WHEN CONTRACTS GO SOUR: Drafting and Due …eo2.commpartners.com/users/accchap/downloads/outline.pdf · Drafting and Due Diligence Lessons Learned From Litigation ... 5. As a result

WHEN CONTRACTS GO SOUR: Drafting and Due Diligence Lessons

Learned From Litigation

Washington Metropolitan Area Corporate Counsel Association

April 8, 2008

Richmond, VA

Chicago • New York • Washington, DC

Jenner & Block LLP www.jenner.com

Jerome L. Epstein, Partner Jenner & Block LLP Tel: 202 639-6062

E-mail: [email protected]

Tobias L. Knapp, Partner Jenner & Block LLP Tel: 212 891-1655

E-mail: [email protected]

J. Epstein/T. Knapp Jenner & Block

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AGENDA

Drafting, Litigation, and Due Diligence Tips Relating to Frequently Litigated Contractual Clauses

• The Intersection of Fraud and Contract: Integration

Clauses, Disclaimers, and other Tools to Ward Off Fraud Claims

• Lessons from Recent Decisions Concerning Specific Performance/Material Adverse Change

• Best Efforts

• Arbitration Clauses

• Indemnification Clauses and Limitations of Liability


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I. FRAUD CLAIMS ARISING OUT OF “CONTRACTUAL” DISPUTES

A. Essential Elements of a Common Law Fraud Claim

1. Seller made false representation of fact to Buyer

2. Seller knew representation was false

3. Seller intended to deceive Buyer

4. Buyer justifiably relied on statement and was induced by it to act

5. As a result of such reliance, Buyer was damaged

B. Determining Justifiable Reliance

1. Frequently the most contested factual issue in fraud litigation, and informs drafting/due diligence strategy

2. Plaintiff must first prove actual reliance on the misrepresentation; that involves examination of plaintiff’s actual conduct and motives.

a) For misrepresentation of material fact, some courts presume reliance.1

b) Misrepresented fact need not be sole cause of plaintiff’s actions.

3. Whether reliance was “reasonable” or “justifiable” is determined based on an objective “reasonable person” test.

4. What is a material fact?

a) Also typically determined using an objective test — e.g., would a reasonable person have considered the misrepresented fact important to the action taken?

b) Some courts evaluate materiality in the context of “reasonable” reliance; unreasonable for Seller to rely to its detriment on immaterial fact.

1 Issues involving state or federal securities laws are beyond the scope of this presentation.


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C. The Familiar Elements Of Breach Of Contract

1. Plaintiff must first establish the existence of a legally enforceable contract (e.g., meeting of the minds on material terms; offer; acceptance; consideration; reasonably certain terms).

2. Breach

a) Buyer complied with its obligations

b) Seller did not

c) Seller’s breach damaged Buyer

D. Why do We Care if a Seeming “Breach” is Presented as an Intentional Tort?

1. All that hard work to negotiate a limitation on damages! Fraud

claims are often made to evade contractual limitations on damages.

2. Even punitive damages are possible with a fraud claim, and rescission is more likely.

E. When a Buyer Sues in Tort – Fraudulent Inducement

1. Classic claim: the seller lied or withheld material facts in order to induce me to sign the contract, and the goods/services/business are not what I was promised.

2. E.g., Greenfield v. Heckenbach, 797 A.2d 63 (Md. Ct. Spec. App. 2002) (buyer of real estate alleges seller fraudulently misrepresented scope of building plans on adjoining property, in order to induce purchase of real property)

3. DIMON Inc. v. Folium, Inc., 48 F. Supp. 2d 359 (S.D.N.Y. 1999) (purchaser of company sued for fraud after discovering seller had overstated net worth through elaborate accounting scheme stored only in coded files)

4. J.E. Robert Co. v. J. Robert Co., 343 S.E.2d 350, 353-54 (Va. 1986) (plaintiff alleging fraud must prove other party made


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promise it never intended to perform, in order to induce plaintiff to enter into agreement)

F. Drafting Tips for Avoiding Fraudulent Inducement Claims

1. Note that the parol evidence rule will not protect a seller from a fraudulent inducement claim. The parol evidence rule bars evidence of prior communications to contradict or vary the terms of an integrated agreement, but does not bar a claim that fraudulent representations induced a contract.

2. Protection from Merger/Integration Clause?

a) Example: “This Agreement constitutes the entire agreement between the parties and supersedes any prior and contemporaneous understandings, agreements or representations by or between the parties, written or oral, that may have related in any way to the subject matter hereof.”

b) Merger/integration clauses are usually necessary but not sufficient. An integration clause typically will not, standing alone, defeat a fraud claim. See, e.g., Whelan v. Abell, 48 F.3d 1247, 1258 (D.C. Cir. 1995) (conclusion that “an integration clause bars fraud-in-the-inducement claims . . . would leave swindlers free to extinguish their victims’ remedies simply by sticking in a bit of boilerplate”).

c) But merger/integration clauses are nonetheless critical!

i. For other defenses and evidentiary limitations – they are important to establish conclusively that the parties intended an integrated agreement. Merger/integration clauses are used to defeat claims that the representations and promises in an agreement should be supplemented or superseded by oral or written statements outside of the four corners of the agreement.

ii. And as a part of the totality of factors to defeat a


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fraudulent inducement claim. See, e.g., Dresner v. Utility.com, Inc., 371 F. Supp. 2d 476, 492-493 (S.D.N.Y. 2005) (“In light of the clear language of the merger clause, the sophistication of the parties, the relative parity of bargaining power, the litany of representations and warranties contained in the Merger Agreement, as well as the cautionary language in the Information Statement that qualified any pre-Merger Agreement statements, plaintiffs have failed to proffer facts suggesting it would have been reasonable for them to rely on representations made in advance of the Merger Agreement.” (emphasis added)

3. Protection from a Disclaimer? General vs. Specific.

a) Example of a general “non-reliance” provision: “Except for the representations and warranties contained in this Agreement, the Buyer acknowledges that the Seller makes no express or implied representation or warranty, at law or in equity, with respect to the [Acquired Company], [the Shares], the [Business] or otherwise, including as to merchantability or fitness for any particular use or purpose. All other representations or warranties are hereby disclaimed.”

i. Purpose is to defeat any argument by the Buyer that it justifiably relied on any express or implied oral or written representations outside the four corners of the acquisition agreement.

b) A minority of courts have suggested that a “general,” or “non-specific” disclaimer of reliance may defeat a claim of reasonable reliance. E.g., Rissman v. Rissman, 213 F.3d 381, 383 (7th Cir. 2000) (“‘The parties further declare that they have not relied upon any representation of any party hereby released . . . or of their attorneys . . . agents, or other representatives . . . .’”). But even there, the court noted additional facts – plaintiff had asked for a specific


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representation (that a business would not go public), and defendant had refused to provide the rep, so it was unreasonable for plaintiff to claim reliance.

c) The vast majority of courts, however, treat non-specific clauses as relevant but not dispositive. E.g., Slack v. James, 614 S.E.2d 636, 640-41 (S.C. 2005) (“Both Buyer and Seller hereby acknowledge that they have not received or relied upon any statements or representations by either Broker or their agents which are not expressly stipulated herein.”) (“A general non-reliance clause, just as a merger clause, does not prevent one from proceeding on tort theories of . . . fraud”) (emphasis added); Jackvony v. RIHT Fin. Corp., 873 F.2d 411 (1st Cir. 1989) (Breyer, J.); One-O-One Enters., Inc. v. Caruso, 848 F.2d 1283 (D.C. Cir. 1988) (R.B. Ginsburg, J.); see also Rissman, 213 F.3d at 388 (Rovner, J., concurring) (non-reliance clause does not “preclude[] a fraud claim in all cases” but “is a factor that may defeat a claim of reliance”).

4. Specific Disclaimers

a) A number of courts have approvingly noted the importance of specific disclaimers in establishing that the Buyer could not have justifiably relied on a representation outside the four corners of the acquisition agreement.

b) E.g., Danann Realty Corp. v. Harris, 157 N.E.2d 597, 599 (N.Y. 1959) (specific contractual disclaimer of reliance “destroys the allegations in plaintiff’s complaint that the agreement was executed in reliance upon . . . contrary oral representations”).

c) Example of specific disclaimer, from DynCorp v. GTE Corp., 215 F. Supp. 2d 308 (S.D.N.Y. 2002)

“Except for the representations and warranties contained in this Agreement, Buyer acknowledges that [the] Seller . . . makes [no] express or implied representation or warranty with respect to the . . . Company [GTE Information], the


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Business [the business that Contel is selling and that DynCorp is buying] or otherwise or with respect to any other information provided to Buyer, . . . including as to (a) merchantability or fitness for any particular use or purpose, (b) the operation of the Business by Buyer after the Closing in any manner other than as used and operated by Seller or (c) the probable success or profitability of the ownership, use or operation of the Business by Buyer after the Closing. . . . Neither Seller nor any other Person will have or be subject to any liability or indemnification obligation to Buyer or any other Person resulting from the distribution to Buyer, or Buyer’s use of any such information, including the Confidential Offering Memorandum dated July 1999 . . . related to the Business and any information, documents or material made available to the Buyer in certain ‘data rooms,’ management presentations, functional ‘breakout’ discussions, responses to questions submitted on behalf of Buyer, whether orally or in writing, or in any other form in expectation of the transactions contemplated by this agreement” (emphasis added). DynCorp, 215 F. Supp. 2d at 311-12.

d) See also, e.g., Genesco, Inc. v. The Finish Line, Inc., Mem. Op., No. 07-2137-II, slip op. 22-24 (Tenn. Ch. Dec. 27, 2007) (citing multiple clauses disclaiming any representations or liability with respect to representations not in final agreement, including management representations as to projections, forecasts, etc.)

e) Specific disclaimers defeat the element of reasonable reliance by the buyer – i.e., the core elements of a fraudulent inducement claim cannot be met even if a false representation of a material fact had occurred.

5. Courts are more likely to reject fraud claims where a contract is between two sophisticated parties. E.g., Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 195 F. Supp. 2d 551, 561-63 (S.D.N.Y. 2002), aff’d in part, rev’d in part on other grounds, 343 F.3d 189 (2d Cir. 2003). That will often be


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apparent from the identity of the parties or the negotiating history, but it is always a good idea to include a clause that the contract was jointly drafted, and should be interpreted without any presumption as to who drafted it.

6. Other contractual clauses that help defeat fraud claims, even if insufficient standing alone (in addition to merger clause):

a) “As is” clause. E.g., DRR, L.L.C. v. Sears, Roebuck & Co., 949 F. Supp. 1132, 1139-40 (D. Del. 1996) (Though an “as is” clause does not insulate a seller from suit for fraudulent misrepresentation, it is factor that will help to defeat a fraud claim).

b) Access to information – e.g., clause granting buyer access to premises, books and records, and requiring seller to respond to reasonable requests from the buyer. Helps to defeat claim by buyer that it reasonably relied on a misrepresentation or an omission of a material fact.

c) Indemnification as buyer’s exclusive remedy. Certainly not sufficient by itself, but another factor a court will consider.

d) Anti-sandbagging clause – buyer is not at the time aware of any facts that would serve as a basis for a claim of breach or violation of pre-closing reps and warranties, or withholding of material information. (Unscrupulous buyers may otherwise save a damaging fact for later use if problems occur.)

e) Caveats in offering memorandum or other pre-contract formal descriptions. E.g., memorandum is informational only and is not intended to provide complete information to a potential buyer or serve as a substitute for due diligence. Disclaim any and all representations about accuracy of offering memorandum. Affirmative statement that recipient shall be entitled to rely solely on the representations and warranties made to it by or on behalf of the Seller in any final purchase agreement.


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G. Due Diligence Tips

1. In addition to erring on the side of full disclosure, Seller should keep a detailed and accurate record of all documents provided to the Buyer.

2. At least one representative of the Seller should be present to witness any interviews between the Buyer and any of the Seller’s employees.

3. Seller should include a requirement that Buyer must seek updated diligence; at least one court has noted that where due diligence procedures require parties to specifically request updated diligence and do not, that failure may be used to defeat a claim for misrepresentation. (See, e.g., Genesco, Inc. v. The Finish Line, Inc., Mem. Op., (Tenn. Ch. Dec. 27, 2007))

4. Buyers, in turn, must be careful to follow up on key items on their own diligence lists, which may be turned over in discovery.

5. Establish a clear record that the other party was asked if it required more information.

H. Litigation Tips for Defending Fraud Claims Between Parties to a

Contract

1. Don’t rule out motion to dismiss

a) Reasonable reliance is generally a fact inquiry, but a court may find absence of reasonable reliance as a matter of law, particularly if the contract is between sophisticated parties and/or contains specific disclaimers. See, e.g., Danann, 157 N.E.2d 597 (New York law); Dresner, 371 F. Supp. 2d 476 (New York law) (both granting motions to dismiss).

2. If applicable, argue that the allegedly missing information was not in the Seller’s “exclusive knowledge” and/or should have been discovered through reasonable due diligence. This is particularly


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important where the allegation is a failure to disclose, as opposed to an affirmative misrepresentation.

3. If applicable, note that alleged misrepresentation was a statement of opinion, not fact, or was mere puffery. E.g., Andersen v. Bungee Int’l Mfg. Corp., 44 F. Supp. 2d 534 (S.D.N.Y. 1999) (product of “premium quality”); Fifty Assocs. v. Prudential Ins. Co., 450 F.2d 1007 (9th Cir. 1971) (commercial lessor could not reasonably rely on other party’s mere estimate of property value).

4. Reliance, reliance, reliance!

a) If complaint survives dismissal, fighting reasonable reliance is often the key to defeating a fraud claim.

i. Use independent research and discovery to show Buyer knew or should have known exactly what risks it was assuming.

a) e.g., Internet research of trade press showing Buyer knew or should have known of risks with assets/products/industry, and assumed those risks by failing to exact specific warranties.

b) Advantage of independent research is that it doesn’t tip plaintiff off on defense theories, as with formal discovery.

c) Public disclosures are also useful to rebut claim that purportedly undisclosed material fact was so secret Buyer could not have known even to ask for warranty.

ii. Use totality of contractual clauses noted above, even if

no one clause is sufficient to defeat fraud claim.

iii. Discovery of Buyer’s due diligence research and assessment of purchase price.


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May show not only that reliance would not have been “reasonable,” but also absence of any actual reliance on claimed misrepresentation. (We must have this strategic acquisition for X purpose regardless of other factors.)

iv. Investigate what other Buyers knew.

v. If applicable, argue that the conduct complained of is, at best, a breach of an express contractual term – not a misrepresentation outside the four corners of the agreement. This may be particularly beneficial if the contract includes limitations on liability. Also helps to show trier of fact you are not trying to escape responsibility for problems contemplated in the four corners of the agreement.

II. SPECIFIC PERFORMANCE/MAC CLAUSES

A. Litigation Increasingly Prevalent

1. Disputes over deals that do not go through are typically resolved through negotiation. But there has been a recent increase in high-profile disputes – e.g., Harman Industries, Sallie Mae, etc.

2. Two recent cases bring out the intersection of specific-performance

and MAC clauses.

B. A Recent Example: United Rentals, Inc. v. RAM Holdings, Inc., No. 3360-CC (Del. Ch. Dec. 21, 2007)

1. RAM entered into an agreement to purchase United Rentals. The

parties agreed to two specific and somewhat contradictory provisions. First, a specific performance provision:

The parties agree that irreparable damage would occur in the event that any of the provisions of


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this Agreement were not performed in accordance with their specific terms or were otherwise breached. Accordingly . . . (b) [United Rentals] shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement by [RAM] or to enforce specifically the terms and provisions of this Agreement and the Guarantee to prevent breaches of or enforce compliance with those covenants of [RAM] . . . to (i) use its reasonable best efforts to obtain the Financing and satisfy the conditions to closing . . . and (ii) consummate the transactions contemplated by this Agreement . . . . The provisions of this Section 9.10 shall be subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto . . . . (emphasis added)

2. The second provision is a termination fee provision:

In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [RAM] . . . be subject to any liability in excess of [the $100 million reverse termination fee] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by [RAM] of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall [United Rentals] seek equitable relief or seek to recover any money damages in excess of such amount from [RAM] . . . or any of their respective Representatives. (emphasis added)

3. RAM walks and United sues


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RAM informed United that it was not going to proceed with the merger on its terms and offered to renegotiate. United sued for specific performance. United argued that the reverse transaction fee of $100 million had no effect on its right to compel specific performance and that it was entitled to specific performance. RAM argued that the $100 million fee was RAM’s exclusive obligation in spite of the specific performance clause, the fact that the plaintiff/seller suffered no MAC, and that financing was in place.

4. Court Opinion

The court found that the agreement was ambiguous and permitted extrinsic evidence. The court further determined that the evidence was inconclusive and that the Seller unequivocally knew that Buyer had always communicated its view that the break up fee was the exclusive remedy in the event Buyer refused to close; the Seller therefore had a duty to clarify its position in light of an ambiguous contract.

5. Take-Aways

a) In negotiations, do not assume protection from the parol evidence rule. Anything you say may be used against you – and in this case even your silence!

b) The decision whether to apply a break-up fee will be examined in the context of all the transaction papers.

c) Get a fresh read of important contracts by an outsider not steeped in the transaction – to head off mutually inconsistent (or arguably inconsistent) contractual terms before they lead to expensive litigation and potential


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liability.

d) If a break-up fee is the sole remedy, say so! And do not take away with the left hand the clean remedy clause provided by the right hand.

i. May want to specify that break-up fee is at Buyer’s option.

ii. Or, on the sell side, specify that limitation on liability/liquidated damage provision does not preclude Seller from seeking specific performance where Buyer can obtain contemplated financing (and spell out the terms).

e) An LOI can create the same kind of specific performance problem.

i. The situation arises where one of the parties to a transaction decides to walk away and the “spurned suitor” claims breach of good faith in negotiating and threatens to sue for performance of the LOI terms.

ii. What factors/clauses will courts look for in order to decide whether an LOI is enforceable?

• Basic test is whether there was an intention to reach a binding agreement.

• Has there has been an express reservation of the right not to be bound in absence of subsequent writing?

• Has there been partial performance already?

• Are all terms of the ultimate contract already spelled out?

• Is this the type of agreement that is normally committed to a subsequent writing?


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See, e.g., Burbach Broad Co. v. Elkins Radio Corp., 278 F.3d 401, 408 (4th Cir. 2002)

C. Recent Lessons On MAC Clauses

1. Especially critical if break-up clauses are ambiguous

2. Another recent lesson: Genesco, Inc. v. The Finish Line, Inc., Mem. Op., No. 07-2137-II (Tenn. Ch. Dec. 27, 2007)

a) Another case of Buyer’s remorse. Here the Buyer (Finish Line) was not excused from specific performance. The Buyer tried to rely on a MAC clause to back out, but the court viewed the MAC clause inoperative; while the Seller’s financial performances had deteriorated, the MAC clause exempted adverse effects resulting from general economic conditions. The facts of the case led the court to view Genesco’s (Seller’s) deteriorating performance as resulting from pervasive economic effects such as heating oil prices and the like, not covered by the MAC clause.

3. Take-Aways

a) Litigation over MAC clauses is abundant, and the subject of numerous articles and programs. We focus here on a few practice points from the recent cases:

b) Carving out adverse impacts from general economic conditions is certainly a good practice for a seller. Parties may want to take that a step further and focus on the issue of companies in the industry and/or the region or even sub-categories beyond that (peer group, intra-industry comparisons, etc.). Buyers would want to limit all carve-outs from a MAC clause.

c) A buyer will often want to include material changes to “prospects,” not just “events,” but consider again taking that to another level – prospects that are separate from “operations or results of the Company”? Whose prospects? See, e.g., Pacheco v. Cambridge Technology Partners, 85


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F. Supp. 2d 69 (D. Mass 2000) (in a stock-for-stock transaction, seller argued that Buyer’s business had plummeted, but contract defined MAC to include changes only to seller’s prospects).

d) Consider defining the duration of the event in order to be considered adverse – e.g., if longer than X months, it is a MAC.

e) Use a dollar threshold for the MAC.

f) A second cousin to a MAC is the issue of “diligence out” for due diligence-customer interviews. That is, a set of due-diligence examinations that result in a condition permitting an acquirer to refuse to close on a transaction; can apply as well to a purchaser of services. Due diligence issues to consider:

i. Talking to customers; how many; how determined

ii. What’s the script; who attends; use of surrogate; who gets the report

iii. Timing

iv. Pros and cons of pre-signing; or post-signing/pre-close

v. What can go wrong: failure to agree on parameters and protocols of diligence in advance can lead parties to spend time and money while ignoring the threshold issue.

g) Post-signing (examples of MAC-type “diligence out” clauses that have worked)

i. Customer Meetings. The Customer Meetings shall have occurred prior to the Closing Date to the reasonable satisfaction of Buyer.

ii. Customer Interviews. The Purchaser, with the


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cooperation and assistance of the Sellers, shall have completed satisfactory interviews with the cognizant program manager, contracting officer, and contracting officer’s technical representative for each of the Company’s four largest customers as measured by their estimated contribution to 2007 revenues. Such satisfactory interviews shall have confirmed the information received by the Purchaser from the Company, including scope of current work, contractual details, [deliberately omitted] recertification issues and overall quality of performance.

III. BEST EFFORTS

A. Example: Party A Shall Use its “Best Efforts” to Sell the Product B. Do You Really Need This Clause? The Litigators’ Full Employment

Act C. “Best Efforts” is a Notoriously Ambiguous Term That Can Lead to Protracted, Fact-Intensive, and Intrusive Discovery D. Courts Have Widely Varying Interpretations

1. Seems to be clear that at a minimum “good faith” is required, but that is a pretty low bar. Some courts seem to require nothing more.

2. At the very least, a total lack of effort would violate a best efforts

clause. See, e.g., Hinc v. Lime-O-Sol Co., 382 F.3d 716, 721 (7th Cir. 2004) (“‘Best efforts,’ as commonly understood, means, at the very least, some effort. It certainly does not mean zero effort.”).

a. That provides at least some comfort to the beneficiary of the

best efforts clause, and can act as a deterrent to “zero” effort, but it’s the unusual case where a party will be found to have expended no effort.


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3. Often good faith alone is not enough. Usually the term “reasonable”

is read in, but that still leaves a wide window. 4. e.g., courts may require reasonable diligence in light of the party’s

own existing capabilities. This is a hybrid objective/subjective test – what is reasonable given your client’s circumstances. See, e.g., Bloor v. Falstaff Brewing Corp., 601 F.2d 609, 613 n.7 (2d Cir. 1979) (noting one formulation of “best efforts” test under New York law is to act in good faith “in light of one’s own capabilities.”)

5. Other courts use a more objective test, such as what is

“commercially reasonable.” See, e.g., Bloor, 601 F.2d at 613 n.7 (noting different formulation by New York courts – that “best efforts” requires party to perform as well as an “average prudent comparable” company in the same business).

E. Problems with an Open-ended “Best Efforts” Clause

1. Can be interpreted as requiring you to maintain quality at a level comparable to industry participants with greater resources and options

e.g., McKinley Allsopp, Inc. v. Jetborne Int’l, Inc., No. 89 Civ. 1489 (PNL), 1990 WL 138959, at *7 (S.D.N.Y. Sept. 19, 1990) (“the efforts expended by McKinley were not in conformity with the understandings prevailing in the investment banking community regarding a ‘best efforts’ undertaking”).

2. Opens up all kinds of discovery as to what other companies are

capable of in order to show what is “reasonable.” This also increases discovery costs, and the fact-specific nature of the question makes a trial more likely.

3. Can also open up discovery on negotiations – using parol evidence

to help define an ambiguous term


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4. The business client’s nightmare: inviting discovery as to other business decisions your client has made to determine whether more effort, or different decisions, would have been “reasonable”, or what your client’s “capabilities” are. e.g., would have been reasonable to invest in this project just 25% of the bonus paid last year to your CEO.

5. Watch the back door – may be read to prevent party from pursuing

opportunities with other partners (divided loyalty), even when the contract does not otherwise have an exclusivity obligation.

F. Drafting Tips

1. If you are the party who will be doing the heavy lifting, try to avoid a general “best efforts” clause entirely.

2. If you are the beneficiary of the “best efforts,” it is a helpful standard

to keep the other side’s feet to the fire – but you may still suffer from endless fact-intensive disputes.

3. Consider metrics or specific factors as alternative to “best efforts.”

a. e.g., in lieu of “best efforts” clause, party shall make a

minimum of Y sales calls per week; shall expend no less than $$ on mass media advertising.

b. Party X shall be responsible for filing all forms required for

regulatory approval, no later than Y date. c. Party X shall assist with securing Y type of financing by X date.

4. If you must use a “best efforts” clause (because, for example, there

is no way adequately to specify the required level of effort)

a. Consider at a minimum specifying that “best efforts” means “commercially reasonable,” although that will eliminate only a few of the problems noted above (e.g., whether “best efforts” means merely “good faith”)


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b. Better still define “best efforts” to mean “commercially

reasonable efforts, taking into account reasonable efforts for a business similarly situated to Y in the X industry”

c. Or specify even further – commercially reasonable to a

company in X industry, taking into account competing demands on resources, industry conditions, and the market potential of the product. This will not eliminate fact-intensive disputes, but can help lessen the chance of liability, such as being held to the standard of competitors with more resources.

d. Use the types of specific examples noted above (e.g., filing

certain forms, degree of sales efforts or expenditures), as part of the definition of “best efforts.” Could be “including, but not limited to” or “best efforts principally to be determined by commercially reasonable efforts in the areas of x, y, and z”).

e. Or use specific metrics as part of definition of “best efforts,”

but as a ceiling – X shall use commercially reasonable efforts to market the product but in no event shall X be required to deploy more than 25 salespersons, or incur more than $Y on advertising, incur any expenditures beyond those expressly contemplated in Article Z, above, etc.

f. Use other contractual clauses to eliminate unintended breadth of

“best efforts” clause – e.g., “Notwithstanding any other provision in this Agreement, Party X shall not be prevented from marketing any type of product of any other person or entity.”

5. Require other side to meet “clear and convincing evidence” or other

high bar in dispute resolution clause in the event of dispute arising out of “best efforts” clause.

6. Include an opportunity-to-cure provision as a condition to

termination.


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7. During contract performance, maintain a good record that decisions were made based on “normal” exercise of business judgment in the industry. Assume business plans, risk-benefit analyses, etc., could be subject to discovery. (And advise your business clients of that reality before agreeing to a “best efforts” clause!)

IV. ARBITRATION CLAUSES

A. Pros and Cons

1. Far less risk of runaway verdict, so especially advantageous if you are the “Goliath” or the other side has a greater likelihood of significant consequential damages (e.g., lost profits, insolvency)

2. Generally less costly and much shorter (but fees can add up for

three-arbitrator panel) 3. Witnesses/hearing more likely (dismissal on motions rare) – and

hearing will typically occur far earlier than in court 4. Confidentiality/lack of publicity can be a major plus, and

precedential effect limited or none 5. Discovery typically far more limited than in court (which can be a

significant disadvantage if your claim requires robust discovery) 6. Advantageous for recurring disputes (e.g., advertising wars),

disputes requiring short turn-around from claim to decision, or disputes involving specialized subject matter (can require arbitrators with specific background)

7. Much less opportunity to correct even fairly egregious errors

(“manifest disregard” of law vs. legal error, and courts have heavy presumption against reviewing arbitration awards)

B. Traps and Drafting Tips

1. Don’t Reinvent the Wheel for a Standard Clause


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a. Comprehensive, standard clauses are available from each of the

major associations (e.g., AAA, CPR, JAMS) b. e.g., “Any dispute arising out of or relating to this contract,

including the breach, termination or validity thereof, shall be finally resolved by arbitration in accordance with [the CPR Institute for Dispute Resolution Rules for Non-Administered Arbitration] then currently in effect, by a sole arbitrator [or panel]. The arbitration shall be governed by the Federal Arbitration Act, 9 U.S.C. §§ 1-16, and judgment upon the award rendered by the arbitrator may be entered by any court having jurisdiction thereof [or specify court].” (emphasis added)

c. Advantage of “standard” terms is that courts have already dealt

with them frequently. For example, broad scope of arbitration clause (“arising out of”; “including validity”); non-appealable absent strict federal standards (“finally resolved,” FAA applies)

2. Improving the Wheel – Additional Drafting Details to Consider

a. Mandatory Mediation

If delay will harm your side more, watch out for mandatory mediation. Include short turn-around or unilateral right to terminate mediation at any time

b. Mandatory Expertise/Background of Panelists

Can be very helpful where industry practice differs from what generalist attorneys may be familiar with (e.g., pharmaceutical, engineering, complex financing)

But watch for greater likelihood of bias. e.g., requirement of “Big 4” experience in engagement agreement with audit firm

c. Confidentiality


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A good protection, but not bullet-proof – e.g., subject to court discovery with appropriate protective order

d. Specifying Scope of Discovery

e.g., can specify x depositions per side, or preclude depositions altogether. Otherwise arbitration panel has tremendous discretion regarding scope of discovery, if any

e. Time Limits/Schedule

Can be critical to meeting business needs and for reducing costs

f. Place of Arbitration

Can as a practical matter tip the balance in settlement negotiations (e.g., if arbitration occurs during a particularly busy time for small business or key employees. Will top execs be willing to travel across country for 2-week hearing?)

g. Allocation of Costs and Fees

e.g., are you dealing with known litigious party that needs a greater disincentive to sue?

h. Limitations on Damages

Can be part of arbitration clause or separate

i. Form of Award/Decision

e.g., limiting the text of the award to the name of the prevailing party and amount helps secure faster decision, reduces ability to appeal, and greatly limits possible precedential impact. In a high stakes case, you may want to preserve your limited options for review by requiring a more


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detailed decision. This is an issue that can also be agreed to at the time of the arbitration.

j. Limitations on Types of Claims

Do not assume all terms will be enforced if sophistication of one side/ability to negotiate are limited (e.g., consumer claims). Courts are growing increasingly hostile to clauses such as restrictions on class actions, caps on recovery, etc. Check state law carefully for consumer contracts – and choice of law can be significant.

V. INDEMNIFICATION AND LIMITATIONS OF LIABILITY

A. Tips from a Litigator’s Perspective

1. Don’t assume you cannot get a limitation on consequentials, incidentals, etc. Too often we have seen sophisticated businesses who do have sufficient negotiating leverage simply neglect to include such a limitation, or give up too easily when the other side resists.

a. Typical clause: “In no event will seller be liable for any lost

profits, loss of business, incidental, special, indirect, or other consequential damages arising out of any breach of its obligations under this Agreement.”

b. Can emphasize in negotiations that direct damages can amply

protect the parties in the event of a dispute, or other clauses such as performance penalties, liquidated damages, etc.

2. The flip side, of course, is to resist such limitations just as strongly if

you are the party whose sales, profits, or solvency are heavily dependent on the performance of a particular vendor, supplier, or partner. A middle ground may be an arbitration clause – protect your side against debilitating losses, but give some comfort to other side that it will not face an irrational jury.


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3. Beware of “form” contracts or lopsided negotiations with one-sided

indemnification clauses. Courts can enforce agreements where you have agreed to indemnify the other side for losses, even when the other side is negligent. At a minimum exclude responsibility for acts or negligence of the other side, and consider whether you want to business with anyone who would reject this basic parity.

4. Specify who is being indemnified (e.g., in addition to contracting

party, its officers, directors, employees, agents)

5. Specify the conduct triggering indemnification; e.g., any act or omission arising out of seller’s performance, including its subcontractors? Only for breach of contract? Only for negligence? As buyer, push for the broadest formulation – e.g., “any loss to buyer arising out of the agreement,” or “acts arising out of seller’s performance.”

6. Watch for ambiguity as to the type of indemnification or types of losses to which indemnification applies – e.g., for personal injury, property damage, attorneys’ fees and duty to defend/costs of defense, economic loss?

7. Watch for damages you thought were excluded coming in through the back door – e.g., in a termination clause, or an additional form contract incorporated by reference.

8. Consider caps – applying a specific cap to a set of specific indemnifiable events.

a. Caps vary according to the subject matter of the indemnification. Caps in an M&A context also may vary according to the industry space, size of target, and customer base of the target. There are a variety of tools/deal metrics charts which are helpful to the drafting of caps.

9. A note on survival terms in the M&A context

a. A topic worthy of a separate seminar, but as a general matter, note that indemnification periods vary according to the subject


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matter of indemnification. It is standard to see one time period for ownership/authority/capitalization; another for litigation/contracts; a third for ERISA/Tax; a fourth for general indemnification. Factors to consider in looking at survival terms are audit periods, statutes of limitations for certain issues (tax, ERISA), indefinite survival for certain issues, and the competitive marketplace for similar deals.

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WHEN CONTRACTS GO SOUR: Drafting and Due …eo2.commpartners.com/users/accchap/downloads/outline.pdf · Drafting and Due Diligence Lessons Learned From Litigation ... 5. As a result