lessons learned from contract drafting - association of corporate

LESSONS LEARNED FROM CONTRACT DRAFTING:

WHAT YOU MAY RISK LITIGATING

Michael A. Prokop

Penelope M. Taylor

William D. Wallach

September 21, 2012

BOSTON // HARTFORD // NEW YORK // NEWARK // STAMFORD // PHILADELPHIA // WILMINGTON

Topics

Common Terminology and Definitions

Useful Provisions to Consider Including

Avoid Fine Print

Print contract in a font size that

meets the applicable legal

requirements.

CPLR4544

Representations & Warranties

A lawyer drafting a business contract has multiple responsibilities, but two of

the most important are to protect his client against risks and to secure those

advantages that are reasonable and appropriate. Having a client receive

both "representations and warranties" will generally help you fulfill these

responsibilities.

Representations and warranties are important — but different — tools for

the contract drafter. But receiving both of them from the other side usually

— but not always — provides a client with the best protection.

Representations are statements of present or past fact. For example, "The

financial statements fairly present the financial condition of the seller."

Future "facts" cannot generally form the basis of representations because

no one can know the future. At best, someone can have an opinion.

If a representation is intentionally false, a plaintiff can make a common law

claim of deceit (a tort) and allege fraudulent misrepresentation. Even if not

intentionally false, a plaintiff can assert a claim for breach of contract.


Common law warranty is a promise that a fact is true.

The seminal case is CBS Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496 (1990). In

that case, Ziff-Davis "represented and warranted" the financial condition of the

division it was selling to CBS. CBS, however, as part of its due diligence, sent in its

own accountants to review the division's financial statements. They reported that the

financial condition was not as represented and warranted. The parties closed

anyway, and then CBS sued. In New York's highest court, the issue was whether

CBS had a cause of action for breach of warranty. Ziff-Davis argued that CBS did not

because it had known about the problems with the financial statements and had not

justifiably relied on the warranties. Stated differently, Ziff-Davis argued that the

standards for a cause of action for a fraudulent misrepresentation and a breach of

warranty both required justifiable reliance on the truthfulness of the statement. Ziff-

Davis lost. According to the New York court, a warranty is a promise of indemnity if a

statement of fact is false. A promisee does not have to believe that the statement is

true. Indeed, the warranty's purpose is to relieve a promisee from the obligation of

determining a fact's truthfulness.

Representations, Warranties &

Disclaimers

Since the CBS case was decided, the majority of states (including

New Jersey) have followed New York.

The meaning of warranty is critical to plaintiffs whose defendants

made both representations and warranties. A plaintiff's fraudulent

misrepresentation claim will fail if he knew the statement was false.

But, if a plaintiff's jurisdiction follows the CBS/Ziff-Davis rule, the

plaintiff may sue for breach of warranty on the same statement and

recover despite knowledge of the falsity of the statement, subject to

some limitations.

Other consequences flow from coupling representations and

warranties: A plaintiff may be able to win a breach of warranty claim

when it would have lost a claim for fraudulent misrepresentation

because it could not prove scienter.


Some parties, as a matter of principle, refuse to take fraud risk (read

punitive damages), and will not make representations, only warranties.

A more sophisticated version of this issue can arise in acquisitions.

Occasionally, a buyer will ask a seller to represent as a fact something that

the seller knows is not true or does not know whether it is true. Technically,

doing so is fraud. A buyer nonetheless defends its request by telling the

seller, "It's just risk allocation." In other words, even if the statement is not

true, it represents the business deal. A seller often accedes to this request

on the theory that it is not fraud because it has "worked it out" with the

buyer. This is cold comfort when the buyer sues for fraud, "forgetting" that it

was "just risk allocation" and "forgetting" that the seller explained the

situation's actual status. As an alternative, the seller can merely "warrant"

the statement. In that case, the seller makes no representation that can be

the basis of a fraudulent misrepresentation, and the warranty is the promise

of indemnity, precisely the risk allocation the buyer sought.


Remedies are a critical factor in assessing the relative

benefits of representations and warranties.

Generally, a party injured by a fraudulent

misrepresentation has a choice of remedies. He may

rescind the contract and obtain restitution, or he may

affirm the contract and sue for damages. The ability to

rescind — to unwind a closed transaction — is a remedy

not available to a party suing for a breach of warranty,

and therefore is a benefit of including representations in

a contract.

A second benefit is that the party may be able to obtain

punitive damages under certain circumstances.

Merger and Integration Clauses

Typically provide that written instrument

embodies whole agreement between the

parties

Purpose is to avoid evidence outside of the

four corners of the contract if a dispute arises

Increases chance parol evidence rule will

apply if there is a dispute

Merger and Integration Clause

Example:

This Agreement and the attached exhibits

contain the entire agreement of the parties

with respect to the subject matter of this

Agreement, and supersede all prior

negotiations, agreements, and

understandings. This Agreement may be

amended only by a written document,

signed by all parties.

Choice-of-Law Clause

Parties agree that law of particular jurisdiction will govern disputes arising

under the contract

Provision also may exclude application of conflict of law rules of jurisdiction

Presumptively enforceable as long as there is some relationship between

the transaction and the jurisdiction whose law would govern or another

reasonable basis for choosing the law

Choice-of-law does not = forum selection

Exceptions—Example UCC Article 9

Select a law

– with which you are familiar

– that offers a specific and tangible benefit

– that will be upheld

Choice of Law – Additional Benefits

A choice of law provision can be used to defeat

a forum non conveniens motion.

“[T]he court shall not stay or dismiss any action on

the ground of inconvenient forum, where the action

arises out of or relates to a contract . . . , and the

parties to the contract have agreed that the law of

this state shall govern their rights or duties in whole

or in part.” N.Y. C.P.L.R. 327(b).

Choice of Law: Drafting Considerations

Attend to procedural conflicts of law

“This Agreement shall be governed in all respects,

including validity, interpretation and effect, by the laws of

the State of New Jersey without giving effect to its

conflict of law principles.”

or

“This Agreement shall be governed by and construed

under the substantive laws of the State of New Jersey.”

Choice-of-Law Clause

Examples:

This agreement shall be interpreted under the laws of the State of New Jersey without

regard to principles of conflict of laws.

Forum Designation. Any suit brought by either party against the other party for claims

arising out of this Agreement shall be brought in the United States District Court for the

District of New Jersey, or in the event that court lacks jurisdiction to hear the claim, in the

New Jersey Superior Court, Law Division, Essex County.

Forum Selection Clause

Parties agree that litigation resulting from or relating to contract will be filed

in a particular jurisdiction

Will be enforced in New Jersey unless: they are the result of "fraud or

coercive bargaining power"; enforcement of the clause would "be seriously

inconvenient for the trial"; or enforcement would violate a "strong public

policy" of the state

Forum selection clauses are enforceable because the parties should be

allowed to agree in advance to a mutually satisfactory forum, thus insuring a

predictable and neutral locus for the resolution of any dispute.

Forum selection does not = choice-of-law

Cannot create federal jurisdiction by contract

Delaware's courts and law considered to be favorable to the needs and

interests of corporations

Forum Selection Clause

Example:

Any litigation under this agreement shall be

resolved in the trial courts of Los Angeles

County, State of California.

Contractual Limitations Periods

Agree to shorten otherwise applicable statutes of

limitation

Court generally enforce unless period is

unreasonable short or result from fraud, duress,

or misrepresentation

Some states prohibit limiting to less than a

certain number of years.

Contractual Limitations Periods

Examples:

The parties agree that any action relating to an alleged breach of this Agreement shall be

commenced within one year of the date of the breach, without regard to the date the

breach is discovered. Any action not brought within that one-year time period shall be

barred, without regard to any other limitations period set forth by law or statute.

Claims for loss, damage or delay in connection with the shipment of products shipped

must be instituted within one year of the date of shipment.

No Survival of Representations and Warranties. The Parties hereto agree that the

representations and warranties contained in this Agreement shall not survive the Closing

hereunder, and none of the Parties shall have any liability to each other after the Closing

for any breach thereof. The Parties hereto agree that the covenants contained in this

Agreement to be performed at or after the Closing shall survive the Closing hereunder,

and each Party hereto shall be liable to the other after the Closing for any breach thereof.

Liability Limitations

Consider possible liability limitations and exclusions

In New Jersey, liability limitations are enforceable so long as they do not

violate public policy

In the context of commercial contracts, parties in New Jersey can agree to

limit/cap or exclude damages (e.g., consequential damages)

References to indirect or consequential loss are a standard feature of

exclusion clauses. Indirect and consequential losses are often less obvious

losses than those arising directly and are harder to predict and quantify

when the contract is drawn up. A party wishing to keep his liability within

predictable confines should expressly exclude indirect or consequential

damages and should try to spell out within the exclusion clause examples of

the categories of loss that are intended to be excluded (e,g., loss of profit,

anticipated savings, etc.)

In the sale of goods, the limitations are set forth in the Uniform Commercial

Code

Indemnification Clauses

Purpose is to provide one party (such as a buyer) with a clear contractual

remedy for recovering post-closing monetary damages arising from: breach

of a covenant, breach of representation or warranty, claims by third parties,

or other claims provided in the agreement.

Provision must be clear as to scope of coverage (include duty to defend?)

Tend to be strictly and narrowly construed by courts

Be specific as to damages covered (attorneys’ fees?)

Some types of indemnification may be invalid (e.g., violations of securities

laws, etc.)

Punitive damages may not be covered

If duty to defend, then clearly identify when duty is triggered, who can

control the defense, by when notice is required, when and how settlement

may be made, etc.

Indemnification Drafting Considerations

Should the provision include a duty to defend? Who controls the defense

and selects counsel?

Should there be mutual indemnity?

Limit to third party claims?

If there is more than one indemnitor for a loss, how will liability be

apportioned? Joint and several? Pro rata?

Should the obligation be supported by insurance?

Does the indemnity apply to willful misrepresentations?

Will the indemnitor pay attorney’s fees? If so, for defense only or also those

incurred enforcing the indemnification provision?

Will the indemnitor pay consequential damages, punitive damages, litigation

costs and expenses, fines, penalties, accountant’s fees, court costs,

insurance deductibles, and investigation expenses?

What is the duration of the indemnity?

Is there any cap or limit on the obligation?


Example:

Subcontractor agrees to indemnify and hold

harmless the contractor against loss or

threatened loss or expense by reason of the

liability or potential liability of the contractor

for or arising out of any claims for damages.

How could this clause be improved? What

issues does it leave open?


Should there be more than one indemnitor (if so, joint and several liability)?

Who are the indemnitees? Do third parties have the right to enforce the

indemnification provisions?

What losses or expenses are covered by the indemnity? For example, is the

indemnitor required to pay the indemnitee’s attorneys’ fees incurred in enforcing the

indemnification provision?

What is the duration of the indemnity?

Is there a ceiling or a hurdle on the indemnitor’s liability?

Does the indemnity limit or even eliminate the right to pursue common law remedies?

Are recoverable “damages, liability and claims” intended to include any loss or

damage, even if beyond common law contract or tort measures of damages? Only

“direct” damages? Are “consequential” damages intended to be recoverable?

What are the procedural mechanisms by which the indemnitee is to enforce the

indemnity?

If there is a high likelihood of a particular type of claim, the process and issues raised

by that claim should be resolved in the indemnity provision.

Procedural Mechanisms for Indemnification

Indemnity provisions may require some type of notice to be given by the

indemnitee to the indemnitor. If the notice clause is drafted as a covenant,

then the indemnitor will argue that failure to deliver notice is a breach of the

indemnity agreement. The indemnitor would contend that it is entitled to

damages based on the lack of notice and that, ifdeliveryof notice is a

condition precedent to the indemnitor’sobligation to indemnify, the failure to

satisfy the condition precedent relieves the indemnitor of its obligation to

defend or indemnify.

The delivery of notice may be a particularly significant issue when

indemnification is being sought because of a claim by a third party.

Indemnity provisions may be drafted to state that defective notice does not

excuse the indemnification obligation unless or except to the extent that as

a result, the damages to be indemnified are increased or the indemnitor is

otherwise prejudiced, e.g., the indemnitor’s ability to provide a defense is

somehow prejudiced.

Time of Performance

Example:

Time is of the essence for the completion of

the work described in this contract. It is

anticipated by the parties that all work

described herein will be completed within

two (2) weeks of the date of execution, and

that any delay in the completion of the work

described herein shall constitute a material

breach of this contract.

Time of Performance

Failure to Properly Draft: Powder Hollow Limited Partnership I v. Powder Hollow Associates, A-

4682-96T5(N.J. Super. App. Div. 1998) (Unpublished)

Dealing with a poorly drafted contract without a definite time for closing, the

court chose to terminate a contract rather than grant specific performance

which would have required the court to monitor performance for ten or more

years.

The matter before the court dealt with an unusual land sale contract which

provided one price for a particular piece of property if an interstate highway

interchange was constructed and about a 50% reduction in the purchase

price if it was not. What the contract lacked, however, was a definite time at

which closing would take place in the event that the interchange was not

built.

Arbitration Clauses

Arbitration is an option in most commercial contexts, but

may be prohibited in some states if involves consumer

contracts (e.g. NY General Business Law section 399-c

provided arbitration clauses void in consumer contracts

for goods and services)

Consider pros and cons of arbitration

Pros: Faster, confidential, expert analysis of complex

issues, greater finality, no runaway juries

Cons: Limited judicial review, harder to delay, uncertain

rules and procedures

Class actions included?

Arbitration Clauses—Drafting Considerations

Panel size

Who will administer (AAA, ICA, JAMS, etc.)

Location and governing law

Who pays what/costs/fees

Special qualification of arbitrators

Time limits and discovery

Pre-hearing and post-hearing briefing

Process for resolving prehearing disputes

Format of final hearing

Timing and form of award

Confidentiality

Appeals (judicial or non-judicial)

Consent to entry of judgment

Scope—broad versus narrow (exclusions)

Arbitration Clauses

Arbitration is likely to be best for your client if: You want

to force payment of money quickly, you may otherwise

be exposed to an unfavorable forum, you need careful

analysis of complex

Litigation may be best if: You need injunctive relief, have

a favorable home court, want to delay resolution, your

opponent wants to avoid a public trial

Clauses should be tailored to specify established

organization such as AAA, JAMS, ICC, procedure for

choosing, and any injunctive relief carve out (e.g., non-

competes)

Arbitration

Example:

All disputes, controversies, or claims arising

out of or relating to this contract shall be

submitted binding arbitration in accordance

with the applicable rules of the American

Arbitration Association then in effect.

ADR – Sample Clause

Any dispute in relation to this contract, or the interpretation, making, performance,

breach or termination of it, shall be finally settled by binding arbitration in Newark,

NJ under the Commercial Arbitration Rules of the American Arbitration Association

(“Rules”) by an arbitrator appointed in accordance with the Rules. This contract

shall be governed by New Jersey law without reference to rules of conflict of law.

The arbitration proceedings shall be governed by the Rules without reference to

state arbitration law. Any award rendered in the arbitration proceedings shall be

non-appealable and final and binding upon the parties (and any attempted appeal

shall be void and of no effect), and judgment on the award may be entered by the

Superior Court of the State of New Jersey, Law Division, Essex County and

application may be made to that court for judicial acceptance of any award or an

order of enforcement. The parties consent to personal and exclusive jurisdiction

and venue in that court with regard to any such application. The parties agree that,

any provision of applicable law notwithstanding, they will not request, and the

arbitrator shall have no authority to award punitive or exemplary damages. The

costs of the arbitration, including administrative and arbitrator’s fees, shall be

shared equally by the parties. Each party shall bear the cost of its own attorneys’

fees and expert witness fees.

Jury Waiver Clauses

Generally can waive right to jury

Consider pros and cons of waiving a jury (likely

to be a plaintiff or defendant, forum, jury pool in

forum, legal arguments appeal more to jury)

Some jurisdictions do not permit, but can use

arbitration agreement as an alternative

Clauses will be strictly construed

Severability

Example:

If any provision of this Contract is held

unenforceable, then such provision will be

modified to reflect the parties’ intention and

all remaining provisions of this Contract shall

remain in full force and effect.

Attorneys’ Fees Clauses

Fee shifting provision provides that the losing

party in a dispute relating to the contract will pay

attorneys’ fees of prevailing party

Pros: Provides disincentive to litigate

Cons: Raises potential costs of vindicating your

company’s rights

Fee shifting provisions in consumer contracts

may not be enforceable

Carefully draft conditions– “Prevailing party” or

“party who recovers damages”

Attorney Fees

Example –

In the event of litigation relating to the

subject matter of this Agreement, the non-

prevailing party shall reimburse the

prevailing party for all of their reasonable

attorneys’ fees and costs.

Non-Waiver

Example:

The failure by one party to require

performance of any provision shall not affect

that party's right to require performance at

any time thereafter, nor shall a waiver of any

breach or default of this Contract constitute

a waiver of any subsequent breach or

default or a waiver of the provision itself.

Liquidated Damages Clause

Establish a predetermined sum that must be paid if a

party fails to perform as promised

Permissible if not contrary to public policy or

unconscionable

Need to be reciprocal

Where agreed sum is vastly below actual damages,

aggrieved party may be able to void clause and recover

actual damages (needs to be a reasonable forecast of

damages)

Narrowly construed

Will not bar equitable relief unless explicitly says so

Liquidated Damages Clauses

Know the law that may apply

Some jurisdictions only permit if impossible or impractical to estimate

damages with any degree of certainty time of contract (e.g.. TX)

Applying New Jersey's principles regarding liquidated damages in the

context of a contract for services, the federal district court in New Jersey

has held that liquidated damages amounting to triple the amount of the

injury were not by their very nature unreasonable. Specifically, the court did

not find that such liquidated damages were either "unconscionable" or a

"penalty".

“The general rule in Delaware is that an enforceable liquidated damages

provision is distinguishable from a penalty where two criteria are met. First,

the damages which the parties might reasonably anticipate to result from a

breach must be difficult or impossible to prove accurately and second, the

agreed upon sum must be reasonable.” Pierce Assoc., Inc. v. Nemours

Foundation, 856 F.2d 530, 546 (3d Cir. 1988)

Liquidated Damages Clauses—Drafting

Considerations

State rationale or criteria for amount

chosen

Be as detailed and specific as possible

Make damages commensurate with injury

Use industry standards, if possible

Need not be monetary damages

Liquidated Damages

Example:

Monthly parking tenants canceling their

parking contracts after the 1st of the month

shall pay liquidated damages in the amount

of $10.00 per day for the remainder or

unexpired portion of their monthly

agreements, not to exceed $100.

Assignment

An assignment-consent requirement can give the non-assigning party a chokehold on

a future merger or corporate reorganization by the assigning party

A party being asked to agree to an assignment-consent requirement should consider

trying to negotiate carve-out provisions below. For example, when the assignment is

connection with a sale of substantially all the assets of the assignor’s business.

Case illustration--The Dubai port In 2006, a Dubai company that operated several

U.S. ports agreed to sell those operations. (The agreement came about because of

publicity and political pressure about the alleged national-security implications of

having Middle-Eastern companies in charge of U.S. port operations.) A complication

arose in the case of the Port of Newark: The Dubai company’s lease agreement gave

the Port Authority of New York and New Jersey the right to consent to any

assignment of the agreement — and that agency initially demanded $84 million for its

consent. After harsh criticism from political leaders, the Port Authority backed down a

bit: it gave consent in return for “only” a $10 million consent fee, plus $40 million

investment commitment by the buyer.

Assignment

Possible language--Consent is not required for an assignment of this Agreement in connection

with a sale or other disposition of substantially all the assets of the assigning party’s business.

Optional: Alternatively, the sale or other disposition may be of substantially all the assets of the

assigning party’s business to which this Agreement specifically relates. Optional: The assignee

must not be a competitor of the non-assigning party.

Consider if either party may assign this Agreement without consent to its affiliate. Optional: The

assigning party must unconditionally guarantee the assignee’s performance. Optional: The affiliate

must not be a competitor of the non-assigning party. Optional: The affiliate must be a majority-

ownership affiliate of the assigning party.

Consider a provision that consent may not be unreasonably withheld or delayed. Optional: For

the avoidance of doubt, any damages suffered by a party seeking a required consent to

assignment of this Agreement, resulting from an unreasonable withholding or delay of such

consent, are to be treated as direct damages. Optional: For the avoidance of doubt, any damages

suffered by a party seeking a required consent to assignment of this Agreement, resulting from an

unreasonable withholding or delay of such consent, are not subject to any exclusion of remedies

or other limitation of liability in this Agreement.

Even if this provision were absent, applicable law might impose a reasonableness requirement.

An unreasonable-withholding provision should make the non-assigning party think twice about

dragging its feet .

If a party wants the absolute right to withhold consent to an assignment in its sole discretion

include that in the contract language.

Termination Clauses

How and under what circumstances can the contract be terminated?

– Cancellation by default (require material breach? Define?)

– Without cause (cancellation for convenience)

– Cancellation by mutual consent

– Notice

– Default and right to cure breach

– Termination fees

– Termination if bankruptcy

– Any value given automatic stay?

Facts court consider in determining whether a breach was material:

– Was there a failure of an essential feature on the contract which had induced the

non-breaching party to enter the contract?

– Did the breach go to the substance of the contract and defeat the non-breaching

party's purpose for making it?

– Did the non-breaching party receive substantially less or different from that which

he had bargained?

Remedies on Breach

Declare termination of contract

Interest

Damages

Liquidated Damages

Consequential Damages

Consent to entry of judgment

Checklist of Boilerplate Provisions

Costs and attorneys’ fees

Waiver

Severability

Integration

Notice

Assignment

Indemnification

Liquidated Damages

Arbitration/ADR

Fee shifting

Checklist of Provisions to Consider

Termination

Escrow

Jury trial waivers

Limits on damages/liability

Confidentiality

Counterparts

Choice-of Law

Forum Selection

Contractual limitations

Representations and Warranties

Thank You!

Questions?

Remember: One way to avoid or

limit legal fees later is by well

thought out contract drafting

lessons learned from contract drafting - association of corporate

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