguous: Is Nurse required to put a bowl of food down for Patient's cat each day? Or is Nurse required to feed cat food to Patient?
- Moreover, if the parties had the first meaning of the sentence in mind, then the sentence would also be vague if it turned out that Patient had more than one cat. (The first meaning is also vague in another sense, namely that the term cat food encompasses wet food, dry food, etc.)
Spotting ambiguities before the contract is signed is a prime duty of contract drafters and reviewers
If an ambiguity in a contract is spotted after the contract is signed, the parties might well find themselves disagreeing about what the ambiguous provision was intended to mean. To borrow a phrase from one of my then-students (in a different context), "that's a conversation I don't want to have."
Ambiguities are resolved in accordance with "canons of contract construction"
- Ambiguities are resolved, where possible, by consulting the following, to see what if any light can be shed:
- other language in the contract; and/or
- extrinsic evidence — not merely attorney argument — about matters such as:
- the parties' course of dealing; and
- custom and usage in the trade.
- Just because the parties disagree about the proper intepretation of a contract provision, that doesn't mean the provision is ambiguous.
[DCT TO DO: CITATIONS & LINKS NEEDED]
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Any amendment to this Agreement must (1) be in writing; (2) be signed by at least the party sought to be bound; and (3) make it clear that this Agreement is being amended.
- Some drafters might prefer to require instead that amendments be signed by each party, not merely by the party to be bound; see also the discussion in the background reading.
- CAUTION: Some courts might not give effect to an amendments-in-writing provision in some contracts: as discussed in the background reading, the position usually taken by these courts (citing an opinion by then-Judge Cardozo) is that — absent a statute-of-frauds issue — the parties to a written contract are always free to later agree orally to ignore an amendments-in-writing provision in the written contract.
- Subdivision (3) is intended to forestall later assertions that "stray" communications should be retroactively viewed as having amended the Agreement.
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- A court might not honor an amendments-in-writing provision
- An amendments-in-writing provision, though, might be validated by statute
- Which party — or parties — must sign an amendment?
- An amendment can be done as a complete "amended and restated agreement"
- Numbering and dating the amendments (including in their titles) might be a good idea
Many contracts include provisions stating, in effect, that the agreement cannot be amended except in writing. In contract litigation (or arbitration), though, one party or another might claim that the parties orally agreed to modify the contract terms, including the amendments-in-writing provision itself. (The "business risk" preamble in the Common Draft provision is included in the hope of helping to persuade the tribunal to reject such a claim.) Courts have sometimes held that, subject to any applicable requirements of the Statute of Frauds, parties to a contract are indeed free to orally amend or waive a contract provision, even if the contract contains an express amendment-in writing or waiver-in-writing requirement.
(Note the use of orally above — the term "verbal" traces its origins to the Latin verbum, meaning "word," which encompasses writing as well as speech.)
Courts sometimes quote something that then-Judge (later Justice) Cardozo said in a 1919 New York case:
Those who make a contract, may unmake it. The clause which forbids a change may be changed like any other. The prohibition of oral waiver may itself be [orally] waived. Every such agreement is ended by the new one which contradicts it … What is excluded by one act, is restored by another. You may put it out by the door, it is back through the window. Whenever two men contract, no limitation self-imposed can destroy their power to contract again.
A statute might validate a contract's statement that the contract can be amended only in writing. For example:
• In contracts for the sales of goods, section 2-209(2) of the Uniform Commercial Code provides that "[a] signed agreement which [sic] excludes modification or rescission except by a signed writing cannot be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party." (Emphasis added.) See also the notes concerning the term merchant, as well as, e.g., Wisconsin Knife Works v. Nat'l Metal Crafters, 781 F.2d 1280, 1284 (7th Cir. 1986) (Posner, J., on a panel with Easterbrook, J.) (reversing and remanding judgment on jury verdict that contract had been orally modified).
• On the other hand, under subdivision (4) of the same UCC section, a contract provision can be waived without a writing, which is why many contracts also state, as in the Waivers in Writing Clause, that waivers likewise must be in writing.
• In New York, General Obligations Law § 15-301(1) provides that '[a] written agreement or other written instrument which contains a provision to the effect that it cannot be changed orally, cannot be changed by an executory agreement unless such executory agreement is in writing and signed by the party against whom enforcement of the change is sought or by his agent.' For a discussion of the history of that statute, see the opinion in of the Court of Appeals of New York (that state's highest court) in Israel v. Chabra, 12 N.Y.3d at 163-67 (2009) (on certification to the Second Circuit).
In a 2014 opinion, the Second Circuit explained the two judge-made exceptions to that New York statute:
First, under the principle of equitable estoppel, if a party to a written agreement has induced another's significant and substantial reliance upon an oral modification, then the party may be estopped from invoking the bar on oral modification.
Second, where there is partial performance of the oral modification sought to be enforced, the requirement of a writing may be avoided.
To invoke equitable estoppel, the parties' conduct must not otherwise be compatible with the agreement as written
and, for partial performance, the parties' conduct must be unequivocally referable to the oral modification.
Aircraft Services Resales LLC v. Oceanic Capital Co., No. 13-3738-cv, slip op. at 3-4 (2d Cir. Oct. 9, 2014) (summary order affirming district court ruling that both listed exceptions applied) (extra paragraphing added), citing Rose v. Spa Realty Assocs., 42 N.Y.2d 338, 343-44 (1977).
The Common Draft provision states that an amendment need be signed only by the party sought to be bound and not by both (or all) parties. This comports with a 2012 opinion in which the Seventh Circuit held 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." Hess v. Kanoski & Assoc., 668 F.3d 446, 453 (7th Cir. 2012), on remand, No. 3:09-CV-03334-SLD-JAG (C.D. Ill. March 28, 2014) (granting motion for summary judgment), affirmed, No. 14-1921 (7th Cir. May 4, 2015).
Some drafters state that amendments must be signed by all signatory parties; this can be done by redefining the term Required Amendment Signer.
An amendment can be done as a complete "amended and restated agreement"
For example, as of February 16 2016, 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).
Numbering and dating the amendments (including in their titles) might be a good idea
To reduce the chance of possible future confusion, it might be helpful to give an amendment a series number and date in its title, e.g., "First Amendment, Dated December 25, 20X7, to Asset Purchase Agreement."
This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- Which party or parties is allowed to amend this Agreement unilaterally?
- [FILL IN]; each such party is referred to as an "Amending Party."
- How much advance written notice of a unilateral amendment must the Amending Party give?
- At least 30 days.
- Can the other party stop a unilateral amendment from going into effect?
- Yes, by giving notice of termination of this Agreement.
- What is the deadline for the other party to stop the unilateral amendment from going into effect?
- The notice of termination must be effective no later than 12 midnight at the beginning of the day that the amendment would go into effect.
- CAUTION: A Web-site posting of a proposed amendment might not be enough notice to make the amendment effective; see the background reading.
- CAUTION: Advance notice of a unilateral contract amendment might be necessary to save an arbitration provision in the contract, as discussed in the background reading.
- 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.
(a) No unilateral amendment will affect any accrued right or liability under this Agreement.
(1) will not retroactively eliminate or modify any binding dispute-resolution provision of this Agreement (for example, a binding-arbitration), if any, that otherwise would apply to a then-accrued claim of breach of this Agreement;
(2) will apply equally to any such claims of any party; and
(3) will not take effect without at least the required advance notice of unilateral amendment to each other party.
- Subdivision (a) is included to help make this provision palatable to a prospective non-amending party, which might be concerned that an amending party might modify the contract retroactively.
- Subdivision (b) is a so-called Halliburton exception; Halliburton exception; it is included to prevent the agreement from being deemed unenforceable.
Unilateral amendment – optional plug-in provision
(a) A party other than the Amending Party may reject a proposed unilateral amendment that would alter any binding dispute-resolution provision of this Agreement (for example, a binding-arbitration provision) by giving notice of rejection within 30 days after the effective date of the notice of unilateral amendment.
(b) IF: A party does not timely give notice of rejection in accordance with subdivision (a); 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.
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).
Table of Contents
- Business use of unilateral amendments
- Caution: Web-site notice of a unilateral amendment might not be enough
- A employer's unilateral notice to employees can change employment-agreement terms
- Dispute-resolution exceptions to unilateral amendment
- Advance notice of unilateral amendment might be required to save arbitration provision
Just changing an agreement on the Web 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.
- Talk America tried to enforce an arbitration clause and class-action waiver in the provider's standard on-line service contract. Talk America wanted to preclude a class-action lawsuit brought by a customer, one Joe Douglas, who was upset with certain charges on his bill.
- Talk America's standard contract form, though, was not what Mr. Douglas had agreed to with Talk America's predecessor, America OnLine. Mr. Douglas's original contract with AOL did not contain an arbitration clause, nor a class-action waiver. Talk America had unilaterally changed its contract form by posting the revised contract on its Web site. It claimed that Mr. Douglas had agreed to the revised contract by continuing to use the long-distance service.
The Ninth Circuit gave short shrift to Talk America's claim, saying:
Douglas alleges that Talk America changed his service contract without notifying him. He could only have become aware of the new terms if he had visited Talk America's website and examined the contract for possible changes.
The district court seems to have assumed Douglas had visited the website when it noted that the contract was available on "the web site on which Plaintiff paid his bills." However, Douglas claims that he authorized AOL to charge his credit card automatically and Talk America continued this practice, so he had no occasion to visit Talk America's website to pay his bills.
Even if Douglas had visited the website, he would have had no reason to look at the contract posted there. Parties to a contract have no obligation to check the terms on a periodic basis to learn whether they have been changed by the other side. [FN1]
[FN1:] Nor would a party know when to check the website for possible changes to the contract terms without being notified that the contract has been changed and how. Douglas would have had to check the contract every day for possible changes.
Without notice, an examination would be fairly cumbersome, as Douglas would have had to compare every word of the posted contract with his existing contract in order to detect whether it had changed.
Indeed, a party can't unilaterally change the terms of a contract; it must obtain the other party's consent before doing so. This is because a revised contract is merely an offer and does not bind the parties until it is accepted. And generally an offeree cannot actually assent to an offer unless he knows of its existence.
Even if Douglas's continued use of Talk America's service could be considered assent, such assent can only be inferred after he received proper notice of the proposed changes. Douglas claims that no such notice was given.
Douglas v. United States District Court ex rel. Talk America Inc., 493 F.3d 1062, 1066 (9th Cir. 2007) (vacating district court's order compelling arbitration) (emphasis in original, extra paragraphing added).
Accord, Rodman v. Safeway Inc., No. 11-cv-03003-JST part III-C (N.D. Cal. Dec. 10, 2014) (granting class plaintiff's motion for summary judgment that Safeway had overcharged on-line customers).
In Davis v. Nordstrom, Inc., the U.S. Court of Appeals for the Ninth Circuit held that an employee of Nordstrom's, the famous department store, had voluntarily given up her right to class-action litigation against the store by not opting for it when the store gave her notice that it had changed its dispute-resolution policy:
The handbook Davis received when she began work established the ground rules of her employment, including that Davis and Nordstrom would arbitrate certain disputes. She accepted employment on this basis, so there was a binding agreement to arbitrate.
Under California law, Nordstrom was permitted to unilaterally change the terms of Davis's employment, including those terms included in its employee handbook. Nordstrom was also entitled to enforce the terms of employment identified in this handbook, and any modifications made to it, as it could any other contract.
Indeed, it is settled that an employer may unilaterally alter the terms of an employment agreement, Where an employee continues in his or her employment after being given notice of the changed terms or conditions, he or she has accepted those new terms or conditions.
Davis v. Nordstrom, Inc., No. 12-17403, part III-A (9th Cir. June 23, 2014) (reversing denial of Nordstrom's motion to compel arbitration; citations, footnote, and alteration marks omitted).
This provision sets out one element of a so-called Halliburton exception to the right to unilaterally amend the agreement; that exception is discussed in the Harris v. Blockbuster case discussed below.
A provision much like this was responsible for saving an arbitration clause from invalidation in Lizalde v. Vista Quality Markets, Inc., 746 F.3d 222 (5th Cir. 2014) (reversing district court's denial of employer's motion to compel arbitration of employee's claim for on-the-job injury). In that case, the 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. Id. at 224.
Without a Halliburton exception of the kind set forth here:
- A unilateral-amendment provision might cause some or all of a contract — for example, an arbitration provision with a class-action waiver — 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, on grounds that the customer agreement was illusory and therefore was unenforceable under the relevant state law.
See Harris v. Blockbuster, Inc., 622 F.Supp.2d 396, 400 (N.D. Tex. 2009). (See also the notes to (Plug-in:) Prohibited Arbitrator Actions concerning prohibitions of class- or colletive-action arbitration.)
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.
See Carey v. 24 Hour Fitness USA, Inc., 669 F.3d 202 (5th Cir. 2012).
Not quite on point: Instagram changed its terms of service and gave its users 30 days to stop using the service if they did not want to be bound by the new terms of service. One Rodriguez continued to use the service, but sued Instagram for breach of the duty of good faith and for violation of California's unfair-competition law. In March 2014 a California state court rejected the plaintiff's claims, as discussed in a post on Prof. Eric Goldman's blog.
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. See Watch House Int'l, LLC v. Nelson, No. 15-10531 (5th Cir. Mar. 2, 2016) (reversing and remanding order compelling arbitration).
The term and/or, whether or not capitalized, means the inclusive or. EXAMPLE: "The parties expect to meet on Tuesday, Wednesday, and/or Thursday" means that they expect to meet on one or more of those days, not on one and only one of them.
And/or helps remedy a deficiency in the English language, namely the lack of an inclusive-or term. (Mathematicians and computer programmers use XOR for that purpose.)
Opinions vary (to put it mildly) as to whether and/or is "proper" English. For example, one appellate judge excoriated the use of and/or as "indolent." That judge — evidently not a slave to brevity — proclaimed that instead a drafter "could express a series of items as, A, B, C, and D together, or any combination together, or any one of them alone." See Carley Foundry, Inc. v. CBIZ BVKT, LLC, No. 62-CV-08-9791, final paragraph (Minn. Ct. App., Apr. 6, 2010) (italics added). Um, sure, your honor. See also Ted Tjaden, Do Not Use "and/or" in Legal Writing, Jul. 27, 2011, at http://goo.gl/7d74L (slaw.ca).
Alternative phrasing: Ken Adams, author of A Manual of Style for Contract Drafting, helpfully suggests that, when dealing with a list of three or more items, use "one or more of A, B, and C." That might well work in many cases. See Kenneth A. Adams, "A, B, and/or C", Dec. 2, 2012, at http://goo.gl/m9U3p (adamsdrafting.com).
Granted, it's possible to use and/or inappropriately. See, e.g., the examples collected by Wayne Scheiss, director of the legal-writing program at the University of Texas School of Law, in In the Land of Andorians (Jan. 2013).
But let's face it: Trying to ban and/or might be an exercise in frustration, because many drafters will use the term anyway. And properly used, the term and/or can be a serviceable shorthand expression. So the better practice is just to define the term and be done with it.
See also the Or Definition Clause.
Table of Contents
- Arbitration Term Sheet
- Arbitration Terms & Conditions
- Cross-reference: "Baseball" arbitration
- (Plug-in:) Conference-Call Interview Procedure
- (Plug-in:) Written Deposition-Question Procedure
- (Plug-in:) Partial Court Retrial of Arbitration Award
- (Plug-in:) Enhanced Judicial Review of Arbitration Award
- (Plug-in:) Prohibited Arbitrator Actions
- (Plug-in:) Jettison of Arbitration Provisions
- Other plug-in arbitration provisions
- Extended notes (and cautions) for arbitration
This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- What types of dispute must be arbitrated?
- Any dispute arising out of or relating to this Agreement or any transaction or relationship resulting from it; each such dispute is referred to as an "Arbitrable Dispute."
- If the parties disagree about whether a particular dispute must be arbitrated, must that disagreement itself be arbitrated?
- What law, and what arbitration rules, are to govern any arbitration proceedings?
- The U.S. Federal Arbitration Act and the Commercial Arbitration Rules of the American Arbitration Association, referred to as the "Arbitral Law" and the "Arbitration Rules," respectively.
- Who will serve as the arbitrator(s)?
- A single arbitrator (i) with the qualifications specified in the Arbitration Rules, and (ii) selected in accordance with the Arbitration Rules or, failing that, as provided by law (the "Arbitral Tribunal").
- Where is the arbitration hearing to be conducted?
- At a location agreed to by the parties or, if not agreed, as determined in accordance with the Arbitral Rules.
- Who will administer the arbitration (if anyone)?
- The American Arbitration Association.
- What language is to be used for the arbitration and for any resulting award?
- English as spoken in the United States of America.
- Can "small claims" be litigated in court without arbitrating them?
- Yes, if (i) the amount in controversy in the dispute in question does not exceed the jurisdictional limits of a small-claims court having jurisdiction, and (ii) that court is not precluded by a forum-selection provision of this Agreement. (This exception to the arbitration requirement does not in itself authorize class- or collective-action arbitration.)
- The definition of Arbitrable Disputes is intentionally broad, for reasons discussed in the background reading.
- The "any transaction or relationship" language comes from a pair of court cases.
- The "any dispute about arbitrability" language addresses a specific requirement of (U.S.) law: A court will decide any "gateway" or "threshold" disputes about whether a particular dispute is arbitrable unless the parties' agreement clearly delegates that decision to the arbitrator.
- Various arbitration rules are available.
- See the background reading for discussions of the choice of Arbitral Law.
- Many arbitration experts recommend that the Arbitral Tribunal consist of a single arbitrator in most cases to save time and money.
- The choice of arbitral location can have significant procedural implications, such as in determining the Arbitral Law.
- Many arbitrators and parties prefer for arbitration to be administered by an arbitration provider, as opposed to conducting "ad hoc" arbitration administered by the arbitrator.
- In transnational contracts, the parties might well choose English, the global lingua franca, as the arbitral language. Consider also, though, where the arbitration award might need to be enforced.
- The small-claims exception can make sense for minor disputes.
- See also the prohibition of class- and collection-action arbitration as well as the forum-selection provisions.
Table of Contents
- 1. Arbitration Requirement — Additional Details
- 3. Arbitration of Disputes About Arbitrability
- 4. Class- and Collective-Action Arbitration
- 5. Confidentiality of Arbitration
- 6. Preliminary Relief
- 7. Arbitration Streamlining Measures
- 8. WAIVER OF JURY TRIAL
- 9. Binding Effect; Enforcement of Award
- 10. Attorney Fees for Unsuccessful Challenges to Arbitration
(a) An Arbitrable Dispute is to be submitted to arbitration as provided in this Agreement upon written demand by either party, regardless whether a given dispute arises under, for example:
(1) common law, whether of contracts, torts, strict liability, or otherwise;
(2) a constitution, statute, or regulation (for example, state- or federal anti-discrimination statutes); or
(3) any other legal doctrine or principle (including, for example, intellectual-property disputes).
(b) The provisions of this Agreement relating to arbitration are intended to survive any termination or expiration of (i) this Agreement or (ii) any one or more rights or obligations under this Agreement.
(c) The Arbitration Rules are agreed to as a choice of rules and not of forum.
Concerning the "choice of rules and not of forum" language in subdivision (c), see the background reading.
Unless this Agreement expressly states otherwise, any dispute ("secondary dispute") about the arbitrability of another dispute ("primary dispute") is likewise to be arbitrated — such secondary disputes include, for example, any dispute about:
(1) whether the parties have in fact entered into an agreement to arbitrate the primary dispute;
(2) whether the agreement to arbitrate is binding;
(3) whether the agreement to arbitrate is enforceable;
(4) whether any party has waived its right to require arbitration under the agreement to arbitrate;
(5) whether the agreement to arbitrate applies to a particular type of controversy or a particular primary dispute; and
(6) whether the agreement to arbitrate conflicts with a statutory right that cannot be waived by contract.
See the background reading.for an extended discussion of on this subject.
Unless this Agreement expressly states otherwise, a claimant must arbitrate a dispute only in its individual capacity; it may not do so as a plaintiff or representative class member in a purported class- or representative proceeding, nor in a capacity of private attorney general.
Unless this Agreement expressly provides otherwise, each party to the dispute; each member of the Arbitral Tribunal; and each other participant in the arbitration proceedings, is to:
(1) maintain in confidence all non-public information that may be disclosed, in the course of the proceedings, by any party to the dispute;
(2) use any such information only for purposes of the 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.
Confidentiality is one of the principal attractions of arbitration as an alternative to court litigation; some arbitration rules expressly require confidentiality, but others don't.
(a) Any party to an arbitration under this Agreement may seek temporary, interim, or preliminary injunctive relief, in accordance with applicable law, from one or both of (1) a court or other tribunal of competent jurisdiction; and (2) the Arbitral Tribunal.
(b) A party's seeking of such relief from other than the Arbitral Tribunal will not in itself waive that party's right to arbitrate.
Subdivision (b) is intended to forestall an argument that plaintiffs' counsel sometimes make.
The parties desire that the Arbitral Tribunal take appropriate measures to actively manage the arbitration proceedings, with due notice to the parties, and with the goals of (1) reducing the time and expense required for each party to present pertinent and material evidence in support of its position, while still (2) preserving the fundamental fairness of the proceedings.
By agreeing to arbitration, each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES the right to have its case heard in court, as well any right it might have to a jury trial, except to the limited extent (if any) that this Agreement expressly states otherwise.
A New Jersey supreme court decision held that an arbitration provision was unenforceable because it did not expressly waive jury trial; to the surprise of many observers, the Supreme Court denied certiorari (that is, the Court declined to hear the losing side's appeal). See Atalese v. US Legal Serv. Group, LLP, 219 N.J. 430 99 A.3d 306 (2014), cert. denied, 576 U.S. _ (U.S. Jun. 8, 2015). • To be on the safe side, the jury-trial waiver here is in bold-faced type for conspicuousness.
Except to the extent that this Agreement expressly states otherwise, any award in an arbitration under this Agreement: (1) will be binding; and (2) may be enforced in any court or other forum having jurisdiction.
Concerning the "binding" language, consider also:
(a) A party that unsuccessfully challenges the arbitrability of a dispute in court (for example, by refusing to arbitrate or by moving to enjoin arbitration) must reimburse the other party to the dispute for the other party's Dispute Expenses incurred in connection with the arbitrability challenge, in both trial- and appellate courts, in an amount to be determined by the Arbitral Tribunal, regardless of any other relief that might be granted to any party.
(b) A party that successfully seeks judicial confirmation or ‑enforcement of an arbitration award under this Agreement, following a failure by another party to comply with the award, will be entitled to recover from the other party its Dispute Expenses, in both trial- and appellate courts, for all stages of the confirmation or ‑enforcement proceedings, in addition to any other relief that may be granted to the seeking party.
The provision for awarding attorney fees in cases of an unsuccessful challenge to arbitrability is based on a suggestion by Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration § 2, Corporate Counsel (Apr. 22, 2013).
The provision for awarding attorney fees in cases of an unsuccessful challenge to the award is intended to avoid the result in Diathegen, LLC v. Phyton Biotech, Inc., No. 04-14-00267-CV (Tex. App.–San Antonio Aug. 26, 2015), in which the appeals court affirmed a trial court's refusal to award attorney fees that were incurred in post-arbitration confirmation proceedings.
See also the background reading for additional case citations.
Cross-reference: "Baseball" arbitration
When so agreed by the parties, any party may conduct, record, and introduce into evidence a conference-call interview of an individual (a witness), without thereby limiting any right the party might have (if any) to take a later deposition of that witness.
(a) Recording of interview:
(1) Any party that participates in such a conference-call interview may record it, electronically or by stenographic transcription, at that party's own expense.
(2) A party that records such a conference-call interview is to announce that fact while the witness and all parties are on the line.
(b) Swearing of witness is optional: A party conducting such a conference-call interview may arrange for the witness to be sworn; alternatively, the party may ask the witness simply to state that he or she will tell the truth.
(c) Witness's right to refuse: During such a conference-call interview, the witness may, in his or her sole discretion, on advice of counsel or otherwise:
(1) decline to be sworn or to state that he or she will tell the truth;
(2) decline to answer one or more questions; and
(3) terminate the conference-call interview.
(d) Weight of testimony: In determining how much weight to give to a witness's testimony in such a conference-call interview, the Arbitral Tribunal may take into account (in addition to any other appropriate evidence) the circumstances of the case in the categories set forth in subdivision (c) above.
(e) Other questioning not precluded: A party’s right, if any, to question a witness (on direct examination, cross-examination, re-direct, re-cross, etc.) in an informal interview or in a subsequent deposition, hearing, or trial is not waived, limited, nor expanded:
(1) by that party’s participation or non-participation in such a conference-call interview of that witness; nor
(2) by the witness’s refusal to participate in such a conference-call interview; nor
(2) by the witness’s refusal to answer any particular question during such a conference-call interview.
(f) Video-conference deposition: When so agreed by the parties and the witness, such a conference-call interview may be conducted by video conference, for example using laptop Web cameras and a service such as Skype, Zoom.us, GoToMeeting, etc. (no endorsement of these providers is implied).
Conference-call interviews by agreement can be useful because:
- They can reduce the perceived need for compulsory depositions (assuming that compulsory depositions are an option at all); and
- If a party or a prospective deponent were to prove uncooperative, that might help to confirm the need for a compulsory deposition (if available).
This procedure is based largely on one developed by a special litigation committee of the American Bar Association's Section of Intellectual Property Law in the late 1990s. See American Bar Association Section of Intellectual Property Law, Special Committee on Intellectual Property Litigation Forms, Model Case Management Orders for Patent Cases, Model Order No. 30.1 (1998). (I chaired the committee and served as lead drafter.) See also section 11.3 of the CPR Economical Litigation Agreement (2010 edition), which proposes a similar procedure.
(a) Any party conducting an oral deposition may provide the deponent, in advance, with written questions, especially but not exclusively concerning subjects expected not to be in dispute such as (for example) questions about work history, dates, participants in meetings, etc.
(b) Whether or not to respond in writing to any particular written question is within the sole discretion of the deponent, on advice of counsel or otherwise.
(c) The parties, each in its sole discretion, may agree on a procedure for accepting the deponent's written answers to particular questions, if any, in lieu of orally posing those questions to the witness.
(d) A deponent's’s written answer to, or failure to answer, a particular written question will not in itself limit or expand the questioner’s right, if any, to ask the same question again orally at a deposition or at the arbitration hearing.
In many depositions and interviews, the use of advance written questions could save time and money for all concerned.
This procedure is based largely on one developed by a special litigation committee of the American Bar Association's Section of Intellectual Property Law in the late 1990s. See American Bar Association Section of Intellectual Property Law, Special Committee on Intellectual Property Litigation Forms, Model Case Management Orders for Patent Cases, Model Order No. 30.11 (1998). (Disclosure: I chaired the committee and served as lead drafter.)
Table of Contents
(a) Delay of binding effect: A final award by an Arbitral Tribunal will not be binding, and the relevant part or parts of the underlying dispute may be adjudicated de novo in a court of competent jurisdiction (subject to any forum-selection provision of this Agreement), if any party to the arbitration (each, a Challenger) challenges the award in accordance with this Compact.
(b) Notice of challenge: The Challenger must give notice of its challenge to each other party, effective no later than the Challenge Notice Deadline (namely, 12:00:00 midnight UTC at the end of the day on the date five business days after the issuance of the final award), setting forth a short and plain statement of the challenge showing that the Challenger is entitled to relief.
(c) Filing and service of Challenge Action: The Challenger must duly file and serve an action (the Challenge Action), in such a court, against one or more other parties to the arbitration (each, a Respondent), no later than the Challenge Filing Deadline (namely, the close of business for the court in question on the date ten business days after the issuance of the final award); the Challenge Action must seek only one or both of the following:
(1) relief that the Challenger sought, but was not granted, from or against the Respondent in the arbitration; and/or
(2) a declaratory judgment (or comparable action by the court) that a Respondent was not entitled to relief that was granted against the Challenger in the final award.
(d) Award binding if not timely challenged: Time is of the essence of the Challenger's obligations under subdivisions (b) and (c); for the avoidance of doubt, IF: A Challenger, for any reason, does not both (i) give notice of a Challenge, and (ii) file a Challenge Action, in each case within the specified times; THEN: The final award will automatically become binding as between that Challenger and that Respondent, without further action on the part of any individual or organization.
This provision tries to remedy what some practitioners see as a significant disadvantage, and even a fatal one, of arbitration: Under U.S. federal law, a party dissatisfied with an arbitration award might well have only a limited right to appeal or otherwise contest the award on its merits and/or on procedural grounds, even if the parties had previously agreed otherwise. See generally the commentary to the (Plug-in:) Enhanced Judicial Review of Arbitration Award.
This provision's delay in an award's binding effect could well help promote settlement; see generally the settlement recounted in Barbara Reeves Neal and Kenneth C. Gibbs, Construction Defect Disputes and the Abandoned Policyholder: Getting the Carrier to the Table (Law.com June 9, 2014). (Hat tip: Paul Lurie of Schiff Hardin.)
Any applicable limitation period, as defined below, is to be extended until the Challenge Action Filing Deadline to the extent necessary to permit filing of the Challenge Action.
(1) For this purpose, the term "applicable limitation period" refers to any limitation period whose expiration did not preclude asserting a claim for relief in arbitration, but would preclude filing the Challenge Action.
(2) Against the possibility that applicable law does not permit the above extension of the applicable limitation period, the relevant Respondent separately and expressly agrees not to assert the expiration of the applicable limitation period as a defense to the Challenge Action.
It's entirely possible that, by the time an arbitration award is issued, the deadline will have already passed for filing a lawsuit under a relevant statute of limitations. This provision expressly addresses that possibility by extending the limitation period, known as "tolling" the statute, to the extent necessary for the filing of a Challenge Action.
To the greatest extent not prohibited by applicable law, EACH PARTY KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any right it may have to trial by jury of the Challenge Action or any related issue.
This clause's waiver of a jury trial should be enforceable even in states such as California and Georgia, which prohibit advance waivers of the jury-trial right. That's because the Challenger would not make the decision to bring the Challenge Action — and, thus, would not make the decision to waive a jury trial — until after an arbitration award. That, of course, would be long after the dispute arose, and so the Challenger's waiver of a jury trial would not be an advance waiver.
A party seeking to enforce the waiver might try to argue that state-law prohibitions of jury-trial waivers were pre-empted by the Federal Arbitration Act.
See generally the commentary to the JURY TRIAL WAIVER.
In the Challenge Action, any Challenger or Respondent may file one or more of the following motions, and represent to the court that it is a joint motion with all other parties to the Challenge Action:
(1) a motion that the court admit into evidence some or all of the record in the arbitration hearing (this provision does not preclude any Challenger or Respondent from arguing that particular evidence should be given more or less weight than indicated by the Arbitral Tribunal); and/or
(2) a motion that the court deem the non-binding final award of the Arbitral Tribunal to be the report and recommendation of a master who was appointed, with the consent of the parties, to hold trial proceedings and recommend findings of fact, with the same effect as stated in Rule 53(f) of the [U.S.] Federal Rules of Civil Procedure.
Concerning subdivision (1): It would waste time and money to re-do the process of developing an evidentiary record. This language provides for re-using the record already developed in the arbitration, while still allowing either party to challenge particular evidence (as to its weight, not its admissibility).
Concerning subdivision (2): Because of the jury-trial waiver of this clause, the Challenge Action will be heard by a judge, not a jury. That means there's no reason not to allow the judge to consider the arbitration award "for what it's worth."
The Challenge Action will give the losing party a fresh opportunity to reargue the case to the judge. That's because, under Rule 53(f) of the [U.S.] Federal Rules of Civil Procedure (which is referenced in this language), the judge:
- must give the parties notice and an opportunity to be heard;
- may receive evidence;
- must decide de novo, that is, decide independently, all objections made by the parties to any findings of fact and conclusions of law in the award.
5. Discovery Restrictions
In the interest of reducing cost and duplication of effort in the Challenge Action, neither party will be entitled to — and each party agrees not to seek — discovery in or concerning the Challenge Action except by leave of the court for good cause shown.
With respect to any given Respondent, IF: The final judgment in the Challenge Action, from which no further appeal is taken or possible, is not at least the Required Margin of Favorability (namely, 20%) more favorable to the Challenger than the arbitration award; THEN: The Challenger must pay or reimburse that Respondent for its Dispute Expenses in the Challenge Action.
The cost- and expense-shifting provisions of this provision are designed to discourage challenges to the arbitration award. The provisions are similar to those of:
- Fed. R. Civ. P. 68 (offers of judgment; shifts costs only, not attorney fees)
- Ariz. Rev. Stat. § 12-133(I) (the letter in parentheses at the end is I, "eye") (relates directly to trial de novo of arbitrations)
- Fla. Stat. § 44.103 (ditto)
- Ga. Code Ann. § 9-11-68 (offer of judgment; shifts both court costs and attorney fees)
- New Jersey Court Rule 4:58 (ditto)
- Tex. Civ. Prac. & Rem. Code ch. 42 (ditto)
These cost- and expense-shifting provisions also fit a U.S. Department of Defense description of incentive arbitration:
In non-binding arbitration, the parties agree to a penalty [sic] if one of them rejects the arbitrator's decision, resorts to litigation, and fails to improve his position by some specified percentage or formula. Penalties may include payment of attorney fees incurred in the litigation.
(a) The powers of an arbitral tribunal 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 this Agreement or not available under applicable law.
(b) The parties expressly agree that IF: An arbitration award under this Agreement is based, in whole or in part, on one or more of the factors enumerated in subdivision (a); THEN: The award may be vacated, by a court of competent jurisdiction, on grounds that the arbitral tribunal thereby exceeded its agreed powers.
Normally, judicial review of an arbitration award is extremely limited; this provision might or might not make a difference, as discussed in the background reading.
(c) The (Plug-in:) Jettison of Arbitration Provisions provision applies to this Compact.
This rescission language is based on the one seen in Pugh's Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252 (Tenn. 2010), where the state's supreme court held that an agreement to arbitrate in a contract must be rescinded for mutual mistake in view of the court's holding that the agreement's expansion of the scope of judicial review was invalid.
(a) For purposes of defining the term Prohibited Arbitrator Action below, the following capitalized terms have the stated meanings:
(1) Permanent Injunctive Relief refers to including, in any award, one or more permanent injunctions or similar directions to any party other than directions to pay one or more sums of money.
(2) Punitive Damages refers to including, in any award, one or more directions to pay punitive damages, exemplary damages, multiple (e.g., treble) damages, or similar relief; IF: Punitive Damages is listed among the Prohibited Arbitrator Actions; THEN: Each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES all such damages and similar relief in respect of each claim being arbitrated.
(3) Punitive Sanctions refers to ordering one or more 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.
(4) Multiple-Party Joinder refers to joining or consolidating claims in arbitration by or against multiple individuals or entities.
(5) Collective-Action Arbitration refers to arbitrating any collective-action claim, for example under the [U.S.] Fair Labor Standards Act.
(b) The Arbitral Tribunal has no power to take any of the following Prohibited Arbitrator Actions without the express prior written consent of all parties against which the prohibited action would be taken: [SUGGESTION TO DRAFTER: Fill in Prohibited Arbitrator Actions using the defined terms above]
(c) IF: One or both of Amiable Compositeur and Ex Aequo et Bono are prohibited; THEN: In rendering the award, the Arbitral Tribunal may not act as amiable compositeur or ex aequo et bono; the Arbitral Tribunal instead has the power only to award such relief as would be both:
(1) legally able to be awarded in a court proceeding under applicable law concerning the dispute in question — including for example any applicable statute of limitation or of repose; and
(2) consistent with this Agreement, including for example any limitation of liability (a term that includes for example exclusions of remedies) and any shortened limitation period stated in this Agreement.
(d) This (Plug-in:) Prohibited Arbitrator Actions provision is subject to the (Plug-in:) Jettison of Arbitration Provisions provision.
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Parties considering agreeing to arbitration sometimes 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. Depending on the applicable law and the arbitration rules, that might not be an unwarranted concern.
For example, some critics 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. See David E. Sanger, Fight Ends For I.B.M. And Fujitsu, NY Times, Sept. 16, 1987. For more background on the dispute, see a student note from the 1980s by Anita Stork (now a prominent antitrust litigator), The Use of Arbitration in Copyright Disputes: IBM v. Fujitsu, 3 Berkeley Tech. L.J. 241 (1988).
As another example, in a 2014 case, Minnesota's supreme court upheld a $600 million arbitration award that in essence was a punitive sanction against a party for fabricating evidence. See Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750 (Minn. 2014), discussed in the commentary to the (Plug-in:) Prohibited Arbitrator Actions subclause. The court quoted one of its earlier holdings, that "Where the arbitrators are not restricted by the submission to decide according to principles of law, they may make an award according to their own notion of justice without regard to the law." Id. at 764.
Uniform standards in this area don't exist; in some jurisdictions, and under some arbitral rules:
… absent provision in the arbitration clause itself, an arbitrator is not bound by principles of substantive law or by rules of evidence.
He may do justice as he sees it, applying his own sense of law and equity to the facts as he finds them to be and making an award reflecting the spirit rather than the letter of the agreement, even though the award exceeds the remedy requested by the parties.
His award will not be vacated even though the court concludes that his interpretation of the agreement misconstrues or disregards its plain meaning or misapplies substantive rules of law, unless it is violative of a strong public policy, or is totally irrational, or exceeds a specifically enumerated limitation on his power.
Nor will an arbitration award be vacated on the mere possibility that it violates an express limitation on the arbitrator's power.
Silverman v. Benmor Coats, Inc., 61 N.Y.2d 299, 300, 308-09, 473 N.Y.S.2d 774, 461 N.E.2d 1261 (1984) (affirming confirmation of arbitration award) (extra paragraphing added, citations and internal quotation marks omitted), cited in County of Nassau v. Chase, No. 09-3643-cv (2d Cir. Oct. 4, 2010) (affirming district court's refusal to vacate award) (non-precedential; internal quotation marks omitted) and Advanced Aerofoil Technologies, AG v. Todaro, No. 13 Civ. 7181 (RWS) (S.D.N.Y. Apr. 15, 2014) (confirming arbitration award); see also, e.g., LG Electronics, Inc. v. Interdigital Communications, Inc., No. 9747-VCL, part II-B, esp. text accompanying n.4 et seq. (Del. Ch. Aug. 20, 2014) (extensively-annotated discussion).
And Rule 47 of the AAA's Commercial Arbitration Rules expressly authorizes the arbitrator to "grant any remedy or relief that the arbitrator deems just and equitable and within the scope of the agreement of the parties …."
On the other hand:
- In some jurisdictions it's the other way around. That is, an arbitrator is not permitted to act as amiable compositeur or ex aequo et bono unless the arbitration agreement expressly says so;
- Likewise, Article 21.3 of the ICC Rules of Arbitration require agreement of the parties as a prerequisite to the arbitrator's deciding as amiable compositeur or ex aequo et bono; ditto Article 33.2 of the UNCITRAL Arbitration Rules and Article 59(a) of the WIPO Arbitration Rules.
Preliminary relief not prohibited
The 6. Preliminary Relief subdivision takes precedence over this subdivision's prohibition of injunctive relief (because the preamble of that prohibition contains an except-as-otherwise-agreed carve-out).
Prohibition of punitive damages in arbitration
• The prohibition of punitive damages is phrased without the qualifier, "to the maximum extent permitted by law"; otherwise, the prohibition might be disregarded, as happened in Stark v. Sandberg, Phoenix & von Gontard, P.C., 381 F.3d 793 (8th Cir. 2004) (reversing and remanding vacation of award).
• Portions of this language are adapted from a provision at issue in Wells Fargo Bank, N.A. v. WMR e-PIN, LLC, 653 F.3d 702 (8th Cir. 2011) (affirming confirmation of award, albeit for procedural reasons).
Applicable law might invalidate a provision prohibiting the award of punitive damages in arbitration. Against that possibility, a "jettison" clause can save an arbitration clause that might otherwise be unenforceable because a no-punitives provision. See Booker v. Robert Half Int'l, Inc., 415 F.3d 77 (D.C. Cir. 2005), in which the court, in an opinion by then-Judge (now Chief Justice) John Roberts affirmed an order compelling arbitration, despite the fact that the arbitration provision included an invalid prohibition against the award of punitive damages.
This prohibition seeks to avoid the result in Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750 (Minn. 2014). In that case, Western Digital was hit with an arbitration award in excess of $600 million for misappropriation of a Seagate trade secret by a former Seagate employee that Western Digital had hired away.
- The arbitrator found that all of Seagate's other alleged trade secrets had been publicly known.
- The arbitrator prohibited Western Digital from making the same assertion about the remaining trade secret because the former Seagate employee had fabricated evidence on that point.
- Upholding the award, the Minnesota supreme court held that the arbitration agreement and the applicable arbitration rules authorized the arbitrator to enter the punitive sanctions that he did.
- The supreme court rejected the respondents' pleas that the former employee's fabrication of evidence didn't warrant the extremity of the sanction imposed. The court responded, in essence, that the respondents made their bed by requesting arbitration, which was subject only to limited judicial review. The court quoted one of its earlier holdings, that "Where the arbitrators are not restricted by the submission to decide according to principles of law, they may make an award according to their own notion of justice without regard to the law."
(a) Certain other provisions of this Agreement (each, a Referring Provision) state that they are subject to this provision. The parties consider that each such Referring Provision is a material consideration for, and a material condition of, the parties' agreement to arbitrate. Consequently:
(b) With respect to any such Referring Provision, IF: Either of the Triggering Events described in subdivision (c) below occurs; THEN: Each party will have a Rescission Option — exercisable unilaterally by that party in its sole discretion by timely written election as set forth in subdivision (d) below — to rescind and render unenforceable the following:
(1) any award rendered by the Arbitral Tribunal in respect of the claim or claims in question; and
(2) if so specified in the rescinding party's written election: the parties' agreement to arbitrate the claim or claims in question (but not other portions of this Agreement and not the agreement to arbitrate other claims).
(c) For any Referring Provision, the Triggering Events giving rise to the Rescission Option are the following:
(1) the Arbitral Tribunal issues an award or other directive inconsistent with that Referring Provision (an Inconsistent Order); or
(2) that Referring Provision is finally determined, by a court of competent jurisdiction, to be invalid, void, or otherwise unenforceable (a Final Invalidity Determination).
(d) A party's written election to exercise the Rescission Option under subdivision (b) must be delivered to the other party by notice in accordance with this Agreement. The notice must be effective no later than the last day for challenging the Inconsistent Order or the Final Invalidity Determination in court, whether (i) in an action to confirm or vacate an award or (ii) in an appeal, at any level, from a decision in such an action.
Language like this (sometimes referred to as "jettison" language) is not uncommon in consumer-contract arbitration clauses. See, e.g., Murphy v. DirecTV, Inc., 724 F.3d 1218, 1224 (9th Cir. 2013) (affirming order compelling arbitration against one co-defendant but reversing as to other co-defendant that was not a party to the agreement to arbitrate).
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If so requested by either party, the Arbitral Tribunal is to arrange to have the parties provided with a transcript of any hearing, prepared by a suitably-qualified reporter.
Transcripts of arbitration proceedings add to the expense, but during a long hearing the arbitrator may have trouble listening to testimony and taking notes at the same time; moreover, a transcript might be needed for appellate review.
To save money, another possibility might be to make an audio recording of the hearing and have only selected portions transcribed — that, though, might be a false economy if counsel ended up spending additional billable time in reviewing the audio recording.
(a) Applicability: This provision applies only if (i) the Arbitral Tribunal consists of a single arbitrator, and (ii) the final award by the single arbitrator (the First Award) includes one or more of the following against a party (the Appealing Party):
(1) a take-nothing award against the Appealing Party for any claim or counterclaim exceeding the Threshold Amount for Redo Arbitration (namely, USD $10,000);
(2) an award in favor of the Appealing Party, on any claim or counterclaim by the Appealing Party, where the claim exceeded the Threshold Amount for Redo Arbitration, but the award was at least 20% less than that amount;
(3) an award against the Appealing Party of more than the Threshold Amount for Redo Arbitration;
(4) an award of injunctive relief against the Appealing Party, or denial of injunctive relief duly sought by the Appealing Party. (This subdivision does not in itself authorize or prohibit injunctive relief.)
(b) Redo notice: Before the expiration of the Deadline for Notice of Redo Arbitration (namely, ten business days after the date of the final award), the Appealing Party may notify the other party or parties, as well as the Arbitration Adminstrator, in writing, that it demands a second, new arbitration under the Arbitration Rules and this Agreement (the Redo Arbitration).
(1) If the Appealing Party timely provides such notice, then it is entitled to the Redo Arbitration.
(2) IF: No party duly and timely demands a Redo Arbitration; THEN: The First Award will automatically become binding upon the expiration of the Deadline for Notice of Redo Arbitration.
(c) Three-arbitrator panel: In the Redo Arbitration, the Arbitral Tribunal is to consist of a three-arbitrator panel selected in accordance with the Arbitration Rules and this Agreement.
(d) Expense-shifting: As an economic incentive for the Appealing Party to accept the First Award, IF: The Appealing Party demands a Redo Arbitration; THEN: The Appealing Party must pay:
(1) all fees and expenses charged for the Redo Arbitration by the arbitration administrator (if any) and by the members of the three-arbitrator tribunal; and
(2) all reasonable expenses for the Redo Arbitration incurred by any other party to the Redo Arbitration.
Caution: In a case involving a consumer contract, a California court found that a redo-arbitration clause like this one was unconscionable because its provisions "create a situation in which the arbitration appellate rules benefit the economically stronger party (the automobile dealer) to the detriment of the weaker party (the consumer) and, in doing so, defeat an essential purpose of the FAA [Federal Arbitration Act], which is to encourage efficient and speedy dispute resolution." Trabert v. Consumer Portfolio Servs., Inc., 234 Cal. App. 4th 1154, 1158 & n.1 (2015) (internal quotation marks omitted). The appeals court, though, reversed the trial court's refusal to sever the redo-arbitration clause from the rest of the arbitration terms. See id. at 1167.
If so requested by either party, the Arbitral Tribunal is to issue its award in a written statement that sets forth the tribunal's reasons for the award, with enough detail to provide reasonable support for the award (in case of subsequent judicial review) without being excessively wordy.
Losing parties usually want at least some explanation of why they lost, but a "reasoned award" might be overkill, costing more money (in arbitrator fees) and taking more time than is warranted.
In addition, a reasoned award might well give the losing party more ideas about possible ways to attack the award in court.
The Arbitration Rules will probably specify whether a "reasoned" award is to be provided. Some parties might want the Arbitral Tribunal to produce findings of fact and conclusions of law, but that can increase the cost of the award.
If so requested by either party, the Arbitral Tribunal is to include findings of fact and conclusions of law in its award.
A reasoned award might be preferable to findings of fact and conclusions of law; the latter will require more arbitrator time to prepare (especially for a three-arbitrator panel) and thus will be more expensive.
If the Arbitral Tribunal comprises multiple arbitrators, then if so requested by either party, all arbitrators are to remain at the place of the arbitration, or at some other convenient place with access to suitable administrative support and research‑ and writing resources, where they are to devote their full time and attention to the preparation of the award (except in case of true emergency or force majeure).
I've never seen this provision in an actual agreement — it's based on a suggestion by the late Tom Arnold, my former senior partner, mentor, and friend, in his arbitration checklist, which unfortunately is no longer available on-line. The provision's intent is to give the arbitrators an incentive to finish the award promptly so they can go home.
No party other than a Signatory Party ("Non-Party") may demand arbitration under the arbitration provisions of this Agreement.
This clause is informed in part by an arbitration provision that, according to both the Fifth and Eleventh Circuits, allowed a non-party to demand arbitration. See Sherer v. Green Tree Servicing LLC, 548 F.3d 379, 382-83 (5th Cir. 2008) (reversing denial of motion to compel arbitration) (emphasis added), citing Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1310 (11th Cir. 2005) (same).
Table of Contents
- Legal effect of arbitration
- Appeal of an arbitration award is limited
- Cautions for drafters of arbitration provisions
- Just which disputes should be arbitrated?
- Arbitrability of disputes about arbitrability
- Prohibition of class- and collective-action arbitration
- Choosing the arbitral language
- Choosing the arbitral law
- The arbitral location can affect things
- Picking the arbitrator(s)
- Should the arbitration be administered by a third party?
- Deciding on the arbitral rules
- Preliminary relief in arbitration
- Arbitration streamlining techniques
- Where should the arbitration award be enforced
- Confidentiality of arbitration
- Attorney fees for unsuccessful challenges
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- Unlike mediation, arbitration is generally binding (unless otherwise agreed)
- Some arbitration provisions might be unenforceable under U.S. federal law
- U.S. state statutes might purport to invalidate or restrict certain arbitration agreements (but might be preempted by federal law)
- Judicial reference as an alternative to arbitration (California)
Arbitration is a private, voluntary, non-judicial process in which the parties to a dispute, by mutual agreement, present their cases to a neutral arbitrator, who then decides the dispute by issuing a binding, legally-enforceable award.
[TO DO: Add discussion of Federal Arbitration Act, state arbitration statutes, and New York Convention.]
(In the Common Draft Arbitration Pattern Clause, the binding-except-as-otherwise-agreed language takes into account that the parties might agree to the (Plug-in:) Partial Court Retrial of Arbitration Award provision; in that case, the arbitration award would not become binding until after a period of time in which either party can challenge the award.)
People sometimes confuse arbitration with mediation, in which a neutral mediator meets with the parties and tries to help them figure out a mutually-agreed settlement of the dispute. The mediator might also advise the parties how he or she thinks the dispute is likely to be decided by a court or arbitrator, but generally the mediator has no authority to decide the dispute.
(Mediation is typically a voluntary process too, but it's not unusual for courts to order parties to disputes to go to mediation.)
Some arbitration provisions might be unenforceable under U.S. federal law
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. See generally, e.g., Federal Courts Split on Whether Dodd-Frank's Bar on Arbitration of Whistleblower Retaliation Claims Under Sarbanes-Oxley Is Retroactive (Oct. 9, 2012) (sutherland.com).
- 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. See Frank Murray, Assessing the Franken Amendment (Feb. 16, 2011).
Moreover, in July 2014, President Obama signed an executive order stating that in federal-goverment 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. See 15 U.S.C. § 1226(a)(2).
- 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. See 10 U.S.C. § 987(e)(3), implemented in 32 C.F.R. § 232.9(d).
- 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 addidtion the Secretary of Agriculture apparently has the power to review arbitration 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." See 9 C.F.R. § 201.218.
U.S. state statutes might purport to invalidate or restrict certain arbitration agreements (but might be preempted by federal law)
State laws in the U.S. have not always been friendly to non-judicial arbitration. But any time a question of state-law unenforceability arises concerning arbitration, the reader should consider the possible preemptive effect of the Federal Arbitration Act. See generally, e.g., Doctor's Associates, Inc. v. Casarotto 517 U.S. 681, 687-688 (1996), where:
- The case involved an arbitration provision in the franchise agreement for Subway sandwich shops.
- A Montana statute required a specific notice to be included on the first page of any contract containing an arbitration provision, otherwise the arbitration provision would be unenforceable.
- Reversing the Montana supreme court, the Supreme Court held that under the federal Act, state courts "may not … invalidate arbitration agreements under state laws applicable only to arbitration provisions." Id. at 687 (emphasis in original).
More recently, in California the Legislature passed, but the governor vetoed, AB 465, which would have clamped down severely on arbitration provisions in employment agreements. Governor Brown's veto message explained that, among other things, he wanted to see the outcome of some pending U.S. Supreme Court cases. (For a pre-veto discussion of the bill and its implications for employers, see Fenwick Employment Brief, Sept. 2015.)
As an alternative to arbitration, drafters of contracts that would be litigated in California can consider including a provision requiring disputes to be heard in a bench trial to a judicial referee, instead of to a judge, under sections 638 through 645.1 of the California Code of Civil Procedure. See generally What You Need To Know About Judicial Reference (Sidley.com 2014).
This clause attempts to expand the very-limited appealability of an arbitration award under the (U.S.) Federal Arbitration Act. See Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 128 S.Ct. 1396 (2008). The limitation on the right of appeal can be a significant deterrent to parties' willingness to include arbitration provisions in their contracts. See generally, e.g., Thomas J. Stipanowich, Arbitration: The New Litigation, 2010 Ill. L. Rev. 1.
The "do not include the power" language attempts to trigger one of the limited federal statutory grounds for vacating an arbitration award, namely that "the arbitrators exceeded their powers …." That language represents an effort to "write around" the Hall Street decision.
In Hall Street, the 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 an arbitration proceeding under the Federal Arbitration Act, it likely will be difficult to persuade a reviewing court that the arbitrator exceeded his or her powers. As the U.S. Supreme Court explained in a later case:
A party seeking relief under [§ 10(a)(4) of the Act] bears a heavy burden. It is not enough to show that the arbitrator committed an error — or even a serious error.
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.
Oxford Health Plans LLC v. Sutter, 569 U.S. _, 133 S. Ct. 2064, 2068 (2013) (citations, internal quotation marks, and alteration marks omitted; emphasis and extra paragraphing added).
The rationale of this clause is that the parties bargained for the arbitrator's legally-correct interpretation of the Agreement. It's unclear how a reviewing federal court would view that rationale in light of Oxford Health Plans.
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 — see Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 82 Cal. Rptr.3d 229, 190 P.3d 586 (2008) (reversing and remanding reversal of district court's vacating of arbitration award); Nafta Traders, Inc. v. Quinn, 339 S.W.3d 84 (Tex. 2011) (reversing and remanding confirmation of arbitration award that failed to address losing party's allegation that arbitrator did not comply with law as required by arbitration agreement).
• 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. See Pugh's Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252 (Tenn. 2010) (vacating judgment confirming arbitrator's award).
• 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." N.J. Stat. Ann. § 2A:23B-4(c); see also Hogoboom v. Hogoboom, 924 A.2d 602, 606, 393 N.J. Super. 509 (App. Div. 2007) (explaining history of expanded-review statute, and holding that initial review must be by trial court, not appellate court). (Hat tip: arbitrator Laura Kaster.)
Drafting tip: Parties desiring enhanced review should seriously consider specifying that the Arbitral Law is that of a jurisdiction that permits such review.
In BNSF R.R. Co. v. Alstom Transp., Inc., BNSF lost an arbitration; on appeal it cleimed that the arbitration panel had "completely botched" certain issues. The Fifth Circuit held that under Oxford Health Plans, the railroad was stuck with the arbitration panel's interpretation of the relevant contract, even if that interpretation was arguably incorrect. The Fifth Circuit rejected BNSF's contention that the court should engage in more-searching review of the award under either the Texas or Illinois arbitration acts. 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., No. 13-11274, part II (5th Cir. Feb. 12, 2015) (vacating district court's vacatur of arbitration award and remanding with instructions to reinstate award; citations omitted, extra paragraphing added), citing Action Indus., Inc. v. U.S. Fid. & Guar. Co., 358 F.3d 337, 341 (5th Cir. 2004).
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- Be sure arbitration-agreement signatures can be satisfactorily proved up
- Be very clear that arbitration is mandatory, not optional
- A badly-drafted forum selection provision might kill an arbitration provision
- A broad arbitration provision coupled with a narrow choice-of-law provision could spell trouble
- A one-way arbitration clause might be vulnerable to challenge for unconscionability and/or lack of mutuality
It behooves a party wanting arbitration to make sure a complete signed copy of the arbitration agreement is available in the record. Otherwise, a party opposing arbitration might well deny having signed the arbitration agreement. See, e.g., Ashburn v. AIG Financial Advisors, Inc., 234 Cal. App.4th 79 (2015) (reversing grant of motion to compel arbitration and remanding for evidentiary hearing); Ruiz v. Moss Bros. Auto Group, Inc., 181 Cal. Rptr.3d 781, 232 Cal. App.4th 836, 844-45 (2014) (affirming denial of motion to compel arbitration, but offering suggestions on how to prove up electronic signatures to arbitration agreement).
Feel-good language making it seem that arbitration is optional can kill an arbitration provision. Consider, for example, Quam Construction Co. v. City of Redfield, No. 14-1037 (8th Cir. Oct. 21, 2014). The arbitration clause said:
Arbitration: If 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: ….
(Emphasis by the court.) 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.
A badly-drafted forum selection provision might kill an arbitration provision
It's not unheard of for (thoughtless) contract drafters to include both (i) an arbitration provision and (ii) a forum-selection provision requiring all disputes to be litigated in a specified court. That might well cause a court to refuse to enforce the arbitration provision. For more details, see the discussion in the commentary to the forum-selection provisions.
A broad arbitration provision coupled with a narrow choice-of-law provision could spell trouble
See this discussion of how the combination described in the subheading resulted in a treble-damage award of $48 million against an investment-advisory firm.
A one-way arbitration clause might be vulnerable to challenge for unconscionability and/or lack of mutuality
A drafter might be tempted to craft a provision requiring arbitration if a particular party requests it, but requiring court litigation otherwise. Such a provision might be held unenforceable for unconscionability. See, for example:
- Armendariz v. Foundation Health Psychcare, Inc., 24 Cal. 4th 83, 6 P.3d 669, 775, part II-D-2 (2000), where the California supreme court reversed the court of appeals and upheld the trial court's denial of an employer's motion to compel arbitration of employees' claims; and
- Eaton v. CMH Homes, Inc., 461 S.W.3d 426 (Mo. 2015) (en banc), where the Missouri supreme court reversed the trial court's refusal to compel arbitration, but also "clarifie[d] that a lack of mutuality of the obligation to arbitrate is one of the relevant factors a court will consider, along with the other terms of the contract, in determining whether the agreement to arbitrate otherwise is unconscionable."
In a puzzling 2014 Arkansas case — decided by a 4-3 majority — a cell-phone carrier's consumer contract included an arbitration provision. The contract also said that if the carrier failed to enforce any right or remedy, that failure would not constitute a waiver on the carrier's part: "If we do not enforce any right or remedy available under this Agreement, that failure is not a waiver." a majority of the Arkansas supreme court held that this rendered the arbitration provision void for lack of mutuality. See Alltel Corp. v. Rosenow, 2014 Ark. 375. (The dissent in that case arguably has the stronger position.)
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One experienced arbitrator points out that "[i]t makes no sense to limit the arbitrator's purview to contract claims, allowing related tort and statutory claims to be litigated in court on a parallel track." Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration, Corporate Counsel (Apr. 22, 2013).
According to the Fourth Circuit in its Dickey's Barbecue Restaurants opinion, just that sort of piecemeal litigation was mandated by the arbitration provision in a franchise agreement:
- The arbitration provision included a carve-out, which stated that franchisees need not arbitrate claims arising under Maryland franchise law.
- The franchisor, unhappy with the performance of some of its franchisees, demanded arbitration of claims for the franchisees' alleged breach of the franchise agreement.
- In response, the franchisees filed a lawsuit seeking to enjoin the arbitration and asserting claims for violation of the Maryland franchise laws. (DCT note: Litigators know that whenever you file a lawsuit or arbitration demand, it's almost a certainty that the other side's lawyers will be looking for some kind of counterclaim or other counterattack, to gain leverage against you.)
See Chorley Enterprises, Inc., v. Dickey's Barbecue Restaurants, Inc. No. 14-1799 (4th Cir. Aug. 5, 2015).
In court, Dickey's moved to compel arbitration of all claims. The trial court punted, ruling that the franchise agreement's arbitration provision was ambiguous and therefore a jury trial was needed to determine its meaning. See id., slip op. at 7.
The Fourth Circuit reversed, ruling that:
… As a matter of law, the clear and unambiguous language of these [arbitration] provisions requires that[:]
- the common law claims asserted by Dickey’s must proceed in arbitration,
- while the franchisees’ Maryland Franchise Law claims must proceed in the Maryland district court.
We recognize that requiring the parties to litigate in two different forums may be inefficient, and could lead to conflicting results. But this outcome is mandated by the Federal Arbitration Act, which requires piecemeal litigation where, as here, the agreements call for arbitration of some claims, but not others.
Accordingly, we reverse with instructions to compel arbitration of the common law claims only.
Id., slip op. at 5 (extra paragraphing and bullets added).
In the Pattern Clause's specification of arbitrable definition of /Arbitrable Dispute, the phrase any transaction or relationship … is informed in part by an arbitration provision seen in cases decided by the Fifth and Eleventh Circuits respectively. The provision in question stated that "[a]ll disputes, claims, or controversies arising from or relating to this Agreement or the relationships which result from this Agreement… shall be resolved by binding arbitration." See Sherer v. Green Tree Servicing LLC, 548 F.3d 379, 382-83 (5th Cir. 2008) (reversing denial of motion to compel arbitration), citing Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1310 (11th Cir. 2005) (same).
Exceptions such as this are often seen in consumer-facing contracts; the intent is to give the company an argument against a claim that the arbitration provision is unconscionable because the expense of arbitration would make it uneconomical to bring a small claim.
A New Mexico court of appeals ruled that a small-claims exception in a consumer-contract arbitration provision was an element contributing to the unconscionability of the arbitration provision, because as a practical matter the exception was one-sided. At this writing an appeal to the state's supreme court is apparently pending. See Dalton v. Santander Consumer USA Inc., No. 33,136 (N.M. App. Dec. 30, 2014), cert. granted, 2015 NMCERT 003.
See generally, e.g.:
- U-Haul arbitration provision (accessed Aug. 22, 2015) (includes small-claims exception)
- Lawrence Mortorff, David A. Robinson, and Richard Chernick, Before Closing That Killer Deal: Considerations for Negotiating and Drafting Appropriate and Enforceable Arbitration Provisions at 21 (ADR.org 2012) (example of small-claims exception)
Statutory claims can be arbitrated only by agreement
U.S. courts have held that statute-based claims can be arbitrated, but only if the parties so agree. For example:
• 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. See Ibarra v. United Parcel Service, 695 F.3d 354, 356 (5th Cir. 2012) (reviewing Supreme Court cases; vacating and remanding summary judgment in favor of employer).
• 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. See 14 Penn Plaza LLC v. Pyett, 556 U.S. 249 (2009) (reversing court of appeals; citation omitted).
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Courts will decide arbitrability unless the arbitration agreement clearly delegates that authority
Under U.S. law, it is the court, not the arbitrator, that normally must determine whether the parties have agreed to arbitrate — unless, that is, the arbitration agreement itself clearly delegates that power to the arbitrator. See First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995) (reversing court of appeals and holding that agreement in question did not give arbitrator power to determine arbitrability).
And even then, any challenge specifically to the "delegation agreement" itself will be heard by the court, not by the arbitrator. See Rent-a-Center, West, Inc. v. Jackson, 561 U.S. 63, 130 S.Ct. 2772 (2010) (reversing 9th Circuit holding that court must determine enforceability of arbitration agreement).
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.
Arbitration rules might require arbitration of arbitrability disputes
Of course, by agreeing to a particular set of arbitration rules, the parties to a contract might implicitly delegate arbitrability disputes to the arbitrator. See, e.g., Oracle America, Inc. v. Myriad Group AG, 724 F.3d 1069, 1071-74 (9th Cir. 2013) (reversing partial denial of motion to compel arbitration; citing cases).
Caution: Other clauses can screw this up
Other badly-drafted clauses might undermine an arbitration-arbitrability clause. For example, in a California case, the contract included an arbitration clause, but the savings clause referred to the possibility that a court might determine that the agreement as a whole was unenforceble. The California appeals court held that the contract had not clearly and unmistakably delegated the question of enforceability to an arbitrator. Therefore, said the appeals court, that question was properly resolved by the courts, not by the arbitrator. the appeals court reversed a trial-court order directing the parties to arbitrate the case instead of trying it in a lawsuit. See Peleg v. Neiman Marcus Group, Inc., 204 Cal. App. 4th 1425, 1442-43, 140 Cal. Rptr. 3d 38 (2012).
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This clause merely restates the law, at least for arbitrations that will be conducted under the U.S. Federal Arbitration Act, because the U.S. Supreme Court has held that class-action arbitration is prohibited under the Act unless the parties have clearly agreed to it. See Stolt-Nielsen SA v. AnimalFeeds International, 559 U.S. 662, 130 S. Ct. 1758 (2010).
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. See id., 130 S.Ct. at 1775.
- The Act preempts state law barring enforcement of a class-arbitration waiver – see AT&T Mobility LLC v. Concepcion, 563 U.S. __, 131 S. Ct. 1740 (2011) (reversing Ninth Circuit); see also, e.g., Davis v. Nordstrom, Inc., 755 F.3d 1089, 1092-94 (9th Cir. 2014) (reversing denial of Nordstrom's motion to compel employee to arbitrate her claims individually and not as a class); 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. See American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013) (reversing Second Circuit).
On the other hand, the Court has held that if an arbitrator holds that an arbitration agreement allows class-action arbitration, then a court may not set aside that holding except on the very-limited grounds permitted by the Act. See Oxford Health Plans LLC v. Sutter, 133 S. Ct. 2064 (2013) (affirming denial of motion to vacate arbitrator's approval of class action).
Some companies are including 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. But how many people will actually bother to opt out?
The case of Johnmohammadi v. Bloomingdale's, Inc., involving an arbitration provision in an employment agreement, is instructive; as summarized by the court:
The relevant facts aren't in dispute. When Bloomingdale's hired Johnmohammadi as a sales associate, she received a set of documents describing the company's dispute resolution program. Those documents informed her that she agreed to resolve all employment-related disputes through arbitration unless she returned an enclosed form within 30 days electing, as the form put it, "NOT to be covered by the benefits of Arbitration."
Johnmohammadi did not return the opt-out form. She does not contest the district court's findings that she made a fully informed and voluntary decision, and that no threats of termination or retaliation were made to influence her decision.
By not opting out within the 30-day period, she became bound by the terms of the arbitration agreement.
The arbitration agreement is quite detailed, but the provision that matters here is the one that forbids arbitration on a class-wide basis: "The Arbitrator shall not consolidate claims of different Associates into one (1) proceeding, nor shall the Arbitrator have the power to hear an arbitration as a class action. …" Employees who fail to opt out waive their right to pursue employment-related claims on a collective basis in any forum, judicial or arbitral. …
Johnmohammadi v. Bloomingdale's, Inc., 755 F.3d 1072, 1074 (9th Cir. 2014) (affirming grant of Bloomingdale's motion to compel arbitration of employee's claim and dismissal of her class-action suit) (citation omitted).
Class-arbitration prohibitions in employment agreements are coming under attack
See Murphy Oil USA, Inc. v. NLRB, No. 14-60800 (5th Cir. Oct. 26, 2015): Murphy Oil's employees were required to sign an arbitration agreement that prohibited "class action" arbitrations. The NRLB ruled that this constituted an unfair labor practice. The Fifth Circuit disagreed — but it did agree that Murphy Oil was required to clarify the language in its arbitration agreement to ensure that employees understood that they were not barred from filing charges with the NLRB.
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.
A drafter specifying a choice of arbitral language should think ahead to where future enforcement- or challenge proceedings might be brought, with an eye to reducing the expense (and time delay) of providing a translation. That might be necessary under Article IV.2 of the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention),which provides that:
If the said [sic] award or agreement is not made in an official language of the country in which the award is relied upon, the party applying for recognition and enforcement of the award shall produce a translation of these documents into such language.
The translation shall be certified by an official or sworn translator or by a diplomatic or consular agent.
(Extra paragraphing added.)
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In a U.S. Supreme Court case, a securities firm's customer agreement stated that New York law applied, and also required arbitration of disputes. New York law stated that arbitrators could not award punitive damages, but an arbitrator in Illinois awarded punitives anyway, as permitted by the agreed arbitration rules. The Supreme Court held that the parties' choice of New York law did not preclude the award of punitive damages, because:
We think the best way to harmonize the choice-of law provision with the arbitration provision is to read "the laws of the State of New York" to encompass substantive principles that New York courts would apply, but not to include special [state-law] rules limiting the authority of arbitrators.
Thus, the choice-of-law provision covers the rights and duties of the parties, while the arbitration clause covers arbitration; neither sentence intrudes upon the other.
Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 63-64 (1995) (reversing 7th Circuit's affirmance of district-court action vacating punitive-damage portion of arbitration award) (extra paragraphing added).
The choice of arbitral law might make a difference, for example if the parties were to choose the Federal Arbitration Act (FAA) instead of state arbitration law.
The choice of law might affect the standard of review on appeal, because the arbitration laws in California, New York, and Texas (for example) allow a broader scope of appellate review than does the Federal Arbitration Act. See County of Nassau v. Chase, No. 09-3643-cv (2d Cir. Oct. 4, 2010) (comparing New York and federal arbitration statutes in affirming district court's granting of motion to confirm arbitration award) (non-precedential); see also Cindy G. Buys, The Arbitrators' Duty to Respect the Parties' Choice of Law in Commercial Arbitration, 79 St. John's L. Rev. 59 (2005).
(See also the notes to the (Plug-in:) Enhanced Judicial Review of Arbitration Award subclause.)
A contract drafter's failure to specify the choice of arbitral law could have have made a difference in California's Baltazar case, where an employee brought a sexual-harassment claim. Baltazar v. Forever 21, Inc., 212 Cal. App. 4th 221 (2012). The employer moved to compel arbitration; the lower court denied the motion. The appeals court concluded that the defendant had not made a showing that the employee arbitration agreement involved "commerce"; therefore, said the court, the contract was governed by the California Arbitration Act and not by the Federal Arbitration Act. Id., 212 Cal. App. at 228-30. (That turned out not to make a difference in the result, though: the appellate court reversed the lower court's denial of the employer's motion to compel arbitration of the sexual harassment claim, holding that the arbitration agreement was not unconscionable.)
The Fifth Circuit has held that the Federal Arbiration Act applies "absent clear and unambiguous contractual language to the contrary" in which the contract "expressly references state arbitration law." BNSF R.R. Co. v. Alston Transp., Inc., No. 13-11274, part II (5th Cir. Feb. 12, 2015) (vacating district court's vacatur of arbitration award and remanding with instructions to reinstate award), quoting Action Indus., Inc. v. U.S. Fid. & Guar. Co., 358 F.3d 337, 341 (5th Cir. 2004) (emphasis by the BNSF court, internal quotation marks omitted).
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.
The Second Circuit applied this principle in Zurich American Insurance Co. v. Team Tankers A.S., No. 14-4036, slip op. at 8 (2d Cir. Jan. 28, 2015), noting that:
The award in this case having been rendered in the United States, available grounds for vacatur include all the express grounds for vacating an award under the FAA.
The New York Convention specifically contemplates that the state in which the award is made, will be free to set aside or modify an award in accordance with its domestic arbitral law and its full panoply of express and implied grounds for relief.
Id., slip op. at 8 (citation, internal quotation marks, and alteration marks omitted, extra paragraphing added).
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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 jusst one.
Folk wisdom among litigators and arbitrators, however, is that the cost of three arbitrators is likely to increase both delay and expense. Contract negotiators therefore might want to specify appointing a single arbitrator in cases of comparatively low value, reserving the use of 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.
Different procedures for selecting arbitrators are used by different arbitral institutions such as the American Arbitration Association and the International Chamber of Commerce.
For example, under the AAA's [U.S.] commercial arbitration rules, the AAA provides the parties with a list of candidates from the AAA's roster, which is sometimes referred to colloquially as the "commercial panel." (Disclosure: I'm a member of the AAA's commercial panel.) Each party strikes any candidates to which it objects, and ranks the remaining ones in order of preference. The AAA then asks the remaining candidate with the highest mutual ranking if he or she will accept appointment. See generally Rules R-12 through R-16 of the AAA's Commercial Arbitration Rules.
When three arbitrators are used, it's not uncommon for one arbitrator to be appointed by each party, with the third arbitrator (who will serve as chair of the Arbitral Tribunal) being appointed by the other two arbitrators (sometimes referred to colloquially as "wing" arbitrators).
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; and
- for accounting disputes to be arbitrated by an accounting referree.
See BP America Production Co. v. Chesapeake Exploration LLC, Nos. 13-6108 and 13-6122, slip op. at 3-4 (10th Cir. May 2, 2014) (affirming a variety of orders by the district court).
Many practitioners, myself included, prefer "administered" arbitration to "ad hoc" arbitration in which the arbitration is administered by the parties themselves. Among the reasons for preferring administered arbitration:
• Administration chores such as scheduling, invoicing, etc., are unavoidable in arbitration. 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.
• An experienced arbitrator points out that:
AAA's vetting process formalizes disclosures of potential conflicts/biases and thus minimizes the likelihood of a flawed proceeding.
Picture this: The parties select a panel and spend considerable time and money getting to an award. The losing party seeks vacatur because the arbitrator failed to disclose prior relationships with a party.
A lower court decides the issue, then an appellate court, then the state supreme court.
Two years post-hearing, the award is vacated with instructions that the matter be reheard by a new panel.
Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration, Corporate Counsel (Apr. 22, 2013) (parentheses omitted, extra paragraphing added).
• 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. See id.
• "[A] competent administrator will goad an arbitrator who is not moving the proceeding apace." Id.
• 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." Eric S. Sherby, A Checklist for Drafting an International Arbitration Clause (Sept. 10, 2010).
The arbitration adminstrator could be:
- the American Arbitration Association ("AAA") or its International Centre for Dispute Resolution (disclosure: I'm a member of the AAA's panel of commercial arbitrators)
- the International Institute for Conflict Prevention and Resolution (CPR)
- the London Court of International Arbitration (LCIA)
- the International Court of Arbitration of the International Chamber of Commerce
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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.
Which rules to choose?
Drafters have considerable choice in their selection of Arbitration Rules, such as, for example:
- The Commercial Arbitration Rules of the American Arbitration Association seem to be 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: I'm a member of the AAA's commercial arbitration panel.)
- The International Arbitration Rules of the International Centre for Dispute Resolution ("ICDR"), which has published its International Arbitration Rules, are said to be based on the UNCITRAL Rules (mentioned below) but with administration features included. For a discussion of the 2014 revisions to the ICDR rules, see Eduardo R. Guzman and Joseph M. Kelleher, International Centre for Dispute Resolution ("ICDR") Revised Rules Came Into Effect on June 1, 2014.
- The LCIA Arbitration Rules of the London Court of International Arbitration (LCIA) is popular in international arbitrations.
- the ICC arbitration rules of the International Chamber of Commerce (ICC) is believed to be among the most popular world-wide, in part because the arbitration award prepared by the Arbitral Tribunal will be scrutinized, before being released to the parties, by the ICC's International Court of Arbitration. Others, though, believe that these putative benefits must be weighed against the likely cost of an ICC arbitration; see, e.g., Latham & Watkins, Guide to International Arbitration, ch. IV.
- The UNCITRAL arbitration rules do not provide for administration; to some, the absence of administration would be a serious deficiency.
- The World Intellectual Property Organization (WIPO) has published arbitration rules and expedited arbitration rules.
- The JAMS Streamlined Arbitration Rules have been praised by some arbitrators as effective; JAMS also has a set of international arbitration rules.
- The International Institute for Conflict Prevention and Resolution (CPR) rules are favored by some.
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.
In the designation of Arbitration Rules, the phrase "choice of rules and not of forum" is designed to forestall the strange result that occurred in the 1995 Salomon securities class-action case. There, 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. In that case, however, the NYSE declined to accept the case for hearing — and the court held that this action by the NYSE negated the parties' agreement to arbitrate. See, for example:
- In re Salomon Inc. Shareholders'Derivative Lit., 68 F.3d 554 (2d Cir. 1995);
- Inetianbor v. CashCall, Inc., No. 13-13822 (11th Cir. Oct. 2, 2014) (affirming denial of motion to compel arbitration);
- Grant v. Magnolia Manor-Greenwood, Inc., 383 S.C. 125, 678 S.E.2d 435 (2009) (citing Salomon in affirming denial of motion to compel arbitration);
- PoolRe Ins. Corp. v. Organizational Strategies, Inc., No. 14-20433, part III-A.2, slip op. at 11-12 (5th Cir. Apr. 7, 2015) (affirming vacatur of arbitration award and denial of motion to compel second phase of arbitration) (citing cases).
Other courts, however, have reached what seems to be the opposite result, namely that the unavailability of the designated arbitral body will not negate the agreement to arbitrate unless that designation was material to the agreement. See, e.g.:
- Ferrini v. Cambece, No. 2:12-cv-01954 (E.D. Cal. June 3, 2013) (magistrate judge's recommendation that motion to compel arbitration be granted) (citing cases);
- GAR Energy & Assoc., Inc. v. Ivanhoe Energy Inc., No. 1:11-CV-00907 (E.D. Cal. Dec. 23, 2011) (magistrate judge's recommendation that motion to compel arbitration be granted; the record contained no indication that the parties regarded the agreement's selection of a now-defunct arbitration association as significant) (citing cases), recommendation adopted in full, Jan. 19, 2012;
- Nachmani v by Design, LLC, 2010 NY Slip Op 04847 [74 AD3d 478] (June 8, 2010) (affirming order compelling arbitration not administered by AAA and staying arbitration that was to be administered by AAA; agreement to AAA rules was a choice of rules and not of an administrator).
Some arbitration rules provide for preliminary relief, e.g., Rule R-37 of the AAA's Commercial Arbitration Rules.
If a party were to seek preliminary relief in court, that might raise the issue whether the party waived its right to compel arbitration. In 2011, the Eleventh Circuit joined the First, Third, and Sixth Circuits in ruling that "it is presumptively for the courts to adjudicate disputes about whether a party, by earlier litigating in court, has waived the right to arbitrate. This presumption leaves the waiver issue to the decisionmaker with greater expertise in recognizing and controlling abusive forum-shopping." Grigsby & Associates Inc. v. M Securities Investment, 664 F.3d 1350, 1353-54 (11th Cir. 2011) (emphasis added, citations omitted). In that case, the appellate court vacated and remanded two actions by the trial court: Denial of a motion to enjoin arbitration, and confirmation of an arbitration award.
In a 2016 California supreme court case, an employer-employee arbitration agreement allowed either side to seek preliminary relief in court. The employee argued that this made the arbitration agreement substantively unconscionable because as a practical matter it was only the employer that likely would seek preliminary relief. The supreme court rejected that argument, noting that the arbitration agreement did no more than restate California law. See Baltazar v. Forever 21, Inc., No. S208345, slip op. at 10-11 (Cal. Mar. 28, 2016).
Table of Contents
- "Pertinent and material evidence"
- "Impair … fundamental fairness"
- Specific streamlining measures
- Questioning the parties
- Motion practice for early disposition of issues
- Early deposition scheduling for specific weeks
- Representative depositions to reduce the number of individual depositions
- Direct examination testimony by written statement
- Examining multiple witnesses at once
- Summary exhibits
- Chess clock
- Tentative or draft award
- Overruling of arbitrator case-management decisions
It can sometimes be very useful for an arbitration agreement to explicitly encourage arbitrators to streamline the proceedings, because otherwise their inclination might be to go along with requests by the parties' counsel for (expensive) discovery, motion practice, etc. That can happen in part because attorneys (and arbitrators who are attorneys) are comfortable with familiar rules of civil procedure, and because arbitrators, desiring repeat business, can be reluctant to hold counsel's feet to the fire. See generally, e.g., Thomas J. Stipanowich, Arbitration: The New Litigation, 2010 Ill. L. Rev. 1, 12-13.
You might think that such encouragement wouldn't be necessary, because most arbitration rules already give the tribunal at least some authority to manage the proceedings. See, e.g., Rules R-32 through R-35 of the October 2013 revision of the American Arbitration Association's Commercial Arbitration Rules.
Any given arbitrator, though, might secretly fear the consequences of taking too "muscular" an approach to managing the proceedings:
- The arbitrator might worry, for example, that excessive streamlining of a case could make the award vulnerable to being overturned in subsequent court proceedings: Under the [U.S.] Federal Arbitration Act, for example, one of the few grounds on which a court is allowed to vacate an arbitration award is that "the arbitrators were guilty of misconduct … in refusing to hear evidence pertinent and material to the controversy." 9 U.S.C. § 10. See Stipanowich, supra, at 12-13.
- The arbitrator might also worry that streamlining the case will irritate one side or the other, potentially jeopardizing the arbitrator's chances of getting future business from that side and its lawyers. See id.
For both these reasons, drafting the arbitration agreement to include an express request to "please, please streamline the proceedings" can help overcome any reluctance on the part of the arbitrator to do so.
"Pertinent and material evidence"
The phrase "pertinent and material evidence" is copied from the provision in the U.S. Federal Arbitration Act, section 10 of title 9 of the U.S. Code, stating the limited grounds on which arbitration awards can be vacated. See 9 U.S.C. § 10.
"Impair … fundamental fairness"
In the arbitration-streamlining clause, the term "impair the fundamental fairness of the proceedings" is essentially copied from the decision of the U.S. Court of Appeals for the Second Circuit in LJL 33rd Street Assoc. LLC v. Pitcairn Properties Inc., 725 F.3d 184, 194-95 (2d Cir. 2013). In that case:
- An arbitrator excluded hearsay evidence.
- That exclusion caused a trial court to vacate his award.
- The appellate court reversed, holding that "[a]rbitrators have substantial discretion to admit or exclude evidence," and that "[t]he exclusions in this case did not impair the fundamental fairness of the proceeding." Id. (citations and internal quotation marks omitted).
See also, e.g., Doral Financial Corp. v. Garcia-Velez, 725 F.3d 27 (1st Cir. 2013) (affirming confirmation of arbitration award; arbitrator did not abuse discretion by refusing to issue pre-hearing and hearing subpoenas to third party).
In appropriate circumstances, specific streamlining measures could include, for example, some or all of the following:
- questioning the parties about the specific facts they intend to prove and how they intend to prove them;
- drafting and periodic updating of a detailed timeline of relevant events, annotated with citations to specific evidence such as exhibits; written witness statements; and witness testimony.
- motion practice for early disposition of issues;
- encouraging the parties to use conference-call interviews of one or more witnesses as a prelude to, or in lieu of, deposing that witness;
- encouraging the parties to propound written questions to witnesses about likely-to-be-uncontroverted matters;
- setting specific periods of time (e.g., specific weeks) for particular parties to take depositions, produce documents, etc.;
- asking the parties whether they wish to agree to "representative"-type discovery depositions, along the general lines of Rule 30(b)6. of the (U.S.) Federal Rules of Civil Procedure, to reduce the number of individual depositions (assuming discovery depositions are permitted at all in the arbitration in question);
- in the absence of timely objection, admission into evidence any document offered by a party, without the need for foundation or authentication — but in case of objection, the offering party must also adduce such evidence to establish foundation and authenticity as may be required by the Arbitral Tribunal in its discretion;
- testimony by telephone- or video conference;
- direct testimony by written narrative statement, with oral summarizing by the witness followed by oral cross-examination;
- joint written reports by opposing expert witnesses, explaining their points of agreement and disagreement;
- witness-examination procedures such as "witness panel" or "hot-tub" examination of fact- and/or expert witnesses;
- summary exhibits to supplement or substitute for voluminous evidence;
- use of a chess clock to allocate time between the parties;
- use of "baseball" arbitration for one or more specific issues, in the interest of promoting settlement of such issues;
- issuance of a tentative or draft award to allow the parties an opportunity to comment before issuance of the final award.
There seems to be a consensus among arbitrators that questioning the parties and their counsel can help significantly speed up and reduce the cost of an arbitration proceeding. For example:
- AAA Commercial Rule R-32(b) provides in part that “The arbitrator, exercising his or her discretion, shall conduct the proceedings with a view to expediting the resolution of the dispute and may … direct the parties to focus their presentations on issues the decision of which could dispose of all or part of the case.”
- The arbitrator code of ethics of the American Arbitration Association contemplates that arbitrators will “engage in discourse with the parties or their counsel, draw out arguments or contentions [and] comment on the law or evidence …. These activities are integral parts of an arbitration.” Commentary, Canon I of the AAA's Code of Ethics for Arbitrators in Commercial Disputes, available at https://goo.gl/kbAmoX (ADR.org).
Federal trial judges appear to feel the same way: A federal judicial manual recommends that at the initial pre-trial conference in complex cases, “the judge should require the attorneys to describe the material facts they intend to prove and how they intend to prove them,” Federal Judicial Center, Manual for Complex Litigation § 11.33 at 44 (4th ed. 2004), and that judges “requir[e] with respect to one or more issues, that the parties present a detailed statement of their contentions, with supporting facts and evidence ….” Id. at 46.
(In the above quotations, all emphasis is mine — DCT.)
Motion practice for early disposition of issues
In some disputes, considerable time and money might be saved by employing early-disposition procedures such as those of Rule 12(b)(6) or Rule 56 of the U.S. Federal Rules of Civil Procedure. The Arbitration Rules might expressly allow for such dispositive motions, as is the case with, e.g., Rule R-33 of the AAA's Commercial Arbitration Rules.
Some arbitrators are reluctant to grant motions to dismiss or for summary judgment. Their concern, generally, is that failing to allow a party to put on whatever evidence the party deemed appropriate could jeopardize the enforceability of the arbitration award under applicable law or the New York Convention.
Other arbitrators take a different view: They reason that contracting parties can be reluctant to agree to arbitration if an expensive, time-consuming, full-blown evidentiary hearing would be required for all issues, with no possibility of early disposition of meritless claims or defenses. See, e.g., Catherine Amifar and Claudio D. Salas, How summary adjudication can promote fairness and efficiency in international arbitration, in the International Bar Association Arbitration Newsletter, Sept. 2010, at 77.
Some general guidelines on early disposition of claims or defenses can be found at the CPR Guidelines on Early Disposition of Issues in Arbitration.
Early deposition scheduling for specific weeks
To help keep costs down, it can be useful to get the parties' counsel to commit, early on, to taking depositions during specific time periods (assuming, of course, that depositions are permitted in the first place by the relevant arbitration rules).
Parkinson's Law — "work expands to fill the time available" — is alive and well in litigation and arbitration. Counsel usually must juggle a number of cases and other commitments; that can make it hard for counsel to organize an aggressive effort to "get in, get it done, get out."
Just setting a discovery cutoff date won't do much to remedy the problem. What can help, though, is encouraging the parties to schedule, near the beginning of the process, specific time periods for taking depositions.
(Hat tip: Houston arbitrator David Waddell, who says he routinely does this in his pre-hearing scheduling orders.)
Assuming depositions are even allowed in a given arbitration, it might well make sense for a party to designate a representative to serve as a witness on the party's behalf. U.S. litigators are quite familiar with this procedure under Rule 30(b)(6) of the Federal Rules of Civil Procedure and its state-law counterparts.
(This is based on a suggestion by a senior litigation partner at the K&L Gates firm; see Stephen J. O'Neil, Managing Depositions in Arbitration to Minimize Cost and Maximize Value, 69 Dispute Resolution J. 15 (2014).) [Added 2014-07-22]
An increasing number of courts are conducting bench trials by having each fact witness prepare a written statement of his or her testimony and provide it to the other side in advance (much as expert witnesses have been required to do for years). Then at trial:
- The witness is sworn; presented with a copy of her written statement; and asked to orally adopt it.
- The written statement, once orally adopted by the witness, is admitted into evidence, subject to objection as to particular assertions in the same manner as oral testimony.
- Counsel for the party that called the witness conducts a short oral direct examination, having the witness briefly re-cap her written testimony. This helps the witness to get comfortable with being on the stand.
- Opposing counsel is given an opportunity to cross-examine the witness about her testimony, both oral and written.
See, e.g., a press release by the U.S. Court of Appeals for the Second Circuit and New York County Lawyers' Association, First-of-Its-Kind CLE Program on Using Affidavits in Lieu of Direct Testimony at Trial (2011).
Some lawyers object to providing written witness statements in advance because they fear that preparation of the statements will entail extra costs for the client. But:
- Any competent counsel will spend time preparing the witness to testify anyway; the incremental cost of reducing her assertions to writing should be comparatively little — and the calling lawyer gets to craft exactly what the witness will "say" on direct examination and needn't worry that she will get it wrong on the stand.
- The witness can relax about getting her direct testimony "right," because it is written down in advance; the written statement can even serve as a cheat sheet that she can consult if she wishes.
Other lawyers object to preparing witness statements because it supposedly gives opposing counsel a road map for cross-examination. But a competent and thorough pre-trial deposition of the witness by opposing counsel will do much the same thing — at greater cost for all concerned.
Many courts in the U.S. are turning to the use of written witness statements. For example;
• In the famous e-book pricing conspiracy trial of U.S. v. Apple, federal district judge Denise Cote directed that witness testimony on direct examination be taken mainly by affidavit. See United States v. Apple, Inc., No. 12 CIV 2826, slip op. at 5-6 & n.2,(S.D.N.Y. July 10, 2013) (Cote, J.).
• The U.S. Federal Judicial Center has published Sample Form 49, a model order setting out procedures for direct testimony by written statement, based on an order used by then-Chief Judge Vaughn Walker of the Northern District of California.
• Similar practices are followed by some other U.S. federal district judges, including, for example, Colleen McMahon of the Southern District of New York; Thomas C. Platt of the Eastern District of New York; and Douglas P. Woodlock of the District of Massachusetts. See, e.g., Individual Practices and Procedures, Judge Colleen McMahon (Dec. 20, 2012); Individual Practices of Judge Thomas C. Platt, at 8 (Dec. 18, 2002); Order Regulating Non-Jury Civil Trial, part III.2 (Woodlock, J.).
The use of written statements for direct-examination testimony is said to be a common practice in commercial cases in England and Scotland. See generally The use of signed witness statements or affidavits in commercial actions (March 2012).
Apparently it's not uncommon in Australian courts to have expert witnesses testify together in a panel-discussion format, known colloquially as "hot-tubbing" the witnesses; this reportedly results in dramatic time savings. See, e.g.:
- John D. Hanify, Jason C. Weida, John Emmerig, and Michael Legg, Is There Room In American Courts For An Australian Hot Tub? in the Metropolitan Corporate Counsel, vol. 21, no. 5 (May 13, 2013), available at http://goo.gl/QcCXY (jonesday.com)
- Steven Ranes, Expert Evidence in Copyright Cases – Concurrent Expert Evidence and the "Hot Tub" (Oct. 15, 2009); Gary Edmond, Merton and the Hot Tub: Scientific Conventions and Expert Evidence in Australian Civil Procedure, 72 Law & Contemp. Probl. 159 (Winter 2009);
- [New South Wales] Uniform Civil Procedure Rules 2005, Reg. 31.23 (expert witness code of conduct); 31.24 (conference between expert witnesses); 31.26 (joint report of expert witnesses); 31.35 (opinion evidence by expert witnesses);
- Expert witness code of conduct, Schedule 7 to [New South Wales] Uniform Civil Procedure Rules 2005.
One Australian commentator says, "It is remarkable how the demeanour of some expert witnesses will change when sitting alongside their opposite number and answering questions from the tribunal rather than the advocate on the other side." Lionel Persey QC, Effective Case Management at 4 (undated).
In an appropriate case, a similar procedure might save time and trouble even for fact witnesses, especially if their credibility is not in issue. (In some cases, of course, the Arbitral Tribunal might have to actively manage the proceeding to maintain civility among opposing witnesses.)
Chess-clock procedures are not uncommon in international arbitration. See Albert A. Monichino, Stop Clock Hearing Procedures in Arbitration (2009). One British commentator observes:
The chess-clock procedure is increasingly used in arbitrations. In my view its use should be the rule rather than the exception. It encourages the parties and their advocates to focus on the real issues in the case.
We all know from experience that most cases turn on very few key points at the end of the day and that much of the evidence that is adduced proves to be completely irrelevant to the outcome. …
Absent any bombshells, there should be no excuse for hearings overrunning.
Lionel Persey QC, Effective Case Management at 4 (undated).
Having the arbitral tribunal circulate a "draft" award for comments might well be the parties' only shot at correcting (what they regard as) errors in the draft, because:
- Under the doctrine of functus officio, once the final award is issued, the arbitral tribunal will likely have little or no power to alter the award. See, e.g., Bosack v. Soward, 586 F.3d 1096, 1103 (9th Cir. 2009) (functus officio doctrine "forbids an arbitrator to redetermine an issue which he has already decided") (internal quotation marks and citation omitted).
- And in many jurisdictions, a party disappointed with the final award will have only limited grounds for appeal. See, e.g., Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 128 S.Ct. 1396 (2008), in which the Supreme Court of the United States ruled that an appeal of an award rendered under the Federal Arbitration Act could be appealed only on the grounds stated in 9 U.S.C. § 10.
The Eighth and Ninth Circuits have held that awards not expressly stated to be final are not subject to functus officio. See Bosack v. Soward, 586 F.3d at 1103 (citing and following Eighth Circuit decision).
Some state courts in California routinely issue tentative rulings on motions. That gives the court the opportunity to fine-tune the ruling, based on input from the parties. See, e.g., Superior Court of California, Alameda County, Tentative Rulings.
Experienced arbitrators and administrators have said that parties to arbitration can get frustrated with the time and expense of arbitration, to the point that many companies refuse to agree to it. Some think that the increase in time and expense arises in part from the willingness of the parties' counsel to go along with, e.g., postponements; overly-thorough process; and other things that give counsel more flexibility (and also reduce counsel's risk of being criticized later by disgruntled clients for supposedly not having done enough to win). Consequently, this provision requires the agreement of the parties themselves, not merely of their counsel, to overrule any case-management decision of the Arbitral Tribunal.
Several of the streamlining steps in this clause are adapted from suggestions in the Debevoise & Plimpton LLP Protocol to Promote Efficiency in International Arbitration. See also, e.g., Elizabeth G. Thornburg, The Managerial Judge Goes to Trial, 44 U. Rich. L. Rev. 1261, 1280-81 (2010).
Thanks to the following for specific suggestions for language in this clause:
Thanks also to the following who provided input and comments:
Any errors are of course mine alone.
- Rule R-52(c) of the Commercial Arbitration Rules of the American Arbitration Association provides that "[p]arties to an arbitration under these rules shall be deemed to have consented that judgment upon the arbitration award may be entered in any federal or state court having jurisdiction thereof." Other arbitration rules likely have comparable provisions.
- Section 9 of the [U.S.] Federal Arbitration Act, 9 U.S.C. § 9, provides in part that "… If no court is specified in the agreement of the parties, then such application [to confirm the award] may be made to the United States court in and for the district within which such award was made"; section 13 provides for enforcement, as a judgment, of an order confirming the award.
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.
The chances are that the Arbitration Rules will include more-detailed confidentiality provisions. For example,
- 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. See, e.g., Veleron Holding, B.V. v. Morgan Stanley, No. 12 Civ. 5966(CM), slip op. at part II (S.D.N.Y. Apr. 16, 2014) (partially granting plaintiff's motion to unseal record). [Online link not available; try checking the U.S. federal courts' PACER system.]
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; see Claude R. Thomson & Annie M. K. Finn, Confidentiality in Arbitration …, Dispute Resolution Journal, May-Jul 2007.
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.
Compare Westgate Resorts, Ltd. v. Adel, 2016 UT 2, slip op. at 2, 5-7 (2016), where the Utah supreme court affirmed that the state's arbitration statute did not authorize the arbitration panel to award fees (in advance) for post-arbitration judicial enforcement of award. The supreme court noted that the parties had not briefed the question whether the district court could have awarded such fees, and so the supreme court did not address that question. See id. at 2 n.1.
On a related note: Invoking the 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 "Texas rule," which is to the same effect.) See Zurich American Insurance Co. v. Team Tankers A.S., No. 14-4036, slip op. at 11-15 (2d Cir. Jan. 28, 2015). There:
- The contract in suit provided for an award of attorney fees for successfully prosecuting a claim for breach of the contract.
- The agreement, though, did not provide for an award of fees to a respondent for successfully defending against a claim for breach.
- The district court had awarded the successful respondent its attorney fees anyway.
The Second Circuit reversed the district court. The appeals court rejected the respondent's argument that (i) the parties had agreed to be bound by the arbitral panel’s decision, and therefore (ii) the losing claimant breached that agreement by resisting entry of judgment in court on the award.
The Second Circuit held that:
For two reasons, we are unconvinced. … The parties having effectively incorporated FAA [Federal Arbitration Act] review into their contract, the argument that the [unsuccessful claimant] breached that contract by making arguments the FAA permits is unconvincing.
Second, even if the contract did oblige the [unsuccessful claimant] to forbear from resisting confirmation of the award, it would be to that extent unenforceable. Read that way, the contract would authorize a federal court to confirm the arbitral award while effectively preventing that court from ensuring that the award complied with the FAA. …
Id., slip op. at 12-13 (emphasis in original).
In a 2014 insurance-coverage case, the Tenth Circuit observed that:
The language arising out of has been construed broadly. Couch on Insurance explains:
The phrase ["arising out of" is] generally considered to mean "flowing from" or "having its origin in." Accordingly, use of these phrases does not require a direct proximate causal connection but instead merely requires some causal relation or connection.
Courts have split on where "arising out of" falls on the causation scheme with some courts finding it equivalent to "but for" causation and others finding it somewhere between "but for" causation and proximate causation.
Higby Crane Service, LLC v. National Helium, LLC, No. 13-3001 (10th Cir. May 13, 2014) (reversing and remanding summary judgment for plaintiffs) (citations omitted, extra paragraphing added), citing, among others, 7 Steven Plitt et al., Couch on Insurance § 101:52 (3d ed. 2005).
Each party acknowledges that this Agreement is the result of arm’s-length negotiations by sophisticated parties.
Contracts sometimes contain acknowledgements that the parties engaged in arms-length negotiations, so as to try to preclude either party from claiming duress, procedural unconscionability, etc. Such language is often seen in, for example, merger- and acquisition agreements. See generally Glenn D. West & W. Benton Lewis, Jr., Contracting to Avoid Extra-Contractual Liability — Can Your Contractual Deal Ever Really Be the "Entire" Deal?, 64 BUS. LAW. 999, 1036 (2009); the entire article is worth a complete and close reading.
Consider also an acknowledgement that each party had the opportunity to be represented by counsel.
Table of Contents
This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- Which party, if any, must obtain the consent of another party before Assigning this Agreement?
- [FILL IN]; each such party is referred to as an Assigning Party.
- Which party has the right to grant that consent?
- The other party; each such party is referred to as a Non-Assigning Party.
- Is a Pledge of rights under this Agreement (for example, a pledge of a right to payment) exempt from the assignment-consent requirement?
- If an Assignment is to be made in conjunction with an All-Asset Transfer, is that Assignment exempt from the consent requirement?
- Not specified.
- If an Assignment is to be made in conjunction with a Line-of-Business Asset Transfer, is that Assignment exempt from the consent requirement?
- Not specified.
- May the Non-Assigning Party withhold, delay, or condition its consent to assignment in its sole discretion, or must it instead not unreasonably do so?
- Not specified — applicable law will govern.
- If an Assignment is made without a required consent, is that Assignment a material breach of this Agreement?
- Not specified — applicable law will govern.
- If an Assignment is made without a required consent, is that Assignment to be deemed void?
- Not specified — applicable law will govern.
See the background reading for notes on:
- The consenting party's autonomy in granting consent — at discretion, or not to be unreasonably withheld?
- Exemptions from the assignment-consent requirement for:
- Assignment without required consent as material breach
- Voidness of assignment without required consent
(1) an assignment or pledge of a right under this Agreement; and/or
(2) a grant of a security interest in any such right, regardless whether the assignment, pledge or grant is absolute or collateral, SO LONG AS the assignment, pledge, or grant: (A) does not purport to delegate any obligation of the Assigning Party under this Agreement and (B) does not have such effect as a matter of law.
See the notes to the term sheet for links to notes on these subjects.
2. Additional Details
(b) An assignment does not relieve the assigning party of its responsibility to the non-assigning party for performance of its duties under this Agreement unless the non-assigning party expressly agrees otherwise in writing.
(c) Unless the assignment expressly states otherwise (e.g., in the case of a pledge), an assignee's acceptance of an assignment constitutes the assignee's promise to perform the assigning party's duties under this Agreement; that promise is enforceable by either the assigning party or the non-assigning party.
(d) An assignee of or Successor to an Assigning Party must obtain consent to Assignment of this Agreement to the same extent as the Assigning Party.
(e) For the avoidance of doubt, an assignee of or Successor to the Non-Assigning Party has the sole right to grant consent to an Assignment of this Agreement, to the exclusion of any predecessor Non-Assigning Party.
Subdivision (b) does not address whether an assignment of an agreement relieves the assigning party of its responsibility to third-party beneficiaries, if any (see also the Third-Party Beneficiary Disclaimer).
Table of Contents
- Legal background (under U.S. law)
- Business background: "Alice" might want to restrict "Bob's" ability to assign the agreement
- Government contracts might require consent by statute
- Consent exceptions for specific types of transaction
- Possible alternative: Consultation requirement?
- Assignment of rights only
- Assignment effect
- Consent to assignment: At discretion, or not to be unreasonably withheld?
- Assignment without required consent as material breach
- If an assignment is made without a required consent, is it void?
- Consent required in cases of mergers, etc.
Imagine these hypothetical facts:
- Justice is a teenaged singer who has posted a lot of homemade music videos to YouTube. As a result, he has become wildly popular with 'tween girls all over the world.
- Justice has a longstanding contract with Connie; the contract calls for him to do a birthday show for Connie's twelve-year old daughter and her friends.
- Then Justice gets a huge career break: The Why, a legendary rock group from the Sixties, want Justice to open for them in their reunion tour. Unfortunately, for Justice to open for The Why, he would have to miss Connie's daughter's birthday party.
- Justice comes up with a solution: His long-time friend, Sam, who is trying to break into the business, should sing at Connie's party instead, so that Justice can open for The Why.
- In that situation, though, a reasonable person likely would think that Sam was not an acceptable substitute for Justice at Connie's daughter's birthday party.
- Consequently, U.S. law probably would not allow Justice to delegate his birthday-party performance to Sam unless Connie consented to it.
Another example: Under U.S. law, licenses of intellectual property are an exception to the general rule of assignability — an IP licensee may not assign its license rights, nor delegate its license obligations, without the licensor's consent, even when the license agreement is silent on the subject. See, e.g.:
- Trademark licenses: In re XMH Corp., 647 F.3d 690 (7th Cir. 2011) (Posner, J.)
- Copyright licenses: Cincom Sys., Inc. v. Novelis Corp., 581 F.3d 431 (6th Cir. 2009)
- Patent licenses: Rhone-Poulenc Agro, S.A. v. DeKalb Genetics Corp., 284 F.3d 1323 (Fed. Cir. 2002)
For further discussion of the assignability of IP licenses, see this article, posted on the Web site of the Licensing Executives Society, by Finnegan Henderson attorneys John Paul, Brian Kacedon, and Douglas W. Meier.
The non-assignability of IP licenses is a good deal for IP owners and can put IP licensees in something of a bind. EXAMPLE: Imagine that you're a customer that will be taking a license to intellectual property, for example computer software, from a supplier. In the U.S., you can't assign the license without the supplier's consent — and the supplier might want to be the sole source of licenses, so that no one else can make money selling licenses.
For real-world examples of a software vendor controlling the supply of its software licenses in this way, see, for example:
- Vernor v. Autodesk, Inc., 621 F.3d 1102 (9th Cir. 2010) (vacating summary judgment granting declaratory judgment). In that case, Vernor bought used copies of Autodesk's AutoCad software from Autodesk's direct customers and then resold those copies on eBay. The appeals court held that Autodesk did not sell copies of its software, but licensed them, and therefore Vernor's actions were prohibited by copyright law, because the first-sale doctrine did not apply;
- The Sixth Circuit's Cincom case, in which a software supplier successfully sued a customer and, in effect, forced the customer to re-buy the customer's software license after the customer did a corporate reorganization;
- Adobe Systems Inc. v. Hoops Enterprise LLC, No. C 10 2769 (N.D. Cal. Feb. 1, 2012), in which the court granted partial summary judgment dismissing the defendants' counterclaim of copyright misuse.
Now imagine these different hypothetical facts:
- Supplier A and Customer have a contract for Supplier A to deliver a hill of beans to Customer's back yard.
- Supplier A discovers that another supplier, Supplier B, has a bean farm that's closer to Customer's house; Supplier B could deliver the beans to Customer's house with lower transportation costs.
- Supplier B is willing to buy Customer's bean-delivery contract from Supplier A; that way, both suppliers can make some money from the contract, and Supplier A can use his own resources to pursue other business.
- Customer, the buyer of the beans, doesn't care which supplier delivers the hill of beans, as long as someone makes it happen.
Supplier A's transfer of "the Customer contract" to Supplier B is referred to as an assignment of the contract. In the U.S. and similar legal systems, the law usually favors such assignments, because they promote economic efficiency, which is (usually) regarded as a Good Thing. As a result, Supplier A is normally free to assign the Customer contract to Supplier B, which also entails delegating Supplier A's contractual duties to Supplier B. This is more than a little bit like subcontracting. The major difference is that:
- If Supplier A were to subcontract to Supplier B, then Supplier B would deal with Supplier A, and Supplier A would deal with Customer.
- On the other hand, with an assignment of the contract, Supplier B would take over dealing directly with Customer — but either way, Supplier A would still be liable to Customer for any damage she suffered if Supplier B didn't deliver the hill of beans as promised.
An excellent general resource on this subject is Tina L. Stark, Assignment and Delegation, which is Chapter 3 of her book Negotiating and Drafting Contract Boilerplate (2003). Disclosure: Professor Stark is a friend and colleague; I've been using her Drafting Contracts textbook in my classes for a number of years now.
Why a party might want to restrict the other party's right to assign
In some situations, even though the law would normally allow assignment of a contract, one party to the contract might want its opposite number not to be free to assign it. Contracts often include language to this effect. Such language can be great for a party that has the right to consent to another party's assignment — and very not-great for a party that must obtain consent to such an assignment.
For example: You're a supplier. You're talking to a potential customer about a contract to sell them your stuff. The customer will often want you to agree not to assign the contract to anyone without their consent. The customer's rationale is basically this: We don't care if assignability is good for commerce in general: We want to decide who we do business with. (Yes, grammatically this gets the who-whom bit wrong.)
And customers sometime demand assignment-consent restrictions "Just Because." They're especially likely to do so if they went to some trouble picking out a supplier, for example by going through a request for proposal (RFP) process.
Problem 1: De facto control of assigning party's destiny
In a long-term contractual relationship, a customer's desire to restrict assignment can be dangerous for a provider. Suppose that a provider were required to get a customer's consent before the provider assigned a contract between them. That could give the customer a de facto veto over the provider's future strategic decisions, such as spinning off an unincorporated division, selling off a product line, or reshuffling its assets among different affiliates in its corporate "family."
EXAMPLE: In one high-profile, politically-sensitive case involving a Dubai company, the Port of New York and New Jersey was able to extract a $10 million consent fee, plus a commitment to invest $40 million in improvements to terminal operations, in return for its consent to an assignment of a lease agreement, as reported in the New York Times.
EXAMPLE: A woman dying of cancer arranged to leave her ownership interest in a real-estate investment to a trust for the benefit of her long-time companion. A court held that this was ineffective because of an anti-assignment clause in the investment contract documents. See Lee Graham Shopping Center, LLC v. Estate of Diane Z. Kirsch, 777 F.3d 678 (4th Cir. 2015) (affirming summary judgment).
Problem 2: Burden of obtaining consents
Obtaining assignment consents could be burdensome: In one case involving assignment consents, the assigning party wanted to sell a product line but had to seek consent from some 25 different companies. At a minimum, this would be time-consuming and could easily delay closing the deal; at worst, 25 different companies could each try to extract a price for their consent — possibly with each successive company demanding more than the previous one. See MDS (Canada) Inc. v. Rad Source Tech., Inc., 720 F.3d 833, 850 (11th Cir. 2013) (affirming district court's judgment in part and certifying question of sublicense-as-assignment to Florida supreme court), certified question answered in part, No. SC13-1215 (Fla. July 10, 2014).
Some government contracts, by law, cannot be assigned by a New York statute provides that, whenever a company enters into a contract with a state agency, the company cannot assign the contract without the agency's consent; if the contractor fails to obtain the consent, the agency shall revoke and annul such contract," and the contractor forfeits all payments except that needed to pay its employees. See N.Y. State Fin. L. art. 9, § 138. That, of course, would give the state agency considerable leverage — which New York state agencies apparently can be unabashed about wielding, as seen in the Dubai deal discussed above.
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 if Bob's company wanted to retain control over its own strategic destiny. It also could keep Bob's assignee ("Betty") from having to re-buy and pay again for an IP license that the assigning party already paid for once, as happened in the Cincom case discussed above.
In their contract negotiation, Bob might argue for a consent carve-out 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 might respond in the negotiation with something like this:
What if you decided to sell a product line or a division to one of our competitors? We need to retain control over that possibility. The only way for us to do that is to retain the absolute right to consent to any assignment you might make.
Possible alternative: Consultation requirement?
It might not be necessary to give Alice an absolute veto over an asset-disposition assignment by Bob. Instead, Bob might consider giving Alice the right to terminate the contract for convenience, as provided in the Non-Assigning Party May Terminate Agreement. Of course, the implications of termination would have to be carefully thought through.
Courts have distinguished between assigning an agreement in its entirety and assigning certain rights and benefits under the Agreement. Consider, for example, Bioscience West, Inc. v. Gulfstream Prop. & Cas. Ins. Co., No. 2D14-3946 (Fla. App. Feb. 5, 2016): In that case, an insurance policyholder assigned the benefits of her homeowner's insurance to an emergency water mitigation company (the "assignee"). The insurance carrier refused to pay the homeowner's claim, on grounds that the policy voided any "[a]ssignment of this policy" if made without the carrier's permission. In the trial court, the insurance carrier won summary judgment; after examining the policy language, though, the appellate court reversed, holding that the homeowner had not assigned the policy, but a post-loss right to payment. Id., slip op. at 4-7. (I haven't researched whether a court would apply the same reasoning in a case that didn't involve an insurance policy; in many jurisdictions, insurance policies are construed strictly against the insurance carrier and in favor of the policyholder.)
In a Wyoming case, a state district court granted summary judgment that an assignor of a contract interest who was not formally released was still obligated under the contract (but then held that enforcement was barred by laches). See Windsor Energy Group, L.L.C. v. Noble Energy, Inc., 2014 WY 96, 330 P.3d 285, 285 ¶ 1 (affirming on laches grounds).
If Bob wants to maintain his freedom to assign his contract with Alice, then he should at least consider asking Alice to agree that Alice will not unreasonably withhold, delay, or condition her consent. This requirement is set up to give Alice some "skin in the game." If the contract language didn't expressly require Alice to be reasonable in granting or withholding consent, then Alice might be tempted to drag her feet; that could cause delays, which in turn could scuttle Bob's proposed transaction.
One warning for Bob, though: This is another example of a "kicking a sleeping dog" clause — asking for a reasonableness requirement, but not getting the other side to agree to it, could backfire later.
- Suppose that during contract negotiations, Bob asked Alice to agree to such a clause, saying that consent to assignment would not be unreasonably withheld.
- Suppose also that Alice refused to agree to the proposed language, and the final, signed contract did not include the language.
- In that situation, a court could well construe that sequence of events as a signal that Alice and Bob implicitly intended the opposite of the requested language — namely that Alice could grant or withhold consent to an assignment by Bob at her pleasure.
And even an express reasonableness requirement might not be enough to keep Alice from dragging her feet, in the hope of extracting concessions from Bob or his assignee (see the discussion of the New York port lease agreement assignment).
Still, a prohibition against unreasonably withholding consent should make Alice at least think twice about doing so, because of the potential threat that Bob might sue for damages for killing his deal.
Unreasonable withholding of assignment consent under the law
Even if the agreement is silent as to unreasonable withholding of assignment consent, the law might have something to say about it:
• Section 1995.260 of the California Civil Code provides that:
If a restriction on transfer of the tenant’s interest in a lease requires the landlord’s consent for transfer but provides no standard for giving or withholding consent, the restriction on transfer shall be construed to include an implied standard that the landlord’s consent may not be unreasonably withheld. …
Apropos of that statutory provision, a California appeals court held in 2008 that a contract provision allowing the landlord to withhold consent “for any reason or no reason” was not to be construed as including an unreasonably-withheld standard, saying that “the parties’ express agreement to a ‘sole discretion’ standard is permitted under legal standards existing before and after enactment of section 1995.260, as long as the provision is freely negotiated and not illegal.” Nevada Atlantic Corp. v. Wrec Lido Venture, LLC, No. G039825 (Cal. App. Dec. 8, 2008) (unpublished; reversing trial-court judgment that withholding of consent was unreasonable).
• In the Pacific First Bank case, in a lease agreement prohibited the tenant from assigning the agreement, including by operation of law, without the landlord's consent. The lease agreement also stated that the landlord would not unreasonably withhold its consent to an assignment of the lease to a subtenant that met certain qualifications. Notably, though, the lease agreement did not include a similar statement for other assignments. The Oregon supreme court held that ordinarily, the state's law would have required the landlord to act in good faith in deciding whether or not to consent to an assignment. But, the court said, the parties had implicitly agreed otherwise; therefore, the landlord did not have such a duty of good faith. See Pacific First Bank v. New Morgan Park Corp., 876 P.2d 761 (Or. 1994) (affirming court of appeals decision on different grounds, and reversing trial-court declaration that bank-tenant had not materially breached lease agreement).
• In a factually-messy Eleventh Circuit case, the court upheld a trial court's finding that the owner of a patent, which had exclusively licensed the patent to another party, had not acted unreasonably when it refused consent to an assignment by the licensee to a party that wanted to acquire the licensee's relevant product line. MDS (Canada) Inc. v. Rad Source Tech., Inc., 720 F.3d 833, 850 (11th Cir. July 1, 2013) (affirming district court's judgment in part and certifying question of sublicense-as-assignment to Florida supreme court).
• The Tennessee supreme court held that "where the parties have contracted to allow assignment of an agreement with the consent of the non-assigning party, and the agreement is silent regarding the anticipated standard of conduct in withholding consent, an implied covenant of good faith and fair dealing applies and requires the nonassigning party to act with good faith and in a commercially reasonable manner in deciding whether to consent to the assignment." Dick Broadcasting Co. v. Oak Ridge FM, Inc., 395 S.W.3d 653, 656-57 (Tenn. 2013) (affirming vacation of summary judgment and remand to district court).
• Likewise, the Alabama supreme court alluded to such a possibility in the Shoney's case. The contract in suit specifically gave Shoney's the right, in its sole discretion, to consent to any proposed assignment or sublease. The supreme court held that this express language trumped a rule that had been laid down in prior case law, namely that a refusal to consent is to be judged by a reasonableness standard under an implied covenant of good faith. "Succinctly stated, under Alabama law 'sole discretion' means an absolute reservation of a right. It is not mitigated by an implied covenant of good faith and fair dealing in contracts because an unqualified reservation of a right in the sole discretion of one of the parties to a contract expresses the intent of the parties to be subject to terms that are inconsistent with any such implied covenant." Shoney's LLC v. MAC East, LLC, 27 So.3d 1216, 1220-21 (Ala. 2009) (on certification by Eleventh Circuit).
• State law also might impose a reasonableness requirement if a commercial- or residential lease agreement requires the landlord's consent before the tenant can assign the lease. I haven't researched this in any depth, but I did run across an unpublished California opinion and an old law review article, each collecting cases (the citations for which I seem to have misplaced).
Unreasonable withholding as retroactive consent to assignment
The retroactive-consent language of the not-to-be-unreasonably-withheld option is adapted from language suggested in a comment by Ric Gruder at Ken Adams's blog — but it could be dangerous for an assigning party, because as a practical matter it could transform the option into an illusory, sleeves-from-my-vest concession by the non-assigning party.
The not-to-be-unreasonably-withheld option states that damages for unreasonable withholding are not limited unless the Agreement expressly says so.
Drafters should consider whether a would-be assigning party's damages for a busted M&A deal should be categorized as "consequential" damages — and thus subject to an exclusion of consequential damages set forth elsewhere in the agreement. If that were to be the case, then the non-assigning party might not have to pay any damages if the contract excluded such damages, as many contracts do.
To give an idea of the potential size of a damages award in such a case, recall the famous Pennzoil vs. Texaco case: Texaco was hit with a $10.5 billion jury verdict — in 1987 dollars — for tortiously interfering with Pennzoil's agreement to acquire Getty Oil. (The case ultimately settled for some $3 billion.) See, e.g., Tamar Lewin, Pennzoil-Texaco Fight Raised Key Questions, N.Y. Times, Dec. 19, 1987.
Motivation 1 for this provision: Leverage
To put the material-breach option into context, suppose that:
- Alice and Bob are negotiating a contract.
- Alice wants the contract to say that Bob must obtain Alice's prior written consent if he wants to assign the contract to someone else.
- Alice also wants the contract to state that if Bob fails to obtain Alice's consent to assignment, then that will constitute a material breach of the contract.
In this situation, Alice probably wants the right not merely to seek damages, but also the right to terminate the Agreement — or even rescind it, that is, unwind it — if Bob were to make an unauthorized assignment of the Agreement. That prospect might give Alice a lot of leverage to demand money or other concessions from Bob or his would-be assignee.
Alice could get that right if the contract stated that Bob's assignment of the agreement without Alice's consent constitute a material breach.
(But giving the non-assigning party the right to terminate could help break an impasse about the assignment-consent issue; see the Non-Assigning Party May Terminate Agreement provision.)
Motivation 2: Greener pastures
A material-breach clause would also give Alice an excuse to scrap her contractual relationship with Bob and take up with another, more-lucrative party.
The desire to ditch an existing contract relationship seems to have been at work in Hess Energy Inc. v. Lightning Oil Co., 276 F.3d 646, 649-51 (4th Cir. 2002) (reversing summary judgment). In that case:
- The contract in suit was a natural-gas supply contract.
- The customer buying the natural gas was acquired by a larger company, which became the customer's new parent company.
- The new parent company took over some of the customer's contract-administration responsibilities, such as payment of the natural-gas vendor's invoices.
- The vendor decided it wanted to sell its natural gas to someone else – at a higher price than it was getting under the contract with its existing customer.
- The vendor therefore sent a notice of termination to the customer's new parent company; the alleged grounds for termination were that the customer had supposedly "assigned" the agreement to its new parent company, in violation of the contract's assignment-consent provision.
The Hess appeals court expressed considerable doubt that the customer had indeed assigned the contract. The court went on to say that, even if the customer had in fact assigned the contract, the resulting breach of the agreement would not have been a material breach, and therefore the vendor did not have the right to terminate the contract.
But what if it's later adjuged not to have been a material breach?
Suppose further that Alice doesn't include a material-breach clause in the assignment-consent provision of her contract with Bob. In that case:
- Alice might not be able to terminate the contract merely because Bob assigned the agreement without her consent. That in turn could mean that Alice would be stuck with a new contract partner. Alice's only remedy against Bob for assigning without his consent would presumably be money damages — and it might be difficult and expensive for Alice to establish, with evidence, the fact and amount of her damages.
- Moreover, if Alice did give notice of termination for material breach, Alice's action might itself constitute a material breach of its own, analogous to what happened in the Southland Metals case.
Suppose that Bob purports to assign his contract with Alice without her consent, in violation of a requirement in the contract. Is the assignment a nullity? Or instead is the assignment technically valid, but a breach of the agreement, for which Alice can recover her proved damages – if any? The law varies on this point.
The classical approach
A court applying the so-called 'classical approach' might hold that the unconsented assignment was void. That was the result in Colorado's Condo v. Connors case, where the state's supreme court affirmed a holding that an assignment of an interest in a limited liability company (LLC) was void because consent to the assignment was not obtained as required by the LLC operating agreement. See Condo v. Connors, No. 10sc703 (Colo. Dec. 19, 2011).
The modern approach
In contrast, a court applying the so-called 'modern approach' (or one of its variations) 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." See id., slip op. at 10 & n.4, 19-25 (citing cases).
A similar result occurred in Connecticut's David Caron Chrysler case: the state supreme court followed the modern approach, holding that the acquisition of majority interest in an LLC without consent, in violation of a contractual prohibition, was not void. See David Caron Chrysler Motors, LLC v. Goodhall's, Inc., 43 A.3d 164, 170-72 (Conn. 2012) (reversing decisions of trial- and appellate courts; reviewing case law from numerous jurisdictions).
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The law seems to vary as to whether a merger or similar transaction effects an assignment of contracts by operation of law.
• In one case, the Delaware chancery court ruled, on summary judgment, that "mergers do not result in an assignment by operation of law of assets that began as property of the surviving entity and continued to be such after the merger." Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH 62 A.3d 62 (Del. Ch. 2013) (partially granting motion for summary judgment) (emphasis added).
• A California federal court, reviewing case law, noted the existence of variations in different states' laws on this point. The court held that the law governing the license agreement would control. See Netbula, Llc v. BindView Development Corp., 516 F. Supp.2d 1137, 1148-50 (N.D. Cal. 2007), where the court granted the defendants' motion for summary judgment dismissing the plaintiff's claim of copyright infringement. (Disclosure: I was vice president and general counsel of the defendant BindView during most of the relevant events and was a deposition witness in the lawsuit.)
• See generally a state-by-state survey by Jolisa Dobbs of the Thompson Knight law firm at http://goo.gl/Sd1wz3.
Indemnity rights under a contract might disappear if the indemnified party were to merge without the consent of the indemnifying party. This was the issue in a 2011 Delaware case: the parties' indemnification agreement prohibited assignment, but also stated that the rights of the indemnified party extended to its successors and assigns. The court held that the contract language was ambiguous about whether the indemnity right survived the unauthorized merger; consequently, the court denied a motion for summary judgment brought by the indemnified party's successor in interest. ClubCorp, Inc. v. Pinehurst, LLC, C.A. No. 5120-VCP, slip op. at 6 (Del. Ch. Nov. 15, 2011) (Parsons, V.C.) (denying motion for summary judgment). See also the Indemnity rights not assignable provision.
The Oregon supreme court ruled, in effect, that a bank materially breached a lease agreement when it merged with its own wholly-owned subsidiary without first obtaining the landlord's consent. See Pacific First Bank v. New Morgan Park Corp., 876 P.2d 761 (Ore. 1994) (reversing trial-court judgment).
That ruling presumably gave the landlord the right to demand whatever it wanted from the bank to cure the breach — at least if the bank wanted to continue to occupy the leased premises.
In the Sixth Circuit's Cincom case, a customer of a software vendor did an internal reorganization involving certain merger activity among corporate affiliates. As a result, the vendor's software ended up being operated by a sister company of the original customer.
The vendor demanded that the sister company buy a new license; when the sister company refused, the vendor successfully sued for copyright infringement and received the price of a new license as its damages.
The appeals court held that it did not matter whether state law would have considered the merger to have effectuated an assignment of the software license: Under the federal law governing the assignment of copyright licenses, said the court, the merger did indeed constitute an assignment, and the consent of the licensor was required. Cincom Sys., Inc. v. Novelis Corp., 581 F.3d 431 (6th Cir. 2009) (affirming summary judgment in favor of software vendor).
(DCT comment: The Cincom case strikes me as shortsighted behavior on the part of the software vendor — I can't imagine that the customer was ever again willing to buy anything else from that vendor.)
A Seventh Circuit opinion followed what seems to be the general (U.S.) rule that a mere change of control of a licensee corporation, through a transfer of the corporation's stock to a new owner, does not constitute an "assignment" of the license that would require consent of the licensor (assuming, that is, that the licensee remains a separately-functioning corporation):
… [T]he sale of all the stock in a closely held corporation whose principal asset is a contract does not violate a nonassignment clause even when the stock is sold to a person to whom, previously, the counterparty had explicitly refused that the contract be assigned.
If the counterparty to a contract with a corporation wishes to limit the persons to whom ownership or control of the corporation can be sold, it must do this through specific language to that effect in the contract (a "change of control" clause); a nonassignment clause will not suffice.
[T]he mere change of stock ownership would not nullify a non-assignable license, absent a change in control provision.
VDF Futureceuticals, Inc. v. Stiefel Labs., Inc., No. 14-3232, slip op. at 7 (7th Cir. July 10, 2015) (Posner, J.) quoting Kenneth Ayotte & Henry Hansmann, Legal Entities as Transferable Bundles of Contracts, 111 Mich. L. Rev. 715, 724 (2013), and Elaine D. Ziff, The Effect of Corporate Acquisitions on the Target Company’s License Rights, 57 Bus. Lawyer 767, 789 (2002).
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IF: A Tribunal holds, in a final judgment or award (or comparable action) from which no further appeal is taken or possible, that the Non-Assigning Party unreasonably Withheld its consent to an assignment of this Agreement; THEN:
(1) the Non-Assigning Party will be deemed to have given its consent to that assignment, effective as of the date the consent was requested; and
(2) the Non-Assigning Party will not be liable to the Assigning Party, nor to any third party, for money damages for having Withheld its consent.
This could be seriously-bad news for an assigning party; see this discussion.
For the avoidance of doubt: (1) A third-party beneficiary of this Agreement (if any) may not assign its rights deriving from that status; and (2) this provision is not to be interpreted as implying that any third party is entitled to benefit from this Agreement.
See also Third-Party Beneficiary Disclaimer.
(a) IF: An Assigning Party assigns this Agreement; THEN: The other party ("Non-Assigning Party") may terminate this Agreement, regardless whether the assignment was a breach of this Agreement, by giving notice of termination to the Assigning Party or its assignee.
(b) Any notice under subdivision (a) must be effective no later than the end of the Termination Period (namely, The 90-day period following the Non-Assigning Party's receipt of written notice of the assignment from either the Assigning Party or the assignee).
(c) For the avoidance of doubt, the Non-Assigning Party's right to terminate under this clause does not limit:
(1) any right that the Non-Assigning Party might have to terminate this Agreement if the assignment in question constituted a breach of this Agreement; nor
(2) any remedy that the Non-Assigning Party might have for such a breach.
- Sometimes parties can get into an impasse about assignment-consent provisions. a provision such as this one could help break an impasse between, say, a customer that wants an assignment-consent right, so as to control with whom it does business, and a vendor that wants to maintain control of its strategic destiny.
- The 90-day time for exercising the termination option gives the Assigning Party (and its assignee) a significant incentive to notify the non-assigning party as soon as the assignment becomes effective. That's because the only way the clock will start running on the non-assigning party's right to terminate is for the assignor or the assignee to give notice to the non-assigning party.
- The [U.S.] Uniform Commercial Code has a provision similar to this clause, namely UCC § 2-210(5) (which applies by its terms only to sales of goods). It 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. Under the latter UCC section, the non-assigning party may suspend its performance (if commercially reasonable) and eventually treat the agreement as repudiated if the assignee does not provide adequate assurances. agreement if it does not receive adequate assurances.
See also Termination Clause.
(a) The term Operation-of-Law Transaction refers to a merger, consolidation, amalgamation, or other similar transaction or series of transactions involving the Assigning Party in which the Assigning Party is not the surviving entity, regardless whether an assignment is deemed to occur by operation of law.
(b) An Operation-of-Law Transaction requires Consent to the same extent, if any, as would an Assignment by the Assigning Party outside of such a transaction.
A consent requirement for an assignment by operation of law could be quite dangerous for the assigning party, as discussed in the background reading.
(a) For purposes of this provision, the term Change of Control refers to [TO DO: DEFINITION].
(b) A Change of Control requires Consent to the same extent, if any, as would an Assignment by the Assigning Party outside of such a transaction.
A consent requirement for a change of control could likewise be quite dangerous for the assigning party, as discussed in the background reading.
(a) A non-assigning party may treat any assignment that delegates the assigning party's performance obligations without the non-assigning party's consent as creating reasonable grounds for insecurity.
(b) In any such case, without prejudice to the non-assigning party's rights against the assigning party:
(1) The non-assigning party may, by notice in accordance with this Agreement, demand assurance of due performance, from one or more of the non-assigning party and the assignee, that is commercially reasonable under the circumstances of the particular case.
(2) Until the non-assigning party receives such assurance, the non-assigning party may, if commercially reasonable to do so, suspend any performance under this Agreement for which it has not already received the agreed return.
(3) Failure by the assignee and the assigning party to provide such assurance, within a reasonable time (not to exceed 30 days) after the effective date of the notice, is a repudiation of this Agreement.
The Associated Individuals of an organization, if any are the following: (1) Each individual who at the relevant time is an employee, officer, director, shareholder, general- and limited partner, member, or manager of that organization; and (2) any other individuals specified in this Agreement, if any.
This definition is used, for example, in the Exclusion of Consequential Damages, Etc..
Parties sometimes want to extend a contract's limitations of liability to individuals who might be brought in as defendants in their personal capacities. For example:
- A plaintiff might believe that a defendant company had few assets that could be seized to satisfy a judgment, but that the officers of the company personally owned substantial assets.
- In that case, the plaintiff's counsel might be tempted to name the company officers as defendants in their personal capacities; among other advantages, that would increase the pressure on the company to settle the case before trial.
An association's rules might not count as a binding contract. From a Fifth Circuit case:
Dr. Barrash claims that because he was a member of the [American Association of Neurological Surgeons ("AANS"), the association’s bylaws formed a contract between them. The bylaws include the disciplinary procedures to be followed by the [AANS's Professional Conduct Committee ("PCC")]. Dr. Barrash argues that the AANS breached the bylaws when it censured him because the PCC did not strictly comply with its own procedures. He claims that this breach caused damages because he lost income opportunities as an expert witness following publication of the censure.
To date, no Texas court has allowed a plaintiff to challenge a professional organization’s internal disciplinary procedures under a breach of contract theory.
Based on Texas precedent and the doctrine of judicial non-intervention, we find that Dr. Barrash has failed to state a plausible breach of contract claim.
Barrash v. American Association of Neurological Surgeons, Inc., No. 14-20764, slip op. at 8 (5th Cir. Jan. 29, 2016) (affirming dismissal for failure to state a claim upon which relief can be granted).
From a Utah supreme court case:
It is a basic principle of contract law that parties are generally free to contract according to their desires in whatever terms they can agree upon. This includes assuming risks that third parties or external environmental circumstances will fail to conform to the parties‘ expectations.
And absent language in the contract to the contrary, a party who contracts knowing that governmental permission or license will be required ordinarily assumes the obligation of assuring that permission will be granted.
Mind & Motion Utah Investments, LLC, v. Celtic Bank Corp., 2016 UT 6, para. 35 (affirming summary judgment) (footnotes omitted) (citing, among other things, 14 James P. Nehf, Corbin on Contracts § 76.5 (2001)) (extra paragraphing added)
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(a) In any litigation, arbitration, or other action arising out of or relating to this Agreement or any transaction or relationship resulting from it, the prevailing party, if any, will be entitled to recover its Dispute Expenses from the other party, in addition to any other relief that may be granted.
(b) All provisions of this Agreement relating to the recovery of attorney fees and other Dispute Expenses will survive each of the following:
(1) any termination, expiration, or other coming to an end of this Agreement; and
(2) the entry of a judgment, arbitration award, or other decision in a contested proceeding — for the avoidance of doubt, this Attorney Fees Clause is not to be considered to have merged into that decision.
- Drafters could consider defining the term Recovering Party, in the text, as one of the following:
- any party that succeeds in enforcing one or more rights under this Agreement;
- a specified party if it is the prevailing party (but not the other party even if it prevails);
- neither party — that is, each party will bear its own attorney fees and expenses.
- While this provision uses the term Dispute Expenses, the concept is often stated as attorneys' fees or attorney's fees. Legal-language maven Bryan Garner suggests using the singular attorney fees.
- Subdivision (b) is informed in part by the attorneys-fees clause in the contract in suit in Seaport Village Ltd. v. Seaport Village Operating Co., No. 8841-VCL (Del. Ch. Sept. 24, 2014) (letter opinion awarding attorney fees).
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- Legal background: The "American rule" vs. "loser pays"
- What constitutes a prevailing party?
- The Texas rule: A successful contract enforcer can recover fees, but only from an individual or corporation
- The California rule: It's all "prevailing party"
- Attorney fees in arbitration awards
- One-sided attorney-fee clauses might well be enforced
- Attorney-fee awards for failure to prove certain serious accusations
The general rule in the U.S., sometimes known as the "American rule," is that each party must pay its own attorney fees. See, e.g., Zurich American Insurance Co. v. Team Tankers A.S., No. 14-4036, slip op. at 11 (2d Cir. Jan. 28, 2015) (reversing award of attorney fees).
Some, though, view a prevailing-party allocation of attorney fees as fundamentally more fair: If you lose a case, presumably you were responsible for the case having to be litigated, so you should pay the attorney fees and expenses that you forced the prevailing party to spend.
(The prevailing-party rule is sometimes called the "loser pays" rule, or the "everywhere but America" rule.)
Complicating the picture: Big companies sometimes regard litigation expenses as a cost of doing business. Once in a while, a big company might try to use its superior financial strength to bully a weaker counterparty. Smaller companies can try to offset that advantage by negotiating a prevailing-party clause.
Of course, a prevailing-party clause raises the stakes for a smaller litigant as well: If the smaller litigant were to lose the case, then the smaller litigant would be liable for the bigger litigant's attorney fees; those fees will often have been billed by a big, expensive law firm.
What constitutes a prevailing party?
Some courts have held that, if the putatively-winning side is not the "prevailing party" if it did not receive any monetary damages or equitable relief. See, e.g., Intercontinental Group Partnership v. KB Home Lone Star LP, 295 S.W.3d 650 (Tex. 2009) (5-4 reversal of $66,000 attorney fees award to plaintiff that had received a zero-dollar damages award and no declaratory or other equitable relief).
Some commentators have suggested that drafters should specify what they mean by "prevailing party," but my guess is that most will not want to do so.
The Texas rule: A successful contract enforcer can recover fees, but only from an individual or corporation
If a party negotiating a contract thinks it might be more likely to be the defendant in a dispute than the plaintiff, it might want to affirmatively include a "pay your own lawyer" provision in the contract.
In Texas, absent an agreement otherwise, a party that successfully enforces a claim against an individual or corporation on an oral or written contract — but not a party that successfully defends against an enforcement action — is entitled to recover attorney fees. See Tex. Civ. Prac. & Rem. Code § 38.001.
Courts have held that under section 38.001, attorney fees are recoverable only from an individual or corporation. See Hoffman v. L&M Arts, No. 3:10-CV-0953-D, slip op. at part III (N.D. Tex. Mar. 6, 2015) (citing cases). In 2015, a bill to change that died in committee in the Texas Legislature. See Tate Hemingson, Recovery of attorney fees under Civil Practice & Remedies Code Section 38.001 (Strasburger.com 2015).
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.
Attorney fees in arbitration awards
In an arbitration proceeding, applicable law might override the parties' agreement that attorney fees can, or cannot, be awarded. See Recovery of Attorney Fees in International Arbitration: the Dueling "English" and "American" Rules, by John L. Gardiner & Timothy G. Nelson of Skadden Arps, available at http://goo.gl/jsjy4 (accessed Jan. 30, 2010).
One-sided attorney-fee clauses might well be enforced
Some contracts contain unilateral attorneys' fee clauses; for example, a real-estate lease agreement might state that the landlord can recover its attorney fees if it has to sue the tenant, while remaining silent as to whether the tenant can ever recover its attorney fees. (Under the 'American rule,' that would normally mean that the tenant could not recover, even if it were the prevailing party in a suit brought by the landlord — except in California, as noted above.)
Such unilateral clauses might well be enforceable. See, e.g., Allied Indus. Scrap, Inc., v. OmniSource Corp., No. 14-3403 (Ohio Jan. 21, 2015) (reversing district court's denial of attorney fees), discussing Wilborn v. Bank One Corp., 906 N.E.2d 396 (Ohio 2009) (affirming dismissal of borrowers' lawsuit against lenders claiming that unilateral attorneys' fee clause in residential mortgage loan agreement form was void as contrary to public policy).
Many litigators 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 warranted by the facts. For an example of such a loaded-up case, see Falco v. Farmers Ins. Gp., No. 14-2733 (8th Cir. Aug. 3, 2015), in which the appeals court affirmed summary judgment in favor of defendants, including dismissal of the plaintiff's claim that the defendants had supposedly breached a fiduciary duty.
The strategic thinking often seems to be something like this: We might as well go ahead and make these accusations — there's no downside to us for doing so, and the jury might believe the accusations. 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.
Such strategic thinking can work out very well for the claimant (sometimes spectacularly so, as discussed elsewhere in this work).
Unfortunately, even when utterly baseless, Serious Accusations can pose major problems for their targets. Such accusations:
- can unfairly influence jurors;
- in themselves 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;
- 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
- 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 Serious Accusations, by giving a prospective accuser a significant financial downside if it proceeds to make such an accusation but then fails to prove it.
The concept was inspired by a remark by my then-law partner (and longtime friend and mentor), über-patent-litigator John F. Lynch. At that time, 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 — paraphrasing 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. This provision 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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(a) This provision is agreed to as an incentive for the parties to amicably resolve any subsidiary- or ancillary dispute that is brought before a tribunal in a case (each, a Motion).
(b) The prevailing party in the Motion will be entitled to recover its Dispute Expenses for the Motion unless the Tribunal, for good cause, rules otherwise; the Tribunal's decision on the attorney-fee recovery issue for the Motion is final and non-appeable.
(c) Motion-related Dispute Expense recoveries may not be recaptured as part of a later recovery of Dispute Expenses for the overall action.
EXAMPLE: Suppose that a party ("Alice") recovers Dispute Expenses from another party ("Bob") in connection with a Motion in an action. Suppose also that Bob later prevails in the overall action and becomes entitled to recover Dispute Expenses from Alice, either by agreement or by law. In that case, Bob is not entitled to a refund of the Dispute Expenses that Alice recovered from him in connection with the Motion.
(a) Serious Accusation refers to an assertion (i) by one or more individuals and/or organizations (each, a "claimant"), (ii) before any Tribunal, (iii) by way of claim or defense to a claim, (iv) that one or more other individuals and/or organizations (each, a "defendant") engaged or is engaged in one or more of the following:
(1) conduct punishable as a felony;
(3) bad faith;
(5) breach of an express or implied obligation of good faith and fair dealing;
(6) breach of fiduciary duty;
(7) gross negligence;
(8) willful misconduct; and
(9) any other particular Serious Accusations expressly agreed to in writing by the parties, if any — for the avoidance of doubt, it is immaterial if one or more such other particular Serious Accusations is also in another category listed above.
(b) Applicability: This Attorney-Fee Liability for Failure to Prove Serious Accusation provision applies in any case in which:
(1) a claimant makes a Serious Accusation; and
(2) in the final judgment in litigation or final arbitration award, as the case may be, the Tribunal does not find that the claimant proved the Serious Accusation by the quantum of proof required by law, or if greater, the quantum of proof required by this Agreement.
(c) Liability: In any case described in subdivision (b), regardless of any other outcome of the litigation or arbitration, the claimant:
(1) must reimburse the defendant for all of its Dispute Expenses incurred in the entire case (not merely in defending against the Serious Accusation), unless the Tribunal determines otherwise for good reason supported by clear and convincing evidence;
(2) is not entitled to recover any of its attorney fees or other expenses or costs of the litigation or arbitration, and hereby KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any such recovery, regardless whether such recovery would otherwise be available under this Agreement or applicable law; and
(3) must pay the defendant the Serious Accusation Liquidated Damages Amount (namely, USD $100,000) to compensate the defendant for the additional expense, burden, and inconvenience of defending against all of the one or more Serious Accusations in the case, over and above the defendant's Dispute Expenses.
(d) Severability: The parties intend for subdivision (c)(3) to be severable.
This provision is intended to discourage parties and their trial counsel from making baseless accusations in the hope of prejudicing the jury, judge, or arbitrator; see this discussion for more details.
(a) Background: The parties believe that the following categories of dispute-resolution provision (each, a Dispute-Resolution Provision) hold out the possibility of promoting amicable settlement of disputes between the parties, or at least of helping reduce the expense and burden of such disputes:
(2) early neutral evaluation;
(3) economical litigation agreement;
(4) escalation of disputes;
(5) forum selection;
(6) jury-trial waiver;
(8) mini-trial to management;
(9) service of process by courier.
(b) Applicability: To create an incentive for the parties to comply with any Dispute-Resolution Provisions that are included in this Agreement (if any), this clause applies if a party (the Non-Participating Party) does any of the following:
(1) fails, upon written request by another party, to participate in dispute-resolution efforts or proceedings required by a Dispute-Resolution Provision; or
(2) challenges the validity or enforceability of a Dispute Resolution Provision.
(c) Disqualification: No Non-Participating Party will be entitled to recover its Dispute Expenses, and each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES ANY CLAIM TO SUCH RECOVERY to the extent that the waiving party is such a Non-Participating Party, even if the Non-Participating Party:
(1) would otherwise have been entitled to such a recovery, whether under this Agreement or under applicable law; and/or
(2) prevails in the dispute in question or in the challenge against validity or enforceability of the Dispute-Resolution Provision in question.
(d) For the avoidance of doubt, this Attorney-Fee Recovery Waived by ADR Non-Participation provision does not limit any other party's right to relief, if any, in respect of an action or omission by the Non-Participating Party.
This clause is modeled on a mediation provision in a standard California residential real-estate purchase agreement, which has been enforced at least twice by courts. See generally:
- Cullen v. Corwin, 206 Cal. App. 4th 1074, 142 Cal. Rptr. 3d 419 (2012) (reversing award of attorney fees to prevailing defendant, on grounds that the defendant had refused to participate in mediation as required by contract);
- Lange v. Schilling, 163 Cal. App. 4th 1412 (2008) (reversing award of attorney fees to prevailing plaintiff).
Cf. Thompson v. Cloud, 764 F.3d 82 (1st Cir. 2014), where the court denied the winning party's request for attorney fees under an analogous clause, on grounds that the winning party never asked for mediation and thus the losing party didn't refuse to mediate. See id. at 92.
The use of bold-faced type for the waiver language is for conspicuousness.
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This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- 1. Which party must keep records under this Agreement?
- [FILL IN] (the "Recordkeeping Party").
- 2. What records must the Recordkeeping Party keep?
- [FILL IN] (the "Auditable Record").
- 3. Which party has the right to audit Auditable Records?
- [FILL IN] (the "Auditing Party").
- 4. Who may conduct audits under this Agreement?
- (i) Any Big Four accounting firm, and (ii) any other auditor proposed by the Auditing Party and reasonably acceptable to the Recordkeeping Party.
- 5. How much advance notice of an audit must the Auditing Party give to the Recordkeeping Party?
- At least ten business days before the requested audit start date.
- 6. What is the deadline for the Auditing Party to give notice of a given audit?
- For any given Auditable Record, (i) the end of the record-retention period, specified in this Agreement or by law, for the particular Auditable Record(s) in question, or (ii) if no record-retention period is specified in this Agreement or by law, then two years after the end of the calendar quarter in which that Auditable Record was most-recently updated, in either case except for good reason clearly shown.
- 7. What is the deadline for the auditor(s) to complete a given audit?
- Three months after the effective date of the request for audit, except for good reason clearly shown.
- 8. How often may the Auditing Party conduct audits?
- No more than once per 12-month period, and once per period audited, except for good reason clearly shown.
- 9. What interest rate may be charged for over- or underpayments revealed by an audit?
- The maximum rate permitted by law, referred to as the Audit Interest Rate.
- 10. The term Expense-Shifting Threshold Percentage refers to:
- Deadlines: Three months should normally be more than enough time for an auditor to complete a reasonable audit unless one or another party is unreasonable about scheduling, access, etc. See also the definition of good reason.
- Record retention: At some point, the recordkeeping party might want to be able to get rid of its records; also, it won't want to have to support an audit of (say) 20 years of past records. See also the definition of good reason.
- Audit frequency: An audit might end up being at least somewhat burdensome and disruptive to the recordkeeping party; most recordkeeping parties will want to limit the auditing party's ability to initiate audits. See also:
(a) Each audit is to be conducted:
(1) at the location or locations where the Auditable Records are kept in the ordinary course of business, during the regular working hours, at that location, of the party having custody of the records; or
(2) at the Recordkeeping Party's option, at one or more other reasonable times and places designated in advance by the Recordkeeping Party in consultation with the Auditing Party.
(b) The Recordkeeping Party is to make its relevant personnel reasonably available to the auditor(s), and direct them to answer reasonable questions from the auditor(s), except as otherwise provided in this Agreement.
(c) The Auditing Party's right to audit Auditable Records does not extend:
(1) to information that, under applicable law, would be immune from discovery in litigation, for example on grounds of attorney-client privilege, work-product immunity, or any other privilege; nor
(2) to clearly-unrelated or -irrelevant information.
(d) IF: An audit is to be conducted at one or more sites controlled by the Recordkeeping Party; THEN: If so requested by the Auditing Party, the Recordkeeping Party is to provide the auditor(s) with appropriate facilities at the audit site(s), of the type customarily used by knowledge-based professionals. Such facilities are to include, for example, appropriate furniture, lighting, air conditioning, electrical outlets, and Internet access.
(e) The Recordkeeping Party need not give the auditor(s) access to the Recordkeeping Party's facilities, computer systems, etc., to the extent inconsistent with any facility-access restrictions that are expressly agreed to in writing.
(f) Auditable Records are to be made available for audit in the form, electronic or otherwise, in which the Recordkeeping Party keeps those records in the ordinary course of the Recordkeeping Party's business.
(g) The auditor(s) may make and keep copies of the records that it audits, so long as the auditor(s):
(1) comply with the audit-confidentiality requirements of this Agreement; and
(2) return or destroy the copies, in accordance with the auditor's regular, commercially-reasonable policies and processes, within a reasonable time after the end of the last period for which Auditable Records are required to be maintained under this Agreement or by law.
- Auditor's copies of records: 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.
- Outside auditors might insist on being able to take copies with them to file as part of their work papers.
- 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.
- Location: This provision reminds drafters that in an unfriendly audit, the auditing party might try to demand that auditable records be produced for audit at a location not desired by the recordkeeping party, or vice versa. In some contracts it might be desirable for the audit provision to specify either (1) an agreed location for audits, or (2) if a specific location can't be satisfactorily determined in advance, an agreed procedure for determining the location if the parties are unable to agree on one. (This is an example of the truth that if parties can't agree in advance on an outcome – possibly because one or more of them simply doesn't know what outcome they want – then perhaps they can agree on a process for determining the outcome when the circumstanes arise.)
- Where kept in the ordinary course of business: An auditing party probably would not want a recordkeeping party to just print out its electronic records on paper and deliver them to the auditors; in all likelihood, that would significantly increase the cost of the audit. See Ryan C. Hubbs, The Importance of Auditing In An Anti-Fraud World — Designing, Interpreting, And Executing Right to Audit Clauses For Fraud Examiners, at 4 (Assoc. of Certified Fraud Examiners 2012).
(a) IF: An audit reveals the apparent existence of a billing- or payment discrepancy such as (for example) over- or underbilling or over- or underpayment; THEN: The party benefiting from that discrepancy is to promptly take such action as may be necessary to remedy the discrepancy, including, for example, refunding an overpayment or paying a shortfall, as the case may be.
(b) IF: A party, due to its own error, must pay a shortfall or refund an overpayment under subdivision (a); THEN: That party must also pay interest on the shortfall or refund at the Audit Interest Rate.
CAUTION: If an agreement is going to provide for charging interest on past-due amounts apart from an audit provision, then that interest provision probably should be separate from the audit provision. In the 2014 Cellport case, a contract drafter's failure to keep the two provisions separate resulted in a contract plaintiff's winning the case, but receiving a much-lower interest rate than was called for by its contract. See Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016, 1028-29 (10th Cir. 2014).
The Recordkeeping Party is to reimburse the Auditing Party for reasonable expenses actually incurred — for example, reasonable auditors' fees and expenses — if an audit reveals the existence of one or more of the following:
(1) a discrepancy in billing or payment, for the period being audited, that: (A) is equal to or greater than the Expense-Shifting Threshold Percentage; and (B) was caused by an error made by, or imputable to, the Recordkeeping Party; and (C) favors the Recordkeeping Party; or
- Typical expense-shifting thresholds: The threshold for shifting audit expenses might well be negotiable, often falling in the range between 3% and 7% for royalty-payment discrepancies and perhaps in the range of 0.5% for services billing discrepancies.
- Discrepancy for the period being audited: The discrepancy revealed by the audit must exceed the stated threshold percentage for the period being audited. That will help to avoid unfair expense shifting if, say, a discrepancy for a single month was discovered in an audit for five years' worth of records. In that kind of situation, the Recordkeeping Party argably shouldn't have to foot the bill for the entire five-year audit; on the other hand, neither should the Recordkeeping Party necessarily escape the consequences of the ten-percent discrepancy in that one month. The language of this provision represents a compromise position.
- Reasons for shifting audit expenses: Shifting of audit expenses can be at least somewhat of a disincentive to cheating by the Recordkeeping Party. Imagine that the Recordkeeping Party's only obligation was to pay what it should have paid in the first place, perhaps with interest. Clearly, the Recordkeeping Party would then have an implicit economic incentive to "roll the dice" by cheating. (Of course, the Recordkeeping Party would risk losing the Auditing Party's trust, which could be an even bigger disincentive to cheating.)
(a) Absent consent of the Recordkeeping Party, the Auditing Party:
(1) may not use any nonpublic information that is learned or derived in the course of any such audit, except to the extent necessary to protect the Auditing Party's rights and/or for the Auditing Party's performance of its obligations under this Agreement;
(2) may not disclose any such information to third parties except in response to compulsory legal process, after first: (A) advising the Recordkeeping Party of such process (where not prohibited by law); and (B) providing reasonable cooperation in any efforts by the Recordkeeping Party to preserve the confidentiality of such information.
(b) The Auditing Party must enter into binding written agreements with its auditors requiring them to comply with the audit-confidentiality requirements of this Agreement.
If so requested by the Recordkeeping Party, the Auditing Party is to remind the auditor(s) to make reasonable efforts to minimize the burden and expense of the audit on the Recordkeeping Party.
In the interest of avoiding satellite disputes or even satellite litigation — yet while still giving the Recordkeeping Party some comfort — this provision intentionally doesn't take a hard line as to what the Auditing Party is supposed to do to reduce the burden of the audit on the Recordkeeping Party.
(a) IF: This Agreement expressly states that the Audit Flowdown Requirement applies; THEN: The Recordkeeping Party is to include, in each subcontract under this Agreement, if any, provisions for the benefit of the Auditing Party as a third-party beneficiary, as follows:
(1) a requirement that the subcontractor permit audits by the Auditing Party in accordance with the audit provisions of this Agreement; and
(2) an authorization for the subcontractor to deal directly with the Auditing Party and its auditor(s) in connection with any such audit.
(b) For the avoidance of doubt, the Audit Flowdown Requirement neither authorizes nor prohibits the Recordkeeping Party's use of subcontractors under this Agreement.
(1) significant lack of cooperation, by the Recordkeeping Party, in an audit under this Agreement; and
Either of the two listed items might well warrant setting aside the usual agreed limitations on advance notice, deadlines, etc.
The audit provisions of this Agreement will survive any termination or expiration of this Agreement (but will also remain subject to all deadlines and other limitations stated in this Agreement).
Not specifying that audit rights survive termination of the Agreement might result in the audit right ending when the Agreement does. That happened in New England Carpenters Central Collection Agency v. Labonte Drywall Co., No. 14-1739 (1st Cir. July 31, 2015) (affirming district court's judgment after bench trial).
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Any audit conducted under this Agreement must conform to commercially-reasonable standards.
Upon a written request by the Recordkeeping Party, the Auditing Party will promptly cause the Recordkeeping Party to be provided with a complete and accurate copy of each audit report provided to the Auditing Party by the auditor(s).
The Recordkeeping Party might not care about getting a copy of an audit report if the report says, basically, everything's cool here. But if the Recordkeeping Party will have to come up with extra money, or is accused of a material breach, it likely will indeed want to get a copy of the audit report.
The Auditing Party might object to providing the Recordkeeping Party with a copy of the audit report. But face it: If the dispute goes to litigation or even arbitration, the odds are high that the Auditing 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)
The auditor(s) must agree in writing:
(1) to disclose to the Auditing Party only whether a reportable discrepancy was revealed by the audit, and if so, the size and general nature of the discrepancy; and
(2) that the Recordkeeping Party is a third-party beneficiary of that written agreement.
IF: For a particular audit, the Recordkeeping Party is not required under this Agreement to reimburse the Auditing Party's expenses of the audit; THEN: The Auditing Party will reimburse the Recordkeeping Party (and its subcontractors, if applicable) for reasonable expenses actually incurred in connection with the audit, such as (for example) reasonable fees and expenses for an auditor engaged by the Recordkeeping Party to monitor the audit.
An article by two construction lawyers points out 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 signicant overbilling by the Contractor." Albert Bates, Jr. and Amy Joseph Coles, Audit Provisions in Private Construction Contracts …, 6 J. Am. Coll. Constr. Lawyers 111, 132 (2012).
IF: The Recordkeeping Party complies with the obligations of this clause in respect of any invoicing- or payment discrepancy revealed by an audit within 30 days after receiving notice of the discrepancy and a copy of the audit report; THEN: the Recordkeeping Party will have no further obligation or liability in respect of that discrepancy.
A software customer might want this clause as a get-out-of-jail-free card in case a software vendor's audit reveals that the customer is making more use of the software than it paid for. The customer might reason that:
If licensees are going to expose themselves to the administrative and legal burdens associated with software audits – which often result in questionable or disputed findings – then it is reasonable for them to expect to receive a release of past liability upon purchasing any required licenses or otherwise remediating any compliance deficiencies identified as a result of audits. License agreements therefore should obligate publishers to provide such releases.
Christopher Barnett, Top Three Revisions To Request In Software License Audit Clauses (ScottAndScottLLP.com 2015).
Software vendors might well be willing to go along with that — 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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- Introduction: Reasons to ask for audit rights
- Permissible auditors
- Audit request deadlines
- Auditor access to recordkeeping-party personnel
- Exclusion of certain information from audit
- Audit facilities
- Access restrictions
- Ordinary course of business
- Auditors' copies of records
- Interest on under- or overpayment
The nuclear Navy, in which I served, has a saying: You get what you inspect, not what you expect. This saying can be equally true in the world of contract relationships: Mistakes can happen — and sometimes, so do creative accounting, stonewalling, and even outright fraud. Here's a real-world situation in which an audit clause came in handy:
- A Saudi company signed a consignment agreement with a Florida company. Under that agreement, the Florida company would sell what was expected to be around $500 million worth of aircraft parts.
- The parties apparently didn't have any procedure in place for confirming just what parts the Saudi company had shipped to the Florida company to be sold off. (The court's opinion suggests that the Florida company might have used "creative" accounting techniques in that regard.)
- The Saudi company tried to get discovery to find out just how much the Florida company had really sold.
- The Florida company evidently stonewalled on producing its records.
- The district court refused to order an accounting — this, even though the parties' contract included an audit provision.
- The appellate court reversed and remanded, stating that the district court abused its discretion by refusing to order an accounting.
See Zaki Kulaibee Establishment v. McFliker, 771 F.3d 1301 (11th Cir. 2014).
One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships." Craig L. Greene, Audit Those Vendors (2003). Greene lists a number of things that fraud examiners watch for, including, for example:
- fictitious "shell entities" that submit faked invoices for payment;
- cheating on:
- shipments of goods (e.g., by short-shipping goods or sending the wrong ones) or
- performance of services (e.g., by performing unnecessary services or by invoicing for services not performed);
- billing at higher-than-agreed prices;
- kickbacks and other forms of corruption;
and others. See id.
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.
On the other hand, the auditing party might not want to bear the expense of having an outside auditor do the job, and might prefer instead to send in one of its own employees to "look at the books."
A recordkeeping party might want the ability to veto the auditing party's choice of auditors. On the other hand, the auditing party might not trust the recordkeeping party to be reasonable in exercising that veto, and could be concerned that a dispute over that issue would be time-consuming and expensive.
An audit request should be timely; otherwise, a creative counsel might try to argue that the party had the right to conduct an audit even when, for example, the underlying agreement had expired or been terminated.
A would-be auditing party's counsel tried unsuccessfully to make such an argument in New England Carpenters Central Collection Agency v. Labonte Drywall Co., No. 14-1739 (1st Cir. July 31, 2015) (affirming district court's judgment after bench trial).
Audits sometimes happen after business relationships start to turn sour. In situations like that, it's not unheard of for recordkeeping parties to make life as difficult as possible for auditors. It can help to lay out ground rules for what might otherwise be an unfriendly episode.
This clause excludes from auditing any information that is subject to the attorney-client privilege and any other applicable privilege. That's because 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 want to specify Other Particular Audit Exclusions to be specific about particular information to which an auditor will not have access.
Audits sometimes happen after business relationships start to turn sour. This clause can help lay out ground rules for what might otherwise be an unfriendly episode.
As one example, it's not unheard of for recordkeeping parties to make life as difficult as possible for auditors. This clause tries to forestall such uncooperative behavior.
A party agreeing to an audit clause might want to restrict the auditor's access to the facilities, computers, etc., of the party being audited. For example:
- Software vendors often include audit provisions in their license agreements.
- Such provisions allow a vendor to audit a customer's use of the software to confirm that all such use is appropriately licensed (and paid for).
- A software vendor's audit clause might allow the vendor to access the customer's computer systems.
- The customer might not want this, especially if the customer is in a sensitive industry such as finance or health care.
A possible compromise might be to allow a third-party auditor to have limited access to computer systems, etc., under a strict confidentiality agreement.
(Hat tip: Christopher Barnett, Top Three Revisions To Request In Software License Audit Clauses (ScottAndScottLLP.com 2015).)
It's probably not a bad idea to try to avoid using the word avoid (yes, I get the self-contradiction), because it could later be branded as a representation of some kind. Instead, consider reduce the chances of as a softer, less-committal alternative.
AWKWARD: "… to avoid a significant risk of the Partnership or the Operating Partnership becoming taxable as a corporation …." (From the Enterprise Products Partners limited-partnership agreement, section 4.7(b).)
BETTER: "… to reduce the risk of the Partnership or the Operating Partnership becoming taxable as a corporation …."
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"Transparent" backdating for non-deceptive purposes can be perfectly legitimate
Signing a contract that is "backdated" to be effective as of an earlier date might well be OK. (This is referred to in legalese as nunc pro tunc, or "now for then.")
The fact that you're doing this should be made clear in the contract itself, to help forestall later accusations that you had an intent to deceive.
EXAMPLE: Suppose that you disclose your company's confidential information to a potential business partner, after she first orally agrees to keep the information confidential. You might well want to enter into a written nondisclosure agreement that states it is effective as of the date of your oral disclosure. (Check with your lawyer.)
But backdating a contract could lead to prison time and/or civil liability
At this writing, the former CEO of software giant Computer Associates, Sanjay Kumar, is serving a 12-year sentence for securities fraud through, among other things, backdating sales contracts. (NY Times) Mr. 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 back-dating. 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 — 10 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. The company had booked the sales a few days earlier than was proper. 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. See Raceway Ford Cases, 229 Cal. App. 4th 1119, part IV-B, slip op. at 15-20, 28 (2014) (reversing and remanding trial court judgment in part), review granted, No. S222211 (Cal. Dec. 17, 2014).
Three reasons a court might not give effect to a backdated date
Suppose that you and your counterparty agree to date a contract "to be effective as of" a past date. That doesn't mean a court will necessarily give effect to that agreed past date if, for example:
- the evidence does not indicate that the parties had agreed to the material terms of the agreement on or before the as-of date; or
- the contract language does not unambiguously state that the parties intend the agreement to have retroactive effect; or
- an unrelated third party's rights and obligations might be affected by the backdating.
See, e.g., FH Partners, LLC v. Complete Home Concepts, Inc., 378 S.W.3d 387 (Mo. App. 2012) (reversing in part and remanding summary judgment), analyzed in Brian Rogers, Backdating Contracts Is Tricky Business (2013).
Don't knowingly write, or accept, an incorrect date as your "date signed"
Many contracts' signature blocks include spaces in which the signers are expected to hand-write the signature date, or in which a date is already printed. To avoid later questions about possible deceptive intent, a signer should always write the actual signature date; if an incorrect date is already printed in the signature block, the signer should insist that the incorrect date be changed, or perhaps manually correct the date in pen and ink, initialing the change.
Colin Riegels, Backdating Contracts And Other Documents And Instruments (Mondaq.com Apr. 2016)
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How to draft a Background section (a.k.a. the "recitals")
The "Background" section of the contract should briefly explain to a future reader why the parties are entering into the contract. See generally the detailed guidelines in Stark § 6.3.
Avoid "Witnesseth" and "Whereas" clauses
Caution: Recitals might be binding
A court might give special or even binding weight to recitals in a contract. For example, California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added; hat tip: Commenter "Kazu" at the Adams Drafting blog.)
See also the notes to the Acknowledgement Definition Clause.
In settlement agreements, documenting the dispute background can be a good idea
When an agreement is made to settle a dispute, it can be really advantageous for the background ssection of the signed agreement to document that fact. This advantage is illustrated in Pappas v. Tzolis, 20 N.Y.3d 228 (2012). In that case:
- Tzolis, a businessman, owned part of a limited liability company ("LLC") along with two colleagues, Pappas and Tziolis invested $50,000 in the company, while Ifantopoulos invested $25,000. The LLC acquired a long-term lease on a building in Lower Manhattan.
- About a year later, after repeated disputes had arisen, Tzolis bought out Pappas and Ifantopoulos for 20 times (!) their respective investments.
- A few months later, Tzolis sold the building lease for $17.5 million.
- Pappas and Ifantopoulos sued Tzolis for (among other things) fraud and breach of fiduciary duty, claiming that Tzolis had arranged the sale before he bought them out, without telling them he was doing so.
New York's highest court ruled that Pappas's and Ifantopoulos's complaint should have been summarily dismissed:
Here, plaintiffs were sophisticated businessmen represented by counsel. Moreover, plaintiffs' own allegations make it clear that at the time of the buyout, the relationship between the parties was not one of trust, and reliance on Tzolis's representations as a fiduciary would not have been reasonable.
According to plaintiffs, there had been numerous business disputes, between Tzolis and them, concerning the sublease. Both the complaint and Pappas's affidavit opposing the motion to dismiss portray Tzolis as uncooperative and intransigent in the face of plaintiffs' preferences concerning the sublease. The relationship between plaintiffs and Tzolis had become antagonistic, to the extent that plaintiffs could no longer reasonably regard Tzolis as trustworthy.
Therefore, crediting plaintiffs' allegations, the release contained in the Certificate is valid, and plaintiffs cannot prevail on their cause of action alleging breach of fiduciary duty.
Id. at 233 (emphasis and extra paragraphing added).
In similar fashion, if the Background section of the agreement recites facts about a dispute between the parties, the court likely will accept those facts as true; see the commentary to the Acknowledgement Definition Clause. That can help counter what one commentator says will be the plaintiffs' lawyers' response to the Pappas decision, namely not to stipulate in their complaints that the parties had a dispute. See Peter Mahler, Pappas Saga Ends … (2012).
[TO DO: Cross reference to "Release" language when written]
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This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- 1. Which party is to conduct background checks?
- The Checking Party, namely: [FILL IN NAME]; the other party is referred to as the Requesting Party.
- 2. What individual(s) must undergo background checks?
- All Checked Individuals, namely: any individual whom a Checking Party, directly or indirectly, causes or permits to engage in one or more Restricted Activities.
- 3. What specific background checks must be completed on each Checked Individual?
- The Required Background Checks, namely: a Criminal-History Check.
- 4. If a Checked Individual "fails" a specified background check, is that individual to be barred from certain positions?
- Yes, per the Personnel-Disqualification Obligation.
- 5. Is the Checking Party be responsible for third-party claims arising from failure to comply with legal requirements for background checks?
- Yes, per the Legal-Compliance Indemnity Obligation.
- 5. Is the Requesting Party required to reimburse the Checking Party's reasonable expenses of conducting the Required Background Checks?
- Yes, per the Expense-Reimbursement Obligation.
See the extended notes for related discussions and cautions.
For purposes of this Background Checks Terms & Conditions:
(a) Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question.
(c) Driving-Record Check refers to a check of records of accidents; driver's-license status; driver's-license suspensions or revocations; traffic violations; criminal charges (e.g., DUI).
(d) Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals.
(e) Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.
(f) Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years.
(g) If the Expense-Reimbursement Obligation applies, the Requesting Party is to reimburse the Checking Party for all reasonable out-of-pocket expenses incurred by or on behalf of the Checking Party in connection with performing background checks required by this Agreement.
(h) If the Legal-Compliance Indemnity Obligation applies, the Checking Party must defend and indemnify the Requesting Party and its Protected Group against any and all third-party claims — including but not limited to any claim by a Checked Individual and any claim by a government authority — arising from any allegation of breach of governing law in the performance of background checks under this Agreement by or at the direction of the Checking Party.
(i) Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings.
(j) 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.
(k) If the Personnel-Disqualification Obligation applies, the Checking Party is not to assign nor permit any Checked Individual to engage in any Restricted Activity without the prior, specific, written consent of the Requesting Party if either or both of the following are true:
(1) The criminal-history check (if any) of the Checked Individual indicates that the Checked Individual has been convicted of, or pled guilty or no contest to, one or more of (A) a felony; and/or (B) a misdemeanor involving fraud or moral turpitude; or
(2) A drug test of the Checked Individual (if conducted) indicates one or more of (A) the use of illegal drugs; and/or (B) the use of prescription drugs other than in accordance with a lawfully-issued prescription.
(l) Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years.
(m) Restricted Activity refers to any one or more of the following, when engaged in 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 for example remote access) to the Requesting Party's equipment or computer network;
(3) having access to the Requesting Party's confidential information; and
(4) interacting with the Requesting Party's employees, suppliers, or customers.
(1) any applicable privacy laws, including for example any requirement to obtain the consent of the relevant Checked Individual; and
(2) any applicable requirement (for example, in credit-reporting laws) that the relevant Checked Individual must be notified before or after a decision is made using information learned in the background check.
Subdivision (a) requires the Checking Party to cause all Required Background Checks to be completed, in recognition of the fact that the Checking Party might well engage a third-party service to conduct the checks.
Subdivision (b) is phrased in terms of "prudent measures," as opposed to an absolute obligation; it can be beefed up by specifying, in the Term Sheet, that the Legal-Compliance Indemnity Obligation applies.
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As a safeguard against falsified references, all reference checks (if any) other than personal character references are to be completed using contact information obtained other than from the Checked Individual.
(1) the Checking Party will cooperate with the Requesting Party in attempting to obtain any necessary consent for such checks from each Checked Individual;
(2) in conducting any such background checks, the Requesting Party will comply with the background-check provisions of this Agreement, and defend and indemnify the Requesting Party for any noncompliance, as though the Requesting Party were the Checking Party and vice versa; and
(3) the Requesting Party will bear its own expenses associated with any background checks that it conducts.
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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.
Caution: Obtaining consent of Checked Individuals might be advisable even if not legally mandatory
Parties conducting or commissioning background checks should be sure to check applicable law to see if any particular form of consent is required. See also the compliance-with-law annotation.
It might well be prudent to obtain consent to a background check even if the law doesn't require it. If the individual were to learn of an unconsented background check, his displeasure might go viral on social media, especially given today's heightened sensitivity to privacy concerns.
Have background checks already been done?
It's entirely possible that, due to the nature of the industry (e.g., technology consulting services), the contractor might have already had background checks performed on its relevant people.
Expressly requiring the Checking Party to comply with law is arguably superfluous. Still, doing so can be useful —
- to remind drafters and parties of privacy laws protecting employees and consumers, including for example:
- to give the other party a contractual remedy — not to mention a certain amount of political cover — in case the party required to conduct background checks violates the law in doing so.
See generally, e.g.:
- Kim C. Stanger, HIPAA: disclosing exam results to employers (Lexology.com 2015)
Consider checking the Wikipedia entry on background checks to get ideas for further research on this subject.
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Criminal records checks
Basic online criminal records checks seem to be available from any number of Web sites at low cost. (I've 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.
This check has in mind that an individual might omit one or more previous residence addresses in the hope of evading a criminal-records check.
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.
This is another check designed in part to detect people who were "creative" on their résumés.
Credit checks can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act. One particular procedural requirement seems to come up in class-action lawsuits: Section 1681b(b)(2)(A) of the Act, which states that, with certain very-limited exceptions:
… a person may not procure a consumer report, or cause a consumer report to be procured, for employment purposes with respect to any consumer, unless–
- a clear and conspicuous disclosure has been made in writing to the consumer at any time before the report is procured or caused to be procured, in a document that consists solely of the disclosure, that a consumer report may be obtained for employment purposes; and
ii) the consumer has authorized in writing … the procurement of the report by that person.
(Emphasis and paragraphing added.) Hat tip: Ken Remson, Employers Hit With Background Check Lawsuits, May 20, 2014; see also Todd Lebowitz, Publix to Pay $6.8 Million Settlement over Noncompliant Background Check Forms (EmploymentClassActionReport.com Nov. 3, 2014).
In July 2015, the Chuck E. Cheese restaurant company settled a class-action lawsuit by employees who asserted that the company's background-check consent form did not comply with the FCRA's strict requirements. See, e.g., David M. Gettings, Timothy St. George and David N. Anthony, Chuck E. Cheese Settles Background Check Lawsuit For $1.75 Million (Mondaq.com).
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.
Companies, though, should think about 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.
Companies should also be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use.
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A blanket prohibition against using personnel with criminal records could be problematic: It might be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the U.S. See generally the EEOC general counsel's enforcement guidance published in April 2012.
The EEOC has filed lawsuits against employers who allegedly "violated Title VII of the Civil Rights Act by implementing and utilizing a criminal background policy that resulted in employees being fired and others being screened out for employment …." EEOC press release, June 11, 2013.
Companies should also be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use, as opposed to making accommodations of some sort.
In addition, some states might likewise restrict an employer's ability to rely on criminal background information in making employment-related decisions. Drafters should pay particular attention to the law in New York, Massachusetts, Illinois, and Pennsylvania (not necessarily an exhaustive list).
On a related note: "Bills pending in both houses of Congress would make it unlawful for most federal contractors to request a job applicant, whether orally or in writing, to disclose criminal history record information before the applicant has received a conditional offer of employment." Garen E. Dodge, Richard I. Greenberg, and Susan M. Corcoran, Proposed ‘Ban the Box’ Legislation Would Limit Criminal History Inquiries by Federal Contractors (JacksonLewis.com 2015).
For a list of states and cities with ban-the-box laws, see Michelle Natividad Rodriguez and Nayantara Mehta, Ban the Box: U.S. Cities, Counties, and States Adopt Fair Hiring Policies (NELP.com 2015).
Expense reimbursement obligation
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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Suppose that Customer requires Provider to have background checks done on all Provider personnel who will be accessing Customer's premises. Then suppose that a Provider employee complains that the background check violated his rights under applicable law. The Provider employee might be tempted to sue Customer, not just Provider. In that situation, this provision would require Provider to protect Customer from the cost of defending and/or paying damages for such claims.
"Cause to be …"
The "cause … to be defended and indemnified" language has in mind that Provider likely would hire a presumably-reputable professional firm to do background checks. In that situation, Provider party likely wouldn't want to be obligated to indemnify Customer itself, but instead would want the professional firm to be responsible for any third-party claims arising from the firm's work.
Indemnity liability – greater than ordinary contract damages?
As with any indemnity obligation, drafters should consider whether the indemnifying party might be liable for unforeseeable damages as well as foreseeable damages; see this note for additional details.
IP and bankruptcy
The parties intend and acknowledge that the rights and licenses granted to Licensee under this Agreement are licenses to rights of "intellectual property", as set forth in section 365(n) of Title 11 of the United States Code, or other similar comparable provisions of the insolvency or bankruptcy laws of any other jurisdiction, and that Licensee will have the benefit of suchthose provisions. If Licensor is under anybecomes subject to one or more insolvency, bankruptcy or similar proceedings (each, a "Proceeding"), Licensee maywill, to the fullest extent permitted by applicable law, retain and continue to exercise allits rights under this Agreement, even if this Agreement is rejected or repudiated in any such pthe Proceeding. If notwithstanding the foregoing, the continuation of Licensee's rights under this Agreement is terminated, impaired or subject to mandatory renegotiation pursuant to such pa Proceedings, then to the extent permitted by the applicable law Licensor shall promptly offer to Licensee a license to the same intellectual property rights that are the subject of this Agreement under fair, reasonable and non-discriminatory (FRAND) licensing terms, and such FRAND. For purposes of the preceding sentence, no licensing terms will be deemed FRAND if their royalty rates will not exceed the rates set forth in this Agreement.
- Robert A. Cox, Jr., My Customer Is Bankrupt? But We Just Shipped Them Goods! (Mondaq.com 2015).
Steps to take if a counterparty is in trouble
(a) The parties intend that all Baseball Disputes, as defined in subdivision (b), be decided in accordance with the procedure set forth in this 1. Applicability (the Baseball Process), regardless whether the context is (i) a final resolution of the dispute in question, e.g., a final arbitration award or final judgment; or (ii) an interim resolution, e.g., an interim arbitration award or a decision on a motion.
(b) IF: The Baseball Dispute in question is being resolved by arbitration; THEN: The arbitral tribunal is to use the Baseball Process to decide the dispute.
(c) IF: The dispute in question is being resolved in litigation or other proceeding before a court, administrative agency, or other governmental authority having jurisdiction; THEN: The parties hereby jointly request that the governmental authority decide the dispute in accordance with the Baseball Process.
2. Baseball Dispute Definition
(1) any numerical quantity, e.g., revenues, costs, profits, damages, etc.;
(2) what if any action (or omission) by any individual or organization — including for example a Decision Maker — would be required, or was required, to comply with an Action Standard, which refers to any requirement: (A) of law; (B) of this Agreement; (C) of good faith; (D) of fair dealing; or (E) of reasonableness;
(3) whether a specific proposed or past action (or omission) by such an individual or organization would comply or did comply with an Action Standard;
(4) any matter as to which the parties have agreed to the use of a baseball-style procedure (also known as a final-offer or last-best-offer procedure) in litigation, arbitration, or other dispute-resolution process;
(5) any other matter as to which a Decision Maker, for example an arbitral tribunal or a court, having authority to do so (whether by agreement of the parties or by law), directs the parties to proceed with a baseball-style procedure; and
(6) any other particular Baseball Disputes expressly agreed to in writing by the parties, if any — for the avoidance of doubt, it is immaterial if one or more such other particular Baseball Disputes is also in another category listed above.
(a) Each party is to provide both the Decision Maker and the other party with at least one, but no more than two, written proposed resolutions of the Baseball Dispute (each, a Proposed Resolution). If the parties do not agree to a deadline for exchanging their Proposed Resolutions, then the Decision Maker is to specify a deadline.
(b) Each party may include, in any Proposed Resolution, a brief explanation why the Decision Maker should select that Proposed Resolution.
(c) The Decision Maker may advise the parties, no more than once, that in the Decision Maker's view, no Proposed Resolution should be selected (preferably explaining why), in which case the Decision Maker is to allow the parties more time to submit revised Proposed Resolutions.
(d) Except as provided in subdivision (3), the Decision Maker is to select (if an arbitration tribunal), or is requested to select (if a court or other governmental authority), as the resolution of the dispute, without modification, the one Proposed Resolution that the Decision Maker regards as most-closely matching the resolution that the Decision Maker would adopt had the parties not agreed to use the Baseball Process.
(e) The parties' agreement and applicable law will determine the effect of the Decision Maker's selection of a Proposed Resolution (for example, the extent, if any, to which the determination is binding on the parties).
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"Baseball" arbitration is designed to encourage settlement
This Baseball Arbitration Clause provision is modeled on, wait for it, baseball arbitration, which "is designed to produce a settlement, not a verdict." Thomas Gorman, The Arbitration Process – the Basics, in Baseball Prospectus (Jan. 31, 2005) (emphasis added).
Here's how that can work:
- When baseball-style dispute resolution is used, the decision maker must choose from among the proposed resolutions submitted by the parties — the decision maker has no discretion to make any other determination about the issue.
- That constraint forces each party, in submitting its proposed resolution(s) for the issue, to think hard about:
- how the decision maker sees the case, as opposed to how convinced the party is of the rightness of its own view; and
- the risk that the decision maker might regard the other party's proposed resolution as being closer to the "correct" one — in golf terms, "closest to the pin" — and therefore be forced by this clause to adopt that other proposed resolution.
- That in turn improves the odds that the parties will reach an agreed settlement.
Author's note: In my own practice, in the space of about one year, three different lawsuits, for three different clients, were settled not long after the parties had agreed to baseball arbitration. I had the impression that, after seeing each other's proposed awards, the business people on each side looked at each other and said, in effect, wait a minute — we're not that far apart; we don't need to pay the arbitrator and the lawyers for this.
Another story: a lawyer friend in Silicon Valley recounted how a client of hers once got into a dispute concerning a contract that she had drafted for the client. She told the client's CEO that the contract required baseball arbitration, and explained what that entailed. The CEO responded: "Goddamn it, that means I have to be reasonable." (The parties settled the dispute.)
This is an avoidance-of-doubt provision; its wording is intended to be tactful, in acknowledgement that:
- Under most laws governing arbitration, the parties can in essence direct the arbitral tribunal to use baseball-style procedures;
- In contrast, judges and other governmental authorities generally would not be bound by the parties' agreement; consequently, this provision states the parties' joint request that baseball-style procedures be used.
One of the perceived advantages of baseball-style decision-making is that the decision-maker can neither "go rogue" nor "split the baby." That's because the decision-maker is permitted only to choose one or another of the Proposed Resolutions of the issue in question.
This provision allows each party to submit up to two Proposed Resolutions for an issue being decided by the baseball-style procedure of this clause; that allows each party to hedge its bets somewhat.
If a "baseball" provision is being used in arbitration, the parties' arbitration agreement might provide that the resulting issue determination does not immediately become binding; see, for example, the (Plug-in:) Partial Court Retrial of Arbitration Award provision.
(a) Best efforts, whether or not capitalized, refers to the diligent making of reasonable efforts.
(b) For the avoidance of doubt, a party required to use best efforts:
(1) need not take every conceivable action to achieve the stated objective;
(2) need not materially harm its own interests; and
(3) need not take any action that would not qualify as a reasonable effort.
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- Diligence as the touchstone of "best efforts"
- Business context of best-efforts requests
- A sports analogy
- Possible variation: "All reasonable efforts" instead of "best efforts"
- Does "reasonable efforts" necessarily mean all reasonable efforts?
- Best efforts means different things to different courts
- "Best efforts" might be held to be unenforceably vague
- "Every effort" clauses and the like are often interpreted similarly
- Best-efforts takeaways
- Asking for a best-efforts commitment can make business sense
- Agreeing to a best-efforts commitment might lead to trouble
- Further reading
Best-efforts clauses can be (quite) problematic, but are often used anyway because many business people like them. Providing a definition can at least reduce some of the associated uncertainty.
Diligence as 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." Restatement (Second) of Agency § 13, comment a (1957), quoted in Corporate Lodging Consultants, Inc. v. Bombardier Aerospace Corp., No. 6:03-cv-01467-WEB, slip op. at 9 (D. Kan. May 11, 2005) (finding that CLC had not failed to use its best efforts to obtain lowest and most-competitive hotel rates for Bombardier) (citation and alteration marks omitted).
Business context of best-efforts requests
Best-efforts obligations are especially common when one party grants another party exclusive rights, for example exclusive distribution rights or an exclusive license under a patent, trademark, or copyright. That was the situation in the Kevin Ehringer Enterprises case, for example.
To many business people, it may seem self-evident that when a contract uses the term best efforts, it calls for "something more" than mere reasonable efforts — otherwise, why bother even saying best efforts? That is, reasonable efforts will cover a range of possibilities, while best efforts refers to somewhere near the top of that range. I have no formal research to support this view, but I've negotiated more than a few contracts with best-efforts clauses in them, so I'd like to think I have at least some sense of what many business people are after.
A sports analogy
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.
- 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.
Possible variation: "All reasonable efforts" instead of "best efforts"
- A drafter could specify that best efforts requires the diligent making of all reasonable efforts. Reportedly, that's a common formulation in the UK; see the Helms et al. article cited below.
- A drafter could also add, at the end of subdivision (a), the phrase, leaving no stone unturned in seeking to achieve the stated objective. This language is from an opinion by the supreme court of British Columbia. See Atmospheric Diving Systems Inc. v. International Hard Suits Inc., 89 B.C.L.R. (2d) 356 (1994). I've not been able to find the full text of this opinion freely available online. It's extensively excerpted by Ken Adams in his posting "Best Efforts" Under Canadian Law.
Does "reasonable efforts" necessarily mean all reasonable efforts?
In an extended LinkedIn group discussion (membership required), a commenter opined that anything less than all reasonable efforts was, by definition, unreasonable. I responded that many people would disagree: Reasonable efforts can encompass a range of efforts; it doesn't have to be a binary, yes-no dichotomy.
Consider Scenario 1, in which Alice's contract with Bob requires Alice to make reasonable efforts to advise Bob in writing if some (non-emergency) Event X occurs. If Event X were to occur, then Alice might send Bob an email to that effect, using the email address that Bob has consistently used in his dealings with Alice. In 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.
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, etc. — until she received positive confirmation that Bob had in fact received the message.
Best efforts means different things to different courts
Depending on the jurisdiction, a court might not share the view of best efforts just described.
• As one court explained, "[c]ontracting parties ordinarily use best efforts language when they are uncertain about what can be achieved, given their limited resources." See CKB & Assoc., Inc. v. Moore McCormack Petroleum, Inc., 809 S.W.2d 577, 581-82 (Tex. App. – Dallas 1990) (affirming summary judgment that defendant had failed to use its best efforts).
On the facts of the case, the court affirmed summary judgment that an oil refiner had failed to use its best efforts to produce specified volumes of refined petroleum products. The refiner had focused its efforts on high-priced products, while making no effort to produce the specific products that it was contractually obligated to produce. The court remarked that "[a]s a matter of law, no efforts cannot be best efforts."
• Some — but not all — U.S. courts have seemingly equated best efforts with mere reasonable efforts, contrary to what business people are likely to think they're getting in a best-efforts clause.
As one 2005 review of case law puts it, "For years U.S. courts have used the phrases 'reasonable efforts' and 'best efforts' interchangeably within and between opinions. Where only one of the terms is used, the best-efforts obligation frequently appears indistinguishable from a reasonable-efforts obligation. Some recent cases have gone so far as to equate best efforts and reasonable efforts." See Scott-Macon Securities, Inc. v. Zoltek Cos., Nos. 04 Civ. 2124 (MBM), 04 Civ. 4896 (MBM), part II-C (S.D.N.Y. May 11, 2005) (citing cases).
(Some of those cases, though, might be interpreted more narrowly as holding merely that a best-efforts obligation does not require the obligated party to make unreasonable efforts, while still requiring diligence in the making of reasonable efforts.)
• Fortunately, still other U.S. courts seem to have recognized that best efforts means something more than merely reasonable efforts.
For example, in the Tigg Corp. v. Dow Corning Corp. case, the Third Circuit held that, at least where the contract involved an exclusive-dealing arrangement, "[t]he obligation of best efforts forces the buyer/reseller to consider the best interests of the seller and itself as if they were one firm." the appellate court affirmed a trial court's judgment, based on a jury verdict, holding Dow Corning liable for breaching a best-efforts obligation in an exclusive-dealing agreement. The appellate court agreed with Dow Corning, however, that the trial court had erred in entering judgment on the amount of monetary damages Dow Corning should pay, and remanded the case for a new trial on that issue. Tigg Corp. v. Dow Corning Corp., 962 F.2d 1119 (3d Cir. 1992).
Likewise, in Macksey v. Egan, a Massachusetts appeals court construed the term best efforts "in the natural sense of the words as requiring that the party put its muscles to work to perform with full energy and fairness the relevant express promises and reasonable implications therefrom." Macksey v. Egan, 36 Mass. App. Ct. 463, 472, 633 N.E.2d 408 (1994) (reversing judgment on jury verdict that defendant had breached best-efforts obligation; extensive citations omitted).
• Some UK and Canadian courts have defined the standard of performance for best efforts as, in essence, all reasonable efforts. For a survey of such cases, see Shawn C. Helms, David Harding, and John R. Phillips, Best Efforts and Endeavours – Case Analysis and Practical Guidance Under U.S. and U.K. Law, July 2007.
For example, in its Atmospheric Diving Systems opinion (1994), the supreme court of British Columbia held that best efforts requires "taking, in good faith, all reasonable steps to achieve the objective, carrying the process to its logical conclusion and leaving no stone unturned. … doing everything known to be usual, necessary and proper for ensuring the success of the endeavour."
Similarly, in Australia, the term best endeavours seems to be treated as synonymous with all reasonable endeavours; in its Hospital Products opinion (1984), that country's highest court held that "an obligation to use 'best endeavours' does not require the person who undertakes the obligation to go beyond the bounds of reason; he is required to do all he reasonably can in the circumstances to achieve the contractual object, but no more … [A] person who had given such an undertaking … in effect promised to do all he reasonably could …." Hospital Prods. Ltd v. United States Surgical Corp., 1984 HCA 64, 156 CLR 41, paras. 24, 25.
Adding to the difficulty, some U.S. courts have held that the term best efforts is too vague to be enforceable unless the parties agree to some sort of objective standard of performance, "some kind of goal or guideline against which best efforts may be measured," in a case quoted by the court in the Kevin Ehringer Enterprises case.
One court held that "as promptly as practicable" and "in the most expeditious manner possible" were sufficient to meet that requirement. See Herrmann Holdings Ltd. v. Lucent Technologies Inc., 302 F.3d 552, 559-61 (5th Cir. 2002) (reversing dismissal under Rule 12(b)(6); citing cases).
With all of this in mind, the definition of best efforts in this clause attempts to draw at least a somewhat-bright line that provides an objective standard of performance (albeit one that might require a trial to determine whether it had been met).
[TO DO: Look up California law – all efforts even if bankruptcy? https://www.linkedin.com/grp/post/4036673-6027114806685810691]
"Best efforts" might be held to be unenforceably vague
According to some U.S. courts, the term best efforts is too vague to be enforceable unless the parties agree to some sort of objective standard of performance. In the Kevin Ehringer Enterprises case, the Fifth Circuit, quoting a Texas appellate court, held that under state law, "to be enforceable, a best efforts contract must set some kind of goal or guideline against which best efforts may be measured."
"Every effort" clauses and the like are often interpreted similarly
"When confronted with idiosyncratic contractual language expressing sentiments akin to doing all that one can or 'all that is necessary' to complete a task, Texas courts often interpret such language as requiring 'best efforts'–an expression with a more clearly established meaning and history." Hoffman v. L & M Arts, 774 F. Supp. 2d 826, 833 (N.D. Tex. 2011) (citing cases).
"[C]ourts and arbitrators interpreting similar phrases [the phrase in question was 'every effort'] have determined, like the district court here, that they impose an obligation to make all reasonable efforts to reach the identified end." Aeronautical Indus. Dist. Lodge 91 v. United Tech. Corp.., 230 F.3d 569, 578 (2d Cir. 2000) (citations omitted).
• 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.
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.
- The Reasonable Efforts Definition Clause clause
- John Pavolotsky, Best efforts clauses – what buyers expect versus how suppliers respond (IACCM.com 2015).
- Shawn C. Helms, David Harding, and John R. Phillips, Best Efforts and Endeavours – Case Analysis and Practical Guidance Under U.S. and U.K. Law (JonesDay.com 2007).
- Jonathan Pink, Making the Best of a Best Efforts Clause (Blogspot.com 2008).
- Janet T. Erskine, Best Efforts versus Reasonable Efforts: Canada and Australia (McCarthy.ca 2007).
- Aaron Singer, What do "Best Efforts" and "Reasonable Commercial Efforts" mean? (BCRElinks.com 2003).
- David Shine, "Best Efforts" Standards Under New York Law: Legal and Practical Issues, in The M&A Lawyer, March 2004, at 15.
- Akash D. Sethi, Derrick Carson, and Brad L. Whitlock, Boilerplate Provisions, 44 Tex. J. Bus. L. 157, 168 & n.37 (2012).
- Kenneth A. Adams, What the Heck Does "Best Efforts" Mean? (adamsdrafting.com 2008). Note: Ken thinks that best efforts is in essence a synonym for reasonable efforts, and that therefore drafters should abjure the former term in favor of the latter. While Ken does have at least some support in the case law for this position, in my view it amounts to telling business people, with no good reason: No, you can't do your deal the way you want; you have to do it the way I want. To my way of thinking, that oversteps the proper role of a lawyer or other drafter per se.
- Kenneth A. Adams, The Fifth Circuit Considers "Best Efforts," (adamsdrafting.com 2011).
- Kenneth A. Adams, "Best Efforts" Under Canadian Law (adamsdrafting.com 2009).
(a) Each signatory party acknowledges that it has read this Agreement; understands it; and agrees to be bound by it.
(b) This Agreement is likewise binding on the respective heirs, legal representatives, successors, and assigns of the parties, if any — this subdivision (b), though, is not to be interpreted as one party's consent to assignment of this Agreement by another party.
Contracts sometimes recite that their terms are binding (i) on the parties and, sometimes, (ii) on the parties' successors and assigns.
Ken Adams, author of A Manual on Style for Contract Drafting, has no use for successors-and-assigns clauses and argues they should be eliminated. See Kenneth A. Adams, It's Time to Get Rid of the "Successors and Assigns" Provision, The Advocate, June/July 2013, at 30.
Me, I'm not so sure; such clauses could be an example of how a few extra words can provide cheap insurance against the wiles of trial counsel seeking to put a "creative" spin on contract language.
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FROM MICHAEL LITTLE, http://goo.gl/gzCpeO:
"Breach of Contract. to the maximum extent permitted by applicable law, Seller must defend, release and indemnify Buyer from and against any Claims for Seller's breach or alleged breach of any provision of this Contract. These Claims include Seller's breach or alleged breach of any representation or warranty. [Buyer: this indemnity applies regardless if Buyer disclosed the possibility of any losses to Seller prior to signing this Contract. Further, this indemnity applies regardless if Seller could have reasonably foreseen the possibility of Buyer incurring the losses as a consequence of Seller's breach.] [Seller: this indemnity only applies to any losses that were the natural, probable and reasonably foreseeable result of Seller's breach prior to signing this Contract]."
CAUTION: Anyone drafting a Web site terms-of-service agreement should seriously consider doing this one thing: State explicitly — and, preferably, conspicuously — that use of the Web site will constitute assent to the terms of service. Even that might not be enough, for reasons discussed in the cases mentioned below.
Barnes & Noble's Web site terms of service didn't do that. As a result, the company is now facing a class-action lawsuit, because its terms of service were insufficient to bind the user to an arbitration clause. See Nguyen v. Barnes & Noble, Inc., 763 F.3d 1171 (9th Cir. 2014). Drafters would do well to study this scholarly opinion, which surveys case law from other circuits and concludes that Barnes & Noble's "terms of service" notice was insufficient.
Another detailed and scholarly opinion is that in Berkin v. Gogo LLC, No. 14-CV-1199, parts IV and IV (E.D.N.Y. Apr. 9, 2015), in which Judge Jack Weinstein denied Gogo's motion to compel arbitration; see especially the slip opinion beginning at page 61 for the court's summary of "general principles regarding the validity and enforceability of internet agreements …." The court said that "[p]roof of special know-how based on the background of the potential buyer or adequate warning of adverse terms by the design of the agreement page or pages should be required before adverse terms, such as compelled arbitration or forced venue, are enforced." Id., slip op. at 64.
The term business day, whether or not capitalized, refers to a day other than a Saturday; a Sunday; or a holiday on which banks in the Bank City (namely, New York City) are generally closed.
For time periods greater than five- or ten business days, it might be simpler to use the term calendar day (and indeed for all time periods), so as not to have to figure out what counts as a business day, especially if different jurisdictions are involved. See a 2015 LinkedIn discussion on that subject (membership required).
See also Day Definition Clause.
Table of Contents
- Calendar Year Definition Clause
- Claim Definition Clause
- Clear and Convincing Evidence Definition Clause
- Commercially reasonable
- Conditions in contracts
- Confidential information
- Confidentiality of parties' dealings
- Consent – unreasonable withhholding
- Consequential damages
- Consultation Clause
- Consumer Price Index definition (cross-reference)
- Contra profererentem
- Cooperation Clause
- Copies of Agreement Clause
- Counsel Consultation Pattern Acknowledgement
- Course of Dealing Pattern Exclusion
- CPI (consumer price index)
- Customer Definition Clause
(a) The term calendar year, whether or not capitalized, refers to a year according to the Gregorian calendar, beginning at the beginning of January 1 and ending at the end of the following December 31.
(b) An interval of a calendar year, specified as beginning at any time on a particular date or as following a particular date, ends at exactly 12:00:00 midnight at the beginning of the same date one (Gregorian) 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.
Many parties entering into contracts, even in non-Western countries, will likely operate on the West's conventional Gregorian calendar, but that might not be the case in, e.g., Muslim countries. See generally the blog post and comments at Ken Adams's post, Referring to the Gregorian calendar? (Nov. 14, 2013).
Note the use of "12:00:00 midnight at the beginning of the same date …" to remove ambiguity (is it midnight at the beginning of the day or at the end of the day?
Claim refers to any request or demand for relief by an individual or organization (including without limitation a governmental entity), where the request or demand for relief is set forth, by or on behalf of the claimant:
(1) in a written communication such as, for example, a letter or email; and/or
(2) in an original or amended complaint, petition, counterclaim, cross-claim, or other paper that is filed with (or otherwise submitted to) any court, arbitration panel, administrative agency, or other tribunal of competent jurisdiction.
This definition of claim 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.
For an assertion to be proved by clear and convincing evidence, the evidence must be sufficient to produce in the factfinder an abiding conviction that the assertion's truth is highly probable.
This definition is a rephrasing, in somewhat-plainer language, of the standard set out by the Supreme Court of the United States in Colorado v. New Mexico, 467 U.S. 310, 316 (1984) (original proceeding; holding that Colorado had not shown by clear and convincing evidence that water should be diverted from Vermejo River); see also Ninth Circuit Model Jury Instructions § 1.4.
• 22 Reasons Why Commas Are The Most Important Things In The World (BuzzFeed.com) (warning: contains graphic foul language in text messages).
• Village of West Jefferson v. Cammelleri, 2015 Ohio 2463 (Oh. App.) – a woman was issued a parking citation for leaving her pickup truck parked on the street overnight, in violation of a village parking ordinance. The ordinance stated that "[i]t shall be unlawful for any person * to park * upon any street * * * in the Village, any motor vehicle camper, trailer, farm implement and/or non-motorized vehicle for a continued period of twenty-four hours * ." The woman successfully argued that her pickup truck was not a motor vehicle camper, and that it didn't fit into any of the other categories stated in the ordinance; therefore, it was not a violation for her to park the truck on the street overnight.
• Stark v. Advanced Magnetics, Inc., 119 F.3d 1551, 1555 (Fed. Cir. 1997): The U.S. patent statute uses a comma in one provision but not in a related, substantially-identical provision; the appeals court held that the comma made a substantive difference in the proof required to show that a patent is invalid.
(a) Defining the term with an illustrative example, commercially-reasonable efforts (whether or not the term is capitalized) refers to at least those efforts that people experienced in the relevant business would generally regard as sufficient to constitute reasonable efforts in the relevant circumstances. Other uses of the term commercially-reasonable have corresponding meanings.
(b) For the avoidance of doubt, a party does not fail to act in a commercially-reasonable manner, or to take commercially-reasonable action, solely because it gives preference to its own interests over those of another party.
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Overview: A "kick the can" provision
Commercially-reasonable is a kick-the-can-down-the-road term; it's often used in routine contracts, especially for matters for which the parties are confident they can amicably resolve any disputes that might arise.
Commercial reasonableness might be proved up indirectly
A party seeking to prove (or disprove) commercial reasonableness of a transaction, contract term, decision, etc., might want to focus on the process by which the transaction, etc., came into being. The U.S. Court of Appeals for the Fifth Circuit has said that "Where two sophisticated businesses reach a hard-fought agreement through lengthy negotiations, it is difficult to conclude that any negotiated term placed in their contract is commercially unreasonable." West Texas Transmission, LP v. Enron Corp., 907 F.2d 1554, 1563 (5th Cir. 1990) (affirrming district court's refusal to grant specific performance of right of first refusal) (extensive citations omitted, extra paragraphing added).
Is the term commercially reasonable too vague?
See the commentary to the Reasonable Efforts Definition Clause for a discussion of the vagueries of that term, which of course are inherited by the term commercially reasonable.
A court might apply a "prudence" standard
In a major lawsuit between the (U.S.) state of Indiana and IBM, the contract in question took a stricter view of commercially reasonable efforts. That contract defined the term as "taking commercially reasonable steps [circularity, anyone?] and performing in such a manner as a well managed entity would undertake with respect to a matter in which it was acting in a determined, prudent, businesslike and reasonable manner to achieve a particular result." Indiana v. IBM Corp., No. 49A02-1211-PL-875, slip op. at 27 n.12 (Ind. App. Feb. 13, 2014) (emphasis added, citation to trial record omitted), affirmed, Indiana v. IBM Corp., No. 49S02-1408-PL-00513 (Ind. Mar. 22, 2016).
In that case, the contract in suit called for IBM to overhaul Indiana's computer system for managing its welfare program; the project ended up being in essence a train wreck, after which the parties sued each other. The trial court rendered judgment in favor of IBM, but a state appellate court reversed in part and remanded, holding that while IBM was entitled to be paid for its work, that payment would be subject to offset (to be determined on remand), on grounds that IBM had materially breached the contract.
Giving preference to one's own interests
The issue addressed in this clause came up in a 2014 English case arising from the financial crisis of late 2008, Barclays Bank PLC v. Unicredit Bank AG,  EWCA Civ 302 (affirming trial-court ruling). There, Barclays had the right to consent to a particular type of financial transaction, but it was obligated to grant or withhold such consent in a commercially-reasonable manner. The England and Wales Court of Appeals rejected Unicredit's argument that this meant that Barclays was required to take Unicredit's interests into account, not merely Barclays's own interests. See id. at para. 16; see also this annotation.
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Conditions precedent vs. conditions subsequent
Conditions can be loosely classified as:
- prerequisites, formally known as conditions precedent; and
- exceptions, formally known as conditions subsequent.
EXAMPLE: Except in case of emergency, Landlord must give Tenant at least 24 hours notice before entering the Leased Premises: Here, the 24‑hour notice requirement is a (partial) prerequisite, and thus a condition precedent, to Landlord's being able to enter the Leased Premises.
EXAMPLE: Landlord will allow Tenant to use the Apartment Complex's recreational facilities unless Tenant is delinquent in rent payments: Here, the delinquency exception is a condition subsequent that excuses Landlord from this particular obligation.
Courts prefer to interpret obligations as covenants (i.e., promises), not as conditions
From a Utah supreme court case:
… the parties employed explicitly mandatory language to characterize [one contract] provision, while using explicitly conditional language elsewhere in the agreement. Based on these features of the [contract], we conclude that there is no plausible way to read the [relevant] provision as anything other than a covenant.
Mind & Motion Utah Investments, LLC, v. Celtic Bank Corp., 2016 UT 6, para. 45 (affirming summary judgment). The court later explained:
Although Celtic Bank‘s ability to meet the recording deadline hinged in large part on the approval of county officials, the parties couched the recording obligation in mandatory language while employing explicitly conditional language elsewhere in the REPC to describe other performance obligations. This shows that Celtic Bank and Mind & Motion, both sophisticated parties, knew how to draft a condition when they so desired. Accordingly, it is not plausible to read Celtic Bank‘s duty to record the phase 1 plat as anything other than a covenant, and the REPC is therefore not facially ambiguous.
Id. at para. 16. And:
… when parties employ mandatory terms to characterize an obligation whose fulfillment hinges on the action of a third party, this may indicate an express assumption by one party of the risk that the condition will remain unfulfilled.
Id. at para. 23 (footnote, citing Restatement (Second) of Contracts § 227 cmt. b (Am. Law Inst. 1981), omitted).
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This term sheet and the Common Draft Confidential Information Clause (i) are intended to be read as a single integrated provision, and (ii) must not be relied on as a substitute for legal advice.
- The Confidential Information of which party or parties is to be protected by this Agreement?
- Each party (each, a Disclosing Party).
(2) is disclosed to one or more other parties bound by this Agreement (each, a Receiving Party), by or with the authorization of the Disclosing Party, in connection with this Agreement; and
(3) is not excluded from Confidential-Information status.
(b) Exclusions: At any particular time, the term Confidential Information does not include information that is shown to be or to have been, at that time, within one or more of the following categories:
(1) The information was known by the Receiving Party before it obtained access to the information under this Agreement; or
(2) The information was provided to the Receiving Party by a third party that, at the time in question, was not under a legally-enforceable obligation of confidence benefiting the Disclosing Party in respect of the information; or
(3) The information was independently developed by the Receiving Party without use of Confidential Information; or
(4) The information was published, or otherwise made generally available to one or more others not under a legally-enforceable obligation of confidence benefiting the Disclosing Party, without breach of this Agreement by the Receiving Party; or
(5) The information was disclosed, by the Disclosing Party or with its authorization, to one or more third parties that, at the time of such disclosure or any time afterwards, were not under a legally-enforceable obligation of confidence that: (A) benefited the Disclosing Party, and (B) included restrictions on disclosure and use comparable to those of this Agreement; or
(6) Any other particular Excluded Information Categories expressly agreed to in writing by the parties, if any — for the avoidance of doubt, it is immaterial if one or more other particular Excluded Information Categories is also in another category listed above.
(b) Corroboration of exclusion claims: In the interest of promoting accuracy in fact-finding, all claims of exclusion from Confidential Information status must be supported by reasonable corroborating evidence.
(c) Interpretation: For the avoidance of doubt, except to the extent (if any) that this Agreement specifically provides otherwise:
(1) The term Confidential Information encompasses, by way of example and not of limitation, the following types of information when the information is otherwise eligible under this Agreement: Algorithms; audit reports. Biological materials; business plans; business records. Circuit records; commercial information; compounds; computer programs; contracts; construction records. Data-center designs; designs; diagrams; documents; draft publications; drawings. Engineering records. Financial information; financial projections; financial statements; forecasts; formulas. Hardware items. Ideas; interpretations; invention disclosures. Leases. Machine-readable data; maps; market projections; marketing information; methods. Offers; operational data; opinions. Patent applications (unpublished); plans; pricing information; procedures; processes; product development plans; product information programs; projections; proposals. Research data; research plans. Samples; server-configuration designs; source code for computer programs; specifications; strategies. Tax bills; technical information; technical reports; technological developments; test data; title reports.
(2) The term Confidential Information likewise encompasses analyses; compilations; forecasts; interpretations; notes; reports; studies; summaries; and similar materials prepared by (or for, or on behalf of) the Receiving Party that contain Confidential Information.
(3) Information owned or maintained by a third party, when otherwise eligible, is considered Confidential Information to the same extent as if the information were that of the Disclosing Party, if the third-party information is disclosed or made accessible to the Receiving Party, by or on behalf of the Disclosing Party, pursuant to this Agreement.
(4) A specific selection or combination of items of information can be eligible for Confidential Information status even if some or all of the items are not themselves confidential.
(5) Information not maintained in confidence by a Disclosing Party named as such in this Agreement is not protected by the confidentiality provisions of this Agreement, regardless whether any other party maintains the information in confidence. (Such information may of course be subject to any confidentiality requirements that might be imposed by law and/or by other agreements binding on the Receiving Party.)
(6) The fact that Confidential Information comes within the scope of a subpoena or other Legal Demand does not in itself mean that the information becomes categorically excluded from Confidential Information status.
(a) Applicability; duration: The obligations of this Rider apply:
(1) except to the extent (if any) expressly authorized otherwise by this Agreement; and
(2) at all times, including for example after any termination or expiration of this Agreement, or of any other right or obligation under this Agreement, for the remaining duration of the Confidentiality Period, which refers to the period that begins on the effective date of this Agreement and continues until the information in question no longer qualifies as Confidential Information.
(b) Precautions: The Receiving Party must cause the following precautions to be taken to safeguard Confidential Information in its possession, custody, or control:
(1) at least the same precautions as the Receiving Party takes for its own information of comparable significance;
(2) in no case less than those precautions that a prudent person would take in the same circumstances; and
(3) any other particular security precautions expressly agreed to in writing by the parties, if any — for the avoidance of doubt, it is immaterial if one or more such other particular security precautions is also in another category listed above.
(c) Non-use, non-disclosure, etc.: The Receiving Party may not disclose, use, or copy Confidential Information, in whole or in part, except as expressly provided in this Agreement.
Solely during the Authorized Use Period (namely, the term of this Agreement), the Receiving Party may use Confidential Information to the extent reasonably necessary for one or more of the following:
(1) performing the Receiving Party's obligations under this Agreement;
(2) exercising the Receiving Party's rights under this Agreement;
(3) assessing whether to enter into another agreement with the Disclosing Party; and
(4) any other particular authorized uses expressly agreed to in writing by the parties — it is immaterial if one or more of such other authorized uses, if any, falls within any of subdivisions (1) through (3) above.
(a) Solely during the Authorized-Use Period, the Receiving Party may disclose Confidential Information — on a strict need-to-know basis in connection with the Receiving Party's use of Confidential Information permitted by this Agreement — to one or more of the following, if any:
(1) the Receiving Party's officers, directors, and employees, and individuals having comparable status if the Receiving Party is a non-corporate type of organization (for example, managers of a limited liability company and general partners of a general- or limited partnership); and
(2) any other authorized recipients expressly agreed to in writing by the parties, if any. (It is immaterial if one or more such other authorized recipients comes within the scope of subdivision (1) above.)
(b) Each individual to whom Confidential Information is disclosed by the Receiving Party must be legally bound to comply with the provisions of this Agreement protecting Confidential Information, either:
(1) by a written agreement with the Receiving Party containing confidentiality obligations, comparable to those of this Agreement, that apply to Confidential Information; or
(2) as a matter of law, for example where (A) the recipient is an employee of the the Receiving Party and (B) under applicable law an employee is bound to preserve in confidence the confidential information of the employer.
(a) Definition: The term Legal Demand refers to a demand for information such as (for example) a subpoena; a search warrant; a civil investigative demand; or a discovery request in a lawsuit; if in each such case, both of the following are true:
(1) the demand for information is initiated or propounded by a third party such as (for example) a litigant or a governmental entity; and
(2) the Receiving Party's compliance with the demand for information may be compelled under penalty of law.
(b) Disclosure procedure: The Receiving Party may disclose Confidential Information in response to a Legal Demand, as follows:
(1) The Receiving Party must seasonably advise the Disclosing Party of the Legal Demand (to the extent that doing so is not prohibited by law);
(2) The Receiving Party must disclose only so much Confidential Information as is required to comply with the Legal Demand.
(c) Efforts to limit disclosure:
(1) If so requested by the Disclosing Party, the Receiving Party must provide reasonable cooperation with any efforts by the Disclosing Party to limit the disclosure, and/or to obtain legal protection for the information to be disclosed, in response to the Legal Demand.
(2) Upon request by the Receiving Party, accompanied by (and/or supplemented with) reasonable supporting documentation, the Disclosing Party will reimburse the Receiving Party for all reasonable expenses incurred in providing the cooperation referred to in subdivision (1), including for example reasonable attorney fees.
(d) Only compulsory disclosures: For the avoidance of doubt, except as provided in "6. Disclosures Authorized by Law" or as otherwise agreed in writing, the Receiving Party is not authorized to disclose Confidential Information in a submission to a government authority that does not qualify as a Legal Demand (for example, a discretionary filing under the securities laws).
(a) The confidentiality provisions of this Agreement are not to be interpreted:
(1) as precluding the Receiving Party from disclosing Confidential Information, to the minimum extent required by law, as part of any of the following:
(A) reporting possible violations of law or regulation to any governmental agency or entity having jurisdiction, including but not limited to the United States Department of Justice, Securities and Exchange Commission, Congress, and any agency inspector general; or
(B) making other disclosures by the Receiving Party that are positively authorized by law or regulation, for example the [U.S.] National Labor Relations Act or other labor- or employment law; nor
(2) as requiring the Receiving Party to obtain the prior consent of the Disclosing Party to make such reports or disclosures; nor
(3) as requiring the Receiving Party to notify the Disclosing Party that it has made such reports or disclosures.
(b) In the interest of promoting the prompt identification and correction of possible violations of law or regulation, the Receiving Party is strongly urged to promptly advise the Disclosing Party of any facts, material to the Disclosing Party or to the relationship between the Disclosing Party and the Receiving Party, that would be contained in any report or disclosure referred to in subdivision (a)(1).
(a) During the Authorized-Use Period, but not afterwards, the Receiving Party may make copies and excerpts of Confidential Information, solely to the extent reasonably necessary for use or disclosure permitted by this Agreement.
(b) The Receiving Party must ensure that any such copy or excerpt substantially duplicates any confidentiality marking on the copy from which the copy or excerpt is made.
(c) For the avoidance of doubt, the confidentiality obligations of this Agreement apply to all such copies or excerpts.
(a) Except as provided in subdivision (b), upon a seasonable written request by the Disclosing Party following any termination or expiration of this Agreement, the Receiving Party will cause one of two actions to be taken in respect of each Specimen of Confidential Information, namely each copy of, and each physical object embodying, Confidential Information — for example, any paper- or electronic copy and any hardware sample — that is in the possession, custody, or control of: (i) the Receiving Party, and/or (ii) any individual or organization to which the Receiving Party made Confidential Information accessible, as follows:
(1) return the Specimen to the Disclosing Party or to another individual or organization designated in writing by the Disclosing Party; or
(2) only with the prior written consent of the Disclosing Party, destroy the Specimen.
(b) Specimens of Confidential Information need not be returned or destroyed to the extent that they are not reasonably capable of being readily located and segregated without undue burden or expense — for example, Confidential Information contained in email correspondence or electronic back-up systems.
Table of Contents
- Confidentiality of Disclosing-Party Affiliates' Information
- Presumption of Confidentiality
- Marking Exception for Obviously-Confidential Information
- Receiving Party's Indemnity Obligation Concerning Certain Third-Party Claims
- Receiving-Party Cooperation Concerning Potential Misappropriation
- Specific Instructions to Individual Recipients
- Copies of Recipients' Confidentiality Agreements to be Provided
- Compliance with Law in Dealing with Confidential Information
- Indemnity for Noncompliance with Law
- Receiving Party Liability for Certain Recipient Misappropriations
- Receiving Party's Representation of Its Status and Intentions
- Inspections to Confirm Confidentiality-Obligation Compliance
- Confidentiality Obligations Continue for Retained Specimens
- Certificate of Return or Destruction Required Upon Request
- Disclosing Party's Disclaimers
- No Reliance by Receiving Party
- Disclosing Party's Right to Withhold Confidential Information
- Other Rights and Obligations Survive Confidentiality Period
(a) Information of one or more affiliates of a Disclosing Party is to be considered Confidential Information to the same extent as if it were owned or maintained by the Disclosing Party itself, but only if the information is clearly marked as being subject to this Agreement.
(b) For the avoidance of doubt, the marking requirement of subdivision (a) applies regardless whether this Agreement requires Confidential Information of the Disclosing Party itself to be marked as such.
This language reflects a compromise between the following party positions:
- A disclosing party will often want its affiliates' confidential information to be protected without the affiliates' having to negotiate and sign separate confidentiality agreements.
- On the other hand, a receiving party might insist on knowing exactly which companies conceivably might sue the receiving party someday for breach of contract. The language of this clause allows affiliate information to be protected, while reducing the chances that the receiving party might someday be ambushed by claims of misappropriation of information that its people had no real reason to know was confidential.
All information of, or maintained by, the Disclosing Party is to be presumed to be Confidential Information unless and until shown otherwise.
Information that, under the circumstances, would be recognized, by a reasonable person, as obviously being confidential is to be treated as Confidential Information regardless whether the information is marked as such.
Some disclosing parties don't want to be bothered with having to mark their confidential information as such. Such a preference can be accommodated with this clause.
A receiving party might well object to this provision because of the potential for later disputes about whether particular information qualified as "obviously" confidential.
(a) The Receiving Party will defend and indemnify the Disclosing Party, its Affiliates, and the Associated Individuals of each of them, against any claim by a third party arising out of the use or disclosure of Confidential Information by, on behalf of, or with the permission of, the Receiving Party.
(b) For the avoidance of doubt, the obligations of this provision will survive any termination or expiration of this Agreement.
Some disclosing parties will want this kind of clause.
Some receiving parties might balk at this indemnity requirement, especially if the indemnity obligation might encompass unforeseeable harm; see this note for additional details.
During the Authorized-Use Period, in response to any reasonable request by (and at the expense of) the Disclosing Party, the Receiving Party will provide reasonable cooperation with the Disclosing Party and/or its designees in investigating and/or taking action against a third party in connection with possible misappropriation of Confidential Information provided to the Receiving Party.
Before Confidential Information may be provided to an individual recipient under the 3. Authorized Uses of Confidential Information provision, the Receiving Party must first take reasonable steps to cause the individual to be specifically instructed that he or she has a duty to abide by the confidentiality obligations of this Agreement.
(a) Upon request by the Disclosing Party, the Receiving Party will provide the Disclosing Party with a copy of the written confidentiality agreement between the Receiving Party and each individual or organization to which the Receiving Party provides Confidential Information.
(b) Such copies may be redacted, if so desired by the Receiving Party, to prevent disclosure to the Disclosing Party of confidential information of the Receiving Party.
The Receiving Party must ensure that any use, disclosure, or copying of Confidential Information, by or on behalf of the Receiving Party or any party receiving Confidential Information from the Receiving Party complies with applicable law, including for example any applicable law concerning (i) privacy or (ii) export controls.
A requirement like this can be handy if the Receiving Party will be dealing with information whose distribution is restricted by law, for example personal health information or export-controlled information.
See also Indemnity for Noncompliance with Law.
Some receiving parties might balk at this indemnity requirement, especially if the indemnity obligation might encompass unforeseeable harm; see this note for additional details.
IF: A third party, referred to as the Recipient – for this purpose including, for example, any employee of the Receiving Party – obtains or otherwise accesses Confidential Information in question as a result of the Recipient's relationship with the Receiving Party;
AND: The Recipient uses, discloses, and/or copies that Confidential Information in a manner not permitted by this Agreement;
THEN: The Receiving Party will be liable to the Disclosing Party for any resulting harm to the Disclosing Party or its interests, to the same extent as if the damage had been caused by use, disclosure, or copying of the Confidential Information by the Receiving Party.
A disclosing party will sometimes ask a receiving party to be liable (or, "be responsible") for any misappropriation of Confidential Information by the receiving party's employees, contractors, etc. This is an example of the "one throat to choke" principle. (OK, OK, that's an outdated expression; it's still useful.)
If a receiving party objects to this provision, the objection might trigger questions from the disclosing party about the receiving party's intentions (or competence).
To induce the Disclosing Party to provide it with access to Confidential Information, the Receiving Party makes the following Receiving Party's Representation to the Disclosing Party concerning the Receiving Party's status and its intentions for the use of Confidential Information, and with the intent that the Disclosing Party rely on that representation: None specified.
Having the Receiving Party certify its status and its intentions for the Confidential Information would "tee up" a fraud claim against the Receiving Party if it turned out that the Receiving Party in fact intended to make an unauthorized use of Confidential Information.
A clause of this kind can be seen in [TO DO: CITE NEEDED].
(a) During the Confidentiality Period, the Disclosing Party, upon reasonable advance written notice to the Receiving Party, may cause reasonable inspections of the Receiving Party's relevant properties and premises to be conducted to confirm compliance with the Receiving Party's confidentiality obligations under this Agreement.
(b) For the avoidance of doubt, the right of inspection of this provision extends, by way of illustrative example and not of limitation, to any or all hard-copy and electronic records of any kind in the possession, custody, or control of the Receiving Party.
The confidentiality obligations of this Agreement will continue to apply to all Specimens of Confidential Information that for any reason are not returned or destroyed for so long as those obligations remain in effect.
IF: The Disclosing Party so requests in writing within a reasonable time after the 8. Return or Destruction of Confidential Information provision becomes applicable; THEN: The Receiving Party will promptly provide the Disclosing Party with a certificate of its compliance with that provision; the certificate must:
(1) be signed by an officer of the party or other individual authorized to bind the party;
(2) note any known compliance exceptions; and
(3) for each exception, note whether and how the exception is authorized by this Agreement.
Requiring the Receiving Party to certify its compliance with the return-or-destruction requirements would:
- provide the Disclosing Party with "they lied!" ammunition in case it turned out that some Specimens of Confidential Information were not returned or destroyed; BUT …
- as a result, give the Receiving Party an incentive to do a good job in complying with the return-or-destruction requirement; and
- help the parties identify specific areas that might need attention before a dispute arises, and thus possibly help avoid the dispute in the first place.
For the avoidance of doubt, EXCEPT to the extent (if any) that this Agreement or another written agreement between the parties expressly states otherwise:
(1) This Agreement does not grant to the Receiving Party, nor to any other individual or organization, any license right or ownership right of any kind, in Confidential Information, nor in other any intellectual property of the Disclosing Party; and
(2) The Disclosing Party DISCLAIMS all warranties, representations, conditions, and terms of quality, express or implied, about Confidential Information, including for example all warranties of completeness or accuracy; all Confidential Information is provided or otherwise made available AS IS, WITH ALL FAULTS.
(c) THE DISCLOSING PARTY WILL NOT BE LIABLE for any use of Confidential Information made by the Receiving Party EXCEPT to the extent (if any) expressly stated otherwise in this Agreement, for example:
(1) in a warranty clause concerning the Confidential Information, if applicable; and/or
(2) in a relevant indemnity obligation concerning the Confidential Information, if applicable.
Some drafters make a practice of including disclaimer language like this for use as litigation sound bites.
Some language in this disclaimer is in all-caps bold-faced type so that the language will be conspicuous.
The Receiving Party is not entitled to rely, and agrees not to rely, on Confidential Information for any purpose, except to the extent (if any) expressly stated otherwise in this Agreement.
For the avoidance of doubt, the Disclosing Party need not provide any particular Confidential Information to the Receiving Party except to the extent, if any, that this Agreement expressly indicates otherwise.
For the avoidance of doubt, any termination or expiration of the Confidentiality Period:
(1) will not waive or otherwise affect the Disclosing Party's ability to enforce its other intellectual-property rights (for example, copyrights and patents) against the Receiving Party except to the extent, if any, that the parties expressly agree otherwise in writing; and
(2) will not affect any obligation of confidentiality imposed by law.
Table of Contents
- Protected-Disclosure Time Limits
- Marking Requirement for Confidential Information
- Disclosing Party Warranty of Authority to Disclose
- Disclosing Party Indemnity Obligation for Unauthorized Disclosure to Receiving Party
- Expiration of Confidentiality Obligations
- Protection Limited to Specified Information Categories Only
- Only Commercially-Reasonable Efforts Needed to Return or Destroy
- Confidential Information Archive Copies Rider
- Disclosure of Confidential Information to Prospective Acquirer in Secure Data Room
- Receiving Party's Right to Freely Use "Residuals" of Confidential Information
- Disclosure of Confidential Information in Public Filings
- Receiving Party's Consent Required for Specific Disclosures to It
- Confidentiality Obligations Do Not Imply Fiduciary Relationship
- Receiving Party's Freedom of Action Otherwise
For particular information to be considered Confidential Information, it must be initially disclosed to the Receiving Party during the Protected Disclosure Period, which refers to the term of this Agreement unless this Agreement states otherwise.
A receiving party wouldn't want to be ambushed by claims that disclosed information was supposedly secret when the information was first provided to the receiving party long after the agreement was signed — by which time the parties' business people might well have forgotten that their companies still technically had a confidentiality agreement in place.
The "default" language ties the Protected-Disclosure Period to the term of the Agreement. A receiving party might want to request an even shorter disclosure period such as (for example) the expected duration of a negotiation, plus perhaps a safety margin.
NOTE: Even disclosures made outside the Protected-Disclosure Period might still be subject to obligations of confidence under applicable law, for example, the laws governing protected health information or nonpublic personal financial information.
(a) Marking required: Except as otherwise provided below, information that is made available to the Receiving Party in connection with this Agreement, by or on behalf of the Disclosing Party, will not be considered Confidential Information unless the information:
(1) is set forth (or summarized) in tangible form (including for example an electronic storage device); and
(2) is marked with a reasonably-prominent, visually-readable notice such as (for example) "Confidential information of [name]" or "Subject to NDA."
(b) Catch-up marking: IF: A Disclosing Party discloses putatively-Confidential Information that is not marked as such (for example, disclosure in an unmarked writing or by a demonstration or oral disclosure); THEN: The Disclosing Party may retroactively mark the information as confidential, with the same effect as if the information had been timely marked, as follows.
(1) At the time of the initial unmarked disclosure of the information in question, the Disclosing Party must advise the Receiving Party, orally or otherwise, that the Disclosing Party considers the information to be Confidential Information.
(2) In addition, no later than the end of the Catch-Up Marking Period (namely, ten business days after the initial unmarked disclosure of the specific information in question), the Disclosing Party must: (A) furnish the Receiving Party with a copy or written summary of the Confidential Information that is marked as Confidential Information; and (B) give the Receiving Party notice that it has done so.
(c) Marking not required for in-place access: IF: The Receiving Party is given access to a particular document or thing containing Confidential Information as it is kept in the ordinary course of business — for example in the Disclosing Party's paper- or electronic files — THEN: That particular document or thing need not be marked as confidential.
Table of Contents
- Purpose of marking requirement
- Courts pay attention to the absence of marking
- Catch-up marking: A compromise
- Caution: Some information might be confidential by law even without marking
- Catch-up marking
- Notice of catch-up marking
- Forgetting catch-up marking can destroy trade-secret rights
- No marking needed for in-place access
The basic objectives of the marking requirement are usually:
- to alert the receiving party's personnel that particular information is subject to confidentiality obligations;
- conversely, to let the receiving party's personnel know what particular information is not subject to confidentiality obligations and therefore may be used freely; 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.
In assessing whether a disclosing party in fact maintained particular information in confidence, a court very likely will give significant weight to whether the disclosing party 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. See Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant; applying Illinois law).
To like effect was a Seventh Circuit case, nClosures, Inc. v. Block & Co., 770 F.3d 598, 600 (7th Cir. 2014), where the court affirmed a summary judgment that "no reasonable jury could find that nClosures took reasonable steps to keep its proprietary information confidential," and therefore the confidentiality agreement between the parties was unenforceable.
A 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. See Convolve, Inc. v. Compaq Computer Corp., No. 2012-1074, slip op. at 14, 21.
See [TO DO]
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.
This provision can be used in connection with the Marking Requirement for Confidential Information provision.
In business, confidential information is sometimes disclosed in unmarked form, e.g., orally or in a demonstration, facilities tour, etc. With that possibility in mind:
- The disclosing party likely would prefer not to have a marking requirement at all — but that would mean that all disclosed information would be considered Confidential Information;
- The receiving party likely would prefer having any unmarked information be immediately and permanently deemed non-confidential and thus free for the receiving party to use and/or disclose as it saw fit;
- Allowing for catch-up marking is a frequently-adopted compromise between those two preferences.
If a disclosing party were to make an initial unmarked disclosure but then later do catch-up marking:
- The receiving party likely would want a formal written reminder that the information is confidential.
- Sending the notice would help document the fact that the disclosing party did in fact do catch-up marking; the disclosing party might later be grateful that it had created such documentation.
A company's failure to do catch-up marking of confidential information after an oral disclosure to another party can kill the company's claim to trade-secret rights in the information. In Convolve v. Compaq, the computer manufacturer Compaq (then part of Hewlett-Packard) defeated Convolve's claim that Compaq had misappropriated Convolve's trade secrets concerning hard-disk technology. Compaq won because Convolve, which claimed trade-secret rights in certain information, had disclosed some of that information orally to Compaq, but didn't follow up those oral disclosures with written summaries, which was required by the parties' non-disclosure agreement. See Convolve, Inc. v. Compaq Computer Corp., No. 2012-1074, slip op. at 14, 21 (Fed. Cir. July 1, 2013) (affirming summary judgment; non-precedential).
If the receiving party will be, for example, a consultant hired by the disclosing party, then the disclosing party won't want to have to mark all of its internal information as confidential (even though of course that might be a good idea).
The Disclosing Party will not disclose to the Receiving Party, any information that, at the time of disclosure, is subject to a legally-enforceable right of a third party to prohibit the disclosure, unless the Disclosing Party possesses either:
(1) the third party's consent to make the disclosure; or
(2) a legally-enforceable right to make the disclosure without the third party's consent.
The Disclosing Party will defend and indemnify the Receiving Party and its Protected Group from any claim, by any third party, that the Disclosing Party's disclosure to the Receiving Party was in violation of the third party's rights in the information in question.
Some drafters like to say that a breaching party must indemnify the other party (usually the drafter's client) against any damages resulting from the breach. This, though, might expose the breaching party to greater liability than it would otherwise have; see Indemnity vs. breach of contract for a more extensive discussion.
The confidentiality obligations of this Agreement apply only during the Confidentiality Period, which refers to the period that begins on the effective date of this Agreement and continues until the information in question no longer qualifies as Confidential Information.
Table of Contents
- Reasons to let confidentiality obligations expire
- Danger of letting confidentiality obligations expire
- Possible expiration dates for confidentiality obligations
- Expiration of other obligations doesn't affect confidentiality obligations
- Expiration of confidentiality doesn't affect other IP rights
- Rule against perpetuities?
Disclosing parties will normally be reluctant to agree to a fixed confidentiality period. That's because doing so can result in destruction of the disclosing party's trade-secret rights in its confidential information after the end of the confidentiality period.
Receiving parties, of course, generally prefer to have fixed expiration dates for confidentiality obligations.
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 could 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.
Many receiving parties want an expiration date for confidentiality obligations as a safe harbor. After Xyears have gone by, it might well require time and energy for a 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 would prefer instead to have a bright-line "sunset" (am I mixing my metaphors?), after which the receiving party can do whatever it wants without having to incur the burden of analyzing the facts and circumstances.
An expiration date for confidentiality obligations might be acceptable to a disclosing party, depending largely on:
- how sensitive the information is, in the disclosing party's eyes, and
- how long it will be until the confidentiality obligations expire.
For example: Suppose that:
- the confidential information relates to the design of a product manufactured and sold by the disclosing party, and
- 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. That would provide the receiving party with a bright-line sunset date as well as providing the disclosing party with a year or two of safety margin.
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. [CITATION NEEDED]
The parties could specify that the Receiving Party's confidentiality obligations will expire Xmonths or years after:
- the date that all copies of the information are returned or destroyed;
- the effective date of the Agreement;
- the effective date of termination or expiration of the Agreement.
The language, any other right or obligation under this Agreement, addresses the situation in which an agreement includes noncompetition or non-solicitation provisions in addition to confidentiality provisions — the language attempts to make it clear that the confidentiality obligations continue even if (for example) the non-competition covenant expires.
Conceivably, a receiving party might try to argue that post-termination confidentiality obligations violated the Rule against Perpetual Contracts and therefore were terminable at will. See generally Brett A. August and Andrew N. Downer, Equitable Exceptions to the Rule Against Perpetual Contracts, Intellectual Property Litigation, Volume 21, No. 4 (ABA Section of Litigation, summer 2010).
Such an argument, though, would have to overcome the long-established rule that "[t]rade secret licenses may endure even where the trade secret itself is destroyed by general disclosure." Nova Chemicals, Inc. v. Sekisui Plastics Co., 579 F.3d 319, 328 (f3d Cir. 2009), discussing Aronson v. Quick Point Pencil Co., 440 U.S. 257, 266 (1979) and Warner-Lambert Pharm. Co. v. John J. Reynolds, Inc., 178 F.Supp. 655, 665-66 (S.D.N.Y. 1959), aff'd, 280 F.2d 197 (2d Cir. 1960) (per curiam, adopting district court opinion).
For particular information to be considered Confidential Information, it must fall into a Protected Information Category specified in this Agreement (all categories if not otherwise specified).
A receiving party might want to limit its confidentiality obligations to specific categories of information, such as (for example) financial data, design data, etc. That way, if the disclosing party (or its personnel) provide other types of information to the receiving party, the provided information will be free for use by the receiving party without restriction.
The Receiving Party need only make commercially-reasonable efforts to carry out its obligations of the 8. Return or Destruction of Confidential Information provision.
(a) The Receiving Party may engage an external Archive Custodian, reasonably acceptable to the Disclosing Party, to maintain, for an indefinite period, in confidence, on behalf of the Receiving Party, a set of archive copies of Confidential Information, including reasonable backups for such copies, for the sole purposes of:
(1) helping the Receiving Party ascertain and confirm compliance with its continuing confidentiality obligations; and
(2) documenting the parties' interactions in connection with this Agreement.
(b) Such archive copies must be maintained in accordance with commercially-reasonable security standards, for example in the custody of a reputable commercial records-storage organization that is contractually obligated to maintain the archive copies in confidence.
(c) Such archive copies and the Confidential Information contained therein are to be made accessible to the Receiving Party's personnel (other than Archive Custodians if among the Receiving Party's personnel) only:
(1) as directed or permitted by a tribunal of competent jurisdiction; or
(2) with the Disclosing Party's prior written consent.
This provision is likely to be used as an exception to 8. Return or Destruction of Confidential Information.
A receiving party might want to be able to retain copies of Confidential Information — even after termination of the agreement — in case, for example:
- the parties later got into a dispute about what the disclosing party did or did not actually disclose; or
- a third party sued the receiving party (e.g., a customer of the disclosing party that claimed to have been injured as a result of the receiving party's work) and the receiving party wanted to use Confidential Information in its defense. The Archive Custodian(s) might be, for example, the receiving party's IT staff.
Or, a disclosing party might want the Archive Custodian(s) to be limited to the receiving party's outside counsel. The phrase outside counsel only is well understood to lawyers who work in litigation. See, for example, paragraph 11(c) of the protective order entered in an antitrust case brought by the [U.S.] Department of Justice.
(a) The Receiving Party may, without the Disclosing Party's consent, disclose Confidential Information to a prospective acquirer of: (1) substantially all shares (or equivalent ownership interest under applicable law) of the Receiving Party itself; or (2) substantially all of the assets of the Receiving Party's business specifically associated with this Agreement.
(b) Any such prospective recipient of Confidential Information must agree in writing to abide by the Receiving Party's obligations in this Agreement relating to Confidential Information.
(c) Any such disclosure must be done in one or more secure physical data rooms or via a secure online data room.
(d) The Receiving Party must not allow the recipient to keep copies of Confidential Information without the Disclosing Party's prior written consent.
(a) Residuals refers to ideas, concepts, know-how, techniques, and similar information that may be retained in the unaided memory of the Receiving Party's personnel who did not intentionally memorize the information for that purpose.
(b) The Receiving Party may use Residuals as it sees fit without obligation to the Disclosing Party — this subdivision, however, does not negate any restriction of this Agreement on the Receiving Party's disclosure of Confidential Information to third parties.
(c) For the avoidance of doubt, any use of Residuals by the Receiving Party will be subject to any applicable patent rights, copyrights, trademark rights, or other intellectual-property rights owned or assertable by the Disclosing Party.
A disclosing party likely will push back strongly against any request for this provision. In practice, the provision can amount to a blank check for the receiving party and its people to do whatever they want with the disclosing party's confidential information.
- Michael D. Scott, Scott on Information Technology Law § 6.25[D] (accessed Nov. 26, 2010).
- Brian R. Suffredini, Negotiating Residual Information Provisions in IT and Business Process Outsourcing Transactions (2004).
- Tom Reaume, This Residuals Clause Left a Bad Residue (2011).
The Receiving Party may include Confidential Information in a submission to a regulatory agency or other governmental body, if:
(1) the inclusion is compelled by law, to the same extent as if the inclusion were compelled by law in response to a Legal Demand;
(2) the Receiving Party first consults with the Disclosing Party a sufficient time in advance to give the Disclosing Party a reasonable opportunity to seek a protective order or other relief;
(3) the Receiving Party discloses only so much Confidential Information as is required to comply with the law; and
(4) the Receiving Party provides reasonable cooperation with any efforts by the Disclosing Party 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 Legal Demand.
A Receiving Party that is, or wants to be, publicly traded might feel it must disclose Confidential Information in its public filings. Such disclosure, though, can destroy the confidentiality status of the information. See generally, e.g., Ruckelshaus v. Monsanto Co., 467 U.S. 986, 1011-12, esp. text accompanying n.15 (1984) (noting that Environmental Protection Agency's disclosure of Monsanto's pesticide test data would destroy Monsanto's trade-secret rights in the data).
This basic issue arose in Martin Marietta Materials, Inc v. Vulcan Materials Co., 56 A.3d 1072, 1147 (Del. Ch. 2012), aff'd, 45 A. 3d 148 (Del. 2012) (en banc): In that case, Martin Marietta was held to have breached a confidentiality agreement by including confidential information of Vulcan Materials in a public filing with the Securities and Exchange Commission.
The Receiving Party will be under no obligation of confidence under this Agreement with respect to any Confidential Information disclosed to it unless the Receiving Party first consents in writing to the specific disclosure.
For the avoidance of doubt, the Receiving Party's undertaking of the obligations of this Agreement concerning Confidential Information is not intended and should not be interpreted as in itself establishing a confidential‑ or fiduciary relationship between the parties.
(a) This provision applies in respect of any information that the Disclosing Party causes to be disclosed or made available to the Receiving Party pursuant to this Agreement ("Disclosed Information").
(b) The Receiving Party is bound solely by:
(1) the confidentiality obligations of this Agreement;
(2) any confidentiality obligations that may exist in any other extant and applicable written agreement between the parties; and
(3) any confidentiality obligations imposed by applicable law (for example, privacy law).
(c) Consequently, as between the parties, so long as the Receiving Party abides by the confidentiality obligations of this Agreement, the Receiving Party is free to use and/or disclose any or all such Disclosed Information:
(1) as the Receiving Party sees fit in its sole and unfettered discretion;
(2) without any obligation of compensation to the Disclosing Party or any other party claiming through the Disclosing Party;
(3) but only if such use or disclosure does not violate another intellectual-property right of the Disclosing Party (if any), such as, for example, patent rights, trademark rights, or copyrights.
Some receiving parties might want this "roadblock" clause to use as ammunition in litigation.
Extended notes (and cautions)
Table of Contents
Table of Contents
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.
Potential investors in a company might be reluctant to sign a nondisclosure agreement ("NDA"). Venture capitalists in particular often flatly refuse to do so. With folks like that, you basically have to take your chances that they won't "steal" your idea.
As a practical matter, going without an NDA with 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.
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. But a jury might well punish a company that it found breached the contract. See, e.g., Celeritas Technologies Ltd. v. Rockwell Int'l, Inc., 150 F.3d 1354 (1998), where a federal-court jury in Los Angeles awarded a startup company more than $57 million because the jury found that Rockwell had breached an NDA. (Disclosure: I was part of Rockwell's trial team in that case.)
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- Reasons for defining "Disclosing Party"
- A two-way confidentiality agreement will usually be signed sooner
- A two-way confidentiality agreement will usually be safer
- A two-way agreement might help avoid future embarrassment
- What can qualify as "Confidential Information"?
- Reasonable confidentiality efforts are crucial
- Fort-Knox security measures aren't necessary (usually)
- But some secrecy efforts are virtually mandatory
- Disclosed "in connection with this Agreement …."
- Exclusion for information released without restriction by Disclosing Party
- No exclusion just because of subpoena, etc.
- Corroboration of exclusion claims
- Specific illustrative examples of Confidential Information
- Selections and combinations of non-confidential information
- Other information not protected
The term Disclosing Party implicitly defines whose Confidential Information will be protected. 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).
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
In contrast, 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.)
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 Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant). There, the plaintiff's confidentiality agreement with the defendant protected only the defendant's information. Consequently, said the court, the plaintiff's afterthought disclosures of its own confidential information were unprotected.
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.
Consider the Coca-Cola® formula; KFC's® secret blend of herbs and spices; company customer lists; pricing information; and contract terms and conditions. These are just a few examples of information that can be the subject of a confidentiality agreement, if they're the subject of reasonable efforts to keep them confidential.
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One [U.S.] state supreme court summarized the public-policy basis for enforcing confidentiality agreements:
The basic logic of the common law of trade secrets recognizes that private parties invest extensive sums of money in certain information that loses its value when published to the world at large.
Based on this logic, trade secret law creates a property right defined by the extent to which the owner of the secret protects his interest from disclosure to others.
In doing so, [trade secret law] allows the trade secret owner to reap the fruits of its labor ….
Trade secret law promotes the sharing of knowledge, and the efficient operation of industry; it permits the individual inventor to reap the rewards of his labor by contracting with a company large enough to develop and exploit it. [Quoting Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470, 493 (1974).]
DVD Copy Control Assn., Inc. v. Bunner, 31 Cal.4th 864, 880, 75 P.3d 1 (2003) (reversing court of appeal, and holding that preliminary injunction against Web site operator, prohibiting disclosure of trade secrets, did not violate the First Amendment) (citations omitted, extra paragraphing added), as excerpted by Altavion, Inc. v. Konica Minolta Sys. Lab. Inc., 226 Cal. App. 4th 26, 34 (2014) (affirming judgment of trade-secret misappropriation) (alteration marks edited, emphasis added).
The law protects just about any information that is kept confidential and provides a competitive advantage. This prerequisite generally comes from the definition of "trade secret," as found either in the relevant statute — which typically will be a variation of the Uniform Trade Secrets Act — or section 757 of the Restatement of Torts. As summarized by the Seventh Circuit court of appeals:
Illinois courts frequently refer to six common law factors (which are derived from § 757 of the Restatement (First) of Torts) in determining whether a trade secret exists:
(1) the extent to which the information is known outside of the plaintiff's business;
(2) the extent to which the information is known by employees and others involved in the plaintiff's business;
(3) the extent of measures taken by the plaintiff to guard the secrecy of the information;
(4) the value of the information to the plaintiff's business and to its competitors;
(5) the amount of time, effort and money expended by the plaintiff in developing the information; and
(6) the ease or difficulty with which the information could be properly acquired or duplicated by others.
Learning Curve Toys, Inc. v. PlayWood Toys, Inc., 342 F.3d 714, 722 (7th Cir. 2003).
Some people mistakenly think that legal protection won't be available for confidential information unless every possible security measure is taken. That's not how the law works. It's not mandatory to keep confidential information locked up in Fort Knox-like secrecy; in many circumstances, less-strict security measures may well suffice. See, e.g., Learning Curve Toys, Inc. v. PlayWood Toys, Inc., supra (reversing judgment as a matter of law and remanding with instructions to reinstate jury verdict of misappropriation; applying Illinois law).
As one court remarked:
… there always are more security precautions that can be taken. Just because there is something else that Luzenac could have done does not mean that their efforts were unreasonable under the circumstances. In light of undisputed precautions that Luzenac took, we do not think that the record demonstrates beyond dispute that Luzenac's measures to protect the secrecy of 604AV were merely "superficial." … Whether these precautions were, in fact, reasonable, will have to be decided by a jury.
Hertz v. Luzenac Group, 576 F.3d 1103, 1113 (10th Cir. 2009) (emphasis added, citations omitted); in that case, the appeals court vacated a summary judgment that legal protection was not available for a company's talc-production process, and remanded the case back to the lower court for a trial.
Still, the disclosing party will have to show that it made at least some efforts to keep the information confidential — obviously "more is better," but more is also more costly.
Failure on this point can be fatal to a trade-secret claim: In one case, the Seventh Circuit noted pointedly that the party asserting misappropriation had made no effort to preserve the so-called trade secrets in confidence. See Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant; applying Illinois law).
The "[disclosed] in connection with this Agreement" language helps put fences around the parties' confidentiality obligations. That can be useful for large companies that might:
- have multiple dealings with each other, including other dealings outside the scope of the Agreement; and
- don't necessarily want confidentiality obligations spilling over from one transaction to the parties' other dealings.
Most confidentiality agreements contain express exclusions from confidentiality such as these. This numbered list of exclusions clause is fairly typical.
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A disclosing party might try to omit exclusion #5, but in that case:
- The receiving party would probably push back, on the theory that if others get to use the disclosing party's information without legal restriction, then why shouldn't I?
- It's unclear what the legal effect of omitting exclusion #5 would be, because by law (at least in the U.S.), disclosure of information to a third party without confidentiality restrictions has the effect of killing any trade-secret rights the discloser might have had in the information, as discussed here.
Some badly-drafted confidentiality exclusion language includes subpoenaed information as a specific category of exclusion. 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 resulted in the subpoenaed information being automatically 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 the one taken by this provision.
Unlike some provisions of this kind, this provision requires only reasonable corroboration of a claim of exclusion from confidentiality, as as opposed to documentary proof of the claim. This balances:
- the interest of the disclosing party in avoiding self-interested (or even fraudulent) claims of, say, independent development by the receiving party, against —
- the interest of the receiving party in not having to meet an impossible burden of proof.
The U.S. Court of Appeals for the Federal Circuit explained this balancing concept in an analogous context, namely the patent-law requirement that claims of prior invention must be corroborated. According to the court, that requirement helps to guard against the possibility that someone 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." See Sandt Technology, Ltd. v. Resco Metal & Plastics Corp., 264 F.3d 1344, 1350 (Fed. Cir. 2001) (affirming relevant part of summary judgment; internal quotation marks and citation omitted).
Another useful patent-law analogy might the requirement of corroboration to support an assertion that an issued patent is invalid due to prior public use. "This corroboration requirement for testimony by an interested party is based on the sometimes unreliable nature of oral testimony, due to 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." TransWeb LLC v. 3M Innovative Properties Co., No. 2014-1646, slip op. at 6 (Fed. Cir. Feb. 10, 2016) (affirming award of treble damages and trebled attorney fees; internal quotation marks omitted), quoting Washburn & Moen Mfg. Co. v. Beat ‘Em All Barbed-Wire Co., 143 U.S. 275, 284 (1892). Such cases are governed by a rule of reason; not every detail need be "independently and conclusively supported by corroborating evidence," id. at 7 (internal quotation marks and citation omitted); "there are no hard and fast rules as to what constitutes sufficient corroboration, and each case must be decided on its own facts." Id.
This laundry list of examples is an example of a "roadblock" clause; disclosing-party counsel sometimes want it to serve as an explicit reminder to the receiving party (and also as ammunition in litigation).
Third-party confidential information is often protected in confidentiality provisions.
This language reflects established law (at least in the U.S.): A party can claim trade-secret rights in particular selections and compilations of non-secret information. See, e.g.:
- Tewari De-Ox Systems, Inc., v. Mountain States/Rosen, L.L.C., 637 F.3d 604, 613-14 (5th Cir. 2010), where the appeals court held that a genuine dispute existed as to whether the plaintiff's specific combination of published- or otherwise commonly-known information about meat packing was itself confidential, and thus vacated a summary judgment in favor of the defendant (citing cases);
- Hertz v. Luzenac Group, 576 F.3d 1103, 1110 (10th Cir. 2009), where the appeals court likewise vacated a summary judgment that a company had no trade-secret rights in its process for producing vinyl silane-coated talc;
- Integrated Cash Mgmt. Servs., Inc. v. Digital Transactions, Inc., 920 F.2d 171, 174 (2d Cir. 1990), in which the appeals court affirmed an injunction against the defendant's use of the plaintiff's "winning combination" of generic software programs. (It probably did not help the defendant's case that a defecting employee had brought copies of the plaintiff's computer code with him to his new job with the defendant.)
Negotiation possibility: Confidentiality of Disclosing-Party Affiliates' Information.
This provision sets forh "roadblock" language, designed to preclude a party that signed a one-way confidentiality agreement from suddenly claiming that its own confidential information was protected. A receiving party tried this — unsuccessfully — in Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant; applying Illinois law).
See also the commentary beginning at Reasons for defining "Disclosing Party".
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A disclosing party should always insist on including a provision like this in a confidentiality agreement. Otherwise, a court is likely to hold hold that the disclosing party had failed to make reasonble efforts to protect its confidential information. See, e.g.:
- Gal-Or v. United States, No. 09-869C (Ct. Fed. Cl. Nov. 21, 2013) (dismissing plaintiff's trade-secret claims): "[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.]
- Southwest Stainless, LP v. Sappington, 582 F.3d 1176, 1189-90 (10th Cir. 2009) (reversing judgment of misappropriation of trade secrets): A supplier gave specific price-quote information to a customer without any sort of confidentiality obligation; that defeated the supplier's claim of trade-secret misappropriation against a former employee.
- Lockheed Martin Corp. v. L-3 Comm. Integrated Sys. L.P., No. 1:05-CV-902-CAP (N.D. Ga. March 31, 2010) (granting L-3's motion for new trial): The court set aside a $37 million damages verdict for trade-secret misappropriation in favor of Lockheed after it came to light that Lockheed had disclosed the trade secrets in question to a competitor without restrictions. The case later settled; see, e.g., R. Robin McDonald, Discovery Failure Sinks Lockheed's $37 Million Win, Apr. 6, 2010; see also R. Robin McDonald, Lockheed and L-3 settle five-year battle, Nov. 29, 2010. For a more-detailed discussion of the specifics of the lawsuit, see this blog entry of Apr. 6, 2010 by "Todd" (Todd Harris?) at the Womble Carlyle trade secrets blog.
- E.I. DuPont De Nemours & Co. v. Kolon Industries, Inc. 748 F.3d 16 (4th Cir. 2014): A jury found South Korea-based Kolon Industries liable for misappropriating DuPont's trade-secret information in DuPont's Kevlar® production process. The jury awarded DuPont nearly $1 billion in damages, and the trial judge enjoined Kolon from producing Kevlar-type fiber for 20 years.During the trial, Kolon had argued that DuPont, in earlier litigation with its then-primary competitor, had supposedly failed to keep the information confidential. The trial judge, though, did not allow Kolon to put on evidence of this. Kolon had better luck with this argument on appeal: The appellate court reluctantly vacated the jury verdict and ordered a new trial. (The appellate court also ordered that a different district judge be assigned to hear the case.) The civil case later settled on undisclosed terms; this was in conjunction with Kolon's guilty plea in a related criminal case, where Kolon agreed to pay a $360 million penalty. See Andrew Zajac, Kolon Guilty in Kevlar Secrets Case, Settles with DuPont (Bloomberg.com Apr. 30, 2015).
- Events Media Network, Inc. v. The Weather Channel Interactive, Inc., No. 13-03 (D.N.J. Feb. 3, 2015): Events Media Network ("EMNI") was in the business of collecting, reviewing, and compiling detailed information about various local and national events and attractions. EMNI licensed the information to other companies, including The Weather Channel ("TWC"). EMNI made its information available on its Web site; it claimed that technical restrictions precluded anyone from accessing all of the information. TWC's license agreement with EMNI allowed TWC to use the EMNI information in TWC's own Web properties. The parties allowed the license agreement to expire. EMNI claimed that TWC continued using the EMNI information after expiration, and that this allegedly constituted misappropriation of EMNI's trade secrets and breach of contract. TWC moved for summary judgment dismissing EMNI's trade-secret claim, on grounds that the information in question wasn't preserved in confidence and therefore could not be the subject of a trade-secret misappropriation claim. The district court granted that part of TWC's summary-judgment motion — the court said that under the license agreement, "EMNI was not attempting to protect the Information from public disclosure, but increase its dissemination, giving TWC broad discretion over how and where it would use the Information publicly to achieve this end." Id., slip op. at 16 (emphasis added).
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; see generally the additional notes. 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.
The requirement of disclosing-party consent to destruction has in mind the situation in which the disclosing party doesn't itself have a copy of Confidential Information to be destroyed. That might occur if, say, (i) a contractor had developed particular information that, under the parties' agreement, was the property of the customer, but (ii) the contractor hadn't yet provided any copies of the information to the customer.
A receiving party might find it to be tremendously burdensome and expensive to try to return or destroy all copies of a disclosing party's confidential information, even those in emails, backup systems, etc.
Many confidential-information clause templates don't specify any pre-authorized uses of Confidential Information; typically, the parties end up negotiating some fairly-standard categories of authorized use. To save negotiation time, this provision simply goes ahead and pre-authorizes some of those particular categories of use.
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Limiting disclosures by the Receiving Party to a need-to-know basis is pretty standard in confidentiality provisions.
Drafters should consider the extent — if any — to which the Receiving Party's contractors, affiliates, etc., should be permitted to receive Confidential Information.
This will be especially true if the Receiving Party's workforce includes so-called leased employees or other individuals working long-term in independent-contractor status.
This subdivision ia a corollary to the 2. Confidentiality Obligations; see generally its commentary.
The Annex provision makes it clear that voluntary or discretionary disclosures of Confidential Information are not allowed, for example in public filings with the Securities and Exchange Commission (SEC).
For a case in which the voluntary-filing issue was litigated, see Martin Marietta Materials, Inc v. Vulcan Materials Co., 56 A.3d 1072 (Del. Ch. 2012), aff'd, 45 A. 3d 148 (Del. 2012) (en banc). There, the court held that Martin Marietta had breached a non-disclosure agreement by including Vulcan's confidential information in an SEC filing about Martin Marietta's proposed takeover of Vulcan.
Several U.S. Government agencies fiercely assert 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 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 discussion of how the [U.S.] National Labor Relations Board has taken a similar view about employees' discussing salary- and working-conditions with each other.
Each party is to preserve in confidence:
(1) the fact and content of the parties' dealings with each other, including if applicable the fact and content of their discussions or negotiations;
(2) the fact that the parties have entered into this Agreement; and
(3) the terms and conditions of this Agreement.
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Parties often want the mere fact that they are in discussions to remain confidential, let alone the details of their business dealings. That can present some tricky issues, though, especially in an employment-related agreement, as discussed in more detail below.
For example, in a sales agreement:
- The vendor might want for the pricing and terms of the agreement to be kept confidential. Otherwise, a buyer for a future prospective customer might say, "I know you gave our competitor a 30% discount, and I want to show my boss that I can get a better deal than our competitor did, so you need to give me a 35% discount if you want my business.”
- Conversely, the customer might not want others to know who its suppliers are, possibly because the customer doesn't want its competitors trying to use the same suppliers.
Likewise, parties to “strategic” contracts such as merger and acquisition agreements very often want their discussions to be confidential. If the word leaks out that a company is interested in being acquired, that could send its stock price down.
Confidentiality of parties' dealings, not of their relationship
This clause states that the parties' dealings are confidential, not their relationship. If it were otherwise — that is, if this clause said that the parties’ relationship was confidential — it might be (mis)interpreted as a declaration of a “confidential relationship”; that in turn imply unwanted fiduciary obligations.
Confidential-dealings clauses have been enforced
Clauses requiring parties' contract terms to be kept confidential have been enforced. For example, in 2013 the Delaware chancery court held that a party materially breached an agreement by publicly disclosing the agreement's terms in violation of a confidentiality clause, thereby justifying other party's termination of agreement. See eCommerce Indus., Inc. v. MWA Intelligence, Inc., No. 7471-VCP, part II-A, text accompanying notes 117 et seq. (Del. Ch. Oct. 4, 2013).
But a confidential-dealings clause might not be "material"
In a different case, the Supreme Court of Delaware held that in a patent license agreement, a provision requiring the terms of the license to be kept confidential was not material, because the gravamen of the contract was the patent license, not the confidentiality provision; as a result, when the licensee publicly disclosed the royalty terms, the patent owner was not entitled to terminate the license agreement for material breach. See Qualcomm Inc. v. Texas Instr. Inc., 875 A.2d 626, 628 (Del. 2005) (affirming holding of chancery court).
In employment agreements, confidentiality provisions sometimes require the employee to keep confidential all information about salary, bonus, and other compensation. The NLRB and some courts have taken the position that such a requirement violates Section 7 of the National Labor Relations Act, as explained in this Baker Hostetler memo. (See also the discussion of how the [U.S.] Securities and Exchange Commission has taken a similar view about employees' reporting possible criminal violations to government authorities.)
For a discussion of one particular type of situation where this issue can arise, see this annotation.
In the context of unreasonable withholding of consent to assignment of the agreement, see this discussion.
For a review of English case law — and a reminder that such cases will usually be highly fact-intensive — see generally Porton Capital Technology Funds v. 3M UK Holdings Ltd,  EWHC 2895 (Comm), paragraphs 219 et seq. In that case:
- A biotech company sold itself to 3M. As is not uncommon in such cases, the biotech company's shareholders received not only cash but, importantly, an earn-out, that is, the right to a series of future payments whose amounts would rise or fall with the success of the company under 3M's ownership.
- The agreement required 3M to obtain the consent of the shareholders before shutting down the business (because shutting the business down would deprive the shareholders of potential earn-out payments), but the shareholders could not unreasonably withhold their consent.
- The business did not do well, and 3M wanted to shut it down; the shareholders refused to consent, but 3M shut the business down anyway, and the shareholders sued.
- After reviewing prior holdings and the evidence in the case, the court held that the shareholders' withholding of consent had not been unreasonable, and awarded them damages equivalent to USD $1.3 million.
But the opposite result occurred in Barclays Bank PLC v. Unicredit Bank AG,  EWCA Civ 302 (affirming trial-court ruling). There:
- Barclays had the right to consent to a particular type of financial transaction, but it was obligated to grant or withhold such consent in a commercially-reasonable manner.
- The England and Wales Court of Appeals rejected Unicredit's argument that this meant that Barclays was required to take Unicredit's interests into account, not merely Barclays's own interests.
See id. at para. 16.
Consequential damages, whether or not capitalized,
(1) refers to damages for loss, where the loss in question would be, in the ordinary course of events, a natural result — but not a necessary result — of a breach of this Agreement or other event or other event or situation for which the law permits damages to be awarded; and
(2) includes, without limitation, lost profits from collateral business arrangements.
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The difference between consequential damages and "general" damages can sometimes be unclear. The commentary to the Restatement (Second) of Contracts contrasts the two terms:
Loss that results from a breach in the ordinary course of events is foreseeable as the probable result of the breach. Such loss is sometimes said to be the "natural" result of the breach, in the sense that its occurrence accords with the common experience of ordinary persons. … The damages recoverable for such loss that results in the ordinary course of events are sometimes called "general" damages.
If loss results other than in the ordinary course of events, there can be no recovery for it unless it was foreseeable by the party in breach because of special circumstances that he had reason to know when he made the contract. … The damages recoverable for loss that results other than in the ordinary course of events are sometimes called "special" or "consequential" damages.
These terms are often misleading, however, and it is not necessary to distinguish between "general" and "special" or "consequential" damages for the purpose of the rule stated in this Section.
Restatement (Second) of Contracts § 351, "Unforeseeability And Related Limitations On Damages," comment b (citations omitted, emphasis and extra paragraphing added).
FOOTNOTE: The above-quoted Restatement excerpt exemplifies what seems to be a modern trend of collapsing the traditional two-prong formulation of Hadley v. Baxendale into a single test: Whether the claimed damages were foreseeable by the breaching party. Under that test, one way for the non-breaching party to establish that its particular damages were foreseeable is for the non-breaching party to inform the breaching party, at the time the breaching party became bound by the obligation, of the non-breaching party's particular requirements or circumstances. See generally, e.g., Thomas A. Diamond & Howard Foss, Consequential Damages for Commercial Loss: An Alternative to Hadley v. Baxendale, 63 Fordham L. Rev. 665, part I-B, esp. n.35 & accompanying text (1994) (reviewing modern approaches to Hadley).
In the Uniform Commercial Code, section 2-715(2) defines consequential damages as follows:
Consequential damages resulting from the seller's breach include[:] (a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise …."
The Supreme Court of Texas has observed that:
Direct damages are the necessary and usual result of the defendant's wrongful act; they flow naturally and necessarily from the wrong…. Consequential damages, on the other hand, result naturally, but not necessarily….
El Paso Marketing, L.P. v. Wolf Hollow I, L.P., 383 S.W.3d 138, 144 (Tex. 2012) (internal quotation marks and footnote omitted, alterations by the court), subsequent proceeding, No. 13-0816, (Tex. Nov. 21, 2014) (reversing court of appeals order remanding for new trial on damages).
"Consequential" damages can be big
Noted practitioner-commentator Glenn D. West observes:
In 1984, an Atlantic City casino entered into a contract with a construction manager respecting the casino’s renovation. The construction manager was to be paid a $600,000 fee for its construction management services. In breach of the agreement, completion of construction was delayed by several months. As a result, the casino was unable to open on time and lost profits, ultimately determined by an arbitration panel to be in the amount of $14,500,000. There was no consequential damages waiver in the contract at issue in this case.
Glenn D. West, Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements, 70 BUS. L. 971, 984 (Weil.com 2015) (footnote omitted), citing Perini Corp. v. Greate Bay Hotel & Casino, Inc., 129 N.J. 479, 610 A.2d 364 (1992) (affirming judgment confirming arbitration award), abrogated on other grounds by Tretina Printing, Inc. v. Fitzpatrick & Assocs., Inc., 35 N.J. 349, 640 A.2d 788 (1994) (restricting grounds on which arbitration awards can be reviewed by courts, but stating that parties could expand those grounds by contract).
As another example, a Dr. Kitchen, an Australian opthmalmologist, wrongfully terminated his service agreement with an eye clinic. The service agreement did not include an exclusion of consequential damages. The Supreme Court of Queensland held him held liable for the clinic's lost profits and other amounts, in the total sum of AUD $10,845,476. See Vision Eye Institute Ltd v Kitchen,  QSC 66, discussed in Jodie Burger and Viva Paxton, Australia: A stitch in time saves nine: How excluding consequential loss could save you millions (Mondaq.com 2015).
Consequential damages — other specific examples
Some drafters like to enumerate specific categories of risk for which damages cannot be recovered, and cross their fingers that a court will enforce the enumeration congenially to them. The following categories have been harvested from various agreement forms but should be reviewed carefully, as some could be a bad idea:
- breach of statutory duty;
- business interruption;
- loss of business or of business opportunity;
- loss of competitive advantage;
- loss of data;
- loss of privacy;
- loss of confidentiality [Editorial comment: This would normally be a really bad idea, at least from the perspective of a party disclosing confidential information.]
- loss of goodwill;
- loss of investment;
- loss of product;
- loss of production;
- loss of profits from collateral business arrangements;
- loss of cost savings;
- loss of use;
- loss of revenue.
For a summary of cases in U.S., English, and Australian courts addressing such "laundry lists," see West, Consequential Damages Redux, supra, 70 BUS. L. at 987-91.
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. See, e.g., Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 2014 NY Slip Op. 02101 (reversing intermediate appellate court, reviewing case laws), where New York's highest court held that, on the facts of that 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; see also Thomas H. Warren, W. Jason Allman & Andrew D. Morris, Top Ten Consequential Damages Waiver Language Provisions to Consider (2012) and West, Consequential Damages Redux, supra, 70 BUS. L. at 992.
Fourth Circuit's lecture to negotiators of consequential-damages exclusions
The Fourth Circuit 'splained things to customers that negotiate services contracts containing consequential-damages exclusions:
Companies faced with consequential damages limitations in contracts have two ways to protect themselves.
First, they may purchase outside insurance to cover the consequential risks of a contractual breach, and second, they may attempt to bargain for greater protection against breach from their contractual partner.
Severn apparently did take the former precaution – it has recovered over $19 million in insurance proceeds from a company whose own business involves the contractual allocation of risk.
But it did not take the latter one, and there is no inequity in our declining to rewrite its contractual bargain now.
Severn Peanut Co. v. Industrial Fumigant Co., No. 15-1063, slip op. at 9 (4th Cir. Dec. 2, 2015) (affirming summary judgment in favor of service provider that had caused millions of dollars to its customer's facility) (extra paragraphing added).
- Thomas H. Warren, W. Jason Allman, & Andrew D. Morris, Top Ten Consequential Damages Waiver Language Provisions to Consider (ACC.com 2012).
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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: All-caps doesn't necessarily make something conspicuous. (Just less readable.)
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 eneacted. Still, its definition of "conspicuous" in section 1-201(10) (Texas version) nevertheless provides useful guidance:
A term or clause is conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it.
A printed heading in capitals (as: NON-NEGOTIABLE BILL OF LADING) is conspicuous.
Language in the body of a form is "conspicuous" if it is in larger or other contrasting type or color.
But in a telegram any stated term is "conspicuous".
Tex. Bus. & Com. Code § 1.201(10) (extra paragraphing added).
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 Code cases is familiar to the courts of this state and conforms to our objectives of commercial certainty and uniformity. We thus adopt the standard for conspicuousness contained in the Code for indemnity agreements and releases like those in this case that relieve a party in advance of responsibility for its own negligence.
When a reasonable person against whom a clause is to operate ought to have noticed it, the clause is conspicuous.
For example, language in capital headings, language in contrasting type or color, and language in an extremely short document, such as a telegram, is conspicuous.
Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (citations omitted, emphasis and extra paragraphing added).
The Dresser court also pointed out that the fair-notice requirement did not apply to settlement releases: "Today's opinion applies the fair notice requirements to indemnity agreements and releases only when such exculpatory agreements are utilized to relieve a party of liability for its own negligence in advance." Id., 853 S.W.2d at 508 n.1 (emphasis added).
Texas's Dresser court noted an exception to the conspicuousness requirement: "The fair notice requirements are not applicable when the indemnitee establishes that the indemnitor possessed actual notice or knowledge of the indemnity agreement." Id., 853 S.W.2d at 508 n.2 (emphasis added, citation omitted).
Note especially the italicized portion of the quotation, which implies that the burden of proof of actual notice or knowledge is on the party claiming indemnification from its own negligence.
In contrast, a federal district judge in Houston granted Enron's motion to dismiss Hewitt Associates' claim for indemnity, on grounds that the contract in question did not comply with the conspicuousness requirement of the express-negligence rule; 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.).
Conspicuous doesn't necessarily mean all-caps, bold-faced type, etc.
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).
In fact, contract drafters sometimes put entire paragraphs into all-capital letters in the hope of making them "conspicuous"; you've probably seen examples of this particular disorder in warranty disclaimers and limitations of liability. But keeping the all-caps going for line, after line, after line, can be self-defeating, 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.
Raysoni v. Payless Auto Deals, LLC, No. S13G1826, slip op. at 6 n.5 (Ga. Nov. 17, 2014) (reversing and remanding judgment on the pleadings) (emphasis and extra paragraphing added).
The drafting tips here, of course, are:
- Be judicious about what you put in all-caps.
- Don't use too-small a font for language that you want to be conspicuous.
See Linda R. Stahl, Beware the Boilerplate: Waiver Provisions (Andrews Kurth Jan. 14, 2013) (citing Texas cases)
(a) This Consultation Clause applies whenever this Agreement provides that a specified party (the "acting party"):
(1) must consult with another party before taking or omitting a specified action, or
(2) must take or omit the action "in consultation with" another party or words to that effect.
(b) Before taking or omitting the action in question, the acting party must:
(1) seasonably advise the other party, preferably but not necessarily in writing, that it intends to take or omit the action; and
(2) if so requested by the other party, provide the other party with: (A) such relevant information about the acting party's intentions as the acting party deems appropriate in its reasonable discretion; and (B) a reasonable opportunity to be heard by the acting party concerning the action to be taken or omitted.
(c) For the avoidance of doubt, a consultation requirement does not limit the freedom of the acting party to take or omit the specified action unless this Agreement expressly states otherwise.
Suppose that Alice and Bob are negotiating a contract under which Bob will supply Alice with widgets. During the negotiation:
- Alice demands that Bob not raise prices without Alice's prior written consent.
- Bob, not wanting to limit his flexibility, pushes back in response; he wants to be able to raise prices in his sole discretion.
A possible compromise would be for the parties to agree that Bob will not raise prices without first consulting with Alice.
The term consult is vague, though; that vagueness could later lead to disputes about whether Bob had complied with the consultation obligation.
With that in mind, this definition sets out a specific procedure for consultation, while leaving the ultimate decision authority alone.
This definition is drafted in contemplation that it might be part of a package of shelf clauses that as a group, but not individually, are incorporated by reference into an agreement.
This clause does not specifically require the acting party to advise the other party in writing. The acting party, though, will of course want to consider doing so in order to avoid later "he said, she said" disputes about whether the acting party complied with this requirement.
See also Seasonable Definition Clause.
This subdivision is a "roadblock" provision, intended to reassure an acting party that might be nervous about about how a court might interpret the contract language.
The parties agree that the contra proferentem ("against the offeror") principle of contract interpretation is not to be applied to this Agreement. That is, any ambiguity or inconsistency in this Agreement is not to be resolved strictly against the party that drafted the ambiguous or inconsistent provision(s), but instead is to be resolved in accordance with the most reasonable construction.
The contra proferentem principle of contract interpretation holds that if an ambiguity in particular 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 contra proferentem principle gives drafters a powerful incentive to draft clearly: As between the drafter of ambiguous language, on the one hand, and the "innocent" other party, it's the drafter that must bear the consequences of the ambiguity.
As the Supreme Court of the United States put it:
… respondents cannot overcome the common-law rule of contract interpretation that a court should construe ambiguous language against the interest of the party that drafted it. 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's affirmance of district-court action vacating punitive-damage portion of arbitration award) (emphasis added, citations and footnotes omitted).
A contra-proferentem prohibition could cause problems if a contract provision was ambiguous. Suppose that a court or arbitrator concluded that there was no way to resolve the ambiguity other than contra proferentem — 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 provision could not be enforced — which in some circumstaces might jeopardize the enforceability of the entire contract.
For additional information, see generally:
- The Wikipedia article Contra proferentem
- Michelle E. Boardman,Contra Proferentem: The Allure of Ambiguous Boilerplate, 104 Mich. L. Rev. 1105 (2006) (hat tip: Anna Sharova in a LinkedIn group discussion (group membership required).
[DCT NOTE: These materials need further thought; I'm posting them for use as a reference.]
(a) Applicability: This Annex applies in any case as to which this Agreement provides, in this clause or elsewhere, that a party must cooperate with another party in connection with the other party's performance of obligations or exercise of rights under this Agreement. This includes, for example, situations in which the other party is:
(1) attempting to diagnose and/or repair a defect or malfunction of the cooperating party's equipment, software, configuration, or the like;
(2) rendering other services to or for the benefit of the cooperating party;
(3) inspecting or auditing the cooperating party or its records.
(b) Reasonable information to be provided: The cooperating party will timely provide relevant information to the other party or its agents when reasonably requested by one or more of them. (See also the confidentiality provisions of the Agreement, if any, to the extent applicable.)
(c) Option: Suitable working space: IF: This Agreement states that the cooperating party must provide suitable working space; THEN: The cooperating party will timely make the following available to the other party or its agents to the extent reasonably requested by the other party:
(1) working space, appropriately located and ‑furnished;
(2) any necessary utilities, such as (for example) electrical power, heating and air conditioning, and water;
(3) Internet connectivity; and
(4) any necessary parking space.
The idea for this definition came from, among other places, an Oracle license-agreement document.
The provision concerning reasonable working space was inspired by tales of parties intentionally making it difficult and uncomfortable for other parties to take actions.
Any reproduction of this Agreement, or of any of its pages or other components parts, that is made by reliable means is to be considered an original.
This language is akin to Fed. R. Evid. 1003, which provides that in federal-court litigation, "[a] duplicate is admissible to the same extent as the original unless a genuine question is raised about the original's authenticity or the circumstances make it unfair to admit the duplicate."
On the subject of co-tenancy, see Matthew P. Seeberger, Top Ten Issues in Co-Tenancy Provisions in Retail Leases (AmericanBar.org)
Each party acknowledges that, in connection with the parties' negotiation of and entry into this Agreement:
(1) it has had the opportunity to be represented, by counsel of that party's choice, in deciding whether to enter into this Agreement on the terms and conditions set forth in it; and
(2) it has not been and is not being represented by, and it is not relying on advice from, the legal counsel of any other party.
This clause says that the parties have had the opportunity to be represented by counsel, as opposed to saying that the parties have been represented by counsel.
This clause also refers to representation by counsel when the parties were entering into the Agreement, not to when they were negotiating the Agreement. That's because, as a factual matter, there might not actually have been any negotiations.
Consider also Arms-Length Negotiation Pattern Acknowledgement.
Subdivision (2) can provide protection for the parties' attorneys against later claims, by a disgruntled counterparty, to the effect of, I thought you were my lawyer; you had a conflict of interest and didn't disclose it.
(Claiming conflict of interest is not an uncommon tactic when suing attorneys — it's something easy for jurors to understand, akin to They lied!)
No course of prior dealing or usage of the trade is to be used to modify, supplement, or explain any term of this Agreement.
See also Ambiguity and vagueness.
Clauses like this are sometimes seen in purchase-order terms and conditions. I haven't researched whether a prohibition like this would be given effect by a court.
And even if the prohibition were enforceable, it's not at all clear that it'd be a good idea to take away a potentially-useful tool for resolving ambiguity or confusion in a contract.
CPI clauses are sometimes included in contracts for ongoing sales or goods or services. Such contracts will typically lock in the agreed pricing for a specified number of years, subject to periodic increases by X% per year (let's say) or by the corresponding increase in CPI, whichever is greater (or sometimes, whichever is less).
Depending on the industry, CPI-U might or might not be the best specific index for estimating how much a provider's costs have increased. this is explained in the FAQ page of the Bureau of Labor Statistics (accessed Aug. 16, 2012).
Caution: "The lesser of CPI or X%" could be dangerous
Prohibiting a provider from increasing its pricing by more than the increase in CPI or X percent per year, whichever is less, would force the provider to 'eat' any increases in its own costs that exceeded the increase in the particular index chosen.
Consider: What if CPI goes down?
A drafter might want to specify whether agreed pricing, rent, etc., can ever decrease as a result of changes in CPI.
Consider: Are pricing increases to be compounded?
If price increases are limited to adjusting for increases in CPI over a baseline figure, that will automatically take care of compounding.
But if the permissible price increase is "the change in CPI or X%, whichever is greater," then the X% might end up being compounded over time, so that the X% increase in Year One would itself be increased by another X% in Year Two. [NEED EXAMPLE]
- Malik Crawford and Kenneth J. Stewart, Writing an escalation clause using the Consumer Price Index (BLS Nov. 2012)
- Bureau of Labor Statistics, Frequently Asked Questions (FAQs)
A UK legislative drafting guide suggests, at page 25, § 3.10 (with examples):
- A cross-reference might not be needed.
- "3.10.2 It is helpful to refer to a substantive rule or proposition, rather than the statutory provision containing it (in which readers are unlikely to be interested)."
- "3.10.4 It is generally helpful to provide a parenthetical description [of a cross-referenced provision] …. But consider the usefulness of the descriptive words against the disadvantage of interrupting the flow of text."
(Thanks to English solicitor Paul de Cordova for the above link.)
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- Day Definition Clause
- Deadline Definition Clause
- Deceptive-Practices Prohibition Clause
- Defects in products and services
- Definitions (preamble language for Definitions section)
- Deliverable Definition Clause
- Discretion, reasonable discretion, & sole discretion
- Disparagement Prohibition Clause
- Dispute escalation
- Dispute Expense Definition Clause
Unless this Agreement expressly states otherwise:
(1) The term day, whether or not capitalized, refers to a calendar day; and
(2) A period of X days begins on the specified date and ends at exactly 12 midnight (UTC if not otherwise specified) at the end of the day X days later. EXAMPLE: If a five-day period begins on January 1, it ends at exactly 12 midnight at the end of January 6.
See also the Business Day Definition Clause.
IF: This Agreement states a deadline date marking the end of a specified period, but does not clearly indicate a time at which the period ends; THEN: The period ends at exactly 12 midnight, in the time zone where the relevant actor (or action to be taken) is (or is to be) located, at the end of the indicated date.
Each Obligted Party (namely, each party) is to:
(1) refrain from knowingly engaging in any deceptive practice in connection with its activities relating to this Agreement; and
Clauses like this are sometimes seen in contracts where, say, a manufacturer's reputation might be adversely affected by deceptive conduct on the party of a reseller.
CAUTION: This clause might strike the reader as unlikely to be controversial — who could object to it? — but in the hands of litigation counsel it could complicate the resolution of a dispute. See the commentary to Reliance Disclaimer.
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.
For purposes of this Defect-Correction Clause, the following terms have the stated meanings:
(1) Provider refers to a party that, under this Agreement, is to provide goods or services to another party (each, a Customer).
(2) Customer: See the definition of Provider above.
(3) Defect refers to any failure, by one or more deliverables or one or more services provided under this Agreement, to comply with agreed written specifications (for example, in this Agreement or in a purchase order or statement of work).
(1) report the relevant Defect to Provider in writing before the Defect-Reporting Deadline (namely, 60 days after delivery of the relevant deliverable or completion of the relevant service, as applicable); and
(2) furnish Provider, at Provider's request, with reasonable supporting documentation and other information about the Defect in question and the surrounding circumstances.
For any timely-reported Defect, Provider, at its own expense, will do one or both of the following before the Defect-Correction Deadline (namely, 30 days after Customer's report of the Defect in question to Provider):
(1) correct the Defect, which may include repairing or replacing a defective deliverable or re-performing defective services; and/or
(2) deliver a commercially-reasonable workaround for the Defect.
IF: Provider does not timely take the action or actions required by this Annex in respect of any Defect; THEN: Unless this Agreement expressly states otherwise, at Customer's written request, Provider will promptly:
(1) cause a refund to be made of all amounts paid, by or on behalf of Customer, for the relevant deliverable(s) or service(s); and
(2) cancel any unpaid invoice calling for payment, by or on behalf of Customer, for those deliverable(s) and service(s).
Unless this Agreement expressly states otherwise, Provider's defect-correction obligations stated in this Annex 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.
The Protocol below sets out (what I think of as) a reasonable, workable approach to requiring a supplier to correct defects in a deliverable.
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The definitions in this worksheet are phrased with a view to making the defect-correction provisions workable as long as the incorporating agreement is clear that Defects are to be corrected.
The definition of Defect is fairly standard. Notably, it does not include a materiality qualifier; the materiality of Defects can be addressed in other provisions.
This language tries to stave off finger-pointing between Provider and Customer if a Defect arises, by:
- requiring Customer to provide information to Provider upon request;
- but putting the burden on Provider to ask for the information.
It is not unusual for Defect-Reporting Deadlines to be anywhere from 10 days to 120 days after delivery or completion of services.
This is a fairly-standard protocol for correction of software defects; it should also be useful in other contexts.
Refund as backup remedy for Defects
Providing the right to a refund as a "backup" remedy might be crucial in case other 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.
See, e.g., John F. Zabriskie, Martin J. Bishop, and Bryan M. Westhoff, Protecting Consequential Damages Waivers In Software License Agreements (2008).
For a now-dated student note reviewing case law in this area, see Daniel C. Hagen, Sections 2-719(2) & 2-719(3) of the Uniform Commercial Code: the Limited Warranty Package & Consequential Damages, 31 Val. U. L. Rev. 111, 116-18 (1996).
"Cause" a refund to be made
This subdivision requires Provider 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.
Suppliers are very prone to include clauses 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 eample is BAE Sys. Information & Electr. Sys. Integration, Inc. v. SpaceKey Components, Inc., No. 13-2240 (1st Cir. May 9, 2014):
- A vendor delivered lower-quality integrated circuits ("ICs") to a customer than had been called for by their contract.
- The vendor 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 vendor would reduce the price.)
- The customer refused to pay for the nonconforming ICs.
- The vendor 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 vendor.
As used in this Agreement, the following terms have the stated meanings; other terms might be defined "in line" in the provisions in which they are used.
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Defined terms can be quite useful (as long as they're not overdone); this clause refers to the three most-common ways of setting up the definitions, namely:
1) in a separate section of the contract; 2) as the defined terms occur in the contract text; or 3) both 1) and 2) in the same contract.
It's a really good idea to be consistent about capitalization when drafting a contract. If you define a capitalized term but then use a similar term without capitalization, that might give rise to an ambiguity in the language — which in turn might preclude a quick, inexpensive resolution of a lawsuit.
Something like that happened in the Clinton Ass'n for a Renewed Environment case:
- The defendant asserted that the plaintiff's claim was barred by the statute of limitations and therefore should be immediately dismissed.
- The plaintiff, however, countered that the limitation period began to run much later than the defendant had said.
- The court held that inconsistency of capitalization of the term "substantial completion" precluded an immediate dismissal of the plaintiff's claim.
See Clinton Ass'n for a Renewed Environment, Inc., v. Monadnock Construction, Inc., 2013 NY Slip Op 30224(U) (denying defendant's motion to dismiss on the pleadings; citations omitted, extra paragraphing added).
A drafter can place a separate "definitions" section:
- near the beginning of the agreement — this is perhaps the most-common practice;
- at the back (with results that might be surprising);
- in a separate exhibit or schedule (which can be handy if using the same definitions for multiple documents in a deal).
On his blog, IACCM founder and president Tim Cummins tells of an IACCM member whose company saved hours of negotiating time — up to a day and a half per contract — by moving the "definitions" section from the front of its contract form to an appendix at the back of the document. Cummins recounted that "by the time the parties reached 'Definitions', they were already comfortable with the substance of the agreement and had a shared context for the definitions. So effort was saved and substantive issues were resolved." Tim Cummins, Change does not have to be complicated (July 21, 2014).
Deliverable, whether or not capitalized, refers to an item that a party is required to cause to be delivered to another party, for example pursuant to a Statement of Work for Services, other than Toolkit Items.
See also Services Clause.
Discretion and reasonable discretion, whether or not capitalized, refers to discretion that is exercised in a manner that is not arbitrary, capricious, or irrational.
See this annotation.
(a) IF: This Agreement states that a party (the "electing party") may take (or not take) an action in its sole discretion (whether or not the term is capitalized); THEN: Unless this Agreement expressly states otherwise:
(1) The electing party is free to take or not take the action, with a view solely toward its own interests and desires as it perceives them.
(2) The electing party's action or inaction per se is to be conclusively deemed (i) to have complied with any applicable standard of reasonableness, good faith, or fair dealing, and (ii) not to be arbitrary, capricious, or irrational.
(b) No other party is to make any claim against an electing party that is inconsistent with subdivision (a).
(c) Subdivision (b) does not in itself preclude a claim by another party that an electing party took action in a particular manner that breached this Agreement or applicable law.
See this annotation.
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In Illinois, a party's discretion might be constrained by an obligation of reasonableness. See Han v. United Continental Holdings, Inc., 762 F.3d 598 (7th Cir. 2014) (affirming dismissal with prejudice of purported class-action complaint). As it happens, in that case the appeals court upheld a ruling that United Airlines did not unreasonably exercise its discretion in interpreting the term "miles flown," in the rules for its frequent-flier program, as the miles between the relevant airports and not the miles actually flown by the aircraft in traveling between the two airports.
On the hand:
[U]nder Alabama law "sole discretion" means an absolute reservation of a right. It is not mitigated by an implied covenant of good faith and fair dealing in contracts because an unqualified reservation of a right in the sole discretion of one of the parties to a contract expresses the intent of the parties to be subject to terms that are inconsistent with any such implied covenant.
Shoney's LLC v. MAC East, LLC, 27 So.3d 1216, 1220-21 (Ala. 2009) (on certification by Eleventh Circuit; emphasis added, footnote and citations omitted).
See also Discretion Definition Clause.
There is case law in the UK indicating that discretion cannot be exercised arbitrarily, capriciously, or irrationally. See Barry Donnelly and Jonathan Pratt, Are you obliged to act reasonably?, in the In-House Lawyer [UK] (June 12, 2013); they summarize the case law as indicating that:
Where a contract confers on one party an absolute discretion to take a decision, choosing from a range of options which will have an impact on the interests of another contracting party, the court will, as a bare minimum, imply a term that the discretion must be exercised in good faith in a manner which is not arbitrary, capricious or irrational.
Subject to those limitations, the decision maker will be entitled to act in accordance with its own best interests.
It is very difficult, albeit not ‘utterly impossible', to exclude such an implied term.
Where, however, the only choice conferred on a contracting party is whether or not to exercise an absolute contractual right provided under the contract, no such term will be implied.
(Emphasis and extra paragraphing added.)
(a) No Obligated Party, defined as each party, will disparage any other Signatory Party, nor the products or services of that other Signatory Party, to third parties.
(b) For the avoidance of doubt, another Signatory Party's affiliates and the officers, employees, distributors, resellers, and agents of each of them are not considered third parties for purposes of this provision.
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Manufacturers sometimes ask for clauses like this in their distribution- or reseller agreements, with the idea that they can prohibit their distributors and resellers from making negative comments to end-customers.
Distributors and resellers might well object to this statement, wanting to preserve their freedom to say whatever they please to their own customers.
A disparagement prohibition can lead to terrible PR, as discussed in the commentary to the Review Restrictions concerning product reviews.
Parties wanting a clause like this should consider the Streisand effect, which is named for the famed singer and actress: When word got out that she was trying to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her original purpose of her suppression attempt. (The Wikipedia article contains numerous other examples.)
See the decision of Maryland's highest court in O’Brien & Gere Engineers, Inc. v. City of Salisbury No. 15 (Md. Apr. 26, 2016).
(a) Whenever requested in writing by either party, the parties will jointly refer any Dispute (namely, any Agreement-Related Dispute) "up," in succession:
(1) if necessary, to a total of at least the Required Number of Escalation Levels (namely, two levels) of management; or
(2) if a party has fewer levels "up" remaining in its management structure, to the highest management level (e.g., CEO).
(b) Upon any request for escalation of a Dispute, each party will promptly advise the other party in writing of the name and contact information of a representative at the relevant management level (each, a Representative) who:
(1) has authority to discuss — and, preferably, the authority to settle — the Dispute on behalf of the advising party, and
(2) is available for the meeting(s) required by this Dispute-Escalation Clause.
(c) EXAMPLE: Suppose (hypothetically) that the parties normally deal with each other at the manager level, with each party's manager reporting to a director, and each director reporting to a vice president. Suppose also that the managers cannot resolve a dispute, and that the Required Number of Escalation Levels is two. In that case:
(1) At either party's request, the managers' respective directors must personally participate as provided in this clause; and
(2) If the parties' directors are unable to resolve the dispute, then at either party's request, the directors' respective vice presidents must personally participate as provided in this clause.
(a) Upon a request for dispute escalation, each party will promptly cause its Representative:
(1) to meet with the other party's Representative at least once by telephone, or if so agreed by the Representatives, by video conference or in person; and
(2) at each such meeting or meetings, to attempt in good faith to settle the Dispute.
(b) A reasonable time in advance of each meeting, each party is to provide the other party with a reasonably-detailed written statement of the providing party's then-current position in the dispute. (A written statement need not conform to any particular requirements of format or content.)
(c) All meeting arrangements are to be coordinated by the party making the request for escalation.
(d) Each party will be responsible for its own expenses of all Representatives' meetings.
A party desiring to bring legal action against another party before any tribunal in respect of the Dispute must first escalate the dispute accordance with this Dispute-Escalation Clause EXCEPT to the minimum extent, if any, necessary:
(1) to prevent irreparable harm, or
(2) to avoid a bar under an applicable statute of limitations.
All oral, written, and other communications under this clause are to be treated as made in compromise negotiations; neither party will attempt to offer any such communication into evidence, either to prove or disprove the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction.
The "whenever requested" phrase in subdivision 1(a) should give the other side ammunition with which to respond if one party's "guy" were to balk at escalating a disagreement up the chain of command. The requesting party can ask the balking individual, "hey, look — are you going to get your boss involved here, like the contract says, or does our lawyer have to call your lawyer about breach of contract?"
The exceptions in subdivision 3 are intended to overcome possible opposition to the escalation requirement.
For another example of escalation-clause language, see the CPR International Model Multi-Step Dispute Resolution Clause (scroll down to "(A) Negotiation").
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Purpose; success anecdote
Some lawyers believe that escalating disputes up the parties' respective chains of command can increase the chance of an amicable settlement. Getting new people involved in a dispute can sometimes bypass individual animosities, hidden personal agendas, and other foibles; this can help break an impasse.
A settlement specialist with experience both as a law-firm litigator and as in-house counsel recalls putting a dispute-escalation provision into KPMG Consulting's standard contracts; he says, "the results were outstanding — we litigated with our clients less and got back to business sooner." John DeGroote, Multi-Step Dispute Resolution Clauses: 7 Reasons Why They Work (2010; accessed July 23, 2012); see also John DeGroote, The Multi-Step Dispute Resolution Clause: a Few Reasons Why Clients Like Them (2010).
How many escalation levels "up" to require
Forcing the parties to escalate a dispute at least two successive levels "up" in their respective hierarchies should be enough to get each party to take a fresh look at the dispute.
Some such provisions require escalation all the way up to "executive-level management." Apart from the vagueness of the quoted term, a giant multinational corporation isn't likely to want to be forced to escalate a small-dollar dispute all the way to its executive suite.
Creating financial incentives to comply
To provide parties with financial incentives to comply with a dispute-escalaton requirement, consider also including in the Agreement the Attorney-Fee Recovery Waived by ADR Non-Participation provision.
When a dispute is escalated, video-conference meetings might well offer many of the benefits of in-person meetings, with greater timing flexibility and lower expense.
An exchange of written statements can help clarify the dispute, especially if it were to turn out that the parties had previously been "talking past each other."
A contractual requirement that parties discuss their disputes with each other will normally include a provision analogous to Rule 408 of the [U.S.] Federal Rules of Evidence. American litigators will of course know that Rule 408 provides that — with certain limited exceptions — communications made in the course settlement discussions are inadmissible in court. (So, too, do many counterpart state-law rules.) The rationale for inadmissibility is that parties are likely to be more candid in settlement discussions if they have some basis for assuming that a carelessly-worded comment, by a party or by counsel, won't later be quoted by opposing counsel in front of a judge or jury.
(1) reasonable fees billed by (or by one or more firms for the services of) attorneys; law clerks, paralegals, and other persons not admitted to the bar but performing services under the supervision of an attorney; and expert witnesses;
(2) reasonable expenses actually incurred by individuals and/or firms referred to in subdivision (1) in connection with the proceeding, such as (for example) printing, photocopying, duplicating, and shipping;
(3) the costs of the litigation, arbitration, or other proceeding, such as for example costs of court; administration fees charged by an arbitration provider; and arbitrator fees and expenses; and
(4) costs, fees, and other expenses incurred in enforcing a right to recover Dispute Expenses.
The text of this provision is informed in part by the attorneys-fees clause in the contract in suit in Seaport Village Ltd. v. Seaport Village Operating Co., No. 8841-VCL (Del. Ch. Sept. 24, 2014) (letter opinion awarding attorney fees). • Note that any attorney fees, etc., incurred in enforcing the right to attorney fees are themselves recoverable.
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- Early neutral evaluation
- Economic loss doctrine
- Economic Litigation Agreement
- Effective Date (cross-reference)
- Electronic signatures (cross-reference)
- Employee solicitation & hiring by other party
- Employees' labor-law redress (cross-reference)
- Employment agreements (notes only, so far)
- Ending Time Definition Clause
- Entire agreement
- Escalation of disputes (cross-reference)
- Escrow provisions (to do)
- Evergreen extensions
- Ex Works and EXW Definition Pattern Clauses
- Example Definition Clause
- Exclusion of Other Terms Clause
- Expiration definition (cross-reference)
- Express-negligence doctrine
- Expense reimbursement
- Extensions (cross-reference)
- Extensions, unilateral (cross-reference)
- Extrinsic Evidence Pattern Exclusion
1. ENE Requirement
IF: Any dispute arising out of or relating to this Agreement becomes, or appears reasonably likely to become, the subject of litigation or arbitration; THEN:
(1) At any time before trial (including for this purpose an arbitration hearing), either party may submit the dispute to (nonbinding) early neutral evaluation in accordance with the ENE Rules (namely, the Early Neutral Evaluation procedures of the American Arbitration Association as then in effect) or such other rules or procedures as the parties may agree; and
(2) Each party is to participate in the early neutral evaluation proceedings in good faith.
2. What ENE is Not
(a) The goal of early neutral evaluation is merely to provide parties to a dispute and their counsel with a neutral "reality check."
(b) In the evaluation proceedings, no party need reveal any particular information to the other party or to the evaluator (but are encouraged to make a full disclosure of their position and supporting evidence).
(c) If a party privately discloses information to the evaluator, then the evaluator is not to reveal that information to any other party without the disclosing party's consent.
(d) The results of the evaluation are confidential and not shared with the trial judge or arbitrator.
(e) The evaluator has no power to impose settlement and does not attempt to coerce a party to accept any proposed terms.
(f) While the parties may agree to a binding settlement, if no settlement is reached, the case remains on the litigation- or arbitration track, as applicable.
(g) Any applicable rights the parties may have, under the relevant rules of procedure, to engage in discovery and motion practice are unaffected by the evaluation procedure itself.
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Overview: Why ENE can be useful
In any dispute, early neutral evaluation can be useful, either to get the case settled entirely or at least to cut down on expensive discovery fishing expeditions and satellite litigation. ENE can come in handy because:
- Each side's lawyers – especially male lawyers – might well be overly optimistic about whether they're going to win their cases; see this summary in the ABA Journal of the published research findings.
- Both lawyers and clients can get into ego clashes with the other side, sometimes vulgarly referred to as "[anatomy]-measuring contests."
- Lawyers want to be perceived by their clients as team players who are committed to doing "whatever it takes" to win the case for the client; they therefore have at least some incentive to tell their clients what they think the clients want to hear, and to try to protect their clients from unpleasant truths.
- And of course lawyers will miss out on a certain amount of fee income from litigation if their clients' disputes are settled early.
These factors can hamper getting disputes settled quickly, and in fact can cause disputes to escalate. That will usually result in extra expense and grief for all concerned.
In that situation, sometimes an early, non-binding "sanity check" from a knowledgeable neutral can help the parties and their lawyers get back onto more-productive tracks. Otherwise, positions can harden and business relationships can suffer — and of course, legal bills will start to mount up.
Court use of early neutral evaluation
Some courts refer selected cases to mandatory early neutral evaluation. this is explained at the Web site of the U.S. District Court for the Northern District of California, the federal court whose district includes Silicon Valley:
- The goals of early neutral evaluation include "provid[ing] a 'reality check' for clients and lawyers";
- "The evaluator has no power to impose settlement and does not attempt to coerce a party to accept any proposed terms."
- "The parties' formal discovery, disclosure and motion practice rights are fully preserved."
- "The confidential evaluation is non-binding and is not shared with the trial judge."
- "The parties may agree to a binding settlement."
- "If no settlement is reached, the case remains on the litigation track."
See U.S. Dist. Ct. for the N.D. of Cal., Early Neutral Evaluation (ENE).
The ENE process apparently helped the Chuck E. Cheese restaurant operation to settle a class-action lawsuit by employees who asserted that the company's background-check consent form did not comply with the FCRA's strict requirements. In issuing its preliminary approval of the settlement, the district court noted that "the case … went through the Early Neutral Evaluation process which encouraged the settlement." See Ford v. CEC Entertainment, Inc. d/b/a Chuck E. Cheese’s, No. 14-CV-677, slip op. at 11:1 (S.D. Cal. July 7, 2015) (order granting preliminary approval of class-action settlement); see also David M. Gettings, Timothy St. George and David N. Anthony, Chuck E. Cheese Settles Background Check Lawsuit For $1.75 Million (Mondaq.com).
ENE rules & administrator
Procedurally, this clause provides for resort to the American Arbitration Association's Early Neutral Evaluation procedures if the parties don't agree otherwise.
AAA involvement in a consultation with a neutral would entail an administration fee payable to the AAA ($500 per party when last checked). The parties might prefer to avoid this expense by doing a self-administered ENE, but many practitioners have found that having a neutral administrator is often well worth the money.
Other ENE rules include, for example, those of the U.S. district courts for:
A contrary view of ENE
Not everyone is a fan of early neutral evaluation. See, for example, the commentary to ADR Rule 2-3(a) of the U.S. District Court for the Northern District of Illinois (which encompasses Chicago), which states in part:
… The [advisory committee on a pilot mediation program] recommended to the court that non-binding arbitration and early neutral evaluation not be court annexed alternatives in the Western Division.
Regarding early neutral evaluation, the recommendation of the committee was based on the impression that early neutral evaluation appeared, under the Northern District of California Local Rules, to offer no more than mediation and to lack the resolution oriented approach of mediation.
It is assumed, however, that mediators, although neutrals, will not only act to facilitate compromise but will be willing and able to offer litigants frank and confidential third-party assessments of their relative positions and risks.
(Emphasis and extra paragraphing added.) Author's note: I don't share the view just quoted. True, in theory mediators will "offer litigants frank … assessments of their relative positions and risks." My (limited) experience as litigation counsel in mediation, though, indicates that too many mediators refuse to do so, even though that might be precisely what's needed.
Much of this subdivision is adapted from the Early Neutral Evaluation (ENE) Web page of the U.S. District Court for the Northern District of California, the federal court whose district includes Silicon Valley.
The American Arbitration Association Early Neutral Evaluation procedures provide (among other things) for confidentiality of the proceedings, including evidentiary provisions analogous to Rule 408 of the Federal Rules of Evidence. Litigators will of course remember Rule 408 as providing that — with certain limited exceptions — communications made in the course settlement discussions are inadmissible in court. (So, too, do many counterpart state-law rules.)
The rationale for confidentiality is that parties are likely to be more candid in settlement discussions if they have some basis for assuming that a carelessly-worded comment, by a party or by counsel, won't later be quoted by opposing counsel in front of a judge or jury.
- Sandy Gage, Early Neutral Evaluation – panacea or pitfall? (Jan. 2007)
- American Arbitration Association, Early Neutral Evaluation: Getting an Expert's Opinion (2005)
- Association for Conflict Resolution, list of ENE resources
- Craig Pollack, Evaluative Mediation and Some of the Considerations in Deciding Whether to Agree to It (JAMSInternational.com 2012) (recounting an unsatisfactory experience with ENE, due to, in the author's view, the evaluator's not having invested enough time in the process and not being accountable to judicial review or peer pressure)
The economic loss doctrine generally precludes recovery in tort for purely-economic losses resulting from a party’s failure to perform under a contract when the harm consists only of the economic loss of a contractual expectancy.
- Under this doctrine, if the defendant’s conduct would give rise to liability only because it breaches the parties’ agreement, the plaintiff’s claim ordinarily sounds only in contract.
- However, the doctrine does not bar all tort claims arising out of a contractual setting. A party states a tort claim when the duty allegedly breached is independent of the contractual undertaking and the harm suffered is not merely the economic loss of a contractual benefit.
In this analysis, the nature of the injury most often determines which duty or duties are breached.
- If the injury would give rise to liability independent of the fact that a contract exists between the parties, the plaintiff’s claim may also sound in tort.
- The economic loss rule does not preclude tort recovery if the injury involves physical harm to the ultimate user or consumer or other property.
The foregoing summary is adapted from the text (which contains extensive citations of Texas law) of Shakeri v. ADT Security Services, Inc., No. 15-10539, slip op. at 10-11 (5th Cir. Mar. 7, 2016) (per curiam). In that case:
- The owners of a jewelry store sued an alarm-system company for damages after the store were robbed at gunpoint and one of the owners was severely beaten and tasered; the alarm system's panic button failed, allegedly because of faulty workmanship by a technician working for the alarm-system company. See id., slip op. at 4. The owners pleaded that the technician failed to properly repair the alarm system, left it in a condition where it did not work, yet told the owner that the alarm was in working order. See id., slip op. at 13 n.2.
- The appeals court held that the district court had improperly dismissed the owners' negligence claim against the alarm-system company because the owner's physical injuries were not covered by the economic loss rule. (The appeals court affirmed dismissal of the plaintiffs' other tort claims. The district court also had limited the plaintiffs' breach-of-contract damages to $1,000 in accordance with a damages-cap provision; the Fifth Circuit did not address that ruling, as discussed here. )
See also Restatement (Third) of Torts: Liab. for Econ. Harm § 3 cmt. b (Am. Law Inst. 2012) (“An actor whose negligence causes personal injury or physical harm to the property of another can be held liable in tort regardless of whether the negligence occurs in the performance of a contract between the parties.”), quoted in Shakeri, slip op. at 11.
For more on the economic-loss doctrine, see Economic Loss Doctrine in All 50 States (MWL-Law.com 2013).
Except as otherwise provided below, any dispute arising out of or relating to this Agreement or any transaction or relationship arising from it is to be finally resolved by civil litigation in accordance with the CPR Economical Litigation Agreement (2010 edition) (the ELA), including, without limitation: (1) all disputes concerning breach, termination, or validity of this Agreement; and (2) all disputes based on action in contract, tort, or otherwise.
2. Notification Required; Opt-Out Window
(a) A party that intends to enforce this Rider in the context of a specific dispute must give seasonable written notice of that intent to each other party that is putatively bound by this Rider.
(b) Each such other party may opt out of the ELA by giving written notice to the enforcing party within five business days after the effective date of the enforcing party's notice of intent.
3. JURY TRIAL WAIVER
EACH PARTY KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY AGREES TO TRIAL TO A JUDGE SITTING WITHOUT A JURY, EXCEPT that trial will be to a jury:
(1) in jurisdictions where pre-dispute waiver of jury trial is prohibited by law; or
(2) where all parties to this Agreement agree in writing to trial by jury.
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Caution: Is the ELA "ready for prime time"?
The CPR Economical Litigation Agreement (a.k.a. a "litigation pre-nup") is a relatively new document. In the abstract, its provisions make a great deal of sense, but a party might not want to agree to them in the abstract. A drafter or negotiator should think carefully before including the ELA in a contract.
Some U.S. jurisdictions, notably California and Georgia, prohibit advance waivers of jury trials; see the commentary to the JURY TRIAL WAIVER.
Some key features of the ELA
Some of the salient features of the ELA include:
- Waiver of jury trial (except where advance waiver is prohibited by law)
- Mandatory pre-litigation dispute resolution (with statute-of-limitation exception), including:
- escalating negotiation
- Service of process by overnight delivery
- Automatic extension of time to answer
- Appointment of arbitrator to oversee discovery and decide discovery motions
- Consent to appearing at pretrial conferences by conference call
- Discovery sequencing
- Discovery limits
- Deposition procedures
- Informal witness interviews not unlike those of (Plug-in:) Conference-Call Interview Procedure
- Electronic-discovery procedures
- Duty of preservation
Notification requirement and opt-out window
When the ELA was proposed in 2010, I warned against making an irrevocable commitment to it, because:
- the concept was just too new;
- as a result, parties likely would be reluctant to agree to its (voluminous) provisions and also to take the time to think through the provisions; and so
- to reduce what I expected would be "sales resistance" among counsel, I suggested providing an opt-out window, so that companies could agree to the ELA in principle while deferring the need to make a final decision until an actual dispute arose.
The notification requirement and opt-out window of subdivision (2)(b) is included toward that end.
Alternative: New York accelerated litigation rules
(a) Employ and Employment refer to one or more of: (A) directly or indirectly hiring or employing an individual as an employee or independent contractor; and (B) assisting any other person to do so.
(e) Restriction Period refers to the period from the effective date of this Agreement until three months after termination of (i) the Off-Limits Employer's employment of the Off-Limits Employee in question or (ii) the relevant Statement of Work, whichever comes first.
(f) Solicit and Solicitation refer to one or more of: (A) directly or indirectly recruiting or soliciting an individual, on behalf of any person, for Employment; and (B) assisting any other person to do so.
2. Restriction on Solicitation
3. Exception for Non-Targeted Recruiting
This Annex does not apply in any case in which a Restricted Party hires an Off-Limits Employee who is shown to have made contact with the Restricted Party: (1) for that purpose, (2) on his or her own initiative, (3) without any direct or indirect solicitation for that purpose by the Restricted Party — for example in response to a general advertisement or solicitation that was not directed toward or targeted at employees of the Off-Limits Employer.
4. Option: Finder's Fee
IF: The parties agree in writing that this Finder's Fee Option applies; AND: During the Restriction Period, a Restricted Party engages any Off-Limits Employee in breach of this Employee Solicitation Restrictions Clause; THEN: The Restricted Party will pay the Employer the Finder's Fee Amount (namely, one year's base salary of the Off-Limits Employee as in effect 30 days before the Off-Limits Employee's departure from the Off-Limits Employer), (i) as liquidated damages and also (ii) as the Off-Limits Employer's EXCLUSIVE REMEDY for the breach.
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This provision could result in legal trouble for the parties. For example, a number of Silicon Valley companies such as Apple, Pixar, and Google entered into a consent judgment prohibiting the companies from entering into or enforcing so-called "no poaching" agreements.
(Part V of the consent judgment sets out a list of exceptions in which narrowly-tailored agreements of this kind would not violate the prohibition.)
The Justice Department's filing of the civil action against the companies was (predictably) followed by a class-action lawsuit, on behalf of some 64,000 employees, claiming that those companies had engaged in "wage theft." The lawsuit was settled for some $415 million after embarrassing emails among company executives were revealed publicly. For an extensive list of court documents and news reports, see the Wikipedia entry on the litigation.
Restrictions such as those of this provision can run in both directions. For example:
- An IT-services firm might not want its customer to lure away the service firm's trained, experienced staff members to come work for the customer's in-house IT department.
- Conversely, the customer might not want its services firm — having identified which of the customer's in-house IT staff were especially sharp — to cherry-pick the best of those staff members.
Independent contractor restriction
The "independent contractor" language has in mind the situation in which (say) a customer of a supplier says something like the following to an employee of the supplier: "Jane, we love working with you, but we're not entirely happy with your employer, and it's obvious that you're not entirely happy with them either. So, why don't you leave to start your own company; we'll switch our business to you."
Defining "Off-Limits Employee"
Drafters might want to tailor this definition to match their particular circumstances. As a general rule of thumb, the narrower the restriction, the less likely it is that a court would hold that the restriction was unenforceable.
Duration of Restriction Period
From an enforceability standpoint, the shorter the Restriction Period, the better, for reasons that should be clear from the notes below.
Unenforceable without protectable interest?
The federal court in New York City said that a former employer must have a protectable interest for a no-hire or no-solicit covenant to be enforceable. See Reed Elsevier, Inc. v. TransUnion Holding Co., No. 13 Civ. 8739 (PKC) (S.D.N.Y. Jan. 8, 2014) (denying former employer's motion for preliminary injunction.
Likewise, the Seventh Circuit, in an opinion by Judge Easterbrook, affirmed a judgment that a no-solicit obligation, in an IT staffing company's employment agreement, was unenforceable under Illinois law. The court held that on the facts, the district court did not clearly err in finding that the staffing company did not have a protectable interest. See Interest Tech. LLC v. DeFazio, No. 14-2132, slip op. at 3-4 (7th Cir. July 14, 2015) (affirming bench-trial judgment that no party was liable to any other party), affirming 40 F. Supp.3d 989 (N.D. Ill. 2014).
Exception for non-targeted solicitations
These exceptions are typically-used carve-outs for clauses of this nature.
CAUTION: Including this Finder's Fee provision might preclude the Employer from obtaining injunctive relief to enforce the restrictions of this Clause: the defendant could argue, quite plausibly, that the Employer had already agreed that monetary damages would sufficiently compensate the Employer for the Restricted Behavior, and therefore the Employer was incapable of making one of the key factual showings to support injunctive relief, namely "irreparable harm." See generally Injunctive relief and its commentary.
The exclusive-remedy language in this provision might help protect the Clause from antitrust challenge.
In the heading of this provision, the Finder's Fee is pegged to the salary as in effect 30 days before the employee's departure. This is to (try to) preclude a situation where:
- an Off-Limits Employee gives her Employer two weeks notice that she is quitting to go to work for the Restricted Party;
- the Employer reduces the Off-Limits Employee's salary to minimum wage and then, the next day, fires her;
- the Employer then claims that the amount of the Finder's Fee is one year of minimum wage and not one year of the (former) employee's salary before she gave notice.
Employees' labor-law redress (cross-reference)
Golden-parachute payments: Companies participating in the federal Troubled Assets Relief Program (TARP) after the Great Recession are constrained in their ability to make golden-parachute payments. See generally Hampton Roads Bankshares, Inc. v. Harvard, No. 150323 (Va. Jan. 14, 2016): The court ruled that "EESA § 111, as implemented by the June Rule, renders HRB’s payment of the severance allowance impossible. Therefore, the circuit court erred in overruling the plea in bar. Because federal law prohibits the golden parachute payment under these circumstances, Section 3(b)(iii) of the Employment Agreement is void and unenforceable. Accordingly, we reverse the judgment of the circuit court and vacate the award of damages in favor of Harvard. Moreover, because federal law also bars any payment pursuant to Section 11 of the Employment Agreement, we also reverse the judgment of the circuit court with respect thereto and vacate the award of attorney’s fees in favor of Harvard." Id., slip op. at 14.
(a) For the avoidance of doubt, IF: This Agreement states that a time period ends or expires on a specified day, but it does not specify the time of day that the period ends; THEN: The period ends or expires (1) at exactly 12 midnight at the end of that day, (2) in the time zone where the party that is allowed or required to take action during the expiring time period is located. (See also the Deadline Definition Clause clause.)
(b) For purposes of this Ending Time Definition Clause, the term "expires on" in respect to a date has the same meaning as "ends on" in respect to that date.
Another possibility is to use Universal Time, which is basically Greenwich Mean Time, with a few technical differences; see generally the Wikipedia article Universal Time.
This Agreement: (1) sets forth the final, complete, exclusive, and binding expression of the agreement of the parties concerning the subject matter of this Agreement; and (2) supersedes any prior agreements and commitments, both written and oral, between or on behalf of the parties with respect to that subject matter; all such prior agreements and commitments, if any, are merged into this Agreement.
"Final, complete, [and] exclusive"
The "final, complete, exclusive, and binding" language is modeled on UCC 2-202.
"Concerning its subject matter" allows for use in a master agreement
Companies often enter into master agreements that don't create any obligations of their own, but do set up a framework for any agreed transactions.
For an example of a master agreement with an entire-agreement clause, see Grandoe Corp. v. Gander Mountain Co., 761 F.3d 876 (8th Cir. 2014) (affirming denial of defendant's motion for judgment as a matter of law). In that case:
- The plaintiff was a manufacturer of gloves; the defendant was a national retailer of outdoor sporting goods.
- The manufacturer and the retailer entered into a written contract (the "RAC") that established percentage discounts and a few other terms that would apply to the retailer's oral orders for gloves.
- The written contract did not obligate either party to sell or buy gloves.
The court noted that:
… notwithstanding the RAC's integration clause, it does not appear that the parties intended the RAC to be the final expression of their agreement.
Rather, the RAC explicitly contemplates a future contract for the sale of gloves, and it does not specify that such a contract must be in writing.
The RAC's integration clause itself reflects this understanding: it states that the RAC “is the entire agreement between the parties with respect to the subject matter of this Agreement” (emphasis added), but the subject matter of the RAC does not include the actual sale or purchase of gloves.
If that were the case, then no gloves would ever have been exchanged, since the RAC does not include a quantity term.
Id. at 887 (emphasis by the court, extra paragraphing added).
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- Reliance on external representations isn't necessarily ruled out
- Ban extrinsic evidence from contract interpretation?
- Can an entire-agreement clause be beefed up?
- Caution: A court might not enforce an entire-agreement clause
- Caution: An entire-agreement clause might wipe out previously-existing favorable terms
Reliance on external representations isn't necessarily ruled out
See Reliance Disclaimer.
Ban extrinsic evidence from contract interpretation?
Entire-agreement clauses (sometimes known as "integration clauses" or "merger clauses" or "zipper clauses") are very common in contracts, but they won't necessarily preclude a party from claiming fraudulent misrepresentation by the other side; that possibility can be addressed with a no-reliance provision.
Can an entire-agreement clause be beefed up?
Drafters should consider trying to "beef up" their entire-agreement clauses to increase the chances that a court would enforce the clause. Here are several possibilities:
- Specify that one or both parties disclaims reliance on any external representations or promises, perhaps using the Reliance Disclaimer (an entire-agreement clause generally won't suffice for that purpose). Of course, if you're representing the party that might want to bring a misrepresentation claim, then you wouldn't want to suggest this.
- Make the entire-agreement clause conspicuous – but this is likely to be overkill in a commercial contract;
- Include a statement just above the signature line to the effect that the signers had read and understood the entire agreement, including the entire-agreement clause (and perhaps the arbitration clause) (ditto about overkill);
- Require the other party to initial the entire-agreement clause — although in a commercial contract that likely would be overkill, and it also could be dangerous: Suppose that the contract included underlined spaces in the margin where the parties were supposed to write their initials. But suppose also that the parties — or just one party — didn't initial in the margin where indicated. Trial counsel might argue that this meant the non-initialing party didn't agree to the entire-agreement clause.
Caution: A court might not enforce an entire-agreement clause
Whether a court will enforce an entire-agreement clause may depend on the jurisdiction and the circumstances.
For example, in a 2008 case, a group of Shell gasoline dealers claimed that Shell had orally amended the franchise agreement — this, even though the agreement purported to rule out oral promises. The appeals court affirmed the judgment against Shell. Marcoux v. Shell Oil Prods. Co. LLC, 524 F.3d 33 (1st Cir. 2008). The court quoted the Restatement (Second) of Contracts § 209 cmt. b (1981): "Written contracts, signed by both parties, may include an explicit declaration that there are no other agreements between the parties, but such a declaration may not be conclusive." (Emphasis added.)
See also the discussion in the commentary to the Waivers in Writing Clause.
Caution: An entire-agreement clause might wipe out previously-existing favorable terms
The flip side of the coin is that a court might indeed enforce an entire-agreement clause, thereby wiping out prior terms that were more favorable to one party or another.
Consider what happened in Dasher v. RBC Bank, 745 F.3d 1111 (11th Cir. 2014):
- RBC Bank tried to enforce an arbitration clause in its agreement with a customer.
- Unfortunately for RBC, it had been acquired by another company, which had exercised its right under the old agreement to cause an entirely new customer agreement to be sent out (cf. unilateral amendments).
- Under the terms of the old agreement, the new agreement superseded the old agreement — and the new agreement did not include an arbitration clause.
As a result, the district court refused to compel arbitration; the appellate court affirmed.
Similarly, another arbitration provision was wiped out in Grey v. American Mgmt. Serv., 204 Cal. App. 4th 803, 807-08, 139 Cal. Rptr. 3d 210 (2012). In that case:
- An employee signed an employment application containing a broad arbitration clause.
- The employee later signed an employment agreement.
- The employment agreement also contained an arbitration clause — but of considerably-narrower scope than the arbitration clause of the employment application.
- The employment agreement also contained a typical entire-agreement clause that included "supersedes" language.
- The employee brought a lawsuit against the company.
- A district court granted the employer's motion to compel arbitration.
- The arbitrator rendered an award in favor of the company.
The district court confirmed the award, whereupon the employee appealed. The appellate court held that:
- The later, narrower arbitration clause superseded the earlier, broader one; and
- The employee's claim was not covered by the later, narrower arbitration clause.
The appeals court therefore reversed the district court's order confirming the arbitration award; it remanded the case to the district court with instructions to vacate the award.
Escrow provisions (to do)
Cal. S. Ct. explanation of escrow agent duties: https://scholar.google.com/scholar_case?case=11301981884307642549
(a) For purposes of this Evergreen-Extensions Clause, the following terms have the stated meanings unless otherwise agreed in writing:
Evergreen Period: Any otherwise-expiring period that this Agreement states is subject to evergreen- or automatic extension.
Extension Duration: One year.
Maximum Number of Extensions: An unlimited number.
Party Eligible to Opt Out: Each party.
Opt-Out Deadline: 12 midnight at the end of the last business day before the then-current expiration date of the Extendable Period.
(b) Each Evergreen Period will be automatically extended for the Extension Duration, with no other extension action required by either party, for up to the Maximum Number of Extensions, with such extensions (if any) running successively and continuously, UNLESS a Party Eligible To Opt Out, in its sole discretion, gives notice of non-extension to each other party; any such notice of non-extension must be effective no later than the then-current Opt-Out Deadline.
The "sole discretion to opt out" language is intended to forestall any claim that non-extension is subject to some sort of duty of good faith and/or fair dealing. See the cases (including U.S. cases) cited by by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495, ¶ 91.
CAUTION: A Canadian case decided after Bhasin involved the agreement between 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." Data & Scientific Inc. v. Oracle Corp., 2015 ONSC 4178 (CanLII).
(a) Any party opting out of an extension under the Evergreen-Extensions Clause must pay the other party an Opt-Out Fee, in an amount specified in this Agreement, 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, automatically with no further action by any party.
(b) For the avoidance of doubt, the Opt-Out Fee is intended to provide an alternative form of performance and not as liquidated damages.
This provision was inspired by an analogous provision in Foodmark, Inc. v. Alasko Foods, Inc., 768 F.3d 42 (1st Cir. 2014). In that case, 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.
See also Plug-in provision.
Table of Contents
- Business purpose
- Checklist question: Which party has the right to opt out?
- Choosing the deadline for non-extension notice
- Evergreen extension periods could be of different lengths
- Long extension periods can be problematic
- Maximum number of extensions
- Caution: Statutory restrictions on evergreen extensions
- Further reading
Evergreen clauses are typically used by parties who expect to be in a long-term contractual relationship but want the ability to opt out every now and then in case things aren't going well.
This provision allows either party to opt out, but in some contractual relationships (e.g., a customer-supplier relationship), one party might might feel that it should have more flexibility than the other party to opt out of an evergreen extension.
Choosing the deadline for non-extension notice
The deadline for giving notice of non-extension should be considered carefully for its possible business implications.
In some supplier-customer relationships, a customer might want the ability to opt out right up to the then-current expiration date, or even for a limited period of time after the automatic extension.
On the other hand, a supplier might want several months' advance warning that its customer was opting out of the relationship, or vice versa, to allow time for planning to wind down the relationship, find replacement business, etc.
Pro tip: Be sure to calendar the Opt-Out Deadline — a client of mine once missed an important opt-out date, as discussed below.
Evergreen extension periods could be of different lengths
It's not carved in stone that all automatic-extension periods should be of the same duration. For example, in some contractual relationships, a first extension period might be relatively short, to give the parties a chance to find out what it's like working together. Then, if neither party opts out, subsequent extension periods could be of longer duration.
Here's a real-world example of an evergreen automatic-extension provision gone awry:
- A client of mine once agreed to give a steep pricing discount to a particular customer for five years, if memory serves. (I hadn't been involved in that deal.)
- The agreement provided that the the discount would be automatically extended for another five years if my client didn't opt out when the first five-year period was expiring.
- Sure enough, no one in the client's organization noticed that the five-year discount period was ending.
- As a result, the client didn't send the customer a notice that the client was opting out of the pricing commitment.
- The client had to honor the steeply-discounted pricing for that customer for another five years. This, even though the client had raised its prices significantly for the rest of its customer base.
If the parties' relationship is working well and either party can opt out, then there might be no reason to have it come to an end unless one party wants it to end.
On the other hand, it might be that only one party has the right to opt out. This might be the case in a supply agreement, in which the customer may opt out but the supplier may not. In that situation, the supplier might want to limit the number of automatic extension periods.
Caution: Statutory restrictions on evergreen extensions
Some states restrict automatic extension or renewal of certain contracts unless specific notice requirements are met. Examples of such states include California, Illinois, New York, North Carolina, and Wisconsin. See Cal. Bus. & Prof. Code § 17600-17606 (consumer contracts); 815 ILCS § 601 (consumer contracts); N.Y. Gen. Oblig. L. § 5-903, contracts for services, maintenance or repair N.C. Gen. Stat. § 75-41 (consumer contracts); Wis. Stat. § 134.49 (business equipment leases and business services).
See the discussion of the distinction between extend and renew.
(a) Examples (and terms such as for example), whether or not capitalized, are used in this Agreement for purposes of illustration, not of limitation, unless another meaning is clear from the context.
(b) For the avoidance of doubt, if in some places this Agreement uses longer expressions such as "by way of example and not of limitation," such usage does not mean that the parties intend for shorter expressions such as "for example" to serve as limitations unless expressly stated otherwise.
(1) Other Term refers to any substantive term in a quotation, purchase order, confirmation of order, shipping manifest, invoice, or similar document that may be provided by a party in connection with a transaction pursuant to this Agreement, where the substantive term is (i) in addition to, or (ii) different from, the terms and conditions of this Agreement.
(2) For the avoidance of doubt, the term Other Term does not encompass case-specific details that are not addressed in this Agreement such as (for example, and to the extent applicable) the price, quantity, and delivery date of goods being sold in a particular sale transaction under this Agreement; the services to be performed under a statement of work; and the like.
(b) Amendment requirements apply: Other Terms will be of no effect unless the amendment requirements of this Agreement are satisfied so as to modify this Agreement, either generally or for a particular case only.
(c) Examples of actions not constituting assent: For the avoidance of doubt and as illustrative examples, a party is not to be deemed to have assented to Other Terms by doing one or more of the following pursuant to a previously-formed contract:
(1) performing one or more actions called for by, or otherwise described in, Other Terms;
(2) shipping an orally-agreed order after receiving a written purchase order containing Other Terms;
(3) paying an invoice containing Other Terms; and/or
(4) accepting or paying for goods or services after receiving an order confirmation or other document containing Other Terms.
Table of Contents
- CAUTION: Filling a purchase order might well mean that the buyer's T&Cs apply
- Background: The Battle of the Forms
- Caution: The UN CISG relies on the "mirror image" (or "last shot") rule
- Definition of Other Terms
- Conformance to amendment requirements
- Examples of things that are not deemed "assent" to Other Terms
- Additional reading
This provision is intended to preclude either party from "re-trading the deal" later on (intentionally or not) through the use of additional or different terms in a purchase order, confirmation, invoice, etc. See the additional notes concerning the Battle of the Forms.
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."
When a corporate buyer makes a significant purchase, it's quite common for the buyer's procurement people to send the seller a purchase order. Typically, if the seller wants to get paid, it must quote the purchase-order number on the invoice, otherwise the buyer's accounts-payable department simply won't pay the bill. This is a routine internal-controls measure implemented by buyers to help prevent fraud.
Many buyers, however, try to use their purchase-order forms, not just for fraud prevention, but to impose legal terms and conditions on the seller. These buyers put a lot of fine print on the backs of their purchase-order forms; the terms of the fine print typically include:
- detailed — and often onerous — terms for the purchase, including for example expansive indemnity requirements; and
- language to the effect of, our terms and conditions are the only ones that will apply; yours don't count, no matter what you do.
Sellers aren't always innocent parties in this little mating ritual, either: It's not uncommon for a seller's quotation to state that all customer orders are subject to acceptance in writing by the seller. Then, the seller's written acceptance takes the form of an "order confirmation" that itself contains detailed terms and conditions — some of which might directly conflict with the buyer's purchase order.
This is known as the "Battle of the Forms," of the kind contemplated by UCC § 2-207 and sometimes experienced in common-law situations as well. That subject won't be discussed here, because this notebook's contract terms are very likely to be used when the parties are negotiating the terms and conditions of their agreement, and it simply won't be appropriate for either party to try to impose its own standard-form terms and conditions.
CAUTION: Analysis of the Battle of the Forms is different under the UN Convention on Contracts for the International Sale of Goods. See generally, e.g., VLM Food Trading Int'l, Inc. v. Illinois Trading Co., No. 14-2776 (7th Cir. Jan. 21, 2016), where the appeals court affirmed a judgment below that, "because Illinois Trading never expressly assented to the attorney's fees provision in VLM's trailing invoices, under the Convention that term did not become a part of the parties' contracts." Id., slip op. at 2. The appeals court explained:
[T]he Convention departs dramatically from the UCC by using the common-law “mirror image” rule (sometimes called the “last shot” rule) to resolve “battles of the forms.” With respect to the battle of the forms, the determinative factor under the Convention is when the contract was formed. The terms of the contract are those embodied in the last offer (or counteroffer) made prior to a contract being formed. Under the mirror-image rule, as expressed in Article 19(1) of the Convention, “[a] reply to an offer which purports to be an acceptance but contains additions, limitations or other modifications is a rejection of the offer and constitutes a counter-offer.”
Id., slip op. at 5-6 (citations, internal quotation marks, and some alteration marks omitted; emphasis added).
This definition tries to "cover the waterfront" of documents in which parties might sometimes try to slip in their own preferred terms and conditions.
The "in addition to or different from, the terms and conditions of this Agreement" language is adapted from UCC § 2-207.
This language gives the parties the flexibility to agree to vary the terms of the contract for specific situations, e.g., one-off transactions.
This subdivision lists some specific examples of things that do not count as assent to additional terms, in the interest of discouraging parties from claiming that such terms supposedly govern.
For a review of some of the case law on this point, see C9 Ventures v. SVC-West, L.P., 202 Cal. App. 4th 1483 (2012), where the court held that, in the particular circumstances of the case, the fact that a buyer paid a seller's invoice did not mean that the buyer had agreed to the seller's terms that were printed on the invoice.
- Amendments in Writing Clause
- Entire Agreement Clause
- 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 that might well become a teaching case, 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.
Expiration definition (cross-reference)
Suppose that a contract requires Alice to indemnify Bob against harm caused by Bob's own negligence. In jurisdictions that follow the express-negligence doctrine (e.g., Texas), that requirement is unenforceable unless it is both express and conspicuous, as discussed in more detail here and here and here.
(a) This provision applies when this Agreement requires a the the party indicated in this Agreement, if any (namely, Reimbursing Party) to reimburse a the the party indicated in this Agreement, if any (namely, Incurring Party) for expenses.
(b) When invoiced by the Incurring Party, the Reimbursing Party is to reimburse the Incurring Party for reasonable expenses actually incurred by the Incurring Party in the performance of the Incurring Party's obligations under this Agreement.
(c) Such expenses are to be invoiced on a straight pass-through basis, with no markup, unless otherwise agreed in writing.
Expense-reimbursement provisions are typically seen in, for example, services agreements, in which the Incurring Party might be a services provider or a subcontractor; the Reimbursing Party might be the customer of a services agreement, or possibly a prime contractor that must reimburse a subcontractor for the latter's expenses.
Note the "reasonable" and "actually incurred" qualifiers in this provision.
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(a) From time to time the Reimbursing Party may provide the Incurring Party with a copy of the Reimbursing Party's then-current standard written reimbursement policy.
(b) IF: The Reimbursing Party provides the Incurring Party with such a written policy so at least a reasonable time before the Incurring Party incurs the relevant expense(s) or otherwise becomes obligated to pay them; THEN: The Incurring Party will not invoice the Reimbursing Party for expenses, and the Reimbursing Party need not reimburse expenses, except in conformance with that policy.
(c) IF: This Agreement specifies that the Reimbursing Party's current written reimbursement policy is attached or has been otherwise provided to the Incurring Party (e.g., by email); THEN: That policy will apply until such time, if any, as the Reimbursing Party provides a different written policy.
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, while leaving that option open for the future.
In invoicing reimbursable expenses, the Incurring Party may mark up the expenses by up to the Maximum Permissible Expense Markup specified in this Agreement, if any; if none is specified, then the Incurring Party may not mark up the expenses.
Many contracts prohibit marking up of expenses, but some contracts are "cost-plus."
(a) The Incurring Party may arrange for individual expenses of at least USD $1,000 (the Direct Billing Threshold Amount) to be billed directly to the Reimbursing Party; the Reimbursing Party is to timely pay any such direct-billed expense.
(b) If so requested by the Reimbursing Party for a particular expense, the Incurring Party will consult with the Reimbursing Party before arranging for direct billing of that expense to the Reimbursing Party.
Extensions, unilateral (cross-reference)
The parties desire that extrinsic evidence not be considered in determining the meaning of this Agreement, or any provision of it, in any judicial- or arbitral proceeding; each party agrees not to offer any such evidence for that purpose.
This provision is based on one that was successfully asserted by a defendant in Hot Rods, LLC, v. Northrop Grumman Sys. Corp., No. G049953 (Cal. App. 4th Dist. Dec. 7, 2015) (reversing and remanding damages award). The language in that agreement was the following:
The Parties further intend that this Agreement constitutes the complete and exclusive statement of its terms and that no extrinsic evidence whatsoever may be introduced in any judicial proceedings involving this Agreement.
Id., slip op. at 9 (emphasis added, internal quotation marks omitted). Rejecting Hot Rod's public-policy arguments, the appellate court agreed with Northrop Grumman that a referee in the court below erred by admitting extrinsic evidence to interpret the parties' agreement. See id., slip op. at 10-12.
CAUTION: A party that asks for such provision might be setting a trap for itself — imagine a judge's reaction if that party later changed its mind and sought to offer extrinsic evidence to support its preferred interpretation of the contract after all.
NOTE: UCC § 2-202(a) expressly permits the terms of an agreement to be supplemented or explained by "course of dealing or usage of trade … or by course of performance," even when the agreement contains an entire-agreement provision.
See also Entire Agreement Clause.
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A false imperative exists when a contract purports to impose an obligation, but without specifying who is responsible for carrying it out. For example, an apartment lease might state: "The apartment shall be regularly serviced by a professional pest-control service" — this doesn't indicate which party is required to arrange for the pest-control service (and thus might be in breach for failing to do so).
Tina Stark discusses false imperatives in her book, Negotiating and Drafting Contract Boilerplate § 2.03[b] (excerpt available at https://goo.gl/hUHZHn). She gives another example: "This Agreement shall inure to, and be binding upon, the parties and their respective successors and assigns." Id. To paraphrase Stark, an agreement can't be compelled to do anything, nor can it be held liable for failing to do so.
For a discussion of false imperatives in the context of legislative drafting, see generally Jery Payne, The False Imperative, in The Legislative Lawyer (Dec. 2010).
Safe-harbor language can sometimes contractually eliminate fiduciary duties
See Dieckman v. Regency GP LP, No. 11130-CB (Del. Ch. Mar. 29, 2016), where the court dismissed a complaint, by a former limited partner, that the general partner breached its fiduciary duty. The limited-partnership agreement contained a (typical) safe-harbor provision that expressly authorized certain potentially-conflicted transactions as long as any one of several stated procedures was followed:
(a) Unless otherwise expressly provided in this Agreement . . ., whenever a potential conflict of interest exists or arises between the General Partner or any of its Affiliates, on the one hand, and the Partnership, any Group Member or any Partner, on the other,
any resolution or course of action by the General Partner or its Affiliates in respect of such conflict of interest shall be permitted and deemed approved by all Partners, and shall not constitute a breach of this Agreement . . . or of any duty stated or implied by law or equity,
if the resolution or course of action in respect of such conflict of interest is
(i) approved by Special Approval [defined elsewhere as approval by a Conflicts Committee of directors of the corporate general partner],
(ii) approved by the vote of a majority of the Common Units (excluding Common Units owned by the General Partner and its Affiliates),
(iii) on terms no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or
(iv) fair and reasonable to the Partnership, taking into account the totality of the relationships between the parties involved (including other transactions that may be particularly favorable or advantageous to the Partnership).
Id. at part I.B, text accompanying n.2 (footnote omitted, extra paragraphing added). The chancery court held that this provision, and the defendants' compliance with one of the safe-harbor procedures, eliminated the defendants' putative fiduciary duty.
Flip insurance is (my term for) a type of clause sometimes seen in, for example, asset-sale agreements. Such a clause provides that if the buyer sells the purchased asset at a higher price within a stated period of time (often one year), then the seller is entitled to a share of the difference.
HYPOTHETICAL EXAMPLE: Buyer pays Seller $100 for an asset. Their contract contains a flip-insurance clause stating that Seller is entitled to 50% of Buyer's profit if Buyer sells the asset within one year after the closing of Buyer's purchase from Seller.
Other terms for this type of clause are jerk insurance and schmuck insurance — see Peter Mahler, “Jerk Insurance” Takes on New Meaning in Buyout Dispute (NYBusinessDivorce 2015).
In one example of a badly-drafted flip-insurance clause, a federal district court held that Seller was entitled to 20% of the entire proceeds of Buyer's flip sale, not just to 20% of Buyer's profit on the flip sale. See Charron v. Sallyport Global Holdings, Inc., No. 12cv6837, part III (S.D.N.Y. Dec. 10, 2014) (setting forth findings of fact and conclusions of law after bench trial).
The term for the avoidance of doubt signifies agreed guidance concerning the intended meaning of a provision.
The term for the avoidance of doubt seems to be frequently used in British contracts.
Ken Adams dislikes the term, describing it as "a turkey"; he says: "How’s this for a categorical statement: Never use for the avoidance of doubt."
(Ken's injunction illustrates something I've said from time to time: All categorical statements are bad, including this one.)
Willem Wiggers is more restrained on this subject; at his WeAgree contract-drafting site, he says that the term for the avoidance of doubt could be used, for example, when "considering the agreement as a whole, the subject matter is important enough to be addressed (i.e. not being aware of the to-be-avoided doubt may be a source of disputes or disappointment for the parties)."
My own view is that drafters should use the term for the avoidance of doubt when they want their client's litigation counsel to have a "sound bite" to use in a lawsuit or arbitration, e.g., by quoting it in a brief or showing it on a PowerPoint slide or poster board.
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(1) that causes a failure of timely performance under this Agreement; and
(2) as to which a prudent person, in the position of an Invoking Party (namely, either party), would not reasonably have been able to anticipate the event or events and avoid the failure of timely performance.
(b) In response to actual or imminent occurrence of one or more Force-Majeure Events, an Invoking Party may invoke force majeure by advising another affected party by notice or other reasonable means.
(c) An Invoking Party that seasonably invokes force majeure will not be liable under this Agreement 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.
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(1) any event that (i) is not an Excluded Event and (ii) falls within one or more of the following categories (some are in bold-faced type to call drafters' attention to 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 of this Agreement. Act or threat of terrorism. Blockade. Boycott. Civil disturbance. Court order. Drought. Earthquake. Economic-condition changes generally. Electrical-power outage. Embargo imposed by a governmental authority. Epidemic. 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 governmental authority. Nationalization. Payment failure resulting from failure of or interruption in one or more third-party payment systems. Riot. Sabotage. Storm. Supplier default. Telecommunications service failure. Transportation service unavailability. Tornado. Weather in general; and
(2) all other particular examples of Force Majeure (if any) identified in this Agreement — it is immaterial if one or more of them also comes within the scope of subdivision (1) above.
This "laundry list" of force-majeure examples was drawn from various agreement specimens.
Some drafters might want to use the "other particular examples …" defined term to specify particular force-majeure risks.
- Concerning economic changes generally, see Kevin Jacobs and Benjamin Sweet, 'Force Majeure' In the Wake of the Financial Crisis, Corp. Coupsel, Jan. 16, 2014.
- Concerning a certain geopolitical issue, see Simon Moore, Russia and Ukraine sanctions - Their effect on contracts: Top 10 Tips (FieldFisher.com 2014).
In some customer-oriented supply- and service contract forms, labor difficulties are excluded from the definition of force-majeure event.
IF: One or more properly-invoked Force-Majeure Events make it impracticable or impossible for an Invoking Party to timely exercise a right, under this Agreement; THEN: The time for exercising that right will be deemed extended for the duration of the delay resulting from the Force-Majeure Event or Events.
This clause addresses a potential gap (depending on one's perspective) in many force-majeure clauses. This gap caused fracking companies to lose a case in New York's highest court.
- A lease agreement gives the lessee certain rights, e.g., the right to drill for oil and gas on the leased property;
- The lessee's drilling rights last for five years — or, if longer, as long as the lessee is producing oil and gas from the leased property;
- The agreement contains a force-majeure clause, which states that in case of delay caused by force majeure, the time of such delay or interruption "shall not be counted against" the lessee; and
- A force-majeure event — namely a government prohibition of drilling — prevents the lessee from drilling oil wells on the leased property during the five-year drilling period.
In approximately that situation, the Court of Appeals of New York (that state's highest court) held that the force-majeure clause, as drafted, did not stop the lessee's drilling rights from expiring at the five-year point, because the clause was not explicit on that point. See Beardsley v. Inflection Energy, LLC, 2015 NY Slip Op 02677 at 9-11 (on certification from Second Circuit). In doing so, the court aligned itself with courts in several other "oil" jurisdictions. See id. at 12.
Effective upon written notice to all other Signatory Parties (or at such later time as may be stated in the notice), any Party Entitled To Terminate (namely, each party) may terminate its obligations under this Agreement if the aggregate effect of the relevant Force-Majeure Event(s):
(1) is material to this Agreement as a whole; and
(2) lasts past the Earliest Termination Date (namely, 30 days after invocation of force majeure by any party entitled to do so under this Agreement).
Drafters should give some thought to what they would like to see as the consequences of termination for force majeure.
The "material to this Agreement as a whole" language is is adapted from the "outsourcing" master services agreement in Indiana v. IBM Corp., No. 49Dl0-1005-PL-021451, slip op. at 1, 47 (Marion Cty In. Sup. Ct. July 18, 2012) (granting judgment for IBM), reversed, 4 N.E.3d 696 No. 49A02-1211-PL-875, (Ind. App. Feb. 13, 2014), affirmed, Indiana v. IBM Corp., No. 49S02-1408-PL-00513 (Ind. Mar. 22, 2016).
In some situations, a party might want to negotiate for more flexibility to terminate for force majeure than the other side gets.
The parties might negotiate different Earliest Termination Dates for different parties or different situations. For example, in a supply- or services agreement, the customer might want to be able to "pull the plug" after a relatively-short period, while keeping the supplier "on the hook" for a longer period.
Any party receiving any force-majeure status information from an Invoking Party must maintain that information in confidence unless and until the information becomes available to the general public.
A party invoking force majeure might not want its business made public.
See also Force-Majeure Status Reports.
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.
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A failure of timely performance by an Invoking Party that is caused by a failure of performance of a subcontractor or supplier to the Invoking Party will be excused under this clause only if:
(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.
If so requested by another affected party, the Invoking Party will provide reasonable information, from time to time, about its efforts, if any, to remedy or mitigate the effect of the force majeure.
Depending on the nature of the contract, a party might not want to commit to providing force-majeure status reports.
For example, suppose that the force-majeure clause were part of a consumer-services contract. In that situation:
- The service provider might well be willing to update its customers about the status of a force-majeure service outage — especially in this era of near-instantaneous public criticism on social media.
- On the other hand, the provider might equally well not want to be contractually obligated to provide such status reports.
Each Invoking Party is to make any Required Mitigation Efforts that are expressly specified in this Agreement (if any) to mitigate the effects of the force majeure.
Mitigation, remediation, or both? Note that there are two distinct options presented here: One for mitigation, one for remediation, which are two different things.
Some drafters might insist that the other party use its best efforts to mitigate or remediate the effects of of force majeure; see, e.g., [TO DO – CITE NEEDED – Honeywell PO 4].
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.
In a supply- or services agreement, the customer might not want to be bound by any mitigation obligation.
If Required Mitigation- or Remediation Efforts are going to be defined, it might make sense to refer to an exhibit or appendix where the term can be spelled out in appropriate detail.
Each Remediating Party (if any; none unless expressly agreed otherwise) is to make the Required Remediation Efforts (if any; none unless expressly agreed otherwise) to remediate the effects of the force majeure.
See the notes to the Force-Majeure Mitigation Requirement.
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Force-majeure provisions codify common-law concepts
Force majeure clauses are not uncommon in commercial contracts. To one degree or another, they mirror the way that the law generally works anyway in many jurisdictions. The Supreme Court of North Dakota provided a useful recap of the (U.S.) law concerning force majeure:
… Black's Law Dictionary defines a force majeure clause as "[a] contractual provision allocating the risk of loss if performance becomes impossible or impracticable, esp[ecially] as a result of an event or effect that the parties could not have anticipated or controlled." Black's Law Dictionary 718 (9th ed. 2009).
According to 30 Williston on Contracts § 77.31, at 364 (4th ed. 2004), a force majeure clause is equivalent to an affirmative defense. "What types of events constitute force majeure depend on the specific language included in the clause itself." Id.
"[N]ot every force majeure event need be beyond the parties' reasonable control to still qualify as an excuse." Id. at 367.
"A party relying on a force majeure clause to excuse performance bears the burden of proving that the event was beyond its control and without its fault or negligence." Id. at 365.
[A] force majeure clause relieves one of liability only where nonperformance is due to causes beyond the control of a person who is performing under a contract. An express force majeure clause in a contract must be accompanied by proof that the failure to perform was proximately caused by a contingency and that, in spite of skill, diligence, and good faith on the promisor's part, performance remains impossible or unreasonably expensive. Id. at 366.
Entzel v. Moritz Sport & Marine 2014 N.D. 12 (extra paragraphing added, alteration marks by the court).
But are force-majeure clauses even appropriate anymore?
Lawyer Jeff Gordon makes the thought-provoking argument that "most [force-majeure events] can be planned for … even something like terrorism and war (especially when they're happening right now), should be planned for," and that contracting parties should have a backup plan for such events. See Jeff Gordon, Things that shouldn't count as force majeure (Jan. 5, 2010).
Of course, as a matter of business-risk allocation, parties negotiating a contract might not want to take the time for detailed planning, especially if they don't really know what such detailed plans should be. In that situation, it might well be a defensible business decision to use a force-majeure clause instead.
- Michael Polkinghorne and Charles B. Rosenberg, Expecting the Unexpected: The Force Majeure Clause (WhiteCase.com 2015) (addresses both common-law and civil-law doctrines);
- Jessica S. Hoppe and William S. Wright, Force Majeure Clauses in Leases, Probate & Property, March/April 2007, at 8;
- DLA Piper, Force Majeure Clauses – Revisited (DLAPiper.com 2012) (focuses on force majeure clauses in project agreements).
(a) Definition: Selected Forum refers to any of the one or more forums specified in this Agreement, if any.
(b) Any action arising out of this Agreement (each, an Affected Action) against a party (the "defendant") may be brought in a Selected Forum, regardless where the defendant is geographically located or conducts business.
(c) IF: This Agreement states simply that (for example) disputes may be brought in a specified city or other location; THEN:
(1) Any Affected Action may be brought in any court having jurisdiction in that location; AND:
(2) Each such court is a Selected Forum.
(a) IF: This Agreement clearly states (whether or not in so many words) that a Selected Forum is (or that the Selected Forums are) to be exclusive; THEN: Unless this Agreement expressly states otherwise, no party is to do or attempt either of the following: (1) commence an Affected Action in any forum, nor (2) transfer or remove an Affected Action to any forum, other than the Selected Forum (or, if more than one Selected Forum, to another Selected Forum).
(b) IF: This Agreement provides for more than one Selected Forum; THEN: Any reference to the Selected Forum being exclusive is to be interpreted as likewise referring to the Selected Forums, plural, being collectively exclusive.
Even if this Agreement provides that a Selected Forum is exclusive, the parties do not intend for that provision to negate or limit any provision of this Agreement, nor of any other agreement between the parties, that requires:
(1) arbitration or other non-judicial dispute resolution procedure; nor
(2) non-binding action to attempt to resolve a dispute by agreement, such as (for example) escalation of the dispute to higher levels of the parties' managements; early neutral evaluation; and/or mediation.
Each party consents to the specific jurisdiction of the Selected Forum (or each of them, if more than one), but solely for Affected Actions; nothing in this clause is intended as a consent by a party to the general jurisdiction of any court or other tribunal.
(1) to commence an Affected Action or otherwise assert a claim in any other proper forum; nor
(2) to seek to transfer an Affected Action to another venue, for example on grounds of greater convenience to the parties and witnesses or on first-to-file grounds; nor
(3) to remove an Affected Action from one court to another, for example to remove an action filed in state court (in the United States) to federal court.
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- Litigation may be "brought"
- Regardless where geographically located
- Affected Actions: "Arising out of," but not "relating to," this Agreement
- Alternative: Any Agreement-Related Dispute
- Caution: Saying "the courts of" a jurisdiction could be dangerous
- Caution: The term "shall be subject to" might confer exclusive jurisdiction
- "Submit to"
- An exclusive-forum clause is a hand grenade (it might be thrown back)
- An exclusive-forum clause might be tactically disadvantageous
This Protocol does not say that any Agreement-Related Dispute will be litigated in the agreed forum, but only that litigation "may be brought" — and that language is non-exclusive; it does not rule out either filing a lawsuit in another venue nor seeking a transfer of a case to another forum.
FOOTNOTE: "First to file" is one of the (U.S.) statutory grounds for transfer to a more-convenient court; that basis for transfer came into play (but was not dispositive) in Stone & Webster, Inc. v. Georgia Power Co., No. 13-7151 (D.C. Cir. March 10, 2015). Interestingly, in that case two parties filed lawsuits against each other in two different federal district courts at the same second. The D.C. district court granted a motion to dismis, on grounds that the other federal court (in Georgia) was better suited for hearing the controversy because of the location of witnesses and other considerations; the appellate court affirmed.
The "regardless where the defendant is geographically located" language in subdivision (b) is adapted from a forum-selection clause that was successfully asserted on appeal by the plaintiff in BlueTarp Fin., Inc. v. Matrix Constr. Co., 709 F.3d 72 (1st Cir. 2013); in that case, the appeals court reversed and remanded the trial court's dismissal of the case for lack of personal jurisdiction over the defendant.
The forum selection does not encompass proceedings "relating to" the parties' agreement. Here's a hypothetical example:
- Provider licenses its software to Customer.
- The license agreement requires any litigation arising from the agreement to be brought in the city of Customer's principal place of business; let's assume that's Atlanta.
- One day, 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, 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 br brought in Atlanta.
Another possibility would be to have the forum-selection clause apply to any Agreement-Related Dispute.
This provision 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 Doe 1 v. AOL, LLC, 552 F.3d 1077, 1081-82 (9th Cir. 2009) (per curiam), where the appeals court also held that the forum-selection clause was unenforceable.
In an English case, a Hong Kong freight forwarder used its standard bill-of-lading form in accepting cargo for shipment from China to Venezuela. The form provided in part that "[t]his Bill of Lading and any claim or dispute arising hereunder shall be subject to English law and the jurisdiction of the English High Court of Justice in London." The UK Court of Appeal, after reviewing case law concerning similar language, held that the bill of lading's wording conferred exclusive jurisdiction on the English courts. Hin-Pro International Logistics Limited v Compania Sud Americana De Vapores S.A.  EWCA Civ 401 ¶¶ 4, 61-78. (Hat tip: Mark Anderson, who in his write-up makes additional observations about the case.)
The term "submit to" is likely to be held to confer non-exclusive jurisdiction. In a Nevada case, a group of borrowers signed a loan agreement with a credit union. The forum-selection provision in the loan agreement stated that "[t]he parties agree and submit themselves to the jurisdiction of the courts of the State of Utah with regard to the subject matter of this agreement." The credit union filed suit, in Nevada, against the borrowers, who moved successfully to dismiss the case on grounds that the forum-selection provision precluded a suit in Nevada. the state's supreme court reversed, holding that the forum-selection provision was permissive, not mandatory. America First Fed. Credit Union v. Soro, No. 64130, 131 Nev. Adv. Op. 73 (Nev. 2015) (citing cases).
This submit-to language might be superfluous: "[T]o agree to a forum thus is to agree to personal jurisdiction in that forum." BouMatic LLC v. Idento Operations BV, 759 F.3d 790, 793 (7th Cir. 2014) (vacating and remanding dismissal for lack of personal jurisdiction). "Litigants cannot confer subject-matter jurisdiction by agreement or omission, but personal jurisdiction is a personal right that a litigant may waive or forfeit." Id. (emphasis added).
Consider this not-so-hypothetical example:
- You're helping to negotiate a contract between your client, "Alice," and another party, "Bob."
- Your draft contract is a tough one; among other things, it contains an exclusive-jurisdiction forum clause that requires all litigation to be conducted in Alice's home-court jurisdiction.
- In negotiating the contract, Bob's counsel says, sure, an exclusive-jurisdiction clause is fine with us — but the exclusive jurisdiction has to be Bob's home court, not Alice's.
In that case, if Bob has more bargaining power, your proposal of a tough first-draft contract might have created problems for your client Alice.
In a negotiation of a big commercial deal, the client had forwarded its standard form contract — which I hadn't written — to a prospective customer that had significantly-more bargaining power than my client did. The customer's lawyer saw the forum-selection clause, and said we needed to turn it around so that the exclusive forum would be the customer's home city. Fortunately, the customer's lawyer went along with my suggestion that we just drop the forum-selection clause entirely.
Back to our Alice-and-Bob hypothetical: Now imagine that Alice prevailed on Bob to accept an exclusive-jurisdiction forum clause, specifying that all litigation will be in Alice's home jurisdiction. And imagine that years (or days) after signing the contract, Alice wanted to seek a temporary restraining order or preliminary injunction against Bob. That might be, for example, because Bob appeared to be violating a confidentiality clause requiring him to keep Alice's information secret.
In that case, Alice might well be better off suing Bob in his own home jurisdiction, because:
- In kicking off the lawsuit, it's likely that Alice will be able to complete the necessary service of process on Bob more quickly in his own home court.
- If Alice had to court to compel Bob to produce documents or witnesses, Bob would probably have a harder time resisting an order from a judge in Bob's own home jurisdiction.
- Even if Alice were successful in getting a court to issue an injunction affecting Bob, the injunction likely wouldn't take effect until it has been formally served on Bob; service might well be quicker and easier in Bob's home jurisdiction.
- if Bob violated the injunction, Alice probably would be able to haul him back more quickly into court for contempt proceedings in his own home jurisdiction.
So: Alice should think twice before insisting that Bob agree to exclusive jurisdiction in Alice's home court.
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Subject to the requirements for a case to be heard in the Commercial Division of the New York State Supreme Court, the parties agree to submit to (i) the EXCLUSIVE JURISDICTION of the Commercial Division and (ii) the application of the court's accelerated procedures, in connection with any dispute, claim or controversy arising out of or relating to this agreement, or the breach, termination, enforcement or validity thereof.
This clause is based on a New York statutory rule; it's copied largely verbatim from the suggested language in Rule 9 of 22 NYCRR § 202.70(g).
This is essentially a type of forum-selection clause, coupled with an agreement to streamlined litigation in accordance with the cited rule. This means drafters should be careful not to be inconsistent by agreeing to a different forum-selection clause.
See also the notes to the Accelerated Litigation Clause.
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- Legal background
- A court might not honor the parties' agreement to an improper forum
- And forum-selection clauses might be disregarded for policy reasons
- Caution: Don't inadvertently wipe out an arbitration provision
- Caution: A Massachusetts forum might be dangerous for defendants
- Caution: A forum-selection clause might backfire if the forum proves unfriendly
U.S. federal courts routinely enforce forum-selection clauses "unless extraordinary circumstances unrelated to the case clearly disfavor a transfer." Atlantic Marine Construction Co., Inc. v. United States District Court, _ U.S. _, 134 S.Ct. 568, 187 L.Ed.2d 487 (2013); Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 n.14 (1985); BouMatic LLC v. Idento Operations BV, 759 F.3d 790, 793 (7th Cir. 2014) (vacating and remanding dismissal for lack of personal jurisdiction).
"It is well established that forum selection clauses are prima facie valid and should be enforced unless enforcement is shown by the resisting party to be unreasonable under the circumstances. More specifically, a forum selection clause should be enforced unless the resisting party can show that enforcement would be unreasonable and unjust, or that the clause was invalid for such reasons as fraud or overreaching or that enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision." Rivera v. Centro Medico de Turabo, Inc., 575 F. 3d 10, 18 (1st Cir. 2009) (affirming dismissal of action based on forum-selection clause), in part quoting M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 10, 15 (1972) (internal quotation marks, alteration marks, and citations by First Circuit omitted).
Likewise, state courts in the U.S. generally honor forum-selection provisions "unless the party challenging enforcement establishes that such provisions are unfair or unreasonable, or are affected by fraud or unequal bargaining power." Paul Business Systems, Inc. v. Canon U.S.A., Inc., 97 S.E.2d 804, 807-08 (Va. 1990) (affirming dismissal of complaint) (emphasis added, extensive citations and internal quotation marks omitted).
A court might not honor the parties' agreement to an improper forum
In many American states, a statute specifies the location where a lawsuit must be brought. Typically, this will be either the county where the plaintiff resides or the county where the defendant resides. If a contract's forum-selection clause specifies a county that does not meet the statutory requirement, a court might refuse to enforce the forum selection. This happened in A&D Envt'l Serv., Inc. v. Miller, No. 14 CVS 6328 (N.C. App. Apr. 7, 2015) (affirming denial of defendant's motion to enforce forum-selection clause).
The A&D court noted, though, that "a forum selection clause which favored a court in another State was enforceable …." Id., slip op. at 4 (emphasis in original, citation and internal quotation marks omitted).
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. For example:
• Doe 1 v. AOL, LLC, 552 F.3d 1077, 1084 (9th Cir. 2009): a group of users of the America OnLine (AOL) service sued AOL in California and sought class-action status. The AOL user agreement required all disputes to be litigated in Virginia. Citing the forum-selection clause, a federal district court in California dismissed the case but said it could be re-filed in Virginia state courts as required by the user agreement.
The federal appeals court disagreed. It held that California had a strong public policy favoring class-action relief, and noted that such relief was not available in Virginia state courts. Therefore, said the appeals court, "the forum selection clause in the instant member agreement is unenforceable as to California resident plaintiffs bringing class action claims under California consumer law."
• In re AutoNation, Inc., 228 S.W.3d 663 (Tex. 2007): this Texas case had a very different outcome: a Florida-based car dealer filed suit, in Florida, against a former employee who lived in Texas and had worked for the car dealer there. The former employee's employment agreement contained a choice-of-law clause calling for Florida law to apply, together with a forum-selection clause requiring any litigation to take place in Florida.
Before learning of the Florida action, the former employee sued the car dealer in Texas, seeking a declaratory judgment that the non-competition covenant of the employment agreement was unenforceable under prior Texas supreme court precedent. Granting a writ of mandamus, the Texas supreme court ruled that while it was not questioning the validity of its prior precedent, it would still enforce the "freely negotiated" [sic] forum-selection clause to allow the first-filed suit in Florida to proceed.
(Thanks to my then-student Glen Tedham for alerting me to this case.)
For additional discussion and case citations, see generally Paulo B. McKeeby, Solving the Multi-State Non-Compete Puzzle Through Choice of Law and Venue (2012).
QUESTION: On the AutoNation facts, what are the odds that the Florida court would have applied Texas law, given that the contract included a Florida choice-of-law clause?
An exclusive forum-selection provision might be held to trump an arbitration provision in a prior or "background" agreement. At this writing there is a split in the circuits on that point:
- The Second and Ninth Circuits have held that an exclusive forum-selection clause does trump an arbitration provision. See Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, No. 13-797-cv (2d. Cir. Aug. 21, 2014), in which the appeals court affirmed a trial court's grant of Goldman's motion to enjoin FINRA arbitration, on grounds that the forum-selection clauses in the parties' agreements superseded the arbitration provision (hat tip: Michael Oberman); see also Goldman, Sachs & Co. v. City of Reno, No. 13-15445, at part III-C, slip op. at 15-16, 19-28, 747 F.3d 733, 736 (9th Cir. 2014), where the appeals court reversed a denial of preliminary injunction and final judgment on the same grounds.
- In contrast, the Fourth Circuit has held that an exclusive forum-selection clause does not trump an arbitration clause, on grounds that the forum-selection clause referred to litigation, not arbitration, and "we believe that it would never cross a reader's mind that the [forum-selection] clause provides that the right to FINRA arbitration was being superseded or waived." UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319, 329-30 (4th Cir. 2013); see also UBS Sec. LLC v. Allina Health Sys., No. 12–2090, 2013 WL 500373 (D. Minn. Feb. 11, 2013) (following Carilion Clinic).
On a related point, see Mohamed v. Uber Technologies, Inc. No. 3:14-cv-05241-EMC (N.D. Cal. June 9, 2015) (denying motion to compel arbitration):
- Ride-sharing service Uber's contracts with its drivers included an arbitration clause (in various versions).
- That clause specified that any disputes about arbitrability would be decided by the arbitrator, not by a court.
- But Uber's contract also contained a forum-selection clause stating that exclusive jurisdiction for all disputes would be in the state and federal courts located in San Francisco.
- That, said a federal district court, meant that the delegation clause was not clear and unmistakable. As a result, said the court, the decision as to arbitrability would have to be made by the court, not by an arbitrator. The court rejected the defendants' arguments to the contrary.
- (The court then ruled that the arbitration clause itself was invalid because it was unconscionable. That means that the Uber drivers might well be able to pursue a class-action lawsuit against the company in court, instead of having to arbitrate their claims individually.)
In a similar vein was Narayan v. Ritz Carlton Dev. Co., No. SCWC–12–0000819 (Haw. June 3, 2015). In that case:
- A condominium purchase agreement said that venue for litigation would be in a specified court in Hawai'i.
- The purchase agreement incorporated a condominium declaration, which contained an arbitration clause.
- The Hawai'i supreme court ruled that this inconsistency meant that the arbitration clause was unenforceable. (The court also held that the arbitration clause was unconscionable because it prohibited discovery and punitive damages.)
Caution: A Massachusetts forum might be dangerous for defendants
If a contract specifies Massachusetts as the forum state for litigating disputes, the defendant might find that its bank account and other assets have been "attached" even before trial if the plaintiff can show a likelihood of success on the merits. See Shep Davidson, When an Out-of-State Company Can Be Sued in Massachusetts and Why You Should Care (2013).
Caution: A forum-selection clause might backfire if the forum proves unfriendly
Asking for – or insisting on – a forum-selection clause might fall into the category of "be careful what you wish for"; the courts in the forum state might decide matters differently than what you expected. A Massachusetts company learned a painful lesson in that regard in Taylor v. Eastern Connection Operating, Inc., discussed in the commentary to
Nothing in this Agreement is to be construed as making any party a franchisee of the other party; each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES the benefit of any state or federal statutes dealing with the establishment and regulation of franchises.
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.
(1) that the person made an untrue statement of a material fact with knowledge of the statement's untruth; or
(2) 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.
(1) The requirements of subdivision (a) apply (A) to any claim of fraud arising out of or relating to this Agreement or any transaction or relationship resulting from it; and (B) whether the claim is in contract, tort, strict liability, statute, or otherwise; and
(2) Each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any claim of fraud not supported by facts shown in accordance with subdivision (a).
The requirement that fraud be proved by clear and convincing evidence is based on the widely-applied standard in U.S. law. See, e.g., New York Pattern Jury Instruction 3:20 (not available on-line, apparently).
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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 — because "they lied!" is the trial lawyer's weapon of choice.
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.
"They lied!" is usually an easier sell in court: Litigation counsel know that jurors typically won't understand whatever technology is involved. (In fact, the customer's lawyers might well try to exclude any prospective juror who knows even a little about the technology.) That can make it hard for customers to win such cases on garden-variety ‘technical' grounds such as breach of contract or breach of warranty.
Judges and jurors absolutely do get it, on the other hand, when it appears someone lied or cheated.
We see this in the civil complaint filed by the state of Oregon against Oracle, in which the second paragraph said, in its entirety (with extra paragraphing added for readability):
Oracle lied to the State about the “Oracle Solution.”
Oracle lied when it said the “Oracle Solution” could meet both of the State’s needs with Oracle products that worked “out-of-the-box.”
Oracle lied when it said its products were “flexible,” “integrated,” worked “easily” with other programs, required little customization and could be set up quickly.
Oracle lied when it claimed it had “the most comprehensive and secure solution with regards to the total functionality necessary for Oregon.”
As another example, consider BSkyB Ltd. v. HP Enterprise Services UK Ltd.,  EWHC 86 (TCC). In that case:
- British Sky Broadcasting ("Sky") contracted with EDS to develop a customer relationship management (CRM) software system.
- Things didn't go as planned, and Sky eventually filed suit.
- In the (non-jury) trial, the judge concluded that EDS had made fraudulent misrepresentations when one of EDS's senior UK executives, wanting very much to get Sky's business, lied to Sky about EDS's analysis of the amount of elapsed time needed to complete the initial delivery and go-live of the system. See id. at ¶ 2331 and ¶¶ 194-196.
- The judge also concluded that during subsequent talks to modify the contract, EDS made additional misstatements that didn't rise to the level of fraud, but still qualified as negligent misrepresentations. See id. at ¶ 2336.
- A limitation-of-liability clause in the EDS-Sky contract capped the potential damage award at £30 million.
- By its terms, though, that limitation did not apply to fraudulent misrepresentations; the judge held that the limitation didn't apply to negligent misrepresentations either. See id. at ¶¶ 372-389.
(One of the most interesting aspect of the judge's opinion, it seems to me, is its detailed exposition of the facts, which illustrate the ‘sausage factory' by which technology deals sometimes get made — and how even just one vendor representative can make a deal go terribly wrong for his employer.)
In early June 2010, EDS reportedly agreed to pay Sky some US$460 million — more than four times the value of the original contract — to settle the case. See Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.
Another example is Waste Management, Inc.'s lawsuit against SAP over a failed enterprise resource planning (ERP) software implementation, reported to have settled for an undisclosed sum. At the heart of Waste Management's case was its allegation, not just that SAP had breached the contract, but that it was guilty of fraudulent inducement, fraud, and negligent misrepresentation. See Chris Kanaracus, SAP, Waste Management settle lawsuit, Computerworld, May 3, 2010.
The threat of punitive damages and rescission raises the stakes
If a customer's lawyers can prove fraud by the vendor, then the customer may be able to recover not just ‘benefit of the bargain' contract damages, but possibly punitive damages as well. This is important because "punis" ordinarily aren't available in garden-variety contract cases. For that reason, even when evidence of fraud is weak, the mere threat of punitive damages can give the customer more leverage in making settlement demands.
A fraud claim also raises the spectre of rescission, that is, unwinding the transaction and putting the parties back at Square One, which conceivably could be equally scary to the claim's target.
Fraud claims can be expensive to defend against
A fraud claim might well be more expensive to defend against than would a garden-variety breach-of-contract claim. That's because the defendant's intent is relevant to the fraud inquiry, which opens up all kinds of possibilities for requests by the claimant for costly discovery.
In California, mere negligent misrepresentation counts as "fraud"
"Under California law, negligent misrepresentation is a species of actual fraud and a form of deceit." Wong v. Stoler, No. A138270, part III-B(2), slip op. at 12 (Cal. App. May 26, 2015) (designated as not for publication; citing cases).
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GAAP refers to generally accepted accounting principles, as established and interpreted in the United States, consistently applied.
When necessary, unless the context clearly requires otherwise, any gender-specific or gender-neutral term in this Agreement (for example, he, she, it, etc.) is to be read as referring to any other gender or to no gender.
This Protocol consists of the following Common Draft provisions:
- Accelerated Litigation Clause
- Arbitration Terms & Conditions and Baseball Arbitration Clause
- Arms-Length Negotiation Pattern Acknowledgement
- Assignment Consent Terms & Conditions
- Attorney Fees Clause
- Cooperation Clause
- Consultation Clause
- Contra Proferentem Disclaimer Clause
- Copies of Agreement Clause
- Counsel Consultation Pattern Acknowledgement
- Course of Dealing Pattern Exclusion
- Disparagement Prohibition Clause
- Electronic-Signature Authorization
- Early Neutral Evaluation Clause
- Dispute-Escalation Clause
- Franchise-Law Benefits Waiver
- Governing Law Clause
- Government Subcontract Disclaimer Clause
- Headings for Reference Only
- Injunctive-Relief Clause
- Labor-Law Rights Pattern Acknowledgement
- Language choice
- Legal Compliance Clause
- Mini-Trial to Senior Management
- Other Necessary Actions
- Policy Statements Not Disputable
- Progressive Dispute Resolution
- Prohibitions of Attempts, Etc.
- Reliance Disclaimer
- Review Restrictions
- Savings Clause
- Service of Legal Process by Courier
- Settlement Rejection Consequences
- Signatures Clause
- Signers' Personal Representations of Signature Date and -Authority
- Site Visits & Network Access Clause
- Successors & Assigns
- Third-Party Beneficiary Disclaimer
- Waivers in Writing Clause
Executives' employment agreements commonly prohibit the employer from terminating the employment except for "cause," which is typically defined with great care. See, e.g., the 2012 employment agreement between Facebook and its chief operating officer Sheryl Sandberg.
In a Seventh Circuit case, the contract in suit defined good cause, allowing a dairy-equipment to terminate a dealership, as "Dealer’s failure to comply substantially with essential and reasonable requirements imposed upon Dealer by BouMatic." Tilstra v. BouMatic LLC, 791 F.3d 749, 751 (7th Cir. 2015) (Posner, J). In that case, the manufacturer eliminated the dealer's territory, under a clause giving the manufacturer the right to adjust territory boundaries, in order to force the dealer to sell out to another dealer. The jury concluded that the manufacturer had effectively terminated the dealership, but without good cause, and awarded damages; the appeals court affirmed judgment on the jury's verdict.
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The term 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.
This language 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."
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- Good-Faith Commitment
- Limitation of Good-Faith Commitment
- Good Faith Does Not Impose General Duty to Disclose Material Information
- Waiver Of Inconsistent Assertions
- Dispute Resolution Process Applies to Good-Faith Claims
- Remedies for Breach of Good Faith Are in Contract, Not Tort
- Baseball-Arbitration Process Applies to Good-Faith Allegations
- Clear and Convincing Evidence Required for Bad-Faith Allegations
Each party is to act in good faith in the performance and enforcement of this Agreement; a party that does so is to be conclusively deemed to have satisfied any applicable duty of good faith, fair dealing, honest performance, or similar requirement, imposed by law or otherwise, in respect of this Agreement and any transaction or relationship resulting from it.
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As with the implied duty of good faith and fair dealing, this clause applies only to the performance and enforcement of the Agreement. Application of the commitment to negotiation of the Agreement could open a very large can of worms. See generally Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 5 (MayerBrown.com 2014).
See also Good Faith Definition Clause.
Except to the extent (if any) expressly stated otherwise in this Agreement, nothing in this Agreement obligates any party:
(1) to serve the interests of another party at all times or in all cases; nor
(2) to comply with the obligations of a fiduciary, for example a duty of loyalty to another party or a duty to put the interests of another party first; no party is to assert otherwise.
This language is informed by the discussion by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495, ¶¶ 65, explaining some of the limitations of the general duty of good faith.
Except to the extent (if any) expressly stated otherwise in this Agreement, nothing in this Agreement is to be interpreted as obligating a party to disclose material information; no party is to assert otherwise. (The previous sentence, though, does not excuse a party from any other applicable duty, if any, to disclose material information.)
This language is informed by the discussion by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495, ¶¶ 86-87.
Any claim that a party breached either (i) the Good-Faith Commitment provision or (ii) a duty of good faith or fair dealing, must be submitted to the dispute-resolution process set forth in the Progressive Dispute Resolution provision if so requested in writing by either party.
(a) A party that breaches a duty of good faith, fair dealing, or similar duty, under this Agreement, is liable only for contract remedies; no other party will seek any other type of remedy, including for example tort remedies, in any forum, for any such breach.
(b) Subdivision (a) does not preclude a party from seeking non-contract remedies for conduct that would be subject to such remedies regardless whether the duty encompassed by subdivision (a) had been breached.
This language is likewise informed by the discussion by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495, ¶ 88.
Any claim that a party breached a duty of good faith, fair dealing, or similar duty, under this Agreement, if not settled, must be submitted to the process set forth in the Baseball Arbitration Clause provision.
As discussed in the commentary to the Baseball Arbitration Clause provision, "baseball" arbitration is designed to produce a settlement, not an actual enforceable award.
This provision follows the principle: When In Doubt, Define. Why bother? Because [U.S.] Supreme Court has noted the absence of a uniform definition of good faith:
While most States recognize some form of the good faith and fair dealing doctrine, it does not appear that there is any uniform understanding of the doctrine's precise meaning. The concept of good faith in the performance of contracts is a phrase without general meaning (or meanings) of its own.
Of particular importance here, while some States are said to use the doctrine to effectuate the intentions of parties or to protect their reasonable expectations, other States clearly employ the doctrine to ensure that a party does not violate community standards of decency, fairness, or reasonableness.
Northwest, Inc. v. Ginsberg, 134 S. Ct. 1422, 1431, at part III (2014) (internal quotation marks, alteration marks, and extensive citations omitted).
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In many — but not all — U.S. jurisdictions, and in Canada, every contract includes an implied covenant of good faith and fair dealing. See, e.g., the following:
- Uniform Commercial Code § 1-304 (imposing obligation of good faith on all contracts and duties within the UCC),
- UCC § 2-103(b) (definition of "good faith");
- Restatement of Contracts (Second) § 205;
- Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495 (Canada).
- "The doctrine [of good faith and fair dealing] is invoked in practically every type of commercial contract dispute, including insurance, employment contracts, franchise and dealer contracts, leases, and construction disputes." Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 6 (MayerBrown.com 2014.)
Business rationale for good-faith commitment
In Bhasin v. Hrynew, 2014 SCC 71  3 S.C.R. 495, Canada's supreme court explained the business rationale for implying an obligation of good faith:
 Commercial parties reasonably expect a basic level of honesty and good faith in contractual dealings. While they [the parties] remain at arm’s length and are not subject to the duties of a fiduciary, a basic level of honest conduct is necessary to the proper functioning of commerce.
- The growth of longer term, relational contracts that depend on an element of trust and cooperation clearly call for a basic element of honesty in performance,
- but, even in transactional exchanges, misleading or deceitful conduct will fly in the face of the expectations of the parties[.]
 … [E]mpirical research suggests that commercial parties do in fact expect that their contracting parties will conduct themselves in good faith[.]
It is, to say the least, counterintuitive to think that reasonable commercial parties would accept a contract which contained a provision to the effect that they were not obliged to act honestly in performing their contractual obligations.
Id. at ¶¶ 60-61 (citations omitted, bracketed paragraph numbers in original, extra paragraphing and bullets added).
Examples of bad faith
The Restatement lists examples of conduct that would breach the duty of good faith:
A complete catalogue of types of bad faith is impossible, but the following types are among those which have been recognized in judicial decisions:
- evasion of the spirit of the bargain,
- lack of diligence and slacking off,
- willful rendering of imperfect performance,
- abuse of a power to specify terms, and
- interference with or failure to cooperate in the other party’s performance.
Restatement of Contracts (Second) § 205, comment d, quoted in Marcia G. Madsen and Michelle E. Litteken The Implied Duty of Good Faith & Fair Dealing in Government & Commercial Contracts — An Age-Old Concept in Need of an Update? at 1 (MayerBrown.com 2014).
See also, e.g., Steven J. Burton, Good Faith in Articles 1 and 2 of the U.C.C.: The Practice View, 35 Wm. & Mary L. Rev. 1533 (1994),
In a 2016 decision, Massachusetts's highest court upheld a trial court's award of $44 million in damages and interest against a financial company's CEO on grounds that the CEO had violated the implied covenant of good faith and fair dealing by "stiffing" (my word) an investor and friend who had staked the CEO to more than $650,000 to buy additional shares in the company. See Robert and Ardis James Foundation v. Meyers, No. SJC-11898 (Mass. Apr. 21, 2016), reversing 87 Mass. App. Ct. 85 (2015).
(a) Definitions: For purposes of this Governing Law Clause:
Covered Dispute refers to any Agreement-Related Dispute.
Governing-Law Jurisdiction refers to the jurisdiction specified in this Agreement (none if not specified).
Excluded Law refers to any body of law or other principles that this Agreement states will not apply, whether or not using those words (none if not specified).
(b) Choice of law: Except to the extent (if any) that this Agreement expressly states otherwise, the law applicable to contracts made and performed entirely in the Governing-Law Jurisdiction, by residents of that jurisdiction, is to be applied in any Covered Dispute, without regard to conflicts-of-law or choice-of-law rules.
(b) No effect on agreed arbitral law: For the avoidance of doubt:
(1) Any arbitration of a dispute, pursuant to an agreement to arbitrate in this Agreement (if any), will be governed by the law(s) specified in this Clause unless this Agreement expressly provides for a different arbitral law.
(2) Hypothetical example: IF: This Agreement specifies that Texas is the Governing-Law Jurisdiction; BUT: This Agreement contains an arbitration provision that specifies that New York law will apply as the arbitral law; THEN: Any arbitration pursuant to that provision will itself be governed by New York arbitration law and, if applicable, the U.S. Federal Arbitration Act, not by Texas arbitration law.
(c) Excluded laws: Any Excluded Law is not to be applied in any dispute to which this Governing Law Clause applies.
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Renvoi: "Without regard to conflicts-of-law or choice-of-law rules"
This provision addresses the renvoi issue: The law of the chosen jurisdiction might include choice-of-law provisions that could cause another jurisdiction's substantive rules to be applied.
Renvoi shouldn't be an issue in a contract governed by New York law. See Ministers and Missionaries Benefit Bd. v. Snow, No. 131 (N.Y. Dec. 15, 2015); IRB-Brasil Resseguros, S.A. v. Inepar Invs., S.A., 20 N.Y.3d 310 (2012).
No effect on agreed arbitral law
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- Legal background
- Which governing law?
- Which governing law for international transactions?
- Choose the law of the agreed forum?
- A governing-law clause might backfire
- Public policy might trump a choice-of-law clause
- Too-narrow a governing-law clause can be problematic
- A narrow choice-of-law provision coupled with a broad arbitration provision could spell trouble
- Multi-national transactions
- Exclusions from governing law
In the U.S., courts typically enforce choice-of-law provisions in a contract — with exceptions, as noted in the discussion below.
In fact, a California statutory provision expressly validates a contractual choice of California law for non-personal contracts having a value of at least $250,000, even if there is no relationship between the contract and California. See Cal. Civ. Code § 1646.5.
Which governing law?
Drafters wondering which governing law to choose should give some thought to the specifics of the laws being considered. Several years ago I started a choice-of-law cheat sheet for U.S. states (still a work in progress) that might be helpful.
Which governing law for international transactions?
In international transactions, a party from a jurisdiction with a civil code (e.g., continental Europe; Latin America) might be reluctant to agree to the law of a common-law country (e.g., England and its former colonies), or vice versa. Those parties might find the UN CISG (discussed below) to be somewhat of a "neutral" choice.
Choose the law of the agreed forum?
If the parties are also going to agree to a choice of forum — for which they can use one or more of the forum selection provisions — then they might want to choose the law of the agreed forum as their governing law. That could increase the chances of having their choice of law enforced in a dispute.
For example: the parties might agree to New York law, in part to take advantage of the statutory provision validating clauses requiring amendments to be in writing in certain contracts; see the commentary to Amendments in Writing Clause. a New York court would seem to be more likely to give effect to that provision, and thus to an amendments-in-writing clause, than a court in another jurisdiction.
A governing-law clause might backfire
Specifying the law that you want to govern your contract, or your contractual relationship, might lead to unexpected results.
• Consider the case of Taylor v. Eastern Connection Operating, Inc., 465 Mass. 191 (2013): this was an overtime case; a group of couriers, working in New York as couriers for a Massachusetts-based company, sued the company in Massachusetts. These New-York based couriers claimed to be entitled to the protection of Massachusetts statutes governing independent contractors, wages, and overtime.
Normally, people who file employment-type lawsuits against their companies tend to do so in their own home jurisdictions. That's understandable; the home-court advantage is not to be sneezed at – and it's also why companies like for their contracts to specify their home court for any lawsuits.
Well, that's just what had happened here: the courier company had used a standard form for its contracts with its New York courier personnel. The contract form stated that Massachusetts law would apply and that all disputes would be litigated in Massachusetts.
When confronted by an actual employee lawsuit in the forum it had specified, the company moved to dismiss the case — and the Massachusetts trial court granted the motion — on the theory that the employment laws of Massachusetts did not apply to people who worked in New York.
The Massachusetts supreme court disagreed; it reversed the trial court's decision, giving an interim win to the New York-based courier personnel. The supreme court held that it would not be unfair to enforce the courier company's own forum-selection and governing-law clauses against the company. Moreover, said the supreme court, enforcement of those clauses would not contravene a fundamental policy of the state of New York, where the couriers actually worked.
The supreme court said that the trial court would need to conduct an evidentiary hearing to determine whether, on the facts of the case, the forum-selection and governing-law clauses should be enforced. The court remanded the case to the trial court for further proceedings.
• To similar effect was another Massachusetts case, Dow v. Casale, 83 Mass. App. Ct. 751 (2014): a Florida-based employee of a Massachusetts-based company successfully sued the CEO of his employer — personally — for unpaid sales commissions and other amounts, under a Massachusetts statute that created a private right of action. The employment agreement stated that Massachusetts law applied. The court, citing Taylor, held that the Massachusetts statute applied and affirmed summary judgment in favor of the employee.
• In a Canadian franchise-dispute case, an appeals court held that Ontario law — which gave franchisees specific rights — applied even to franchisees outside Ontario because the franchise agreement specified that Ontario law would apply. See 405341 Ontario Ltd. v. Midas Canada Inc., 2010 ONCA 478 ¶¶ 40-45. In that case, a provision in the franchise agreement stated that a franchisee, as a condition of renewing or transfering its rights, must release the franchisor from liability. The appeals court affirmed the trial court's ruling that, for purposes of the instant class action, that franchise-agreement provision was unenforceable and void.
• But in contrast, in O'Connor v. Uber Tech., Inc., No. C-13-3826, at part II-F (N.D. Cal. Sept. 4, 2014) a federal district court in San Francisco held that Uber drivers working outside California could not sue the company for violation of a California wage-and-hour statute, even though the drivers' contract with Uber included a California choice-of-law clause:
Under California law, a presumption exists against the extraterritorial application state law. *
[A] contractual choice of law provision that incorporates California law presumably incorporates all of California law — including California's presumption against extraterritorial application of its law.
Id. at part II-F. The court granted Uber's motion for dismissal on the pleadings.
Public policy might trump a choice-of-law clause
A court might not give effect to a governing-law clause in a contract if doing so would lead to a result that contravened a fundamental public policy of the law of the jurisdiction in which the court sits. Here are some examples.
• In New York, a non-solicitation provision in an employment agreement (as in, no soliciting our customers after you leave), purporting to bind an employee in that state, is judged by New York law, not the governing law stated in the employment agreement. Brown & Brown, Inc. v. Johnson, No. 92 (N.Y. June 11, 2015) (affirming, in pertinent part, judgment that choice-of-law clause was unenforceable in respect to non-solicitation clause).
• Pathway Medical Technologies, Inc. v. Nelson, No. CV11-0857 PHX DGC (D. Ariz. Sept. 30, 2011): a medical-device sales representative quit his job in Arizona and started working for a direct competitor of his former company. So, the former company filed a lawsuit in federal court in Arizona. The former company wanted to enforce a non-competition covenant in the sale rep's employment agreement; it asked the court for an immediate temporary restraining order (TRO) to prohibit the sales rep from working for the competitor.
The Arizona federal court refused to grant the requested restraining order. The court recognized that the employment agreement's governing-law clause specified that the law of Washington state would apply. But, said the Arizona court, in this area the laws of Arizona gave more weight to employees' right to earn a living than did Washington law, and this was an area of fundamental public policy for Arizona law. Consequently, the court refused to give effect to the agreement's choice of Washington law; the court also held that under Arizona law, the sales rep's non-competition covenant was unenforceable.
• Narascyan v. EGL Inc., 616 F.3d 895 (9th Cir. 2010): a California truck driver sued the Texas-based trucking company for which he worked for violating California employment law. The driver's contract with the company specified that Texas law would apply and said that the driver was an independent contractor, not an employee.
A California federal court granted summary judgment in favor of the employer. The court reasoned that Texas law governed, as required by the contract. Applying Texas law to the facts of the case, the court concluded that the driver was indeed an independent contractor and therefore could not sue the company for violating California employment law.
The federal appeals court, though, reversed. It held that California courts would not give effect to the contract's choice of Texas law, but instead would apply California law. Under California law, said the appeals court, the driver was really an employee, not an independent contractor, and therefore could properly sue the trucking company for violating California employment law.
• Dinan v. Alpha Networks, Inc., No. 13-1976 (1st Cir. Aug. 20, 2014) (vacating judgment on jury verdict): The parties were a Maine-based sales representative and his employer, a California company. The sales rep's employment agreement included a California choice-of-law clause. The company failed to pay commissions on certain sales. The appeals court held that Maine law governed, and therefore the sales rep was entitled, not only to back commissions, but also to treble damages and attorney fees under a Maine statute.
• But see Exxon Mobil Corp. v. Drennen, No. 12-0621, slip op. at 16-18 (Tex. Aug. 29, 2014): The Supreme Court of Texas held that it was permissible for Exxon Mobil to choose New York law for its employee stock-option and restricted-stock programs, because multi-national companies should be able to choose the laws they want to follow, in the interest of uniformity. (OK, the "choose the laws they want to follow" part does overstate the court's holding just a bit, but not by much; I agree with the court's holding on the merits of the specific issue, but the court arguably opened the door wide for corporations to purport to impose onerous terms and conditions on their employees while using a choice-of-law clause to strip the employees of their legal protections.)
Too-narrow a governing-law clause can be problematic
Drafters and reviewers should pay attention to the scope of the governing-law clause. a Canadian software company had too-narrow a clause in its end user license agreement ("EULA") and, as a result, found itself forced to defend a class-action lawsuit in Chicago instead of in Victoria, B.C. See Beaton v. SpeedyPC Software, No. 13-cv-08389 (N.D. Ill. June 5, 2015) (denying defendant's motion to dismiss for forum non conveniens). In that case, the court said:
Here, the EULA states only that "[t]his Agreement shall be governed exclusively by the laws of the Province of British Columbia and the laws of Canada applicable therein …." The plain language of this provision limits its effect to the interpretation of the EULA itself, and is significantly more limited than broadly-stated choice of law provisions that apply the choice of law to all claims "arising out of" or "relating to" the contract.
Thus, the Court finds that there was no intent for the EULA to apply Canadian law to all claims relating to the Software. …
[T]he claims being asserted are not sufficiently related to the EULA for the choice of law provision to govern them. Beaton's claims under the ICFA and Illinois common law of fraudulent inducement and unjust enrichment have nothing to do with the subject matter of the EULA, which dictates only the terms on which the purchaser of the SpeedyPC Pro license may use the Software, rather than the specifications and functions of the Software itself.
Instead, Beaton's claims against SpeedyPC are based on its marketing and advertising activities, which are separate and apart from the specifications set out in the EULA
Id. (emphasis by the court, citations and footnote omitted, extra paragraphing added).
(Hat tip: Richard Raysman.)
Another example of a too-narrow governing-law provision is seen in a 2015 Massachusetts case, Family Endowment Partners, L.P., et al. v. Sutow, et al., Lawyers Weekly No. 12-126-15 (the opnion isn't available for free on-line):
- The contract in suite was between an investment firm and one of its clients (a married couple).
- The contract contained an arbitration provision that applied broadly, encompassing all disputes relating to the agreement.
- The contract also contained a choice-of-law provision, but it applied only to the interpretation and enforcement of the agreement — and, notably, not to related claims as did the arbitration provision.
- The client's claims against the investment firm included claims under a Pennsylvania unfair-trade-practices statute. The arbitrator held that, because the choice-of-law provision did not apply to non-contract claims, the Pennsylvania statute was available to the client; the arbitrator awarded treble damages under that statute.
- A Massachusetts trial court upheld the arbitration award.
- The court held that the contract's provision excluding "special, consequential or incidental damages" was not sufficient to exclude punitive- or multiple damages.
See, e.g., Pat Murphy, $48M arbitration award vs. investment advisor upheld (McCarter.com 2015).
English law is often chosen for multi-national transactions. See generally, e.g., Melanie Willems, English Law – a Love Letter (AndrewsKurth.com 2014).
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Many governing-law provisions exclude one or more bodies of law or other governing guidance. The Common Draft governing-law provision gives drafters an easy way to do this.
Possible exclusion: UN CISG
The United Nations Convention on Contracts for the International Sale of Goods ("UN CISG" or "Vienna Convention"), in some ways, amounts to an international version of the U.S. Uniform Commercial Code, but with some non-trivial differences. See generally the Wikipedia article on the UN CISG; for a comparison of the Uniform Commercial Code and the UN CISG, see John C. Tracy, UCC and CISG (Jul. 5, 2011).
Possible exclusion: UCITA
The Uniform Computer Information Transactions Act ("UCITA") is (was?) a controversial proposed uniform law. It was enacted only in Maryland and Virginia, and otherwise appears to be essentially dead. See generally the Wikipedia article on UCITA.
Section 104 of UCITA allows parties to a contract to "opt out" of the Act's applicability. Going even farther, some states have enacted so-called "bomb-shelter" legislation voiding any contractual choice of law that would result in UCITA being applied. According to materials published by an advocacy group calling itself AFFECT, Americans for Fair Electronic Commerce Transactions, such legislation has been enacted in Iowa, North Carolina, Vermont, and West Virginia.
Possible exclusion: ALI software-law principles
• The ALI Principles of Law of Software Contracts caused something of a stir when they were announced in 2009. Fortunately (in my view), since then they appear to have vanished from view.
The ALI Software Principles are disliked by many software vendors. See, for example, Mark F. Radcliffe, New and Flawed Rules: Dealing with the ALI Principles of Law of Software Contracts (Jul 6, 2009) – this piece contains a checklist of steps software vendors could take to conform their license agreements to the Principles; Raymond T. Nimmer, Flawed ALI Software Contract Principles (May 11, 2009) (pointing out problems with the new implied warranty of no known material defects); Sean Hogle, ALI's Principles: My Recommendation for Software Vendors (June 8, 2009); Kristie Prinz, Series on ALI Software Contract Principles (June 23, 2009).
As one problematic example, the Principles proclaim, out of thin air, a warranty — which cannot be disclaimed — that the software contains no known material hidden defects. Many vendors would regard this as ludicrous, for a couple of reasons: First, the standard of materiality is vague, which would invite expensive, discovery-intensive litigation. Second, in most cases, the cost of testing software, and of documenting the test results, to achieve that vague standard would make it inordinately expensive. The Reporter for the project makes the dubious claim that this non-disclaimable warranty merely restates existing law. See Robert A. Hillman, American Law Institute Approves the Principles of the Law of Software Contracts (June 2, 2009) (written by one of the two Reporters for the Principles). to many practitioners, though, this warranty seems more like a stimulus package for underemployed litigation counsel.
The actual text of the Principles — which the drafters clearly intended to be adopted by courts as law — is available only by buying it from ALI for $87, or as a $40 download of the proposed final draft.
At this writing (spring 2016), I've seen no indication that anyone pays attention to the Principles. So far as I've been able to tell, the Principles have not been adopted by any state legislature, nor has any court has followed or even cited them. (Something purporting to be a 2015 edition is available on Amazon, but the ALI's Web site refers only to the 2010 edition.)
So in all likelihood, software vendors needn't bother concerning themselves with the Principles.
The exception in this clause takes into account that the Agreement might specify the law of other jurisdictions for particular subjects such as arbitration.
The terms government authority and governmental authority, whether or not capitalized:
(1) refer to any individual or group (collectively, authority), anywhere in the world, exercising de jure or de facto governmental- or regulatory power of any kind, whether administrative, executive, judicial, legislative, policy, regulatory or taxing power; and
(2) include, for example, 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).
(a) Not a government subcontract: Each party (each, a Warranting Party) warrants, to each other Signatory Party, that — except to the extent (if any) expressly disclosed otherwise in this Agreement — this Agreement is not a subcontract in respect of a contract between the Warranting Party and any governmental authority.
(b) No authority to bind other party: Without the other party's express prior written consent, the Warranting Party will not purport to:
(1) obligate the other party, as a subcontractor or otherwise: (A) to any government authority; nor (B) to the terms of any government contract, whether through flow-down provisions or otherwise;
(2) make any representation, warranty, or certification, on behalf of the other party, concerning the other party's business practices, work force, or other status, in any report to a government authority (for example, an equal-opportunity compliance report).
(c) Indemnity obligation: Unless this Agreement expressly states otherwise, each Warranting Party will defend and indemnify each other party against any claim that arises out of the Warranting Party's breach of subdivisions (a) or (b) above.
The indemnity obligation of subdivision (c) might well carry greater financial exposure than damages for a "plain" breach of contract or breach of warranty; see this note for additional details.
Depending on the law, a subcontractor under a government contract could be subject to specific requirements imposed by statute or regulation; for that reason, a disclaimer might be in order. [TO DO: NEED CITES]
(Entire books have been written on the issues arising from government subcontracting, of course; the disclaimer provision below is intended to try to rule out the need to understand those issues.)
(a) Definition: The term gross negligence, whether or not capitalized, refers to conduct that evinces a reckless disregard for or indifference to the rights of others, tantamount to intentional wrongdoing; it differs in kind, not only in degree, from ordinary negligence.
(b) Proof requirement: If so specified in this Agreement, any assertion of gross negligence must be proved by clear and convincing evidence, whether the assertion is made in a claim, in a defense, or otherwise.
Contracts sometimes use the term gross negligence, as distinct from ordinary negligence. For example, a contractual limitation on a party's liability for negligence might include a carve-out saying that the limitation will not apply if the party is grossly negligent. Unfortunately, the difference between negligence and gross negligence may be hard to assess in practice.
With a view to usage in non-U.S. jurisdictions where the term might not be defined by law — this clause sets out a definition of gross negligence in the terms used by the Court of Appeals of New York (that state's highest court), which seems to achieve a reasonable balance of fairness and precision. See Sommer v. Federal Signal Corp., 79 N.Y.2d 540, 554 (1992).
See also the extended notes for definitions in other states' laws.
Subdivision (b) reminds drafters to consider requiring clear and convincing evidence of gross negligence, the same standard as is required in many jurisdictions for proof of fraud. [DCT TO DO: CITATIONS NEEDED]
Drafters can also consider including Attorney-Fee Liability for Failure to Prove Serious Accusation.
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A Texas statute, in the context of establishing prerequisites for awards of punitive damages, sets out a far-more restrictive definition of gross negligence, added as part of a far-reaching 2003 tort-reform package enacted by the legislature. See Tex. Civ. Prac. & Rem. Code § 41.001(11), discussed in Robert J. Witte and James G. Ruiz, House Bill 4 – Article 13 – Damages, J. Tex. Consumer L. 33 (date not available). The definition is used in § 41.003, which conditions an award of punitive damages on a showing, by clear and convincing evidence, of fraud, malice, or gross negligence:
(11) "Gross negligence" means an act or omission:
(A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and
(B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.
The California supreme court, in its 2007 Janeway opinion, noted that "[g]ross negligence long has been defined in California and other jurisdictions as either a want of even scant care or an extreme departure from the ordinary standard of conduct." City of Santa Barbara v. Janeway, No. 1111681, slip op. at 6, 161 P.3d 1095 (Cal. 2007) (internal quotation marks and citations omitted, emphasis added). The supreme court held that in cases of gross negligence, advance releases of liability are unenforceable as being against public policy; the court affirmed a judgment that release language in a contract did not shield a defendant from an allegation of gross negligence in the drowning death of a disabled teen-ager at a city pool.
In the litigation over the notorious "BP oil spill" in the Gulf of Mexico, a federal district court wrote at length about the definition of gross negligence in the context of the (federal) Oil Pollution Act of 1990 and how BP was guilty of gross negligence; the court held that gross negligence was less than reckless conduct (much as in the California definition discussed above). See In re: Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mexico, on April 20, 2010, paragraphs 481 et seq., esp. 494 & n.180, 495 (E.D. La. Sept. 4, 2014) (findings of fact and conclusions of law).
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This Term Sheet incorporates by reference the Common Draft Terms & Conditions of the same title.
- 1. Guarantor refers to:
- Each individual or organization that states, in a writing signed by the individual or organization, that the individual or organization guarantees a Guaranteed Payment Obligation.
- 2. Creditor refers to:
- Any person to which a Guaranteed Payment Obligation is owed.
- 3. Payer refers to:
- Any person that owes a Guaranteed Payment Obligation.
- 4. Guaranteed Payment Obligation refers to:
- any payment, under any Guaranteed Agreement, that is guaranteed in writing.
- 5. Guaranteed Agreement refers to:
- This Agreement.
- The default definitions of Guarantor, Creditor, etc., are designed to give contract drafters additional flexibility: they allow a drafter to incorporate this provision by reference without having to worry about using the exact defined terms verbatim. For example, a contract drafter representing "Alice" in a negotiation with "Bob" could say, in the draft contract, "Buford guarantees Bob's payment obligation to Alice in accordance with the Common Draft Guaranty Term Sheet."
- Only payment obligations are guaranteed here; that's because guaranties of performance of other types of obligation (for example, an obligation to perform consulting services, repair work, building construction, etc.) might well require considerably-more negotiation and customized language.
- Drafters of guaranty language intended for ongoing use will want to be careful how they identify the guaranteed obligations, as discussed in the extended notes.
(b) Consideration: Each Guarantor undertakes its obligations under this Guaranty Terms & Conditions in consideration of, and to induce, the entry, by each Creditor, into the Guaranteed Agreement.
The "in consideration of" language in subdivision (c) is included because otherwise the guaranty might not be enforceable.
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- Guarantor Waiver of Creditor Signature
- Expense Reimbursement for Collection and Guaranty Enforcement
- Guarantor Deficiency Liability After Foreclosure
- Guarantor WAIVER of Election-of-Remedies Rights and Defenses
- Guarantor WAIVER of Defenses Against Enforcement
- Return of Payments After Bankruptcy, etc.
- Joint and Several Guarantor Liability
- Unconditional Guaranty Liability
- No Discharge by Alteration of Payment Obligation
Each Guarantor waives notice of acceptance of the Guaranty by the Creditors; the Guaranty will be enforceable even if some or all Creditors do not sign it.
Many guaranty clauses include waiver-of-acceptance and waiver-of-signature language, even though it very well might merely duplicate applicable law. See, e.g., US Bank Nat'l Ass'n v. Polyphase Elec. Co., No. 10-4881 (D. Minn. Apr. 23, 2012): In that case, the court granted granted summary judgment that a bank was entitled to enforce guaranties of loans made by the bank, even though the bank had not signed the guaranty documents.
The Guarantor must pay or reimburse all court costs and all reasonable expenses — including for example reasonable attorney fees and expenses — that any Creditor incurs in attempting to enforce:
(1) that Creditor's rights against that Guarantor under the Guaranty; and
(2) the Guaranteed Payment Obligation in question.
Each Guarantor will be (and remain) liable, to the fullest extent permitted by applicable law, for any deficiency remaining after foreclosure of any lien or other security interest in collateral or other rights or property securing a Guaranteed Payment Obligation, even if the Payer's liability for such a deficiency is discharged pursuant to statute or judicial decision.
This language is based on that of the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 309 (Ala. 2012); see also the similar language of the guaranty in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, No. 54 (N.Y. June 9, 2015), slip op. at 4.
Each Guarantor KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES all rights and defenses arising out of an election of remedies by a Creditor, even if that election of remedies, such as a nonjudicial foreclosure with respect to security for a Guaranteed Payment Obligation, resulted in impairment or destruction of the Guarantor's rights of subrogation and reimbursement against the Payer.
(a) Each Guarantor KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any and all defenses — and expressly agrees that it will not assert (and it will cause its affiliates not to assert):
(1) any claim or defense that the Guarantor's obligations under this Guaranty are allegedly illegal, invalid, void, or otherwise unenforceable; and/or
(2) any claim or defense pertaining to any Guaranteed Payment Obligation, other than the defense of discharge by full performance; and/or
(3) any other circumstance which might otherwise constitute a defense available to, or a discharge of, the Payer or any Guarantor.
(b) Without limiting the generality of the waiver in subdivision (a), the Guarantor will not assert, plead or enforce, against any Creditor:
(1) any defense of waiver, release, statute of limitations, res judicata, statute of frauds, fraud, incapacity, minority, usury, illegality or unenforceability which may be available to the Payer or any other person liable in respect of any Guaranteed Payment Obligation; nor
(2) any setoff available to the Payer or any other such person liable, whether or not on account of a related transaction.
Some of this language is based on that of the respective guaranties in:
- Eagerton v. Vision Bank, 99 So. 3d 299, 309 (Ala. 2012); and
- Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, No. 54 (N.Y. June 9, 2015), slip op. at 3-4.
The use of all-caps and bold-faced type is for conspicuousness.
This is not uncommon language for a guaranty. See, e.g., the guaranty in suit in Moayedi v. Interstate 35/Chisam Road, LP, 438 S.W.3d 1 (Tex. 2014) (affirming that guarantor's waiver of defenses negated statutory right of offset):
7. Guarantor further agrees that this Guaranty shall not be discharged, impaired or affected by[:]
- The transfer by the Borrower of all or any portion of the real estate or improvements thereon, or of any security or collateral described in the Deed of Trust or in any other security document, or
- any defense (other than the full payment of the indebtedness hereby guaranteed in accordance with the terms hereof) that the Guarantor may or might have as to Guarantor’s respective undertakings, liabilities and obligations hereunder, each and every such defense being hereby waived by the undersigned Guarantor.
Id. at 3 (extra paragraphing added).
The "expressly agrees" language in this clause is technically redundant, but in litigation it might be useful as a sound bite in a brief or trial exhibit.
Some drafters might wish to consider adding: Each Guarantor also waives any defense to liability that could be asserted by any Payer in respect of the Guaranteed Payment Obligation.
(a) This provision applies if a Creditor:
(1) refunds (as defined below) a payment made by a Payer on a Guaranteed Payment Obligation because of a requirement of bankruptcy law; fraudulent-transfer law; or comparable law; or
(2) makes a partial refund of such a payment in settlement of a claim for a larger refund.
(b) In any such case, each Guarantor, jointly and severally, must reimburse the Creditor for the amount of the refund or partial refund and as well as reasonable attorney fees and expenses and costs of court, if any.
(c) For purposes of this provision, the term refund includes payments made by the Creditor to third parties, for example to a trustee in bankruptcy, a debtor-in-possession, or a receiver.
This provision addresses an issue that can arise in troubled economic times: If a principal of a guaranteed payment obligation were to file for bankruptcy protection (under U.S. law), then the obligation's creditor might be forced to return any payments that were made by the principal within the 90 days preceding the bankruptcy filing date. Such payments are known as "avoidable preferences." See generally, e.g., Patricia Dzikowski, The Bankruptcy Trustee and Preference Claims (Nolo.com; undated); see also the guaranty language in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, No. 54 (N.Y. June 9, 2015), slip op. at 4.
A creditor in bankruptcy has the right to contest its obligation to refund an avoidable preference. That can be difficult, though; the creditor must successfully jump through some hoops to prove that it was entitled to the payment. See generally, e.g., Kathleen Michon, Pre-Bankruptcy Payments to Creditors: Can the Trustee Get the Money Back? (Nolo.com; undated).
As a practical matter, many avoidable-preference cases are settled, with the creditor making a partial refund in lieu of incurring the expense of jumping through those proof hoops. In such a situation, if the original obligation had been guaranteed, then the creditor likely would want to try to recoup the partial refund from the guarantor.
Except to the extent (if any) that this Agreement expressly states otherwise, each Guarantor is jointly and severally liable to each Creditor for each Guaranteed Payment Obligation.
It's a really good idea for drafters (and reviewers) to be clear about the extent to which multiple guarantors are to be jointly and severally liable for the guaranteed payment obligation(s).
In a given transaction, for example, Alice might guarantee the obligations of Alfie, 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 Alfie's obligations.
Except to the extent (if any) that this Agreement expressly states otherwise:
(a) Each Guarantor's obligations under the Guaranty:
(1) are unconditional, direct and primary; and
(2) will accrue immediately, upon written demand by the Creditor to the Guarantor, after any default by the Payer in the relevant Guaranteed Payment Obligation.
(b) IF: The Guaranteed Agreement provides the Payer with the right to notice and a cure period in which to cure an alleged breach of a Guaranteed Payment Obligation; THEN: The Guarantor's obligations under the Guaranty will not accrue before the end of that cure period.
(c) The Creditor need not attempt to enforce the Guaranteed Payment Obligation against the Payer; for example, the Guarantor need not attempt:
(1) to collect a judgment against the Payer, nor
(2) to foreclose on any lien, security interest, or other collateral securing the Guaranteed Payment Obligation.
See the notes accompanying Guaranty of Collection Only.
For the avoidance of doubt, an amendment to or modification of a Guaranteed Payment Obligation does not discharge or otherwise affect the guaranty obligation of any Guarantor in respect of that Guaranteed Payment Obligation.
The intent of this provision is to override the general rule — which is strictly applied by courts — that "a guarantor is discharged if, without his or her consent, the contract of guaranty is materially altered." Eagerton v. Vision Bank, 99 So. 3d 299, 305-06 (Ala. 2012) (holding that modification of loan discharged guarantors from further obligations) (citations, quotation marks, and alterations omitted); accord, Sterling Development Group Three, LLC, v. Carlson, 2015 N.D. 39 (affirming holding that guaranty was discharged by alteration of guaranteed obligations without guarantor's knowledge or consent) (citing state statute).
For an example of clause language like this, see the guaranty in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, No. 54 (N.Y. June 9, 2015), slip op. at 3-4.
Check with your lawyer before incorporating by reference (possibly with modifications) one or more of the following "wish list" terms
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This Guaranty may not be enforced as to any Guaranteed Payment Obligation until the Creditor:
(1) has obtained a final judgment against the Payer, from which no further appeal is taken or possible, enforcing, in whole or in part, the Guaranteed Payment Obligation in question; and
(2) has been unable to collect the judgment after diligently making reasonable efforts to do so.
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In U.S. law, the terms "guaranty" and "guarantee" are usually associated with a third party's commitment to make good on a principal party's failure to comply with an obligation. Traditionally, "guaranty" is the noun, while "guarantee" is the verb; see, e.g., Uhlmann v. Richardson, 287 P.3d 287 (Kan. App. 2012), citing Bryan Garner, Garner's Dictionary of Legal Usage 399 (3d ed. 2011).
For example, when my daughter was in college, I signed a guaranty (noun) in which I guaranteed (verb) her payment of her apartment rent.
A related point: People sometimes use the terms guarantee (or guaranty) and warranty interchangeably, but but technically there are some differences in conventional usage that drafters should keep in mind; see the commentary to Warranty Definition Clause for additional discussion.
Drafters of guaranties will want to be careful, because in the U.S., guaranties are typically construed strictly in favor of the guarantor, with ambiguities resolved against the creditor. See, e.g., Haggard v. Bank of Ozarks Inc., 668 F.3d 196, 201-02 (5th Cir. 2012) (vacating and remanding summary judgment in favor of bank).
Signers of guarantiies, though, should be equally cautious if not more so, because an "absolute and unconditional" guaranty is likely to be enforced even in what might seem like unfair circumstances such as collusion between the lender and the principal. For an example of this, see the decision by the Court of Appeals of New York (which is that state's highest court) in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, No. 54 (N.Y. June 9, 2015). In that case, a guarantor sought to avoid liability as provided under an "unconditional and absolute" guaranty in favor of plaintiff, on grounds that the default judgment against the guarantor was obtained by the plaintiff's collusion. The court of appeals concluded that the plaintiff's collusion claim constituted a defense, and therefore was barred by the express language of the guaranty. (The court of appeals also concluded that the guarantor's claim of collusion was contradicted by the record.) See id., slip op. at 1-2.
Drafters representing guarantors will want to be careful to define precisely which payment obligations are being guaranteed. A bit of an oddball case on this point was McLane Foodservice, Inc. v. Table Rock Restaurants, LLC, 736 F.3d 375 (5th Cir. 2013) (affirming district-court judgment in favor of alleged guarantor):
- A restaurant company, Table Rock, went out of business owing a food-service company, McLane Foodservice, some $447,000.
- McLane Foodservice apparently noticed that nearly 14 years earlier, the treasurer and 40%-owner of the Table Rock restaurant company had signed a personal guaranty of the debts of another restaurant company, Border Patrol, to a division of PepsiCo.
- In the interim, the PepsiCo division had sold its assets to another company, Ameriserve, which later filed for bankruptcy protection and sold its assets to McLean Foodservice, which presumably had the treasurer's signed guaranty in the files it inherited.
- Importantly (at least to the courts), the PepsiCo division never extended credit to the Table Rock restaurant company; it was McLane Foodservice, PepsiCo's successor-twice-removed, that did so.
Both the trial court and the appellate court held that the treasurer's guaranty, by its terms, covered only debts to the PepsiCo division — and because Table Rock had never incurred any such debts, its treasurer wasn't liable to McLane Foodservices under the guaranty.
The appellate court's opinion didn't even mention that, judging by the facts recited in the opinion, Table Rock's treasurer apparently had not guaranteed Table Rock's debts — his guaranty, from nearly 14 years before, was for the debts of the Border Patrol restaurant company, which had no evident connection to Table Rock. (If those were indeed the facts, then I'm surprised that McLane Foodservices' counsel wasn't sanctioned by the court for bringing a frivolous lawsuit against the treasurer.)
LESSON: Leaving aside the problem mentioned in the previous paragraph, the guaranty in McLane Foodservices could have recited that the guaranty covered all credit extended to the by the PepsiCo division and by PepsiCo's successors and assigns.
A court might hold a guaranty to be unenforceable if it's not supported by at least some consideration for the guarantor. That consideration might well be the guarantor's desire to support the creditor — but not always.
EXAMPLE: In Yellow Book, Inc. v. Tocci, 2014 Mass. App. Div. 20 (2014), the court reversed a judgment that a company's bookkeeper, who had signed an order ad space in a Yellow Pages phone book, was personally liable for the ad charges:
… An owner, investor, or principal of Pro Investors who signed would certainly have a benefit from the deferred obligation of the owner’s company, and consideration would thus be received by that person.
Yellow Book has failed, however, to show how Tocci, a mere salaried employee, would receive any benefit from the right of deferred payment given to her employer. In her capacity dealing with Pro Insulator’s vendors generally, Tocci’s obvious purpose was to order advertising for her employer.
True, by her signature, Tocci promised to be individually liable for Pro Insulator’s debt. And her misreading or failing to read the agreements is no defense. One who signs a writing that is designed to serve as a legal document, as this and its enclosure were, is presumed to know its contents.
But she received no compensation, from either Pro Insulators or Yellow Book, for this promise. No enforceable contract can be rested on such a promise as it was without consideration. To this conclusion, Yellow Book offers no refutation.
Id. at 22-23 (citations and internal quotation marks omitted, extra paragraphing added). The case is discussed in Robert W. Stetson, Four Tips for Drafting Enforceable Personal Guarantees, in (BNA) Corporate Counsel Weekly Newsletter, Apr. 9, 2014, which includes numerous case citations.
Guaranties often have negotiated conditions and limits attached to them. For example:
- A guaranty for a lease agreement might state that the landlord cannot proceed against the guarantor before the landlord has exhausted all possible avenues of collection against the tenant, including obtaining a judgment against the tenant (this is known as a guaranty of collection).
- Or, the guaranty might state that the landlord can proceed against the guarantor as soon as the tenant fails to pay, without having to take the tenant to court (this is a guaranty of payment, and is fairly common in residential apartment lease agreement guaranties).
- A guaranty might have a dollar cap attached to it; a waiver of defenses; and other negotiated terms.
Drafters representing a guaranty creditor should consider other possible ways of securing the guaranteed payment obligation, such as (for example):
- a standby letter of credit from a bank or other financial institution;
- a payment bond, which is a type of surety bond, which is in essence an insurance policy (and is often issued by an insurance carrier);
- taking — and perfecting — a security interest in an asset that could be seized and sold, with the sale proceeds being used to satisfy the payment obligation in whole or in part and any remaining proceeds being delivered to the (previous) owner(s) of the asset.
An interesting form of payment security can be seen in Falco v. Farmers Ins. Gp., No. 14-2733 (8th Cir. Aug. 3, 2015) (affirming summary judgment in favor of defendants). In that case:
- An independent insurance agent's contract with an insurance carrier entitled the agent to a certain termination payment if he ever ceased representing the carrier.
- Some 16 years after signing on with the insurance carrier, the agent took out a line-of-credit loan from the carrier's employee credit union.
- As part of the loan documentation, the agent signed a power of attorney giving the credit union the power to submit the agent's resignation from representing the carrier, in which case the carrier would pay the agent's termination payment to the credit union.
- Five years later, the agent didn't make his payments on his line-of-credit loan, so the credit union did just as described above: It tendered the agent's resignation from representing the insurance carrier; collected the termination payment and applied it to the agent's outstanding loan balance; and remitted the balance to the agent.
The agent filed suit against pretty much everyone in sight. The district court granted summary judgment in favor of all defendants; the appeals court affirmed.
- Henri Chalouh, The Commercial Lease Guarantee: An Overview For Landlords And Tenants (Mondaq.com 2015)
Add language for:
- Guarantor must provide audited financials periodically
- Guarantor consents to jurisdiction somewhere convenient to the creditor (e.g., where leased property is located if guarantor is guaranteeing tenant's payment of lease)
- Guarantor appoints an agent for service of process
- Representation by signer of corporate guaranty that the signer is duly authorized to do so.
These are inspired by Pamela Westhoff, Charles Donovan and Lydia Lake, Commercial Lease Guaranties From Foreign Entities: What You Need to Know to Safeguard Your Security (Shepard Mullin 2015).
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Harm, whether or not capitalized, refers to any claim, demand, liability, cost, charge, suit, judgment, or expense, of any kind.
This definition comes from the insurance contract in suit in Hanover Ins. Co. v. Northern Building Co., No. 13-2675, slip op. at 8 (7th Cir. May 8, 2014) (affirming district court award of damages and attorney fees to surety bond company against its contractor-customer), affirming 891 F.Supp.2d 1019 (N.D. Ill. 2012).
Any drafting choice stated in a heading — as a hypothetical example, "Governing law: New York" — is to be given effect; otherwise, however, headings and subheadings in this Agreement are included for convenient reference only and are not to be considered in construing the corresponding text of this Agreement.
The definition presented here reflects what seems to be a consensus by legal-writing experts as to what the term means as a matter of law. Still, it might make sense to include the definition in a contract anyway (especially with multi-national parties) to avoid the confusion that has arisen in some courts. See also Indemnities Clause and its commentary.
The term "hold harmless" is very often the second part of the doublet indemnify and hold harmless. Legal lexicographer Bryan Garner marshals an impressive body of evidence that the two should be treated as synonyms, asserting that the former is Latinate in origin, while the latter is the English counterpart. See Bryan A. Garner, Garner's Dictionary of Legal Usage, at 443-45 (2011), excerpt available at http://goo.gl/LdVxN.
(This, even though courts ordinarily construe contracts so as to give effect to each provision.)
In the Majkowski case (2006), Delaware's then-vice-chancellor Leo Strine observed:
As a result of its traditional usage, the phrase "indemnify and hold harmless" just naturally rolls off the tongue (and out of the word processors) of American commercial lawyers. The two terms almost always go together.
Indeed, modern authorities confirm that "hold harmless" has little, if any, different meaning than the word "indemnify." Black's Law Dictionary in fact defines "hold harmless" by using the word "indemnify." It defines "hold harmless agreement" as a "contract in which one party agrees to indemnify the other." In defining "hold harmless clause," it simply says "[s]ee INDEMNITY CLAUSE." ) [Footnotes omitted]
Majkowski v. American Imaging Management Services, LLC, 913 A.2d 572, 588-89 (Del. Ch. 2006) (Strine, V.C.) (holding that indemnity- and hold-harmless provision did not entitle a protected person to advancement of expenses in a lawsuit against him by the indemnifying party).
Still, the conceptual distinction between hold harmless and indemnify is worth pondering.
On the one hand, the term indemnify is more-or-less universally understood as a commitment by the promisor to reimburse the protected person for stated losses or liabilities.
On the other hand, the term hold harmless has been treated by some courts as amounting to an advance waiver, release, or exculpation, of stated claims against the person held harmless. For example:
• In its 2012 Morrison opinion, the Idaho supreme court consistently referred to an advance-release form, and to similar language in other contracts, as a "hold harmless agreement." Morrison v. Northwest Nazarene University, 273 P.3d 1253, passim (Id. 2012) (affirming summary judgment dismissing injured employee's claim against university).
• A California court of appeals, after reviewing (and in some cases distinguishing) California case law, mused:
Are the words "indemnify'"and"'hold harmless" synonymous? No. One is offensive and the other is defensive — even though both contemplate third-party liability situations.
"Indemnify" is an offensive right — a sword allowing an indemnitee to seek indemnification.
"Hold harmless" is defensive: the right not to be bothered by the other party itself seeking indemnification.
Queen Villas Homeowners Ass'n v. TCB Prop. Mgmt., No. G037019, slip. op. at 9-10 (Cal. App. Mar. 29, 2007) (reversing summary judgment in favor of defendant; emphasis in original, extra paragraphing added).
Bryan Garner mocked the Queens Villa Homeowners reasoning as "just explicit judicial nonsense," Garner at 445, which Ken Adams, author of A Manual on Style for Contract Drafting, dismisses it as a "fabricated" distinction. See Kenneth A. Adams, Revisiting "Indemnify," July 27, 2012.
Regardless who is right, the brute fact is that opinions differ: not all lawyers and judges equate hold harmless with indemnify. Prudent contract drafters will therefore do well to follow the principle: When in doubt, define. If parties negotiating a contract believe that the two terms ought to have different meanings, they should seriously consider drafting their contract language accordingly, so as to make their intentions clear to future readers.
With that in mind, the definition of hold harmless in the text follows what seems to be the conventional approach: It peremptorily declares hold harmless and indemnify to be synonymous. That approach also fits in with the fact that the hold-harmless language of UCC § 2-312(3), concerning infringement warranties, appears to have been treated by courts as simply an indemnification obligation. See generally the cases cited in Charlene M. Morrow, Indemnity Exclusions for Goods Made According to SpeCiFication or Industry StandArd, parts I-B and I-G (2009).
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- If Definition Clause
- Implied warranty disclaimer (cross-reference)
- In-House Personnel Definition Clause
- Incidental Damages (cross-reference)
- Including Definition Clause
- Incorporation by reference
- Indebtedness Definition (notes only)
- Indemnities Clause
- Independent contractors
- Individual Definition Clause
- Infringement Claim Definition (to do)
- Injunctive relief
- Insurance (notes only)
- Intellectual Property Definition Clause
- Intellectual Property Right Definition Clause
- Intellectual property ownership (notes only)
- International contracts (notes only)
(a) For the avoidance of doubt, the term if, when used in granting a right or imposing an obligation that would not otherwise apply, means if and only if.
(b) A hypothetical example: Consider the sentence If Alice gives Bob $10.00 by 12 noon next Tuesday, then she may take the ballpoint pen from Bob's shirt pocket and keep it. That sentence implicitly means that Alice may not take a pen from Bob's shirt pocket unless she gives him $10.00.her path.
The motivation for this clause is not entirely far-fetched. Consider Trovare Capital Group, LLC v. Simkins Indus., Inc., 646 F.3d 994 (7th Cir. 2011) (reversing and remanding summary judgment):
- A cardboard-box manufacturer, whose principal owner wanted to retire and whose children weren't interested in the business, entered into a letter of intent (LOI) to sell the company.
- The LOI stated that: "If the Seller … provides to Buyer written notice that negotiations toward a definitive asset purchase agreement are terminated, then Seller shall pay Buyer a breakup fee of two hundred thousand dollars ($200,000)." Id. at 996 n.1 (emphasis added).
- The LOI also stated that after a stated termination date, neither party would be obligated to continue pursuing the sale. See id. at 996.
- The negotiations were contentious, so much so that, more than a month before the stated termination date, the buyer began demanding that the seler pay the $200,000 breakup fee. The buyer claimed that the seller had internally decided that it no longer wished to pursue the sale, and therefore had de facto terminated negotiations, while continuing to pretend to negotiate in order to avoid having to pay the breakup fee. See id. at 997-98.
- Communications between the parties continued until after the stated termination date. At some point, though, the seller's principal owner transferred his controlling interest in the company to his children, and his son became president of the holding company. See id. at 998.
- The buyer sued the seller for breach of the implied covenant of good faith and fair dealing under Illinois law. See id. at 998.
By itself, this clause's definition of if probably would not have prevented the Trovare plaintiff from claiming breach of the implied covenant of good faith and fair dealing, but it might have helped sustain the summary judgment.
Postscript: On remand, the trial court found that the sellers had not engaged in sham negotiations and therefore did not have to pay the breakup fee; the appeals court affirmed. See No. 13-2005 (7th Cir. July 23, 2015).
Implied warranty disclaimer (cross-reference)
See the Implied-Warranty Disclaimer.
The term in-house personnel, whether or not capitalized, when used in respect of a party, refers collectively to the following individuals:
(1) the employees of the party;
(2) the officers and directors of the party if the party is a corporation or comparable organization;
(3) the managers of the party if the party is a limited liability company (LLC) or comparable organization; and
(4) the general partners of the party if the party is a general- or limited partnership.
See Exclusion of Incidental Damages and its commentary.
(a) The terms including and like words (for example, include, includes, and included), whether or not capitalized:
(1) are to be deemed followed by the phrase by way of illustrative example and not of limitation if not followed literally by that phrase;
(2) signal the parties' intent that the listed included items should not be construed, under the principle of ejusdem generis, as defining a limiting class.
(b) For the avoidance of doubt, if in some places this Agreement uses other expressions such as including but not limited to or including without limitation, such usage does not mean that the parties intend for expressions such as simply including to serve as limitations unless expressly stated otherwise.
The definition in this clause eliminates the need to repeatedly write (and read), for example, "including without limitation." It's not uncommon in contracts, and generally uncontroversial.
Subdivision (a)(2) is intended to distinguish judicial opinions such as:
- Shelby County State Bank v. Van Diest Supply Co., 303 F.3d 832, 835-37 (7th Cir. 2002) (dictum)
- In re Clark, 910 A.2d 1198, 1200 (N.H. 2006): In that case, a state statute concerning payment of child support defined "gross income" by providing a laundry list of examples. The state's supreme court held that "the application of that statute is limited to the types of items therein particularized," id. at 1199-1200, and thus that certain in-kind benefits received by a father from his employer were not properly counted as gross income for purposes of determining the amount of child support that the father should pay. (The supreme court cautioned that this did not necessarily mean that the amount of child support would not be subject to adjustment based on the in-kind benefits; see id. at 1200.)
- Horse Cave State Bank v. Nolin Production Credit Ass’n, 672 S.W.2d 66 (Ky. Ct. App. 1984): A bank sought to enforce a lien on a borrower's collateral to which another creditor had a senior lien. The bank attacked the senior lien on grounds that the description of the collateral in the senior financing statement — "all farm equipment, including but not limited to tractor, plow and disc …." did not meet the requirement for statutory descriptiveness under the state supreme court's interpretation of that statute. The appellate court held that the including-but-not-limited-to language "gave appellant and other persons notice that PCA's financing statement was intended to cover any tractor, plow, and disc owned by the debtor as well as all similar farm machinery. In our opinion, such a description is sufficient to enable a creditor to reasonably identify the covered collateral." Id. at 67.
Hat tip: Ken Adams, An Update on "Including But Not Limited To" (AdamsDrafting 2015), whence the above citations are drawn. Get some popcorn before reading Ken's post, because he goes after noted legal-writing authority Bryan Garner for his (Garner's) view of the Seventh Circuit's Van Diest Supply opinion. (Personally I think Garner has the better view; I don't understand why Ken feels the need to be so imperiously dismissive, and even insulting, to people who disagree with him.)
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Incorporation of material by reference into this Agreement has the same force and effect as setting forth the full text of the material in the body of this Agreement.
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- Incorporation by reference language must be clear
- Attachment "for general reference" might not incorporate by reference
- But a clear intent to incorporate might suffice
- Mentioning one provision of a document won't incorporate the whole thing
- Pro tip: At least provide a link to external documents
- Provisions following the signature blocks should be clearly incorporated by reference
- Incorporation by reference is consistent with an entire-agreement clause
This clause migh be overkill, but its definition should reassure a drafter who worries that the other side might get "creative" in its contract intepretation. Its language is adapted from Clauses Incorporated by Reference in the Federal Acquisition Regulations, set forth in the Code of Federal Regulations at 48 C.F.R. § 52.252-2.