Common Draft — A Contracts Deskbook
Common Draft — A Contracts Deskbook
Short- and long-form contract terms, in plain language. With annotations, playbook notes, and flashcards. (A work in progress.)
Also includes links to selected real-world contract forms.
Free for (limited) use under a Creative Commons license. Copyright © 2013-2016 D. C. Toedt III.
Working draft no. 2016-03.4; last modified Wednesday September 14, 2016 18:57 Houston time.
(NOTE, August 2018: An update is in the works.) See also the prior versions.
NOT A SUBSTITUTE FOR LEGAL ADVICE; see the Cautions below.
1 Introduction (with cautions)
1.1 How to use the Common Draft materials
1.1.1 Use the short-form contract drafts as discussion agendas
Both a contract drafter and a contract reviewer can save some time by first reviewing — together — the Common Draft short-form contract drafts (as well as other clause titles) and discussing just what types of provision they want in their document.
1.1.2 Use the clause text under a (limited) Creative Commons license
You're free to use the Common Draft materials (which are copyrighted) in accordance with the following license; all of the following permissions are given on the express condition that you agree to the Cautions below.
- Anyone is free to use the Common Draft materials, at no charge, for educational (non-commmercial) purposes, subject to the restrictions in the Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. Attribution should include a link to www.CommonDraft.org.
- If you're a licensed attorney (or acting under the direction of a licensed attorney), you're free to reproduce and/or modify any or all Common Draft clauses for use in specific individual contracts, and/or in your general-terms-and-conditions forms, at no charge; there's no need for attribution or sharing, although both would be certainly be welcome.
- In case there's any doubt, the authorizations above don't extend to reproduction, distribution, display, or performance in, or as part of, an automated document-drafting or document-assembly offering (e.g., systems offered by contract-automation providers). I'd be happy to discuss that possibility; please contact me at [email protected].
1.1.3 Or use the clauses like the INCOTERMS®
The INCOTERMS® are "a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) [that are] widely used in international commercial transactions …. [for] the transportation and delivery of goods." (Wikipedia.com).
Imagine that a German widget manufacturer and an American customer are negotiating an order. They want to allocate responsibily for arranging for shipping the widgets; insurance; export clearances; and customs.
The manufacturer and customer needn't bother negotiating the wording for those responsibilities. Instead, they likely will "order from the menu" of the INCOTERMS 2010 publication: By specifying a standardized three-letter abbreviation — DDP, EXW, or whatever — the parties can quickly signal which of that publication's pre-defined terms and conditions they wish to use.
In the same vein, to save time, contract drafters (and reviewers) can consider incorporating selected Common Draft sections, or even entire contract drafts, by reference and specifying any desired variations or modifications — this could be thought of as "drafting by exception" or even as like INCOTERMS on steroids.*
* For clarity: The Common Draft project is not sponsored, endorsed by, or otherwise associated with the International Chamber of Commerce, which produces the INCOTERMS® 2010 rules.
Suggestion: If you incorporate one or more Common Draft provisions by reference, consider using your browser's "Save to PDF" or "Print to PDF" capability to preserve a copy of this deskbook for future reference.
1.2 CAUTIONS
- Of course, you shouldn't rely on the Common Draft materials as a substitute for legal advice about your specific needs.
- You acknowledge that your use of the Common Draft materials doesn't establish an attorney-client relationship with the author or anyone else who might be associated, in any capacity, with the Common Draft project.
- Keep in mind that very-small changes in facts or in wording can sometimes make a big difference in the legal outcome.
- (At the risk of beating this horse to death:) The Common Draft materials are provided AS IS, WITH ALL FAULTS; use at your own risk.
1.3 Long-term goal: A lasting public repository
The long-term goal of the Common Draft project is to serve as a lasting, public repository of carefully-drafted contract provisions that cover a wide variety of business needs, with annotations, commentary, and student exercises.
Please email me with suggestions for additions or revisions at [email protected]. Unless you say otherwise, I'll credit you in these materials for any suggestions that I incorporate.
Also, please sign up to be notified of updates (I won't spam you).
1.4 Selected actual contracts
Some of the contracts I've consulted in researching this deskbook are:
1.4.1 Employment
1.4.2 Merger & acquisitions
- BP-Tesero refinery purchase agreement (site44.com)
- Continental-United merger agreement (edgar-online.com) (DCT annotated version)
- Google and Motorola Mobility Holdings (SEC.gov)
- Verizon-Yahoo stock purchase agreement and attendant reorganization agreement (SEC.gov)
1.4.3 Purchase and sale of goods and services
- BAE Systems General Terms | Commercial Subcontracts / Purchase Orders (OneCLE.com)
- Baxter - U.S. Purchase Order Terms and Conditions (Baxter.com)
- Cisco Standard Terms and Conditions of Purchase – United States (Cisco.com)
- Computer Associates Purchase Order Terms and Conditions (CA.com)
- GE Terms and Conditions for Sale of Products and Services (ES-104) (GEPowerConversion.com)
- GE Energy Connections U.S. Terms of Purchase (GEEnergyConnections.com)
- Honeywell Standard Purchase Order Terms and Conditions for Goods and Services (Honeywell.com)
- Honeywell International Conditions of Sale (Honeywell.com)
- IBM standard purchase order terms and conditions (IBM.com)
- Pfizer Purchase Order Terms and Conditions (U.S.) (Pfizer.com)
1.4.4 Real-estate leasing
- Tesla-Stanford University lease agreement (SEC.gov) (DCT annotated version)
- Workday Inc. lease agreement (SEC.gov)
2 Short-form contract drafts
[THIS SECTION IS BEING EXTENSIVELY "REMODELED" so that all the drafts are similar in format to the short-form confidentiality agreement. ]
[NOTE: Don't rely on the drafts below as a substitute for legal advice about your specific situation. See the Cautions for more details.]
2.1 Short-Form Confidentiality Agreement
Confidential Information (short-form clause)
- 1. The following Common Draft provisions are incorporated by reference:
- CD-6.1. Confidential Information Baseline Terms
- 2. "Disclosing Party" refers to:
- Each Signatory Party when disclosing its Confidential Information under the Agreement.
- 3. "Receiving Party" refers to:
- Each other Signatory Party when receiving Confidential Information from a Disclosing Party under the Agreement.
- 4. "Protected Disclosure Period" refers to: CD 6.1.1.1
- The term of the Agreement.
- 5. Must Confidential Information be marked as such? CD 6.1.2.1
- Yes.
- 6. "Catch-Up Marking Period" refers to: CD 6.1.2.2
- Ten business days after the initial unmarked disclosure of the specific information in question.
- 7. (If #5 is "yes":) Must even clearly-Confidential Information be marked as such? CD 6.1.2.3
- Yes.
- 8. "Confidentiality-Obligation Period" refers to: CD 6.1.3.4
- The period (i) beginning on the effective date of the Agreement and (ii) continuing until the information question qualifies for at least one exclusion from Confidential Information status under CD 6.1.1.6.
- 9. "Authorized Use Period" refers to: CD 6.1.4.2
- The term of the Agreement.
- 10. Are any special uses or disclosures of Confidential Information preauthorized? CD 6.1.4.2
- None apart from the standard ones (including limited disclosure under subpoena).
- 11. Must copies and other specimens of Confidential Information be returned or destroyed? CD 6.1.3.7
- No.
- 12. (If #11 is "yes":) Does the undue-burden exception apply? CD 6.1.3.8
- N/A.
- 13. (If #11 is "yes":) Does destruction require the Disclosing Party's advance approval? CD 6.1.3.9
- N/A.
- 14. Variations / additional provisions:
- None.
2.2 Letter of intent term sheet
Consider the following provisions. NOT A SUBSTITUTE FOR LEGAL ADVICE.
- 9.1. Final, Formal Agreement Prerequisite
- 9.2. Preservation of Any Separate Confidentiality Agreement
- 9.3. Exclusivity (if Any) to Be Expressly Stated
- 9.4. Option to Terminate Negotiations
- 9.5. Good-Faith Obligations Deemed Satisfied
- 9.6. Performance Before Signature Not Binding
- 9.7. Good-Faith Negotiation Obligation
- Additional notes: Letters of intent
- Self-test questions for letters of intent
CD-18.4. Confidentiality of Parties' Dealings
CD-18.9. Employee Solicitation Restriction
CD-18.13. Publicity Approval Requirement
- 23.1. Effects of Termination
- 23.2. Termination Notice Requirement
- 23.3. Expiration = Termination
- 23.4. Right to Terminate for Breach
- Caution: An improper termination for breach can result in an "own goal" against the terminating party
- A supposedly-incurable breach … might not be, which could lead to another own-goal
- If cure of the breach is impossible
- Is a termination-for-breach provision even necessary?
- Which party should be able to terminate for breach?
- Language choices
- Cure-period duration
- Termination not exclusive remedy for breach
- Termination for breach: Other notes
- 23.5. Right to Terminate Transaction Instead
- 23.6. Right to Terminate for Legal Violation
- 23.7. Right to Terminate for Reputation Risk
- 23.8. Alternative Termination Grounds
- 23.9. Post-Termination Obligations (editing required)
- 23.10. Right to Terminate at Will
- 23.11. Early Termination Buyout Fee Requirement
- 23.12. Right to Terminate for Insolvency, Etc.
- 23.13. Right to Terminate After Change of Control
- 23.14. Termination After Certain Personnel Changes
- 23.15. WAIVER of Damages for Termination
- 23.16. Cross-Default Termination
- 23.17. No Other Termination
- 23.18. Termination Not Permitted
- 23.19. No Waiver of Termination by Subsequent Conduct
CD-22.17. Progressive Dispute Resolution
- General Provisions (short-form clause)
- 24.1. General Provisions Baseline Terms
- 24.1.1. Amendments in Writing
- 24.1.2. Binding Nature
- 24.1.3. Copies of Agreement
- 24.1.4. Entire Agreement; Terms in Other Documents
- 24.1.5. Forum Selection
- 24.1.6. Governing Law
- 24.1.7. Independent Contractors
- 24.1.8. Notices
- 24.1.9. Redlining Representation
- 24.1.10. Signature & Delivery of Documents
- 24.1.11. Successors & Assigns
- 24.1.12. Third-Party Beneficiary Disclaimer
- 24.2. General Provisions – optional provisions
- 24.3. [Reserved: Change of control]
- 24.4. Counsel Consultation
- 24.5. Course of Dealing Exclusion
- 24.6. Franchise-Law Benefits WAIVER
- 24.7. Government Subcontracting Disclaimer
- 24.8. Labor-Law Rights Acknowledgement
- 24.9. Language of the Agreement
- 24.10. Other Necessary Actions
- 24.11. Policy Statements
- 24.12. Prohibitions Apply to Attempts
- 24.13. Reliance Disclaimer
- 24.14. Savings
- 24.15. Survival
- 24.16. Unilateral Amendments
- 24.17. Waivers in Writing
2.3 Services agreement term sheet
Consider the following provisions. NOT A SUBSTITUTE FOR LEGAL ADVICE.
- 14.1. Definitions: Provider, Customer
- 14.2. Statements of Work
- 14.2.1. Exclusive Services Obligations in Statements of Work
- 14.2.2. No Obligation to Agree to Statement of Work
- 14.2.3. Requirement for Written Changes to Statements of Work
- 14.2.4. Terms re Statements of Work as Separate Agreements
- 14.2.5. Precedence of Statements of Work
- 14.2.6. Electronic Signatures for Statements of Work
- 14.3. Permits and Licenses Responsibilities
- 14.4. Services Performance Obligation
- 14.4.1. Workmanlike Performance
- 14.4.2. All Necessary Tasks and Materials
- 14.4.3. Provider Control of Means and Manner
- 14.4.4. Defects
- 14.4.5. Limitation on Provider Use of Customer Confidential Information
- 14.4.6. Notification of Bodily Harm or Significant Property Damage
- 14.4.7. Provider Cooperation With Other Customer Contractors
- 14.4.8. Customer Option to Perform Services Itself
- 14.4.9. Limitation of Customer Liability for Hindering Performance
- 14.4.10. Restrictions on Suspension of Work
- 14.4.11. Presumption of Proper Performance
- 14.5. Billing for Services
- 14.6. [Reserved: Services indemnities]
- 14.7. Customer's Rights in Deliverables
- 14.8. Ownership of Services-Produced IP
- 14.9. Requirements Upon Termination of Statement of Work
- Additional notes: Services
- Confidential Information (short-form clause)
- 6.1. Confidential Information Baseline Terms
- 6.2. Confidential Information – optional provisions
- 6.2.1. Protection Limited to Specified Information Categories
- 6.2.2. Confidentiality of Affiliate Information
- 6.2.3. Warranty of Disclosure Authority
- 6.2.4. Presumption of Confidentiality
- 6.2.5. Consent Requirement for Specific Disclosures
- 6.2.6. Disclosing Party's Indemnity Obligation
- 6.2.7. Obligation to Segregate Confidential Information
- 6.2.8. Obligation to Instruct Individual Recipients
- 6.2.9. Return or Destruction Obligation
- 6.2.10. Exception to Return-or-Destruction Obligation
- 6.2.11. Requirement to Obtain Advance Consent to Destruction
- 6.2.12. Obligation to Provide Certificate of Return or Destruction
- 6.2.13. Agreement Not to Rely on Confidential Information
- 6.2.14. Disclaimer of Obligation to Provide Confidential Information
- 6.2.15. Option to Retain Archive Copies
- 6.2.16. Requirement for Archive-Custodian Independence
- 6.2.17. Disclosing Party's Right to Inspect Confidentiality Compliance
- 6.2.18. Receiving Party's Indemnity Obligation
- 6.2.19. Obligation to Cooperate Against Misappropriators
- 6.2.20. Obligation to Provide Recipient Confidentiality Agreements
- 6.2.21. Receiving Party's Liability for Recipient Misappropriation
- 6.2.22. Reasonable-Efforts Option re Return or Destruction
- 6.2.23. Receiving Party Representation of Intentions
- 6.2.24. Receiving Party Freedom of Action
- 6.2.25. Residuals Rights
- 6.2.26. Disclosure in Secure Data Room
- 6.2.27. Disclosure in Public Filings
- Additional notes: Confidential Information
- Review questions about confidentiality agreements
- General Provisions (short-form clause)
- 24.1. General Provisions Baseline Terms
- 24.1.1. Amendments in Writing
- 24.1.2. Binding Nature
- 24.1.3. Copies of Agreement
- 24.1.4. Entire Agreement; Terms in Other Documents
- 24.1.5. Forum Selection
- 24.1.6. Governing Law
- 24.1.7. Independent Contractors
- 24.1.8. Notices
- 24.1.9. Redlining Representation
- 24.1.10. Signature & Delivery of Documents
- 24.1.11. Successors & Assigns
- 24.1.12. Third-Party Beneficiary Disclaimer
- 24.2. General Provisions – optional provisions
- 24.3. [Reserved: Change of control]
- 24.4. Counsel Consultation
- 24.5. Course of Dealing Exclusion
- 24.6. Franchise-Law Benefits WAIVER
- 24.7. Government Subcontracting Disclaimer
- 24.8. Labor-Law Rights Acknowledgement
- 24.9. Language of the Agreement
- 24.10. Other Necessary Actions
- 24.11. Policy Statements
- 24.12. Prohibitions Apply to Attempts
- 24.13. Reliance Disclaimer
- 24.14. Savings
- 24.15. Survival
- 24.16. Unilateral Amendments
- 24.17. Waivers in Writing
3 Front Matter of a Contract
3.1 Preamble [of Agreement]
Clause text
The parties to this [FILL IN TYPE OF AGREEMENT] (this Agreement) are:
- ABC Corporation (ABC or Provider), a Delaware corporation, having a place of business and initial address for notice at 123 Main Street, AnyTown, AnyState 12345-6789; and
- XYZ LLC (XYZ or Customer), a New York limited liability company, having a place of business and initial address for notice at 456 Commerce Street, OtherTown, OtherState 98765-4321.
The Agreement is effective as of the Effective Date, namely the date on which the Agreement was signed and delivered by or on behalf of the party whose signature and delivery were the final ones required for the Agreement to form a contract.
Comments
- Be sure your "party" has the legal capacity to enter into a contract
- Be sure you're naming the correct party as "the other side" — or consider negotiating a guaranty from a solvent affiliate
- Caution: Don't make affiliates "parties" to the Agreement unless they actually sign
- Why the corporate status is recited in the preamble (e.g., "a Delaware corporation")
- Why the parties' places of business are stated in the preamble
- Why the parties' initial addresses for notice are recited in the preamble
- Some countries might require specific information in the preamble
- How to state the effective date in the preamble
- Related provisions
Be sure your "party" has the legal capacity to enter into a contract
Depending on the law of the jurisdiction, an unincorporated association or trust might not be legally capable of entering into contracts. See generally Ken Adams, Can a Trust Enter Into a Contract? (AdamsDrafting.com Dec. 2014).
If a contract is purportedly entered into by a party that doesn't have the legal capacity to do so, then conceivably the individual who signed the contract on behalf of that party might be personally liable for the party's obligations.
Be sure you're naming the correct party as "the other side" — or consider negotiating a guaranty from a solvent affiliate
Failing to name the correct corporate entity as the other party to the contract could leave the drafter's client holding the bag. This seems to have happened in Northbound Group, Inc. v. Norvax, Inc., 795 F.3d 647 (7th Cir. 2015):
- Northbound Group was a company that generated leads for life-insurance sales. Facing financial difficulties, it agreed to sell its assets to Norvax, which generated leads for health-insurance sales.
- The actual asset-purchase agreement, though, was not between Northbound and Norvax, but between Northbound and a newly-created subsidiary of Norvax.
- Northbound later claimed that both the new subsidiary and its parent company Norvax breached the asset-purchase agreement in various ways.
- When Northbound filed suit, it sued only Norvax, not the subsidiary; the latter purportedly had no assets, see id. at 650, and thus might well have been judgment-proof.
Northbound's decision to sue the parent company, and not the subsidiary that was the named party to the contract, proved fatal to Northbound's breach-of-contract case. The Seventh Circuit affirmed summary judgment in favor of the parent company, saying:
It goes without saying that a contract cannot bind a nonparty. … If appellant is entitled to damages for breach of contract, [it] can not recover them in a suit against appellee because appellee was not a party to the contract.
These are the general rules of corporate and contract law, but they come with exceptions, of course. Northbound tries to create one new exception and invokes two established ones. We find no basis for holding Norvax liable for any alleged breach of the contract between Northbound and … the Norvax subsidiary.
Id. at 650-51 (internal quotation marks and citations omitted).
Caution: Don't make affiliates "parties" to the Agreement unless they actually sign
Some agreements, in identifying the parties to the agreement on the front page, state that the parties are, say, ABC Corporation and its Affiliates. In my view that's a bad idea unless each such affiliate actually signs the agreement as a party and therefore commits on its own to the contractual obligations.
The much-better practice is to state the specific rights and obligations that affiliates have under the contract. This is sometimes done in "master" agreements that are available to the affiliates of one or more parties.
CAUTION: An affiliate of a contracting party might be bound by the contract if the contracting party — or its signatory — controls the affiliate and the contract states that the contract is to benefit the affiliate. That was the result in Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10948-CB, slip op. at 3, 52-53 (Del. Ch. Aug. 18, 2016). In that case, the contract (i) stated that it was creating a strategic alliance for the contracting party and its affiliates, and (ii) was signed by the president of the contracting party, who was also the sole managing member of the affiliate. The court held that the affiliate was bound by, and violated, certain restrictions in the contract.
See also:
- CD-3.3. Master Agreement Acknowledgement and its commentary
- Mark Anderson, Don't Make Affiliates parties to the agreement (2014)
- Ken Adams, Having a Parent Company Enter Into a Contract “On Behalf” of an Affiliate (2008)
Why the corporate status is recited in the preamble (e.g., "a Delaware corporation")
Contract drafters typically include each party's type of organization and the jurisdiction in which it's organized — for example, "ABC Corporation, a Delaware corporation" — as a way of establishing diversity jurisdiction (a U.S. concept that might or might not be applicable) and personal jurisdiction as well as venue.
Including the jurisdiction can simplify a litigator's task of "proving up" the necessary facts: If a contract signed by ABC Corporation recites that ABC is a Delaware corporation, for example, an opposing party generally won't have to prove that fact, because ABC will usually be deemed to have conceded it in advance. (See also CD-25.2. Acknowledgement Definition and its field notes.)
Why the parties' places of business are stated in the preamble
Stipulating that a party has a place of business at a specified location can later help to establish, in a lawsuit, that the party is properly subject to:
- personal jurisdiction, and
- venue,
in that location.
(Such a stipulation might be binding on the party in question, as discussed in the commentary to CD-25.2. Acknowledgement Definition.)
Why the parties' initial addresses for notice are recited in the preamble
It's useful to put the parties' initial addresses for notice in the preamble. That way, if one party later wants to send notice to another, at least the initial notice address can be found right on the front page of the contract, without the reader's having to flip through the other pages.
Some countries might require specific information in the preamble
Apparently the Czech Republic and some other Central- and Eastern-European countries require contracts to include specific identifying information about the parties, e.g., the registered office, the company ID number. and the registration in the Commercial Register. See this Ken Adams blog post; also this one from 2007.
I found similar information in this apparently-Israeli contract.
How to state the effective date in the preamble
This language reflects my preferred approach to writing the effective date. Some other possibilities include:
"The Agreement is made December 31, 20XX, between …."
DCT comment: I tend to avoid this version, because the stated date might turn out to be inaccurate, depending on when the parties actually sign the contract.
CAUTION: Never backdate a contract for deceptive purposes, e.g., to be able to book a sale in an earlier fiscal period; that practice sent more than one tech-company executive to prison.
- "The Agreement is dated December 31, 20XX, between …." DCT comment: I tend to avoid this version as well, for the same reasons stated above.
"The Agreement is entered into, effective December 31, 20XX, by …."
DCT comment: Stating that a contract is effective as of a different date, for non-deceptive purposes, might be just fine, depending on the circumstances.
EXAMPLE: Alice discloses confidential information to Bob after Bob first orally agrees to keep the information confidential; tbey agree to have the lawyers put together a written confidentiality agreement. That written agreement might state that it is effective as of the date of Alice's oral disclosure.
(Alice would not want to backdate her actual signature, though.)
Exercises: Q&A
QUESTION 1: What do you think is the absolute minimum information needed for the introductory paragraph of a contract?
In the U.S. legal system, arguably no introductory paragraph is needed at all: as long as the contract is clear about the identity of the parties, e.g., from the signature block(s)), that probably satisfies any legal requirements.
QUESTION 2: How might a preamble bind the wrong party?
A premable might bind the "wrong" party if the stated party name was not the intended party, e.g., if the stated party was an affiliate of the intended party.
QUESTION 3: When might it be a really bad idea to use an "as of" date?
If trying to backdate the contract for deceptive purposes.
QUESTION 4: Why specify the state in which a corporate party is incorporated?
Because there might be corporations in other states with the same name.
QUESTION 5: Why recite the locations of the parties' principal places of business? (Hint: Think litigation.)
To help establish:
- where that party might be subject to personal jurisdiction, and
- a proper venue for litigation.
Drafting exercise: Rick's Cabaret preamble
Rewrite the preamble and recitals to the Rick's Cabaret purchase agreement. Use short, simple sentences.
3.2 Background of Agreement
[This of course will vary.]
Comments
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, preferably in short, numbered paragraphs.
Avoid "Witnesseth" and "Whereas" clauses
Modern drafters avoid archaic "Witnesseth" and "Whereas" clauses, such as those seen in this real-estate purchase agreement; instead, they draft background recitals.
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 CD-25.2. Acknowledgement Definition.
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 CD-25.2. Acknowledgement Definition. 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).
3.3 Master Agreement Acknowledgement
Clause text
(a) The parties intend to use the Agreement as a pre-negotiated set of terms and conditions for one or more purchase orders, statements of work, or other specific agreements incorporating the Agreement by reference.
(b) The Agreement in itself does not obligate either party except to the extent indicated otherwise.
(c) Any prior master agreement between the parties concerning the subject matter of the Agreement is cancelled, on a going-forward basis only, as follows:
(1) the Agreement (along with any applicable transaction-specific agreement) will govern any transaction concerning that subject matter whose performance is begun during the term of the Agreement.
(2) Unless the Agreement expressly states otherwise, IF: Performance of a transaction has already commenced under a prior master agreement between the parties; THEN: That prior master agreement will remain in effect as to that transaction until its performance is completed.
Comments
- Purpose of master-agreement acknowledgement
- Specific terms to consider in master agreements
- A company can negotiate a master agreement for its corporate "family"
- Pro tip: Have "subsidiary" contracts expressly state that the master agreement controls
- Should a master agreement override purchase orders, etc., no matter what?
- Danger of a master agreement's setting the bar too high
- Further reading on master agreements
Purpose of master-agreement acknowledgement
A pre-negotiated master agreement can be extremely useful in business. It allows parties to negotiate the "legal T&Cs" one time; the parties can re-use those T&Cs in future transactions by signing short-form contracts that (ideally) incorporate the master agreement by reference and set forth any transaction-specific terms.
Specific terms to consider in master agreements
- Pricing terms are sometimes pre-negotiated in master agreements. When that happens, it is useful also to include an agreed mechanism for periodically adjusting the pricing, so that the supplier won't potentially be stuck with outdated pricing long after the deal was struck.
- Evergreen term extensions and unilateral extensions can also be useful, but should be approached with caution.
- a termination-at-will clause (with suitable "fences" around it) can provide parties with a way to bail out of a master agreement that's no longer suitable.
A company can negotiate a master agreement for its corporate "family"
Companies sometimes want to negotiate pricing and other terms & conditions on behalf of their affiliates; that can help to reduce the transaction costs that would attend negotiation of individual contracts between each affiliate and the same counterparty. An easy way to do this is to pre-negotiate a "master" agreement that can be incorporated by reference into other contracts.
EXAMPLE: a company signs a master purchase agreement. It wants its affiliates to be able to make purchases from the seller, on the same negotiated terms and conditions and/or at the same negotiated pricing. By having the master agreement say just that, the company can ensure that its affiliates won't have to negotiate their own deals with the seller. (Of course, any given affiliate might want to negotiate its own deal.)
In that situation, consider doing the following:
- The parent company signs a master agreement with stated pricing and other T&Cs.
- The master agreement states that either party and its affiliates can utilize the master agreement by entering into a short-form agreement (for example, a purchase order) that incorporates the master agreement by reference.
- If a buyer's subsidiary places a purchase order with the seller, then the subsidiary doesn't become a party to the master agreement per se; it's a party only to the contract formed by its own purchase order.
- The purchasing subsidiary is a third-party beneficiary of the master agreement, but only in the limited sense that it has the right to place orders at the stated pricing and under the stated T&Cs.
- The purchasing subsidiary's parent company avoids being liable for the subsidiary's financial obligations under the subsidiary's purchase orders (unless of course the seller negotiates a guarantee from the parent). That's something the parent company's lawyers and finance people will usually want.
- If a lawsuit should come to pass over a particular purchase order, there's little room for satellite disputes about who has standing to sue whom and who the necessary parties are.
See also: Caution: Don't make affiliates "parties" to the Agreement unless they actually sign.
Pro tip: Have "subsidiary" contracts expressly state that the master agreement controls
CAUTION: When using a master agreement, it's best for any subsequent contracts to expressly state that the master agreement's terms are to control. Consider CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, No. 15-1256 (10th Cir. Jul. 19, 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015). In that case:
A Chinese manufacturer of solar-panel products entered into a co-branding agreement with a U.S. retailer. That agreement called for the retailer to order solar-panel products from the manufacturer at stated prices. The co-branding agreement contained an arbitration provision, which expressly required that arbitration proceedings be in English.
- The retailer also entered into specific written sales contracts with the manufacturer; the sales contract contained an arbitration provision, but that provision did not require English-language arbitration.
- The retailer's CEO testified, and the U.S. trial court accepted, that the parties had intended for the co-branding agreement to be a "master" agreement that would govern all sales contracts.
- Apparently, though, neither the co-branding agreement nor the sales contract in question actually said referred to the master agreement (the courts' opinions were not specific on this point).
- The manufacturer and the retailer communicated exclusively in English.
- One shipment of goods had quality problems; the retailer refused to pay. After negotiations went nowhere, the manufacturer filed a demand for arbitration with the Chinese arbitration institution designated in the earlier, co-branding agreement.
- The Chinese arbitration institution sent the U.S. retailer a notice of arbitration, in Chinese. The U.S. retailer did not realize what the notice of arbitration was. Consequently, the retailer did not realize that under the agreed arbitration rules, a 15-day clock was ticking on the retailer's right to participate in selecting the members of the arbitration panel. That deadline passed, and the panel members were selected without input from the retailer.
- The arbitration panel ruled that the so-called master agreement did not apply and that the sales contract controlled. The arbitration panel awarded damages to the manufacturer, which then sought to enforce the award against the retailer in a U.S. court.
The Colorado district court ruled that, contrary to the decision of the arbitration panel, the testimony of the retailer's CEO established that the co-branding agreement had indeed been a "master" agreement; this meant that the Chinese-language notice of arbitration had been insufficient, and that in turn meant that, under the New York Convention, the court could decline to enforce the damages award.
Citing the virtual unreviewability of arbitration awards even when grounded on errors of law, the Tenth Circuit chose not to address the master-agreement issue:
[O]ur holding does not rely on the conclusion that the [sales contract] was bound by the terms of the [co-branding agreement].
Rather, the [co-branding agreement] is one piece of evidence demonstrating that the parties understood their relationship would proceed in English,
and that [the manufacturer] suddenly deviated from that understanding and practice when providing notice.
Id., slip op. at 10 n.2 (emphasis and extra paragraphing added).
DRAFTING LESSON: It's best if purchase orders, statements of work, etc., expressly identify a "master" agreement and state that the master agreement applies.
Should a master agreement override purchase orders, etc., no matter what?
A master agreement might state that its terms apply to all transactions between the parties, even if the parties use a purchase order, statement of work, etc., that doesn't refer to the master agreement. This was suggested in a LinkedIn comment (group membership required) by attorney Michael Little.
I'm on the fence about that one:
- In one sense, Mike's suggestion might be safer, at least in the short term, in that the parties (and thus the client) wouldn't have to remember to incorporate the master agreement by reference.
- On the other hand, it might not be ideal for parties that did a lot of business together in different divisions, geographic territories, etc.
- And this practice could lead to parties, long afterwards, inadvertently incorporating a forgotten "zombie" master agreement by reference, to unclear effect.
My own preference is often to be silent on this point in the master agreement, so that the parties will have to remember to expressly incorporate the master agreement by reference. My guess is that they'll be more likely to remember to do that than to research whether any previously-negotiated master agreement still applies. But this is a judgment call, to be made based on the particular circumstances and the client's desires.
Danger of a master agreement's setting the bar too high
In an Eighth Circuit case, the parties' master services agreement set the bar too high for services agreements, and as a result the master agreement was found not to apply. The master agreement prescribed the exact language that a statement of work was required to include to incorporate the master agreement by reference:
Barkley shall performfor [Gabriel Brothers] certain services which shall be agreed to by the parties on a project-by-project basis . . . . The Services agreed to for each Project shall be designated in a written Statement of Work (“Statement of Work”).
Each Statement of Work shall contain the following provision:
“This Statement of Work is incorporated into, and made a part of, that certain Master Services Agreement . . . between the parties dated [October 5,] 2012, which Agreement governs the relationship of the parties. All terms and conditions provided in the Agreement shall apply to this Statement of Work.”
Barkley Inc. v. Gabriel Bros. Inc., No. 15-2308, part I, slip op. at 3-4 (8th Cir. July 25, 2016) (extra paragraphing added, alteration marks by the court).
As to the relevant statement of work:
- The service provider began working while the parties were negotiating the statement of work.
- At some point the customer pulled the plug by invoking a termination-at-will provision in the master agreement — and at that point the parties had not signed the statement of work; consequently, there was no signed statement of work containing the prescribed incorporation-by-reference language.
- The provider sued the customer; it alleged that, because the customer failed to pay for the work already started for the (unsigned) statement of work, the customer thereby breached the master agreement.
The district court granted partial summary judgment in favor of the customer, on grounds that because the statement of work was never signed, the specific requirements of the master agreement had not been met, so there was no breach of that agreement. The appeals court affirmed. See id., part II-A, slip op. at 9-10.
(A jury, though, held the customer liable for damages for breaching a subsequent [oral?] agreement that apparently wasn't "under" the master agreement; the appeals court affirmed judgment on that verdict.)
In a similar vein, a thoughtful LinkedIn group discussion comment (group membership required) by attorney Michael Little was that a master agreement should "specify" the form of purchase orders, statements of work, etc., by including the form(s) in an exhibit. My own view is different: It can be useful to include such a form as an example, but I don't like to specify that use of that form is required. That's because, in a particular transaction, the parties might thoughtlessly (or intentionally) use a different form instead of one matching the exhibit. That, in turn, might give rise to a dispute over whether the master agreement's terms applied to that transaction.
6 Confidential Information
Confidential Information (short-form clause)
Unless the Agreement provides otherwise:
- 1. The following Common Draft provisions are incorporated by reference:
- CD-6.1. Confidential Information Baseline Terms
- 2. "Disclosing Party" refers to:
- Each Signatory Party when disclosing its Confidential Information under the Agreement.
- 3. "Receiving Party" refers to:
- Each other Signatory Party when receiving Confidential Information from a Disclosing Party under the Agreement.
- 4. "Protected Disclosure Period" refers to: CD 6.1.1.1
- The term of the Agreement.
- 5. Must Confidential Information be marked as such? CD 6.1.2.1
- Yes.
- 6. "Catch-Up Marking Period" refers to: CD 6.1.2.2
- Ten business days after the initial unmarked disclosure of the specific information in question.
- 7. (If #5 is "yes":) Must even clearly-Confidential Information be marked as such? CD 6.1.2.3
- Yes.
- 8. "Confidentiality-Obligation Period" refers to: CD 6.1.3.4
- The period (i) beginning on the effective date of the Agreement and (ii) continuing until the information question qualifies for at least one exclusion from Confidential Information status under CD 6.1.1.6.
- 9. "Authorized Use Period" refers to: CD 6.1.4.2
- The term of the Agreement.
- 10. Are any special uses or disclosures of Confidential Information preauthorized? CD 6.1.4.2
- None apart from the standard ones (including limited disclosure under subpoena).
- 11. Must copies and other specimens of Confidential Information be returned or destroyed? CD 6.1.3.7
- No.
- 12. (If #11 is "yes":) Does the undue-burden exception apply? CD 6.1.3.8
- N/A.
- 13. (If #11 is "yes":) Does destruction require the Disclosing Party's advance approval? CD 6.1.3.9
- N/A.
- 14. Variations / additional provisions:
- None.
6.1 Confidential Information Baseline Terms
6.1.1 Confidential Information Definition
- 6.1.1.1. Confidential Information Basic Definition
- 6.1.1.2. Confidential Information Examples
- 6.1.1.3. Confidentiality of Receiving Party's Notes
- 6.1.1.4. Confidentiality of Third-Party Information
- 6.1.1.5. Confidentiality of Specific Selections and Combinations
- 6.1.1.6. Exclusions from Confidential Information
- 6.1.1.7. Disclaimer of Unstated Warranties and Licenses
6.1.1.1 Confidential Information Basic Definition
Clause text
Confidential Information refers to information — including, for example, information in the categories listed in section 6.1.1.2 — where all of the following are true:
(1) the information is the subject of efforts that are reasonable under the circumstances to maintain its secrecy, by and/or on behalf of a Disclosing Party; and
(2) the information is initially disclosed, by or with the authorization of the Disclosing Party, to a Receiving Party during the Protected-Disclosure Period;
(3) the initial disclosure referred to in subdivision (2) is in connection with the Agreement or a transaction or relationship resulting from the Agreement; and
(4) the information is not excluded from Confidential-Information status under the Agreement by, for example, the enumerated exclusions below or failure to comply with a marking requirement (if applicable).
Language origins
Subdivision (1): The language, "the subject of efforts reasonable under the circumstances," is adapted from the Uniform Trade Secrets Act; see, e.g., Cal. Civ. Code § 3426.1(d)(2); Tex. Civ. Practice & Rem. Code § 134A.002(6)(B); see also these notes. (See also the discussion in the Annotations concerning the secrecy requirement for information to be treated as confidential.)
Subdivision (2): Protected Disclosure Period: 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.
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.
CAUTION: 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.
Subdivision (3): In connection with the Agreement: This 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 that don't necessarily want confidentiality obligations spilling over from one transaction to the parties' other dealings.
Subdivision (4): A transaction or relationship: See the arbitration-clause commentary.
Public policy
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).
Fort-Knox security measures aren't necessary (usually)
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.
But some secrecy efforts are virtually mandatory
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).
6.1.1.2 Confidential Information Examples
Clause text
Except to the extent (if any) that the Agreement specifically provides otherwise, 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 the Agreement:
Algorithms. Audit reports.
Biological materials. Business plans. Business records.
Circuit records. Commercial information. Compounds. Computer programs. Contracts. Construction records.
Data-center designs. Designs. Diagrams. Documents. Draft publications. Drawings.
Engineering records.
Financial information. Financial projections. Financial statements. Forecasts. Formulas.
Hardware items.
Ideas. Interpretations. Invention disclosures.
Leases.
Machine-readable data. Maps. Market projections. Marketing information. Methods.
Offers. Operational data. Opinions.
Patent applications (when unpublished). Plans. Pricing information. Procedures. Processes. Product development plans. Product information programs. Projections. Proposals.
Research data. Research plans.
Samples. Server-configuration designs. Source code for computer programs. Specifications. Strategies.
Tax bills. Technical information. Technical reports. Technological developments. Test data. Title reports.
Comments
This laundry list is a "roadblock" clause; disclosing-party counsel sometimes want to include such examples to serve as explicit reminders to the receiving party (and also as ammunition in litigation).
6.1.1.3 Confidentiality of Receiving Party's Notes
6.1.1.4 Confidentiality of Third-Party Information
Clause text
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 the Agreement.
Comments
A receiving party might want to include CD-6.2.3. Warranty of Disclosure Authority provision.
6.1.1.5 Confidentiality of Specific Selections and Combinations
Clause text
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.
Comment
This language reflects established law (at least in the U.S.). 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.)
6.1.1.6 Exclusions from Confidential Information
Clause text
At any particular time, the term Confidential Information does not include information that is shown — with reasonable corroboration — to be or to have been, at that time, within one or more of the following categories:
(1) The Receiving Party knew the information before obtaining access to it under the Agreement; or
(2) Both of the following are true:
(A) A third party provided the information to the Receiving Party, and
(B) at the time that happened, the third party was not under a legally-enforceable confidentiality obligation that (i) contained specific obligations equivalent to those of section 6.1.3 that are contained in the Agreement; and (ii) benefited the Disclosing Party (a Comparable Confidentiality Obligation);
(3) The Receiving Party independently developed the information without using 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 the Agreement by the Receiving Party; or
(5) Both of the following are true:
(A) The Disclosing Party (or someone authorized by the Disclosing Party) disclosed the information to one or more third parties, and
(B) at that time (or at any time afterwards), at least one of the third parties was not under a Comparable Confidentiality Obligation.
NOTE: The fact that information comes within the scope of a subpoena or other Compulsory Legal Demand does not in itself mean that the information becomes categorically excluded from Confidential Information status.
Language notes
Most confidentiality agreements contain express exclusions from confidentiality such as these. This numbered list of exclusions is fairly typical.
Subdivision (1): The prior-knowledge exception is one of those where the corroboration requirement can come into play. Without corroborating evidence, a judge or jury might well be skeptical of an accused misappropriator's too-convenient claim, after the fact, that: We can't be liable for misappropriating your confidential information because knew the information before you gave it to us.
Subdivision (2): If a third party has the information in question, and isn't obligated to keep the information secret, then it's tough for the Disclosing Party to argue that the information really is the confidential information of the Disclosing Party.
Subdivision (3) (independent development): As a practical matter, an accused misappropriator of confidential information might have a hard time convincing a judge or jury that it independently developed the allegedly-misasppropriated information on its own. For an example, see 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 a confidentiality agreement; the jury rejected Rockwell's assertion that its engineers had independently developed the technology in question after having been exposed to the startup company's information. (Disclosure: I was part of Rockwell's trial team in that case.)
Subdivision (5): A disclosing party might try to omit this exclusion, but in that case:
- The receiving party would probably push back, on the theory that if you [the disclosing party] allow others to use its information without legal restriction, then I get to do the same thing.
- Moreover, it's unclear what the legal effect of omitting exclusion #5 would be, because by law (at least in the U.S.), such a disclosure of information to a third party without confidentiality restrictions would have the effect of killing any trade-secret rights the discloser might have had in the information, as discussed here.
NOTE: Some badly-drafted confidentiality exclusions state that subpoenaed information is excluded from confidentiality. This could be a big mistake for a disclosing party — a receiving party could later argue that the mere issuance of a third-party subpoena automatically resulted in the subpoenaed information being excluded from confidentiality status, even if a court were to issue a protective order restricting what the third party could do with the information. The better approach is the one taken by this provision.
Corroboration of exclusion claims: Analogies from patent law
This list of exclusions requires only reasonable corroboration of a claim of exclusion from confidentiality, as opposed to some provisions of this kind that require 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.
6.1.1.7 Disclaimer of Unstated Warranties and Licenses
Clause text
For the avoidance of doubt, EXCEPT to the extent (if any) that the Agreement or another written agreement between the parties expressly states otherwise:
(1) The 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 the 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.
Comment
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.
6.1.2 Marking of Confidential Information
6.1.2.1 Marking Requirement for Confidential Information
Clause text
(a) Information that is made available to the Receiving Party in connection with the Agreement, by or on behalf of the Disclosing Party, will not be considered Confidential Information unless the information is marked as provided in the Agreement.
(b) Except as otherwise stated below, for information to be considered Confidential Information, the information must:
(1) be set forth (or summarized) in tangible form (including for example an electronic storage device); and
(2) be marked with a reasonably-prominent, visually-readable notice such as (for example) "Confidential information of [name]" or "Subject to NDA."
Purpose of marking requirement
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.
Courts pay attention to the absence of marking
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) (applying Illinois law).
To like effect was another Seventh Circuit case, nClosures, Inc. v. Block & Co., 770 F.3d 598, 600 (7th Cir. 2014), where the court affirmed a summary judgment that "no reasonable jury could find that nClosures took reasonable steps to keep its proprietary information confidential," and therefore the confidentiality agreement between the parties was unenforceable.
A 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.
Caution: Some information might be confidential by law even without marking
Applicable law might independently impose a confidentiality obligation benefiting third parties, regardless of marking. For example, the U.S. Health Insurance Portability and Accountability Act (HIPAA) imposes such obligations in respect of patients' protected health information.
Should marking be required even for in-place access?
A slightly-tricky situation is when a receiving party's people are allowed to look at a disclosing party's internal files but not to make notes, take away copies, etc. In such a situation, it might well be burdensome for the disclosing party to have to go each of the files to ensure that all confidential information is marked, on pain of losing confidentiality protection. There might also later be a he-said, she-said proof problem if a dispute were to arise about whether particular information had in fact been marked.
6.1.2.2 Catch-Up Marking Option
Clause text
(a) 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 stated in subdivisions (b) and (c).
(c) 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.
(d) In addition, no later than the end of the Catch-Up Marking Period, the Disclosing Party must:
(1) furnish the Receiving Party with a copy or written summary of the Confidential Information that is marked as Confidential Information; and
(2) give the Receiving Party notice that it has done so.
Business context of catch-up marking
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.
Notice of catch-up marking
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.
Forgetting catch-up marking can destroy trade-secret rights
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).
6.1.2.3 Marking Exception for Clearly-Confidential Information
Clause text
The marking requirement of section 6.1.2 does not apply to information that would be recognized, by a reasonable person familiar with the type of information in question, as clearly being Confidential Information.
Comment
Some disclosing parties might not want to be bothered with having to mark their confidential information as such. Such a preference can be accommodated at least somewhat by using this provision.
A receiving party, though, might well object to this provision because it's necessarily vague, which could later lead to disputres about whether particular information qualified as "clearly" confidential.
6.1.3 Confidentiality Obligations
- 6.1.3.1. Secrecy Precautions Obligation
- 6.1.3.2. Limitation on Receiving Party Use, Etc.
- 6.1.3.3. Obligation to Comply with Law
- 6.1.3.4. Duration of Confidentiality Obligation
- 6.1.3.5. Survival of Other Rights and Obligations
- 6.1.3.6. Disclaimer of Implied Fiduciary Obligations
- 6.1.3.7. Return or Destruction Obligation
- 6.1.3.8. Undue-Burden Exception to Return-or-Destruction Obligation
- 6.1.3.9. Requirement to Obtain Advance Consent to Destruction
6.1.3.1 Secrecy Precautions Obligation
Clause text
At all times during the Confidentiality-Obligation Period, 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 secrecy precautions stated in the Agreement.
Sometimes even more secrecy precautions will be in order
In many situations, these "standard" precautions are likely to satisfy the disclosing party's desires, but for some types of Confidential Information, a disclosing party might want to insist on special precautions — especially in the era of criminal hackers, and even state actors, breaking into insufficiently-secure computer systems and stealing valuable information, such as happened to Sony Pictures Entertainment, allegedly at the hands of North Korea, and to Home Depot, which booked a charge of $161 million after a 2014 theft of customers' credit-card data.
Not requiring secrecy precautions can kill trade-secret rights
A disclosing party should always insist on imposing confidentiality obligations on a receiving party; otherwise, a court is likely to hold hold that the disclosing party had failed to make reasonable 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).
6.1.3.2 Limitation on Receiving Party Use, Etc.
Clause text
At all times during the Confidentiality-Obligation Period, the Receiving Party must not disclose, use, or copy Confidential Information, in whole or in part, except as expressly provided in the Agreement.
Comment
This is an "umbrella" limitation on what the Receiving Party is allowed to do with Confidential Information; it is subject to the express rights of use, disclosure, and copying stated below.
6.1.3.3 Obligation to Comply with Law
Clause text
The Receiving Party is to take prudent measures to 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.
Comment
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.
This provision uses a prudent-measures standard instead of an absolute obligation.
See also CD-6.2.18. Receiving Party's Indemnity Obligation.
6.1.3.4 Duration of Confidentiality Obligation
Clause text
The obligations of section 6.1.3 apply only during the Confidentiality-Obligation Period; during that time, though, those obligations will continue to apply to all Specimens of Confidential Information, even after any termination or expiration of the Agreement.
Why revising this clause might be controversial
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.
Negotiation arguments for letting confidentiality obligations expire
Whether confidentiality obligations should ever expire might depend on the circumstances:
- Some types of confidential information will have a limited useful life, e.g., future plans. Such information might reasonably have its protection limited to X months or years.
- Other types of confidential information might have essentially-unlimited useful life — for example (putatively), the recipe for making Coca-Cola® syrup.
A receiving party might want an expiration date for confidentiality obligations as a safe harbor. After X years have gone by, it might well take time and energy for the receiving party to figure out (1) which information of the disclosing party is still confidential, and (2) whether the receiving party might be using or disclosing confidential information in violation of the NDA. The receiving party likely would prefer instead to have a bright-line "sunset," after which the receiving party can do whatever it wants without having to incur the burden of analyzing the facts and circumstances.
A disclosing party might regard an expiration date for confidentiality obligations as acceptable, depending largely on:
- 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.
Danger of letting confidentiality obligations expire
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]
Possible expiration dates for confidentiality obligations
The parties could specify that the Receiving Party's confidentiality obligations will expire X months 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.
Expiration of confidentiality doesn't affect other IP rights
Hat tip: Erik Verbraeken in a LinkedIn discussion comment (LinkedIn group membershp required).
Conversely, expiration of other obligations doesn't affect confidentiality obligations
The language, any other right or obligation under the 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.
Rule against perpetuities?
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 (3d 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).
6.1.3.5 Survival of Other Rights and Obligations
Clause text
For the avoidance of doubt, any termination or expiration of the Confidentiality-Obligation 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.
6.1.3.6 Disclaimer of Implied Fiduciary Obligations
Clause text
For the avoidance of doubt, the Receiving Party's undertaking of the obligations of the Agreement concerning Confidential Information is not intended and should not be interpreted as in itself establishing a confidential‑ or fiduciary relationship between the parties.
Comment
A receiving party likely would not want to take on the higher burden of entering into a fiduciary relationship with the disclosing party. (Opinions seem to vary as to whether the term fiduciary relationship and confidential relationship are synonyms; the answer might depend on the jurisdiction. See generally John A. Day, Difference Between Fiduciary Relationships and Confidential Relationships (JohnDayLegal.com) (citing Tennessee cases).
6.1.3.7 Return or Destruction Obligation
Clause text
(a) A Specimen of Confidential Information is any copy of, and any physical object embodying, Confidential Information — for example, any paper- or electronic copy and any specimen of hardware — where the copy or physical object 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.
(b) IF: The Disclosing Party makes a seasonable written request following any termination or expiration of the Agreement; THEN: except as provided in sections 6.1.3.8 and (if applicable) 6.2.22, the Receiving Party will promptly:
Comment
An obligation to return or destroy Confidential Information might not be practical if (for example) Confidential Information is embodied in a deliverable (for example, custom-developed computer software, or a physical object) that the receiving party will have the right to keep on using; this might be the case in a services agreement.
PRO TIP: Unfortunately, sometimes parties forget about return-or-destruction obligations. A disclosing party will want to follow up to be sure that the return-or-destruction requirement is actually complied with; if it were to fail to do so, a receiving party (or a third party) could try to use that as evidence that the disclosing party did not take reasonable precautions to preserve the secrecy of its confidential information, as discussed in this annotation.
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.
SUGGESTION: Consider requiring segregation of Confidential Information — or a Receiving Party could elect to segregate Confidential Information on its own initiative, even without a contractual requirement — for easier compliance with this section.
6.1.3.8 Undue-Burden Exception to Return-or-Destruction Obligation
Clause text
(a) 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.
(b) For the avoidance of doubt, any Specimen of Confidential Information not returned or destroyed remains subject to the Confidentiality Obligations.
6.1.3.9 Requirement to Obtain Advance Consent to Destruction
Clause text
When returning or destroying The Receiving Party may not destroy any Specimen of Confidential Information without the prior written consent of the Disclosing Party.
Comment
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.
6.1.4 Authorization for Certain Uses, Etc.
6.1.4.1 Pre-Authorized Uses
Clause text
Solely during the Authorized Use Period, 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 the Agreement;
(2) exercising the Receiving Party's rights under the 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.
Comment
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.
A receiving party might want to state explicitly that that certain specified uses are authorized.
6.1.4.2 Preauthorized Disclosures
Clause text
(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 the 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, or with the authorization of, the Receiving Party must be legally bound to comply with the provisions of the Agreement protecting Confidential Information, either:
(1) by a written agreement containing confidentiality obligations, comparable to those of the 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.
Comment
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.
Limiting disclosures by the Receiving Party to a need-to-know basis is pretty standard in confidentiality provisions.
Subdivision (b) ia a corollary to the confidentiality obligations; see generally its commentary.
6.1.4.3 Disclosure Under Subpoena, Etc.
Clause text
(a) Compulsory 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) The Receiving Party may disclose Confidential Information in response to a Compulsory Legal Demand, as follows:
(1) The Receiving Party must seasonably advise the Disclosing Party of the Compulsory 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 Compulsory Legal Demand.
(3) 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 Compulsory Legal Demand.
(4) 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.
(c) For the avoidance of doubt, this section 6.1.4.3 does not authorize any disclosure Confidential Information that does not qualify as a Compulsory Legal Demand (for example, a discretionary filing under the securities laws).
Comment
This 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.
See also CD-6.2.27. Disclosure in Public Filings.
6.1.4.4 Other Legally-Authorized Disclosures
Clause text
(a) The confidentiality provisions of the Agreement are not to be interpreted:
(1) as precluding the Receiving Party from disclosing Confidential Information — in confidence and 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, as well as any other federal, state or local government official; nor
(B) disclosure to an attorney solely for the purpose of reporting or investigating a suspected violation of law;
(C) disclosure in a complaint or other document filed in a lawsuit or other proceeding, if the filing is made under seal;
(D) disclosure to an attorney representing the Receiving Party for use in the court proceedings of a lawsuit alleging that the Disclosing Party retaliated against the Receiving Party for reporting a suspected violation of law, as long as any document containing the Confidential Information is filed in court only under seal and the Receiving Party does not otherwise disclose the Confidential Information except under a court order;
(E) 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).
Comment
Subdivisions (a)(1)(A) through (a)(1)(D) have in mind the (U.S.) Defend Trade Secrets Act, enacted in 2016. [CITE NEEDED]. This legislation followed fierce assertions by several U.S. Government agencies that a company may not even arguably discourage, let alone prohibit, the company's employees from disclosing whistleblower information to the agencies. For example, in 2015 the Securities and Exchange Commission went after well-known government contractor KBR for this; the contractor agreed to the entry of a cease-and-desist order and to pay $130,000 settlement. [SEC press release] [SEC order] [Houston Chronicle article] See also the 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.
6.1.4.5 Authorization for Certain Copying
Clause text
(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 the Agreement.
(b) The Receiving Party must ensure that any such copy or excerpt is marked, with reasonable prominence, as the Confidential Information of the Disclosing Party.
(c) For the avoidance of doubt, the confidentiality obligations of the Agreement apply to all such copies or excerpts.
6.2 Confidential Information – optional provisions
- 6.2.1. Protection Limited to Specified Information Categories
- 6.2.2. Confidentiality of Affiliate Information
- 6.2.3. Warranty of Disclosure Authority
- 6.2.4. Presumption of Confidentiality
- 6.2.5. Consent Requirement for Specific Disclosures
- 6.2.6. Disclosing Party's Indemnity Obligation
- 6.2.7. Obligation to Segregate Confidential Information
- 6.2.8. Obligation to Instruct Individual Recipients
- 6.2.9. Return or Destruction Obligation
- 6.2.10. Exception to Return-or-Destruction Obligation
- 6.2.11. Requirement to Obtain Advance Consent to Destruction
- 6.2.12. Obligation to Provide Certificate of Return or Destruction
- 6.2.13. Agreement Not to Rely on Confidential Information
- 6.2.14. Disclaimer of Obligation to Provide Confidential Information
- 6.2.15. Option to Retain Archive Copies
- 6.2.16. Requirement for Archive-Custodian Independence
- 6.2.17. Disclosing Party's Right to Inspect Confidentiality Compliance
- 6.2.18. Receiving Party's Indemnity Obligation
- 6.2.19. Obligation to Cooperate Against Misappropriators
- 6.2.20. Obligation to Provide Recipient Confidentiality Agreements
- 6.2.21. Receiving Party's Liability for Recipient Misappropriation
- 6.2.22. Reasonable-Efforts Option re Return or Destruction
- 6.2.23. Receiving Party Representation of Intentions
- 6.2.24. Receiving Party Freedom of Action
- 6.2.25. Residuals Rights
- 6.2.26. Disclosure in Secure Data Room
- 6.2.27. Disclosure in Public Filings
6.2.1 Protection Limited to Specified Information Categories
Clause text
For particular information to be considered Confidential Information, it must fall into a Protected Information Category specified in the Agreement (all categories if not otherwise specified).
Comment
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.
6.2.2 Confidentiality of Affiliate Information
Clause text
(1) The 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 the Agreement.
(2) For the avoidance of doubt, the marking requirement of subdivision (a) applies regardless whether the Agreement requires Confidential Information of the Disclosing Party itself to be marked as such.
Comment
This affiliate-information 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.
- This language 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.
6.2.3 Warranty of Disclosure Authority
Clause text
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.
6.2.4 Presumption of Confidentiality
6.2.5 Consent Requirement for Specific Disclosures
6.2.6 Disclosing Party's Indemnity Obligation
Clause text
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.
Comment
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. Such an indemnity obligation, though, might expose the breaching party to greater liability than it would otherwise have; see Indemnity liability might be much more than plain breach-of-contract damages for a more extensive discussion.
6.2.7 Obligation to Segregate Confidential Information
Comment
Drafters should consider whether the receiving party's notes can realistically be segregated.
A segregation requirement might have been useful in S.W. Energy Prod. Co. v. Berry-Helfand, No. 13-0896 (Tex. June 10, 2016). In that case, an independent oil-and-gas reservoir engineer disclosed trade-secret information to a production company under a nondisclosure agreement; when the relationship waned, the engineer asked for the information to be returned, but that proved problematic, as one individual ended up retaining some of the information in his files. See id., slip op. at 7.
6.2.9 Return or Destruction Obligation
Clause text
(a) A Specimen of Confidential Information is any copy of, and any physical object embodying, Confidential Information — for example, any paper- or electronic copy and any specimen of hardware — where the copy or physical object 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.
(b) IF: The Disclosing Party makes a seasonable written request following any termination or expiration of the Agreement; THEN: except as provided in sections 6.1.3.8 and (if applicable) 6.2.22, the Receiving Party will promptly:
Comment
An obligation to return or destroy Confidential Information might not be practical if (for example) Confidential Information is embodied in a deliverable (for example, custom-developed computer software, or a physical object) that the receiving party will have the right to keep on using; this might be the case in a services agreement.
PRO TIP: Unfortunately, sometimes parties forget about return-or-destruction obligations. A disclosing party will want to follow up to be sure that the return-or-destruction requirement is actually complied with; if it were to fail to do so, a receiving party (or a third party) could try to use that as evidence that the disclosing party did not take reasonable precautions to preserve the secrecy of its confidential information, as discussed in this annotation.
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.
SUGGESTION: Consider requiring segregation of Confidential Information — or a Receiving Party could elect to segregate Confidential Information on its own initiative, even without a contractual requirement — for easier compliance with this section.
6.2.10 Exception to Return-or-Destruction Obligation
Clause text
(a) 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.
(b) For the avoidance of doubt, any Specimen of Confidential Information not returned or destroyed remains subject to the Confidentiality Obligations.
6.2.11 Requirement to Obtain Advance Consent to Destruction
Clause text
When returning or destroying The Receiving Party may not destroy any Specimen of Confidential Information without the prior written consent of the Disclosing Party.
Comment
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.
6.2.12 Obligation to Provide Certificate of Return or Destruction
Clause text
IF: The Disclosing Party so requests in writing within a reasonable time after the return-or-destruction provisions of the Agreement become applicable; THEN: The Receiving Party will promptly provide the Disclosing Party with a certificate of its compliance with those provisions. 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 the Agreement.
Comment
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 …
- thereby give the Receiving Party an incentive to do a good job in complying with the return-or-destruction requirement; and
- thus help the parties identify specific areas that might need attention before a dispute arose, and thus possibly help to avoid the dispute in the first place.
6.2.13 Agreement Not to Rely on Confidential Information
Clause text
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 the Agreement.
Comment
Some language in this provision is in bold-faced type to make it conspicuous.
See also CD-24.13. Reliance Disclaimer.
6.2.14 Disclaimer of Obligation to Provide Confidential Information
Clause text
For the avoidance of doubt, the Disclosing Party is not required to provide any particular Confidential Information to the Receiving Party except to the extent, if any, that the Agreement expressly indicates otherwise.
6.2.15 Option to Retain Archive Copies
Clause text
(a) Unless otherwise agreed, the Receiving Party may maintain archive copies of Confidential Information for an indefinite period.
(b) The archive copies of Confidential Information may include reasonable backup copies.
(c) No archive copy of Confidential Information is to be used except for the following:
(1) helping the Receiving Party to ascertain and confirm its compliance with its continuing confidentiality obligations;
(2) documenting the parties' interactions in connection with the Agreement; and
(3) reasonable testing of the accuracy the archive copies
(d) 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.
(e) Archive copies and the Confidential Information contained in the copies are not to be made accessible to Receiving-Party personnel — other than Archive Custodians, if the Agreement permits Receiving-Party personnel to serve in that role — except (1) with the Disclosing Party's prior written consent, or (2) as directed or permitted by a tribunal of competent jurisdiction.
Comment
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.
6.2.16 Requirement for Archive-Custodian Independence
Clause text
The Receiving Party may engage one or more independent Archive Custodians, each of which must be reasonably acceptable to the Disclosing Party, to maintain, in strict confidence, on behalf of the Receiving Party, a set of archive copies of Confidential Information.
Comments
If the Archive Custodian(s) does not need to be "independent" (a term well-understood by corporate lawyers), then the Custodian(s) might be, for example, the receiving party's IT staff. Alternatively, 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 by 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.)
6.2.17 Disclosing Party's Right to Inspect Confidentiality Compliance
Clause text
(a) At any time that the Receiving Party has Confidential Information in its possession, 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 the 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.
6.2.18 Receiving Party's Indemnity Obligation
Clause text
(a) The Receiving Party will defend and indemnify the Disclosing Party, its Affiliates, and the Associated Individuals of each of them, against:
(1) 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;
(2) all harm resulting from any violation of law in 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 the Agreement.
Comment
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.
6.2.19 Obligation to Cooperate Against Misappropriators
Clause text
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.
6.2.20 Obligation to Provide Recipient Confidentiality Agreements
Clause text
(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.
6.2.21 Receiving Party's Liability for Recipient Misappropriation
Clause text
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 the 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.
Comment
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).
See also CD-6.2.19. Obligation to Cooperate Against Misappropriators.
6.2.22 Reasonable-Efforts Option re Return or Destruction
Clause text
The Receiving Party need only make commercially-reasonable efforts to carry out its obligations of the return-or-destruction provisions of this section.
6.2.23 Receiving Party Representation of Intentions
Clause text
(a) The Receiving Party makes a representation to the Disclosing Party (the Receiving Party's Representation), concerning the Receiving Party's status and its intentions for the use of Confidential Information, as follows: FILL IN.
(b) The Receiving Party makes the Receiving Party's Representation:
(1) to induce the Disclosing Party to provide the Receiving Party with access to Confidential Information, and
(2) with the intent that the Disclosing Party rely on that representation.
Comment
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 TO AT&T AGREEMENT NEEDED].
6.2.24 Receiving Party Freedom of Action
Clause text
(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 the Agreement ("Disclosed Information").
(b) In respect of the Disclosed Information, the Receiving Party's sole confidentiality obligations are:
(1) the confidentiality obligations of the 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 the 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.
Comment
Some receiving parties might want this "roadblock" clause to use as ammunition in litigation.
6.2.25 Residuals Rights
Clause text
(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 the 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.
Comment
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.
See also:
- 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)
6.2.26 Disclosure in Secure Data Room
Clause text
(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 the Agreement.
(b) Any such prospective recipient of Confidential Information must agree in writing to abide by the Receiving Party's obligations in the 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.
Comment
This provision was inspired by a blog posting by English lawyer Mark Anderson.
See generally the Wikipedia article Data room.
6.2.27 Disclosure in Public Filings
Clause text
The Receiving Party may include Confidential Information in a submission to a regulatory agency or other governmental body, if all of the following conditions are met:
(1) the inclusion is compelled by law, to the same extent as if the inclusion were compelled by law in response to a Compulsory 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 Compulsory Legal Demand.
Comment
A Receiving Party that is publicly traded (or wants to be) 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.
Additional notes: Confidential Information
Gouge (that is, important points to know)
FOR PARTIES THAT MIGHT BE DISCLOSING THEIR CONFIDENTIAL INFORMATION:
- Whose information should be protected? If the other party is also a Disclosing Party, then the first Disclosing Party would have confidentiality obligations concerning the other party's Confidential Information.
- Too-short a Protected-Disclosure Period could result in the Disclosing Party's inadvertently blowing its legal rights in later-disclosed Confidential Information.
- Too-short a Confidentiality-Obligation Period: Ditto.
- If the agreement includes a marking requirement for Confidential Information, the Disclosing Party might inadvertently neglect to comply with the marking requirement as to particular information — which might destroy the Disclosing Party's legal rights in that information.
- Some of the receiving-party playbook options could be troublesome.
FOR PARTIES THAT MIGHT BE RECEIVING ANOTHER PARTY'S CONFIDENTIAL INFORMATION:
- Too-long a Protected-Disclosure Period could result in the Receiving Party's unwittingly running afoul of confidentiality obligations long after the business purpose of the NDA had vanished.
- A requirement to return or destroy Confidential Information might be very burdensome.
Two-way vs. one-way confidentiality agreements
Overview
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 two-way confidentiality agreement will usually be signed sooner
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 confidentiality agreement will usually be safer
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.
A two-way agreement might help avoid future embarrassment
Suppose that Alice and Bob enter into a confidentiality agreement that protects only Alice's information.
Also suppose that the agreement's terms were strongly biased in favor of Alice.
Now suppose that, at a later date, the parties decide that they also needed to protect Bob's confidential information as well, so that Bob can disclose it to Alice.
In that case, with the shoe on the other foot, Alice might not want to live with the obligations that she previously made Bob accept.
As a result, whoever negotiated the (one-way) confidentiality agreement for Alice might find himself in a doubly-embarrassing position:
- First, Alice's negotiator would be asking Bob to review and sign a new confidentiality agreement, and having to explain why Alice isn't willing to live with the same terms she pressed upon Bob.
- Second, Alice might ask pointedly of her negotiator, Why didn't you do this the right way in the first place, instead of wasting everybody's time?
So it's often a good idea to insist that any confidentiality provisions be two-way in their effect from the start, protecting the confidential information of both parties.
Business context for confidentility agreements
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.
Confidentiality agreements ("NDAs") and potential investors
Potential investors in a company might be reluctant to sign a nondisclosure agreement ("NDA"). Venture capitalists in particular often flatly refuse to do so. 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.
Caution: NDAs and prospective BigCo partners / acquirers
It's not unheard of for a big company to approach a small company about being "partners," perhaps hinting that the big company might want to acquire the small company. In that situation, the small company should be alert to the possibility that the big company might be trying to get a free look at the small company's confidential information. See, e.g., this story told by an anonymous commenter on Hacker News.
An NDA can come in very handy in such situations. Enforcing an NDA can take a lot of time and money, especially if the big company is convinced (or convinces itself) that it hasn't done anything wrong. 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.)
Review questions about confidentiality agreements
FACTS:
You represent Seller, Inc., which is considering signing a confidentiality agreement ("NDA," or nondisclosure agreement) with a potential customer, Buyer, Inc.
The NDA says:
The Receiving Party acknowledges that the Confidential Information is proprietary to the Disclosing Party, has been developed and obtained through great efforts by the Disclosing Party and that Disclosing Party regards all of its Confidential Information as trade secrets.
QUESTION 1: Are you OK with this?
MORE FACTS: The NDA contains blanks to be filled in for who will be the "Disclosing Party" and who will be the "Recipient."
QUESTION 2: What should be filled in?
QUESTION 3: Should the NDA include a time limit for when disclosure can be made in confidence? Why or why not?
MORE FACTS: The NDA includes a number of exclusions from the definition of Confidential Information. One of those exclusions is that information subject to a third-party subpoena is not considered Confidential Information.
QUESTION 4: Would you object to this? Why?
QUESTION 5: What would be a better alternative?
MORE FACTS: The NDA states:
The Receiving Party acknowledges that any breach or threatened breach of this Agreement by the Receiving Party would result in irreparable harm to the Disclosing Party, entitling the Disclosing Party to temporary and permanent injunctive relief against the breach; the Receiving Party waives any requirement that the Disclosing Party post a bond.
You remember seeing this sort of clause in a lot of NDAs.
QUESTION 6: From Seller's perspective, do you see any problem with this clause? [Hint: Check out this provision and this one.]
8 [Goods, purchases and sales of]
8.1 Changes to Orders for Goods Upon Customer Request
(a) For any order for goods under the Agreement, Customer may at any time, by written request, make changes to any one or more of the following, so long as all changes are within the general scope of the order:
- quantity;
- specifications;
- drawings or designs;
- packaging;
- method of shipment;
- place of delivery;
- time of delivery;
- grade or quality;
9 Letter of Intent
- 9.1. Final, Formal Agreement Prerequisite
- 9.2. Preservation of Any Separate Confidentiality Agreement
- 9.3. Exclusivity (if Any) to Be Expressly Stated
- 9.4. Option to Terminate Negotiations
- 9.5. Good-Faith Obligations Deemed Satisfied
- 9.6. Performance Before Signature Not Binding
- 9.7. Good-Faith Negotiation Obligation
- Additional notes: Letters of intent
- Self-test questions for letters of intent
9.1 Final, Formal Agreement Prerequisite
Clause text
(a) The parties are entering into a letter of intent, which is referred to here as "the LOI" (and which might be captioned as a memorandum of understanding or some similar title), for the following purposes:
(1) to set out the parties' agreed "ground rules" for their anticipated discussion concerning the potential transaction or relationship that is the subject matter of the LOI, referred to here as the Proposed Arrangement; and
(2) to provide the parties with a tentative, written summary of at least some aspects of their current thinking about the Proposed Arrangement, for use as a convenient reference.
(b) The parties currently intend, but are not making a binding commitment, to negotiate, sign, and deliver a final, integrated, definitive agreement that sets forth all material terms of the Proposed Arrangement (referred to here as an Arrangement Agreement).
(c) Each party acknowledges — with the intent that the other party rely on that acknowledgement in entering into the LOI — and expressly agrees not to assert otherwise:
(1) that the parties have not yet reached agreement on all material terms for the Proposed Arrangement;
(2) that in respect of the Proposed Arrangement, neither party will have any enforceable right against the other nor be bound by any obligation — whether the purported right or obligation allegedly arises in contract, tort, strict liability, quantum meruit, quasi-contract, or otherwise — other than those rights and obligations identified in the LOI as binding, if any — unless and until:
(i) all parties have signed and delivered an Arrangement Agreement, assuming one is agreed to; and
(ii) any other prerequisites stated in the LOI have been met; and
(3) that the other party would not go forward with discussions about the Proposed Arrangement but for the parties' acknowledgement above and the parties' agreement to these "ground rules."
Comment
Subdivision (a) explains to a future reader — mainly, judges — why the parties are bothering to enter into a letter of intent instead of simply proceeding straight to drafting and negotiating an Arrangement Agreement.
Subdivision (a)(1): The term "Proposed Arrangement" is borrowed from generally accepted accounting principles, which require "[p]ersuasive evidence of an arrangement" before revenue can be recognized.
Subdivision (b): Concerning the "intent that the other party rely" language, see the discussion of reliance disclaimers.
Subdivision (c)(2): For annotated examples of short- and long-form provisions that the parties might wish to indeed be binding, see American Bar Association Section of Business Law, Letters of Intent (Ancillary Document B to Model Stock Purchase Agreement, Second Edition), Part Two, at 10.
9.2 Preservation of Any Separate Confidentiality Agreement
Clause text
For the avoidance of doubt, the LOI neither limits nor expands any separate confidentiality agreement that may exist between the parties.
Comment
Letters of intent often contain their own extensive confidentiality provisions, but sometimes parties enter into separate confidentiality agreements. See also the Common Draft confidentiality provisions.
9.3 Exclusivity (if Any) to Be Expressly Stated
Clause text
Unless the LOI expressly states otherwise, the LOI is non-exclusive; each party is free to seek, discuss, negotiate, and/or enter into arrangements that are similar (or even identical) to the Proposed Arrangement, with other parties, even if as a result the party in question would no longer be willing or able to enter into the Proposed Arrangement.
Comment
In some LOIs, one or both parties might insist on an exclusivity provision; this should be negotiated carefully.
9.4 Option to Terminate Negotiations
Clause text
Unless the LOI expressly states otherwise:
(a) No party is obligated to continue in negotiations for the Proposed Arrangement; any party may terminate or withdraw from such negotiations at any time unless, and until, an Arrangement Agreement is signed and delivered by all parties.
(b) For the avoidance of doubt, unless the LOI expressly states otherwise, a party that wishes to terminate or withdraw from negotiations may do so:
(1) in its sole discretion;
(2) with a view toward none but its own interests and desires; and
(3) without obligation or liability of any kind, under any legal- or equitable theory, to any other party.
Comment
Note the "optics" approach taken by subdivision (b)(2), which specifically does not state that any obligation of good faith and fair dealing implied by law will not apply. Leaving aside whether such a statement would be enforceable, imagine how a judge or juror might react to the statement — or how it might look if reported in the newspaper.
Analogously, consider UCC § 1-302(b) (which applies only to contracts that come within the scope of the UCC): "The parties, by agreement, may determine the standards by which the performance of those obligations [of good faith, etc.] is to be measured if those standards are not manifestly unreasonable."
9.5 Good-Faith Obligations Deemed Satisfied
Clause text
Each party is to be considered to have satisfied any applicable standard of good faith, fair dealing, or similar duty, in the negotiation of an Arrangement Agreement.
Comment
This provision tries to forestall a claim that a party failed to comply with a putatively-applicable duty of good faith or fair dealing.
This provision isn't phrased as "the duty of good faith doesn't apply." Leaving aside whether such a statement would be enforceable, imagine how a judge or juror might react to the statement — or how it might look if reported in the newspaper.
Analogously, consider UCC § 1-302(b) (which applies only to contracts that come within the scope of the UCC): "The parties, by agreement, may determine the standards by which the performance of those obligations [of good faith, etc.] is to be measured if those standards are not manifestly unreasonable."
9.6 Performance Before Signature Not Binding
Clause text
(a) The parties anticipate that one or both parties might begin performance of some or all of its obligations, and/or the exercise of some or more of its rights, contemplated for the Proposed Arrangement, before all parties have signed and delivered the Arrangement Agreement.
(b) Each party agrees:
(1) not to assert that neither such performance nor such exercise by a party, nor the acceptance of such performance by another party, in itself, constitutes the agreement, by that party or any other, to be bound in respect of the Proposed Arrangement until the prerequisites of this section 9 have been satisfied; and
(2) that any such performance or exercise is at the acting party's own risk and expense except to the extent (if any) that the parties have expressly agreed otherwise in writing.
Comment
Every first-year law student (at least in the U.S.) learns that an offer for a contract can be accepted by performance. See, e.g., UCC § 2-206. Moreover, under state law a partnership can arise even without a contract.
According to a Texas jury, a partnership arose in that way in the Energy Transfer Partners, L.P. v. Enterprise Products Partners case, where:
- The parties got well underway in building an oil pipeline, even though they'd only signed a supposedly-non-binding (but quite-detailed) "non-binding" letter agreement (which I'll call a letter of intent or "LOI").
- The jury found that:
- the parties, by their post-LOI actions, had in fact formed a partnership, and
- the defendant had breached its fiduciary duties as a partner, notwithstanding all the disclaimers in their LOI.
- The jury awarded the plaintiff $319 million in damages; the judge later added $150 million in disgorged profits and $66.4 million in pre-judgement interest
The case is discussed in ETP v. Enterprise Products: a Cautionary Tale for Prospective Joint Venturers (Sidley.com 2014); see also, e.g., Olivia Pulsinelli, Judge orders Enterprise Products Partners to pay $535.8M in pipeline dispute, Houston Business Journal, July 30, 2014. At this writing, so far as I know, an appeal is pending.
In that case, the LOI included the following language:
Neither this letter nor the JV [Joint Venture] Term Sheet create any binding or enforceable obligations between the Parties
and, except for the Confidentiality Agreement dated March 16, 2011 between the Parties (the "Confidentiality Agreement"),
no binding or enforceable obligations shall exist between the Parties with respect to the Transaction
unless and until the Parties have received their respective board approvals
and definitive agreements memorializing the terms and conditions of the Transaction
have been negotiated, executed and delivered by both of the Parties.
Unless and until such definitive agreements are executed and delivered by both of the Parties, either EPD or ETP, for any reason, may depart from or terminate the negotiations with respect to the Transaction at any time
without any liability or obligation to the other, whether arising in contract, tort, strict liability or otherwise.
Defendants' Exhibit 1 (provided to the author by ETP's trial counsel; extra paragraphing added).
An earlier letter agreement stated that Enterprise and ETP intended to get started on preparations for the pipeline project while they continued to negotiate a definitive agreement — and it spelled out how the parties would unwind the deal if they did not sign and deliver a definitive agreement by a stated date.
Enterprise later walked away from the project and built another pipeline in collaboration with a different company.
The jury accepted that, despite what the LOI said, Enterprise had acted like a partner — a key ETP demonstrative exhibit (provided to the author by ETP's trial counsel) argued that Enterprise had:
- issued press releases;
- made representations to third parties; and
- exercised joint control.
A commentator noted another example:
If the draft agreement contains terms that are unfavorable to a party and that party performs, but the agreement is never executed, that party may have to live with those unfavorable terms.
In DC Media Capital, LLC v. Imagine Fulfillment Services, LLC, 2013 WL 46652 (Cal. App. Aug. 30, 2013) (unpublished), a California appellate court held that a contract electronically sent by a customer to a vendor and not signed by either party was nevertheless enforceable where there was performance by the offeree.
The court held that the defendant’s performance was acceptance of the contract, particularly because the agreement did not specifically preclude acceptance by performance and expressly require a signature to be effective.
Jeffrey Neuburger, Meeting of the Minds at the Inbox: Some Pitfalls of Contracting via Email (Proskauer.com June 2015) (extra paragraphing added). (Hat tip: Brian Rogers a.k.a. @theContractsGuy.)
Review questions
Facts (based on an actual case)
- A hospital and a catering company enter a contract for the catering company to provide various food services, including stocking selected hospital refrigerators with specific food items.
- As a performance incentive, the contract sets up what amounts to a system of fines, under which the company's payment can be reduced for mistakes.
- The hospital reduces the catering company's payment by more than $128,000 when the hospital finds, in one of its refrigerators, a chocolate mousse whose expiration date was the previous day.
- The catering company claims that the hospital has violated its duty of good faith and fair dealing in imposing the payment reduction.
The specific contract language concerning "good faith" is as follows:
3.5 The Hospital and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Hospital to derive the full benefit of the Contract.
Questions
- Under this contract language (and without regard to what the law might say), does the Hospital have: (A) a general duty to cooperate in good faith with the Contractor, or (B) only a limited, specific duty to cooperate in good faith with the Contractor "as is necessary for the efficient transmission of information and instructions and to enable the Hospital to derive the full benefit of the Contract" ?
- What would the answer be if Texas law applied?
- What would the answer be if the UCC applied?
- What would the answer be if the Restatement (Second) applied?
- What would the answer be if English law applied?
- How might you add internal clause numbering, e.g., (a), (1), (i), etc., to the contract language (but make no other significant changes) to make it clear that the Hospital did have a duty of good faith and fair dealing?
- How might you add such internal clause numbering to the contract language (but make no other significant changes) to make it clear that the Hospital did not have a duty of good faith and fair dealing?
9.7 Good-Faith Negotiation Obligation
Clause text
Each party will negotiate in good faith in attempting to reach agreement to the Arrangement Agreement.
Comment
CAUTION: Business people sometimes like to include provisions like this to signal (or protest) their own bona fides. But business people also sometimes think such provisions are mere throwaways. That's far from the case: in many jurisdictions, an agreement to negotiate in good faith will be legally binding — and is likely to be a serious mess to litigate.
[DCT TO DO: Links to further reading?]
Additional notes: Letters of intent
- Business reasons for a letter of intent
- Letters of intent are like teen-aged sex (SFW)
- All the disclaimer language in the world might not be enough
- Pennzoil v. Texaco: The granddaddy of all LOI lawsuits
- Saying "subject to contract" likely won't be enough
- LOI drafting tip: "Would do X" is better than "will do X"
- Further reading
Business reasons for a letter of intent
Business people often like to sign a letter of intent ("LOI") when negotiating a transaction. Many lawyers prefer to go straight to contract drafting, but the business people's perspective is understandable, because:
- A letter of intent gives the business people something they can take to their bosses to demonstrate that they are making "progress" in getting the deal done.
- A letter of intent can also be useful for publicity purposes — although a public disclosure of a letter of intent might be taken for an indicator that the parties really intended for the LOI to be a binding agreement.
Letters of intent are like teen-aged sex (SFW)
Letters of intent and business people can be like sex and teenagers: You can tell the business people that they're likely to be better off not doing it, but sometimes they really, REALLY want to. You won't always be there to chaperone them, and let's face it, in the throes of desire they're likely to forget — or ignore — your advice.
The “consequences” of entering into a letter of intent can be significant if a court finds that the parties intended to enter into a binding contract. The canonical example of this danger, of course, is that of Texaco, Inc. v. Pennzoil Co., discussed below. In that case, Texaco was hit with a damage award of some $10.5 billion, or more than $22 billion in 2014 dollars, for interfering with Pennzoil's agreement with Getty Oil — in the form of a memorandum of understanding — under which Pennzoil would buy Getty.
Unless you want to be stuck dealing with such consequences, it might be a good idea to try to make sure that your "teenagers" use protection if they ignore your advice and start messing around with LOIs. The usual form of protection takes the form of various disclaimers of any intent to be bound.
All the disclaimer language in the world might not be enough
A supposedly-nonbinding letter of intent is one of the scarier types of contract out there. The same is true of its sibling, the memorandum of understanding (MOU). Despite all the disclaimers in the world, a court might hold that the parties' subsequent actions resulted in a binding commitment. For an example of strong LOI language that was nevertheless trumped by the parties' actually getting underway with performance of their putative contract (and a resulting $500-plus-million jury verdict and profits award), see the discussion of the Energy Transfer Partners v. Enterprise Products Partners lawsuit.
As an American Bar Association task force report noted:
There are many things that can overcome the carefully crafted words in a letter of intent purporting to make a document or certain provisions in a document nonbinding.
Loosely worded e-mails, oral communications, and other actions are often given great weight by courts in interpreting the intent of the parties.
Oral statements such as "Looks like we have a deal!" or handshakes can indicate an intent to be bound.
American Bar Association Section of Business Law, Letters of Intent (Ancillary Document B to Model Stock Purchase Agreement, Second Edition), at 4-5 (extra paragraphing added).
Pennzoil v. Texaco: The granddaddy of all LOI lawsuits
Any drafter preparing a letter of intent is well-advised to become familiar with the opinion of the Texas court of appeals in the famous case of Pennzoil v. Texaco, where a jury held Texaco liable for over $10 billion for tortiously interfering with Pennzoil's agreement to buy shares of stock in Getty Oil. See Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. – Houston [1st Dist.] 1987, writ ref'd n.r.e.) (affirming judgment against defendant Texaco as to liability and actual damages, but ordering a remittitur as to punitive damages); see also, e.g., Tamar Lewin, Pennzoil-Texaco Fight Raised Key Questions, N.Y. Times, Dec. 19, 1987; L.M. Sixel, Handshake in New York led to courtroom drama in Texas, Houston Chronicle, Sept. 7, 2016.
The facts in Texaco are somewhat complicated; the key facts are basically this: Pennzoil and the owners of some 51% of Getty Oil signed a "Memorandum of Agreement" that by its terms was subject to approval by the board of Getty Oil. The board initially rejected the deal, but then approved it after a modification (to which Pennzoil agreed). Shortly afterwards, Texaco swooped in with a better offer; the Getty Oil board repudiated the Pennzoil deal and accepted Texaco's offer. Pennzoil's lawsuit against Texaco then followed.
(Author's note: the case was tried in Houston, where it and the subsequent appeals were front-page news for weeks on end.)
On appeal, the parties agreed that New York substantive law applied; the opinion of the Texas court of appeals summarized the relevant points of that law:
Under New York law[:]
- [I]f parties do not intend to be bound to an agreement until it is reduced to writing and signed by both parties, then there is no contract until that event occurs.
- If there is no understanding that a signed writing is necessary before the parties will be bound, and the parties have agreed upon all substantial terms, then an informal agreement can be binding, even though the parties contemplate evidencing their agreement in a formal document later.
- If the parties do intend to contract orally, the mere intention to commit the agreement to writing does not prevent contract formation before execution of that writing, and even a failure to reduce their promises to writing is immaterial to whether they are bound.
- However, if either party communicates the intent not to be bound before a final formal document is executed, then no oral expression of agreement to specific terms will constitute a binding contract.
Thus, under New York law, the parties are given the power to obligate themselves informally or only by a formal signed writing, as they wish.
The emphasis in deciding when a binding contract exists is on intent rather than on form. … Several factors have been articulated to help determine whether the parties intended to be bound only by a formal, signed writing:
- whether a party expressly reserved the right to be bound only when a written agreement is signed;
- whether there was any partial performance by one party that the party disclaiming the contract accepted;
- whether all essential terms of the alleged contract had been agreed upon; and
- whether the complexity or magnitude of the transaction was such that a formal, executed writing would normally be expected.
Id. at 788-89 (extra paragraphing and bullets added, citations omitted).
Saying "subject to contract" likely won't be enough
Just saying that the LOI is "subject to contract" might not be enough to avoid a binding effect. In Pennzoil v. Texaco:
- The press releases issued by the Getty entities and Pennzoil, announcing their deal, said that "the transaction is subject to execution of a definitive merger agreement."
- That wasn't enough to save Texaco from liability of over $10 billion; the court said that "[r]egardless of what interpretation we give to the conditional language in the press release, we conclude that it did not so clearly express the intent of the parties not to be bound to conclusively resolve that issue, as Texaco asserts."
Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768, 789-90 (Tex. App. – Houston [1st Dist.] 1987, writ ref'd n.r.e.) (affirming judgment against defendant Texaco as to liability and actual damages, but ordering a remittitur as to punitive damages) (quoting press release).
LOI drafting tip: "Would do X" is better than "will do X"
Another lesson from the Texaco v. Pennzoil case is that an LOI's description of the proposed deal should say that the parties would do X, Y, and Z if the deal goes through, as opposed to that they will do X, Y, and Z — the latter could well be viewed as evidence that the parties had indeed reached a final and binding agreement:
Any intent of the parties not to be bound before signing a formal document is not so clearly expressed in the press release to establish, as a matter of law, that there was no contract at that time.
The press release does refer to an agreement "in principle" and states that the "transaction" is subject to execution of a definitive merger agreement.
But the release as a whole is worded in indicative terms, not in subjunctive or hypothetical ones. The press release describes what shareholders will receive, what Pennzoil will contribute, that Pennzoil will be granted an option, etc.
729 S.W.2d at 790 (emphasis in original, extra paragraphing added).
An ABA committee recommends going even further:
In Paragraph 1 and throughout Part One [setting out a non-binding outline of the proposed deal], the word "would" is used this word is intended to convey the conditional nature of the proposed acquisition and to contrast with the more definite words used in the binding provisions of Part Two, such as "will."
Other conditional terms may also be used, such as "prospective buyer," "prospective seller," and "proposed transaction." While the conditional language of Part One may appear awkward and stilted at times, it provides another indication of the parties’intent that the provisions of Part One are not be [sic] binding.
American Bar Association Section of Business Law, Letters of Intent (Ancillary Document B to Model Stock Purchase Agreement, Second Edition), at 7 (extra paragraphing added).
Further reading
See also, for example: 8 Steps to Keep Your Letter of Intent Non-Binding (angellawoffices.com; undated).
Self-test questions for letters of intent
QUESTION 1: In a letter of intent, what kinds of terms might the parties want to be binding? Hint: Think about (i) how long it might take to actually get the formal contract drafted and signed, once the LOI is signed, and (ii) what external events might intervene during that interval.
See subdivision (c)(2) of this provision and the associated commentary.
FACTS:
- You represent a party that is negotiating a non-binding letter of intent ("LOI") for a signficant transaction that is to be carefully negotiated. Your client is anxious to get the LOI signed so that the negotiation for the transaction itself can proceed.
- The other side prepares a draft of the LOI, setting forth the basic deal terms that have been discussed to date, and also including some provisions such as a confidentiality provision; an arbitration provision, and a no-shop provision.
- The draft LOI contains a disclaimer legend at the top of the first page, in bold-faced all-capital letters: SUBJECT TO CONTRACT. That's the only reference to whether some or all of the LOI is to be binding or non-binding.
QUESTION 2: Given your client's desire to hurry, is it worth bothering with to ask the other side to beef up the LOI's disclaimer legend? Or is the disclaimer legend, on its own, likely to be enough?
Given that some provisions are to be binding, it would probably be a bad idea to rely on just the disclaimer legend, as Texaco learned to its sorrow.
MORE FACTS: You beef up the LOI with "iron-clad" (um, yeah, sure) disclaimers of binding effect.
QUESTION 3: Might the parties still end up being bound by the agreement described in the LOI? If so, how? If not, why not?
Performance or even partial performance of the transaction described in the LOI might be enough to bind the parties; see the discussion of the Enterprise case in the commentary to CD-9.6. Performance Before Signature Not Binding.
10 [Licensing of IP]
10.0.0.1 What is an IP license, exactly?
As far as patent licenses go, a federal court in Silicon Valley explained that a so-called patent license is simply a promise, by the patent owner, not to sue the licensee for infringing the patent:
Under federal law, there is no substantive difference between an unconditional covenant not to sue and a non-exclusive license. The real question is not whether an agreement is framed in terms of a covenant not to sue or a license. That difference is one of form, not substance—both are properly viewed as authorizations.
A patent license is nothing more than a promise by the patent owner not to sue the licensee.
No particular language or form is necessary to give a license its effect[;] any language from which one may properly infer that the owner consents to his use of the patent in making or using it, or selling it constitutes a license.
Innovus Prime, LLC v. Panasonic Corp., No. C-12-00660-RMW, slip op. at 7 part II-C-2 (N.D. Cal. July 2, 2013) (granting defendant's motion for summary judgment; plaintiff patent owner acquired its rights in the patent subject to prior owner's grant of license to defendant) (extra paragraphing added; citations, internal quotation marks, and alteration marks by the court omitted).
14 Services
- 14.1. Definitions: Provider, Customer
- 14.2. Statements of Work
- 14.2.1. Exclusive Services Obligations in Statements of Work
- 14.2.2. No Obligation to Agree to Statement of Work
- 14.2.3. Requirement for Written Changes to Statements of Work
- 14.2.4. Terms re Statements of Work as Separate Agreements
- 14.2.5. Precedence of Statements of Work
- 14.2.6. Electronic Signatures for Statements of Work
- 14.3. Permits and Licenses Responsibilities
- 14.4. Services Performance Obligation
- 14.4.1. Workmanlike Performance
- 14.4.2. All Necessary Tasks and Materials
- 14.4.3. Provider Control of Means and Manner
- 14.4.4. Defects
- 14.4.5. Limitation on Provider Use of Customer Confidential Information
- 14.4.6. Notification of Bodily Harm or Significant Property Damage
- 14.4.7. Provider Cooperation With Other Customer Contractors
- 14.4.8. Customer Option to Perform Services Itself
- 14.4.9. Limitation of Customer Liability for Hindering Performance
- 14.4.10. Restrictions on Suspension of Work
- 14.4.11. Presumption of Proper Performance
- 14.5. Billing for Services
- 14.6. [Reserved: Services indemnities]
- 14.7. Customer's Rights in Deliverables
- 14.8. Ownership of Services-Produced IP
- 14.9. Requirements Upon Termination of Statement of Work
- Additional notes: Services
14.1 Definitions: Provider, Customer
Comment
The definitions of both Provider and Customer are set up to allow a drafter to simply incorporate this by reference ("grab and go").
CAUTION: Drafters should consider whether there might be a dispute about whether particular services performed by a provider are "governed by the Agreement" — conceivably there might be circumstances in which one party or another claims that particular services were, or were not, so governed.
14.2 Statements of Work
- 14.2.1. Exclusive Services Obligations in Statements of Work
- 14.2.2. No Obligation to Agree to Statement of Work
- 14.2.3. Requirement for Written Changes to Statements of Work
- 14.2.4. Terms re Statements of Work as Separate Agreements
- 14.2.5. Precedence of Statements of Work
- 14.2.6. Electronic Signatures for Statements of Work
14.2.1 Exclusive Services Obligations in Statements of Work
Clause text
(a) The only obligations of Provider to perform services under the Agreement (Services), and the only obligations of Customer to pay for Services, will be as set forth in one or more written statements of work, each signed by Provider and Customer (each, a Statement of Work or SOW).
(b) The Agreement itself may contain a Statement of Work in its provisions, in an exhibit, in an appendix, etc.
Comment
It's extremely common for services agreements to separate the "technical" details of a services contract in a statement of work.
Caution: Some contract reviewers make the mistake of ignoring statements of work, on the sometimes-mistaken assumption that only "technical" information is to be found there. It's a worthwhile exercise for a contract drafter or reviewer (here, "reviewer") at least to glance through any statement of work, because:
- the reviewer will be better able to negotiate the terms and conditions if she has some idea of the technical details; and
- perhaps unconsciously — or perhaps not unconsciously — the other side's drafter might have included important "legal"-type terms and conditions in the statement of work, in the hope that the contract reviewer might overlook them.
14.2.2 No Obligation to Agree to Statement of Work
Clause text
For the avoidance of doubt, no party is obligated to enter into or agree to any particular Statement of Work under the Agreement except to the extent (if any) that the Agreement expressly states otherwise.
Comment
This section is intended to rule out claims by a contractor that a customer implicitly guaranteed that the contractor would get X amount of work. This was litigated in a case by a small contractor against, I believe, IBM; if memory serves, IBM won the case on summary judgment, but it still had to defend against the claim. (Unfortunately I can't find a citation.)
14.2.3 Requirement for Written Changes to Statements of Work
Clause text
No change to a Statement of Work — including, for example, to its specification of the scope, cost, or schedule of Services or Deliverables — will be binding unless set forth in a writing signed by the party sought to be bound; each party specifically agrees not to assert the contrary.
Comment
Both parties often want to require that changes to statements of work must be in writing, but it's not clear that a court would enforce it – see the discussion in the commentary to CD-24.1.1. Amendments in Writing.
14.2.4 Terms re Statements of Work as Separate Agreements
Clause text
Each Statement of Work is to be treated as a separate agreement that incorporates the Agreement by reference, whether or not the incorporation is expressly stated.
Comments
This provision states that each statement of work is a separate agreement. In contrast, some services contracts purport to incorporate each statement of work into the "main" agreement, so that each statement of work becomes part of the main agreement. This is unwise, in my view, because:
- a default in one statement of work could affect other statements of work (this is sometimes referred to as "cross-default"); and
- if the vendor's liability for damages were to be capped at "the amounts paid under the Agreement," then that amount would grow over time as more statements of work were completed; the customer might like that just fine, but the vendor likely wouldn't be wild about the idea.
14.2.5 Precedence of Statements of Work
Clause text
In the event of a conflict or other inconsistency between a Statement of Work and the Agreement, the Statement of Work will take precedence, but only if it says so explicitly and conspicuously in the top half of its first page.
Comments
Not without reason, some corporate legal departments want to maintain tight control over contract-related documentation; they don't want statements of work — which might not be reviewed by "Legal" and could raise all kinds of legal issues — to supersede the contract provisions. (To paraphrase a private remark by a lawyer who shall remain nameless, I keep trying to make my master services agreements idiot-proof, but they keep making better idiots.)
That approach, though, can conflict with the way parties actually do business and could delay getting things done.
This provision attempts a compromise, namely to allow a statement of work to override the terms of a master agreement — but the parties must be explicit about it.
14.2.6 Electronic Signatures for Statements of Work
Clause text
Statements of Work may be signed electronically.
Comment
Some companies are reluctant to allow electronic signatures for statements of work — because of the wide variety of communications that might qualify as "signatures," for example, emails — and instead prefer to require "wet ink" signatures on paper.
14.3 Permits and Licenses Responsibilities
14.3.1 Provider Responsibilities for Permits and Licenses
Clause text
Provider, at its own expense, will cause to be timely obtained:
(1) any professional- or occupational licenses required by law for the performance of services generally (e.g., contractor licenses) by Provider and/or its subcontractors (if any) to the extent necessary for performance of the Services;
(2) any government permits (for example, building permits and the like) that are required by law for performance of the Services; and
(3) any third-party intellectual-property licenses required for Provider to take the specific actions involved in performing the Services, including, for example, any such licenses required for Provider's use of software, data compilations, and similar tools.
Caution: Starting licensed work without a license could cost a provider big bucks
In California, a contractor that undertakes work required to be done by a licensed contractor (e.g., certain construction- or remodeling work), but that does not itself have the proper license(s) at all times while performing the work, may forfeit its right to be paid for any of the work. See, e.g., Great West Contractors, Inc., v. WSS Industrial Construction, Inc., 162 Cal. App. 4th 581, 76 Cal. Rptr. 3d 8 (2d Dist. 2008) (reversing $220,000-plus judgment in favor of subcontractor, on grounds that subcontractor had not obtained the required license when it prepared initial shop drawings and did other preliminary work).
Moreover, under a 2002 'disgorgement' amendment to the California statute, such a contractor might have to repay any payments it did receive for the work. Cf. The Fifth Day, LLC v. Bolotin, 72 Cal. App. 4th 939 (2d Dist. 2009) (reversing summary judgment that party was barred from recovering compensation for services; party was not a "contractor" within the meaaning of the statute).
Caution: Using an unlicensed subcontractor can lead to liability for wages, etc.
California courts have looked to Cal. Lab. Code § 2750.5 to hold that a contractor that uses an unlicensed subcontractor is responsible for unpaid wages, withholding, and worker’s compensation premiums of the subcontractor’s employees; see generally this Pillsbury Winthrop memo.
Other notes
Subdivision (2): In some circumstances — building a natural-gas pipeline comes to mind — the government-permitting process could be a decidedly non-trivial matter.
Subdivision (3): Note that this is a different subject than IP licenses needed for Customer's use of deliverables, discussed below.
14.3.2 IP Licenses for Customer's Use of Deliverables
(a) Except as stated in subdivision (b), as between Provider and its subcontractors (if any) on the one hand, and Customer on the other hand, it is Customer's exclusive responsibility to obtain any licenses or other authorizations required for Customer's use of the Deliverables.
(b) Subdivision (a) does not apply to the extent that Provider expressly warrants that Customer's use of Deliverables will not infringe any third-party intellectual-property rights.
Comment
Even if the Agreement includes a warranty that Deliverables per se do not infringe third-party IP rights, that might not provide Customer with much comfort about third-party infringement claims arising from Customer's use of the Deliverables. In the U.S., cf. UCC § 2-312, which provides in part that:
(3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyerwho furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications.
14.3.3 Procedure for Disagreements About Permit- and License Requirements
Clause text
IF: Provider advises Customer in writing that a particular third-party approval, of any kind, may be necessary for Provider to perform some or all of the Services;
AND: Customer responds in writing that, in Customer's view, the approval in question is not required to proceed with the portion of the Services in question;
THEN: Provider will not be in breach of the Agreement or the relevant Statement of Work if, by written notice to Customer, Provider suspends work, temporarily or indefinitely, on the relevant portion of the Services.
Comment
Suppose that Provider believes that (let's say) performance of the Services would infringe a third party's patent rights, but Customer disagrees. Provider might want to:
- have the right to suspend work; and/or
- ask Customer to defend and indemnify Provider, its Affiliates, and the Associated Individuals of each of them, from any claim arising from the lack of the third-party approval.
See also the indemnity option for permits.
14.3.4 Indemnity Obligation for Permits and Licenses
Clause text
Any party obligated to obtain permits and licenses under the Agreement will defend and indemnify each other party against any third-party claim arising from the party's failure timely to carry out that obligation.
Comment
See:
CD-14.3.1. Provider Responsibilities for Permits and Licenses
CD-14.3.3. Procedure for Disagreements About Permit- and License Requirements.
Keep in mind that damages for breach of a contractual obligation would normally be limited to foreseeable damages, whereas an indemnity obligation might encompass even unforeseeable damages (unless otherwise specified in the indemnity language); see this note for additional details.
14.4 Services Performance Obligation
- 14.4.1. Workmanlike Performance
- 14.4.2. All Necessary Tasks and Materials
- 14.4.3. Provider Control of Means and Manner
- 14.4.4. Defects
- 14.4.5. Limitation on Provider Use of Customer Confidential Information
- 14.4.6. Notification of Bodily Harm or Significant Property Damage
- 14.4.7. Provider Cooperation With Other Customer Contractors
- 14.4.8. Customer Option to Perform Services Itself
- 14.4.9. Limitation of Customer Liability for Hindering Performance
- 14.4.10. Restrictions on Suspension of Work
- 14.4.11. Presumption of Proper Performance
14.4.1 Workmanlike Performance
Clause text
Provider will cause all Services to be performed:
(1) in a workmanlike manner — this refers to a manner that generally would be considered proficient by those who successfully engage in the relevant trade or profession, without necessarily rising to the level of being exceptional, outstanding, or original; and
(2) in accordance with any additional requirements of performance, timeliness, or both, stated in the Statement of Work.
Business context
The performance-related provisions of services contracts are sometimes intensely negotiated. Customers can sometimes want very-demanding performance requirements (often because they've been "burned" before by poor performance). This provision requires the performance of services not only to meet the Performance Standard, but also to meet any timeliness requirements of the Statement of Work.
Language notes
This performance-requirement language sets forth a covenant, that is, a promise, and not a representation or warranty – although a warranty is a type of covenant (specifically, a conditional covenant); see Black's Law Dictionary at 1725 (9th ed.2009), quoted in Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 293 (Tenn. 2011).
The "considered proficient" language comes from a decision by the Supreme Court of Texas, discussing the implied warranty of good and workmanlike quality of services in connection with the repair of tangible goods. See Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 354 (Tex. 1987), quoted in Ewing Constr. Co. v. Amerisure Ins. Co., 420 S.W.3d 30, 37 (Tex. 2014) (responding to certified question from Fifth Circuit).
The "without necessarily rising to the level of being exceptional, outstanding, or original" language is adapted from an alternate definition in the Merriam-Webster dictionary, namely "competent and skillful but not outstanding or original."
What does "workmanlike" mean?
The term workmanlike, defined in a Common Draft provision, seems to be widely used in court decisions, sometimes as "skillful and workmanlike" (which would be redundant). See generally Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 292-93 (Tenn. 2011) (extensively reviewing case law and treatises).
Implied warranties of workmanlike performance
Drafters should be aware that in some states the law might automatically impose a warranty of workmanlike performance, or something close to it. See, e.g., Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 291-94 (Tenn. 2011) (citing numerous authorities but not defining workmanlike).
Implied warranties of workmanlike performance come into play especially in connection with the sale of a new residence. The imposed warranty might even be non-waivable and/or non-disclaimable. For example:
- Home construction: Forty-three states provide an implied warranty of habitability for new residences, according to the Utah supreme court, while three others provide a warranty of workmanlike manner. See generally Davencourt at Pilgrims Landing Homeowners Association v. Davencourt at Pilgrims Landing LC 30, 2009 Utah 65, 221 P.3d 234, 250 (reversing dismissal of implied-warranty claim; "in every contract for the sale of a new residence, a vendor in the business of building or selling such residences makes an implied warranty to the vendee that the residence is constructed in a workmanlike manner and fit for habitation").
- Repairs of tangible goods or property: In its Melody Homes decision, cited above, the Texas supreme court held that an implied warranty of good and workmanlike performance extends to repairs of tangible goods or property. Two sharp dissents (in the form of concurrences in the judgment) noted that the court had defined that implied warranty in a manner that might well require expert testimony in many cases (but that would seem to be true of almost any standard of performance of services).
See also CD-19.5. Implied Warranty Disclaimer and its associated commentary.
Alternative performance standards
Some service providers might balk at using the term "workmanlike" performance because they fear the term could be ambiguous. They might prefer in accordance with the specifications, or perhaps competent and diligent.
Of course, any of those terms is likely to involve factual determinations in litigation or arbitration, so it's hard to see how one is more- or less favorable than the other.
On the other hand, some customers prefer stricter standards of performance such as, for example:
- In a professional manner: This is found in many customer-oriented forms, but providers don't like it because of a concern that, in the minds of judges and juries, the term professional might subtly raise the bar of expected performance.
- In accordance with industry standards: This phrase and workmanlike seem synonymous, in which case the latter term is more conventional and more likely to find acceptance among contract reviewers and the courts.
- In accordance with the highest professional industry standards: For a provider, this is the worst of all worlds: Not only is the phrase vague, but a provider that agrees to this might as well hang a "Kick Me" sign on its own back, because anything less than perfection would be open to cricitism in court. (On a related note, see also the discussion of best efforts.)
Performance standards: Further reading
See generally, e.g.:
- J. Norman Stark, "Workmanlike Manner," Defined (Lorman.com, undated) (citing a few cases).
- Timothy Davis, The Illusive Warranty of Workmanlike Performance: Constructing a Conceptual Framework, 72 Neb. L. Rev. (1993).
14.4.2 All Necessary Tasks and Materials
Clause text
Without limiting section 14.4.1: Except to the extent (if any) provided otherwise in the Agreement and/or in the Statement of Work, Provider will cause the following to be done at no additional expense to Customer:
(1) the performance of all individual tasks necessary for the proper rendering of the Services set forth in the Statement of Work, even if one or more such individual tasks is not expressly set forth there; and
(2) the provision of all materials, equipment, supplies, computer hardware and -software, work locations, electrical power, Internet- and other communications capability, and other items needed for Provider's performance of the Services — this obligation includes any necessary acquisition, installation, and maintenance of all such items.
Comment
For some services projects, it might make sense for Customer to provide some of the listed items. If so, that should be documented in the Statement of Work.
Subdivision (2): Some customers are likely to want this language for comfort purposes. A provider might be concerned that such language could lead to disputes about expensive (and delay-causing) "scope creep"; my own guess, though, is that this language wouldn't do any significant harm. Here's why: Suppose the parties were to end up fighting about the scope of what the provider is supposed to do. In that case, the presence or absence of this language seems unlikely to make a difference one way or the other. So, if this language gives a customer some comfort, why not include it; doing so can help to remove a potential delay on the path to signature.
14.4.3 Provider Control of Means and Manner
Clause text
As between Provider and Customer, Provider will at all times have the exclusive right and the exclusive obligation to control:
(1) the means and manner, and
(2) except as specified otherwise in the Statement of Work, the time and place,
of the performance of the Services.
Comment
See the commentary to the independent-contractor provision(s).
14.4.4 Defects
Clause text
Provider will address any defects in Services, or in Deliverables as delivered by or on behalf of Provider, in accordance with section 18.6.
14.4.5 Limitation on Provider Use of Customer Confidential Information
Clause text
Under the Agreement, Provider:
(1) will not obtain any ownership of Customer's confidential information or other intellectual property as a result of performing the Services; and
(2) may not utilize Customer's confidential information or intellectual property, EXCEPT that Provider may do so solely to the extent necessary for performance of the Services.
14.4.6 Notification of Bodily Harm or Significant Property Damage
Clause text
IF: Any injury to person or significant property damage occurs in connection with the Services; THEN: Provider will promptly:
(1) notify Customer;
(2) respond orally to any reasonable inquiry by Customer and/or Customer's agents concerning the event(s) in question; and
(3) if so requested by Customer, provide Customer or its designee with a non-privileged report of the event(s).
14.4.7 Provider Cooperation With Other Customer Contractors
Clause text
(a) If so requested by Customer, Provider will provide reasonable cooperation with other contractors of Customer in their provision of goods or services for Customer.
(b) The obligation of subdivision (a) is not to be interpreted as, in itself, requiring Provider to do any of the following:
(1) share its confidential information with other contractors;
(2) license its proprietary technology (if any) to other contractors;
(3) perform services not within the scope of the Statement of Work;
(4) take or omit any action where (i) doing so is not required by the Statement of Work, and (ii) a non-trivial risk exists that doing so would increase Provider's cost of complying with the Statement of Work.
14.4.8 Customer Option to Perform Services Itself
Clause text
(a) Customer may elect to perform itself some or all Services (the Elected Services).
(b) Provider will provide reasonable cooperation with Customer in Customer's performance of the Elected Services if Customer so requests.
(c) As between Provider and Customer, Customer will be solely responsible for the performance of all Elected Services.
(d) Any failure of timely performance of the Elected Services is to be taken into account in determining whether Provider is liable for failure to timely perform other Services that are dependent on the Elected Services.
(e) For the avoidance of doubt, this section does not in itself require Provider to share its confidential information with, nor to license its proprietary technology (if any) to, Customer.
14.4.9 Limitation of Customer Liability for Hindering Performance
Clause text
(a) This section applies if Customer, directly or indirectly, delays, obstructs, disrupts, or hinders the performance of the Services (collectively, Customer Hindrance).
(b) Except to the extent (if any) that the Agreement expressly provides otherwise, in subdivision (c) or elsewhere:
(1) Provider will not be entitled to damages for any Customer Hindrance, of reasonable duration, that was within the reasonable contemplation of the parties;
(2) Provider will not make any claim for monetary relief in respect of any such Customer Hindrance; and
(3) Provider's EXCLUSIVE REMEDY for any such events will be an extension of time to complete Provider's performance, of a duration sufficient to compensate for the Customer Hindrance.
(c) For purposes of subdivision (b)(1), denial of job-site access by Customer is not within the reasonable contemplation of the parties unless the denial of access is:
(1) expressly contemplated by the Agreement or otherwise agreed in writing by the parties;
(2) required in case of genuine emergency; or
(3) in accordance with clearly-established and clearly-applicable standard practice.
(d) For purposes of subdivision (b)(1), willful misconduct and reckless- or grossly-negligent conduct by Customer or its agents are not within the reasonable contemplation of the parties.
Comment
This optional provision immunizes Customer if it gets in Provider's way; the provision adapts ideas from:
- C and E Elec., Inc. v. Town of Bethel, No. SC 19162 (Conn. Aug. 5, 2014), in which the state supreme court affirmed rejection of an electrical contractor's claim for additional costs incurred during its work at a school due to interference from ongoing asbestos abatement at the school;
- Jeff Yick, No Damage for Delay (MDCSystems.com, undated), which contains numerous case citations and discussions; and
- Daniel J. Kraftson, No-Damage-for-Delay Contract Clauses (KraftsonCaudle.com, undated), which discusses numerous specific examples of Customer-caused delays.
Drafters should consider including "active interference" by Customer as among the carve-outs to the no-damages-for-delay clause; see generally the discussions in the Yick and Kraftson articles cited above.
In some jurisdictions, though, such a carve-out might be unnecessary, because the majority rule in the U.S. appears to be that, for public-policy reasons, no-damages-for-delay clauses are unenforceable with respect to delays resulting from deliberate and wrongful interference. See Zachry Constr. Co. v. Port of Houston Auth., 449 S.W.3d 98 (Tex. 2014) (reversing court of appeals, with extensive case citations). In that case, the Texas supreme court joined the majority view, although four of its nine justices dissented on other grounds, namely that governmental immunity barred recovery of such damages in that particular case.
14.4.10 Restrictions on Suspension of Work
Clause text
In no event may Provider suspend or terminate performance of the Services except as expressly provided in the Agreement or in the relevant Statement of Work.
Comment
This language ties up a potential loose end in an American Institute of Architects contract form, the relevant clause of which was litigated in U.W. Marx, Inc. v. Koko Contracting, Inc., 124 AD 3d 1121 (N.Y. App. 2015).
14.4.11 Presumption of Proper Performance
Clause text
A performance of Services that conforms to the express requirements of the Agreement (including for example those set forth in the relevant Statement of Work, if applicable) is presumed to have met the Performance Standard; overcoming that presumption as to particular Services requires a showing that those Services were negligently performed.
Comment
The presumption of satisfactory performance comes from Coulson v. Lake LBJ Mun. Utility Dist., 734 S.W.2d 649, 651 (Tex. 1987) (reversing and remanding court of appeals's setting aside of judgment on jury verdict in favor of defendant service provider).
14.5 Billing for Services
14.5.1 Billing Requirements
Clause text
Billing for Services is to be:
(1) as specified in the Statement of Work (if applicable);
(2) accompanied by supporting detail sufficient to document the invoiced charges; and
(3) in accordance with CD-17.1.1. Payment Terms.
14.5.2 Option to Suspend Work for Nonpayment
Clause text
IF: Customer does not pay Provider an amount due under the Agreement within seven days following the original payment due date (the Nonpayment Grace Period; AND: The nonpayment is not due to fault attributable to Provider; THEN:
(1) Provider may suspend its performance of the relevant Services at any time beginning at the end of seven days following notice of suspension (the Required Suspension Notice Period), without prejudice to Provider's other remedies for the nonpayment; and
(2) The price of the relevant Services is to be appropriately adjusted for account for Provider's reasonable costs, including for example those (if any) associated with:
(A) any resulting delay; and
(B) redeployment of personnel- and material resources in connection with (i) the suspension of work and (ii) any resumption of work.
Comment
This language is modeled on an American Institute of Architects contract form, which was litigated in U.W. Marx, Inc. v. Koko Contracting, Inc., 124 AD 3d 1121 (N.Y. App. 2015).
Drafters should consider providing for an independent expert to oversee and, if necessary, to decide the pricing adjustment in subdivision (2).
See also CD-14.4.10. Restrictions on Suspension of Work .
14.5.3 Requirement of Timely Payment as Condition of Customer's Rights
Clause text
Customer's timely payment of any amounts required by the applicable Statement(s) of Work in respect of a particular Deliverable is a prerequisite to Customer's continued exercise of its rights in that Deliverable.
Comment
A customer likely will object to a clause like this; the customer will assert that a minor payment dispute should not call into question the customer's right to use the deliverable(s), possibly even disrupting an M&A transaction.
A provider, on the other hand, will legitimately be concerned that the customer might file for bankruptcy protection, meaning that the customer would continue to enjoy its rights in the deliverable(s) while paying the provider pennies on the dollar if anything.
In the U.S., as a compromise the provider might want: •
- to take a security interest in the customer's right to use the deliverable(s), using a clause provision such as [TO BE DRAFTED]; and
- to "perfect" the security interest by filing a UCC-1 financing statement.
14.5.4 Prohibition of Work Suspension for Payment Disputes
Clause text
In no event may Provider suspend or terminate performance of the Services because of a payment dispute.
Language origin
This language is modeled on § 2.5 of a 2008 outsourcing agreement between Boise Cascade, L.L.C., and Boise Paper Holdings, L.L.C.
14.7 Customer's Rights in Deliverables
14.7.1 Customer's Right to Use Deliverables
Clause text
(a) Customer has the right to utilize any and all Deliverables in Customer's business as Customer sees fit, EXCEPT to the extent (if any) that the Agreement, or the relevant Statement of Work, expressly states otherwise.
(b) Customer's right under subdivision (a) applies to any and all intellectual-property rights owned or otherwise assertable by Provider.
(c) Customer acknowledges that its right under subdivision (a) might be subject to any applicable rights of third parties, for example intellectual-property rights, UNLESS Provider warrants otherwise in writing.
Comment
This will normally be a no-brainer.
Providers of computer software might want to consider also CD-14.7.4. Prohibition of Customer Service-Bureau Use of Deliverables.
14.7.2 Customer's Right to Further Develop Deliverables
Clause text
(a) Customer may modify any Deliverable or have it modified by one or more third parties. For this purpose, "modify" includes, for example, development of improved or otherwise-revised or -altered versions of the Deliverable, including for example derivative works in the case of copyrightable works.
(b) Customer may not modify any Deliverable, nor cause or induce the same, in violation of:
(1) any restrictions imposed by law, for example export-controls laws that might preclude sending Deliverables (or technical information about them) to contractors in other countries; and
(2) Provider's intellectual-property rights not relating to the Deliverable(s) as delivered (if any) to the extent (if any) that such modification or further development is not authorized in writing by Provider. (This subdivision does not limit Customer's right to utilize the Deliverable as delivered by or on behalf of Provider pursuant to section 14.7.1)
Comment
Customers sometimes want the unfettered right to modify or further develop the deliverables furnished by the provider. Their general attitude can be summed up as: We paid for you to build this, so we should be able to do whatever we want with it.
A customer's right to modify Deliverables is not always a given, though. under standard intellectual-property law, just because a customer paid for a deliverable does not mean it necessarily gets to do whatever it wants with the deliverable. In particular, if the deliverable is a copyrighted work of authorship such as computer software, the provider might have the right to prevent the customer from modifying or inproving the deliverable without the provider's permission.
(In litigation the customer might be able to argue successfully that the provider implicitly granted the customer a license to do whatever it wanted with the deliverable; see, e.g., TO DO: CITATION TO SOFTWARE DEV. CASES NEEDED.)
If a provider will be creating something that the customer will be using in its business, the customer might well want to nail down its right to modify or further develop the deliverable.
Some software-related deliverables, though, might include trade secrets of the provider. In that type of situation, the provider likely won't want any of its competitors to have access to the deliverables.
CAUTION: Subdivisions (a) and (b)(2) have been drafted to tr to avoid having them be inconsistent, but drafters should pay attention to that possibility.
14.7.3 Option for Provider to Decline Support for Others' Modifications
Clause text
(a) Provider may, in its sole discretion, decline to provide support for a Deliverable if Provider reasonably determines that the request for support arises from or relates to modification of the Deliverable by any individual or organization other than (i) Provider, or (ii) an individual or organization expressly authorized or directed in writing by Provider to make that modification of the Deliverable.
(b) This section neither authorizes nor prohibits Customer from modifying any Deliverable.
14.7.4 Prohibition of Customer Service-Bureau Use of Deliverables
Clause text
Customer may not use any Deliverable, nor knowingly assist or permit the use of any Deliverable, for service-bureau use, which refers to the providing of services to or for third parties where such services are comprised substantially of functions performed by one or more Deliverables.
Comment
A provider might want to prevent the customer from using the provider's own software, equipment, etc. to go into competition with the provider. (The provider should ask, though, how likely this is to happen, and whether the associated business risk is worth arguing about it with the customer.)
14.8 Ownership of Services-Produced IP
Clause text
(a) As between Provider and Customer, unless the Agreement expressly provides otherwise, Provider (the IP Owner) will own the intellectual-property rights in and to:
(1) any Deliverables, and/or
(2) any Toolkit Items,
that may be created, in the performance of Provider's obligations under the Agreement, by one or more employees of Provider (and/or of Provider's subcontractors, if any).
(b) The provisions of CD-20.12. Intellectual Property Ownership apply to all such intellectual-property rights; upon request by the IP Owner, the other party or parties will take the steps called for by that section.
(c) IF: Customer is the IP Owner under subdivision (a); THEN: Provider will seasonably disclose to Customer, in writing and in detail, all intellectual property to be owned by Customer under subdivision (a).
(d) IF: Provider is the IP Owner under subdivision (a); THEN: Provider's ownership rights are subject to Customer's rights in the Deliverables under the Agreement.
Comment
Subdivision (a): Note the separation of ownership of the intellectual property contained in Deliverables versus IP in Toolkit Items.
It's not unusual for a big customer with barganing power to insist on owning the IP rights in any intellectual property that a smaller provider might create in the course of a services project. Such a customer's attitude is usually along the lines of, "if I pay for it, I own it."
Such a customer might want the right to sue third parties for infringing the IP rights in the Deliverables. If that were ever to be the case, it might be necessary for the customer to own the IP rights in order to establish the customer's standing to bring an infringement action. [CITATION NEEDED] In many cases, though, the customer really won't be especially concerned about third-party infringement, which would tend to negate that purported justification for demanding ownership of the IP rights.
Often a customer's insistence on IP ownership simply won't make business sense, because:
- The provider's ability to do projects at a reasonable price will often depend on its ability to re-use its work product from its prior projects.
- The customer's ownership could choke the provider's ability to compete in its market;
- The customer might have no particular reason to own the IP, other than "I wanna."
- The provider might not have standing to sue for infringement of the IP rights.
FALLBACK: If the customer persists in demanding outright ownership, the provider could propose that:
- The customer's ownership of intellectual-property rights extends only to the specific Deliverables identified in the statement of work.
- The provider has a permanent, irrevocable, worldwide, royalty-free license to use the IP for any and all purposes.
These would not be ideal for the provider, but could be an acceptable business risk.
14.9 Requirements Upon Termination of Statement of Work
14.9.1 Delivery of Work-in-Progress
Clause text
Unless the Statement of Work provides otherwise, upon any termination of a Statement of Work, Provider is to promptly deliver to Customer all completed- and partially-completed Deliverables for that Statement of Work.
Comment
It's not unusual for a customer to "pull the plug" on a statement of work if the provider isn't getting the job done. In that situation, the customer likely will want to get as much finished- and partially-completed work product as it can, so that the customer will have the option of getting someone else to finish the job.
14.9.2 Payment for Completed Work
Clause text
(a) Upon Customer's compliance with its obligations under section 14.9.1 after any termination of a Statement of Work, Customer is pay Provider as provided in the Statement of Work for all materials delivered under that section.
(b) IF: The Statement of Work specifies that payments are to be made based on meeting particular performance criteria, for example, milestone achievement; THEN: Provider will be entitled to payment only in accordance with the criteria actually and completely met as of the effective date of termination.
(c) IF: The Statement of Work is terminated for material breach by Provider; THEN: Customer's payment obligation under this section is to be adjusted (i) as agreed by the parties, or (ii) as determined by a tribunal of competent jurisdiction.
Comment
Subdivision (c) is likely to be important to a customer that "pulls the plug" because of (alleged) poor performance by the provider.
Drafters should consider requiring that disputes about amounts due must be resolved using CD-22.2.11. Baseball Arbitration Procedure.
Additional notes: Termination of statements of work
DCT notes from an article in a State Bar of California publication:
Upon termination of a technology-related services agreement, the customer will generally want:
- the right to obtain all its data in a usable form
- transfers of equipment, software licenses, third-party contracts
- the right to continue using Provider's proprietary technology
- access to Provider personnel
See Blaine Green and Michael Murphy, Lessons from Litigating Technology Services Agreements (PillsburyLaw.com 2014).
Additional notes: Services
In services contracts, customers typically want:
- for the obligations of service providers to be clearly specified;
- to get what they're paying for; and
- to shift as much responsibility and risk as possible onto the shoulders of the provider (and/or the provider's insurance carrier).
On the other hand, service providers typically want:
- to prevent "scope creep" (sometimes known as "requirements creep" or "mission creep") from causing cost increases or delays;
- to be free to re-use as much of their work product as they can for other work and other clients;
- to limit their liability for errors; and
- (of course) to get paid — on time, without having to bug the customer about it or fight out a dispute in court or arbitration.
15 [Software licensing]
15.1 References
- Honeywell–New Mexico Software Master Software License Agreement (edgar.sec.gov) (Honeywell is the licensee)
17 Payment Procedures & Related Matters
- 17.1. Payments
- 17.2. Expense Reimbursement
- 17.3. Invoice Requirements
- 17.4. Sales Taxes
- 17.5. Deposits
- 17.6. Pay If Paid
- 17.7. Pay When Paid
- 17.8. Interest
- 17.9. Usury Savings
- 17.10. Guaranty
- 17.11. Standby Letter of Credit (notes only, so far)
- 17.12. [Financial Assurance – to do later]
- 17.13. Payment Offsets Authorization
- 17.14. Payment Offsets Prohibition
- 17.15. COD Terms After Nonpayment
- 17.16. Non-Payment Not Infringement
17.1 Payments
17.1.1 Payment Terms
Clause text
Unless otherwise agreed in writing, all payments required by the Agreement:
(1) are to be made by any method to which the payee does not timely and reasonably object in writing (each, an Acceptable Payment Method); and
(2) are due and payable on or before net 30 days from receipt of a correctly-stated invoice (the Payment Due Date).
Comment
In the alternative, drafters might wish to consider one or more of the following:
- Change receipt of a correctly-stated invoice to the date of a correctly-stated invoice (which would give the payer less time to make a timely payment).
- Specify a discount for early payment, e.g., 2/10 net 30.
- Require payment by check; certified check; cashier's check; wire transfer or ACH to a bank account specified in writing by the payee; or, immediately-available funds.
- specify that any check must be drawn on a U.S. bank, or a bank reasonably acceptable to the payee.
For an example of very customer-biased payment terms, see section 13 of a Honeywell purchase order form, which provides not only for net-120-day terms, but for payment not even to be scheduled until then.
17.1.2 Payment Disputes
Clause text
(a) Any party disputing an amount that it putatively owes under the Agreement (for example, any party disputing an invoice) must:
(1) bring the dispute to the attention of the putative payee no later than the putative due date of the payment;
(2) furnish the putative payee with a written explanation of the paying party's basis for disputing the amount owed, together with (where applicable) reasonable supporting documentation; and
(3) timely pay any undisputed amount.
(b) IF: Other than for good reason clearly shown, the paying party does not comply with subdivision (a); THEN: The invoice in question invoice will be rebuttably presumed to be correct.
17.1.3 Separate Invoicing of Disputed Amounts
Clause text
IF: A paying party disputes part but not all of an amount invoiced; THEN: To facilitate timely payment:
(1) Upon written request by the payee, the paying party will issue a separate invoice for the undisputed portion.
(2) Payment for the undisputed portion will be due on the date that payment would have been due for the original invoice if none of it had been disputed.
17.2 Expense Reimbursement
17.2.1 Reimbursement Requirement
Clause text
(a) Reimbursing Party refers to a party required by the Agreement to reimburse another party, referred to as the 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 the Agreement.
Comment
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.
In subdivision (b), note the "reasonable" and "actually incurred" qualifiers.
17.2.2 Expense Mark-Up Limitation
Clause text
(a) In invoicing reimbursable expenses, the Incurring Party may mark up the expenses by up to the Maximum Permissible Expense Markup specified in the Agreement, if any.
(b) IF: the Agreement does not specify a Maximum Permissible Expense Markup; THEN: Expenses to be reimbursed under the Agreement are to be invoiced on a straight pass-through basis, with no markup.
Comment
See also:
Many contracts prohibit marking up of expenses, but some contracts are "cost-plus."
17.2.3 Written Expense-Reimbursement Policies
Clause text
(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 is not required to reimburse expenses, except in conformance with that policy.
(c) IF: The 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 the Incurring Party with a different written policy.
Comment
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.
17.2.4 Expense Pre-Approval Requirement
Clause text
The Reimbursing Party is not required to reimburse any expenses that it did not expressly approve in writing in advance.
17.2.5 Direct Billing of Expenses
Clause text
(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.
17.3 Invoice Requirements
Clause text
A party desiring payment from another party of an amount due under the Agreement must send the other party an invoice that meets the following requirements:
(a) The invoice must be in the language in which the Agreement is written or, if required by law, the destination country’s official language.
(b) The invoice must be sent to the invoicing address specified in the Agreement, if any, or if different, the invoicing address specified in the relevant ordering document, or failing both, at any reasonable address.
(c) The invoice must state at least the amount due and, in reasonable detail, what the amount is due for.
(d) If the Agreement expressly sets forth an invoice-submission schedule and/or an invoice-submission deadline: the invoice must be submitted in accordance with that schedule and no later than that deadline, as applicable, failing which the Invoicing Party may in its sole discretion deem payment to have been WAIVED and decline to pay the invoice.
Comment
Companies almost invariably want to receive invoices before paying amounts due, not least because they might be required to do so as part of their internal financial controls to help detect and prevent fraud. Yet many contracts don't even address the subject of invoices (although many do so).
Subdivision (b): A savvy party submitting an invoice will confirm the current address to which the invoice should be sent, lest the invoice be lost in the other party's internal correspondence routing system. (With the rise of electronic invoicing- and payment systems, this provision might become less relevant.)
Subdivision (c): Some companies want their suppliers' invoices to include (in addition to the details specified in this provision) information such as, for example:
- a purchase-order number;
- a supplier identification code;
- a contract identifier;
- part numbers;
- quantities;
- units of measure;
- hours billed;
- unit- and total prices;
- export- and safety-related information.
Subdivision (d): Invoicing schedules are often a subject covered in construction- and other services agreements, where the service provider wants to be paid as work is done, as opposed to waiting to be paid until the work is 100% complete.
Under (U.S.) generally-accepted accounting principles, publicly-traded companies likely will be required to account for expenses in a particular fiscal quarter, and might make it a policy not to pay invoices where that's not possible due to delay in submission. That's because if a supplier were to submit an invoice very late, conceivably the customer could have to restate its earnings for the relevant period. As the Hertz rent-a-car company's 2014 restatement reminded us, for a company to restate its earnings is generally considered a Very Bad Thing, not least because it can almost immediately lead to shareholder lawsuits claiming securities fraud.
HORROR STORY: This got my attention back when I was general counsel of a public company: I read about the general counsel of another public company. That company was incurring big legal bills (for a lawsuit, I think). From what I recall:
- The general counsel didn't submit the law firm's invoices to the company's finance department for payment; instead, he just put them in a drawer.
- When the general counsel did finally submit the invoices for payment, the newly-recorded legal expense had an unwanted effect: it materially affected his company's bottom line for the relevant time period.
- That meant that the company had to restate its earnings.
- The general counsel was fired.
I've tried to find the story online, including just now (August 2014), but have been unable to do so.)
17.4 Sales Taxes
17.4.1 Definitions: Collecting Party; Sales Tax
Clause text
(a) The term Collecting Party refers to any party that, under the Agreement, invoices another party for goods, services, or other things potentially subject to sales taxes (as defined below).
(b) The term sales tax (whether or not capitalized) includes all sales taxes; use taxes; value-added taxes; excise taxes; other forms of ad valorem tax and consumption tax; and equivalent taxes.
Comment
Sales-tax provisions are common in supply agreements and services agreements.
See generally:
- Ad valorem tax (Wikipedia)
- Consumption tax (Wikipedia)
- Excise tax (IRS.gov)
- Sales tax (Wikipedia)
- Sales and Local Tax Rates in 2015 (TaxFoundation.org) (extensively footnoted)
- Value-added tax (Wikipedia)
17.4.2 Collecting Party Obligations
Clause text
Unless the parties agree otherwise in writing in connection with a particular transaction, the Collecting Party will do the following, at its own expense:
(1) determine what if any sales taxes must be paid to an applicable jurisdiction in connection with the transaction;
(2) separately list all sales taxes in the relevant invoice; and
(3) timely report and remit all sales taxes to all relevant taxing authorities anywhere in the world (the Sales-Tax Authorities).
Comment
Determining just where sales taxes must be paid can be a non-trivial task. The issue has drawn major attention from taxing authorities in the age of Amazon.com and other Internet sellers. In supply- and services agreements, customers often want suppliers to take on this responsibility.
See also:
17.4.3 Income-Tax Exclusion
Clause text
For the avoidance of doubt, each party is solely responsible for payment of taxes based on its income, franchise, or capital, and such taxes are not to be billed to any other party under the Agreement, unless expressly stated otherwise in the Agreement.
Comment
Provisions like this are not uncommon in supply- and services agreements. On the other hand, though, in some transactions the price might be "grossed up" so that the amount received by the payee, net of all taxes, is a stated amount.
17.4.4 Sales-Tax Indemnity Obligation
Clause text
The Collecting Party is to defend and indemnify (i) each invoiced party, and (ii) each member of the invoiced party's Protected Group, against any claim by a taxing authority for unpaid Sales Taxes.
Comment
Customers sometimes ask for sales-tax indemnity provisions in supply- and services agreements.
As with any indemnity obligation, a would-be protected party should check whether the indemnifying party has the financial assets with which to meet the obligation; if not, the protected party should consider including a requirement that the indemnifying party carry suitable insurance coverage.
17.5 Deposits
Clause text
Deposits and other advance payments, if any, are to be applied as stated in the Agreement or as otherwise agreed in writing; any remaining balance of a deposit paid under the Agreement is to be promptly refunded, without interest.
Comment
Drafters can consider stating instead that deposit balances will be refunded with interest at a specified rate. CAUTION: Be very careful about usury laws.
17.6 Pay If Paid
Clause text
(a) This section applies if the Agreement clearly states that an obligation on the part of a Paying Party to make a particular payment (the Contingent Payment) is "pay if paid" or comparable wording, regardless of capitalization, in respect of the Paying Party's receipt of one or more Third-Party Payments.
(b) The Paying Party is not required to make the Contingent Payment until all specified Third-Party Payments have been unconditionally made to and accepted by the Paying Party — once that occurs, however, the Paying Party must promptly make the Contingent Payment.
(c) The Paying Party is not required to make any particular efforts to collect any Third-Party Payment; if the Paying Party elects to make such efforts, it does so in its sole discretion and solely for its own benefit.
(d) The party to which the Contingent Payment is owed (the "Payee") represents and warrants that in entering into the Agreement, the Payee:
(1) has considered each third party's solvency and willingness and ability to perform the terms of its contract with the Paying Party;
(2) is relying on the credit and willingness and ability to pay of the third party or third parties, not that of the Paying Party, for the Contingent Payment; and
(3) KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY ASSUMES AND ACCEPTS THE RISK that one or more third parties might be unable or unwilling to perform the terms of its contract with the Paying Party, in which case the Contingent Payment will not be paid (or will not be paid in full).
Comments: Introduction and example
Suppose that:
- A contractor enters into a contract with a homeowner, under which the contractor will remodel the homeowner's kitchen.
- The contractor enters into a subcontract with a painter, under which the painter will do the necessary painting in the kitchen.
In this example, pay if paid means that the contractor is not required to pay the painter unless the homeowner pays the contractor.
A pay-if-paid clause might preclude collecting on a surety bond
See BMD Contractors, Inc. v. Fid. & Dep. Co., 679 F.3d 643 (7th Cir. 2012) (applying Indiana law; affirming summary judgment in favor of surety). (The Common Draft pay-if-paid language is modeled in part on the pay-if-paid provision in that case; see id. at 647.) Hat tip: Steven L. Jones, “Paid If Paid” Clauses – Who Is Left Holding the Bag When a Project Owner Fails to Pay? (IceMiller.com 2015).
Pay-if-paid might be void as against public policy
In some jurisdictions, a pay-when-paid clause implicitly means within a reasonable time; for example, if an end-customer does not pay a prime contractor within a reasonable time, then the prime contractor — or more likely, the insurance carrier that wrote the prime contractor's payment bond — must pay the subcontractor anyway.
On the other hand, in a situation like this, a pay-if-paid clause makes the end-customer's payment a condition precedent to the subcontractor's right to payment; in other words, if the end-customer doesn't pay the prime contractor, then the subcontractor isn't entitled to payment even from the prime contractor's performance bond. This essentially puts the risk of non-payment on the subcontractor — and as a result, in in some jurisdictions the clause might be void as against public policy.
• For example, in New York, pay-if-paid clauses are void, but pay-when-paid are enforceable, according to that state's highest court:
We hold that a pay-when-paid provision which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy set forth in the Lien Law.
By contrast, a pay-when-paid provision which merely fixes a time for payment does not indefinitely suspend a subcontractor's right to payment upon the failure of an owner to pay the general contractor, and does not violate public policy as stated in the Lien Law.
West-Fair Elect. Contractors v. Aetna Cas. & Surety Co., 87 N.Y.2d 148, 158, 661 N.E.2d 967 638 N.Y.S.2d 394 (1995) (on certification from Second Circuit) (extra paragraphing added). The contract clause in question was this:
"IT IS SPECIFICALLY UNDERSTOOD AND AGREED THAT THE PAYMENT TO THE TRADE CONTRACTOR [plaintiff] IS DEPENDENT, AS A CONDITION PRECEDENT, UPON THE CONSTRUCTION MANAGER [the general contractor] RECEIVING CONTRACT PAYMENTS, INCLUDING RETAINER FROM THE OWNER".
Id. at 154 (alterations by the court, capitalization in original).
• In contrast, the Ohio supreme court upheld a pay-if-paid clause in Transtar Electric, Inc. v. A.E.M. Electric Serv. Corp., 2014 Ohio 3095; the court affirmed a summary judgment that the contract's "condition precedent" payment language was sufficient to transfer the risk of nonpayment by a customer from the prime contractor to its subcontractor. That language was as follows:
{¶ 4} … (c) the Contractor shall pay to the Subcontractor the amount due under subparagraph (a) above only upon the satisfaction of all four of the following conditions: * * * (iv) the Contractor has received payment from the Owner for the Work performed by the Subcontractor. RECEIPT OF PAYMENT BY CONTRACTOR FROM THE OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK.
Id. (capitalization in original, bolding omitted). The decision was subject to some criticism for not addressing public-policy considerations; see Scott Wolfe, Jr., Ohio Supreme Court Gets Pay If Paid Decision Wrong, Hurts Subcontractors (ZLien.com 2014).
• In New Jersey, the courts are split about pay-if-paid clauses, according to Michelle Fiorito, The Consequences of "Pay-If-Paid" and "Pay-When-Paid" Construction Contracts Clauses (ZDLaw.com 2012).
• Still another court — in passing, and arguably in a dictum — seems to have implicitly treated a pay-if-paid clause as a pay-when-paid provision. The case was Allstate Interiors & Exteriors, Inc., v. Stonestreet Constr., LLC, 730 F.3d 67 (1st Cir. 2013) (affirming judgment below; rejecting end-customer's challenge to district court's exercise of supplemental jurisdiction). In that case, the relevant contract clause was as follows: "It is agreed that the Contractor [Stonestreet], as a condition precedent to payment of any monies which become due to the Subcontractor, must first receive payment from the Owner." Id. at 70 (emphasis added). The court described the clause as a pay-when-paid clause. See id.
17.7 Pay When Paid
Clause text
(a) This section applies if the Agreement clearly states that an obligation on the part of a Paying Party to make a particular payment (the Contingent Payment) is "pay when paid" or comparable wording, regardless of capitalization, in respect of the Paying Party's receipt of one or more Third-Party Payments.
(b) The Paying Party is not required to make the Contingent Payment until it has received the Third-Party Payment, but the Paying Party must:
(1) make reasonable efforts to collect the Third-Party Payment; and
(2) make the payment promptly upon receiving the Third-Party Payment.
Comment
See the commentary to CD-17.6. Pay If Paid.
17.8 Interest
Clause text
(a) A party to which payment is owed under the Agreement may charge interest on past-due unpaid amounts at no more than 5% per annum simple interest or the maximum rate permitted by law under the circumstances, whichever is less (the Maximum Interest Rate), beginning no earlier than 30 days after the payment due date (the Earliest Interest Start Date).
(b) All payments are to be applied first to accrued interest (if any), then to unpaid principal, in each case in the order in which the obligations were incurred (that is, oldest-first).
Comments
Sequence of payments application
Subdivision (b): Provisions of this kind are often seen in promissory notes. This clause is adapted from a suggestion in David Cook, The Interest Tail Wags the Profit Dog, in Business Law News Issue No. 3, 2014 (State Bar of California Business Law Section; available on-line to Section members).
Will a payee really try to collect interest?
Whether a payee will actually charge and try to collect interest is a real question. For example, suppliers sometimes hesitate to charge interest to their customers, even if their contracts permit them to do.
Some large customers have been known to announce, imperiously: We don't pay interest, period. (On the other hand, some customers can be notoriously slow payers, insisting on as high as net-120-day terms from their suppliers.)
Putting an “interest on past due amounts” clause in an “audit rights” provision might backfire
It's probably a good idea to separate an interest clause from an audit-rights clause. Cellport Systems, Inc. won a lawsuit against Peiker, a German company, for unpaid patent royalties under a license agreement. The agreement included an audit provision that required Peiker to pay interest on past-due royalties at 1.5% per month. The trial court, however, awarded Cellport interest at the (lower) statutory rate, on grounds that, in context, the contractual interest rates was intended to apply only to underpayments revealed in an audit. The Tenth Circuit agreed that the lower rate was proper:
According to Cellport, the License Agreement's reference to the rate contains no limitations on its application.
As the district court explained, however, the sentence is in the middle of a paragraph devoted to Cellport's right to verify the royalty payments it is owed through audits. And we must interpret this provision in its context.
We agree with the district court that the interest rate was contractually intended to apply only to accounting disputes. The application of the statutory rate was appropriate.
Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, No. 13-1029, slip op. at 21-22 (10th Cir. Aug. 5, 2014) (affirming trial-court judgment in part; emphasis and extra paragraphing added).
17.9 Usury Savings
Clause text
The parties intend for any interest charged or paid in connection with the Agreement, in any contingency, to comply with law. Accordingly, IF: A charge or payment in connection with the Agreement is properly characterized as interest; AND: The charge or payment is determined to have exceeded the maximum interest permitted by law (after taking all permitted steps to spread such payments over time); THEN:
(1) The excess interest is to be deemed the result of an inadvertent error, even if the party charging or paid the excess intended to take the action(s) resulting in the excess;
(2) If the excess interest has not yet been paid, then the charge for the excess interest will be canceled; and
(3) If the excess interest has been paid, then the party that was paid the excess interest will refund it, or credit it to any balance still owed by the payer, along with interest on the excess at the maximum rate permitted by law.
Comments
Even an invoice for interest charges can be usurious without an agreement
Vendors sometimes add interest charges to invoices; doing so without the customer's prior agreement can result in the charge being usurious. See Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at part VI-B at 24-25, (SnowSpenceLaw.com; undated), which includes extensive citations to Texas case law.
Usury laws about maximum interest rates can have real teeth
If a party will be charging "interest," then before specifying an interest rate (or an interest start date), the party should be sure to check applicable usury laws, which can have real teeth, including forfeiture of principal and perhaps even criminal penalties. For example, in a case under Rhode Island's usury statute, a court found that "a $4 filing fee — which accounted for the only interest in excess of the maximum interest rate — rendered the entire loan usurious." NV One, LLC v. Potomac Realty Capital, LLC, 84 A.3d 800 (R.I. 2014), citing In re Swartz, 37 B.R. 776, 779 (Bankr. D.R.I. 1984).
Usury-savings provisions might not be given effect
Provisions such as this one, stating that excess interest will be promptly refunded, might or might not be effective in a given jurisdiction. Consider two contrasting examples:
- Texas law permits usury-savings clauses. See Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at 34 (SnowSpenceLaw.com; undated).
- On the other hand, Rhode Island's state supreme court acknowledged that Rhode Island's usury statute was "draconian" and "strong medicine." American Steel Coatings, LLC v. New England Development R.I., LLC, No. 2012-238-Appeal, slip op. at 11 (R.I. June 20, 2014). The court said that the legislature had put the risk of charging too-high an interest rate onto the lender in "an inflexible, hardline approach to usury that is tantamount to strict liability," id. at 13. The supreme court affirmed a trial-court ruling that a commercial loan agreement for more than $400,000 was void as usurious.
Interest start dates can also implicate usury laws
The usury statutes in some states (e.g., Texas) might prohibit charging interest before the end of a specified grace period.
Is a given late charge really "interest"?
Not all so-called "interest" charges will be subject to usury laws. For example, in Texas, interest is defined by statute as "compensation for the use, forbearance, or detention of money. The term does not include time price differential, regardless of how it is denominated. …" Tex. Fin. Code § 301.002(4); See Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at 9 (SnowSpenceLaw.com; undated).
What is this "time price differential" of which the statute speaks? One article explains the quoted term in relation to Texas law:
If certain requirements are met and a transaction is not designed to circumvent the usury laws, a merchant may sell merchandise at a higher price for credit than for cash and the price difference is not usurious. The new statute codifies the common law time-price doctrine.
In order to apply the time-price doctrine, it must be shown that the seller clearly offered to sell goods for both a cash price and a credit or time price, that the purchaser was aware of the two offers, and that the purchaser knowingly chose the higher time or credit price.
If an agreement fails to qualify as a time-price differential contract, then the finance charges may be found to constitute usurious interest.
Spence, supra, part VI-F at 27 (citations omitted, extra paragraphing added).
17.10 Guaranty
- 17.10.1. Guaranty Definitions
- 17.10.2. Guaranty Obligation
- 17.10.3. Guarantor Acceptance Waiver
- 17.10.4. Guaranty Collection Expenses
- 17.10.5. Bankruptcy Refunds
- 17.10.6. Guarantor Deficiency Liability
- 17.10.7. Guaranty Defenses WAIVER
- 17.10.8. Joint and Several Guarantor Liability
- 17.10.9. Unconditional Guarantor Liability
- 17.10.10. Alteration of Guaranteed Obligation
- 17.10.11. Reasonable Collection Efforts
- 17.10.12. Guarantor Liability Cap
- Additional notes: Guaranties
17.10.1 Guaranty Definitions
Clause text
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.
Creditor refers to any individual or organization to which a Guaranteed Payment Obligation is owed.
Payer refers to any person that owes a Guaranteed Payment Obligation.
Guaranteed Payment Obligation refers to any payment, under any Guaranteed Agreement, that is guaranteed in writing.
Guaranteed Agreement refers to the Agreement.
Guaranty Enforcement Forum refers to any court having jurisdiction.
Comment
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."
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 representing guarantors will want to be careful to define just which payment obligations are being guaranteed. A bit of an oddball case on this point was McLane Foodservice, Inc. v. Table Rock Restaurants, LLC, 736 F.3d 375 (5th Cir. 2013) (affirming district-court judgment in favor of alleged guarantor):
- A restaurant company, Table Rock, went out of business owing a food-service company, McLane Foodservice, some $447,000.
- McLane Foodservice apparently noticed that nearly 14 years earlier, the treasurer and 40%-owner of the Table Rock restaurant company had signed a personal guaranty of the debts of another restaurant company, Border Patrol, to a division of PepsiCo.
- In the interim, the PepsiCo division had sold its assets to another company, Ameriserve, which later filed for bankruptcy protection and sold its assets to McLean Foodservice, which presumably had the treasurer's signed guaranty in the files it inherited.
- Importantly (at least to the courts), the PepsiCo division never extended credit to the Table Rock restaurant company; it was McLane Foodservice, PepsiCo's successor-twice-removed, that did so.
Both the trial court and the appellate court held that the treasurer's guaranty, by its terms, covered only debts to the PepsiCo division — and because Table Rock had never incurred any such debts, its treasurer wasn't liable to McLane Foodservices under the guaranty.
The appellate court's opinion didn't even mention that, judging by the facts recited in the opinion, Table Rock's treasurer apparently had not guaranteed Table Rock's debts — his guaranty, from nearly 14 years before, was for the debts of the Border Patrol restaurant company, which had no evident connection to Table Rock. (If those were indeed the facts, then I'm surprised that McLane Foodservices' counsel wasn't sanctioned by the court for bringing a frivolous lawsuit against the treasurer.)
LESSON: Leaving aside the problem mentioned in the previous paragraph, the guaranty in McLane Foodservices could have recited that the guaranty covered all credit extended to the by the PepsiCo division and by PepsiCo's successors and assigns.
17.10.2 Guaranty Obligation
Clause text
(a) Each Guarantor guarantees — to each Creditor and also to that Creditor's successors and assigns — the full and prompt payment, by each Payer, when due, of each Guaranteed Payment Obligation.
(b) The guaranty of subdivision (a) applies without regard to:
(1) how or when the Guaranteed Payment Obligation in question previously came to exist, is coming to exist now, or comes to exist in the future (including, for example, by acceleration or otherwise); or
(2) whether the Guaranteed Payment Obligation is direct or indirect, absolute or contingent.
(c) Each Guarantor undertakes its obligations under this in consideration of, and to induce, the entry, by each Creditor, into the Guaranteed Agreement.
(d) Any action to enforce that guaranty against a Guarantor may be brought in any Guaranty Enforcement Forum.
Comment
Some of the language of this provision is informed by the language of the guaranty in suit in Knauf Insulation, Inc. v. Southern Brands, Inc., No. 15-3157, slip op. at 2 (7th Cir. May 3, 2016) (affirming judgment that guarantors were liable for guaranteed payment obligations) (Posner, J).
Subdivision (c): The "in consideration of" language is included because otherwise a court might hold a guaranty to be unenforceable. The required 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), a company's bookkeeper signed an order for ad space in a Yellow Pages phone book; unhappiily for her, she didn't read the fine print, which contained a statement that she personally guaranteed payment. A court held that she was not liable on the guaranty, because she had received no consideration for it. See id. at 22-23. The case is discussed in Robert W. Stetson, Four Tips for Drafting Enforceable Personal Guarantees, in (BNA) Corporate Counsel Weekly Newsletter, Apr. 9, 2014, which includes numerous case citations.
Subdivision (d): A forum-selection provision much like this one was readily enforced by the Seventh Circuit in the Knauf Insulation case, even though the guarantors purportedly did not have "minimum contacts" with the selected forum; the court remarked that the guarantors "didn't have to have any contacts" with that forum. See slip op. at 3 (citing cases; emphasis in original).
17.10.3 Guarantor Acceptance Waiver
Clause text
Each Guarantor KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES (i) acceptance of the Guaranty by the Creditors, (ii) notice of such acceptance, and (iii) signature of the Guaranty by the Creditors.
Comment
Many guaranty clauses include waiver-of-acceptance and waiver-of-signature language, even though such language might very well merely duplicate applicable law. See, e.g., US Bank Nat'l Ass'n v. Polyphase Elec. Co., No. 10-4881 (D. Minn. Apr. 23, 2012): In that case, the court granted granted summary judgment that a bank was entitled to enforce guaranties of loans made by the bank, even though the bank had not signed the guaranty documents.
17.10.4 Guaranty Collection Expenses
Clause text
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 one or more of: (1) that Creditor's rights against that Guarantor under the Guaranty; and (2) the Guaranteed Payment Obligation in question.
Comment
Language similar to that of this clause was used in clause 4 of the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 305 (Ala. 2012). See also CD-22.3.1. Attorney Fees to Prevailing Party.
17.10.5 Bankruptcy Refunds
Clause text
(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.
Comment
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, 2015 NY Slip Op 4753, at part I.
A creditor in bankruptcy has the right to contest its obligation to refund an avoidable preference. That can be difficult, though; the creditor must successfully jump through some hoops to prove that it was entitled to the payment. See generally, e.g., Kathleen Michon, Pre-Bankruptcy Payments to Creditors: Can the Trustee Get the Money Back? (Nolo.com; undated).
As a practical matter, many avoidable-preference cases are settled, with the creditor making a partial refund in lieu of incurring the expense of jumping through those proof hoops. In such a situation, if the original obligation had been guaranteed, then the creditor likely would want to try to recoup the partial refund from the guarantor.
"Courts have uniformly held that a payment of a debt that is later set aside as an avoidable preference does not discharge a guarantor of its obligation to repay that debt." Coles v. Glaser, No. A145642, slip op at 5 (Cal. App. Aug. 11, 2016) (extensive citations, internal quotation marks, and alteration marks omitted).
17.10.6 Guarantor Deficiency Liability
Clause text
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.
Comment
This language is based on that of the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 309 (Ala. 2012); see also the similar language of the guaranty in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753, at part I.
17.10.7 Guaranty Defenses WAIVER
Clause text
Except to the extent that the Agreement expressly states otherwise, each Guarantor KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES — 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;
(2) any claim or defense pertaining to any Guaranteed Payment Obligation, other than the defense of discharge by full performance, including without limitation any defense of waiver, release, statute of limitations, res judicata, statute of frauds, fraud, incapacity, minority, usury, illegality, invalidity, voidness, or other unenforceability that may be available to the Payer or any other person liable in respect of any Guaranteed Payment Obligation;
(3) any setoff available to the Payer or any other such person liable, whether or not on account of a related transaction;
(4) all rights and defenses arising out of an election of remedies by a Creditor, 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; and
(5) any other circumstance which might otherwise constitute a defense available to, or a discharge of, the Payer or any Guarantor.
Comment
This waiver language is adapted from California Civil Code § 2856(c) and (d).
The use of bold-faced type is for conspicuousness.
The phrase "will not assert" is designed to make it a breach of contract — for which attorney fees might be recoverable as damages — for a guarantor to make any of the listed assertions.
Subdivision (2): Some of the listed items are based on those 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, 2015 NY Slip Op 4753, at part I.
Subdivision (3): The "setoff" language is not uncommon; see, e.g., the guaranty in suit in Moayedi v. Interstate 35/Chisam Road, LP, 438 S.W.3d 1, 3 (Tex. 2014) (affirming that guarantor's waiver of defenses negated statutory right of offset).
After subdivision (5), 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.
17.10.8 Joint and Several Guarantor Liability
Clause text
Except to the extent (if any) that the Agreement expressly states otherwise, each Guarantor is jointly and severally liable to each Creditor for each Guaranteed Payment Obligation.
Comment
It's a really good idea for drafters (and reviewers) to be clear about the extent to which multiple guarantors are to be jointly and severally liable for the guaranteed payment obligation(s). In a given transaction, for example, Alice might guarantee the obligations of Alan, and Bob might guarantee the obligations of Betty, but not vice versa — that is, Alice does not guarantee Betty's obligations nor does Bob guarantee Alan's obligations.
17.10.9 Unconditional Guarantor Liability
Clause text
Except to the extent (if any) that the 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 is not required to attempt to enforce the Guaranteed Payment Obligation against the Payer; for example, the Guarantor is not required to 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.
Comment
Subdivision (a): See the notes accompanying CD-17.10.11. Reasonable Collection Efforts.
An "absolute and unconditional" guaranty is likely to be enforced even in what might seem like unfair circumstances such as collusion between the lender and the principal. For an example of this, see the decision by the Court of Appeals of New York (which is that state's highest court) in Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 2015 NY Slip Op 4753. 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.
17.10.10 Alteration of Guaranteed Obligation
Clause text
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.
Comment
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, 2015 NY Slip Op 4753, at part I.
17.10.11 Reasonable Collection Efforts
Clause text
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.
17.10.12 Guarantor Liability Cap
Clause text
In no event will the Guarantors, in the aggregate, be liable under the Guaranty for more than FILL IN (the Maximum Guarantor Liability).
Comment
In some transactions a cap on Guarantor liability might be a possible negotiation point.
Negotiators can consider attaching other conditions and limitations to guaranty obligations. 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).
Additional notes: Guaranties
Spelling: Guaranty, or gurantee?
In U.S. law, the terms "guaranty" and "guarantee" are usually associated with a third party's commitment to make good on a principal party's failure to comply with an obligation. Traditionally, "guaranty" is the noun, while "guarantee" is the verb; see, e.g., Uhlmann v. Richardson, 287 P.3d 287 (Kan. App. 2012), citing Bryan Garner, Garner's Dictionary of Legal Usage 399 (3d ed. 2011).
For example, when 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 CD-19.3. Warranty Definition for additional discussion.
Both guarantors and creditors should be cautious
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 guaranties, 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. See this discussion.
Consider other ways of "guaranteeing" payment, too
Drafters representing a guaranty creditor should consider other possible ways of securing the guaranteed payment obligation, such as (for example):
- 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.
Additional reading about guaranties
See, e.g.:
- Henri Chalouh, The Commercial Lease Guarantee: An Overview For Landlords And Tenants (Mondaq.com 2015)
[DCT to-do items]
Add language for:
- Guarantor must provide audited financials periodically
- Guarantor consents to jurisdiction somewhere convenient to the creditor (e.g., where leased property is located if guarantor is guaranteeing tenant's payment of lease)
- Guarantor appoints an agent for service of process
- Representation by signer of corporate guaranty that the signer is duly authorized to do so.
These are inspired by Pamela Westhoff, Charles Donovan and Lydia Lake, Commercial Lease Guaranties From Foreign Entities: What You Need to Know to Safeguard Your Security (Shepard Mullin 2015).
17.11 Standby Letter of Credit (notes only, so far)
A standby letter of credit (known as a "SLOC" or "L/C") can be thought of as a special type of guaranty. An L/C is issued by a bank to a third party when requested by one of the bank's customers. The L/C is, in essence, a promise, by the bank to the third party, that the bank will pay the third party if the bank's customer fails to meet its own payment obligation to the third party. The bank charges the customer a fee for issuing the letter of credit; the bank also requires the customer to sign an agreement to indemnify the bank (that is, reimburse the bank) if the bank is ever required to pay the third party under the L/C.
A useful teaching example can be found in Mago Int'l v. LHB AG, No. 15-2776 (2d Cir. Aug. 15, 2016) (affirming summary judgment in favor of defendant bank). In that case:
- A New York-based supplier entered into an agreement to sell meats to a customer in Kosovo. As part of the agreement, the customer's bank and a confirming bank issued a standby letter of credit to the supplier, guaranteeing payment by the customer.
- The supplier shipped twelve containers of meats to the customer. The customer, though, "stiffed" the supplier.
See id., slip op at 3-4.
In its opinion, the Second Circuit explained the basic operation of standby letters of credit:
An SLOC is an agreement by a bank to pay a beneficiary on behalf of a customer who obtains the letter, if the customer defaults on an obligation to the beneficiary.
Originally devised to function in international trade, a letter of credit reduced the risk of nonpayment in cases where credit was extended to strangers in distant places.
- The issuing bank, or a bank that acts as confirming bank for the issuer, takes on an absolute duty to pay the amount of the credit to the beneficiary, so long as the beneficiary complies with the terms of the letter.
- However, in order to protect the issuing or confirming bank, this absolute duty does not arise unless the terms of the letter have been complied with strictly. Adherence to this rule ensures that banks, dealing only in documents, will be able to act quickly, enhancing the letter of credit’s fluidity.
- Literal compliance with the credit therefore is also essential so as not to impose an obligation upon the bank that it did not undertake and so as not to jeopardize the bank’s right to indemnity from its customer.
- Therefore, in determining whether to pay, the bank looks solely at the letter and the documentation the beneficiary presents to determine whether the documentation meets the requirements in the letter.
- The corollary to the rule of strict compliance is that the requirements in letters of credit must be explicit and that all ambiguities are construed against the bank. Since the beneficiary must comply strictly with the requirements of the letter, it must know precisely and unequivocally what those requirements are.
Id., slip op. at 4-5 (emphasis, extra paragraphing, and bullets added, alteration marks by the court omitted). Unhappily for the meat supplier, the first time it sought payment from the bank under the L/C, it did not provide the required documentation showing that it had in fact shipped the meat to the Kosovo customer; by the time the supplier did furnish the necessary documentation, it was too late. The district court accordingly granted summary judgment in favor of the bank, and the Second Circuit affirmed. See id. at 5-7.
17.12 [Financial Assurance – to do later]
17.13 Payment Offsets Authorization
Clause text
Unless otherwise agreed in writing, a paying party may, in its sole discretion, offset against amounts it allegedly owes to another party, any amount that the other party owes to it; otherwise, the paying party may not offset any such amount.
Comment
Apparently in some jurisdictions (e.g. France), an automatic right of offset might not be enforceable, according to a LinkedIn commenter (see http://goo.gl/aWpjDv; membership required).
See also CD-17.14. Payment Offsets Prohibition.
17.14 Payment Offsets Prohibition
Clause text
A paying party may not offset against amounts it allegedly owes to another party, any amount that the other party owes to it.
Comment
See also CD-17.13. Payment Offsets Authorization.
17.15 COD Terms After Nonpayment
Clause text
For the avoidance of doubt, in case of (i) multiple late payments, or (ii) one or more significant late payments, by a party, the other party may require cash-on-delivery (COD) terms for any subsequent transactions.
Comment
Applicable law might well implicitly permit a payee to demand COD terms after late payment if the late payment constituted a material breach of the Agreement.
17.16 Non-Payment Not Infringement
Clause text
For the avoidance of doubt, IF: A party (Customer does not timely pay another party (Provider amounts required by the Agreement for goods or services furnished by Provider; THEN: Provider's remedies (if any) will be for breach of contract and not for infringement of Provider's intellectual property rights.
Comment
A customer purchasing and using (or reselling) goods, or acquiring a license to use software, might be interested in this clause. Without such a clause, non-payment of the required fee might conceivably result in the customer's infringement of the provider's intellectual property rights, which in some circumstances could result in a significantly-higher damage award than simply having to pay the required fee.
Consider the case of Frank Music Corp. v. Metro-Goldwyn-Mayer, Inc., 886 F.2d 1545 (9th Cir. 1989) (Frank Music II):
- The MGM Grand Hotel had a floor show called Hallelujah Hollywood!, which included ‘tributes' to various MGM movies.
- The floor show incorporated significant portions of the musical Kismet, which had been made into an MGM movie.
- The court found that this went beyond MGM's ‘movie rights' and therefore infringed the copyright in the musical.
- The resulting damage award included not just a portion of profits from the floor show itself, but 2% of the overall profits from the MGM Grand's hotel operations — including 2% of the casino profits — which, the court found, were indirectly attributable to the promotional value of the infringing floor show.
This clause would avert such a result if a customer were to fail to pay a provider.
Cf. also the Cincom case, in which a software customer found itself having to pay copyright-infringement damages to the software vendor, in an amount equal to the licensee fee that the customer had already paid, because the customer switched the use of the software to an unauthorized affiliate.
18 Standards; Inspections; Restrictions
- 18.1. [Acceptance – to do later]
- 18.2. Audits
- 18.3. Background Checks
- 18.4. Confidentiality of Parties' Dealings
- 18.5. Deceptive-Practices Prohibition
- 18.6. Defect Correction Procedure
- 18.7. Disparagement Prohibition
- 18.8. [Due diligence]
- 18.9. Employee Solicitation Restriction
- 18.10. Good Faith Commitment
- 18.11. Legal Compliance Requirement
- 18.12. Open-Source Materials (notes only, so far)
- 18.13. Publicity Approval Requirement
- 18.14. Review Restrictions
- 18.15. [Standards of conduct]
- 18.16. Safety Requirements
- 18.17. Site Visits & Network Access
18.2 Audits
- 18.2.1. Audit Definitions
- 18.2.2. Right to Conduct Audits
- 18.2.3. Audit Access
- 18.2.4. Post-Audit Adjustments
- 18.2.5. Reimbursement of Audit Expenses
- 18.2.6. Audit Time and Place
- 18.2.7. Exclusion of Certain Information
- 18.2.8. Audit Notice
- 18.2.9. Audit Frequency
- 18.2.10. Deadlines for Audit Requests
- 18.2.11. Audit Confidentiality Obligation
- 18.2.12. Auditor Work Space
- 18.2.13. Audit "Good Reason" Definition
- 18.2.14. Survival of Audit Provisions
- 18.2.15. Right to Receive Copy of Audit Report
- 18.2.16. Flowdown of Audit Provisions
- 18.2.17. Deadline for Audit Completion
- 18.2.18. Restriction on Audit-Report Content
- 18.2.19. Limitation of Remedies for Audit Discrepancies
- 18.2.20. Auditor Retention of Record Copies
- 18.2.21. Recordkeeping Party Expenses
- Additional notes: Audits
18.2.1 Audit Definitions
Clause text
Auditable Records refers to records sufficient to document each of the following, as applicable,
(1) labor performed and billed under the Agreement;
(2) materials billed under the Agreement;
(3) other items billed under the Agreement;
(4) compliance with specific requirements of the Agreement; and
(5) any other matters as to which, under the Agreement, the Auditing Party has the right to audit records.
Auditing Party refers to a specified party that has the right to cause Auditable Records to be audited under the Agreement.
Permissible Auditors refers to:
(1) any Big Four accounting firm; and
(2) any other auditor proposed by the Auditing Party by written notice and reasonably acceptable to the Recordkeeping Party.
Recordkeeping Party refers to any party that, under the Agreement, is required to keep records that come within the definition of Auditable Records.
Comment
This language is set up in generic terms with a view to having this provision be serviceable even if a drafter doesn't fill in deal-specific details..
Permissible Auditors: Contract-negotiation consultant and author John Tracy suggests (in a LinkedIn discussion thread) that an auditing party should consider agreeing in advance that, if it wishes to audit the recordkeeping parties books and records, the auditing party will engage the outside CPA firm that regularly audits the recordkeeping party's books anyway. John says that this should reduce the cost of the audit and assauge the recordkeeping party's concerns about audit confidentiality; he also says that "the independent CPA will act independently rather than risk the loss of their license and accreditation and get sued for maipractice."
18.2.2 Right to Conduct Audits
Clause text
The Auditing Party may cause one or more audits of Auditable Records to be conducted, in accordance with the audit provisions of the Agreement, by one or more Permissible Auditors.
Comment
In some cases involving multiple parties to a contract, a recordkeeping party might want to defined Auditing Party to include only selected other parties.
The "cause" language has in mind that:
- An auditing party might not want to bear the expense of having an outside auditor do the job, and instead might prefer to send in one of its own employees to "look at the books";
- On the other hand, a recordkeeping party might not want the auditing party's own personnel crawling around in the recordkeeping party's records, but might be OK with having an outside accountant (or other independent professional) do so.
A recordkeeping party might want the absolute right to veto the auditing party's choice of auditors, instead of having the right to give reasonable consent. On the other hand, the auditing party might not trust the recordkeeping party to be reasonable in exercising that veto, and could be concerned that a dispute over that issue would be time-consuming and expensive. This provision represents a compromise.
An auditing party might want to add that consent is deemed given if the recordkeeping party doesn't object in writing within X days after receiving or refusing the auditing party's written proposal of an auditor.
18.2.3 Audit Access
Clause text
(a) The Recordkeeping Party will provide the auditor(s) with access to the Auditable Records to the extent reasonably necessary for the 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.
(b) The Recordkeeping Party will 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 the Agreement.
Comment
Subdivision (a): 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 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, to 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, but 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).)
Subdivision (b): Audits sometimes happen after business relationships start to turn sour. In situations like that, it's not unheard of for recordkeeping parties' personnel to be uncooperative. So, it can help to lay out ground rules for what might otherwise be an unfriendly episode.
18.2.4 Post-Audit Adjustments
Clause text
(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 ("true-up") the discrepancy, including, for example, refunding an overpayment or paying a shortfall, as the case may be.
(b) IF: A party — due to an error that it made or for which it is otherwise responsible — must pay a shortfall or refund an overpayment under section 18.2.4; THEN: That party must also pay interest on the shortfall or refund at 1.5% simple interest per month or the maximum rate permitted by law, whichever is less.
Comment
Subdivision (b) (interest charges): Drafters should be very careful about usury laws, which can have real teeth.
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).
18.2.5 Reimbursement of Audit Expenses
Clause text
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 any of the following, if the Recordkeeping Party is responsible for it under the Agreement:
(1) a discrepancy in billing or payment, for the period being audited, that:
(A) is equal to or greater than 5%; and
(B) was caused by an error made by, or imputable to, the Recordkeeping Party; and
(C) favors the Recordkeeping Party; and/or
(2) an uncured material breach of the Agreement, and/or
(3) fraud.
Comment
Subdivision (1): 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.
Subdivision (1)(A): 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 billing discrepancies in services.
Subdivision (2): Consider also CD-18.2.21. Recordkeeping Party Expenses.
18.2.6 Audit Time and Place
Clause text
Unless otherwise agreed, 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.
Comment
This provision reminds drafters that in an unfriendly audit, the recordkeeping party might try to demand that auditable records be produced for audit at a location not desired by the auditing 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 circumstances arise.)
18.2.7 Exclusion of Certain Information
Clause text
Unless the Agreement expressly states otherwise, the Auditing Party's right to audit Auditable Records does not extend to any of the following:
(1) 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;
(2) trade secrets and other confidential information relating to formulae and/or processes; and
(3) clearly-unrelated or -irrelevant information.
Comment
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 also want to specify other particular audit exclusions.)
Subdivision (2) might be open to dispute, but at least it gives the Recordkeeping Party ammunition with which to oppose an unreasonable "fishing expedition" by the Auditing Party.
18.2.8 Audit Notice
Clause text
The Auditing Party must give the Recordkeeping Party at least ten business days' advance written notice of any proposed audit except for good reason.
18.2.9 Audit Frequency
Clause text
The Auditing Party may conduct audits no more than once per 12-month period and once per period audited except for good reason.
Comment
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 • the definition of good reason; and • the option requiring the Auditing Party to reimburse the Recordkeeping Party's expenses.
18.2.10 Deadlines for Audit Requests
Clause text
(a) Except for good reason, the deadline for the Auditing Party to request an audit for any given Auditable Record is the later of:
(1) the end of any legally-enforceable record retention period for that Auditable Record, if any; and
(2) three years after the end of the calendar quarter in which the substantive content of that Auditable Record was most-recently revised.
(b) For the avoidance of doubt, this subdivision does not in itself require the Recordkeeping Party to maintain that Auditable Record for that period of time, but only states a deadline for the audit request.
Comment
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).
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.
18.2.11 Audit Confidentiality Obligation
Clause text
(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 the 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 the Agreement.
18.2.12 Auditor Work Space
Clause text
IF: An audit is to be conducted at one or more sites controlled by the Recordkeeping Party; THEN: The Recordkeeping Party is to cause the audit site(s) to be furnished with with appropriate facilities of the type customarily used by knowledge-based professionals, including, for example, furniture, lighting, air conditioning, electrical outlets, and Internet access.
18.2.13 Audit "Good Reason" Definition
Clause text
For purposes of the audit provisions of the Agreement, good reason, whether or not capitalized, includes, for example, any one or more of the following:
(1) significant lack of cooperation, by the Recordkeeping Party, in an audit under the Agreement; and
(2) the discovery of substantial evidence of fraud, or of material breach of the Agreement, on the part of the Recordkeeping Party.
Comment
Either of the two listed items might well warrant setting aside the usual agreed limitations on advance notice, deadlines, etc.
18.2.14 Survival of Audit Provisions
Clause text
The audit provisions of the Agreement will survive any termination or expiration of the Agreement (but will also remain subject to all deadlines and other limitations stated in the Agreement).
Comment
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).
18.2.15 Right to Receive Copy of Audit Report
Clause text
The Recordkeeping Party is entitled to receive, from the auditor(s), upon request, at the Auditing Party's expense, a copy of any audit report produced.
Comment
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)
Note for contract-drafting students: This provision is intentionally phrased in a form of passive voice in an effort to make it not only clear but also "palatable."
18.2.16 Flowdown of Audit Provisions
Clause text
(a) The Recordkeeping Party is to include, in each subcontract under the 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 the 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, subdivision (a) neither authorizes nor prohibits the Recordkeeping Party's use of subcontractors under the Agreement.
18.2.17 Deadline for Audit Completion
Clause text
Except for good reason, the deadline for the auditor(s) to complete a given audit is three months after the effective date of the Auditing Party's advance written notice of the audit.
18.2.18 Restriction on Audit-Report Content
Clause text
The auditor(s) must agree in writing (and provide a copy of the agreement to the Recordkeeping Party):
(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.
18.2.19 Limitation of Remedies for Audit Discrepancies
Clause text
IF: In respect of any invoicing- or payment discrepancy revealed by an audit, the Recordkeeping Party complies with the obligations of section 18.2.4 and section 18.2.5 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 for that discrepancy or the actions or omissions that caused it.
Comment
An auditing party might object to this provision if it wanted to be free also (i) to terminate the Agreement if the discrepancy were material, and/or (ii) to demand a greater measure of damages for the discrepancy if that were available by law (such as indirect damages resulting from copyright infringement).
As a contrary example, though: A software customer might want this provision as a shield against an aggressive software licensor in case an audit by the licensor revealed that the customer was making more use of the software than it had paid for. See, e.g., Christopher Barnett, Top Three Revisions To Request In Software License Audit Clauses (ScottAndScottLLP.com 2015). (Software licensors might well be willing to go along with such a limitation of liability — but possibly with the proviso that any catch-up license purchases would be at full retail price, regardless of any negotiated discount; otherwise the customer would have an incentive to roll the dice and cheat on obtaining licenses.)
18.2.20 Auditor Retention of Record Copies
Clause text
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 the 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 the Agreement or by law.
Comment
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.
18.2.21 Recordkeeping Party Expenses
Clause text
IF: For a particular audit, the Recordkeeping Party is not required to reimburse the Auditing Party's expenses of the audit; THEN: The Auditing Party is to reimburse the Recordkeeping Party (and the Recordkeeping Party's 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.
Comment
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) (emphasis added).
Additional notes: Audits
A real-world example
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 can creative accounting, stonewalling, and even outright fraud. Here's a real-world situation in which an audit provision in a contract came in handy for the would-be auditing party:
- A Saudi company signed a consignment agreement with a Florida company. Under that agreement, the Florida company would sell what was expected to be around $500 million worth of aircraft parts.
- The parties apparently didn't have any procedure in place for confirming just what parts the Saudi company had shipped to the Florida company to be sold off. (The court's opinion suggests that the Florida company might have used "creative" accounting techniques in that regard.)
- The Saudi company tried to get discovery to find out just how much the Florida company had really sold.
- The Florida company evidently stonewalled on producing its records.
- The district court refused to order an accounting — this, even though the parties' contract included an audit provision.
- The appellate court reversed and remanded, stating that the district court abused its discretion by refusing to order an accounting.
See Zaki Kulaibee Establishment v. McFliker, 771 F.3d 1301 (11th Cir. 2014).
Some things an audit might uncover
One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships." Craig L. Greene, Audit Those Vendors (2003). Greene lists a number of things that fraud examiners watch for, including, for example:
- fictitious "shell entities" that submit faked invoices for payment;
- cheating on:
- shipments of goods (e.g., by short-shipping goods or sending the wrong ones) or
- performance of services (e.g., by performing unnecessary services or by invoicing for services not performed);
- billing at higher-than-agreed prices;
- kickbacks and other forms of corruption;
and others. See id.
18.3 Background Checks
- 18.3.1. Background-Check Definitions
- 18.3.2. Background Check Requirement
- 18.3.3. Compliance with Law Requirement
- 18.3.4. Criminal-History Consequences
- 18.3.5. Independent Reference Contacts
- 18.3.6. Checking Party Indemnity Obligation
- 18.3.7. Requesting Party Background Checks
- 18.3.8. Checking Party Expenses
- Additional notes: Background checks
18.3.1 Background-Check Definitions
Clause text
Applicable Background Checks refers to the specific background check(s) are to be performed under the Agreement, namely Criminal-History Checks if not otherwise specified.
Checked Individuals refers to the individual or individuals whose backgrounds are to be checked under the Agreement, namely any individual whom a Checking Party, directly or indirectly, causes or permits to engage in one or more Restricted Activities if not otherwise specified.
Checking Party refers to a party that is required to perform background checks under the Agreement.
Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question.
Criminal History, as to a Checked Individual, refers to the Checked Individual's having been convicted of, or having pled guilty or no contest to, one or more of (A) a felony; and/or (B) a misdemeanor involving fraud or moral turpitude.
Criminal-History Check refers to a nationwide check of records of arrests, convictions, incarcerations, and sex-offender status. A Criminal-History Check is not required to include fingerprint submission to confirm identity.
Critical Activity refers to any activity involving a substantial possibility of (i) bodily injury to or death of one or more individuals, including but not limited to a Checked Individual; and/or (ii) loss of, or damage to, tangible or intangible property of any kind; such loss or damage might be physical and/or economic.
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).
Drug Misuse, as to a Checked Individual, refers to evidence of use, by the Checked Individual, of one or more of: (1) illegal drugs; and/or (2) prescription drugs other than in accordance with a lawfully-issued prescription.
Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals.
Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.
Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years.
Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings.
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.
Requesting Party refers to the Signatory Party other than the Checking Party.
Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years.
Restricted Activity refers to any one or more of the following, when engaged in, in connection with the Agreement, 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;
(4) interacting with the Requesting Party's employees, suppliers, or customers; and
(5) any Critical Activity.
Comment
Some drafters will want to specify additional background checks.
The defined term used here is Applicable Background Checks, as opposed to Required Background Checks, for two reasons:
- To avoid creating the implication that the Applicable Background Checks are always an absolute, mandatory requirement, because that could create future difficulties if a background check were skipped and then the checked individual did something bad; and
- less importantly, to have the term be alphabetized with the other definitions just above.
Credit checks, if not done correctly, can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act, as discussed in the Annotations.
Criminal records checks in basic form 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.
Critical Activities: This definition is used in the restrictions on assigning personnel to engage in such activities if their background checks indicate Drug Misuse.
Drug testing: 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 be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use.
Companies might also consider the possible effect on employee morale of asking them to take a drug test – and about what they might have to do if a valued employee were to bust the test. As the saying goes, be careful about asking a question if you're not prepared to deal with the answer.
Educational references: This check is sometimes used as a way of detecting people who falsify their résumés about their education. Sadly, résumé padding is not an uncommon occurrence. For example, in 2014 the chief spokesman of Walmart resigned after the retail giant learned that he had falsely claimed to have graduated from college, when in fact he had not finished his course work (DailyMail.com 2014). Ditto the former dean of admissions at MIT (NPR.org 2015).
Employment verification: Verification of employment dates, in particular, can help expose undisclosed résumé gaps — or "fudging" of employment dates as listed on the résumé to shorten or eliminate gaps.
It's thought by some that a good practice is not to rely on employer contact information provided by the (former) employee, but instead to find the contact information independently. Otherwise, it's possible that the "employer" is actually someone colluding with the former employee to provide false information.
Some parties might want to obtain more than just the listed information, adding (for example) job duties, salary history, reason for leaving, and/or eligibility for rehire.
Some parties want employment history for the past five to ten years, or for the past two to five employers.
Residence addresses: 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.
18.3.2 Background Check Requirement
Clause text
The Checking Party is to cause all Applicable Background Checks to be conducted on all Checked Individuals, as follows:
(a) Any Applicable Background Check by the Checking Party itself is to be performed in a commercially-reasonble manner.
(b) Each other Applicable Background Check is to be performed by a reputable service provider.
Comment
The Checking Party's obligation is to cause background checks to be conducted. Very few parties will actually conduct their own background checks. Even those (few) parties that might be able to conduct their own checks are likely to want to "outsource" that responsibility to an outside party that can do such things more cost-effectively (and at which the finger can be pointed if something goes wrong).
This language gives the Checking Party a safe harbor: If it hires a reputable service provider, then it will have complied with its obligation under this provision. This obligation can be beefed up by using CD-18.3.6. Checking Party Indemnity Obligation.
18.3.3 Compliance with Law Requirement
Clause text
The Checking Party is to take prudent measures to cause each background check to be conducted in accordance with law, including, for example:
(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.
Comment
This obligation is phrased in terms of "prudent measures," as opposed to an absolute obligation; it can be beefed up by using CD-18.3.6. Checking Party Indemnity Obligation drop-in clause.
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:
- the Fair Credit Reporting Act, and
- the HIPPA Privacy Rule, and
- 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)
18.3.4 Criminal-History Consequences
Clause text
(a) IF: A Checked Individual's background check reveals any Criminal History; THEN: The Checking Party is not to assign, nor permit, that individual to engage in any Restricted Activity without first consulting with the Requesting Party.
(b) IF: A Checked Individual's background check indicates any Drug Misuse; THEN: The Checking Party must not assign nor permit that individual:
(1) to engage in any any Critical Activity without the express prior written consent of the Requesting Party; nor
(2) to engage in any other Restricted Activity without first consulting with the Requesting Party.
Comment
This provision requires the Checking Party only to consult with the Requesting Party, as opposed to obtaining the Requesting Party's consent. (The latter seems to be traditional in provisions of this type.) This is because in recent years the practice of automatically disqualifying people with criminal convictions has come under fire from government regulators and the plaintiff's bar as being potentially discriminatory (the so-called "ban the box" movement), as discussed in the Notes.
For obvious reasons, subdivision (b) imposes tighter restrictions on Critical Activities than on other Restricted Activities.
18.3.5 Independent Reference Contacts
Clause text
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.
Comment
This provision helps to guard against the possibility that an applicant might provide a Checking Party with fake contact information when listing former employers, etc., as references. Then when the Checking Party contacts the "references," it ends up talking to one of the applicant's friends who is in on the scam.
18.3.6 Checking Party Indemnity Obligation
Clause text
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 the Agreement by or at the direction of the Checking Party.
Comment
This indemnity obligation is worded carefully to focus on just what breaches are subject to that obligation.
As with any indemnity obligation, drafters should consider pairing this indemnity obligation with an insurance requirement.
18.3.7 Requesting Party Background Checks
Clause text
The Requesting Party may cause its own background checks to be conducted on any or all Checked Individuals, in which case:
(1) in conducting any such background checks, the Requesting Party will comply with the background-check provisions of the Agreement, and defend and indemnify the Requesting Party for any noncompliance, as though the Requesting Party were the Checking Party and vice versa;
(2) the Requesting Party will bear its own expenses associated with any background checks that it conducts;
(3) The Checking Party will provide reasonable cooperation with the Requesting Party in attempting to obtain any necessary consent for checks from each Checked Individual; and
(4) The Requesting Party will provide the same defense and indemnity to the Checking Party and its Protected Group (if any) as the Checking Party must provide under section 18.3.6 (that is, the parties' roles under that section will be reversed).
18.3.8 Checking Party Expenses
Clause text
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 the Agreement.
Comment
Service providers often take the view that any customer that wants background checks to be conducted on the provider's personnel should pony up for that cost.
On the other hand, a customer might take the position that background checks should be an overhead expense that the provider must bear.
Additional notes: Background checks
Background-check overview
Business purpose
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 CD-18.3.3. Compliance with Law Requirement.
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.
Further reading
Consider checking the Wikipedia entry on background checks to get ideas for further research on this subject.
Credit-check issues under the Fair Credit Reporting Act
Credit checks can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act. One particular procedural requirement seems to come up in class-action lawsuits: Section 1681b(b)(2)(A) of the Act, which states that, with certain very-limited exceptions:
… a person may not procure a consumer report, or cause a consumer report to be procured, for employment purposes with respect to any consumer, unless–
- 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).
Legal risks of disqualifying personnel who "fail" a background check
Caution: Restricting personnel assignments might be attacked as discriminatory
A blanket prohibition against using personnel with criminal records could be problematic: It might be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the U.S. See generally the EEOC general counsel's enforcement guidance published in April 2012.
The EEOC has filed lawsuits against employers who allegedly "violated Title VII of the Civil Rights Act by implementing and utilizing a criminal background policy that resulted in employees being fired and others being screened out for employment …." EEOC press release, June 11, 2013.
Companies should also be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use, as opposed to making accommodations of some sort.
Caution: State- or federal law might restrict employers' personnel decisions
In addition, some states might likewise restrict an employer's ability to rely on criminal background information in making employment-related decisions. Drafters should pay particular attention to the law in New York, Massachusetts, Illinois, and Pennsylvania (not necessarily an exhaustive list).
On a related note: "Bills pending in both houses of Congress would make it unlawful for most federal contractors to request a job applicant, whether orally or in writing, to disclose criminal history record information before the applicant has received a conditional offer of employment." Garen E. Dodge, Richard I. Greenberg, and Susan M. Corcoran, Proposed ‘Ban the Box’ Legislation Would Limit Criminal History Inquiries by Federal Contractors (JacksonLewis.com 2015).
For a list of states and cities with ban-the-box laws, see Michelle Natividad Rodriguez and Nayantara Mehta, Ban the Box: U.S. Cities, Counties, and States Adopt Fair Hiring Policies (NELP.com 2015).
Legal-compliance indemnity option
Motivation
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.
18.4 Confidentiality of Parties' Dealings
Clause text
Each party (each, the Obligated 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 the Agreement; and
(3) the terms and conditions of the Agreement.
Comments
Business context
Parties often want the mere fact that they are in discussions to remain confidential, let alone the details of their business dealings. That can present some tricky issues, though, especially in an employment-related agreement, as discussed in more detail below.
For example, in a sales agreement:
- The vendor might want for the pricing and terms of the agreement to be kept confidential. Otherwise, a buyer for a future prospective customer might say, "I know you gave our competitor a 30% discount, and I want to show my boss that I can get a better deal than our competitor did, so you need to give me a 35% discount if you want my business.”
- Conversely, the customer might not want others to know who its suppliers are, possibly because the customer doesn't want its competitors trying to use the same suppliers.
Likewise, parties to “strategic” contracts such as merger and acquisition agreements very often want their discussions to be confidential. If the word leaks out that a company is interested in being acquired, that could send its stock price down.
Tangentially, agreements to settle disputes sometimes require that the settlement terms be kept confidential. See, e.g., Caudill v. Keller Williams Realty, Inc., No. 15-3313 (7th Cir. Jul. 6, 2016) (Posner, J.) (affirming district-court holding that settlement agreement's liquidated-damages provision calling for $20 million payment for breach of confidentiality requirement in settlement : The settlement agreement in a prior dispute had included such a confidentiality requirement, as was unreasonable) (citing Texas law discussed here).
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).
Caution: The government might object to confidential-dealings clauses in employment agreements
In employment agreements, confidentiality provisions sometimes require the employee to keep confidential all information about salary, bonus, and other compensation. The NLRB and some courts have taken the position that such a requirement violates Section 7 of the National Labor Relations Act, as explained in this Baker Hostetler memo. (See also the discussion of how the [U.S.] Securities and Exchange Commission has taken a similar view about employees' reporting possible criminal violations to government authorities.)
18.5 Deceptive-Practices Prohibition
Clause text
Each Obligated Party (namely, each party) is to:
(1) refrain from knowingly engaging in any deceptive practice in connection with its activities relating to the Agreement; and
(2) defend and indemnify the other party against any third-party claim arising out of any breach of subdivision (a) by the Obligated Party.
Comment
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 CD-24.13. 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.
18.6 Defect Correction Procedure
18.6.1 Definitions: Provider; Customer; Defect
Clause text
(a) Provider refers to a Signatory Party that, under the Agreement, is to provide goods or services to another party.
(b) Customer refers to a party to which Provider provides goods or services under the Agreement.
(c) Defect refers to any failure, by one or more deliverables or one or more services provided under the Agreement, to comply with agreed written specifications (for example, in the Agreement or in a purchase order or statement of work).
Comments
This language is set up in generic terms with a view to having this provision be serviceable even if a drafter doesn't fill in deal-specific details..
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.
18.6.3 Correction or Workaround
Clause text
For any Defect reported in accordance with section 18.6.2, Provider — at its own expense — will do one or both of the following before 30 days after Customer's report of the Defect to Provider under subdivision (a) (the Defect-Correction Deadline):
(1) correct the Defect, which may include repairing or replacing a defective deliverable and/or re-performing defective services; and/or
(2) deliver a commercially-reasonable workaround for the Defect if Provider reasonably determines the actions in subdivision (1) to be impractical.
18.6.4 Backup Remedy: Refund of Defect-Related Payments
Clause text
IF: Provider does not timely take the action or actions required by this section 18.6 in respect of any Defect; THEN: Unless the 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).
Comments
This section states that Provider will "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.
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).
18.6.5 EXCLUSIVE REMEDIES for Defects
Comments
Suppliers are very prone to include exclusive-remedy provisions like this in their terms of sale.
Under section 2-719 of the [U.S.] Uniform Commercial Code, a contract for the sale of goods can specify that a remedy is exclusive (but there are restrictions and exceptions to that general rule).
A real-world eample is BAE Sys. Information & Electr. Sys. Integration, Inc. v. SpaceKey Components, Inc., 752 F.3d 72 (1st Cir. 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.
Additional notes: Defect correction
The provisions below represent a fairly-standard protocol for correction of software defects; it should also be useful in other contexts.
Some drafters might want to provide a schedule of different reporting deadlines for different categories of Defect, based on (for example) how long it might take for a particular category of Defect to become apparent.
CAUTION: To provide some protection for limitations of liability, providers should seriously consider including section 18.6.4 (refunds) in the Agreement, especially if they include section 18.6.5 (exclusive remedies).
18.7 Disparagement Prohibition
Clause text
(a) Obligated Party refers to each party.
(b) No Obligated Party is to disparage any other Signatory Party, nor the products or services of that other Signatory Party, to third parties.
(c) 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.
Comments
Business context
Manufacturers sometimes ask for clauses like this in their distribution- or reseller agreements, with the idea that they can prohibit their distributors and resellers from making negative comments to end-customers.
Distributors and resellers might well object to this statement, wanting to preserve their freedom to say whatever they please to their own customers.
State-law prohibitions
In 2014, California enacted Cal. Civ. Code § 1670.8 prohibiting such clauses in consumer contracts, with civil penalties for violation. (Hat tip: Prof. Nancy Kim.)
Bad publicity
A disparagement prohibition can lead to terrible PR, as discussed in the commentary to CD-18.14. Review Restrictions concerning product reviews.
The "Streisand effect"
Parties wanting a clause like this should consider the Streisand effect, which is named for the famed singer and actress: When word got out that she was trying to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her original purpose of her suppression attempt. (The Wikipedia article contains numerous other examples.)
The litigation privilege might trump a non-disparagement provision
See the decision of Maryland's highest court in O’Brien & Gere Engineers, Inc. v. City of Salisbury No. 15 (Md. Apr. 26, 2016).
18.9 Employee Solicitation Restriction
18.9.1 Definitions
Clause text
(a) Employ and Employment refer to one or more of: (1) directly or indirectly hiring or employing an individual as an employee or independent contractor; and (2) encouraging or knowingly assisting any other person to do so.
(b) Off-Limits Employee refers to any employee of an Off-Limits Employer who works on matters relating to the Agreement.
(c) Off-Limits Employer refers to any Signatory Party whose employees are specified in the Agreement as being, in effect, off-limits from solicitation by other parties.
(d) Restricted Party, as to any Off-Limits Employer, refers to any other party.
(e) Restriction Period refers to the period from the effective date of the 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: (1) directly or indirectly recruiting or soliciting an individual, on behalf of any person, for Employment; and (2) encourating or knowingly assisting any other person to do so.
Comment
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.
Subdivision (a): 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."
From an enforceability standpoint, the shorter the Restriction Period, the better, for reasons that should be clear from the Annotations.
18.9.2 Solicitation Restriction
Clause text
During the Restriction Period, no Restricted Party will Solicit for Employment any Off-Limits Employee except: (1) to the extent, if any, specifically stated otherwise in the Agreement; and (2) in any specific cases in which the Off-Limits Employer agrees otherwise in writing.
Comment
Obviously the scope of this provision will depend greatly on the defined terms.
18.9.3 Exception for Non-Targeted Recruiting Efforts
Clause text
This 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, and (3) without any direct or indirect solicitation for that purpose by the Restricted Party — for example in response to (i) a general advertisement or solicitation, or (ii) a job search conducted by an independent third party, that in either case case does not target the Off-Limits Employee.
18.9.4 Finder's Fee as EXCLUSIVE REMEDY
Clause text
IF: During the Restriction Period, a Restricted Party engages any Off-Limits Employee in breach of the Agreement; THEN: The Restricted Party will pay the Employer 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 (the Finder's Fee Amount) (i) as liquidated damages and also (ii) as the Off-Limits Employer's EXCLUSIVE REMEDY for the breach.
Comment
CAUTION: Including this Finder's Fee Option might preclude the Employer from obtaining injunctive relief to enforce the restrictions of this: 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 CD-22.10.1. Injunctive Relief Not Precluded and its commentary.
The exclusive-remedy language in this provision might help protect the from antitrust challenge.
By default, 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.
Additional notes: Employee solicitation restrictions
Caution: Antitrust considerations
This restriction 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.
Business context
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.
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).
18.10 Good Faith Commitment
18.10.1 Good Faith Obligation
Clause text
(a) Each party is to act in good faith in the performance and enforcement of the Agreement; a party that does so is to be conclusively deemed to have satisfied any applicable duty of good faith (as defined in any other way), fair dealing, honest performance, or similar requirement, imposed by law or otherwise, in respect of the Agreement and any transaction or relationship resulting from it.
(b) Except to the extent (if any) expressly stated otherwise in the Agreement, nothing in the 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; nor
(3) 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.)
(c) No party will make, and each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES, any claim or other assertion inconsistent with this section 18.10.1.
Comments
Language choices
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).
Subdivision (b) is informed by the discussion by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71 [2014] 3 S.C.R. 495, ¶¶ 65, explaining some of the limitations of the general duty of good faith.
Subdivision (c) is intended to make it a separate breach of contract for a party to take action contrary to the provision.
Legal background
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 [2014] 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 [2014] 3 S.C.R. 495, Canada's supreme court explained the business rationale for implying an obligation of good faith:
[60] Commercial parties reasonably expect a basic level of honesty and good faith in contractual dealings. While they [the parties] remain at arm’s length and are not subject to the duties of a fiduciary, a basic level of honest conduct is necessary to the proper functioning of commerce.
- The growth of longer term, relational contracts that depend on an element of trust and cooperation clearly call for a basic element of honesty in performance,
- but, even in transactional exchanges, misleading or deceitful conduct will fly in the face of the expectations of the parties[.]
[61] … [E]mpirical research suggests that commercial parties do in fact expect that their contracting parties will conduct themselves in good faith[.]
It is, to say the least, counterintuitive to think that reasonable commercial parties would accept a contract which contained a provision to the effect that they were not obliged to act honestly in performing their contractual obligations.
Id. at ¶¶ 60-61 (citations omitted, bracketed paragraph numbers in original, extra paragraphing and bullets added).
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).
18.10.2 Good Faith Dispute Resolution
Clause text
Any claim that a party breached either (i) CD-18.10.1. Good Faith Obligation or (ii) a duty of good faith or fair dealing, must be submitted to the dispute-resolution process set forth in CD-22.17. Progressive Dispute Resolution if so requested in writing by either party.
18.10.3 Good Faith EXCLUSIVE REMEDIES
Clause text
(a) A party that breaches a duty of good faith, fair dealing, or similar duty, under the 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.
Comment
This language is likewise informed by the discussion by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71 [2014] 3 S.C.R. 495, ¶ 88.
18.10.4 Good Faith Clear and Convincing Evidence Requirement
Clause text
Any claim, before any Tribunal, that a party breached a duty of good faith, fair dealing, or similar duty, whether under the Agreement or otherwise, must be proved by clear and convincing evidence.
18.11 Legal Compliance Requirement
18.11.1 Compliance Obligation
Clause text
(a) In performing its obligations and exercising its rights under the Agreement, each party (each, an Obligated Party) must comply with each of the following to the extent relevant to (i) that party's obligations, and/or (ii) the other party's rights, under the Agreement:
(1) all requirements of law that apply generally to the Obligated Party (for example, corporation law, employment law, and the like);
(2) all requirements of law that apply generally to the type of business engaged in by the Obligated Party (for example, professional-licensing requirements), if any; and
(3) any other particular laws expressly specified in the Agreement.
(b) For the avoidance of doubt, the Obligated Party is not responsible for complying with requirements of law that are specific to any other party or its business, but not to the Obligated Party or its business, unless expressly agreed otherwise in writing.
Comment
The intent of this clause is to make it clear that, if an obligated party fails to comply with relevant provisions of law, then the other party may treat that failure as a breach of the parties' agreement. (That might not always be the case otherwise.)
The defined term Specific Laws for Compliance can be used to emphasize a party's need to comply with particular laws such as (for example) export-control laws; privacy laws; wage-and-hour laws; and the like.
In some contracts, a customer might want to make the compliance-with-law obligation apply only to the supplier, without taking on such an obligation itself.
The compliance-with-law obligation of this clause might not provide much protection for, say, a customer that wanted to make sure that its contractor timely paid its subcontractors, because the law might make the customer responsible for the contractor's noncompliance anyway. For example, in 2014, California enacted Assembly Bill 1897 (codified as Cal. Labor Code § 2810.3), which made certain business customers liable, as a matter of law, for unpaid wages and worker's compensation coverage of their contractors' non-exempt employees. See generally Todd Lebowitz, New California Law Imposes Joint Liability on Businesses and Contract Vendors … (EmploymentLawSpotlight.com Nov. 10, 2014).
18.11.2 Noncompliance Indemnity Obligation
Clause text
Each Obligated Party must defend and indemnify each other party against any third-party claim arising out of that Obligated Party's failure to comply with the compliance-with-law provisions of the Agreement.
18.11.3 Specified Noncompliance as Material Breach
Clause text
(a) Any failure, by an Obligated Party, to comply with one or more particular laws for compliance expressly stated in the Agreement (if any) is to be considered a material breach of the Agreement by that party.
(b) For the avoidance of doubt: This section does not rule out the possibility that one or more failures by an Obligated Party to comply with other laws could also constitute a material breach of the Agreement by that party.
Comment
This option allows the parties to designate particular laws as critical to the contract. Thus, for example, if the Agreement were to designate export-control laws as Particular Laws for Compliance, then any failure, by an Obligated Party, to comply with those laws would automatically constitute a material breach of the Agreement by the Obligated Party.
18.12 Open-Source Materials (notes only, so far)
From Twitter acquisition: (ix) “Open Source Materials” means software or other material that is distributed as “free software,” “open source software” or under similar licensing or distribution terms (including but not limited to the GNU General Public License (GPL), GNU Lesser General Public License (LGPL), Mozilla Public License (MPL), BSD licenses, the Artistic License, the Netscape Public License, the Sun Community Source License (SCSL) the Sun Industry Standards License (SISL), Open Source Initiative, and the Apache License) that (a) could require or could condition the use or distribution of such software or other material, or portion thereof, on (1) the disclosure, licensing, or distribution of any source code for any portion of such software, or (2) the granting to licensees of the right to make derivative works or other modifications to such software or other material or portions thereof, or (b) could otherwise impose any limitation, restriction, or condition on the right or ability of the Company to use, sell, offer for sale, license, distribute or charge for any Company Product.
(o) Open Source Software. Section 2.9(o)(i) of the Company Disclosure Schedule lists any licenses for Open Source Materials pursuant to which any Company Products are made available by the Company to any Person. Section 2.8(o)(ii) of the Company Disclosure Schedule lists all Open Source Materials included in, combined with, or used in the delivery of, any Company Product or other Company Owned Intellectual Property, as the case may be, and identifies each relevant license for such Open Source Materials and describes the manner in which such Open Source Materials were used (such description shall include whether (and, if so, how) the Open Source Materials were modified and/or distributed by the Company).
With respect to Open Source Materials that are or have been included in, combined with, or used by the Company in connection with any Company Product, the Company has been and is in compliance with the terms and conditions of all applicable licenses for the Open Source Materials, including attribution and copyright notice requirements.
Except as set forth in Section 2.8(o)(iii) of the Company Disclosure Schedule, there are no Open Source Materials included in, or distributed with, any Company Products or other Company Owned Intellectual Property, which subject such Company Products or other Company Owned Intellectual Property to the terms of the license agreement to which such Open Source Materials are subject, including in such a way that creates, or purports to create obligations for the Company with respect thereto or grants, or purport to grants, to any third party, any rights or immunities thereunder (including using any Open Source Materials that require, as a condition of use, modification and/or distribution of such Open Source Materials that other software incorporated into, derived from or distributed with such Open Source Materials be (A) disclosed or distributed in source code form, (B) be licensed for the purpose of making derivative works, or (C) be redistributable at no charge).
18.13 Publicity Approval Requirement
Clause text
Without the prior written consent of the other party (the Reviewing Party), no party (each, a Restricted Party will issue any press release about, nor otherwise publicly disclose the existence or terms of (1) the Agreement; nor (2) the parties' business relationship contemplated by the Agreement.
18.14 Review Restrictions
Clause text
During the term of the Agreement, each party (each, a Restricted Party):
(1) will not participate, directly or indirectly, in the preparation or publication of any review (comparative or otherwise) of any product or service of any other party (each, a Protected Party without the prior written consent of that Protected Party; and
(2) will not permit or knowingly assist any other person to engage in any activity within the scope of subdivision (a).
Comment
Some contracts prohibit one party from participating in reviews of products of the other company. This type of provision, though, could lead to serious complications down the road, such as adverse publicity and even litigation. See, for example:
- As of September 2016, the U.S. House and Senate have passed slightly-different versions of a bill that, according to one expert, "voids any effort in a form contract to ban consumer reviews, impose fines for writing consumer reviews, or take the IP rights to consumer reviews. It also makes such contract efforts unlawful and authorizes the FTC to bring enforcement actions (and, in some cases, state AGs)." Eric Goldman, House Passes Consumer Review Fairness Act. Professor Goldman predicts that President Obama will sign the bill.
- The New York attorney general obtained an injunction against the manufacturer of McAfee anti-virus software for including, in its end-user license agreement (EULA), a prohibition against disclosure of benchmark test results or publication of product reviews without the manufacturer's approval. See People v. Network Assoc., Inc., 758 N.Y.S.2d 466, 195 Misc.2d 384 (2003).
- Eric Goldman, California Moving To Protect Consumer Reviews (Forbes.com 2014) (describing pending legislation to ban contractual prohibitions of product- and service reviews).
- Eric Pfeiffer, Woman gets $3,500 fine and bad credit score for writing negative review of business (Yahoo News Nov. 15, 2013).
- Mara Siegler, Hotel fines $500 for every bad review posted online (New York Post Aug. 4, 2014); see also the Hacker News discussion of this news item.
Consider also the so-called Streisand effect: When the legendary singer and actress tried to suppress unauthorized photos of her residence, the resulting viral Internet publicity resulted in the photos being distributed even more widely — thus defeating her purpose. (The Wikipedia article linked at the beginning of this paragraph contains numerous other examples.)
18.16 Safety Requirements
18.16.2 Reasonable Safety Measures Requirement
Clause text
In connection with its activities under the Agreement, each Obligated Party will cause at least the following Minimum Safety Measures to be taken:
(1) commercially-reasonable safety measures; and
(2) any other safety measures specified in the Agreement.
18.16.3 Safety Measures Indemnity Clause
Clause text
Each Obligated Party will defend and indemnify each other Signatory Party and that Signatory Party's Protected Group against any claim, by any third party in any forum or before any tribunal, arising out of the Obligated Party's noncompliance with the safety obligations of this Agreement.
Comment
The indemnity-obligation option is a canary in the coal mine clause: If a prospective Obligated Party were to balk at it, that might raise questions about that party's long-term intentions or capabilities.
Insurance: As with any indemnity obligation, a would-be protected party should check whether the indemnifying party has the financial assets with which to meet the obligation; if not, the protected party should consider including a requirement that the indemnifying party carry suitable insurance coverage.
For a contract with more than two Signatory Parties, it might make sense to limit the number of protected parties.
18.17 Site Visits & Network Access
18.17.1 Site-Visit Definitions
Clause text
For purposes of this CD-18.17. Site Visits & Network Access provision:
(a) Site, in respect of a party specified in the Agreement (each such party, a Host Party)), refers, as the case may be, to:
(1) any physical premises of that Host Party; and
(2) any computer system or network of that Host Party.
(b) Site Visit refers to the physical presence at such premises, and/or access to such a computer system or network, by another party (each, an Accessing Party) or any individual who is subject to the control of an Accessing Party (each, a Site Visitor).
18.17.2 Site-Rules Compliance Obligation
Clause text
Each Accessing Party will cause each of its Site Visitors to comply with such reasonable Site rules and policies as the Host Party may seasonably communicate in writing to the Accessing Party.
Comment
Customers' contract forms for providers of goods and services often include provisions along the lines of this clause.
These definitions recognize that these days "site visits" are sometimes virtual.
In many services-type agreements, the Host Party will be the customer, while the Accessing Party will be the services provider coming onto the customer's site or accessing the customer's computer network. (The same could be true of providers of goods if the provider's personnel will be, e.g., making deliveries at the customer's site, or if sales people will be making in-person calls at the customer's premises.)
In other types of agreement, it might be the other way around, e.g., with a customer's people coming onto a service provider's site for training, to have work done on vehicles or equipment, etc.
This provision doesn't require site rules to be communicated in writing, but obviously that might be advisable for proof purposes if no other reason.
18.17.3 Prohibition of Unlawful Discrimination
Clause text
For the avoidance of doubt, a Host Party may not deny access to, or otherwise discriminate against, any Site Visitor for any reason prohibited by applicable law (for example, antidiscrimination or equal-opportunity law).
18.17.4 Site Visit Indemnity Obligation
Clause text
(a) Each Host Party will defend and indemnify each Accessing Party against any claim by a third party (including for example claims by an individual or a government agency) of:
(1) discrimination against a Site Visitor on the part of the Host Party in breach of section 18.17.3; and/or
(2) other unlawful conduct that affects a Site Visitor,
in either case on the part of any officer, director, employee, or other individual under the control of the Host Party.
(b) Each Accessing Party will defend and indemnify each Host Party against any claim by a third party (including for example claims by an individual or a government agency) of unlawful conduct, on the part of any Site Visitor, affecting any Host-Party personnel.
(c) For purposes of this section 18.17.4, unlawful conduct includes, for example, tortious conduct.
Comment
Indemnity obligations are sometimes objected to, even when the indemnifying party would be liable for breach of contract, for reasons discussed in this annotation.
18.17.5 Employability Evidence Obligation
Clause text
If seasonably requested in writing by a Host Party, an Accessing Party will provide the Host Party with reasonable evidence that the Accessing Party's Site Visitors are legally employable where the Host Party's relevant physical premises are located.
Comment
A given company might feel compelled to verify employability of any individual that comes on its premises. (That's especially possible if a company had previously entered into a non-prosecution agreement after being caught employing aliens not having the legal right to work.)
This provision shouldn't be too contentious, given that U.S. law already requires most if not all employers to verify that their employees have the right to work in this country.
18.17.6 Mutual Noninterference Obligation
Clause text
Each party will make commercially-reasonable efforts to avoid interfering with the activities of the other party at any site where both parties' personnel are present.
19 Representations and Warranties – In General
19.1 Representation Definition
Clause text
A representation is a statement of past or present fact; the verb represent has a corresponding meaning.
Comments
Language notes
The phrase "statement of past- or present fact" was suggested by Professor Tina Stark, author of the well-regarded Drafting Contracts textbook. She suggests making it clear that a statement of future fact is not a representation; such a statement might constitute an enforceable promise (possibly in the form of a warranty), or it might be an unenforceable statement of opinion.
See also:
- Stephen L. Sepinuck, The Virtue of “Represents and Warrants”: Another View, Business Law Today, Nov. 2015 (AmericanBar.org).
- CD-19.2. Misrepresentation Definition.
Bryan Garner's summary
See Bryan Garner's discussion of representations and warranties quoted in this Ken Adams blog post. (As will be apparent, I disagree completely with Ken's contention that represents and warrants are supposedly synonyms, as argued in the posts linked at the beginning of his blog post.)
Bad drafting: "Representation" of future conduct
A curious set of facts is seen in Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539 (Minn. 2014) (on certification from 7th Circuit). In that case, a company that sold photocopying machines entered into a contract with a financing company. (This is not an uncommon way for a seller to do business: the seller makes a deal with a customer, but then sells the equipment to the financing company, which pays the seller and then leases the equipment to the customer.)
The contract between the photocopier seller and the financing company included a representation and warranty (!) by the seller that it would submit, to the financing company, only agreements with end-customers that complied with applicable law. That turned out not to be the case for one of the photocopier seller's customers, a municipality, which stopped payment two years into its six-year lease because a state statute limited municipal equipment leases to no more than five years. See id., slip op. at 3.
The financing company sued the photocopier seller for breach of the representation that it would submit only valid customer lease paper. In response, the seller asserted (among other things) that the financing company could not recover damages because it had not shown that it had relied on the representation.
The Minnesota supreme court noted (rightly) that "[b]ecause [the seller] manifested an intention to act in a specified way … a breach of contract action may be the more appropriate action." Id. at 543 n.4 (emphasis added). The court then treated the so-called representation, in effect, as a promise (or covenant) by another name; it held that proof of reliance on the representation was not needed:
[T]he representation of future legal compliance in this case was much more than a mere expression of opinion. Illinois Paper specifically agreed to indemnify and hold Lyon harmless from any loss resulting from Illinois Paper's breach of the representation that all lease transactions presented to Lyon would be valid and enforceable.
Id. at 540 (emphasis added). The court continued:
… In this case, the parties agreed to allocate the risk of legal noncompliance to Illinois Paper. Holding parties to their promises, without requiring separate reliance on those promises, furthers freedom of contract principles, and there is no reason to refuse to enforce the terms of the parties' bargain here.
Id. at 545 (emphasis added).
Rep-and-warranty insurance
See Howard T. Spilko and Scott A. Abramowitz, Use of Representations and Warranties Insurance Grows in Middle-Market Transactions (NYLJ.com 2015).
19.2 Misrepresentation Definition
Clause text
(a) To establish a person's liability in respect of a claim for misrepresentation in connection with the Agreement, the claimant must show that all of the following are true:
(1) The person made a representation that, at that time, either:
(A) was untrue as to a material fact, or
(B) omitted a material fact necessary in order to make the representation, in the light of the circumstances under which it was made, not misleading.
(2) The person that made the representation either:
(A) failed to use reasonable care or competence in obtaining or communicating the information comprising the representation, or
(B) knew, at the time of making the representation, of the circumstances described in subdivision (1)(A) or (1)(B), as applicable.
(3) The person knew or should have known that the party would rely on the representation—this is deemed conclusively established if the representation is expressly stated in the Agreement with language such as "Party A represents that …."
(4) The claimant's reliance on the representation was reasonable.
(5) The claimant suffered harm as a result of such reliance.
(b) If clearly so stated in the Agreement, each element of proof listed in subdivision (a) must be shown by clear and convincing evidence.
Comment
This provision tries to synthesize various [U.S.] federal- and state-law doctrines.
A claim of misrepresentation can have massive real-world consequences. For example, HP's EDS unit ended up paying more than US$ 460 million to settle British Sky Broadcasting's successful claim for fraudulent inducement and misrepresentation in connection with a software-development contract — this, even though the contract limited EDS's liability to around 10% of that number. See BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC) and Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.
Concerning insurance to cover misrepresentation claims, see Howard T. Spilko and Scott A. Abramowitz, Use of Representations and Warranties Insurance Grows in Middle-Market Transactions (NYLJ.com 2015).
Subdivision (a)(1) is is adapted from the famous Rule 10b-5 promulgated by the U.S. Securities and Exchange Commission. See generally the Wikipedia article "Rule 10b-5."
Subdivision (a)(3) takes it for granted that the claimant will rely on a (mis)representation that is stated in the agreement — otherwise, why would the parties have included the representation in the agreement in the first place? See also the notes to CD-24.13. Reliance Disclaimer.
Concerning subdivision (b): Many [U.S.] states, in civil cases, require proof of at least some of the elements of fraud by clear and convincing evidence, although U.S. federal statutes generally require proof of fraud only by a preponderance of the evidence. See Grogan v. Garner, 490 U.S. 279, part III, text accompanying nn.15-16 (1991) (holding that the standard of proof for the dischargeability exceptions for fraud in bankruptcy proceedings is the ordinary preponderance-of-the-evidence standard).
Exercises
QUESTION 1: Does a representation normally relate to:
(A) a past fact?
(B) a present fact?
(C) a future fact?
A and B.
QUESTION 2: What are the basic elements that a plaintiff generally must establish to succeed in a claim for misrepresentation?
(a) A statement, made by the defendant, that is shown to have been false or misleading when made;
(b) The defendant intended for the plaintiff to rely on the statement;
(c) (With variations:) The defendant knew, or should have known, that the plaintiff would rely on the statement;
(d) The plaintiff did in fact rely on the statement;
(e) The plaintiff's reliance was reasonable; and
(f) The plaintiff suffered damage attributable to the statement.
QUESTION 3: Should factual representations normally be included in an agreement's recitals? Why or why not?
It's not customary to include factual representations in the recitals. It might also be dangerous to do so: If memory serves, in some jurisdictions the courts might not treat the recitals as part of the contract.
The safer thing to do would be to rework the recitals as a "1. Background" section and have the parties make whatever initial representations they're willing to make.
19.3 Warranty Definition
Clause text
(a) The noun warranty (whether or not the term is capitalized) refers to a statement by a party warranting that a specified state of affairs exists (or existed or will exist at or during a specified time). The verb warrant has the corresponding meaning. HYPOTHETICAL EXAMPLE: Alice warrants that the widgets, as delivered to Bob, will be substantially free of defects in materials or workmanship.
(b) A warranty benefits all individuals and organizations expressly specified in the warranty or otherwise in the Agreement (each, a Warranty Beneficiary), for example by language such as "Alice warrants to Bob and Bob's Affiliates."
(c) If not otherwise specified, the only Warranty Beneficiary is the other Signatory Party (if more than one, all other Signatory Parties) (each, a Signing Beneficiary).
(d) Unless the Agreement expressly states otherwise: IF: A Warranty Beneficiary shows that the warranted state of affairs did not exist at the relevant time; THEN: As the Warranty Beneficiary's EXCLUSIVE REMEDY, the warranting party will pay the Warranty Beneficiary for any foreseeable damage shown to have thereby resulted to the Warranty Beneficiary. (This payment obligation is subject to any limitations of liability that are stated in the Agreement or that apply by law.)
(e) For the avoidance of doubt, each Signing Beneficary of a warranty is deemed to have relied on that warranty as part of the basis of the bargain of the Agreement.
Comments
- What is a warranty (1): Learned Hand's view
- What is a warranty (2): A conditional covenant
- Bryan Garner's summary
- No need to prove negligence or intent
- No need to prove justified reliance
- Special case: Sales of goods under the Uniform Commercial Code
- Is a warranty a guarantee?
- Is "represents and warrants" necessary?
- Be careful what you warrant
What is a warranty (1): Learned Hand's view
The concept of "warranty" is not necessarily an easy one to grasp. One widely-held view was expressed by the legendary judge Learned Hand:
[A warranty is] an assurance by one party to a contract of the existence of a fact upon which the other party may rely.
It is intended precisely to relieve the promisee of any duty to ascertain the fact for himself[.]
[I]t amounts to a promise to indemnify the promisee for any loss if the fact warranted proves untrue ….
CBS, Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503, 553 N.E.2d 997, 1001 (1990), quoting Metropolitan Coal Co. v Howard, 155 F.2d 780, 784 (2d Cir 1946) (emphasis by the Ziff-Davis court edited, extra paragraphing added).
What is a warranty (2): A conditional covenant
I submit that a warranty is best thought of as a conditional covenant, tantamount to an insurance policy: In effect, the warranting party promises that, if the warranted state of affairs turns out not to be true, then the warranting party will do as stated in the contract — or, if the contract is silent, then the warranting party will make good on any foreseeable damages that, as a result, are incurred by the party (or parties) to whom the warranty was made.
Consider a contract for Alice to sell a car (the "Car") to Bob. The contract says: Alice warrants that the Car, when delivered, will be in good working order. Now consider two, alternative, fork-in-the-road scenarios:
- In Scenario 1, the contract also says: IF: Bob shows that the Car was not in good working order when delivered; THEN: AS BOB'S EXCLUSIVE REMEDY, Alice will reimburse Bob for up to $X in repair costs. (This means that Alice and Bob are voluntarily sharing the risk that the Car isn't in good working order; that sharing of the risk presumably is reflected in the negotiated price of the Car.)
- In Scenario 2, the contract is silent about what Alice will do if the Car turns out not to have been in good working order when delivered. Under the law, that is equivalent to the contract's saying: IF: Bob shows that the Car, when delivered to him, was not in good working order; AND: As a result, Bob suffers foreseeable damages; THEN: Alice will pay Bob the amount of those damages.
(This is an expanded version of a part of a comment I made at Ken Adams's blog in October 2015.)
Bryan Garner's summary
See Bryan Garner's discussion of representations and warranties quoted in this Ken Adams blog post. (As will be apparent, I disagree completely with Ken's contention that represents and warrants are supposedly synonyms, as argued in the posts linked at the beginning of his blog post.)
No need to prove negligence or intent
Under this clause, a beneficiary doesn't need to prove that the warranting party acted negligently or intentionally in misstating the warranted state of affairs. This is in contrast to tort-based theories of misrepresentation, where a party claiming misrepresentation must provide such proof; see the commentary to CD-19.1. Representation Definition.
No need to prove justified reliance
The phrase "basis of the bargain" is adapted from UCC § 2-313.
In the so-called modern [U.S.] view, a beneficiary is not required to prove that it justifiably relied on a warranty; a leading case on point is from the Court of Appeals of New York (that state's highest court); see CBS, Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503, 553 N.E.2d 997, 1001 (1990). Cf. Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., No. A13-1944, slip op. at 9 n.6 (Minn. July 2, 2014) (declining to decide whether requirement of reliance in 1944 opinion of supreme court is still good law); /see generally/ Matthew J. Duchemin, Whether Reliance on the Warranty is Required in a Common Law Action for Breach of an Express Warranty, 82 Marq. L. Rev. 689 (1999).
A different situation might be presented, however, if, before the contract was signed, a warranting party disclosed that a warranty was not accurate. While the law seems still to be evolving in this area, the influential U.S. Court of Appeals for the Second Circuit summarized New York law thusly:
… a court must evaluate both the extent and the source of the buyer's knowledge about the truth of what the seller is warranting.
Where a buyer closes on a contract in the full knowledge and acceptance of facts disclosed by the seller which would constitute a breach of warranty under the terms of the contract, the buyer should be foreclosed from later asserting the breach.
In that situation, unless the buyer expressly preserves his rights under the warranties … The buyer has waived the breach.
The buyer may preserve his rights by expressly stating that disputes regarding the accuracy of the seller's warranties are unresolved, and that by signing the agreement the buyer does not waive any rights to enforce the terms of the agreement.
On the other hand, if the seller is not the source of the buyer's knowledge, e.g., if it is merely "common knowledge" that the facts warranted are false, or the buyer has been informed of the falsity of the facts by some third party, the buyer may prevail in his claim for breach of warranty.
In these cases, it is not unrealistic to assume that the buyer purchased the seller's warranty as insurance against any future claims, and that is why he insisted on the inclusion of the warranties ….
In short, where the seller discloses up front the inaccuracy of certain of his warranties, it cannot be said that the buyer — absent the express preservation of his rights — believed he was purchasing the seller's promise as to the truth of the warranties.
Accordingly, what the buyer knew and, most importantly, whether he got that knowledge from the seller are the critical questions.
Rogath v. Siebenmann, 129 F. 3d 261, 264-65 (2d Cir. 1997) (vacating and remanding partial summary judgment that seller had breached contract warranty; emphasis added).
Special case: Sales of goods under the Uniform Commercial Code
In a contract for the sale of goods, if Vendor were only to represent that X were true, that representation might well constitute a warranty anyway under the Uniform Commercial Code. UCC § 2-313 provides that, if the representation is related to the goods and forms part of the basis of the bargain, it's deemed a warranty, no matter what it's called.
Is "represents and warrants" necessary?
It's tempting to write the well-known couplet represents and warrants as if by reflex. The two, though, are distinct legal concepts, with different proof requirements and different legal effects. See generally the commentary to CD-19.1. Representation Definition and CD-24.13. Reliance Disclaimer.
This provision tries to make it clear that a warranty is akin to an insurance policy, a contractual commitment to assume certain risks. As the Restatement (Second) of Contracts puts it:
d. Promise of event beyond human control; warranty. Words which in terms promise that an event not within human control will occur may be interpreted to include a promise to answer for harm caused by the failure of the event to occur. An example is a warranty of an existing or past fact, such as a warranty that a horse is sound, or that a ship arrived in a foreign port some days previously. Such promises are often made when the parties are ignorant of the actual facts regarding which they bargain, and may be dealt with as if the warrantor could cause the fact to be as he asserted. …
Restatement (Second) of Contracts § 2 cmt. d.
For extensive additional citations in this area, see, e.g., Tina Stark's scholarly pummeling of the misguided notion that represent and warrant are supposedly interchangeable, in two comments on Ken Adams's blog. (Disclosure: Tina is a friend and mentor and the author of Drafting Contracts, a well-regarded law school course book.)
For an earlier piece on the same subject by Stark, see her Nonbinding Opinion: Another view on reps and warranties, Business Law Today, January/February 2006.
Some of Ken Adams's earlier essays espousing the purported synonymity of the two terms can be found at:
- A lesson in drafting contracts — What's up with 'representations and warranties'?, The Business Lawyer, Nov./Dec. 2005, as well as
- here, here and here.
See also Robert J. Johannes & Thomas A. Simonis, Buyer's Pre-Closing Knowledge of Seller's Breach of Warranty, Wis. Law. (July 2002) (surveying case law).
An English court decision highlighted the difference between representations and warranties: See Sycamore Bidco Ltd v Breslin & Anor [2012] EWHC 3443 (Ch) (2012), discussed in, e.g.:
- Raymond L. Sweigart and Christopher D. Gunson, ‘Reps’ and Warranties: One Could Cost More Than the Other Under English Contract Law (PillsburyLaw.com 2013)
- Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 BUS. LAW. 1049, 1058 n.47 (2014).
Be careful what you warrant
In a British Columbia case:
- A supplier sold water pipes to a customer for use in a construction project designed by the customer.
- The pipes conformed to the customer's specifications — in other words, the supplier delivered what the customer ordered.
- Flaws in the customer's design led to problems.
- The contract's warranty language stated that the supplier warranted that the pipes were "free from all defects arising at any time from faulty design" (emphasis added).
- As a result, the supplier was held liable because of its warranty, even though the problem was the customer's fault.
See Greater Vancouver Water Dist. v. North American Pipe & Steel Ltd., 2012 BCCA 337 (CanLII) (reversing trial court's judgment in favor of supplier). The appeals court said:
[24] North American was obliged to deliver pipe in accordance with the appellant’s specifications. North American agreed to do so.
Quite separately, it warranted and guaranteed that if it so supplied the pipe, it would be free of defects arising from faulty design. These are separate contractual obligations. The fact that a conflict may arise in practice does not render them any the less so.
The warranty and guarantee provisions reflect a distribution of risk.
* * *
[34] Clauses such as 4.4.4 distribute risk. Sometime they appear to do so unfairly, but that is a matter for the marketplace, not for the courts.
There is a danger attached to such clauses. Contractors may refuse to bid or, if they do so, may build in costly contingencies. Those who do not protect themselves from unknown potential risk may pay dearly. … Parties to construction or supply contracts may find it in their best interests to address more practically the assumption of design risk. To fail do to so merely creates the potential for protracted and costly litigation.
Id. at ¶¶ 24, 32 (extra paragraphing added).
19.4 Materiality of Warranties
Clause text
For the avoidance of doubt, each warranty stated in the Agreement is a material provision of the Agreement.
Comment
CAUTION: Warranting parties should be careful about agreeing to a provision such as this, because it might mean that even an inconsequential breach of warranty might be a material breach that could entitle the other party to terminate or even rescind the Agreement.
19.5 Implied Warranty Disclaimer
Clause text
(a) For the avoidance of doubt, any express warranties stated in the Agreement (if any) are unaffected by subdivisions (b) through (d) below.
(b) Each party (each, a Disclaiming Party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY DISCLAIMS all Implied Warranties, namely all warranties, representations, conditions, and terms of quality EXCEPT those that are expressly stated in (or incorporated by reference into) the Agreement.
(c) Without limiting the disclaimer of subdivision (b), the parties intend for that subdivision to encompass, for example, any and all Implied Warranties concerning any of the following:
(1) Merchantability.
(2) Fitness for a particular purpose (whether or not the Disclaiming Party or any of its suppliers or affiliates know, have reason to know, have been advised, or are otherwise in fact aware of any such purpose).
(3) Quiet enjoyment.
(4) Title.
(5) Noninfringement.
(6) Absence of viruses.
(7) Results.
(8) Workmanlike performance or effort.
(9) Implied term of quality.
(10) Non-interference.
(11) Accuracy of informational content.
(12) Correspondence to description.
(d) Without limiting subdivisions (b) and (c), those subdivisions apply regardless whether any allegedly-implied warranty is claimed to arise by law; by reason of custom or usage in the trade; by course of dealing or performance; or by trade practice.
(e) No party will assert that a Disclaiming Party has breached any Implied Warranty.
Comments
Language notes
Subdivision (b): The terms conditions and terms of quality are included to address the requirements of disclaimers under UK law, as discussed below. (The bold-faced, all-caps type is for conspicuousness.)
Subdivision (c): The "without limiting the disclaimer" preamble phrase is intended to avoid a very-strange holding by the Georgia supreme court, discussed below.
Subdivision (c)(2): Concerning the special requirements for disclaimers of the implied warranty of merchantability of goods sold (which arises automatically under the (U.S.) Uniform Commercial Code), including a conspicuousness requirement, see UCC § 2-316(2) and (3).
Subdivision (c)(3): In some jurisdictions an implied warranty of quiet enjoyment might arise in a lease of real property.
Subdivision (c)(4): The (U.S.) Uniform Commercial Code imposes special requirements for a disclaimer of the implied warranty of title in a sale of goods. See UCC S 2-312.
Subdivision (c)(5): Under the (U.S.) Uniform Commercial Code, a "merchant" that sells goods is deemed to give an implied warranty that the goods are free from third-party claims of infringement. See UCC S 2-312.
Subdivision (c)(8): See the definition of workmanlike.
Subdivision (c)(9): "Implied term of quality" is a British-ism.
Subdivision (d): See generally UCC §§ 1-303 and 2-314(3).
Subdivision (e): The intent here is to make such an assertion a separate breach of contract, so that a party making such an assertion would be liable for damages in the form of attorney fees even without an attorney-fee provision.
Consumer-protection statutes vs. warranty disclaimers
Any company offering consumer-product warranties (in the U.S.) should carefully study the requirements of various federal- and state consumer protection laws, such as:
- the Magnuson-Moss Warranty Act, which is the federal law that governs consumer product warranties; it requires manufacturers and sellers of consumer products to provide consumers with detailed information about warranty coverage, and also affects both the rights of consumers and the obligations of warrantors under written warranties (this paragraph is adapted from the FTC guide linked above); and
- state statutes such as California's Song-Beverly Act, which requires manufacturers of consumer goods sold in California to jump through various hoops (and imposes stringent requirements if the manufacturer wants to disclaim the implied warranties of merchatability and fitness).
The E-Warranty Act of 2015 requires any written warranty for consumer products costing more than $15 to be made available before the sale, as discussed here.
A bizarre Georgia supreme court holding
In the Common Draft warranty-disclaimer language, the phrase "[w]ithout limiting the disclaimer of subdivision (a)" shouldn't be necessary, but Georgia's supreme court seemed to think that the words in a contract's warranty disclaimers mean whatever the court wants them to mean. In that court's opinion in Raysoni v. Payless Auto Deals, the main facts (in my view) were the following:
- The plaintiff, Raysoni, had bought a used minivan. Before the sale, he allegedly asked the sales representative whether the vehicle had ever been in an accident; the sales rep allegedly said no, and gave Raysoni a clean CarFax report.
- The sales contract included numerous disclaimers — and also disclosed that at the auction (where presumably the dealership acquired the vehicle), the vehicle had been announced as having had unibody damage; moreover, the contract said, the buyer was urged to have the vehicle checked out before buying it.
- Two months after the sale, Raysoni allegedly learned that the vehicle had in fact been in an accident and suffered frame damage. The dealership rejected Raysoni's request to undo the deal and get his money back. Raysoni sued for fraud.
- The trial court granted judgment on the pleadings in favor of the dealership, saying that in view of the disclaimers in the sales contract, it would have been unreasonable for Raysoni to rely on the alleged written- and oral statements by the sales representative, and therefore Raysoni's fraud claims couldn't succeed. The court of appeals affirmed.
But then the state's supreme court took — how shall I put this — an intriguing view of the meaning of the disclaimer language, holding that:
The more prominent and general disclaimer of warranties—a provision that the minivan was sold "AS IS NO WARRANTY"—is followed immediately by an explanation that arguably qualifies and limits [sic] that disclaimer: "The dealership assumes no responsibility for any repairs regardless of any oral statements about the vehicle."
Raysoni v. Payless Auto Deals, LLC, 296 Ga. 156, 766 S.E.2d 24, 26 (2014) (emphasis added).
Seriously? The court's interpretation seems utterly contrary to the plain, unambiguous language of the contract. The agreement's no-responsibility-for-repairs sentence doesn't qualify or limit the as-is-no-warranty disclaimer, it emphasizes one of its implications.
And that's not all—the supreme court continued:
Likewise, the additional disclaimers of specific warranties that appear in the fine print of the contract are followed by the provision that "NO SALESMAN VERBAL REPRESENTATION IS BINDING ON THE COMPANY," and to the extent that the latter provision can be understood as an explanation of the foregoing disclaimers, it limits [sic] those disclaimers.
Id. (emphasis added). As young people might say: WTF?
Look, I get it; the Georgia supreme court didn't like it that the dealership allegedly gave the buyer a clean CarFax report but then tried to rely on a warranty disclaimer and a written warning that the car had been reported to have been damaged.
But despite the supreme court's unanimous opinion, I still don't see how anyone could reasonably conclude that the dealership's warranty disclaimer was "qualifie[d] and limit[ed]" by the additional contract language.
Moreover, on the facts as stated by the supreme court, I'm not sure what else the dealership could reasonably have done.
The danger now is that every contract drafter whose work might end up in a Georgia court must wonder whether even the most explicit of warranty disclaimers will be enough to avoid a jury trial on fraud charges.
Warranty disclaimers for UK transactions should also disclaim “conditions”
If you're a vendor doing a sales transaction under UK law (England, Wales, Northern Ireland), be sure that your warranty disclaimer addresses not just implied warranties but also implied “conditions.” An oil seller failed to do so and learned that its disclaimer didn't preclude liability. See [KG Bominflot Bunkergesellschaft Für Mineralöle mbh & Co KG v. Petroplus Marketing AG, [2009] EWHC 1088 (Comm). In that case:
- The parties entered into a contract for the sale of gasoil, a type of heating oil. The contract was governed by English law.
- The contract provided that delivery was complete, and title and risk passed to the buyer, when the gasoil was loaded onto a certain ship.
- The gasoil met the contractual specifications when it was loaded. By the time the ship arrived at its destination, however, the gasoil no longer met the agreed specifications. The claimed damages were in excess of US$3 million. Id. para. 8.
The seller took the position that all title and risk had passed, therefore the damages were the buyer's problem. The buyer, though, argued that under the Sale of Goods Act 1979, “it was an implied condition of the sale contract that the goods would be reasonably fit for the purpose of remaining, during their time on the vessel and for a reasonable time thereafter, within the specifications set out in the sale contract." Id. para. 7 (quoting buyer's argument).
The judge agreed with the buyer, holding that by failing to disclaim implied conditions as well as implied warranties, the seller had left itself open to the buyer's claim:
49. If the failure to use the word “condition” renders clause 18 [the warranty disclaimer] of little or no effect, so be it. The sellers agreed to the wording of clause 18 in the face of Wallis v Pratt and must live with the consequences.
(Hat tip: Ken Adams.)
Further reading
See generally, e.g.:
- Timothy Davis, UCC Breach of Warranty and Contract Claims: Clarifying the Distinction, 61 Baylor L. Rev. 783 (2009).
- Howard T. Spilko and Scott A. Abramowitz, Use of Representations and Warranties Insurance Grows in Middle-Market Transactions (NYLJ.com 2015).
19.6 Warranty Survival
Clause text
(a) This section applies in any case in which any warranty stated in the Agreement (each, a Surviving Warranty) is alleged to have been breached.
(b) Subject to the limitations stated in subdivision (c), all Surviving Warranties will survive the closing or other consummation of the transaction or transactions contemplated by the Agreement (the Closing) for the period stated in subdivision (c).
(c) To be entitled to any remedy for breach of a Surviving Warranty, the party alleging the breach must:
(1) give the breaching party notice of the breach before one year after the date of the Closing; and
(2) bring any judicial- or other action for the breach before the expiration of one year and three months after the date of the Closing.
Comment
This provision tries to make it very clear just how, and for how long, specified warranties survive the closing of a contract for the sale of assets. It is intended to address the so-called merger doctrine that, in some circumstances, can extinguish warranties set forth in the contract.
In a contract for sale of real property, the seller will generally make certain stated warranties (which are often extensively negotiatied).
- In some jurisdictions, at the closing of the sale, all such warranties are deemed to "merge" into — and thus be extinguished by — the seller's delivery of the deed conveying the property, that is unless the contract provides otherwise.
- That way, "the deed is deemed to express the final and entire contract between the parties." Ram's Gate Winery, LLC v. Roche, 235 Cal. App. 4th 1071, 1079, 185 Cal. Rptr. 3d 935 (2015) (reversing and remanding summary adjudication and holding that fact issue remained as to whether parties intended warranties to survive closing) (citations and internal quotation marks omitted).
A similar but not-identical issue can arise in corporate merger & acquisition (M&A) transactions: Careless use of the phrase "warranties will survive the closing" can create confusion: If a warranty breach allegedly occurs, it might be unclear whether the non-breaching party must merely notify the breaching party witnin a stated period of time after closing, or whether the non-breaching party must file a lawsuit or demand for arbitration within that time. See, e.g., Jeffrey H. LaBarge, They don't call it a survival clause for nothing … (NixonPeabody.com 2011).
19.7 Warranty Claims Deadline
Clause text
(a) For Provider to be liable for breach of any warranty stated in or otherwise relating to the Agreement, the matters stated in subdivisions (b) through (d) must all be true.
(b) Customer must give Provider written notice that states, in reasonable detail, the facts constituting the alleged breach. The notice must be effective no later than 90 days (the Warranty Notice-Period Duration) after the date that Customer (i) knows, or (ii) in the exercise of reasonable diligence, should know, of the existence of the alleged breach (the Warranty Limitation-Period Start Date).
(c) At Provider's request from time to time, Customer must furnish Provider with reasonable information about the facts constituting the alleged breach.
(d) Customer must duly file and duly serve a claim for the alleged breach no later one year after the Warranty Limitation-Period Start Date.
Comment
An action normally “accrues” at the time of the injury. In some jurisdictions, the discovery rule applies; that rule holds that, in certain circumstances, a claim accrues — and the limitation period starts to run — when the plaintiff first had, or reasonably should have had, a suspicion of wrongdoing. See, e.g., Miller v. Bechtel Corp., 33 Cal. 3d 868, 663 P.2d 177 (1983) (affirming summary judgment on limitation grounds), discussed in Jolly v. Eli Lilly & Co., 44 Cal. 3d 1103, 1111, 751 P.2d 923 (1998) (same).
20 Supporting Provisions
- 20.1. Automatic Approval of Requests
- 20.2. Changes to Orders for Goods or Services
- 20.3. Consultation Procedure
- 20.4. Cooperation (rough draft only)
- 20.5. Escrow [notes only]
- 20.6. Extensions (Evergreen)
- 20.7. Extensions (Unilateral)
- 20.8. [Import and export]
- 20.9. [International contracts]
- 20.10. [Right-of-first-refusal procedure]
- 20.11. Force Majeure
- 20.12. Intellectual Property Ownership
- 20.13. Language for Written Communications
- 20.14. Language Capability for Oral Communications
- 20.15. [Liens]
- 20.16. [Pricing]
- 20.17. Primary-Contact Designation
- 20.18. Recordkeeping Requirement
- 20.19. Status-Review Conferences
- 20.20. Subcontracting
20.1 Automatic Approval of Requests
Clause text
(a) This section applies whenever the Agreement specifies that a party (the Reviewing Party) has a stated period of time (the Request Review Period) in which to approve a particular request for approval (the Approval Request).
(b) The Request Review Period begins on the date that the Approval Request is received by the Reviewing Party.
(c) The Reviewing Party is to be deemed to have approved the Approval Request if the Receiving Party has not delivered, to the Requesting Party, a written objection to the Approval Request by the end of the Request Review Period.
20.2 Changes to Orders for Goods or Services
Provider is not to implement any change requested by any Customer representative until the change request is confirmed in writing by an authorized representative of Customer.
shipment or packing; (c) place and time of delivery; (d) amount of Buyer’s furnished property; (e) quality; (f) quantity; or (g) scope or schedule of goods and/or services..
Customer need not notify any surety or guarantor of , and without notice to sureties, if any,
(b) If any such change causes an increase or decrease in the cost of, or time required for, performance of any part of work under this purchase order/contract, regardless of whether changed by a written order, Buyer shall make an equitable adjustment in purchase order/contract price, delivery schedule, or both, and shall modify purchase order/contract accordingly in writing.
(c) Seller must assert any right it may have to an adjustment in writing to Buyer and any such written assertion must be received by Buyer within 30 days from date of receipt of Seller’s written order. However, if Buyer decides the facts justify it, Buyer may receive and act upon any such claim asserted at any time prior to final payment under this purchase order/contract.
(d) If Seller's proposal for adjustment includes cost of property made obsolete or excess as a result of Buyer's written change order, Buyer shall have the right to prescribe the manner of disposition of the property.
(e) Failure to agree to any adjustment shall be a Dispute under the Disputes clause. However, nothing in this clause shall excuse Seller from proceeding with purchase order/contract as changed.
- CHANGES [GE].
6.1 Buyer Changes. Buyer may at any time make changes within the scope of this Order
Supplier shall not proceed to implement any change until such change is provided in writing by Buyer.
If any changes cause an increase or decrease in the cost or schedule of any work under this Order, an equitable adjustment shall be made in writing to the Order price and/or delivery schedule as applicable.
Any Supplier claim for such adjustment shall be deemed waived unless asserted within thirty (30) days from Supplier’s receipt of the change or suspension notification and may only include reasonable, direct costs that shall necessarily be incurred as a direct result of the change.
6.2 Supplier Changes. Supplier shall notify Buyer in writing in advance of any and all: (a) changes to the goods and/or services, their specifications and/or composition; (b) process changes; (c) plant and/or equipment/tooling changes or moves; (d) transfer of any work hereunder to another site; and/or (e) sub-supplier changes, and no such change shall occur until Buyer has approved such change in writing.
Supplier shall be responsible for obtaining, completing and submitting proper documentation regarding any and all changes, including complying with any written change procedures issued by Buyer.
20.3 Consultation Procedure
20.3.1 Notice and Opportunity to Be Heard
Clause text
(a) This section 20.3 applies whenever the 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.
Comment
Suppose that Alice and Bob are negotiating a contract under which Alice demands that Bob obtain Alice's consent before proceeding with a specified action (e.g., raising prices). 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 provision is drafted in contemplation that it might be part of a package of clauses that as a group, but not individually, are incorporated by reference into an agreement.
This provision 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 CD-25.76. Seasonable Definition.
20.3.2 Freedom of Action Not Limited
Clause text
For the avoidance of doubt, a consultation requirement in itself does not limit the freedom of the acting party to take or omit the specified action unless the Agreement expressly states otherwise.
Comment
This subdivision is a "roadblock" provision, intended to reassure an acting party that might be nervous about about how a court might interpret this.
20.4 Cooperation (rough draft only)
Clause text
(a) Applicability: This Annex applies in any case as to which the 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 the 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: The 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.
Comment
These materials need further thought; I'm posting them for use as a reference. The idea for this definition came from, among other places, an Oracle license-agreement document.
Subdivision (c) was inspired by tales of parties intentionally making it difficult and uncomfortable for other parties to take actions.
20.5 Escrow [notes only]
Cal. S. Ct.'s explanation of escrow agent's duties: https://scholar.google.com/scholar_case?case=11301981884307642549
See the following examples, chosen because their parties are "name-brand companies" who presumably used competent lawyers:
- State Street Bank / Cisco Systems ($40MM escrow)
- TiVo / America Online (escrow of up to $91MM); TiVo / America OnLine ($51MM release of escrowed funds)
- Ticketmaster / ARTISTdirect / JPMorgan Chase
20.6 Extensions (Evergreen)
20.6.1 Evergreen-Extension Definitions
Clause text
Evergreen Period refers to: Any otherwise-expiring period that the Agreement states is subject to evergreen- or automatic extension.
Extension Duration refers to: One year.
Maximum Number of Extensions refers to: An unlimited number.
Party Eligible to Opt Out refers to: Each party.
Opt-Out Deadline refers to: 12 midnight at the end of the last business day before the then-current expiration date of the Extendable Period.
Comments
Business purpose
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.
Checklist question: Which party has the right to opt out?
This provision allows either party to opt out, but in some contractual relationships (e.g., a customer-supplier relationship), one party might might feel that it should have more flexibility than the other party to opt out of an evergreen extension.
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.
Long extension periods can be problematic
Here's a real-world example of an evergreen automatic-extension provision gone awry:
- A client of mine once agreed to give a steep pricing discount to a particular customer for five years, if memory serves. (I hadn't been involved in that deal.)
- The agreement provided that the the discount would be automatically extended for another five years if my client didn't opt out when the first five-year period was expiring.
- Sure enough, no one in the client's organization noticed that the five-year discount period was ending.
- As a result, the client didn't send the customer a notice that the client was opting out of the pricing commitment.
- The client had to honor the steeply-discounted pricing for that customer for another five years. This, even though the client had raised its prices significantly for the rest of its customer base.
Maximum number of extensions
If the parties' relationship is working well and either party can opt out, then there might be no reason to have it come to an end unless one party wants it to end.
On the other hand, it might be that only one party has the right to opt out. This might be the case in a supply agreement, in which the customer may opt out but the supplier may not. In that situation, the supplier might want to limit the number of automatic extension periods.
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).
Further reading
See the discussion of the distinction between extend and renew.
20.6.2 Automatic Extension Subject to Opt-Out
Clause text
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.
Comment
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 [2014] 3 S.C.R. 495, ¶ 91.
CAUTION: In a Canadian case decided after Bhasin, the agreement in suit involved the software giant Oracle Corporation and a member of Oracle's partner network. The agreement gave Oracle the sole discretion to accept the partner's application to renew the agreement. For 20 years the agreement was renewed each year. In 2014, though, Oracle invited the partner to renew the agreement, but then rejected the partner's renewal application. The partner filed suit; the trial court denied Oracle's motion to dismiss, holding that a dictum in Bhasin "does not stand for the (extreme) proposition that under no circumstances does a 'sole discretion' contract renewal power have to be exercised reasonably." Data & Scientific Inc. v. Oracle Corp., 2015 ONSC 4178 (CanLII).
20.6.3 Extension Opt-Out Fee
Clause text
(a) Any party opting out of an extension under section 20.6.2 before [specify date] must pay the other party an Early Opt-Out Fee, in an amount specified in the 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 Early Opt-Out Fee is intended as a form of alternative performance and not as liquidated damages.
Comment
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.
The intent of the Early Opt-Out Fee is to give the other party a specified minimum time in which, say, to recoup the investments it makes in supporting the parties' contractual relationship.
20.7 Extensions (Unilateral)
20.7.1 Right to Extend Unilaterally
Clause text
Except to the extent (if any) that the Agreement provides otherwise, any party specified in the Agreement (each, an Extending Party) may extend the term specified in the Agreement (each such term, an Extendable Period) for up to an unlimited number of successive periods of one year each.
Comment
Customers often want the right to extend the duration of supply agreements; resellers sometimes want the right to extend the duration of their territory rights.
The unilateral-extension concept could be applied not only to the term of the Agreement, but to just about any right or obligation that has an expiration date.
One year seems to be fairly typical as the duration of an Extension Period. CAUTION: Too-long an Extension Period could lock in terms and conditions (e.g., pricing) that the other party might regard as unfavorable, as discussed in this note.
Concerning the maximum number of permitted extensions, see the Notes.
20.7.2 Advance Notice Requirement
Clause text
To extend an Extendable Period, the Extending Party must give notice of extension to each other party; each notice of extension must be effective no later than 90 days before the then-current expiration date of the Extendable Period in question.
20.7.3 Same Terms and Conditions
Clause text
Unless the parties agree otherwise in writing, any unilateral extension of an Extendable Period will be on the same terms and conditions as were in effect immediately before (what would have been) the expiration of that Extendable Period.
Comment
This language is intended to forestall the result in an Eighth Circuit case, where the appellate court affirmed a declaratory judgment that a lease agreement had given the tenant an option to renew rather than an option to extend; consequently, under a state law, the landlord was free to demand that the terms be renegotiated — this, even though the lease agreement expressly termed the option as a right to extend. See Camelot LLC v. AMC ShowPlace Theatres, Inc., 665 F.3d 1008 (2012) (8th Cir. 2012).
In contrast, the Third Circuit held that a contractual right to renew an insurance policy meant renewal on the same or nearly the same terms and conditions. See Indian Harbor Ins. Co. v. F&M Equip., Ltd., No. 14-1897 (3d Cir. Oct. 15, 2015). The appellate court vacated the trial court's denial of the insured's motion for summary judgment and remanded with instructions to enter summary judgment.
20.7.4 Right to Terminate Not Affected
Clause text
The fact that an Extendable Period is unilaterally extended will not affect any right that any party might have, under one or more provisions of the Agreement or of applicable law, (i) to terminate that Extendable Period, and/or (ii) to terminate the Agreement.
20.7.5 Extension Opt-Out Right
Clause text
A unilateral extension will not go into effect if the other party gives notice of non-extension to the Extending Party; that notice must be effective no later than ten business days before expiration of the Extendable Period.
20.7.6 Permanent Lapse of Extension Right
Clause text
IF: For any reason an an Extending Party does not duly extend an Extendable Period before that period expires; THEN: The Extending Party's right to unilaterally extend that Extendable Period will permanently and irrevocably lapse.
20.7.7 Extension Opt-Out Fee
Clause text
IF: A party wishes to opt out of an extension of an Extendable Period; THEN: In addition to giving timely notice under section 20.7.2, that party must pay the Extending Party an Opt-Out Fee in an amount specified in the Agreement. The payment is due no later than the then-current expiration date of the Extendable Period. If the payment is not timely made, then the extension will go into effect and the right to opt out will expire automatically. For the avoidance of doubt, the Opt-Out Fee is intended to provide an alternative form of performance and not as liquidated damages.
Comment
See the note to the evergreen opt-out fee provision.
20.8 [Import and export]
20.9 [International contracts]
See generally Ken Adams and René Mario Scherr, Top Ten Tips in Drafting and Negotiating International Contracts (acc.com April 2015) (see also the PDF file)
20.11 Force Majeure
- 20.11.1. Force Majeure Definition
- 20.11.2. Excused Performance Due to Force Majeure
- 20.11.3. Force Majeure Examples
- 20.11.4. Force Majeure Rights Extension
- 20.11.5. Force Majeure Termination
- 20.11.6. Force Majeure Efforts-Only Option
- 20.11.7. Force Majeure Subcontractor Requirements
- 20.11.8. Force Majeure Status Reports
20.11.1 Force Majeure Definition
Clause text
Force-Majeure Event refers generally to any event or series of events (other than one or more Excluded Events (if any; none unless expressly agreed otherwise)) as to which both of the following are true:
(1) the event or series of events causes a failure of timely performance under the Agreement; and
(2) a prudent person, in the position of the party invoking force majeure, would not reasonably have been able to anticipate and avoid the failure of timely performance.
20.11.2 Excused Performance Due to Force Majeure
Clause text
(a) In response to actual or imminent occurrence of one or more Force-Majeure Events, either party (an Invoking Party may invoke force majeure by advising another affected party by notice or other reasonable means.
(b) An Invoking Party that seasonably invokes force majeure will not be liable under the 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.
(c) Each party is to make any efforts expressly specified for that party in the Agreement — if any — with respect to mitigating (the Required Mitigation Efforts) and remediating (the Required Remediation Efforts) the effects of the force majeure. (This subdivision is not to be interpreted as implicitly requiring any party to make any such efforts.)
Comments
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).
Mitigation- and remediation efforts
Mitigation, remediation, or both? Note that there are two distinct options presented here: One for mitigation, one for remediation, which are two different things.
CAUTION: Some customers might insist that the other party use its "best efforts" to mitigate or remediate the effects of of force majeure; see, e.g., section 4 of a set of Honeywell purchase-order terms and conditions, apparently from February 2014. A supplier might be reluctant to agree to a best-efforts commitment for the reasons discussed in the commentary to CD-25.9. Best Efforts Definition; such a supplier might prefer a commercially-reasonable efforts commitment instead.
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.
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.
Further reading about force majeure
See, e.g.:
- 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).
20.11.3 Force Majeure Examples
Clause text
For the avoidance of doubt, the term Force-Majeure Event includes the following, when otherwise eligible under the Agreement:
(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 the 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 the Agreement — it is immaterial if one or more of them also comes within the scope of subdivision (1) above.
Comment
The "laundry list" of force-majeure examples in subdivision (1) was drawn from various agreement specimens.
Concerning economic changes generally, see Kevin Jacobs and Benjamin Sweet, 'Force Majeure' In the Wake of the Financial Crisis, Corp. Coupsel, Jan. 16, 2014.
In some customer-oriented supply- and service contract forms, labor difficulties are excluded from the definition of force-majeure event.
This list of examples does not include so-called acts of God because of the vagueness of that term.
Some drafters might want to use the "other particular examples …" option in subdivision (b) to specify particular force-majeure risks of concern.
20.11.4 Force Majeure Rights Extension
Clause text
IF: One or more properly-invoked Force-Majeure Events make it impracticable or impossible for an Invoking Party to timely exercise a right, under the 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.
Comment
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. See Beardslee v. Inflection Energy, LLC, 25 N.Y.3d 150, 31 N.E.3d 80, 8 N.Y.S.3d 618 (on certification from Second Circuit), subsequent proceeding, 798 F.3d 90 (2d Cir. 2015) (affirming judgment of district court). In that case, the New York court of appeals aligned itself with courts in several other "oil" jurisdictions. See id., 25 N.Y.3d at 159.
20.11.5 Force Majeure Termination
Clause text
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 the Agreement if the aggregate effect of the relevant Force-Majeure Event(s): (1) is material to the 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 the Agreement).
Comment
The "material to the 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).
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.
20.11.6 Force Majeure Efforts-Only Option
Clause text
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.
20.11.7 Force Majeure Subcontractor Requirements
Clause text
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.
20.11.8 Force Majeure Status Reports
Clause text
(a) 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.
(b) 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.
Comment
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.
Subdivision (b): A party invoking force majeure might not want its business made public.
20.12 Intellectual Property Ownership
20.12.1 IP Ownership Definitions
Clause text
(a) This section 20.12 applies in any case in which the Agreement specifies that an individual or organization (the Owner is to own specified intellectual property (the Specified IP) that is or might be owned by another individual or organization (the Confirming Party).
(b) Each of the Owner's rights under this section 20.12 will pass to the Owner's successors and assigns, if any, in respect of the OWner's business relating to the Agreement.
Language notes
These definitions are designed to allow this form to be used by reference without having to customize it.
Subdivision (b) takes into account that companies sometimes spin off divisions, do corporate reorganizations, etc.
Who should own the rights to IP developed under a services contract?
In my view, a buyer would take too short-term a view, and would be partially free-riding on past buyers' payments, if today's buyer insisted on owning "foreground" IP rights for IP that wasn't critical to its core business competitive position (it's a different analysis without that final qualifier). Here's why:
- The supplier has "background" IP available to offer precisely because yesterday's buyer paid the supplier to develop that background IP, thus reducing the total price that today's buyer must pay.
- It's therefore entirely reasonable for the supplier to insist that whatever foreground IP it develops for today's buyer must likewise be put into that supplier-managed pool of background IP assets.
- So, if today's buyer insists on owning that foreground IP anyway, then the price should go up dramatically — not least because of the future burden to the supplier of tracking which IP is available to it in the future as background IP.
20.12.2 Work Made for Hire
Clause text
To the maximum extent permitted by law, the Specified IP is to be considered a work made for hire whose author or inventor is the Owner.
Comment
Under U.S. copyright law, a contract can't designate a work of authorship as a work made for hire merely by saying so, because the work of authorship itself must meet specific statutory requirements. See generally the Reading Notes on this subject..
As to (U.S.) patents, the concept of work made for hire doesn't really apply. But an individual inventor who is employed, even without an invention-assignment agreement, might be under an implied obligation to assign her ownership rights in her invention to her employer if she (1) is subject to an employment agreement requiring her to do so; (2) was hired to invent; and/or (3) was "set to experimenting" by the employer with the invention being a result. In addition, her employer might have "shop rights" to use the invention if the inventor used the employer's time and/or resources in making the invention. See generally the Reading Notes on this subject.
20.12.3 Assignment of IP
Clause text
The Confirming Party hereby irrevocably assigns to the Owner and its successors and assigns all right, title, interest, and property, anywhere in the world, in and to the Specified IP (to the extent that the Specified IP is not eligible to be a work made for hire under section 20.12.2), together with:
(1) any and all original, continuation, continuation-in-part, divisional, reissue, foreign-counterpart, or other patent applications for the Specified IP, no matter when filed;
(2) any and all patents issuing on each patent application described in subdivision (1);
(3) the right to claim priority in, to, or from any patent application described in subdivision (1) or any patent described in subdivision (2);
(4) any and all registrations for, and any and all applications to register, the copyright or trademark rights (if any) in the Specified IP;
(5) any other intellectual property rights, of whatever nature, in the Specified IP, together with any applications for, or issued registrations for, the same; and
(6) the right to recover, and to bring proceedings to recover, damages and/or obtain other remedies in respect of infringement or misappropriation of any item listed in any of items (1) through (5), whether the infringement or misappropriation was committed before or after the date of the Agreement.
Comment
This provision is phrased as a present assignment – as opposed to a promise to assign at some unspecified point in the future — with the intent of avoiding a timing problem of the kind that resulted in Stanford University's being unable to assert a patent that it owned (or so it had thought). See Bd. of Trs. of the Leland Stanford Junior Univ. v. Roche Molecular Sys., Inc., 583 F.3d 832 (Fed. Cir. 2009), aff'd as to a different issue, 563 U.S. __, 131 S. Ct. 2188, 2194-95 (2011).
20.12.4 IP Ownership Documents
Clause text
(a) Whenever so requested by the Owner from time to time, for no additional compensation, the Confirming Party will cause one or more Vesting Documents (as defined below, and as provided by the Owner at the Owner's expense) to be:
(1) signed;
(2) acknowledged or sworn to before a notary public or comparable official (if applicable); and
(3) delivered to the Owner for filing with appropriate authorities in the Owner's sole discretion and at the Owner's expense.
(b) Vesting Document refers to any of the following:
(1) patent applications and trademark- and copyright-registration applications as described in section 20.12.3(1) and (4);
(2) assignments of patents, patent applications, copyrights, trademark rights, and other intellectual-property rights;
(3) any other document that may be reasonably requested by the Owner to help the Owner or its nominee to:
(A) fully and effectively vest, in the Owner, the rights assigned by the Agreement;
(B) formally register the Owner’s title in the same with relevant government offices; and
(C) enjoy the full and exclusive benefit of those rights, including without limitation the Owner's (i) taking action against infringers and (ii) defending against challenges to the validity of the rights assigned by the Agreement.
Comment
Another "belt and suspenders" variation would be to state that "(1) it's a work for hire; (2) if it's not, you hereby assign the copyright to us; (3) and if that doesn't work, you hereby give us a perpetual paid-up license." Fred von Lohmann, comment on a posting at copyright scholar William Patry's blog.
See also CD-20.12.5. Backup IP License.
20.12.5 Backup IP License
Clause text
To the extent (if any) that, by law, any moral rights or other intellectual property rights in Specified IP cannot be assigned to the Owner, the Confirming Party hereby grants to the Owner and its successors and assigns a perpetual, irrevocable, worldwide, royalty-free, fully-transferable license under all such non-assignable rights.
Comment
This is an anchor-to-windward provision.
see generally the Wikipedia entry on moral rights.
20.12.6 Employee IP Agreements
Clause text
(a) The Confirming Party will ensure that its employees and subcontractors (if any) have signed written agreements sufficient to enable Customer to comply with its obligations under this section 20.12.
(b) This section 20.12.6 in itself neither authorizes nor prohibits the use of subcontractors by the Confirming Party.
Comment
An employee might not need a written agreement to cause the employee's work product to be owned by the employer (at least under U.S. law). See generally this annotated flowchart that I did a few years ago.
On the other hand a subcontractor likely would indeed need to sign such an agreement in order to transfer ownership to another party. The other party might be able to claim an implied license to use and further-develop the deliverable. See, e.g., Graham v. James, 144 F.3d 229 (2d Cir. 1998); Latour v. Columbia University, 12 F.Supp. 3d 658 (S.D.N.Y. 2014); Numbers Licensing LLC v. bVisual USA Inc., No. CV-09-65-EFS, 91 U.S.P.Q.2d 1946 (E.D. Wash. Jul. 15, 2009).
20.12.7 Joint IP Creation Ownership
Clause text
(a) Joint IP Creation refers to any intellectual property that is invented, authored, or otherwise created or developed jointly by two or more Joint IP Creators, where:
(1) a Joint IP Creator is:
(A) an individual Signatory Party, or
(B) an employee or other individual associated with a non-individual Signatory Party,
(each such Signatory Party, a Joint IP Owner); and
(2) each Joint IP Owner is the beneficiary of an obligation, on the part of at least one Joint IP Creator, to assign that Joint IP Creator's interest in the intellectual property to that Joint IP Owner.
(b) The Joint IP Owners will own equal, undivided interests in each Joint IP Creation unless they expressly agree otherwise in writing.
Comment
Joint creation of intellectual property can occur, for example: • in services-type contracts; and • in collaboration agreements of various kinds, e.g., R&D joint-venture agreements. See generally this article about patent joint ownership and this article about copyright joint ownership.
Who is to own jointly-created IP will sometimes be a negotiation point.
20.12.8 Co-Owner Accounting Disclaimer
Clause text
(a) Unless the Joint IP Owners expressly agree otherwise in writing, no Joint IP Owner that "uses" (as defined below) any Joint IP Creation is required to:
(1) share proceeds or profits from such use with any other Joint IP Owner; nor
(2) otherwise account to any other Joint IP Owner for such use.
(b) For purposes of subdivision (a), the term use of a Joint IP Creation refers to any action that, if taken by any person other than a Joint IP Owner, would require a license under one or more intellectual-property rights in the Joint IP Creation.
Comment
Unless otherwise agreed, joint owners of the (U.S.) copyright in a work of authorship must account to each other for their respective uses of the work. In contrast, joint owners of a (U.S.) patent for an invention are not required to account to each other for their respective uses of the patented invention unless otherwise agreed.
20.13 Language for Written Communications
Clause text
The Contract Language is to be used for:
(1) each written notice required or contemplated by this Agreement, including for example any notice of arbitration;
(2) all service of legal process in any Agreement-Related Dispute — if applicable law requires that service of process be made in another language, then a translation into the Contract Language of each other-language document so served is to be served with the other-language document; and
(3) except in cases of emergency, any other written communication made pursuant to the Agreement.
Comment
Requiring written communications to be in a specified language can prove useful in case of litigation, arbitration, or other dispute-related proceedings.
See also CD-24.9. Language of the Agreement and CD-20.14. Language Capability for Oral Communications and CD-20.13. Language for Written Communications.
Subdivision (1) has in mind the situation in CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, No. 15-1256 (10th Cir. Jul. 19, 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015), discussed in the commentary to the master-agreement provision.
20.14 Language Capability for Oral Communications
Clause text
(a) Each party is to maintain the capability of conducting routine business orally (e.g., in person or by telephone) in the Contract Language, whether through party personnel who can speak that language or through translators engaged at the party's expense.
(b) Subdivision (a) does not limit any party's right to communicate orally in any other language when agreed to by the individuals involved and not a hindrance to the purpose of the Agreement.
Comment
This provision tries to balance: • the parties' interest in making sure they can communicate orally, against • the possible threat of legal action from employees claiming discrimination on the basis of national origin. See, e.g., Can You Require Employees to Speak Only English on the Job? (CBIA.com, undated).
See also CD-24.9. Language of the Agreement and CD-20.13. Language for Written Communications.
20.16 [Pricing]
20.17 Primary-Contact Designation
20.17.1 Designation Upon Written Request
Clause text
(a) Upon a written request by any party, each party (each, a Designating Party) is to designate, in writing, and provide contact information for, one or more Primary-Contact Representatives.
(b) Each Primary-Contact Representative is to be an individual of appropriate seniority who is authorized by the Designating Party to act as a contact point on behalf of the Designating Party under the Agreement.
(c) Any such designation may:
(1) be by email;
(2) state limits on the authority of the Primary-Contact Representative;
(3) be amended in writing from time to time by any method permitted for the original designation; and/or
(4) be revoked in writing by any method permitted for the original designation.
Comment
Provisions like this are often seen in, e.g., services- and project agreements, where it can be important for parties to have designated points of contact.
In some circumstances, a party that designates a Primary-Contact Representative might want to restrict the representative's authority by so stating in its designation of the representative.
20.17.2 Binding Communications by Representatives
Clause text
An oral communication from a Primary-Contact Representative to another Signatory Party will not be binding on the Designating Party; a written communication will be binding, and may be relied on by that other Signatory Party for any purpose relating to the Agreement, UNLESS:
(1) the communication exceeds a limitation on the Primary-Contact Representative's authority as stated in the Designating Party's most-recent written designation under subdivision (1); or
(2) the communication itself clearly states that it is not intended to be binding.
20.17.3 Communications by Other Party Personnel
Clause text
Unless otherwise specified in the Agreement or in the written designation of a Primary Contact Representative, IF: An employee or other representative of a Designating Party, other than a Primary-Contract Representative of that party, purports to make a request or issue an instruction on behalf of the Designating Party; THEN: Other parties are not to consider the request or instruction to have been made on behalf of that Designating Party.
Comment
This provision addresses one of the major causes of "troubled" contracts, which is that is unauthorized people can make change requests that can lead to cost overruns and delays. See, e.g., Steve Olsen, Troubled contracts – why missing these steps may trip you up (IACCM.com 2015).
20.18 Recordkeeping Requirement
20.18.1 Definition of Required Records
Clause text
(a) The term Required Records refers to the records specified in subdivisions (b) and (c) below.
(b) During the term of the Agreement (the Recordkeping Period), any party engaged in activities described in subdivisions (1) through (4) below (each, a Recordkeeping Party) is to create and maintain records sufficient to document the following, as applicable:
(1) all deliveries of goods and services, by the Recordkeeping Party to another Signatory Party, under the Agreement;
(2) billing of charges or other amounts, by the Recordkeeping Party to another Signatory Party, under the Agreement;
(3) all payments, by the Recordkeeping Party to another Signatory Party, under the Agreement, of amounts not verifiable by the payee, such as, for example, royalties or rents to be paid to the other party as a percentage of the Recordkeeping Party's sales; and
(4) all other information (if any) that the Agreement requires the Recordkeeping Party to report to another Signatory Party.
(c) The Required Records are to include, for example, where applicable, the following: Sales journals; purchase-order journals; cash-receipts journals; general ledgers; and inventory records; as well as any other records expressly required by the Agreement.
Comments
According to a study of U.S. construction companies, interviewees reported that unless the contract spells out in detail just what records are to be kept, "it is incredibly difficult to obtain the proper records from the Contractor in order to conduct a proper audit." Albert Bates, Jr. and Amy Joseph Coles, Audit Provisions in Private Construction Contracts: Which Costs Are Subject to Audit, Who Bears the Expense of the Audit, and Who Has the Burden of Proof on Audit Claims?, 6 J. Am. Coll. Constr. Lawyers 111, 114 (2012) (footnote omitted).
A sample clause published by the Association of Certified Fraud Examiners contains a laundry list of specific types of documents that a vendor might want to require a contractor to maintain.
The list in subdivision (c) is is adapted from the contract in suit in Zaki Kulaibee Establishment v. McFliker, No. 11-15207, slip op. at 14 n.13 (11th Cir. Nov. 18, 2014) (reversing, as abuse of discretion, and remanding district court's denial of plaintiff's request for an accounting).
In some situations, parties might want to negotiate specific records to be kept.
20.18.2 Standards for Recordkeeping
Clause text
All Required Records are:
(1) to be accurate;
(2) to be materially-complete; and
(3) to comply with:
(A) at least commercially-reasonable standards of recordkeeping; and
(B) if stricter, any other recordkeeping standards specified in the Agreement.
Comments
The term used to describe the Required Records is materially-complete and accurate. Some drafters use the term true and correct, but that seems both redundant and incomplete. Perhaps in an archaic sense the term true might be interpreted broadly to mean materially complete and accurate, but there seems to be little reason to take a chance that a judge would see it that way.
In some situations, parties might want to negotiate specific recordkeeping standards.
20.18.3 Record Retention Obligation
Clause text
The Recordkeeping Party will keep each of the Required Records for at least the longest of the following (the Record-Retention Period):
(1) any retention period required by applicable law;
(2) the duration of any timely-commenced audit of the Required Records permitted by the Agreement; and
(3) any other period specified in the Agreement, if any.
Comment
When services are involved, retaining records for two- to four years after final payment seems to be a not-uncommon requirement. See, for example, the [U.S.] Federal Acquisition Regulations, e.g., Contractor Records Retention, 48 C.F.R. §§ 4.703(a)(1), 4.705.
Some industries or professions might require specific record-retention periods.
NOTE: The Record-Retention Period is not the same as the Recordkeeping Period.
20.18.4 Right to Audit Records
Clause text
Any other Signatory Party described in section 20.18.1(b) may audit the Required Records in accordance with the procedures set forth in section 18.2.
Comment
See generally the Reading Notes on this subject..
20.18.5 Record Retention Per FAR Standards
Clause text
(a) If expressly so stated in the Agreement, the Recordkeeping Party will maintain each of the Required Records for at least the period that the record would be required to be maintained under the (U.S.) Federal Acquisition Regulations ("FARs"), Contractor Records Retention, 48 C.F.R. Subpart 4.7.
(b) For the avoidance of doubt, this section is included for the convenient reference of the parties, who do not intend to imply or concede that the Agreement and/or their relationship are in any way subject to the FARs.
Additional notes: Recordkeeping
Any contract drafter who will be negotiating recordkeeping- and audit clauses would do well to study carefully the primer found in Ryan C. Hubbs, The Importance of Auditing In An Anti-Fraud World — Designing, Interpreting, And Executing Right to Audit Clauses For Fraud Examiners (Assoc. of Certified Fraud Examiners 2012).
20.19 Status-Review Conferences
Clause text
(a) Frequency: Each party is to participate in status-review conferences in accordance with this as reasonably requested by either party.
(b) Type: Conferences are to be by telephone conference call unless otherwise agreed.
(c) Arrangements: Conference arrangements are to be made (i) by the requesting party for requested conferences, and (ii) by each party, on an alternating basis, for regularly-scheduled conferences (if any).
(d) Expenses: Unless otherwise agreed in writing, each party is to bear its own expenses of status-review conferences.
(e) Agenda template: A status-review conference may include discussion of some or all of the following "G-PP-AA" agenda items:
G - goals of the parties in respect of the Agreement;
P - progress to date in achieving those goals;
P - problems encountered or anticipated;
A - action plans for the future, including for example plans for addressing existing or anticipated problems; and
A - assumptions being made, especially any that might prove unwarranted.
(1) Minutes of each status-review conference should preferably be produced and circulated by the party arranging the conference details, but doing so is not mandatory.
(2) Any participating party may, at any time, propose corrections and/or additions to status-review conference minutes.
(3) The timeliness of draft minutes and of proposals for correction and/or addition are to be given due weight in assessing their evidentiary value.
(4) For the avoidance of doubt, status-review conference minutes will not in themselves be deemed to amend the Agreement nor to waive any right or obligation under it, regardless whether one or both parties prepared and/or approved the minutes, unless the minutes meet the requirements of the Agreement for amendment or waiver, as the case may be.
Comment
Many business-contract disputes could be mitigated or even avoided altogether if the participants would just talk with each other once in a while. In particular, it’s often extremely helpful to hold such a conference immediately after — or better yet, before — a missed deadline or other potential breach. Sure, this stuff is basically just "Management 101." But it can’t hurt for the contract to include a reminder.
Subdivision (a): In some situations, the parties might want to specify quarterly, monthly, or even weekly calls.
Subdivision (b): )Video conferences (with screen sharing) are becoming extremely affordable from provides such as Skype Business; Zoom.us; and GoToMeeting.
Subdivision (c): The parties might prefer to have one party (e.g., a supplier or services provider) always be responsible for arranging conference details.
Subdivision (d): To the extent that status-review conferences are conducted by phone, the conference expenses will often be nominal.
Subdivision (e): )The G-PP-AA agenda will generally provide useful topics for discussion. This provision, though, intentionally does not require conferences to follow the G-PP-AA agenda, so as not to create issues for possible dispute later.
Subdivision (f)): Conference minutes can be invaluable if disputes arise later.
Subdivision (f)(2), allowing corrections at any time, is intended to reduce or eliminate possible resistance to the idea of producing conference minutes.
Subdivision (f)(4) makes it clear that conference minutes will not act to amend the Agreement unless specific requirements are met; see also: • CD-24.1.1. Amendments in Writing as well as • CD-24.17. Waivers in Writing.
20.20 Subcontracting
- 20.20.1. Definitions: Provider; Subcontracting
- 20.20.2. Primary Contact
- 20.20.3. Subcontractor IP Agreements
- 20.20.4. Subcontracting Review
- 20.20.5. Unreasonable Delay in Approval
- 20.20.6. Subcontractor Insurance
- 20.20.7. Subcontractor Governmental Reports
- 20.20.8. Government-Contracting Flowdown
- 20.20.9. All Non-Employees as Subcontractors
20.20.1 Definitions: Provider; Subcontracting
Clause text
(a) Customer – see Provider, below.
(b) Provider refers to a party providing deliverables or services under the Agreement to, or for the benefit of, another party (Customer).
(c) Subcontracting, whether or not capitalized, refers to a party's causing or permitting another individual or organization to perform any of the party's obligations under the Agreement.
Comments
These definitions are set up so that these provisions can be referred to in a contract without explicitly stating which party is "Provider" and which is "Customer."
Subdivision (c) adapts language from the contract in suit in UPS Supply Chain Solutions Inc. v. Megatrux Transportation, Inc., 750 F.3d 1282, 1284 n.1 (11th Cir. 2014). In that case, the district court held, and the appeals court affirmed, that the defendant, a trucking company, was liable for the full amount of loss from theft of cargo after the trucking company subcontracted delivery without authorization.
20.20.2 Primary Contact
Clause text
For the avoidance of doubt, notwithstanding any subcontracting, Provider remains Customer's primary contact for all matters relating to Provider's obligations under the Agreement.
20.20.3 Subcontractor IP Agreements
Clause text
To the extent that the Agreement sets forth or affects intellectual-property rights of Customer (including for example Customer's confidential information), Provider will enter into written agreements with its subcontractors (if any) that are at least as protective of those rights of Customer as the Agreement.
20.20.4 Subcontracting Review
Clause text
(a) IF: The Agreement specifies that one or more of advance notice or advance approval of subcontracting is required; THEN: Provider must (i) notify Customer in writing or (ii) obtain Customer's prior written approval, as the case may be, a reasonable time in advance, of any of the following:
(1) that Provider intends to subcontract some or all of its obligations under the Agreement; and
(2) to the extent so specified by the Agreement:
(A) the specific subcontractor(s) Provider intends to use, and
(B) the specific task(s) that Provider intends to subcontract.
(b) For the avoidance of doubt, any review of proposed subcontracting by Customer, and any approval of particular subcontracting, subcontracts, or subcontractors, by Customer, in and of itself:
(1) does not relieve Provider of any duty to perform its obligations under the Agreement nor for liability for breach;
(2) is not to be deemed as creating a direct contractual relationship between Customer and any subcontractor engaged by Provider; and
(3) is for Customer's own benefit only and not for that of Provider.
Comments
Customers sometimes want to include subcontractor review- and/or approval provisions in their services agreements, to allow them to keep track of which companies are actually doing the contracted work. Such provisions can help a customer to at least be alert to possible trouble down the road.
For example: Retail giant Walmart found itself with a publicity problem when a clothing factory in Bangladesh burned, killing over 100 people. The factory reportedly made clothing sold in Walmart stores; Walmart claimed that the the factory was an unauthorized subcontractor to one of Walmart's authorized suppliers.
Subdivision (1) is modeled on the last sentence of UCC § 2-210(4); see also CD-24.2.3.1. Assignment Definition (assignment does not relieve assigning party of its responsibility without non-assigning party's consent).
CAUTION: The more that a customer gets the contractual right to approve subcontracting arrangements, the more credence might be given to a claim that the customer had a direct contractual relationship with the subcontractor; that in turn might conceivably lead to increased exposure for the customer, e.g., on a theory of respondeat superior.
20.20.5 Unreasonable Delay in Approval
Clause text
For the avoidance of doubt, any unreasonable delay by Customer in reviewing or approving subcontracting matters is to be taken into account in determining whether Provider is in breach of its obligations under the Agreement.
20.20.6 Subcontractor Insurance
20.20.7 Subcontractor Governmental Reports
Clause text
At Customer's written request from time to time, Provider will seasonably provide Customer with information about its subcontractors (if any) to the extent reasonably necessary for Customer to make any reports required:
(1) by law (for example, reports concerning equal opportunity or executive compensation), and/or
(2) by a contract between Customer and a governmental entity or a government contractor.
Comments
Many federal contractors are now required to report executive-compensation information for its subcontractors. See generally, e.g., Roger Waldron, Regulatory: Federal Acquisition Regulation Council Amendment Requires Greater Transparency (Sept. 8, 2010).
See also CD-24.7. Government Subcontracting Disclaimer.
20.20.8 Government-Contracting Flowdown
Clause text
Provider will ensure that its agreements with its subcontractors under the Agreement (if any) include all government contracting provisions (if any) that are required by law to be included in such subcontracts.
Comments
Agreeing to this provision likely will put additional administrative burdens on a provider, but as a practical matter that burden might be unavoidable.
See also CD-24.7. Government Subcontracting Disclaimer.
20.20.9 All Non-Employees as Subcontractors
Clause text
For the avoidance of doubt, any individual providing services on behalf of Provider pursuant to the Agreement who is not an employee of Provider is considered a subcontractor for purposes of the Agreement.
Comments
This clause, if demanded by a customer, could be problematic for a provider that uses individual independent contractors on a long-term basis. See generally CD-24.1.7. Independent Contractors.
21 Risk Management & Allocation
21.1 [Insurance]
See Insurance for notes on this subject.
21.2 Indemnity Procedures
- 21.2.1. Applicability of Indemnity Procedures
- 21.2.2. Indemnity Definitions
- 21.2.3. Claim Notification
- 21.2.4. Defense Obligation
- 21.2.5. Defense Without Request
- 21.2.6. Defense Cooperation Obligation
- 21.2.7. Control of Defense
- 21.2.8. Defense Counsel
- 21.2.9. Separate Monitoring Counsel
- 21.2.10. Defense-Counsel Conflict of Interest
- 21.2.11. Control of Settlement
- 21.2.12. Settlement by Protected Person
- 21.2.13. Protected Person Admissions
- 21.2.14. Indemnity Offsets
- 21.2.15. Indemnity Payment Due Date
- Additional notes: Indemnities
Comment
Some of the provisions below are based on ideas stated in a 2011 presentation by Ira Schreger, who was then with Vinson & Elkins LLP in New York.
21.2.1 Applicability of Indemnity Procedures
Clause text
This section 21.2 applies any time that that an Indemnifying Party must defend and/or indemnify a Protected Person against a Covered Claim.
21.2.2 Indemnity Definitions
- 21.2.2.1. Agreement Activities Definition
- 21.2.2.2. Basket Definition
- 21.2.2.3. Business Activities Definition
- 21.2.2.4. Consequential-Damages Indemnity Exclusion Definition
- 21.2.2.5. Covered Claim Definition
- 21.2.2.6. Covered Infringement Claim Definition
- 21.2.2.7. Covered Monetary Award Definition
- 21.2.2.8. Deductible Basket Definition
- 21.2.2.9. Defend & Defense Obligation Definition
- 21.2.2.10. First-Dollar Basket Definition
- 21.2.2.11. Indemnified Financial Obligation Definition
- 21.2.2.12. Indemnifying Party Definition
- 21.2.2.13. Indemnity Definition
- 21.2.2.14. Liability Cap Definition
- 21.2.2.15. Loss and Expense Definition
- 21.2.2.16. Negligence or Misconduct Exception Definition
- 21.2.2.17. Not Assignable Without Consent Definition
- 21.2.2.18. Protected Party Definition
- 21.2.2.19. Protected Person Definition
- Protected Group definition (cross-reference)
- Additional notes: Using indemnity definitions
21.2.2.1 Agreement Activities Definition
Comment
An indemnity concerning Agreement Activities would be narrower than one concerning Business Activities.
21.2.2.2 Basket Definition
Clause text
Basket: See the definitions for Deductible Basket and First-Dollar Basket, below. For the avoidance of doubt, the existence of a basket does not in itself negate, decrease, or increase an agreed limitation of an Indemnifying Party's liability for defense and indemnity, if any.
Comment
A basket amount could:
- apply to all protected parties collectively instead of to each protected party;
- apply to all claims collectively instead of to each claim.
See also:
- This definition of "baskets" published by Practical Law Company
- Stephen I. Glover, Indemnification Provisions: Standard Practice Revisited, in the M&A Lawyer, March 2002, at p.5
- Tina L. Stark, Negotiating and Drafting Contract Boilerplate § 10.10 (2003).
21.2.2.3 Business Activities Definition
Comment
Suppose that a contract required Alice to indemnify Bob in respect of Alice's business activities. Without more, Bob likely wouldn't have to prove that Alice was negligent to be entitled to indemnity. For citations of cases to that effect from various jurisdictions, see the Montana supreme court's opinion in A.M. Welles, Inc. v. Montana Materials, Inc., 2015 MT 38, slip op. at 5-7 (reversing denial of summary judgment in favor of indemnified party).
21.2.2.4 Consequential-Damages Indemnity Exclusion Definition
Clause text
IF: The Agreement provides that consequential damages are excluded from a particular indemnity obligation; THEN: In respect of that indemnity obligation, the Indemnifying Party in question:
(1) is not required to indemnify any Protected Person for consequential, indirect, special, punitive, exemplary, or similar damages suffered by the Protected Person, including (for example) loss of profits from collateral business arrangements or damages from business interruption, other than to the extent any such damages are required to be paid to a third party — other than an affiliate of the Protected Person — pursuant to a claim against the Protected Person by the third party; and
(2) is not required to defend any Protected Person against a claim that seeks no relief other than damages described in subdivision (1).
Comment
The list of excluded damages is adapted from CD-22.12.12. Exclusion of Consequential Damages, Etc.; portions are adapted from the definition of "Excluded Damages" offered by Glenn West as "a potential starting point" for drafting. See West, Consequential Damages Redux, supra, 70 BUS. L. at 1001. In some situations, drafters might prefer simply to cap the Indemnifying Party's financial exposure to indemnity- and defense obligations for particular indemnity obligations, instead of potentially getting into disputes about what kinds of damages were or were not excluded under this language.
21.2.2.5 Covered Claim Definition
Clause text
Covered Claim, whether or not capitalized, refers to any claim that is subject to an obligation of defense and/or indemnity under the Agreement, EXCEPT THAT unless expressly agreed otherwise in writing, the term does not include any claim by one Protected Person against another Protected Person.
Comment
This provision excludes claims by one Protected Person against another. This is akin to the exclusion found in many insurance policies, excluding coverage of claims by one insured against another insured. These exclusions stem from two possible concerns of the indemnifying party:
- Moral hazard: Suppose that Alice and Bob were both protected persons under an agreement that obligated third-party Isabel to indemnify each of them. In that situation, Alice would have an economic incentive to be careless, or worse, in her dealings with Bob. That's because Alice would know that, whatever harm she (Alice) might cause to Bob, it would be Isabel, not Alice or Bob, who would be obligated to pay for the harm.
- Another possible concern might arise if Alice and Bob were affiliates: In such a situation, Alice and Bob might collude to have Alice file (say) a lawsuit for patent infringement against Bob, knowing that indemnifying-party Isabel would be obligated to pay any resulting damage award. That would result in the Alice-Bob corporate family's being able to fatten its combined corporate coffers at Isabel's expense.
21.2.2.6 Covered Infringement Claim Definition
Clause text
Covered Infringement Claim (whether or not the term is capitalized), refers to a Covered Claim that a Protected Person has Infringed, or is or will be Infringing, one or more of the following:
(1) any copyright or trade-secret right of the third party;
(2) if so stated in the Agreement, any U.S. patent or design patent; and
(3) if so stated in the Agreement, any non-U.S. patent or design patent.
Comment
This provision automatically covers only claims of copyright infringement and trade-secret misappropriation; it covers claims of patent infringement only if the Agreement so states. That's because:
- As a general rule, for copyrights and trade secrets, it should be comparatively easy for an indemnifying party to gain reasonable confidence that a product or service was independently created. This is relevant because proof of independent creation would normally provide an absolute defense against copyright- and trade-secret claims, which in turn would limit the indemnifying party's risk of liability from such claims.
- In contrast, for utility patents (which is what people usually mean when they say "patent") and design patents:
- Independent creation is not a defense; that means that a product or service could infringe a patent or design patent that no one had ever heard of (cf. the phenomenon of patent trolls).
- This means in turn that it is a non-trivial undertaking for an indemnifying party to gain reasonable confidence that a product or service does not infringe any patent or design patent; doing so is often burdensome, expensive, and subject to uncertainty.
- As a result, indemnifying parties are often reluctant to take on sweeping indemnity obligations concerning the possibility of patent infringement without specifically negotiating such obligations.
21.2.2.7 Covered Monetary Award Definition
Clause text
Covered Monetary Award, whether or not capitalized, refers to any award of money (no matter how computed or styled) to the asserter of a Covered Claim upon the successful assertion of the claim, as part of a final judgment or arbitration award from which no further appeal or other challenge is taken or possible. A Covered Monetary Award could include, for example, one or more of the following as awarded to the asserter of the Covered Claim:
(1) monetary damages, including for example the Protected Party's profits and/or the asserter's lost profits;
(2) reasonable attorney fees and other reasonable expenses incurred by the asserter of the Covered Claim; and/or
(3) costs of court or of arbitration in respect of the Covered Claim.
21.2.2.8 Deductible Basket Definition
Clause text
Deductible Basket: IF: The Agreement provides that a particular indemnity obligation is subject to a Deductible Basket (whether or not the term capitalized) of a stated amount; THEN: The Indemnifying Party is not required to indemnify any Protected Person until, and then only to the extent, that the aggregate amount that the Indemnifying Party would be required to pay or reimburse exceeds the stated amount.
Comment
Another term for this concept is "true deductible." See generally Danielle Rosato and Tracy A. Belton, Basics In M&A: Indemnification Provisions (Mondaq 2016).
21.2.2.9 Defend & Defense Obligation Definition
Clause text
Defend and Defense Obligation: Each of these terms, whether or not capitalized, in respect of an indemnity obligation under the Agreement, means that the Indemnifying Party, at its own expense, will provide each Protected Person with a defense against each Covered Claim in accordance with section 21.2.4.
Comment
Note that this is only a definition; it does not in itself impose any defense obligation. See also CD-21.2.4. Defense Obligation and its commentary.
21.2.2.10 First-Dollar Basket Definition
Clause text
First-Dollar Basket: IF: The Agreement provides that a particular indemnity obligation is subject to a First-Dollar Basket (whether or not the term capitalized) of a stated amount; THEN:
(1) The Indemnifying Party is not required to indemnify any Protected Person until the aggregate amount that the Indemnifying Party would be required to pay or reimburse equals at least the stated amount; but
(2) once that stated amount is reached or exceeded, the Indemnifying Party must pay or reimburse up the entire aggregate amount in question.
Comment
Another term for this concept is "tipping" basket: once the deductible is reached, the indemnifying party is responsible for all losses in the basket, not just the "overflow" losses as with a deductible- or "true" basket. See generally Danielle Rosato and Tracy A. Belton, Basics In M&A: Indemnification Provisions (Mondaq 2016).
21.2.2.11 Indemnified Financial Obligation Definition
Clause text
Indemnified Financial Obligation, whether or not the term is capitalized, refers to any of the following:
(1) any Covered Monetary Award;
(2) any settlement of a Covered Claim that, under the Agreement, must be paid or otherwise funded by the Indemnifying Party; and
(3) any Loss Or Expense that has been suffered or incurred (or will imminently be suffered or incurred) by a Protected Person, as to which the Agreement requires the Indemnifying Party to indemnify the Protected Person.
21.2.2.13 Indemnity Definition
Clause text
Indemnity, whether or not the term is capitalized, as well as corresponding terms such as indemnify and indemnity obligation, all refer to reimbursing a person for one or more Indemnified Financial Obligations.
Comment
This definition is adapted from the Maryland supreme court deision in Bd. of Trustees v. Patient First Corp., No. 89, slip op. at 1 (Md. Aug. 18, 2015), (footnote omitted), citing BLACK'S LAW DICTIONARY (9th. ed. 2009) at 837-38; see also the explanation of the concept of indemnity by a California court, quoted at length in the research notes. The definition falls in the category of "stating the obvious," but one never knows whether a party's trial counsel might try to argue that capitalization was significant, as discussed in this commentary.
21.2.2.14 Liability Cap Definition
Clause text
Liability Cap IF: The Agreement provides that a particular indemnity obligation is subject to a Liability Cap (whether or not the term is capitalized) of a stated amount; THEN: In relation to that indemnity obligation, that Indemnifying Party is not obligated to pay or reimburse more for indemnity and/or defense under the Agreement — in the aggregate, to all parties in respect of all Indemnified Financial Obligations and all Protected Parties combined, unless the Agreement expressly states otherwise — than the stated Liability Cap amount.
Comment
Drafters might want to negotiate a special cap on indemnity liability, separate from any general cap. Unless applicable law has something weird in it, there shouldn't be any reason that contracting parties couldn't agree to limitations of liability for an indemnification obligation. Indemnities are essentially insurance policies, and insurance companies routinely impose policy limits and policy exclusions.
A party being asked to commit to an indemnity obligation might be more willing to agree to the obligation if:
- its liability were capped at, say:
- a stated dollar amount, or
- a stated multiple of the sums paid to it, or
- the limits of its insurance coverage (if insurance were available); or
- the indemnity did not kick in until the aggregate of all indemnifiable claims exceeded a stated amount, as in the "first-dollar basket" definition.
21.2.2.15 Loss and Expense Definition
Clause text
Loss And Expense and Loss Or Expense, whether or not capitalized, each refers to any and all foreseeable losses, costs, expenses, and damages of any kind (but not including liabilities resulting from third-party claims, which are addressed separately).
Comment
This definition was harvested from a variety of contracts.
Note the exclusion of third-party claims: Absent such an express exclusion, an indemnity obligation might be interpreted as encompassing more losses or expenses incurred by the protected party than just those arising from third-party claims.
That result occurred, for example, in Hot Rods, LLC, v. Northrop Grumman Sys. Corp., No. G049953 (Cal. App. 4th Dist. Dec. 7, 2015) (reversing and remanding damages award). "Indemnity provisions typically refer to third party claims, but if the parties so intend, such provisions may also encompass direct claims." Id., citing Zalkind v. Ceradyne, Inc., 194 Cal. App. 4th 1010, 1023 (2011). "The question whether an indemnity agreement covers a case turns primarily on contractual interpretation, and it is the intent of the parties as expressed in the agreement that should control. When the parties knowingly bargain for the protection at issue, the protection should be afforded." Id. (citation, internal quotation marks, and alteration marks omitted).
In contrast, then-Vice Chancellor Strine noted that the indemnification provisions of an an asset-sale agreement specifically distinguished third-party claims from claims covered generally under the agreement's indemnification remedy. See Certainteed Corp. v. Celotex Corp., No. 471, slip op. at 6-7 & n.7 (Jan. 24, 2005) (denying defendant's motion to dismiss certain claims as time-barred).
See also Nevadacare, Inc. v. Dept. of Human Services, 783 N.W.2d 459, 470 (Ia. 2010): The contract between the parties included an indemnity provision. The defendant, after prevailing at trial, sought an award of attorney fees under the indemnity provision. The supreme court noted that "there is a split of authority as to whether an indemnification provision applies to claims between the parties to the agreement or only to third-party claims." (The court held that under the state's law, an indemnity provision could not be used to recover attorney fees in a dispute between the parties.)
Noted practioner-commentator Glenn West asserts that, in the context of merger-and-acquisition agreements, the term indemnity is understood to have a less-expansive meaning than under common law:
This author believes that much of this confusion is caused by the use of the term “indemnification” itself. In the specific context of a U.S.-style private company acquisition agreement, the term indemnification is used as a contractual term of art to describe a contractual remedy for breaches of representations and warranties. It is not the same as the common law right known as indemnity, which requires the existence of a third-party claim.
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, 999-1000 (Weil.com 2015) (footnotes, alteration marks, and internal quotation marks omitted, emphasis added).
See also Ken Adams's blog post, Indemnification: Glenn West Wades In! (2011), especially the dialogue between Adams and West in the comments to the post.
21.2.2.16 Negligence or Misconduct Exception Definition
Clause text
Neglience or Misconduct Exception and Negligence and Misconduct Exception (regardless of capitalization), in respect of an indemnity obligation, each means that the Indemnifying Party is not required to indemnify any Protected Person against any Covered Claim that is attributable solely to Negligence Or Misconduct by that Protected Person.
Comment
In many jurisdictions, an indemnity obligation is unenforceable to the extent it purports to indemnify a party against the consequences of its own negligence. (Insurance policies are usually exceptions to this rule.) For more details, see the discussion in the research notes.
In some states, e.g., Texas, this rule is tempered by the express-negligence doctrine, which holds that a party can be indemnified from the consequences of its own negligence if the contract provision to that effect is expressed in specific and conspicuous terms, also as discussed in the research notes.
21.2.2.17 Not Assignable Without Consent Definition
Clause text
Not Assignable Without Consent: IF: The Agreement specifies that a right to indemnity and/or defense is Not Assignable Without Consent, whether or not the term is capitalized; THEN: An assignee (direct or indirect) of a Protected Person (direct or indirect) is entitled to indemnity and defense under that obligation only if the Indemnifying Party specifically and expressly consented in writing to assignment of the right to indemnity and/or defense.
Comment
See generally CD-24.2.3. Assignment of Agreement and its commentary.
21.2.2.19 Protected Person Definition
Clause text
Protected Person, whether or not capitalized, refers to:
(1) each Protected Party;
(2) each Affiliate of each Protected Party;
(3) any Other Protected Group Members expressly identified in the Agreement, if any; and
(4) the employees, officers, directors, shareholders (in that capacity), general- and limited partners, members, managers, and other persons occupying comparable positions in respect of each organization within the scope of in subdivisions (1) through (3), as applicable.
Protected Group definition (cross-reference)
Additional notes: Using indemnity definitions
Drafters can use these indemnity definitions to quickly specify detailed indemnity obligations. Here are a few examples:
- Alice will indemnify Bob and his Protected Group against all Claims arising from Alice's Agreement Activities, with a Negligence Or Misconduct Exception and with a Liability Cap of $1 trillion.
- Carl will indemnify Deborah against all Claims and all Losses And Expenses arising from Carl's Business Activities, with a Consequential-Damages Indemnity Exclusion and with a First-Dollar Basket of $1.
- Eva will indemnify Fred against all Claims arising from Negligence Or Misconduct by Eva.
- George will indemnify Harriet and her Protected Group against all Infringement Claims concerning Deliverables or their use.
21.2.3 Claim Notification
Clause text
IF: A Protected Person does not advise the Indemnifying Party of the claim in writing on or before the Claim-Notification Deadline (namely, ten business days after first learning of the claim by any means); THEN:
(1) The Indemnifying Party will have no obligation to indemnify the Protected Person against any harm resulting from the delay in notification.
(2) For the avoidance of doubt, the delay in notification will not otherwise affect the indemnity obligation.
Comment
A drafter representing an indemnifying party might prefer to say instead that the indemnifying party will be completely absolved from any duty to defend or indemnify the protected person against the claim. That, of course, would be a much stronger statement. On the other hand, the prospective protected person would likely push back against such a variation.
21.2.4 Defense Obligation
Clause text
Unless the Agreement expressly states otherwise, the Indemnifying Party, at its own expense, will provide each menber ot the Protected Group with a competent, diligent defense against the claim in accordance with (and subject to the prerequisites of) the Agreement.
Comments
The law might impose a duty to defend a Protected Person even if the parties' agreement didn't expressly do so. For example:
- The California Supreme Court has held that, by statute — specifically, Cal. Civ. Code § 2778(3) — unless the parties to a contract agree otherwise, a party having an indemnity obligation under the contract is also obligated, upon request, to provide a defense for the protected person. See Crawford v. Weather Shield Mfg. Inc., 44 Cal.4th 541, 553 (2008) (affirming court of appeal’s affirmance of trial-court judgment).
- A California appeals court held in 2010 that the duty to defend applies even without an allegation that the indemnifying party was negligent. See UDC-Universal Development v. CH2M Hill, No. H033610, 181 Cal. App. 4th 10 (6th Dist. 2010) (affirming judgment that engineering firm was liable to real-estate developer for cost of defending against negligence suit by homeowner association).
On the other hand, as Dentons partner Stafford Matthews pointed out in a 2014 LinkedIn discussion thread (membership required): "Under the common law of most states, including New York and Illinois for example, an indemnitor generally has no duty to defend unless the contract specifically requires such defense. See, e.g., Bellefleur v. Newark Beth Israel Med. Ctr., 66 A.D.3d 807, 809 (N.Y. App. Div. 2d Dep't 2009); CSX Transp. v. Chicago & N. W. Transp. Co., 62 F.3d 185, 191-192 (7th Cir. 1995)." (Emphasis added; Mr. Matthews was responding to one of my comments there about Califorina law.)
21.2.5 Defense Without Request
Clause text
(a) IF: A Protected Person does not request defense against a Covered Claim; THEN: The Indemnifying Party may (in its sole and unfettered discretion) nevertheless defend the Protected Person against the claim.
(b) IF: An Indemnifying Party exercises its right under subdivision (a) to defend a Covered Claim; THEN: The Indemnifying Party must comply with the provisions of the Agreement that apply to the defense of Covered Claims as if the elected defense were mandatory.
Comment
An indemnifying party might want to defend against a third-party claim even if the protected person has no interest in doing so. EXAMPLE: Suppose that:
- A customer is sued by a third party, claiming that the customer's past use of a particular product infringed the third party's patent rights.
- The manufacturer, a large and well-funded company, is obligated to defend and indemnify the customer against such claims.
- The customer has discontinued its use of the manufacturer's product; it therefore doesn't care whether or not the third-party infringement claim succeeds, because the manufacturer, not the customer, will have to pay any resulting damage award.
In that situation, the customer will have little or no "skin in the game" and might not even request a defense against the infringement claim. The manufacturer, though, might be keenly interested in not having its product adjudged to infringe the third party's patent. This clause makes it clear that the manufacturer has the right to defend againsst the infringement claim, whether or not the customer requests a defense.
21.2.6 Defense Cooperation Obligation
Clause text
IF: An Indemnifying Party provides a Protected Person with a defense to a Covered Claim (whether or not requested by the Protected Person); THEN:
(1) The Protected Person must provide reasonable cooperation with the Indemnnifying Party and its counsel in the conduct of the defense, including for example providing all information reasonably requested by the Indemnifying Party or its counsel.
(2) Upon request by the Protected Person, the Indemnifying Party will pay, or reimburse the Protected Person for, all reasonable, out-of-pocket expenses paid to third parties, by or on behalf of the Protected Person, in providing such cooperation.
Comment
Protected parties are normally glad to agree to this cooperation requirement (as long as it's at the indemnifying party's expense).
Note that subdivision (2) requires reimbursement only of out-of-pocket expenses paid to third parties. Some protected parties with bargaining power might try to ask for reimbursement of internal costs as well, but at least in my experience that would be fairly unusual for most business contexts.
21.2.7 Control of Defense
Clause text
(a) An Indemnifying Party is entitled to control any defense to a Covered Claim that it provides under this clause except as stated in subdivision (b).
(b) If an Indemnifying Party does not provide a Protected Person with a defense to a Covered Claim as required by the Agreement, then: (1) the Protected Person may control its own defense; and (2) the Indemnifying Party must pay, or reimburse the Protected Person, for all reasonable expenses that the Protected Person incurs in the defense.
Comment
Obviously, if an Indemnifying Party doesn't "step up" to provide a defense, then the Protected Person should be able to control its own defense. But if the Indemnifying Party does provide a defense, then it should be able to control the defense — otherwise, the Protected Person's counsel — knowing that it would be the Indemnifying Party, not its client, that would eventually be paying the bills — could be tempted to put on an expensive, gold-plated defense.
21.2.8 Defense Counsel
21.2.9 Separate Monitoring Counsel
Clause text
A Protected Person, at its own expense, may engage separate counsel to monitor a defense provided by an Indemnifying Party; in such an event, the Indemnifying Party and Protected Person will each instruct their their respective counsel to provide reasonable cooperation with each other concerning the defense.
Comment
A protected party will sometimes want this provision because it doesn't want to rely completely on the legal counsel provided and paid by the indemnifying party.
- Under legal ethics in the U.S. (and probably in many other jurisdictions as well), an attorney's loyalty is to the client, not to a third party that's paying the bills.
- But in many cases, the indemnifying party will have its own legal counsel provide the defense for the protected party. The protected party, in turn, might well prefer to have its own regular counsel keeping an eye on the indemnifying party's legal counsel.
21.2.10 Defense-Counsel Conflict of Interest
Clause text
IF: Reasonable minds could conclude that an Indemnifying Party's counsel has a conflict of interest that, under applicable ethics rules, would preclude the Indemnifying Party's counsel from representing the Protected Person in the defense of a Covered Claim; THEN: The Protected Person may in its sole discretion:
(1) assume control of the defense; and
(2) engage separate counsel for the defense, at the Indemnifying Party's expense.
21.2.11 Control of Settlement
Clause text
(a) An Indemnifying Party may, at its own expense, settle a Covered Claim against a Protected Person as provided in this subdivision.
(b) Without the Protected Person's prior written consent, an Indemnifying Party must not settle a Covered Claim, and the Protected Person will not be bound by any purported settlement, on any terms that:
(1) restrict or place conditions on the Protected Person's activities if those activities would not reasonably be regarded as being otherwise unlawful; or
(2) require any action by the Protected Person, other than making one or more payments of money — funded in advance by or on behalf of the Indemnifying Party — to one or more third parties; or
(3) encumber any of the Protected Person's assets; or
(4) include (or require) any admission or public statement by the Protected Person; or
(5) call for the entry of a consent judgment inconsistent with any of subdivisions (1) through (4).
(c) For the avoidance of doubt, the Indemnifying Party's settlement of a Covered Claim may, in the Indemnifying Party's sole and unfettered discretion, include the entry of a consent judgment binding on the Protected Person; the Protected Person must agree to entry of the consent judgment if the consent judgment is not inconsistent with subdivision (b).
Comment
Subdivision (b): Some categories of insurance contract give the insurance carrier essentially-complete control over the settlement of third-party claims. That could cause problems for the protected person if the insurance carrier were to settle a claim but then try to recoup the settlement amount from the protected person. This could happen, for example, if a contractor's surety bond decided to settle a claim and then sued the contractor to recoup the settlement payment. See, e.g., Hanover Ins. Co. v. Northern Building Co., 891 F. Supp.2d 1019, 1026 (N.D. Ill. 2012) (granting summary judgment awarding damages and attorney fees to insurance company), aff'd, No. 13-2675 (7th Cir. May 8, 2014).
Subdivision (c): This is a detailed example of a type of clause that is often found in indemnity- and defense obligations.
21.2.12 Settlement by Protected Person
Clause text
IF: A Protected Person settles a Covered Claim without the Indemnifying Party's prior written consent; THEN: The settlement will have the effect of releasing the Indemnifying Party from any further defense- or indemnity obligation as to that claim UNLESS: The Indemnifying Party unreasonably withheld, delayed, or conditioned its consent to the settlement, in which case the Indemnifying Party is to be deemed to have given its consent to the settlement.
21.2.13 Protected Person Admissions
Clause text
(a) This subdivision applies during any time that the Indemnifying Party is entitled to control the defense against the claim.
(b) Without the Indemnifying Party's prior written consent, a Protected Person must not:
(1) make any non-factual admission or stipulation concerning a Covered Claim — for example, an admission that a third party's patent was valid and enforceable would be such a non-factual admission; nor
(2) waive any defense against a Covered Claim.
(c) A Protected Person is strongly encouraged to consult with the Indemnifying Party before making any factual admission or stipulation concerning a Covered Claim. (As a hypothetical example, an admission that, in calendar year 20XX, the Protected Person sold Y units of its Model ABC widget would be such a factual admission.)
(d) IF: A Protected Person makes an admission or waives a defense in violation of subdivision (b); THEN: The Indemnifying Party will have no further obligation to that Protected Person, in respect of the claim in question, by way of either defense or indemnity.
21.2.14 Indemnity Offsets
Clause text
(a) An Indemnifying Party, in determining the amount it owes under an indemnity obligation of the Agreement, may reduce that amount by the following amounts received by or on behalf of the Protected Person, if any:
(1) insurance proceeds in respect of the subject matter of the indemnity obligation; and
(2) contributions from another liable individual or organization (other than another Protected Person).
(b) For the avoidance of doubt, this provision is not to be interpreted as in itself limiting an Indemnifying Party's indemnity obligation to the amount of either insurance proceeds or of contributions from other liable individuals or organizations.
Comment
This provision is intended to prevent double-dipping by a protected party, which might recover some of its losses from other sources and yet still try to pry money out of an indemnifying party.
NOTE: If Alice is asked to indemnify Bob against any damages that Bob suffers as a result of Carol's actions, then Alice might want to consider laying some groundwork for her to sue Carol under the doctrine of subrogation.
21.2.15 Indemnity Payment Due Date
Clause text
(a) IF: A Protected Person gives notice to the Indemnifying Party that an Indemnified Financial Obligation (i) is due or (ii) has been paid (in which case evidence of payment must accompany the notice); THEN: The Indemnifying Party must do the following no later than the Indemnity-Payment Due Date (namely, ten business days after written notice):
(1) pay each such Indemnified Financial Obligation directly to the individual or organization to which the Protected Person owes it, or
(2) reimburse the payer if the Indemnified Financial Obligation has already been paid by or on behalf of the Protected Person.
(b) Subdivision (a) applies regardless whether applicable law would otherwise require the Protected Person itself to pay the Indemnified Financial Obligation first and then seek reimbursement from the Indemnifying Party.
Comment
Not directly related, but of interest, is the litigation over reimbursement payments by British Petroleum (BP) in the wake of the loss of the Deepwater Horizon drilling rig at the Macondo oil well in the Gulf of Mexico; see generally the Wikipedia article on that topic.
Additional notes: Indemnities
- What exactly is an "indemnity" obligation?
- Caution: Is the indemnity obligation backed by enough money?
- Caution: Is an indemnity obligation a good idea?
- Indemnity liability might be much more than plain breach-of-contract damages
- An obligation to indemnify a party against its own fault might be unenforceable
- The "express negligence rule" might impose conspicuousness requirements for some indemnity obligations
- Caution: Will a contractual indemnity be excluded from the indemnifying party's insurance coverage?
- Stories (in development)
- Additional reading
- Indemnity: Exercises (in development)
What exactly is an "indemnity" obligation?
In many contracts, indemnity provisions are intensely-negotiated. As explained by a California appeals court:
Generally, indemnity is defined as an obligation of one party to [i] pay or [ii] satisfy the [x] loss or [y] damage incurred by another party.
A contractual indemnity provision may be drafted either[:]
- to cover claims between the contracting parties themselves, or
- to cover claims asserted by third parties.
Indemnity agreements are construed under the same rules which govern the interpretation of other contracts. Accordingly, the contract must be interpreted so as to give effect to the mutual intention of the parties.
The intention of the parties is to be ascertained from the clear and explicit language of the contract.
And, unless given some special meaning by the parties, the words of a contract are to be understood in their ordinary and popular sense.
In interpreting an express indemnity agreement, the courts look first to the words of the contract to determine the intended scope of the indemnity agreement.
Rideau v. Stewart Title of Cal., Inc., 235 Cal. App. 4th 1286, 1294, 185 Cal. Rptr. 3d 897 (2015) (interal quotation marks, alteration marks, and extensive citations omitted; extra paragraphing, bracketed numbering, and bullets added).
Caution: Is the indemnity obligation backed by enough money?
A right to be indemnified (like any other) might be worthless if the indemnifying party can't afford to do the needful. Consequently, a party wanting an indemnity commitment should consider negotiating backup sources of cash to support the indemnity obligation, commonly in the form of (for example) an insurance policy; a guaranty from a third party; an escrow; and/or a standby letter of credit (which of course is itself a form of guaranty).
Caution: Is an indemnity obligation a good idea?
Any party asked to agree to an indemnity obligation should think about it carefully. That's especially true if the indemnity obligation would apply regardless of the other party's own negligence or other "misconduct"; if you agree to that kind of obligation, in effect you've become the other party's insurance carrier.
Indemnity liability might be much more than plain breach-of-contract damages
Suppose that Alice agreed to indemnify Bob from all losses, damages, etc., arising from Alice's breach of contract (or breach of warranty or misrepresentation). That might open up Alice to far-greater liability than she would normally risk for a "garden variety" breach of contract. That's because, at least in Anglo-American jurisprudence:
- Damages for breach of contract are generally limited to those that are foreseeable, and a non-breaching party will generally have a duty to mitigate its damages;
- In contrast, liability for indemnity might not be subject to such a foreseeability limitation (although the case law is unclear on this point).
See generally:
- 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, 975 (Weil.com 2015) ("III. A Basic Primer on Contract Damages");
- Id. at 998-99: "[I]t bears repeating that there is, in fact, a very clear distinction (whether or not there is an ultimate difference) between a claim for indemnification and a claim for damages for breach of a representation and warranty in an acquisition agreement."
- Ralph H. Kroman, Contracting with Suppliers – A Balanced Approach to Indemnities and Limitations of Liability at 3‑4 (ACC.com 2011).
- Dennis Agnew, Warranties and indemnities: what’s the difference? (InHouseLawyer.co.uk 2010).
- Nishith Desai (an Indian law firm), Revisiting The Indemnity V/S Damages Debate (Mondaq.com 2016).
An obligation to indemnify a party against its own fault might be unenforceable
In the interest of deterring negligent conduct, some jurisdictions entirely bar a party from being indemnified for the consequences of its own negligence. As the South Carolina supreme court explained:
The policy basis for the negligence rule is simple—barring indemnification when the indemnitee is at fault for the damages serves to deter negligent conduct in the future, for the indemnitee will know that the indemnification agreement will not save it from liability if it fails to act with due care.
Ashley II of Charleston, L.L.C. v. PCS Nitrogen, Inc., No. 27420, part II-A (S.C. July 23, 2014) (on certified question) (emphasis added). The supreme court held that the same rationale did not apply in cases of strict liability, because the same deterrent effect would not be present. See id.
Likewise, California Civil Code Section 1668 provides that "[a]ll contracts which have for their object, directly or indirectly, to exempt any one from responsibility for [i] his own fraud, or [ii] willful injury to the person or property of another, or [iii] violation of law, whether willful or negligent, are against the policy of the law." (Bracketed lettering added.) Such contracts are therefore void under section 1667(2).
In some jurisdictions, legislatures have enacted anti-indemnity statutes that, for certain types of contract, prohibit indemnity clauses that would shift the risk of Bob's own negligence onto Alice. Such indemnity clauses are often found in construction contracts, in which prime contractor Bob might require subcontractor Alice to indemnify him even against the consequences of Bob's own negligence. See, e.g., the Texas Anti-Indemnity Act, codified in Chapter 151 of the Texas Insurance Code. See also Foundation of the American Subcontractors Association, Inc., Anti-Indemnity Statutes in the 50 States (2013).
The "express negligence rule" might impose conspicuousness requirements for some indemnity obligations
Less restrictively than the outright ban just discussed: In some jurisdictions the "express-negligence rule" precludes enforcement of a contract provision requiring Bob to indemnify Alice for the consequences of Alice's own negligence unless the contract provision is both express and conspicuous. See, e.g., Crawford v. Weather Shield Mfg. Inc., 44 Cal. 4th 541, 552 (2008); Dresser Industries v. Page Petroleum, Inc., 853 S.W.2d 505, 508 (Tex. 1993) (conspicuousness requirement); Ethyl Corp. v. Daniel Constr. Co., 725 S.W.2d 705, 708 (Tex. 1987) (express-negligence doctrine). See generally, e.g., Byron F. Egan, Indemnification in M&A Transactions for Strict Liability or Indemnitee Negligence: The Express Negligence Doctrine (JW.com 2014).
Caution: Will a contractual indemnity be excluded from the indemnifying party's insurance coverage?
Any party that is asked to agree to indemnify another party should consider checking whether its applicable insurance policies exclude coverage for indemnity obligations. This was an issue in Ewing Constr. Co. v. Amerisure Ins. Co., 420 S.W.3d 30 (Tex. 2014), which is discussed in this blog post by insurance agent Randy Maniloff.
Stories (in development)
Particular scope-of-indemnity language
A lease agreement for retail space contained an indemnity provision. The indemnity provision required the retailer to indemnify the landlord against, among other things, "any [losses, etc.] caused by injuries to persons or property while in, on or about [the retail premises] …." An employee of the retalier became sick while working in vacant retail space in the building, which the landlord had allowed the retailer to use for temporary storage after flooding. The employee sued the landlord, which cross-sued the retailer on the indemnity provision. The state supreme court held that the indemnity provision did not apply. Once Upon a Time, LLC v. Chappelle Properties, LLC, No. 1141052 (Ala. May 27, 2016) (reversing and remanding trial court's denial of retailer's motion for summary judgment).
Additional reading
- Indemnification (MorganLewis.com; undated)
- Sarah E. Swank, Clarifying the Confusing World of Indemnification, Hold Harmless, and Defense Clauses (Ober.com 2013)
- Corbin Devlin, Indemnity Clause "Red Flags" (2016): This is a list of bullet points of concern, with a brief explaiantion of each point.
Indemnity: Exercises (in development)
Indemnity: Basic questions
- How does an indemnity relate to a warranty?
- IF FALSE, EXPLAIN WHY: IF: Alice agrees to indemnify Bob against damage arising from occurrence of Event X; THEN: This reduces the risk to the parties associated with the (possible) occurrence of Event X. (CAUTION: Read this carefully.)
- IF FALSE, EXPLAIN WHY: An indemnity obligation allocates at least some of the financial risk of Event X.
- IF FALSE, EXPLAIN WHY: The following is an acceptable conventional phrasing: Alice hereby indemnifies Bob against any damage Bob might incur if it rains tomorrow.
Indemnities: Duty to defend
SUGGESTED READING:
- Gilson S. Riecken, The Duty to Defend under Non-Insurance Indemnity Agreements … (search for "Texas")
- California law cheat sheet
FACTS: Suppose that:
- You draft an indemnity obligation that does not expressly require the subcontractor to defend your client, the general contractor, from claims, but merely obligates the subcontractor to indemnify the general contractor.
- An employee of the subcontractor writes a letter to the general contractor, asserting a claim. Assume for this purpose that the employee's claim comes within the scope of the subcontractor's indemnity obligation.
- The general contractor forwards the employee's letter to the subcontractor and demands that the subcontractor engage outside counsel to investigate the claim.
QUESTIONS:
- Must the subcontractor engage outside counsel for the general contractor?
- Would your answer be different if all of this were taking place in Los Angeles instead of Houston? Cite the relevant authority.
Indemnity exercise: The spontaneously-combusting widgets
FACTS:
- Alice manufactures electronic widgets. Each widget has a battery that is sealed into the widget and not replaceable.
- Bob manufactures electronic gadgets that include electronic widgets.
- Bob enters into a contract with Alice to buy electronic widgets from her.
- The contract includes, among other provisions:
- a warranty that the widgets do not contain any defects in design or manufacture;
- a provision requiring Alice to indemnify Bob against any harm Bob suffers from defects in the widgets; and
- an exclusion of incidental- and consequential damages.
- Bob takes delivery of a large quantity of Alice's widgets and stores them in an appropriate storage room.
- In the storage room, the batteries in several of Alice's widgets spontaneously catch fire, resulting in major damage and causing significant "down time" for Bob's gadget-manufacturing operations. (Think: Hoverboards.)
- Citing the indemnity provision, Bob demands that Alice reimburse him for the cost of:
- repairs;
- replacement of the damaged contents of the storage room;
- the travel expenses that Bob incurred in going to China and India to check out alternative sources of widgets;
- the profits that Bob lost from the manufacturing down time.
QUESTIONS:
- EXPLAIN IF FALSE: Alice is not required to reimburse Bob because an indemnity provision covers claims by third parties against the protected party, not direct claims by the protected party against the indemnifying party.
- EXPLAIN IF FALSE: If Bob sues Alice for breach of her indemnity obligation, Alice can probably get Bob's claim for lost profits thrown out early (by moving for partial summary judgment) as barred by the contract's exclusion of consequential damages.
- EXPLAIN IF FALSE: If Alice had negotiated the indemnity provision to cover only third-party claims, the provision likely would be enforceable.
- EXPLAIN IF FALSE: Alice can probably get Bob's claim for travel expenses dismissed on partial summary judgment as barred by the contract's exclusion of incidental damages.
Exercise: Defense against indemnified claims
- FACTS:
(A) Alice's contract with Bob obligates her to reimburse Bob for his attorney fees and expenses in defending against certain third-party claims.
(B) A third party, Carol, brings such a claim against Bob — who hires Skadden Arps (a top NYC firm) to defend him against Carol's claim.
(C) Alice has plenty of money to pay legal bills.
QUESTION: Speculate about what incentives might motivate Skadden in conducting Bob's defense.
QUESTION: Name two ways that Alice, during negotiation of her contract with Bob, could have limited her financial exposure to Bob's cost of defending against Carol's claim. - MORE FACTS:
(D) Alice's contract with Bob also requires her to indemnify Bob against any monetary awards resulting from such third-party claims.
(E) Bob neglects to mention to either Alice or Skadden that Carol had filed her third-party claim weeks before, and that when Bob failed to file a timely answer, Carol moved for and obtained a default judgment for a large amount of money.
QUESTION: Name two ways that Alice, during negotiation of her contract with Bob, could have limited her exposure to Bob's screw-up. - ALTERNATE FACTS:
(F) Alice's contract with Bob requires her to provide Bob with a defense, as opposed to reimbursing Bob for his defense expenses.
(G) Alice engages her regular lawyer, Andy, to conduct Bob's defense against Carol's claim.
(H) Bob finds that he and Andy don't get along so well.
QUESTION: During negotiation of the contract, what sort of clause could Bob have asked to be included in the contract to protect him against this uncomfortable situation? - ALTERNATE FACTS:
(I) It turns out that Alice can't afford to pay Bob's legal bills for defending against Carol's claim.
QUESTION: What if anything might Bob have done during contract negotiation to mitigate this problem?
22 Litigation & Other Dispute Resolution
- 22.1. Accelerated Litigation
- 22.2. Arbitration
- 22.3. Attorney Fees
- 22.4. Contra Proferentem Disclaimer
- 22.5. Dispute Escalation
- 22.6. Early Neutral Evaluation
- 22.7. Economical Litigation Agreement
- 22.8. Extrinsic Evidence Exclusion
- Forum selection (cross-reference)
- 22.9. Fraud Proof
- 22.10. Injunctive Relief
- 22.11. JURY TRIAL WAIVER
- 22.12. Limitations of Liability
- 22.13. Liquidated Damages
- 22.14. Mini-Trial to Senior Management
- 22.15. Mitigation of Damages
- 22.16. Mitigation of Damages WAIVER
- 22.17. Progressive Dispute Resolution
- 22.18. Release
- 22.19. Service of Process
- 22.20. Settlement Rejection Consequences
- 22.21. Softball Arbitration (rough notes only)
- 22.22. Third-Party Immunity
22.1 Accelerated Litigation
Clause text
(a) The parties hereby jointly request that, in any litigation arising out of or relating to the 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.
Comment
Subdivision (a): Concerning the any transaction or relationship term, see the arbitration-clause commentary.
Subdivision (b): A court might be more likely to grant a motion that is labeled as a joint motion — and if a party to the contract were to oppose the motion, the moving party could respond: You see, Your Honor? Clearly these folks think the rules don't apply to them, that they can toss aside their contractual commitments whenever it suits them.
Background: Running a lawsuit in accordance with the New York Commercial Division's accelerated rules could significantly streamline the proceedings. The streamlined procedures of that court's Rule 9 include, for example:
- trial in nine months;
- waiver of the right to jury trial — note that in some forum jurisdictions, though, 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, e.g., the following articles by the Hon. Timothy S. Driscoll (a trial judge of that court):
- The New York State Supreme Court Commercial Division: Past, Present, and Future (AmericanBar.org 2014)
- Recent Developments in the Commercial Division of the New York State Supreme Court (Part Two) (AmericanBar.org 2015)
Consider also CD-22.7. Economical Litigation Agreement.
22.2 Arbitration
- 22.2.1. Arbitration Definitions
- 22.2.2. Arbitration Requirement
- 22.2.3. Arbitration Streamlining
- 22.2.4. Definitions for Prohibited Arbitrator Actions
- 22.2.5. Binding Effect; Enforcement of Award
- 22.2.6. WAIVER OF JURY TRIAL
- 22.2.7. Survival of Arbitration Provisions
- 22.2.8. Arbitration Confidentiality Requirement
- 22.2.9. Preliminary Relief in Arbitration
- 22.2.10. Attorney Fees for Unsuccessful Challenge to Arbitration
- 22.2.11. Baseball Arbitration Procedure
- 22.2.12. Arbitration of Arbitrability
- 22.2.13. Small-Claims Exception to Arbitration Requirement
- 22.2.14. Class Arbitration Prohibition
- 22.2.15. Limitation Period for Claims in Arbitration
- 22.2.16. Severability of Arbitration Provisions
- 22.2.17. Jettison of Arbitration Requirement
- 22.2.18. Reasoned Award Upon Request
- 22.2.19. Findings and Conclusions Upon Request
- 22.2.20. Arbitrator as Mediator
- 22.2.21. No Non-Party Arbitration Demand
- 22.2.22. Conference-Call Interview Procedure
- 22.2.23. Written Deposition-Question Procedure
- 22.2.24. Arbitration Hearing Transcript
- 22.2.25. Three-Arbitrator Redo
- 22.2.26. Arbitrator "Jail" Until Award Rendered
- 22.2.27. Partial Court Retrial
- 22.2.28. Enhanced Judicial Review of Arbitration Award
22.2.1 Arbitration Definitions
22.2.1.1 Arbitrable Dispute Definition
Clause text
Arbitrable Dispute refers to any dispute arising out of or relating to the Agreement or any transaction or relationship resulting from it.
Broad definition to avoid piecemeal litigation?
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 is not required to 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).
"Any transaction or relationship resulting from the Agreement"
In the 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 the Agreement or the relationships which result from the 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).
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).
22.2.1.2 Arbitration Rules Definition
Clause text
(a) All arbitration proceedings are to be governed by the Arbitration Rules, namely the Commercial Arbitration Rules of the American Arbitration Association as in effect at the time of the demand for arbitration.
(b) For the avoidance of doubt, the Arbitration Rules are agreed to as a choice of rules and not of forum.
Which rules to choose?
Many arbitration rules are sufficiently well-developed that they could be thought of as the arbitral version of the Federal Rules of Civil Procedure: Once you agree to such rules, you've agreed, in great detail, how any arbitration proceeding would be conducted.
Drafters have considerable choice in their selection of arbitration rules, such as, for example:
- 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 brief comparison of various rules, see an article by Mark Anderson on the IP Draughts blog at http://goo.gl/ZX1iy.
For a more-detailed comparison of arbitration rules in the U.S. (AAA, JAMS, and CPR), see Liz Kramer, ArbitrationNation Roadmap: When Should You Choose JAMS, AAA or CPR Rules?
For international arbitration, see this October 2014 chart (CorporateCounsel.com), by Kiera Gans and Amy Billing, of selected key aspects of different rules.
Specifying Arbitration Rules as a choice of rules and not of forum
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).
22.2.1.3 Arbitral Law Definition
A choice-of-law clause might not automatically apply to arbitration
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.
- 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).
Some arbitral-law possibilities
The Arbitral Law could be, for example:
- the (U.S.) Federal Arbitration Act
- the (UK) Arbitration Act 1996
- the relevant U.S. state arbitration act (see this list)
- some other jurisdiction's law
The importance of the choice of arbitral law in U.S. cases
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 CD-22.2.28. Enhanced Judicial Review of Arbitration Award.)
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.)
Non-federal arbitral law might need to be expressly referenced
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).
22.2.1.4 Arbitral Tribunal Definition
Clause text
The arbitration is to be heard by the Arbitral Tribunal, namely, a single individual:
(1) having the qualifications (if any) specified in the Agreement and the Arbitration Rules, and
(2) selected in accordance with the Arbitration Rules or, failing that, as provided by law.
One arbitrator, or three? (Many experts say one is better.)
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 three arbitrators are 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.
Arbitrator selection procedures can vary
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).
Arbitrator qualifications are worth some thought
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, 747 F.3d 1253, 1256 (10th Cir. 2014) (affirming a variety of orders by the district court).
"As provided by law" as a fallback selection metjhod
As a fallback, this provision states that the Arbitral Tribunal is to be selected "as provided by law" if for some reason the agreed selection method were to fail. This is to avoid having a court refuse to compel arbitration in such a circumstance — that's the subject of a circuit split among U.S. federal courts, as discussed in Moss v. First Premier Bank, No. 15‐2513‐cv(L), slip op. at 10, 14-15 (2d Cir. Aug. 29, 2016) (affirming district court's refusal to compel consumer-provider arbitration on grounds that the designated arbitration forum had ceased accepting cases of that kind). See also this commentary about designating the Arbitration Rules as a choice of rules and not of forum (discussing the circuit split).
"Evident partiality" of the arbitral tribunal is a basis for challenging the award
Where the (U.S.) Federal Arbitration Act controls, one of the few grounds on which a court may vacate an arbitration award is "evident partiality" on the part of the arbitrator. See 9 U.S.C. § 10(a)(2). The Second Circuit explained its precedent on that subject in its famous "Deflategate" opinion concerning the four-game suspension imposed on NFL superstar quarterback Tom Brady:
Evident partiality may be found only where a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration.
The party seeking vacatur must prove evident partiality by clear and convincing evidence.
However, arbitration is a matter of contract, and consequently, the parties to an arbitration can ask for no more impartiality than inheres in the method they have chosen. Here, the parties contracted in the CBA [collective-bargaining agreement] to specifically allow the [NFL] Commissioner to sit as the arbitrator in [certain specified] disputes …. They did so knowing full well that the Commissioner had the sole power of determining what constitutes "conduct detrimental," and thus knowing that the Commissioner would have a stake both in the underlying discipline and in every arbitration brought pursuant to Section 1(a). Had the parties wished to restrict the Commissioner's authority, they could have fashioned a different agreement.
NFL Mgmt. Council v. NFL Players Ass'n, Nos. 15-2801 (L), 15-2805 (CON), slip op. at 32-33 (2d Cir. Apr. 25, 2016), reversing 125 F. Supp. 3d 449 (S.D.N.Y. 2015) (citations and some internal quotation marks omitted, paragraphing altered).
22.2.1.5 Arbitral Location Definition
Clause text
The arbitration hearing is to be conducted in the Arbitral Location, namely a location to be determined in accordance with the Arbitral Rules.
Comment
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).
22.2.1.6 Arbitration Administrator Definition
Clause text
The arbitration is to be administered by the Arbitration Administrator, namely the American Arbitration Association. If that organization declines or is unable to serve and the parties do not agree on another administrator, then the Arbitral Tribunal is to adminster the arbitration.
Pros and cons of administered arbitration
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.
Disastrous.
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).
Possible arbitration administrators
The arbitration adminstrator could be, for example:
- 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)
- JAMS
- 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
"Declines or is unable to serve …"
The "declines or is unable to serve" language is a fallback provision, intended to save the parties' agreement to arbitrate in case for some reason the designated Arbitration Administrator declines to serve (as has happened in some employment- and consumer-related arbitrations) or even no longer exists.
22.2.1.7 Arbitral Language Definition
(a) The Arbitral Language is the English language as spoken in the United States of America.
(b) Except to the extent that the parties expressly agree otherwise, the Arbitral Language is to be used for:
(1) all notices in any arbitration proceedings under the Agreement;
(2) all written and oral communications in such proceedings; and
(3) any award.
Choose English — or the language of eventual enforcement?
In transnational contracts, the parties might well choose English, the global lingua franca, as the arbitral language. Drafters might also wish to consider the language of where the arbitration award might need to be enforced.
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.)
Be explicit about the Arbitral Language — or else …
An agreement involving multi-national parties should be very clear about the language of arbitration. Failure to do so could lead to nasty surprises, as a U.S. retailer learned in its dealings with a Chinese manufacturer in CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, No. 15-1256 (10th Cir. Jul. 19, 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015), discussed in the commentary to the master-agreement provision.
22.2.2 Arbitration Requirement
Clause text
Unless expressly provided otherwise in the Agreement, every Arbitrable Dispute is to be submitted to arbitration upon written demand by either party, regardless whether the 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- or equitable doctrine or principle.
Comments
- Arbitration of statutory claims
- 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)
- Be sure arbitration-agreement signatures can be satisfactorily proved up
- Employers: Be sure your arbitration policy is actually binding
- 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
- Judicial reference as an alternative to arbitration (California)
Arbitration of statutory claims
U.S. courts have held that statute-based claims can be arbitrated, but only if the parties so agree; presumably the same rule would likely be applied to constitutional- or regulatory claims as well.
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.)
Be sure arbitration-agreement signatures can be satisfactorily proved up
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).
Employers: Be sure your arbitration policy is actually binding
Here's a drafting lesson from a California court of appeal:
The question in this case is whether an arbitration provision in an employee handbook is legally enforceable.
- The employee handbook containing the arbitration provision included a welcome letter as the first page, which stated, “[T]his handbook is not intended to be a contract (express or implied), nor is it intended to otherwise create any legally enforceable obligations on the part of the Company or its employees.”
- The employee signed a form acknowledging she had received the handbook, which mentioned the arbitration provision as one of the “policies, practices, and procedures” of the company.
- The acknowledgement form did not state that the employee agreed to the arbitration provision, and expressly recognized that the employee had not read the handbook at the time she signed the form.
Under these circumstances, we find that the arbitration provision in the employee handbook did not create an enforceable agreement to arbitrate.
We therefore affirm the trial court‟s denial of the employer‟s petition to compel arbitration.
Esparza v. Sand & Sea, Inc., No. B268420, slip op. at 2 (Cal. App. Aug. 22, 2016) (emphasis, extra paragraphing, and bullets added).
Be very clear that arbitration is mandatory, not optional
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 this discussion.
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 the 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.)
Judicial reference as an alternative to arbitration (California)
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).
22.2.3 Arbitration Streamlining
Clause text
The parties desire that the Arbitral Tribunal take appropriate measures to actively manage the arbitration proceedings as a joint business project, with due notice to the parties, and with the goals of: (1) reducing the cost of building a record and an award; and (2) preserving the fundamental fairness of the proceedings.
Comments
- Purpose of streamlining measures
- [Omitted]
- "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
- Acknowledgements
Purpose of streamlining measures
In my view, this is one of the most important provisions in the entire Common Draft arbitration clause. (Consider also CD-22.2.11. Baseball Arbitration Procedure.)
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.
"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).
Specific streamlining measures
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.
Questioning the parties
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.)
Representative depositions to reduce the number of individual depositions
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).)
Direct examination testimony by written statement
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).
Examining multiple witnesses at once
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.)
Summary exhibits
See generally Fed. R. Evid. 611(a) (trial judge should exercise reasonable control over order and mode of presenting evidence), 1006 (summaries).
Chess clock
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).
Tentative or draft award
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.
Overruling of arbitrator case-management decisions
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.
Acknowledgements
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.
22.2.4 Definitions for Prohibited Arbitrator Actions
Clause text
(a) The Arbitral Tribunal has no power to take any action specified in the Agreement as a Prohibited Arbitrator Action without the express prior written consent of all parties against which the prohibited action would be taken.
(For the avoidance of doubt, this section does not in itself prohibit any particular arbitrator action.)
(b) For purposes of defining the term Prohibited Arbitrator Action in section 1 above, the following capitalized terms have the stated meanings:
(1) Amiable compositeur; ex aequo et bono: IF: One or both of amiable compositeur and ex aequo et bono (whether or not either term is capitalized) are listed in the Agreement as among the Prohibited Arbitrator Actions; THEN: In rendering the award, the Arbitral Tribunal may not act as amiable compositeur or ex aequo et bono, and the Arbitral Tribunal has the power only to award such relief as would be both:
(A) 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
(B) consistent with the Agreement, including for example any limitation of liability (a term that includes for example exclusions of remedies) and any shortened limitation period stated in the Agreement.
(2) 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.
(3) 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 are listed as 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.
(4) 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.
(5) Class-Action Arbitration and Multiple-Party Joinder each refer to joining or consolidating claims in arbitration by or against multiple individuals or entities, whether under class-action rules or otherwise.
(6) Collective-Action Arbitration refers to arbitrating any collective-action claim, for example under the [U.S.] Fair Labor Standards Act.
(c) This section 22.2.4 is subject to CD-22.2.17. Jettison of Arbitration Requirement.
Language origins
Prohibitions against specific arbitrator can be specified using the terms defined in subdivision (b).
The "has no power" language is keyed to the [U.S.] Federal Arbitration Act, 9 U.S.C. § 10(a)(4), which states that one of the few grounds on which a court may vacate an arbitration award is that "the arbitrators exceeded their powers …."
Drafters of arbitration agreements might wish to include some of the specific arbitration-action prohibitions below to help alleviate any fear that the arbitral tribunal might "go rogue" — a fear that's not totally irrational, given (1) that arbitral tribunals have sometimes acted in unexpected ways, and (2) that usually a losing party has very little ability to appeal an arbitration award.
Subdivision (1): The doctrines of amiable compositeur and ex aequo et bono give arbitrators extremely-wide latitude to, as one state's supreme court put it, "make an award according to their own notion of justice without regard to the law." See Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750, 764 (Minn. 2014); see also this longer discussion.
Subdivision (b)(2): The preliminary-relief provision would take precedence over a prohibition of permanent injunctive relief (in part because the preamble of that prohibition contains an except-as-otherwise-agreed carve-out).
Subdivision (b)(3): The waiver of punitive damages in this subdivision is in bold-faced type so as to be conspicuous in case applicable law requires it.
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 the punitive-damages prohibition definition 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).
Subdivision (b)(4): The prohibition of punitive sanctions seeks to avoid the result in Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750 (Minn. 2014). In that case, the Minnesota supreme court upheld an award in excess of $600 million — not because the claimant had proved its case, but because the arbitrator barred the respondent from contesting the claimant's assertion on one point, as a punitive sanction for alleged fabrication of evidence. (The case is also discussed in the Annotations.)
Subdivision (b)(5) and (b)(6): These provisions are informed by U.S. Supreme Court decisions about class-action arbitration.
Subdivision (c): The "jettison" provision has in mind that, under applicable law, a prohibition of punitive damages might be invalid. A jettison clause thus could save an arbitration provision that might otherwise be unenforceable because the provision included a no-punitives restriction. 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.
The fear of "rogue" arbitrators
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 CD-22.2.4. Definitions for 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.
See also the respective articles on "Ex aequo et bono" by McGill University and Wikipedia.
22.2.5 Binding Effect; Enforcement of Award
Clause text
Except to the extent that the Agreement expressly states otherwise, any award in an arbitration under the Agreement:
(1) will be binding; and
(2) may be enforced in any court or other forum having jurisdiction.
Comments
Where should the arbitration award be enforced
The Arbitration Rules or Arbitral Law might already provide for enforcement of the arbitration award. For example:
- 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.
The award might not always be binding
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.]
The language of this provision takes into account that the parties might agree to CD-22.2.27. Partial Court Retrial. In that case, the arbitration award would not become binding until after a period of time in which either party can challenge the award.
Arbitration is not mediation
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.)
22.2.6 WAIVER OF JURY TRIAL
Clause text
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 the Agreement expressly states otherwise.
Comment
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.
Advance waivers of jury trials are unenforceable by law in California and Georgia, but those laws likely would be preempted in cases where the (U.S.) Federal Arbitration Act applied.
22.2.7 Survival of Arbitration Provisions
22.2.8 Arbitration Confidentiality Requirement
Clause text
Unless the 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.
Comment
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.
22.2.9 Preliminary Relief in Arbitration
Clause text
Any party to an arbitration under the 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; a party's seeking of such relief from other than the Arbitral Tribunal will not in itself waive that party's right to arbitrate.
Comment
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. On that subject, 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.
(The Common Draft delegation provision expressly delegates issues of waiver to the arbitrator; under the case law cited in the associated comments, that should — but might not — trump the default rule summarized in the previous paragraph.)
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).
22.2.10 Attorney Fees for Unsuccessful Challenge to Arbitration
Clause text
(a) A party that unsuccessfully challenges the arbitrability of a dispute in court (for example, by opposing a motion to compel arbitration 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 the 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.
Comment
Subdivision (a) is based on a suggestion by Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration § 2, Corporate Counsel (Apr. 22, 2013).
Subdivision (b) 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 that case, an appeals court affirmed a trial court's refusal to award attorney fees that were incurred in post-arbitration confirmation proceedings.
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, rejecting the respondent's argument that (i) the parties had agreed to be bound by the arbitral panel’s decision; therefore, (ii) the losing claimant necessarily breached that agreement by resisting entry of judgment in court on the award. See id., slip op. at 12-13.
22.2.11 Baseball Arbitration Procedure
22.2.11.1 Baseball-Arbitration Definitions
Clause text
(a) Baseball Dispute refers to one or more of the following:
(1) any dispute about a numerical quantity, e.g., revenues, costs, profits, damages, etc.;
(2) any dispute about what if any future action (or ‑inaction) by an individual or organization would be required to comply with an applicable requirement:
(i) of law;
(ii) of the Agreement;
(iii) of good faith;
(iv) of fair dealing; or
(v) of reasonableness;
(3) any dispute about what if any action (or inaction) should be ordered by the Decision Maker, where the Decision Maker has authority to issue such an order; and
(4) any other dispute as to which the parties have agreed to the use of the procedure of this section 22.2.11 (the "Baseball Process").
(b) Decision Maker refers to an individual or organization having authority to resolve a Baseball Dispute, defined below. A Decision Maker might be, for example, an arbitral tribunal or a court, having authority to decide the Baseball Dispute (i) by agreement of the parties, or (ii) by law.
22.2.11.2 Applicability of Baseball Process
Clause text
(a) The parties intend that all Baseball Disputes be decided in accordance with 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 Decision Maker is an arbitral tribunal; THEN: The Decision Maker is to use the Baseball Process to decide the dispute.
(c) IF: The Decision Maker is a court, administrative agency, or other governmental authority having jurisdiction; THEN: (i) the parties hereby jointly request that the Decision Maker decide the dispute in accordance with the Baseball Process; and (ii) either party may file a motion or comparable request to that effect and represent to the Decision Maker that it is a joint motion.
Comment
Subdivision (c) takes into account the facts that under most laws governing arbitration, the parties can in essence direct the arbitral tribunal to use baseball-style procedures, but the same wouldn't be true of courts 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.
In subdivision (c)(ii), the authorization of a joint-motion representation is intended to create a first impression in the mind of the judge, law clerk, and/or other individual who consider the motion.
22.2.11.3 Selection of Exactly One Proposed Resolution
Clause text
(a) This section 3 applies whenever the Baseball Process is used.
(b) 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.
(c) Each party may include, in any Proposed Resolution, a brief explanation why the Decision Maker should select that Proposed Resolution.
(d) 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 a reasonable time to submit revised Proposed Resolutions if they so choose.
(e) Except as provided in subdivision (d), the Decision Maker is to select, 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.
Comment
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.
Subdivision (b) allows each party to submit up to two Proposed Resolutions for an issue being decided by the baseball-style procedure of this clause; this allows each party to hedge its bets somewhat.
22.2.11.4 Effect of Baseball Decision
Clause text
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).
Comment
If a "baseball" provision is being used in arbitration, as opposed to litigation, the parties' arbitration agreement might provide that the resulting issue determination does not immediately become binding; see, for example, CD-22.2.27. Partial Court Retrial.
Additional notes: Baseball arbitration
This procedure is modeled on arbitration as used in Major League Baseball; that variety of arbitration "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 thus the risk that the decision make will be required to adopt that other proposed resolution.
- That in turn improves the odds that the parties will reach an agreed settlement.
Author's note: When I was practicing with my law firm, 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 exploded: "Goddamn it, that means I have to be reasonable." (The parties settled the dispute.)
22.2.12 Arbitration of Arbitrability
Clause text
IF: The parties disagree about whether a particular dispute must be arbitrated; THEN: That disagreement is itself to be arbitrated. his includes, without limitation, disagreements about, for example, one or more of the following:
(1) whether the parties have in fact entered into an agreement to arbitrate the primary dispute;
(2) whether the agreement to arbitrate is binding; enforceable; applies to a particular type of controversy; and/or conflicts with a non-waivable legal right; and
(3) whether any party has waived its right to require arbitration.
Comments
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, 68-69, 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).
[ROUGH NOTE: See also http://cases.justia.com/california/court-of-appeal/2015-c078557.pdf – AAA employment rules were referred to and thus were incorporated by reference, giving arbitrator the power to decide disputes about arbitrability.]
But arbitration of arbitrability might result in the case being ping-ponged
The worst of both worlds might occur if (i) a contract contains an arbitration provision that delegates determinations of arbitrability to the arbitrator, but then (ii) the arbitrator determines that the dispute in question is not arbitrable and therefore must go back to court, thus wasting the expense of bringing the arbitrator up to speed.
The stage is set for that to happen in Kubala v. Supreme Proc. Svcs., Inc., No. 15-41507 (5th Cir. July 20, 2016), also available at http://goo.gl/nd1qe6 (ca5.uscourts.gov). In that case:
- An at-will employee in Texas filed a lawsuit against his employer under the (U.S.) Fair Labor Standards Act ("FLSA"), alleging that he and others had not been paid the overtime pay that was due to them.
- Two days later, the employer adopted an arbitration policy that, two days after that, would require all disputes to be arbitrated; under Texas law, the employee was deemed to have agreed to the arbitration policy by continuing to work after the policy's effective date.
- The trial court denied the employer's motion to compel arbitration, on grounds that the new arbitration policy did not address pending cases. The policy did, though, state that arbitration would not be required for claims of which the employer had actual knowledge as of the date the policy went into effect.
- The new arbitration policy contained a delegation provision, which stated that disputes regarding the applicability or interpretation of the agreement were to be resolved exclusively by the arbitrator.
- The Fifth Circuit disagreed with the trial court, saying that the arbitrator, not the court, must determine whether the employer had actual knowledge of the employee's overtime-pay lawsuit at the time the new arbitration policy went into effect. That, in turn, would determine whether or not arbitration was required, or whether instead the case was to be tried in court. See Kubala at part II, slip op. at 3-4. (In court, the case would be tried as a collective action under the FLSA, which surely is what really interested the employee's counsel.)
- The appeals court remanded the case to the district court with instructions to enter an order compelling arbitration.
On the facts of Kubala, it is not at all out of the question that the arbitrator will find that the overtime-pay dispute is not subject to the employer's new arbitration policy and therefore will send the case back to the court system.
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).
22.2.13 Small-Claims Exception to Arbitration Requirement
Clause text
(a) Subject to subdivision (b): A party entitled to demand arbitration under the Agreement may bring a claim in a court, instead of arbitrating the claim, if the amount in controversy is no more than the Small-Claims Limit, defined as USD $10,000.
(b) The court in which a claim is brought under subdivision (a) must:
(1) have jurisdiction over the parties and the subject matter; and
(2) not be precluded by a forum-selection provision of the Agreement.
(c) For the avoidance of doubt, this section does not in itself authorize class- or collective-action arbitration.
Comments
Possible alternative: Rule this out?
To rule out this provision, consider: For the avoidance of doubt, all Arbitrable Disputes must be arbitrated regardless of the amount in controversy.
Pros and cons of small-claim exception
Allowing small claims to be litigated can make sense, because in such cases the cost of arbitration might outweigh the amount in controversy.
Small-claims exceptions "in the wild"
The arbitration provisions in some consumer-facing contracts contain such a small-claims exception. One example is the AT&T Mobility arbitration agreement, mentioned by the [U.S.] Supreme Court in its Concepcion opinion. 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)
22.2.14 Class Arbitration Prohibition
Clause text
(a) Unless the 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-action, collective-action, or representative proceeding, nor in a capacity of private attorney general.
(b) The absence of this provision in the Agreement is not to be implied as an agreement to class- or collective-action arbitration.
Comments
Language origin
The language of this provision is adapted from that of the contract in suit in AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 131 S. Ct. 1740 (2011), in which the Court upheld AT&T Mobility's prohibition of class-action arbitration, as discussed below.
The (U.S.) Supreme Court's Stolt-Nielsen and Concepcion decisions
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.
In other cases, the Court has similarly held that:
- The Act preempts state law barring enforcement of a class-arbitration waiver – see AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 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).
Allow opt-out of a class-arbitration prohibition?
Some companies include opt-out provisions in their arbitration agreements, especially in employment agremeents and customer agreements. Opting out of arbitration would preserve an employee's or customer's right to bring class-action litigation. 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.
Further reading
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.
22.2.15 Limitation Period for Claims in Arbitration
Clause text
The Arbitral Tribunal will have no power to render an award on a claim that is brought after the end of a limitation period that would apply if the claim were to be adjudicated in a court of competent jurisdiction instead of in arbitration.
Comment
See generally Liz Kramer, Don’t Find Yourself SOL: Know Whether the Statute of Limitations Applies to Your Arbitration (ArbitrationNation.com 2016).
22.2.16 Severability of Arbitration Provisions
Clause text
IF: A court of competent jurisdiction determines, in a decision from which no further appeal is taken or possible, that any provision of the parties' agreement to arbitrate is void, invalid, or otherwise unenforceable for any reason; THEN: The parties intend for that provision to be severable from the remainder of the agreement to arbitrate and for the remainder of that agreement to be enforced.
Comment
See generally:
- Liz Kramer, Severability Squared: Can Invalid Provisions Within an Arbitration Agreement Be Severed? (ArbitrationNation.com 2011)
- CD-22.2.17. Jettison of Arbitration Requirement
22.2.17 Jettison of Arbitration Requirement
Clause text
(a) Certain other provisions of the 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 the 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 the 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.
Comment
"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).
Subdivision (c)(2): A California court once ruled — only to be overturned by the (U.S.) Supreme Court — that an arbitration provision with a class-action prohibition was unenforceable because, by its own terms, the arbitration provision did not apply if the class-action prohibition was contrary to "the laws of your state." The Supreme Court held that the lower court's interpretation was preempted by federal law. See DIRECTV, Inc. v. Imburgia, 136 S. Ct. 463 (2015).
22.2.18 Reasoned Award Upon Request
Clause text
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.
Comment
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 might be warranted.
In addition, a reasoned award might well give the losing party more ideas about possible ways to attack the award in court — but on the other hand, a reviewing court might be more inclined to uphold an award that carefully spelled out its reasoning. [TO DO: CITE TO JOHN McARTHUR ARTICLE ABOUT TOM BRADY CASE]
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.
22.2.19 Findings and Conclusions Upon Request
Clause text
If so requested by either party, the Arbitral Tribunal is to include findings of fact and conclusions of law in its award.
Comment
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.
22.2.20 Arbitrator as Mediator
Clause text
(a) Unless either party seasonably objects in writing, a member of the Arbitral Tribunal — by request of either party or at his or her own initiative — may serve as mediator and convene one or more mediation sessions, in accordance with the American Arbitration Association's then-current commercial mediation procedures, to help the parties attempt to resolve the dispute.
(b) For the avoidance of doubt, this section does not obligate any member of the Arbitral Tribunal to serve as a mediator.
Comment
There's no reason to limit mediation to the pre-hearing mediation that's called for in Rule R‑9 of the AAA's Commercial Arbitration Rules. The parties have already paid to bring the arbitrator up to speed on the facts and the law, and he or she has already rendered the award, so he or she likely will be well-suited to serve as mediator. See also the AAA's Commercial Mediation Procedures (2013).
Anecdote: In 2015 I rendered an arbitration award in a case. The award was subsequently confirmed by a district court, but the losing party appealed, whereupon the appeals court summarily ordered the case to mediation. I learned this when the winning party contacted me to ask if I would be willing to serve as the mediator, given that I was already familiar with the facts and the law. I said I would do so if the other side didn't object, but I never heard back about it.
22.2.21 No Non-Party Arbitration Demand
Clause text
No party other than a Signatory Party ("Non-Party") may demand arbitration under the arbitration provisions of the Agreement.
Comment
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).
22.2.22 Conference-Call Interview Procedure
22.2.22.1 Conference-Call Interviews by Agreement
Clause text
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.
Comments
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). 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.
22.2.22.2 Optional Swearing of Witness
22.2.22.3 Witness's Options
Clause text
(a) During a conference-call interview in accordance with this section 22.2.22, 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.
(b) In determining how much weight to give to a witness's testimony in such a conference-call interview, a fact-finder may take into account (in addition to any other appropriate evidence) any circumstances of the case in the categories set forth in subdivisions (a)(1) through (a)(3).
22.2.22.4 Other Questioning Not Precluded
Clause text
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
(3) by the witness’s refusal to answer any particular question during such a conference-call interview.
22.2.22.5 Interview by Video Conference
22.2.22.6 Recording of Interview
Clause text
(a) Any party that participates in such a conference-call interview may record it, electronically or by stenographic transcription, at that party's own expense.
(b) A party that records such a conference-call interview is to announce that fact while the witness and all parties are on the line.
22.2.23 Written Deposition-Question Procedure
Clause text
(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.
Comment
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). (I chaired the committee and served as lead drafter.)
22.2.24 Arbitration Hearing Transcript
Clause text
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.
Comment
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.
22.2.25 Three-Arbitrator Redo
Clause text
(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 a 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: To challenge the awrd, before the expiration of ten business days after the date of the final award (the Deadline for Notice of Redo Arbitration, the Appealing Party must first 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 the Agreement (the Redo Arbitration).
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 the 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.
Comment
This provision allows a party dissatisfied with the result of a single-arbitrator proceeding to have a "re-do" with a three-arbitrator panel — but at a price.
Subdivision (d): 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.)
22.2.26 Arbitrator "Jail" Until Award Rendered
Clause text
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).
Comment
I've never seen this provision in an actual agreement, and I doubt that I'd ever propose it. The provision is 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.
22.2.27 Partial Court Retrial
22.2.27.1 Delay of Binding Effect Pending Challenge
Clause text
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 under this (subject to any forum-selection provision of the Agreement), if any party to the arbitration (each, a Challenger) challenges the award in accordance with this Compact.
Comment
This provision is intended to avoid the lock-in effect that results (under U.S. law) when a final arbitration award is issued, as discussed in int commentary to CD-22.2.28. 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.)
22.2.27.2 Notice of Challenge Deadline
Clause text
The Challenger must give notice of its challenge to each other party, effective no later than 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.
Comment
The notice of challenge must be served on a fairly-short fuse. More time is allowed for the actual filing of the Challenge Action, so as to give the challenger time to get the necessary papers together, and also to give both parties an opportunity to discuss settlement.
22.2.27.3 Filing and Service of Challenge Action
Clause text
(a) The Challenger must duly file and duly 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 close of business for the court in question on the date ten business days after the issuance of the final award (the Challenge Filing Deadline.
(b) For purposes of subdivision (a), the Challenger may, at its option, effect service by (i) email, or (ii) overnight delivery with proof of delivery, in either case to counsel for the Respondent.
Comment
This requires the Challenger to fish or cut bait.
The service-by-email provision is for convenience of all concerned: the Respondent will almost certainly have had counsel in the arbitration, so service by email makes more sense than requiring the Challenger to undertake the burden of official service of process.
22.2.27.4 Limitations on Challenge Action
Clause text
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.
22.2.27.5 Award Binding if not Timely Challenged
Clause text
Time is of the essence of the Challenger's obligations under the notice requirement of section 22.2.27.2 and the filing-and-service requirement of section 22.2.27.3; for the avoidance of doubt, IF: A Challenger, for any reason, does not both (i) give notice of a Challenge, and (ii) file and serve upon the Respondent a Challenge Action, in each case within the specified times; THEN:
(1) 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; and
(2) the Challenger KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any other right to challenge the final award in any forum.
22.2.27.6 Extension of Limitation Period
Clause text
(a) 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.
(b) For this purpose, the term "applicable limitation period" refers to any period, under a statute of limitation or of repose, whose expiration did not preclude asserting a claim for relief in arbitration, but would preclude filing the Challenge Action.
(c) Against the possibility that applicable law does not permit extension of a limitation period by agreement, the relevant Respondent separately and expressly agrees not to assert the expiration of the applicable limitation period as a defense to the Challenge Action.
Comment
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.
22.2.27.7 JURY TRIAL WAIVER
Clause text
To the greatest extent not prohibited by applicable law, by filing the Challenge Action instead of pursuing other avenues of judicial review of the final award, 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.
Comment
This provision'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 CD-22.11. JURY TRIAL WAIVER.
22.2.27.8 Re-Use of Arbitration Award and ‑Record in Challenge Action
Clause text
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.
Comment
To avoid wasting time and money, this language allows for re-use of the record already developed in the arbitration, while still allowing either party to challenge particular evidence (as to its weight, not its admissibility).
Because of the jury-trial waiver, the Challenge Action should be heard by a judge, not a jury. That means there's no reason not to allow the judge to consider the arbitration award and its record "for what it's worth."
In subdivision (2), the master's-report language gives 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; and 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.
22.2.27.9 Discovery Restrictions in Challenge Action
22.2.27.10 Expense-Shifting in Challenge Action
Clause text
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 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, and the Respondent will be entitled to be awarded the same.
Comment
The cost- and expense-shifting features of this provision are designed to discourage challenges to the arbitration award; they are similar to provisions in the Federal Rules of Civil Procedure and in various state statutes, as noted below.
This provision is similar to:
- 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."
Additional notes: Partial court retrial after 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 CD-22.2.28. Enhanced Judicial Review of Arbitration Award.
Some practitioners see this as a significant and even fatal disadvantage of arbitration. This provision tries to remedy that problem.
Thanks to Robert L. Arrington and Paul Lurie for their comments on an earlier version of this clause; any errors or idiocies are of course mine alone.
22.2.28 Enhanced Judicial Review of Arbitration Award
Clause text
(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 the Agreement or not available under applicable law.
(b) The parties expressly agree that IF: An arbitration award under the Agreement is based, in whole or in part, on one or more of the factors enumerated in subdivision (a); THEN: Upon application of either party, the award is to be vacated, by a court of competent jurisdiction, on grounds that the arbitral tribunal thereby exceeded its agreed powers.
(c) The jettison provision applies to this right of enhanced review.
Comments
Federal arbitration law permits only extremely-limited appellate review
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.
State arbitration laws might permit enhanced review
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.
Enhanced review might require an express reference to a congenial Arbitral Law
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).
Jettison of arbitration absent enhanced judicial review
The "jettison" language referenced in subdivision (c) is based on language in the contract in suit in Pugh's Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252 (Tenn. 2010). In that case, the state's supreme court held that an agreement to arbitrate in a contract must be rescinded for mutual mistake in view of that court's holding that the agreement's expansion of the scope of judicial review was invalid.
22.3 Attorney Fees
22.3.1 Attorney Fees to Prevailing Party
Clause text
(a) In any litigation, arbitration, or other action arising out of or relating to the Agreement or any transaction or relationship resulting from it, the Recovering Party, namely 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 the 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 the 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 to Prevailing Party is not to be considered to have merged into that decision.
Comments
- Possible alternative
- Language notes
- Legal background: The "American rule" vs. "loser pays"
- What constitutes a prevailing party?
- The "Texas rule": Only a successful contract enforcer can recover fees, and only from an individual or corporation
- The California rule: It's all "prevailing party"
- Other possible attorney-fee provisions
- Attorney fees in arbitration awards
- One-sided attorney-fee clauses might well be enforced
Possible alternative
If ruling out this provision is desired, consider CD-22.3.3. Attorney Fees Not to Be Awarded.
Language notes
Subdivision (a): 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).
Legal background: The "American rule" vs. "loser pays"
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": Only a successful contract enforcer can recover fees, and 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).
The California rule: It's all "prevailing party"
California Civil Code § 1717 provides, in essence, that any one-way attorney fees provision (as is sometimes seen in consumer-facing contract forms) is to be treated as a prevailing-party provision, and states that attorney fees under the section cannot be waived.
Other possible attorney-fee provisions
Drafters could consider redefining the term Recovering Party as one of the following:
- any party that succeeds in enforcing one or more rights under the Agreement;
- a specified party if it is the prevailing party (but not the other party even if it prevails);
- neither party — that is, each party will bear its own attorney fees and expenses.
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).
22.3.2 Attorney Fees in Motion Practice
Clause text
(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.
22.3.3 Attorney Fees Not to Be Awarded
Clause text
In any litigation, arbitration, or other action arising out of or relating to the Agreement or any transaction or relationship resulting from it, each party is to bear its own Dispute Expenses.
Comment
This is an alternative to CD-22.3.1. Attorney Fees to Prevailing Party.
22.3.4 Serious Accusation Attorney Fees
Clause text
(a) Serious Accusation refers to an assertion by one or more individuals and/or organizations (each, a "claimant"), before any Tribunal, by way of claim or defense to a claim, 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;
(2) fraud;
(3) bad faith;
(4) unfairness;
(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 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 the 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; and
(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 the Agreement or applicable law.
(d) Liquidated damages: In addition, in any case described in subdivision (b), regardless of any other outcome of the litigation or arbitration, the claimant must pay the defendant the Serious Accusation Liquidated Damages Amount (namely, USD $10,000) 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.
(e) Severability: The parties intend for subdivision (d) to be severable from the remainder of this, and for this to be severable from the Agreement, if either is found to be unenforceable for any reason.
Comment
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.
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 — which I paraphrase from memory: If Lawyer A accuses Lawyer B of fraud on the Patent Office, then perhaps at the end of the case, one of the two lawyers should be suspended from practice. 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.
22.3.5 ADR Non-Participation Attorney Fees
Clause text
(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:
(1) arbitration;
(2) early neutral evaluation;
(3) economical litigation agreement;
(4) escalation of disputes;
(5) forum selection;
(6) jury-trial waiver;
(7) mediation;
(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 the 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 the 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 ADR Non-Participation Attorney Fees 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.
Comment
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); and
- Lange v. Schilling, 163 Cal. App. 4th 1412 (2008) (reversing award of attorney fees to prevailing plaintiff). Cf. also 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.
22.4 Contra Proferentem Disclaimer
Clause text
The parties' desire is that the contra proferentem ("against the offeror") principle of contract interpretation is not to be applied to the Agreement; that is, any ambiguity or inconsistency in the 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.
Wording choice
This provision is phrased as a disclaimer, and not as a prohibition. That's because parties to a contract generally can't prohibit a court from applying a particular legal doctrine; they can only request that the court not do apply the doctrine.
Contra proferentem overview
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.
The (U.S.) Supreme Court explained the concept of contra proferentem:
… 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).
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).
Caution: Disclaiming contra proferentem can cause problems if a provision turns out to be ambiguous
Suppose that a court or arbitrator concluded that there was no way to resolve an ambiguity in a contract, other than by applying the contra proferentem principle — but the parties had agreed that contra proferentem was not to be used. The results in that situation might be unpredictable:
- The tribunal might disregard the contra proferentem prohibition and apply the principle to resolve the ambiguity; or
- The tribunal might rule that the ambiguous provision could not be enforced — which in some circumstaces might jeopardize the enforceability of the entire contract.
(Hat tip: Jonathan Ely, in a comment in a LinkedIn group discussion (group membership required).)
Exercise: Contra proferentem rule
FACTS:
- You represent Buyer in negotiating a long-term master purchase agreement with Seller.
- You draft a price-increase clause that limits Seller's permissible price increases to no more than the increase in CPI (and no more than once a year as well).
- A year later, Seller says it is increasing its price by the percentage stated in a particular CPI published by the U.S. Government for the specific industry in which Seller and Buyer operate. You hadn't known there even was such a thing.
- Your client Buyer angrily tells you that Seller's price increase must be limited to the (much-lower) increase in the "regular" CPI, namely CPI-U, US City Average, All Items, 1982–1984=100.
QUESTION: On these facts, how might a court rule on Buyer's claim that Seller's price increases must be limited to the increase in CPI-U and not to the increase in the special CPI?
Chances are that the court would rule in favor of Seller, because you (on behalf of Buyer) drafted the price-increase provision.
22.5 Dispute Escalation
22.5.1 Escalation Requirement
Clause text
(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 section 22.5.
(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.
Comment
In subdivision (a), the "whenever requested" phrase 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?"
In subdivision (a)(1): 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.
For another example of escalation-clause language, see the CPR International Model Multi-Step Dispute Resolution Clause (scroll down to "(A) Negotiation").
To provide parties with financial incentives to comply with a dispute-escalation requirement, consider also including in the Agreement CD-22.3.5. ADR Non-Participation Attorney Fees.
Review questions
- Under the sample clause language, must the parties' CEOs get involved in escalating a dispute if lower-level managers can't resolve it? Explain.
- When might it not be reasonable to expect the parties' CEOs to get involved? Explain.
- Does the Common Draft clause adequately cover the subject raised in Question 2? Explain.
- Is escalation automatic, or must there be some triggering event? Explain.
- Under the sample clause language, what happens if a lower-level manager for one party simply folds her arms and says "No, we're not taking this to upper management; I'm the decider here." Explain.
22.5.2 Meetings; Exchange of Written Statements
Clause text
(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 is not required to 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.
Comment
Subdivision (a): 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.
Subdivision (b): 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."
22.5.3 Escalation Required Before Legal Action
Clause text
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 section 22.5 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 or ‑repose.
22.5.4 Inadmissibility of Escalation Communications
Clause text
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.
Comment
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.
22.6 Early Neutral Evaluation
Clause text
(a) This applies whenever a dispute arising out of or relating to the Agreement becomes, or appears reasonably likely to become, the subject of litigation or arbitration.
(b) 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 Early Neutral Evaluation procedures of the American Arbitration Association as then in effect, or such other rules or procedures as the parties may agree.
(c) Each party is to participate in the early neutral evaluation proceedings in good faith.
(d) For the avoidance of doubt:
(1) The goal of early neutral evaluation is merely to provide parties to a dispute and their counsel with a neutral "reality check."
(2) 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).
(3) 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.
(4) The results of the evaluation are confidential and not shared with the trial judge or arbitrator.
(5) The evaluator has no power to impose settlement and does not attempt to coerce a party to accept any proposed terms.
(6) 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.
(7) 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.
Comments
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.; see also Rick Lowes, Recognizing the Role of Optimism Bias in Case Evaluation (LegalIntelligencer.com June 2016), also available without the paywall (DuaneMorris.com).
- 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:
- the Northern District of California (which encompasses San Francisco and Silicon Valley);
- the Southern District of California;
- the Eastern District of Wisconsin;
- the Western District of Pennsylvania.
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.
Confidentiality & non-binding nature of ENE proceedings
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.
Review questions
- What do you think the principal benefit of ENE would be?
- Why might a party not want to commit to ENE?
- Name three reasons that a lawyer might not want her client to have to go to ENE. (Cynical thinking is OK here.)
- What is the most important way in which ENE differs from arbitration?
- Is ENE automatic, or must it be triggered by some action?
- In ENE, is it a concern that the trial judge might be influenced by the neutral evaluator's views? Why or why not?
Further reading about ENE
See also:
- 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)
22.7 Economical Litigation Agreement
22.7.1 Applicability
Clause text
Except as otherwise provided below, any dispute arising out of or relating to the 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 the Agreement; and
(2) all disputes based on action in contract, tort, or otherwise.
22.7.2 Notification Requirement & Opt-Out Window
Clause text
IF: A party intends to enforce this section 22.7 in the context of a specific dispute; THEN:
(1) That party must give seasonable written notice of that intent to each other party that is putatively bound by this; and
(2) 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.
Comment
When the Economical Litigation Agreement was proposed in 2010, I wrote that making an irrevocable commitment to it would be ill-advised, because:
- the concept was just too new; and
- 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.
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 this section are directed toward that end.
22.7.3 JURY TRIAL WAIVER
Clause text
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 the Agreement agree in writing to trial by jury.
Comment
Some U.S. jurisdictions, notably California and Georgia, prohibit advance waivers of jury trials; see CD-22.11. JURY TRIAL WAIVER and its commentary.
Additional notes: Economical Litigation Agreement
Overview
Some of the salient features of the Economical Litigation Agreement include the following:
- 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
- mediation
- 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 CD-22.2.22. Conference-Call Interview Procedure
- Electronic-discovery procedures
- Duty of preservation
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.
22.8 Extrinsic Evidence Exclusion
Clause text
The parties desire that extrinsic evidence not be considered in determining the meaning of the Agreement, or any provision of it, in any judicial- or arbitral proceeding; each party agrees not to offer any such evidence for that purpose.
Comment
This provision is based on one that was successfully asserted by a defendant in Hot Rods, LLC, v. Northrop Grumman Sys. Corp., No. G049953, slip op. at 9 (Cal. App. 4th Dist. Dec. 7, 2015) (reversing and remanding damages award).
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 CD-24.1.4. Entire Agreement; Terms in Other Documents.
Forum selection (cross-reference)
See CD-24.1.5. Forum Selection.
22.9 Fraud Proof
Clause text
(a) Any claim that a person committed or engaged in fraud must be established by showing one or both of the following by clear and convincing evidence:
(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.
(b) For the avoidance of doubt:
(1) The requirements of subdivision (a) apply (A) to any claim of fraud arising out of or relating to the 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).
Comments
Language choices
Subdivision (a): These proof requirements are adapted from the definition in the famous Rule 10b-5 promulgated by the U.S. Securities and Exchange Commission; see generally the Wikipedia article "Rule 10b-5."
The requirement in subdivision (1) 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).
Motivation: "They lied!" is a go-to phrase for trial counsel
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. 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.”
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.
As another example, consider BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC). In that case:
- British Sky Broadcasting ("Sky") contracted with EDS to develop a customer relationship management (CRM) software system.
- Things didn't go as planned, and Sky eventually filed suit.
- In the (non-jury) trial, the judge concluded that EDS had made fraudulent misrepresentations when one of EDS's senior UK executives, wanting very much to get Sky's business, lied to Sky about EDS's analysis of the amount of elapsed time needed to complete the initial delivery and go-live of the system. See id. at ¶ 2331 and ¶¶ 194-196.
- The judge also concluded that during subsequent talks to modify the contract, EDS made additional misstatements that didn't rise to the level of fraud, but still qualified as negligent misrepresentations. See id. at ¶ 2336.
- A limitation-of-liability clause in the EDS-Sky contract capped the potential damage award at £30 million.
- By its terms, though, that limitation did not apply to fraudulent misrepresentations; the judge held that the limitation didn't apply to negligent misrepresentations either. See id. at ¶¶ 372-389.
(One of the most interesting aspect of the judge's opinion, it seems to me, is its detailed exposition of the facts, which illustrate the ‘sausage factory' by which technology deals sometimes get made — and how even just one vendor representative can make a deal go terribly wrong for his employer.)
In early June 2010, EDS reportedly agreed to pay Sky some US$460 million — more than four times the value of the original contract — to settle the case. See Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.
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).
22.10 Injunctive Relief
22.10.1 Injunctive Relief Not Precluded
Clause text
(a) Nothing in the Agreement precludes any Signatory Party ("Claimant") from seeking injunctive relief (or comparable relief) against any other party ("Respondent") — upon proper proof in accordance with applicable law — in respect of an actual or threatened breach of the Agreement, for the purpose of preventing or stopping irreparable injury or other harm that is not capable of being fully redressed by a monetary award.
(b) For purposes of subdivision (a), the term injunctive relief includes, for example, orders directing specific performance; injunctions; and similar relief.
Comment
Drafters of "form" contracts (for example, consumer contracts) sometimes write "one-way" equitable-relief clauses in which only their side is entitled to relief. This clause is written as a two-way provision, in part because contract reviewers tend to respond more favorably to provisions that apply equally to all parties. (As a practical matter, though, it might be that only one side would be likely ever to seek equitable relief, for example the disclosing party in a one-way confidentiality agreement.)
22.10.2 Presumption of Irreparable Harm
Clause text
Respondent stipulates that: (1) any breach of the Agreement by Respondent will result in harm to Claimant that cannot be adequately compensated by monetary damages or other remedies at law; and (2) Respondent will be entitled to equitable relief, including injunction and specific performance, as remedy for any such breach.
Comments
- Caution: This provision might be a significant concession
- Legal background: The four-factor proof requirement for injunctive relief
- Caution: Stipulating "irreparable harm" is likely to be dangerous
- Stipulations to irreparable harm have been enforced
- But a stipulation to irreparable harm might also be disregarded
Caution: This provision might be a significant concession
A potential future Respondent might not want to stipulate to irreparable harm, because doing so would absolve the Claimant from what might be a significant burden of proof, as discussed below.
On the other hand, in some cases — e.g., misappropriation of crucial trade secrets — the existence of irreparable harm might be pretty obvious. In such a case, it might not be much of a concession for a potential Respondent to stipulate in advance to the existence of irreparable harm.
Legal background: The four-factor proof requirement for injunctive relief
In U.S. jurisdictions, a party seeking an injunction or similar equitable relief must show, not merely allege, that (among other things) it has suffered or is likely to suffer irreparable harm that could not be adequately compensated by remedies available at law, such as monetary damages.
As explained by the Supreme Court of the United States:
According to well-established principles of equity, a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief.
A plaintiff must demonstrate:
(1) that it has suffered an irreparable injury;
(2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury;
(3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and
(4) that the public interest would not be disserved by a permanent injunction.
The decision to grant or deny permanent injunctive relief is an act of equitable discretion by the district court, reviewable on appeal for abuse of discretion.
eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388, 391 (2006) (describing traditional four-factor test in context of patent-infringement injunctions) (citations omitted, emphasis and extra paragraphing added).
Caution: Stipulating "irreparable harm" is likely to be dangerous
An injunctive-relief provision in a contract might contain:
- a stipulation that the party seeking injunctive relief will suffer irreparable harm from a breach of the contract; and/or
- a waiver of any requirement that the party seeking injunctive relief must post a bond.
Reviewers should pay careful attention to such language, because it could end up significantly disadvantaging the party against whom injunctive relief is sought.
Stipulations to irreparable harm have been enforced
In a 2012 opinion, then-chancellor Strine of the Delaware chancery court (now chief justice of the state's supreme court) relied in part on a similar clause in granting a four-month injunction against one company's hostile takeover bid targeting another company:
In Delaware, parties can agree contractually on the existence of requisite elements of a compulsory remedy, such as the existence of irreparable harm in the event of a party's breach, and, in keeping with the contractarian nature of Delaware corporate law, this court has held that such a stipulation is typically sufficient to demonstrate irreparable harm.
Martin Marietta Materials, Inc v. Vulcan Materials Co., 56 A.3d 1072, 1144-45 (Del. Ch.), aff'd, 45 A.3d 148 (Del. 2012) (en banc) (footnotes with extensive citations omitted).
But a stipulation to irreparable harm might also be disregarded
Just because a contract stipulates that a party will suffer irreparable harm from a breach, doesn't mean that a court will give effect to the stipulation. The Delaware chancery court disregarded such a stipulation in a 2015 case:
Parties sometimes, as Renco and M&F did here, agree that contractual failures are to be deemed to impose the risk of irreparable harm. Such an understanding can be helpful when the question of irreparable harm is a close one.
Parties, however, cannot in advance agree to assure themselves (and thereby impair the Court’s exercise of its well-established discretionary role in the context of assessing the reasonableness of interim injunctive relief) the benefit of expedited judicial review through the use of a simple contractual stipulation that a breach of that contract would constitute irreparable harm.
[In footnote 20 the court added:] In part, this is simply a matter that allocation of scarce judicial resources is a judicial function, not a demand option for litigants.
AM General Holdings LLC v. The Renco Group, Inc., No. 7639-VCN, slip op. at 10, text accompanying nn.19-20 (Del. Ch. Dec. 29, 2015) (denying request for preliminary injunction) (footnotes omitted, extra paragraphing added).
22.10.3 Bond WAIVER
Clause text
Respondent KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any requirement that Claimant post a bond as a condition of obtaining injunctive relief or other equitable relief against Respondent for breach or threatened breach of the Agreement.
Comment
When a party seeks preliminary or temporary injunctive relief in a U.S. court, the court will often (and possibly must) require that party to post a bond as security. The purpose of the bond is to guarantee that at least some money (provided by the insurance company that writes the bond) will be available to compensate the defendant for any damage it might have suffered from an improvidently-granted preliminary injunction.
CAUTION: A party agreeing in advance to waive a bond requirement might later find itself subjected to a preliminary injunction, but then prevail at trial — only to find itself unable to otain any meaningful recovery for the wrongful injunction, because the plaintiff was unable to pay a damage award.
See, e.g.:
- Fed. R. Civ. P. 65(c);
- Tex. R. Civ. P. 684.
- Thomas E. Patterson, Handling the Business Emergency, ch.3 (American Bar Association 2009), extensive excerpts available at http://goo.gl/ak7Mt (books.google.com).
22.11 JURY TRIAL WAIVER
Clause text
(a) To the maximum extent not prohibited by law, each party (each, a Waiving Party) KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES ANY RIGHT IT MIGHT HAVE TO TRIAL BY JURY of any dispute arising out of or relating to the Agreement or any transaction or relationship arising from the Agreement.
(b) Each Waiving Party certifies that no representative, agent or attorney of any other party has represented, expressly or otherwise, that such other party would not seek to enforce the Agreement's waiver of jury trial.
(c) Each Waiving Party acknowledges that the other party has been induced to enter into the Agreement by, among other things, the mutual waivers and certifications in this clause.
Comments
Language choices
Subdivision (a) is set up by default as a two-way waiver, because a court would be more likely to disregard a one-way waiver.
The use of bold-faced type is for conspicuousness.
A pre-dispute waiver of jury trial might be unenforceable
In California and Georgia, advance waivers of jury trial are not enforceable. [DCT TO DO: CITES NEEDED]
http://cases.justia.com/federal/appellate-courts/ca9/14-72343/14-72343-2015-04-16.pdf?ts=1429203661 – Ninth Circuit adopts California rule under Erie – Orange County v. Tata Consulting – concerns a contract to develop a computerized property-tax management system.
Caution: Be sure all potential parties waive the right to jury trial, in all relevant agreement documents
Failing to include a jury-trial waiver in the "correct" agreement document can result in disputes under that agreement being tried to a jury even if other related agreement documents include a waiver. That happened in Bank of America, N.A. v. JB Hanna, LLC, No. 12-3239, part II (8th Cir. Sept. 8, 2014). That case involved a tangle of loan agreements, interest-rate swap agreements, and personal guaranties. All contained jury-trial waivers except two loan agreements. The trial court let the jury decide the bank's entire case against the borrowers, on all agreements, notwithstanding the jury-trial waivers in the other agreements; the appeals court affirmed that much of the judgment.
(The jury found for the borrowers on all counts; the appeals court vacated the judgment, and remanded for a new trial, on grounds that the verdict was against the great weight of the evidence. See id. at part IV.)
22.12 Limitations of Liability
- 22.12.1. Affected Disputes
- 22.12.2. Protected Persons Definition
- 22.12.3. Applicability to All Legal Theories
- 22.12.4. Knowledge of Risk Irrelevant
- 22.12.5. Liability Limitations as Material Consideration
- 22.12.6. No Seeking of Inconsistent Damages
- 22.12.7. Some Limitations of Liability Might Not Apply
- 22.12.8. Avoidable Damages Are Excluded
- 22.12.9. Damages Capped as Specified
- 22.12.10. Exclusions from Damages Cap
- 22.12.11. Personal-Injury Damages Not Affected
- 22.12.12. Exclusion of Consequential Damages, Etc.
- 22.12.13. WAIVER of Extra-Contractual Liability
- 22.12.14. Incidental Damages Exclusion
- Additional notes: Limitations of liability
22.12.1 Affected Disputes
Clause text
All limitations of liability stated in the Agreement apply in all Affected Disputes, namely all disputes arising out of the Agreement.
Comment
A drafter representing a Disclaiming Party might want a broader definition of Affected Dispute, such as any dispute arising out of or relating to the Agreement, or even any Agreement-Related Dispute. The other side, though, might well consider such a broader definition to be overreaching.
22.12.2 Protected Persons Definition
Clause text
All limitations of liability of the Agreement apply to all Protected Persons, defined as:
(1) the Disclaiming Party (namely, each party) (each one, if more than one);
(2) the Affiliates and agents of each Disclaiming Party;
(3) the Associated Individuals of each individual and organization listed in subdivisions (1) and (2); and
(4) any other particular Protected Persons 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 Protected Persons is also in another category listed above
22.12.3 Applicability to All Legal Theories
The pa
Clause text
The parties have specifically agreed that each limitation of liability set forth in the Agreement is to apply:
(1) to all claims for damages or other monetary relief, whether alleged to arise in contract, tort (including for example negligence, gross negligence, or willful misconduct), or otherwise;
(2) regardless whether the damages are alleged to arise in contract, negligence, gross negligence, other tort, willful misconduct, or otherwise;
(3) even if the allegedly-liable party was advised, knew, or had reason to know of the possibility of excluded damages and/or of damages in excess of the relevant damages cap, if any; and
(4) even if one or more limited remedies fail of their respective essential purposes.
Comment
This language is an avoidance-of-doubt "roadblock" clause; it hopes to prevent aggressive litigation counsel from trying to do an end-run around the limitations of liability.
The phrase, "The parties have specifically agreed," etc., is redundant; it's included here to create a sound bite that can be used in litigation.
22.12.4 Knowledge of Risk Irrelevant
Clause text
The limitations of liability of the Agreement apply even if the relevant Protected Person and/or its agents knew or had reason to know, at any time, of either or both of the following: (1) the existence of particular circumstances of the party that incurred such damages; and/or (2) that, in such circumstances, such damages were possible, likely, or even highly probable.
22.12.5 Liability Limitations as Material Consideration
22.12.6 No Seeking of Inconsistent Damages
Clause text
Each party expressly agrees not to seek damages in excess of any applicable limitation of liability stated in the Agreement.
Comment
This language is intended to make it a separate breach of contract for a party to seek damages not allowed by the Agreement's limitation(s) of liability; the intent is to allow the other party to recover its attorney fees as damages for that separate breach. (I haven't researched whether a court would give effect to this language.)
22.12.7 Some Limitations of Liability Might Not Apply
Clause text
The parties acknowledge that some jurisdictions might not permit limitation or exclusion of remedies under some circumstances, in which case some or all of the limitations of liability stated in the Agreement might not apply; this sentence, though, is not to be taken as a concession that any particular limitation or exclusion should not apply.
22.12.8 Avoidable Damages Are Excluded
Clause text
For the avoidance of doubt, in any Agreement-Related Dispute, NO PROTECTED PERSON WILL BE LIABLE for any loss (or portion thereof) that would have been avoided by cover or other reasonable avoidance efforts (not involving undue risk or burden) where the party incurring the loss failed to make such efforts.
Comment
This exclusion essentially states the rule in (U.S.) law; its concepts are adapted from: • Restatement (Second) of Contracts § 350, which states in part that "damages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation …. [but] [t]he injured party is not precluded from recovery … to the extent that he has made reasonable but unsuccessful efforts to avoid loss"; and • UCC § 2-715(2)(a), which in effect excludes from the definition of consequential damages any damages "which could not reasonably be prevented by cover or otherwise."
22.12.9 Damages Capped as Specified
Clause text
Except as expressly stated otherwise in the Agreement: The CUMULATIVE TOTAL LIABILITY of all Protected Persons, for any and all breaches of the Agreement by any and all of the Protected Persons, IS NOT TO EXCEED the amount specified in the Agreement (the Damages Cap Amount).
Comments
- Conspicuousness
- Damages caps: Typical use
- Pro tip: Different damages caps for different risks?
- Pro tip: Reduce the damages cap as time passes or as milestones are achieved?
- Trying to exclude all damages might be ineffective
- On the other hand, a disclaimer of all damages just might work
- Statutory limitations of damages liability?
- Limiting damages liability to insurance coverage
Conspicuousness
A portion of this clause is in all-caps to make it "conspicuous," which is expressly or implicitly required for limitations of liability in some jurisdictions.
Damages caps: Typical use
In any given agreement, the specific damages cap amount will very often be negotiated.
For an example of acourt's enforcing an agreed damages cap, see Shakeri v. ADT Security Services, Inc., 816 F.3d 283 (5th Cir. 2016) (per curiam). In that case, the owners of a jewelry store sued an alarm-system company for damages after the store were robbed at gunpoint and one of the owners was severely beaten and tasered; the alarm system's panic button failed, allegedly because of faulty workmanship by a technician working for the alarm-system company. 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.
The parties' contract contained the following language:
E. … if ADT should be found liable for loss, damage, or injury due to a failure of service or equipment in any respect, its liability shall be limited to a sum equal to 10% of the annual service charge or $1,000, whichever is greater, as the agreed upon damages and not as a penalty, as the exclusive remedy;
and that the provisions of this paragraph shall apply if loss, damage or injury, irrespective of cause or origin, results directly or indirectly to person or property from performance or nonperformance of obligations imposed by this contract or from negligence, active or otherwise, strict liability, violation of any applicable consumer protection law or any other alleged fault on the part of adt, its agents or employees.
Id. at 288 (all-caps removed, extra paragraphing added). The district court accordingly limited the plaintiffs' breach-of-contract damages to the agreed $1,000. See id. at 290. The Fifth Circuit's opinion did not address that particular ruling; the opinion isn't clear whether the plaintiffs appealed the ruling.
Pro tip: Different damages caps for different risks?
In some cases, it might make sense to provide separate damage caps for specific risks. a few years ago I did a blog posting on this subject, Negotiating contractual limitations of liability: Do it risk by risk, not one size fits all (2010).
Here's a non-exhaustive list of categories that might be negotiated:
- Defense- and indemnity against third-party claims
- Personal injury or death
- Willful, tortious destruction of property, including for example intentional and unauthorized erasure or corruption of computer programs or -data with the intent to harm.
- Tangible damage to property (does not include erasure, corruption, etc., of information stored in tangible media where the media are not otherwise damaged)
- Infringement of another signatory party's IP rights
- Cost of transaction completion
- Erasure, corruption, etc., of stored information (but such damages are not recoverable to the extent that they could have been avoided or mitigated by reasonable back-ups)
- Loss of profits from collateral business arrangements
- Loss of revenue from collateral business arrangements
- Loss of competitive advantage
- Loss of goodwill
- Interruption to business
- Damages not foreseeable by the breaching party when the breaching party became bound by the specific obligation that it breached *
- Loss of product
- Loss of production
- Delay damages
- Any other purely-economic loss
Depending on the circumstances, that might be when the breaching party entered into the Agreement, or when it agreed to (for example) a statement of work for a services contract or an order for goods.
Pro tip: Reduce the damages cap as time passes or as milestones are achieved?
The risk of something going wrong and causing harm might go down as time passes or as progress milestones are achieved. In such a case, a damages cap might be reduced accordingly.
For example:
- Suppose that a vendor has developed a new product whose risks aren't really that well understood. In that case, the vendor and its customers might agree to a relatively-high damages cap
Trying to exclude all damages might be ineffective
One aggressive drafter included a disclaimer of all damages in a limitation of liability clause. A trial court went along with the disclaimer, but the appellate court had a very different view. See Innovate Tech. Solutions, L.P. v. Youngsoft, Inc., No. 05-12-00658-CV (Tex. App.–Dallas Nov. 19, 2013) (reversing and remanding partial summary judgment and directed verdict).
In that case, Youngsoft and Innovate were companies in the information technology (IT) space. They entered into a professional services agreement for Youngsoft to do some work for Innovate. The agreement included the following limitation of liability clause:
Not withstanding [spelling by the court] anything contained elsewhere in the Agreement and under any circumstance, for any reason whatsoever, YS shall not be liable for any incidental, ancillary, direct, indirect, special or consequential damages, including but not limited to lost profits, whether in tort or contract, and based on any theory of liability. [Emphasis added.]
As the appeals court put it, "[t]here is evidence the project did not proceed smoothly and that the client was unhappy." Innovate failed to pay Youngsoft, which filed a lawsuit to collect what it claimed was owed to it.
Innovate counterclaimed for breach of express warranty and breach of contract. The trial court granted Youngsoft's motion for judgment that Innovate's counterclaims were all barred by the limitation of liability clause.
The appellate court reversed and remanded on that point, agreeing with Innovate that it had been improper for the trial court to focus solely on the purported exclusion of direct damages, because doing so would:
- disregard other provisions in the contract, such as a mutual indemnity clause, a warranty clause, and a confidentiality clause; this would violate the rule that "courts must favor an interpretation that affords some consequence to each part of the instrument so that none of the provisions will be rendered meaningless" (citation and internal quotation marks omitted); and
- render the agreement "illusory, void, and unenforceable."
At this writing, it remains to be seen whether the trial court might strike down still-more portions of the liability limitation.
The lesson for drafters might be like the old advice for stock traders: Bulls make money; bears make money; pigs get slaughtered.
On the other hand, a disclaimer of all damages just might work
See Events Media Network, Inc. v. The Weather Channel Interactive, Inc., No. 13-03 (D.N.J. Feb. 3, 2015) (unpublished). In that case, the data-licensing contract in suit said:
Limitation of Liability. Except with respect to liability arising from a party’s indemnification obligation hereunder, neither party hereto shall be liable to the other for direct, indirect, incidental, consequential, special or exemplary damages (even if such party has been advised of the possibility for such damages such as, but not limited to, loss of revenue or anticipated profits or loss of business.
Id., slip op. at 27 (some emphasis added, all-caps formatting omitted).
The court granted The Weather Channel's motion for summary judgment that the plaintiff EMNI was not entitled to damages for the alleged breach of contract. The court's ruling was based in part on the ground that EMNI didn't argue that the damages disclaimer was ambiguous, in violation of public policy, or unconscionable (the court could have been signaling that the result might have been different otherwise).
Similarly, the creator and host of a YouTube video channel was unable to recover damages when YouTube deleted her channel, because YouTube's terms of service included language that precluded an award of any damages for that occurrence. See Lewis v. YouTube, LLC, 244 Cal. App. 4th 118 (2015) (affirming trial court's sustaining of YouTube's demurrer without leave to amend). The limitation of liability stated in part:
In no event shall YouTube, its officers, directors, employees or agents, be liable to you for any direct, indirect, incidental, special, punitive, or consequential damages whatsoever resulting from … (v) any errors or omissions in any content or for any loss or damage of any kind incurred as a result of your use of and content posted, emailed, transmitted, or otherwise made available via the Services ….
Id., 244 Cal. App. 4th at 124-25 (emphasis added, capitalization modified).
Statutory limitations of damages liability?
A party's liability for damages under a contract might be limited by statute. For example, in the U.S., the Carmack Amendment limits the liability of common carriers for damages to the goods they carry. For a concise history of the Carmack Amendment, see Certain Underwriters at Interest at Lloyds of London v. United Parcel Service of America, Inc., No. 13-4515, part III-A (3d Cir. Aug. 12, 2014). In that case, the Lloyds underwriters, exercising their rights of subrogation, sued UPS for conversion after the disappearance of packages of coins and special metals worth some $150,000; the underwriters alleged that the packages were stolen by UPS employees. The court of appeals affirmed dismissal of the underwriters' complaint, on grounds that the Carmack Amendment preempted their claim.
Limiting damages liability to insurance coverage
If a contract says that liability is limited to the insurance coverage, but not more than $X, whichever is less, then a court might ignore the lower limit – http://www.mondaq.com/article.asp?articleid=464348
22.12.10 Exclusions from Damages Cap
Clause text
Unless expressly stated otherwise in the Agreement, a damages cap under section 22.12.9 does not apply to the liability of a party in any of the following categories (but an agreed damages cap specific to such a category, if any, will apply):
(1) amounts due under the Agreement;
(2) amounts required to be paid under the Agreement for defense and/or indemnity of another party against third-party claims — for the avoidance of doubt, however, a specifically-stated maximum aggregate liability for defense and indemnity obligations will apply;
(3) infringement of another signatory party's patent, copyright, or trademark;
(4) misappropriation of another signatory party's rights in confidential information;
(5) knowing misrepresentation or omission of a material fact, with the intent that another signatory party rely on the misrepresentation or omission in entering into the Agreement, as shown by clear and convincing evidence, where the other signatory party justifiably did so rely — for the avoidance of doubt, this subdivision (5) is intended only as an exception to one or more limitations of liability and not as the parties' assent to non-contractual liability, e.g., tort-based liability for fraud; nor
(6) unlawful conversion of, or the unlawful infliction of harm to, property of another signatory party (for example, erasure or corruption of computer programs or -data), IF the liable party is shown, by clear and convincing evidence,
(A) to have intended the conversion or harm, and
(B) to have known of the unlawful nature of the conversion or harm.
Comments
Damages cap carve-out: Exception for amounts due under the contract
It might not be strictly necessary — but it can still be a good idea — to state explicitly that amounts due under the agreement are not subject to the damages cap.
Consider the IHR Security case: a customer of a software vendor stopped paying the vendor's invoices because the software allegedly didn't function as promised. The vendor sued for payment of some $52,000.
The customer claimed that its liability was capped at $5,000, because that was the cap of a limitation of liability clause that applied to each party: "Notwithstanding anything to the contrary, the total dollar liability of either party under this agreement or otherwise shall be limited to US $5,000."
Read literally and in isolation, the damages cap does seem to say what the customer claimed. Fortunately for the software vendor, the court did some intellectual gymnastics and held that the damages cap applied only to the parties' liability for damages for improper functioning or failure of the software, not to the customer's liability for nonpayment. See IHR Security, LLC v. Innovative Business Software, Inc., — S.W.3d —, 2014 WL 1057306, slip op. at 6 (Tex.App.– El Paso Mar. 19, 2014) (affirming summary judgment in relevant part, reversing and remanding as to other issues).
The bad news for the vendor, of course, was that it had to litigate the issue, which doubtless cost money and delayed resolution of the case.
(Hat tip: Chicago lawyer / blogger Evan Brown, via Brian Rogers aka the Contracts Guy.)
For a comparable holding in an English case, see Fujitsu Services Ltd. v. IBM United Kingdom Ltd., [2014[ EWHC 752 (TCC), para. 52 (2014), where the court said:
… The distinction between a claim for damages and a claim for debt is explained clearly in Jervis v Harris:
"The law of contract draws a clear distinction between a claim for payment of a debt and a claim for damages for breach of contract. …[A] debt is a definite sum of money fixed by the agreement of the parties as payable by one party to the other in return for the performance of a specified obligation by the other party or on the occurrence of some specified event or condition;
whereas damages may be claimed from a party who has broken his primary contractual obligation in some way other than by failure to pay such a debt.
The plaintiff who claims payment of a debt is not required to prove anything beyond the occurrence of the event or condition on the occurrence of which the debt became due. He need prove no loss; the rules as to remoteness of damage and mitigation of loss are irrelevant; …"
(Italics and citations omitted.)
Damages cap carve-out for intentional or reckless misrepresentation
Tip for reviewers: Be exceedingly cautions about agreeing to generalized "fraud" exceptions in limitations of liability — see generally Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of ) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 BUS. LAW. 1049 (2014).
This clause uses the term "intentional or reckless misrepresentation" instead of the term fraud, which can have different meanings in different jurisdictions or to different people. 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, 1033, esp. at text accompanying nn.215-216 (2009); see also id. at part III, "The Many Meanings of the Term Fraud." Mr. West followed up several years later with
Damages cap carve-out for certain harm to another party's property
This carve-out from the Agreement's limitations of liability would encompass, for example, an IT provider's malicious erasure of a customer's data, or sabotage or hijacking of the customer's computer system as "self-help" in a payment dispute.
Note the requirement for proof of intent by clear and convincing evidence.
22.12.11 Personal-Injury Damages Not Affected
Clause text
The limitations of liability of the Agreement do not limit otherwise-recoverable damages for injury to the person (including death) proximately resulting from breach of the Agreement.
Comment
Many limitation-of-liability clauses contain carve-outs similar to this one, which is intended to reduce the chances that a limitation of liability would be found to be unconscionable under UCC § 2‑719(3) (which of course might not apply in a contract for services, or in a contract for the sale of goods in a non-UCC jurisdiction). That UCC provision states: "Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable. Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not." (Emphasis added.)
The phrase proximately resulting from breach is adapted from UCC § 2-715(2)(b).
22.12.12 Exclusion of Consequential Damages, Etc.
Clause text
In any Affected Dispute, NO PROTECTED PERSON WILL BE LIABLE for any form of consequential, punitive, exemplary, special, or multiple (e.g., treble) damages (collectively, Excluded Damages) except to the extent, if any:
Comments
Pro tip: Excluding "consequential" damages might not gain you much in real terms
Depending on the situation, an exclusion of consequential damages might not provide a breaching party with much protection if a tribunal were to conclude that particular damages were "direct."
Ken Adams points out that "courts are prone to holding that elements of damages that the seller might have intended to exclude are in fact direct rather than consequential." He cites a UK case, GB Gas Holdings Ltd. v Accenture (UK) Ltd., [2010] EWCA 912 at paragraphs 66-69, affirming [2009] EWHC 2734 (Comm), in which certain specific claims for damages were held (as a preliminary matter, before trial) not to be categorically excluded from recovery by the contract's exclusion of indirect and consequential damages.
Pro tip: Have "refund" as a backup remedy
When drafting a limited-remedies provision and an exclusion of consequential damages on behalf of a vendor, the drafter should seriously consider having three components to the limited remedies, namely "repair, replace, or refund," to try to protect the consequential-damages exclusion and/or the damages cap in case the first two remedies are later found to have failed of their essential purpose.
If limited remedies fail, will a consequential-damages exclusion go down with them?
• In the 1980s the Ninth Circuit took a case-by-case approach to this question, for example in RRX Industries, Inc. v. Lab-Con, Inc., 772 F.2d 543 (9th Cir. 1985). In that dispute, the defendant was a computer-software vendor; the plaintiff was an unhappy customer that had been promised, but never got, a working system. The parties' contract limited the buyer's remedies to repair or replacement of the faulty software, and also precluded consequential damages.
The trial court held that, because the software company failed to repair or replace the faulty software, those two limited remedies failed of their essential purpose, which killed the disclaimer of consequential damages under UCC § 2-719(2). The Ninth Circuit agreed, holding that "each case must stand on its own facts," 772 F.2d at 547 (alteration marks, internal quotation marks, and citation omitted), and that the lower court "properly found the default of the seller so total and fundamental that its consequential damages limitation was expunged from the contract." Id. (emphasis added); accord, Hawaiian Tel. Co. v. Microform Data Sys., 829 F.2d 919, 923-24 (9th Cir. 1987) (affirming award of consequential damages).
• In contrast, West Virginia's supreme court held that "where an express warranty fails of its essential purpose thereby allowing the buyer to pursue remedies and damages under … [the] Uniform Commercial Code, the seller’s exclusion of consequential damages from the express warranty remains in effect, unless the exclusion is unconscionable." a Appalachian Leasing, Inc. v. Mack Trucks, Inc., No. 13-1247, slip op. at 2, 18-20 (W. Va. Oct. 30, 2014) (reversing and remanding, on other grounds, summary judgment in favor of truck manufacturer).
Idea: Forget excluding consequential damages, and just cap the damages?
There's a school of thought that says:
- It's better not to try to limit consequential damages, because of the uncertainty about the scope that a court would someday give to that term;
- Instead, this thinking goes, drafters should negotiate caps on the amounts of damages that can be recovered for specific types of harm.
22.12.13 WAIVER of Extra-Contractual Liability
Clause text
To the extent not expressly prohibited by law, each party (each, a Waiving Party) KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY:
(1) AGREES that the rights and obligations of the parties arising out of or relating to the Agreement, or any transaction or relationship resulting from the Agreement, are to be defined solely under the law of contract in accordance with the express provisions of the Agreement; and
(2) WAIVES any such obligations allegedly owed by any other party to the Agreement that are not expressly stated in the Agreement, whether those obligations are alleged to arise in (for example) quasi-contract; quantum meruit; unjust enrichment; promissory estoppel; tort; strict liability; by law (including for example any constitution, statute, or regulation); or otherwise.
Comment
This language is modeled on a clause suggested 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 (2009); the entire article is worth a complete and close reading.
Some language is in bold-faced all-capital letters for conspicuousness.
22.12.14 Incidental Damages Exclusion
Comment
Unlike some provisions, the Common Draft option for exclusion of consequential damages does not automatically encompass "incidental" damages, which are generally defined as reasonable expenses reasonably incurred by a party incident to a breach or delay by another party. See generally UCC § 2-710 (seller's incidental damages) and UCC § 2-715(1) (buyer's incidental damages). Of course, UCC Article 2 applies only to sales of goods, and will not apply at all in non-U.S. countries. Still, the same basic concepts of incidental damages might also apply to sales of services, etc.
It has been observed that: "Although incidental damages are often included in the laundry list of waived damages, it is often advisable to remove them since the right to recover incidental damages may encourage mitigation efforts." Thomas H. Warren, W. Jason Allman, & Andrew D. Morris, Top Ten Consequential Damages Waiver Language Provisions to Consider (ACC.com 2012).
Additional notes: Limitations of liability
- Sophisticated parties represented by counsel might have more latitude to limit liability
- Negotiate limitations of liability risk‑by‑risk, not one‑size‑fits‑all
- Negotiate limitations of liability that vary with time or circumstances
- Negotiation strategy: A two-way limitation might be deceptive
- Exclusion of punitive damages
- Limitations of liability: Further reading
Sophisticated parties represented by counsel might have more latitude to limit liability
Some courts take a laissez-faire attitude toward agreed limitations of liability, at least when they were negotiated by sophisticated parties that were represented by counsel.
For example, in one case:
- A bank sold a package of distressed loans to an investment firm.
- The parties’ agreement included a representation about the status of the various assets that collateralized the loans in the package.
- That representation, however, turned out to be incorrect as to some of those assets, meaning that the bank had breached the agreement.
- A limitation-of-liability clause in the parties’ agreement capped the investment firm’s damages at an amount to be determined by computing the result of a specified formula.
- On the facts of the case, that amount turned out to be a negative number, resulting in a zero damage award.
- The investment firm claimed that the limited remedy was unenforceable or waived, or that it failed of its essential purpose.
- The district court disagreed, and granted summary judgment for the bank.
The Seventh Circuit affirmed, saying, "[e]xcept in the most extraordinary circumstances, we hold sophisticated parties to the terms of their bargain." Southern Financial Group, LLC v. McFarland State Bank, No. 13-3378, part III (7th Cir. Aug. 15, 2014).
Negotiate limitations of liability risk‑by‑risk, not one‑size‑fits‑all
Limitation-of-liability provisions usually rank at or near the top of the annual surveys done by the International Association for Contract and Commercial Management concerning the most-frequently-negotiated contract terms. Ironically, the same surveys indicate that contract professionals fervently wish they could spend their time negotiating collaborative provisions (to try to keep trouble from happening) instead of liability provisions (in case trouble does come to pass).
I think I know why many companies have to spend too much time negotiating limitations of liability: A lot of the limitation provisions I've read over the years have been long, boilerplate statements; they might be fine for a simple, low-stakes contract, but their lack of specificity can give a reviewer pause, and complicate the discussion, when more is at risk.
First, consequential-damages exclusions seldom spell out just what specific categories of damages can and cannot be recovered — it seems as though each party crosses its fingers and hope the courts will interpret the phrase consequential damages in its favor. That, of course, makes negotiators nervous, because they don't know whether the particular type of damage they're concerned about will qualify;
Second, damages caps usually take the form of a single, one-size-fits-all number that applies to every conceivable form of liability. It's true that negotiators do sometimes debate whether particular types of damage (e.g., damages covered by an indemnity obligation) should be carved out entirely from the damages cap. But that's a false dichotomy; it assumes, for no reason, that a given type of damages will be either subject to the 'default' cap, or not subject to any cap at all.
Instead of resenting the time it takes to negotiate limitations of liability, perhaps we should try doing things a little differently — not necessarily in every negotiation, but definitely in those in which the liability limitations are likely to be closely scrutinized.
Contract drafters can speed up discussions of liability limitations, I've found, by breaking up general boilerplate language into more-concrete statements of risks that are of particular concern, which the parties can focus on more readily.
One technique that works well is to provide a table that (i) lists specific risks, and (ii) states, for each specified risk, what if any liability limits are agreed. Using that table, the parties can systematically work through the list of risks and, for each risk, negotiate the limitations they're willing to accept.
To be sure, if the non-drafting party won't care much about the limitation of liability anyway, then including such detailed limitation language could actually hinder the overall negotiations. But remember, by hypothesis we're talking about contract negotiations in which the limitation language is indeed going to be carefully negotiated — in which case this kind of systematic approach will almost always make sense.
Negotiate limitations of liability that vary with time or circumstances
Exclusions of consequential damages and damage-cap amounts don't necessarily have to be carved in stone for all time. The parties could easily agree to vary them, either as time passed or as circumstances changed.
Consequential-damages example: Suppose that:
- A software vendor is negotiating an enterprise license agreement with a new customer for a mature software package.
- The customer has successfully completed a pilot project, but it hasn't rolled out the software for enterprise-wide production use.
- Knowing how tricky a production roll-out can sometimes be, the customer is concerned about the vendor's insistence on excluding all 'consequential' damages, whatever that really means.
The vendor might try offering to waive the consequential-damages exclusion during, say, the customer's first three months of production use of the software, subject to an agreed dollar cap on the vendor's aggregate liability for all damages — which might be a higher dollar amount than at other times, as discussed below. This approach could make the customer more comfortable that the vendor is 'standing behind its software' during the roll-out phase.
In theory, certainly, the vendor would be exposed to additional liability risk during those first three months. But the business risk might be eminently worth taking. Remember, we're assuming that the software is mature, that is, most of its significant bugs have already been corrected. In that case, the vendor might be willing to take on that additional theoretical risk — which in any case would go away after three months — in order to help close the sale.
Damages-cap example: Perhaps a vendor could agree that the damages cap would be, say —
- 4X for any damages that arise during, say, the first three months of the relationship, or possibly until a stated milestone has been achieved;
- 3X during the nine months thereafter;
- 2X thereafter.
In the 4X / 3X / 2X language, X could be defined —
- as a stated fixed sum;
- as the amount of the customer's aggregate spend under the contract in the past 12 months, 18 months, etc.;
- in any other convenient way.
The details in the above examples aren't important. The point is that sometimes 'standard' limitation-of-liability language is too broad to allow the parties to specify what they really need. Negotiators might have more success if they drilled down into the language.
Negotiation strategy: A two-way limitation might be deceptive
Negotiators might wish to keep in mind that a two-way limitation of liability (i.e., one protecting each party) will often be more palatable than a one-way limitation that protects only one party (typically, a supplier or service provider).
Of course, as with all supposedly-two-way agreements, in some contracts (for example, a supply- or services agreement), it might be that only one party is likely to have significant potential liability that would be covered by the limitation.
Exclusion of punitive damages
In a 2015 Massachusetts case, Family Endowment Partners v. Sutow (discussed here), a limitation of liability clause excluded "special, consequential or incidental" damages, but it didn't exclude punitive- or multiple damages. Consequently, a trial court upheld an arbitration award of $48 million, including treble damages under a statutory provision.
In an intriguing case, Hallmark Cards brought an arbitration proceeding, and won a damage award, against a contractor for misappropriation of trade secrets. Hallmark then brought a lawsuit for misappropriation against a private equity firm, to which the contractor had wrongfully provided trade-secret information.
In the lawsuit, the jury awarded punitive damages against the private-equity firm. On appeal, the firm claimed that the punitive-damage award was a double recovery for Hallmark because of the damage award that Hallmark had previously obtained from the contractor.
The appeals court said no, this wasn't the case: Hallmark's agreement with the contractor contained an exclusion of punitive damages; the arbitration award against the contractor, therefore, must not have been punitive in nature, and therefore the jury was free to award punitive damages against the private-equity firm. See Hallmark Cards, Inc. v. Monitor Clipper Partners, L.L.C., 758 F.3d 1051, 1057-60 & n.4 (8th Cir. 2014) (affirming denial of motion for judgment as a matter of law and denial of motion to alter or amend the judgment).
Limitations of liability: Further reading
- Glenn D. West and Sara G. Duran, Reassessing the “Consequences” of Consequential Damage Waivers in Acquisition Agreements, 63 BUS. LAW. 777 (2008).
- For a discussion of examples of direct versus indirect losses, see this LinkedIn discussion (membership required).
22.13 Liquidated Damages
22.13.1 Definitions (must be edited)
22.13.1.1 Definition: Breaching Party
Comment
This will normally be a "one-way" provision, because usually only one party would be a Breaching Party. (This might be an exception to the general rule that two-way provisions, protecting and/or burdening each party, are more palatable than one-way clauses.)
PRO TIP: Conceivably, different liquidated-damages provisions might be desired for different triggering breaches and/or different breaching parties. In such a situation, drafters should consider using a table format, instead of a narrative format, to state the different permutations and combinations.
22.13.1.2 Definition: Triggering Breach
Comment
It might be that not every breach will always be a Triggering Breach, especially if a trivial breach were to result in an outlandish liquidated-damages amount as discussed below.
See also the PRO TIP in the commentary to CD-22.13.1.1. Definition: Breaching Party.
22.13.1.3 Definition: Liquidated-Damages Amount
Don't be ridiculous? Judging the liquidated-damages amount in hindsight
Ideally, drafters will consider just which breach(es) should trigger liability for liquidated damages. Not least, doing so might create a stronger impression, in the mind of a judge or arbitrator, that the parties really did thoughtfully consider the liquidated-damages provision, and thus make it somewhat more likely that the provision will be enforced.
It can be dangerous to establish a liquidated-damages amount that ends up being ridiculously disproportionate to the "real" damages. In 2014 the Supreme Court of Texas held that:
- actual damages must be difficult to estimate, and the agreed liquidated damages must be a reasonable forecast of the actual damage; but also:
- if in practice the actual damages and the agreed liquidated damages end up being too far apart, then the liquidated-damages provision will be struck down as a penalty.
The supreme court noted that the highest actual damages supported by the evidence was $6 million, but the liquidated-damages amount assessed by the court below was $29 million. The supreme court said that this was an unacceptable disparity: "When the liquidated damages provisions operate with no rational relationship to actual damages, thus rendering the provisions unreasonable in light of actual damages, they are unenforceable." FPL Energy, LLC, v. TXU Portfolio Management Company, L.P., 426 S.W.3d 59,69-70, 72 (Tex. 2014) (reversing court of appeals and holding that liquidated-damages provision was unenforceable) (emphasis added, citations omitted).
To like effect, the Seventh Circuit rejected a claim for liquidated damages for breach of a confidentiality provision in a settlement agreement. The liquidated-damages provision required a payment of $10,000 for each unauthorized disclosure of the terms of the settlement agreement. The party accused of breaching the confidentiality provision had included detailed information about the settlement in a franchise disclosure document that was distributed to about 2,000 people, not all of whom were required by law to be given a copy. The plaintiff sued for liquidated damages of 2,000 times $10,000, or $20 million. But applying Texas law, the trial court held that this was unreasonable, because the plaintiff had not proven that she had suffered any harm at all, let alone $20 million worth. The Seventh Circuit affirmed; quoting the Texas supreme court's FPL Energy opinion, Judge Posner said that, “when there is an unbridgeable discrepancy between liquidated damages provisions as written and the unfortunate reality in application, we cannot enforce such provisions.” Caudill v. Keller Williams Realty, Inc., No. 15-3313, slip op. at 4 (7th Cir. Jul. 6, 2016) (internal quotation marks and citation omitted).
No Monday-morning quarterbacking?
In Boone Coleman Constr., Inc. v. Village of Piketon, 2016 Ohio 628, ¶¶34-37, the Ohio supreme court held that an appeals court had improperly used hindsight analysis to invalidate a per diem liquidated-damages provision in public-works contract. The court explained:
{¶ 35} We reaffirm that Ohio law requires a court, when considering a liquidated-damages provision, to examine it in light of what the parties knew at the time the contract was formed. If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.
{¶ 36} This prospective or "front end" analysis of a liquidated-damages provision focuses on the reasonableness of the clause at the time the contract was executed rather than looking at the provision retrospectively, i.e., ascertaining the reasonableness of the damages with the benefit of hindsight after a breach.
The prospective approach properly focuses on whether[:]
(1) the parties evaluated, at the time of contract formation, the probable loss resulting from delay in completing the construction,
(2) the parties clearly intended to use liquidated damages in case of a delay because actual damages would be difficult to ascertain, and
(3) [in per-diem cases,] the parties reached an agreement as to a per diem amount for delays.
[P]rospective analysis resolves disputes efficiently by making it unnecessary to wait until actual damages from a breach are proved and eliminates uncertainty and tends to prevent costly future litigation.
The reasonableness of the forecast or estimate in a liquidated-damages provision is usually determined in view of the facts known at the time of contracting, and not at the time of the breach or delayed completion.
Id. at ¶¶ 35-36 (extensive citations, alteration marks by the court, and some internal quotation marks omitted, emphasis and extra paragraphing added).
Alternative computations of liquidated damages
For language setting forth liquidated damages calculated per day of delay, see Federal Acquisition Regulations § 52.211.11.
Liquidated damages based on revenue, not profit, might be enforceable. See the Eighth Circuit's discussion in RSA 1 L.P. v. Paramount Software Assoc., Inc., No. 14-2947 (8th Cir July 17, 2015) (affirming summary judgment awarding liquidated damages; applying Texas law).
22.13.2 Liquidated Damages Payment Obligation
Clause text
(a) IF: A Breaching Party commits a Triggering Breach of the Agreement; THEN: The Breaching Party will pay the other party, as liquidated damages, the Liquidated-Damages Amount.
(b) Each party acknowledges and agrees that the actual damages, in the event of a Triggering Breach, would be difficult or impossible to estimate, and that the Liquidated-Damages Amount is a reasonable forecast of the other party's actual damages, for the reasons stated in the Liquidated-Damages Rationale.
Comment
Some liquidated-damages provisions say that the breaching party will pay, as liquidated damages and not as a penalty, a stated (or computable) amount. This provision doesn't do that, because many courts tend to ignore such self-serving exculpatory language. See, e.g., Purcell v. Schweitzer, 224 Cal. App. 4th 969, 974 169 Cal. Rptr. 3d 90 (2014), where the court disregarded such language and set aside the liquidated-damages provision as an unenforceable penalty; the appeals court affirmed.
And as the Supreme Court of Ohio explained (quoting an appellate-court decision):
[A penalty is] a sum inserted in a contract, not as the measure of compensation for its breach, but rather as a punishment for default, or by way of security for actual damages which may be sustained by reason of nonperformance, and it involves the idea of punishment.
A penalty is an agreement to pay a stipulated sum on breach of contract, irrespective of the damage sustained. Its essence is a payment of money stipulated as in terrorem of the offending party,
while the essence of liquidated damages is a genuine covenanted pre-estimate of damages. The amount is fixed and is not subject to change;
however, if the stipulated sum is deemed to be a penalty, it is not enforceable and the nondefaulting party is left to the recovery of such actual damages as he can prove.
Boone Coleman Constr., Inc. v. Village of Piketon, 2016 Ohio 628, ¶ 17 (citations omitted, emphasis edited, extra paragraphing added).
22.13.3 Exclusive Measure of Damages
Clause text
The Breaching Party's obligation to pay the Liquidated-Damages Amount is the other party's EXCLUSIVE MEASURE OF DAMAGES for the Triggering Breach.
Comment
A similar provision was included in the contract in suit in Indiana v. IBM Corp., No. 49A02-1211-PL-875, slip op. at 33 (Ind. Feb. 13, 2014), affirmed, Indiana v. IBM Corp., No. 49S02-1408-PL-00513 (Ind. Mar. 22, 2016).
22.13.4 Liquidated Damages as EXCLUSIVE REMEDY
Clause text
The Breaching Party's obligation to pay the Liquidated-Damages Amount is the other party's EXCLUSIVE REMEDY for the Triggering Breach.
22.13.5 No Effect on Termination Rights
Clause text
A Breaching Party's payment of liquidated damages does not limit any right another party might have to terminate for material breach of the Agreement.
Comment
See Indiana v. IBM Corp., No. 49A02-1211-PL-875, slip op. at 33 (Ind. Feb. 13, 2014), affirmed, Indiana v. IBM Corp., No. 49S02-1408-PL-00513 (Ind. Mar. 22, 2016). In that case:
- the trial court held that IBM's payment of liquidated damages weighed against the state's assertion of a right to terminate of the contract in suit for material breach;
- but the appeals court reversed. (One appellate judge dissented in pertinent part; see the supreme-court opinion at 88-89 (Friedlander, J.).)
Additional notes: Liquidated damages
- Legal underpinnings
- Creating an option to seek liquidated damages could invalidate the liquidated-damages provision
- A fee for valuable rights might not be an unenforceable penalty
- The Restatement analysis sets up a sliding scale of proof about penalties
- Will the claimant be required to show that it was in fact harmed?
- A California statute creates a presumption of validity for liquidated-damages provisions
- Liquidated damages under UK law
Legal underpinnings
The Supreme Court of Ohio provided a useful explanation of the theoretical underpinnings of liquidated-damages clauses:
Simply stated, liquidated damages are damages that the parties to a contract agree upon, or stipulate to, as the actual damages that will result from a future breach of the contract.
{¶ 12} The effect of a clause for stipulated damages in a contract is to substitute the amount agreed upon as liquidated damages for the actual damages resulting from breach of the contract, and thereby prevents [sic] a controversy between the parties as to the amount of damages.
If a provision is construed to be one for liquidated damages, the sum stipulated forms, in general, the measure of damages in case of a breach, and the recovery must be for that amount. No larger or smaller sum can be awarded even though the actual loss may be greater or less.
Put another way, a liquidated damages clause in a contract is an advance settlement of the anticipated actual damages arising from a future breach.
{¶ 13} The common law viewed liquidated-damages provisions with a gimlet eye, but that historical antipathy dissipated as parties to contracts, attorneys, and the courts recognized that such provisions serve valuable purposes.
{¶ 14} Today the law does not look with disfavor upon liquidated damages provisions in contracts. When they are fair and reasonable attempts to fix just compensation for anticipated loss caused by breach of contract, they are enforced.
The modern rule is to look with candor, if not with favor upon liquidated-damages provisions in contracts when those provisions were deliberately entered into between parties who have equality of opportunity for understanding and insisting upon their rights. Relevant to this inquiry is the sophistication of the parties and whether both sides were represented by able counsel who negotiated the contract at arms length without the ability to overreach the other side.
{¶ 15} Part of the appeal of liquidated-damages provisions is that they allow the contracting parties to protect themselves against the difficulty, uncertainty, and expenses that necessarily follow judicial proceedings when trying to ascertain damages. This benefit is particularly valuable when "actual damages are likely to be difficult to quantify in the event that the contract is breached. Liquidated-damages provisions thereby promote prompt performance of contracts" and adjust in advance, and amicably, matters the settlement of which through courts would often involve difficulty, uncertainty, delay and expense.
Boone Coleman Constr., Inc. v. Village of Piketon, 2016 Ohio 628 (holding that appeals court had improperly used hindsight analysis to invalidate a per diem liquidated-damages provision in public-works contract) (paragraph numbering in original; emphasis and extra paragraphing added; extensive citations, internal quotation marks, and alteration marks omitted).
Creating an option to seek liquidated damages could invalidate the liquidated-damages provision
Giving a party an option either to accept liquidated damages or instead to sue for actual damages could invalidate the liquidated-damages clause. See, e.g., Sagatov Builders LLC v. Hunt, No. CL-2014-5735 (Va. 19th Judicial Circuit July 9, 2014) (sustaining demurrer). In that case:
- A real-estate sales contract gave the seller the right to elect either to retain a deposit as liquidated damages, or instead to apply the deposit towards actual damages.
- Reviewing case law, the trial court ruled:
- that such a provision was penal in nature; and
- that the either-or option defeated the purpose of a liquidated-damages clause because it left the amount of damages still open.
The court ruled that the liquidated-damages clause was therefore unenforceable, but it allowed the plaintiff to amend its complaint to seek actual damages. See id., slip op. at 4.
A fee for valuable rights might not be an unenforceable penalty
[TALK ABOUT INDIANA v. IBM, slip op. at 56]
Indiana v. IBM Corp., No. 49A02-1211-PL-875, slip op. at 33 (Ind. App. Feb. 13, 2014).
The Restatement analysis sets up a sliding scale of proof about penalties
In declining to reverse a finding that a contractual termination fee was an unenforceable penalty, the Fifth Circuit quoted the liquidated-damages analysis of the Restatement of Contracts (Second):
The greater the difficulty either of proving that loss has occurred or of establishing its amount with the requisite certainty (see § 351), the easier it is to show that the amount fixed is reasonable. …
If the difficulty of proof of loss is great, considerable latitude is allowed in the approximation of anticipated or actual harm.
If, on the other hand, the difficulty of proof of loss is slight, less latitude is allowed in that approximation.
If, to take an extreme case, it is clear that no loss at all has occurred, a provision fixing a substantial sum as damages is unenforceable
Comar Marine Corp. v. Raider Marine Logistics, LLC, 792 F.3d 564, 572 (5th Cir. 2015) (footnote 21 omitted, extra paragraphing added), quoting Restatement of Contracts (Second) § 356, comment b.
Will the claimant be required to show that it was in fact harmed?
In a contract for timely delivery of goods or services, the customer's contract negotiator will sometimes ask for a clause requiring the provider to pay liquidated damages for late delivery on a per-day or per-week basis. But what if the late delivery isn't shown to have actually harmed the customer?
That situation arose in Wahlcometroflex Inc. v. Westar Energy, Inc., 73 F.3d 223 (10th Cir. 2014) (affirming district court grant of partial summary judgment). In that case:
- The customer, an electric company, hired a supplier to design and manufacture certain equipment that the electric company would use as part of an upgrade one of its power plants.
- The contract in suit required the supplier to pay liquidated damages for each day that delivery of the equipment was late.
- The deliveries ended up being months late; the electric company withheld the liquidated-damages amounts from its payment to the supplier, which then sued the electric company for the difference.
- In court, the supplier claimed (unsuccessfully) that the liquidated-damages provision required the electric company to show, not only that the supplier had breached, but also that the electric company's upgrade had been delayed as a result.
Both the district court and the appellate court ruled otherwise, namely that the electric company was entitled to recover the liquidated damages merely by showing the fact of late delivery, without having to show that the late delivery caused delay in the electric company's overall upgrade project.
A supplier might try to avoid that result by requiring the customer to show that it suffered harm from the triggering breach, so that the liquidated-damages clause established only the amount, not the fact, of the damage. But the Wahlcometroflex court pointed out the disadvantages of such an approach:
[A]dopting [the supplier's] argument would significantly undercut the effectiveness of liquidated damages provisions. Liquidated damages provisions allow parties to protect themselves against the difficulty, uncertainty, and expense involved with determining damages in court.
Requiring courts to look beyond the language of a contract to discern whether the "anticipated impact event for which the liquidated damages were designed to compensate" had transpired would defeat the purpose of using such provisions.
Id. at 228 (citation and internal quotation marks omitted).
A California statute creates a presumption of validity for liquidated-damages provisions
In California, by statute, “a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” Cal. Civ. Code § 1671(b); see, e.g., El Centro Mall, LLC v. Payless Shoesource, Inc., 174 Cal. App. 4th 58, 94 Cal. Rptr. 3d 43 (2009) (affirming trial court’s award of liquidated damages). The appeals court noted that the plaintiff had put on expert testimony explaining what the liquidated damages were intended to compensate for, and how they represented a reasonable estimate of actual damages. See id., 174 Cal. App. 4th at 64-65.
Liquidated damages under UK law
An article by a British lawyer notes:
The current test is to ascertain whether the liquidated damages clause is a 'secondary obligation' which imposes a detriment on Party B (the 'contract breaker') out of all proportion to any legitimate interest of Party A (the 'innocent party') in the enforcement of the 'primary obligation'. Clearly a technical (far from 'user friendly') test, for contracting parties to understand and apply.
Suriya Edwards, Liquidated Damages And The Recent Change In Law (2016) (Mondaq.com)
22.14 Mini-Trial to Senior Management
Clause text
IF: An Agreement-Related Dispute appears clearly likely to lead to litigation or arbitration; THEN:
(1) Either party may submit the dispute to a non-binding mini-trial in accordance with the Mini-Trial Rules (namely, the then-current mini-trial procedures of the American Arbitration Association); and
(2) In the event of such a submission, each party will provide a senior management representative to participate personally in the mini-trial proceedings as called for by the Mini-Trial Rules.
Overview of mini-trial procedure
As summarized in the AAA's mini-trial procedures [at http://goo.gl/RhRL6Y (adr.org), accessed Jan. 2, 2015], a mini-trial typically consists of an abbreviated "closing argument" presentation, by each party's counsel, to a panel consisting of:
- A senior-management representative of each party; and
- A neutral presiding officer.
After the presentations, the senior-management representatives confer privately, together with the neutral presiding officer, to see if they can work out a resolution to the dispute.
Motivation for mini-trial
In mid-size and large organizations, senior-management representatives will typically have:
- greater authority in their organizations than do more-junior personnel, as well as
- more experience and a broader perspective on their businesses. (Sometimes, junior personnel have more in-depth knowledge of the relevant aspects of the business, so their presence might be needed as well.)
For those reasons, it's not unusual for senior-management representatives to able to reach an agreed settlement of a dispute, where more-junior personnel might not be able to do so.
Two Australian lawyers point out that "[b]ringing in senior management will focus the minds of the parties on the bottom line, and allows senior decision makers who are not caught up in the underlying dispute to approach the situation taking commercial reality into account." Faith Laube and Toby Blyth, Expert determination clauses in contracts – are they worth it? (MyBusiness.com.au 2015))
The head of litigation for a global Fortune 500 company, speaking at a continuing-legal-education (CLE) seminar, said that in his view, mini-trials were the most-effective approach to resolving disputes between companies.
22.15 Mitigation of Damages
Clause text
(a) Each party (each, an Obligated Party) must make reasonable efforts to mitigate its damages resulting from a breach of the Agreement by another party.
(b) For the avoidance of doubt, on the issue of mitigation of damages, the breaching party bears both the burden of coming forward with evidence and the ultimate burden of persuading the finder of fact.
Comment
This clause might be useful in legal systems where the duty to mitigate damages is not clear (or non-existent).
In U.S. jurisdictions, a non-breaching party's duty to mitigate its damages might well arise automatically. See generally Jason T. Strickland, Leaving the Apples to Rot: the Duty of a Wronged Party to Mitigate its Damages and its Potential Waiver in Commercial Contracts (2013).
The Restatement (Second) of Contracts § 350 states in part that "damages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation …. [but] [t]he injured party is not precluded from recovery … to the extent that he has made reasonable but unsuccessful efforts to avoid loss."
And as the Third Circuit explained, "the burden of proving that losses could have been avoided by reasonable effort and expense must always be borne by the party who has broken the contract." VICI Racing, LLC v. T-Mobile USA, Inc., 763 F.3d 273, 298, (3d Cir. 2014) (applying Delaware law; affirming damage award in part and vacating it in part), citing 11 Corbin on Contracts, § 57.11 (1993) (emphasis added, internal quotation marks and alteration marks omitted).
For an interesting teaching case about mitigation of damages — one that really never should have been litigated to that point, if you ask me — see Fischer v. Heymann, 12 N.E.3d 867 (Ind. 2014); the facts and legal reasoning of the opinion are complicated, so I won't try to summarize them here.
22.16 Mitigation of Damages WAIVER
Clause text
Each party (each, a Waiving Party) KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any obligation on the part of another party to mitigate the waiving party's damages resulting from a breach of the Agreement by the waiving party.
Comment
See the notes to CD-22.15. Mitigation of Damages.
22.17 Progressive Dispute Resolution
Clause text
(a) Mandatory dispute-resolution steps before claim assertion: Except as otherwise provided in this, in any Agreement-Related Dispute, no party ("Claimant") may assert a claim against another party ("Respondent") in a lawsuit or arbitration ("Claim") unless the Claim has first been addressed in the dispute-resolution proceedings referred to in this.
(b) Escalation of dispute: The Claim must be escalated at least two levels in accordance with CD-22.5. Dispute Escalation.
(c) Either early neutral evaluation or mediation: If the dispute is not resolved through escalation, then the Claim must be submitted to either of the following, with the choice being that of the Claimant in consultation with the Respondent:
(1) evaluation by a neutral in accordance with CD-22.6. Early Neutral Evaluation, or
(2) mediation administered by the Mediation Administrator (namely, the American Arbitration Association) or such other administrator as the parties may agree.
(d) Mini-trial to senior management: In a trial or other proceeding, the Claimant may not assert the Claim (and agrees not to do so) unless the Claim has been made the subject of a mini-trial in accordance with CD-22.14. Mini-Trial to Senior Management.
(e) Exception for irreparable harm or statute of limitations:
(1) A Claimant may assert a Claim in a lawsuit or arbitration without complying with subdivisions (a) through (d) if such assertion is necessary: (A) to seek equitable relief to prevent irreparable harm; or (B) to meet a deadline under a statute of limitation, a statute of repose, or an agreed limitation period.
(2) A Claimant asserting a Claim in a lawsuit or arbitration under subdivision (1) must immediately: (A) move for a stay of the lawsuit or arbitration to permit the dispute-resolution steps described in this; and (B) in the motion, represent to the tribunal that the motion is a joint motion with the Respondent pursuant to the Agreement.
(f) Waiver of inconsistent relief: Each party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES all relief inconsistent with this until this has been complied with.
(g) Liability for attorney fees: A Claimant that fails to comply with the requirements of this must reimburse the Respondent for all Dispute Expenses associated with seeking a stay of some or all proceedings pending such compliance.
Comments
Subdivision (a): Rare is the relationship unaffected by occasional disputes; it's never a bad idea for drafters to plan ahead for that possibility. This section 22.17 sets out a fairly-standard approach to requiring dispute-resolution efforts before litigation.
Subdivision (b): The number of desired levels of escalation might vary with the situation.
Subdivision (c): Some dispute-resolution clauses require mediation; this one includes early neutral evaluation as an option as well.
Subdivision (d): Mini-trials are regarded by some as the most-effective single approach to resolving disputes, as discussed in the commentary to CD-22.14. Mini-Trial to Senior Management.
Subdivision (e)(1): Only rarely will a party to a contract dispute seek a preliminary injunction or other temporary relief. (In part, this is because it's expensive and challenging to get a court to grant such relief.). Still, the possibility is a checklist issue for contract drafters, so this clause allows for it.
Subdivision (f) attempts to block attempts by creative trial counsel to wiggle out of the requirements of this provision.
Subdivision (g) is intended to give Claimants an additional financial incentive to comply with this Clause.
22.18 Release
Clause text
(a) Applicability: This Release governs whenever one or more parties (each a Releasing Party) releases one or more other parties (each, as well as each of its Associated Persons, defined below [if any], a Discharged Party) from one or more specified Claims, as defined below (each specified Claim, a Released Claim), in a signed and delivered written release document (the Release Document), EXCEPT to the extent, if any, that the Release Document itself expressly states otherwise.
(b) Effect of release: In entering into the Release Document, the Releasing Party (or ‑Parties) and the Discharged Party (or ‑Parties) are completely and fully settling each Released Claim; by signing and delivering the Release Document, the Releasing Party — on behalf of itself and each of its Associated Persons, as defined below, if any — KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY and forever:
(1) RELEASES AND DISCHARGES each Discharged Party from all Released Claims, of any nature whatsoever, no matter how characterized, known and unknown, whether or not apparent, as well as any yet to be discovered, suspected or unsuspected; and
(2) WAIVES all monetary, equitable, and other relief, of any nature whatsoever, in respect of each Released Claim.
(c) Claim definition: For purposes of this Release, the term Claim, in respect of a particular matter, refers to any and all accusations, actions, allegations, causes of action, charges, claims, complaints, controversies, demands, grievances, and suits (each, an Action) that (i) have been made or could be made in or before any court, administrative agency, arbitration body, or other forum anywhere, of any kind or nature (each, a Forum); and (ii) allegedly arise from, or that otherwise relate in any way, to that particular matter.
(1) The term Claim encompasses — by way of example but not of limitation — all allegations of one or more of the following: bad faith; breach of contract; breach of warranty; debt; embarrassment; emotional distress; fraud; humiliation; indemnity; loss or deprivation of anything of any kind, tangible or intangible; mental anguish; misrepresentation; pain and suffering; strict liability; tort; and violation of any federal, state, or local statute, rule, regulation, or ordinance.
(2) The term Claim likewise encompasses — again by way of example but not of limitation — all demands for one or more of the following (incurred or to be incurred in the case of monetary relief): arbitration costs; attorney fees; compensatory damages; court costs; defense costs; enhanced damages; expenses related to any item listed in this subdivision; fees; indemnity; injunctive relief of any kind; liquidated damages; medical costs; penalties; punitive damages; reimbursement; reliance damages; restitution; special damages; specific performance; treble damages and other increased- or multiple damages; and lost, back, and front wages.
(d) Associated Persons: For purposes of this Release, the term Associated Persons, in respect of a Person, refer to:
(1) the Person's predecessors (including without limitation predecessors in interest);
(2) the Person's heirs, administrators, executors, successors (including without limitation successors in interest), and assigns;
(3) the past, present, and future affiliates of each Person listed in subdivisions (1) and (2);
(4) the suppliers, customers, licensors, licensees, and insurers, if any, of each Person listed in subdivisions (1) through (3)
(5) the past, present, and future officers, directors, shareholders, interest holders, members, partners (general, limited, and other), attorneys, accountants, agents, employees, managers, representatives, family members, heirs, assigns, executors, administrators, and insurers of each Person listed in subdivisions (1) through (4); and
(6) each Person acting or claiming by, through, under, or in concert with any Person listed in subdivisions (1) through (5).
(e) Releasing Party's warranties: Each Releasing Party represents and warrants to each Discharged Party:
(1) that the Releasing Party has both the power and the authority to execute and deliver the Release Document for the purpose stated in that document and in this Release;
(2) that no Released Claim has been assigned or transferred; and
(3) that the Releasing Party has identified, to the Discharged Party to which the signed Release Document is being delivered, all actions, suits, and other proceedings, in any Forum, in which any Released Claim has been asserted.
(f) Releasing Party's agreement not to sue, etc.: The Releasing Party specifically agrees:
(1) never to initiate any Action, in any Forum, on or concerning any of the Released Claims; and
(2) promptly to withdraw or move for dismissal with prejudice of any such Action that is now pending.
(g) Option: General release: IF: The Release Document expressly and conspiciously states that the release set forth there is a general release (whether or not the term is capitalized) as to any Discharged Party; THEN:
(1) The Release has the effect described in subdivision (b) for any and all Claims that the Releasing Party could have alleged against that Discharged Party — whether known or unknown; suspected or unsuspected; apparent, hidden or concealed — in any Action in any Forum, at any time in the past up until the Releasing Party's execution and delivery of the Release Document, including but not limited to Claims arising from:
(A) any past- or then-pending litigation or other dispute between the Releasing Party and that Discharged Party; and
(B) any other dealings between the Releasing Party and that Discharged Party, of whatever nature, whether voluntary or otherwise; and
(2) The Releasing Party — having had the opportunity to consult legal counsel of the Releasing Party's choice and to ask questions of one or more of the Discharged Parties — KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES the benefits of Section 1542 of the California Civil Code, which states: "A general release does not extend to claims which the creditor does not know or suspect to exist in his or her favor at the time of executing the release, which if known by him or her must have materially affected his or her settlement with the debtor."
(h) Confidentiality: Unless expressly agreed otherwise in writing, each party specifically agrees to keep in strict confidence all non-public facts and circumstances concerning the Released Claims and the Release Document, other than the fact that the Released Claim(s) were settled by agreement.
(i) No admission: Nothing in the Release Document is intended to constitute an admission of liability by any Discharged Party; the Releasing Party specifically agrees not to assert to the contrary.
(j) Opportunity to consult counsel: Each Releasing Party acknowleges that it has had the opportunity to consult with legal counsel of that Releasing Party’s choice concerning the Released Claims and the Release Document.
(k) Attorney fees: In any Action arising out of or relating to the Release Document, the prevailing party will be entitled to recover its Dispute Expenses.
(l) Savings: If any portion of the Release Document is held to be unenforceable, the remainder shall be enforced to provide Releasees the broadest release possible.
Language sources
This language is distilled from a variety of sources, including:
- The Baker Hughes case discussed below;
- Kenneth G. Hausman and Ellen Kaye Fleishhacker, Limiting Your Liability: How To Protect Yourself With a Well-Written General Release (ArnoldPorter.com 2008);
- Epic Communications, Inc. v. Richwave Technology, Inc., 237 Cal. App. 4th 1342, 1348 n.6, 188 Cal. Rptr. 3d 844 (2015) (reversing summary judgment and holding that defendants had not been rendered inmmune from liability by release executed in settlement of another dispute to which defendants were strangers);
- the proposed release in Billington v. Benton NWA Properties, LLC, 2015 Ark. 291, slip op. at 3 (reversing order enforcing alleged settlement agreement; district court erred in concluding that parties had agreed on the scope of the release language);
- Jeremy A. Mercer and Evan A. Bloch, Settlement Agreement and Release: A U.S. Example (PepperLaw 2011).
The California rights waiver might be open to challenge
Subdivision (g)(2) waives the releasing party's rights under a California statute, but such a waiver might be subject to challenge. See generally Kurt Melchior, Catching a Waiver (Nossaman.com 2009).
CAUTION: A sweeping release might wipe out other, unrelated contract rights
A Sixth Circuit case illustrates the sweeping effect that might be given to a broad general-type release:
- Bruce Stevens worked for Baker Petrolite Corporation and its predecessor for approximately seven years. When his employment ended, Stevens signed a contract in which he promised to maintain the confidentiality of Baker Petrolite’s trade secrets.
- Baker Petrolite and its parent company, Baker Hughes Incorporated (collectively, Baker), sued Stevens 18 years after the contract was signed, alleging a breach of their confidentiality agreement.
- Stevens’s defense, and the outcome of this case, hinges on the validity of a broadly worded settlement agreement that was purportedly reached in the interim as a result of an unrelated lawsuit between the parties [about unpaid compensation].
- Relying on this settlement agreement, the district court entered judgment in favor of Stevens. For the reasons set forth below, we AFFIRM the judgment of the district court.
Baker Hughes Inc. v. S&S Chemical, LLC, No. 15-2413, slip op. at 2 (6th Cir. Sept. 2, 2016) (extra paragraphing and bullets added). The release language quoted by the court was the following:
Except for the obligations set forth in this Agreement, Baker hereby fully and forever remises, releases and discharges Stevens and his attorneys, agents, heirs, executors, administrators, predecessors, successors and assigns (collectively referred to as the “Stevens Release Parties”),
of and from any and all claims, demands, agreements, contracts, covenants, suits, actions, causes of action, obligations, controversies, debts, costs, expenses, damages, judgments, losses and liabilities,
of whatever kind or nature, in law, equity or otherwise,
whether known or unknown, concealed or hidden,
against any of the Stevens Released Parties which Baker has had, may have had or now has, to and including the date of this Agreement.
It is the intention of the parties to this Agreement that the foregoing general releases shall be effective as a bar to all actions, causes of action, suits, claims or demands of every kind, nature or character whatsoever, known or unknown, suspected or unsuspected, fixed or contingent, referred to above. …
Id., slip op. at 3 (paragraphing edited, emphasis added, ellipsis marks by the court).
22.19 Service of Process
Clause text
In connection with any Agreement-Related Dispute, each party irrevocably:
(1) authorizes the other party to cause process to be served on the authorizing party by sending the process via established courier (for example, DHL, Federal Express, UPS, and the like) with proof of delivery; and
(2) KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES any objection to the sufficiency of any such method of service where the process is actually received by the party being served.
Comment
Clauses like this are not uncommon in contracts between businesses; they make service of process more convenient and less expensive.
22.20 Settlement Rejection Consequences
Clause text
(a) Applicability: This section 22.20 applies, in the interest of promoting the settlement of disputes, in any dispute arising out of or relating to the Agreement or any transaction or relationship resulting from the Agreement.
(b) Definition: Covered Settlement Offer refers to a written offer that:
(1) expressly states that it (the offer) is subject to this Clause; and
(2) makes a proposal to settle a dispute.
(c) Expense-shifting: IF: The Rejecting Party finally fails to obtain a result in the dispute at least 20% more favorable than the Covered Settlement Offer; THEN: The Rejecting Party must pay or reimburse the offeror's Dispute Expenses that the offeror incurred in the dispute after making the Covered Settlement Offer.
(d) Procedure: Matters of timing and other procedural issues concerning the offer are to be governed in the general manner provided for an offer of judgment under Rule 68 of the [U.S.] Federal Rules of Civil Procedure (with any necessary change being made) to the extent the parties do not agree otherwise in writing.
(e) Confidentiality: Absent consent of the other party, each party shall preserve in strict confidence:
(1) the existence and details of any Covered Settlement Offer made by the other party;
(2) any communications between the parties regarding any Covered Settlement Offer.
Language origins
This Common Draft provision is modeled roughly on the offer-of-judgment provisions in Rule 68 of the Federal Rules of Civil Procedure. Unfortunately, Rule 68 is largely toothless, because it only shifts subsequently-incurred court costs, which usually don't amount to a lot of money in the scheme of things; moreover, Rule 68 doesn't shift the burden of attorney fees, which can be huge. As a result, most litigators don't regard Rule 68 as providing much of an incentive to settle. See Lewis E. Hassett, "Pretty Soon You're Talking Real Money" — Federal Court Shifts Cost of E-Discovery (MMMLaw.com 2010).
A somewhat-better approach is New Jersey Court Rule 4:58, which shifts not just court costs but also attorney fees. (The New Jersey rule, however, applies only when exclusively-monetary relief is sought; the provision above doesn't contain such a restriction.)
Some empirical research by two law professors, of Northwestern University and (now) the University of Pennsylvania respectively, suggests that the New Jersey rule seems to encourage early settlement and to reduce attorneys' fee expenses, without affecting the size of the damage award for cases that do go to trial. See Albert Yoon and Tom Baker, Offer-of-Judgment Rules and Civil Litigation: An Empirical Study of Automobile Insurance Litigation in the East, 59 Vanderbilt L. Rev. 155 (2006).
Georgia and Florida have fee-shifting statutes similar to New Jersey's — see Ga. Code Ann. § 9-11-68 and Fla. Stat. § 768.79. Texas likewise has a similar expense-shifting statute; see Tex. Civ. Prac. & Rem. Code ch. 42. In 2011, the Texas Legislature tightened the limits on the amount of fees and expenses that could be recovered, which is now capped at the amount of the jury verdict, as explained in this article.
A related concept is implemented in Arizona Rev. Stat. 12-133: In any civil case where the amount in controversy is less than $65,000, the court is normally required to send the case to arbitration. The party that 'loses' the arbitration can still demand a trial de novo in court. If the result of the trial de novo, however, is not at least 23\% [sic] better than the arbitration award, then the party demanding the trial must pay (i) the arbitrators' fee, and (ii) the other side's costs and attorney fees and expenses for the trial de novo. See also Final Report of the Committee on Compulsory Arbitration in the Superior Court in Arizona (June 2006).
Language choices
Subdivision (b)(1): The "expressly states" requirement is intended to prevent a party from being ambushed by another party's claim that (for example) a vague settlement proposal from the other party constituted a Covered Settlement Offer.
Subdivision (d): The general procedures of Rule 68 are adopted here because they cover the required ground reasonably well and are familiar to (U.S.) counsel.
Subdivision (e): Confidentiality of settlement offers would normally be required by standard American rules such as Rule 408 of the Federal Rules of Evidence; this subdivision makes that requirement explicit.
22.21 Softball Arbitration (rough notes only)
This is an embryonic idea — it combines several of the concepts set forth above.
- The dispute is submitted to ENE per CD-22.6. Early Neutral Evaluation, possibly in combination with CD-22.14. Mini-Trial to Senior Management.
- Each party submits a proposed settlement.
- The neutral evaluator chooses one proposed settlement per CD-22.2.11. Baseball Arbitration Procedure.
- The proposed settlement goes into effect unless, within 10 business days, either party serves notice demanding full-blown arbitration, in which case:
- CD-22.20. Settlement Rejection Consequences applies; and
- The losing party in the arbitration can challenge the arbitration award in court per CD-22.2.27. Partial Court Retrial.
22.22 Third-Party Immunity
Clause text
(a) Unless expressly stated otherwise in the Agreement, each party agrees not to assert any Contract-Related Claim (defined below) against any individual or organization, other than an individual or organization expressly identified in the preamble of the Agreement as entering into the Agreement (Contracting Party).
(b) As used in this clause, the term Contract-Related Claim refers to any claim, obligation, liability, or cause of action (each, a Claim) arising out of or relating to any of the following:
(1) the Agreement;
(2) the negotiation, execution, performance, or breach of the Agreement;
(3) any representation or warranty made in, in connection with, or as an inducement to, the Agreement; and
(4) any transaction or relationship resulting from the Agreement.
(c) For the avoidance of doubt, the term Contract-Related Claim encompasses all Claims whether, for example,
(1) in contract or in tort,
(2) in law or in equity, or
(3) granted by a constitution, statute, regulation, order precedent, or other governmentally-enforceable policy.
(d) For the avoidance of doubt, the parties intend for the covenant in subdivision (a) to benefit, for example, the following NonParty Affiliates:
(1) each Affiliate of each Contracting Party; and
(2) each director; officer; employee, incorporator; member; partner; manager; stockholder; agent; attorney; or representative of; and any financial advisor or lender to each Contracting Party and each such affiliate, in each case whether past, present, or future.
(e) To the maximum extent not prohibited by law, each Contracting Party, for itself and any individual organization claiming through or under that Contracting Party, KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY WAIVES AND RELEASES all such Contract-Related Claims against each NonParty Affiliate.
(f) For the avoidance of doubt, the waiver and release of subdivision (e) applies, for example, to all Claims of entitlement to avoid or disregard the entity form of a Contracting Party or otherwise impose liability of a Contracting Party on a Nonparty Affiliate.
(g) The Claims of entitlement referred to in subdivision (f) include, for example, those based on theories of equity; agency; control; instrumentality; alter ego; domination; sham; single business enterprise; piercing the veil; unfairness; undercapitalization; or otherwise.
(h) Each Contracting Party KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY DISCLAIMS, AND AGREES NOT TO ASSERT, ANY RELIANCE UPON, any action or omission (including for example any statement or silence) by any Nonparty Affiliate with respect to:
(1) the performance of the Agreement; or
(2) any representation or warranty made in, in connection with, or as an inducement to the Agreement.
Business context
When embarking on a contract that could result in claims for big dollars being thrown around, a provider might want to think about including some protection for its employees.
Antecedent
This clause is adapted from language proposed by a noted corporate-law practitioner. See Glenn D. West & Natalie A. Smeltzer, Protecting the Integrity of the Entity-Specifc Contract: the "No Recourse Against Others" Clause-Missing or Ineffective Boilerplate?, 67 BUS. LAW. 39, 71-72 (2011).
In an email exchange with me on August 8, 2012, Mr. West commented that "I find general acceptance of some version of my clause as long as it's mutual. Both sides of the transaction have the same general interest in protecting the integrity of the entity-specific nature of the contract; and if they don't, this clause smokes that out and there is a real discussion about guarantors."
This clause is akin to the so-called Himalaya clause, which has its origins in maritime practice.
Example: Oracle employees sued for hundreds of millions
In August 2014, the state of Oregon filed a $3 billion lawsuit against Oracle Corporation and six Oracle employees personally, in the wake of the failed attempt to develop Oregon's health-insurance exchange under the Affordable Care Act a.k.a. Obamacare. The six employees included five executivies at the vice-president level and higher, as well as a technical manager who was accused of having conducted a fraudulent demo of the new system's capabilities. The state is seeking “only” some $45 million from the technical manager, as well as amounts ranging from $87 million to $267 million from various Oracle executives.
In high-dollar and high-profile cases like this, plaintiffs sometimes bring claims against company employees personally. My guess is that the reason often is to to try to rattle the employees and encourage them to cooperate as witnesses against their employers (sort of like the way criminal prosecutors bring charges against low-level employees).
Against that possibility, it's not unheard-of for vendor companies to include, in their contract forms, language protecting employees from being sued in their personal capacities. This clause
I don't know whether the Oregon-Oracle contracts included such language. I wasn't able readily to find the contracts in question, which according to news reports was Oracle's standard license- and services agreement form, used as an umbrella agreement in conjunction with ordering through Dell. Oracle doesn't appear to have posted that standard form (among others) on the Web. The closest thing I could find was a counterpart, apparently dating back to 2004, that seems to have been intended for use in Europe, the Middle East, and Africa (EMEA). I don't recall seeing such language in any actual Oracle contracts.
High-profile lawsuits like this typically settle before trial. Not least, this is because the elected officials who bring or authorize the lawsuits would prefer to trumpet a “victory” instead of rolling the dice with the court.
But such cases don't always settle; see, for example, the state of Indiana's lawsuit against IBM for allegedly botching the building of a new system for administering the state's welfare programs. IBM ended up winning a multi-million dollar judgment in the trial court. See Indiana v. IBM Corp., No. 49Dl0-1005-PL-021451 (Marion Cty Ind. Sup. Ct. July 18, 2012), affirmed in part, reversed in part, No. 49A02-1211-PL-875 (Ind. App.. Feb. 13, 2014) (holding that IBM had materially breached contract but was entitled to be paid, subject to offset), affirmed, Indiana v. IBM Corp., No. 49S02-1408-PL-00513 (Ind. Mar. 22, 2016).
A court, especially a hometown court, might not give effect to such protection in cases of alleged fraud. But such protective language would be better than nothing.