Drafting Points

Critical Thoughts on Contract Drafting

A Guide to Contract Interpretation (July 2014)

Posted in Contract Interpretation and Construction

In October of last year, my former colleague, Michael Zitelli, and I published an update to our Reed Smith white paper entitled A Guide to Contract Interpretation. The guide includes a brief introduction on our philosophy regarding contract interpretation, a flow chart that illustrates the typical contract-interpretation process, and an outline of excerpts from recent opinions rendered by New York and Delaware courts (which form the basis for the contract-interpretation principles that we set forth in the guide).

The guide has been well received, and I’m happy to announce that I’ve published an updated version. You can obtain a copy by clicking on the following link:

A Guide to Contract Interpretation

The updated features of the guide include the following:

  • the analysis takes into account New York and Delaware court opinions from July 2013 to early July 2014;
  • added depth to certain sections to provide a more nuanced treatment of how courts approach interpretive issues; and
  • new sections discussing both interpretive issues and certain types of contracts and contractual provisions that merit special attention.

Additionally, I would like to thank Mike for his contribution in co-authoring prior versions of the guide, as well as Jordan M. Hook, Thomas James, and Aaron Spurlock for their assistance in preparing the current and prior versions of this guide.

Please feel free to send me any questions or comments that you might have on the guide or on contract interpretation generally.

Five Tips on Drafting Definitions

Posted in Categories of Contract-Drafting Language

Definitions are a key part of any sophisticated contract. They provide an efficient way to package a concept and to employ that concept repeatedly in a contract. Here are five tips for drafting your definitions, including some “errors” in drafting definitions that I routinely encounter.

 

1) Do not use “shall” when defining a term.

The word shall should be used to convey an obligation, and should not be used otherwise in contract drafting. See my prior post on this: The Contract Drafter Shall Not Use “Shall” (Except to Convey Obligations). Definitions employ language of policy, not obligations. And please don’t use shall as a proxy for I really mean it. Rhetoric has no place in clear contract drafting. So don’t write:

“Securities Act” shall mean the United States Securities Act of 1933.

You’ve just tried to obligate the term “Securities Act” to mean something. You’re fired. Take a deep breath and use the present tense of the verb “to mean”:

“Securities Act” means the United States Securities Act of 1933.

 

2) In a definitional index, do not embed obligations or categories of language other than language of policy in your definitions.

Language of policy–the category of contract-drafting language used to convey the “rules of the game” for a contract–should be used when defining a term. As noted above, this means using the present tense of the verb “to mean.” (Or, if you’ve got a conditional definition, then you would use the future tense.) But do not sneak in other categories of contract-drafting language. For example, do not do the following:

“Closing Certificate” means a certificate in the form attached as Exhibit A, which the Seller shall deliver to the Buyer at the Closing.

I’m not saying that a court would not enforce the Seller’s obligation to deliver the Closing Certificate at the Closing. It’s just that you’ve lumped in an obligation in an unnatural place. The definitional index is supposed to tell the reader what contract terms mean, not what the parties’ respective obligations are.

 

3) A definition might vary depending on the context in which it is used.

Suppose that you want to include a definition for gross revenues for each party to a contract. That definition will vary depending upon the party that is being referred to in the sentence in which the definition is being used. You could get by with something like:

“Gross Revenues” means a Party’s gross revenues for the period beginning on January 1, 2014 and ending on (and including) December 31, 2014, calculated in accordance with the manner in which such Party prepares such Party’s financial statements during such period.

However, when used in a stand-alone definition in this manner, a Party begs the question: which Party? The implication is that there will be a reference to a particular Party in the operative provision when referring to the term Gross Revenues. But I like to make this “pointing reference” explicit in the definition:

“Gross Revenues” means, with respect to a Party, such Party’s gross revenues for the period beginning on January 1, 2014 and ending on (and including) December 31, 2014, calculated in accordance with the manner in which such Party prepares such Party’s financial statements during such period.

 

4) Be mindful of defined terms that require temporal references.

If the meaning of a particular term could change depending upon when the parties are making a particular determination, then you’ll need a temporal reference in your definition. I see this come up with the definition of Affiliate. Take the following obligation and definition:

Section 2.4 The Stockholder is permitted to Transfer any Shares that the Stockholder holds to any of the Stockholder’s Affiliates.

“Affiliate” means, with respect to a specified Person, any other Person that controls, is controlled by, or is under common control with such specified Person. [I'm putting aside for now what "control" means.]

Are we talking about a Person that is an Affiliate at the time the contract containing this definition and obligation is signed? Or are we talking about a Person that is an Affiliate at the time of Transfer of Shares? There could be a different set of “Affiliates” depending upon how you answer this question. In order to clarify things, you’d want to reference a timing element in the obligation in Section 2.4 and then update the definition of Affiliate accordingly:

Section 2.4 The Stockholder is permitted to Transfer any Shares that the Stockholder holds to any Person that, immediately prior to such Transfer, is an Affiliate of the Stockholder.

“Affiliate” means, with respect to a specified Person and at a given time of determination, any other Person that controls, is controlled by, or is under common control with such specified Person at such time.

Note that, by including a temporal reference in this definition, it means that a “time of determination” must be addressed  when using the defined term Affiliate in your operative provisions. Sometimes you can get away with implicit references:

The Company shall not transfer any Shares to any of the Company’s Affiliates.

When in doubt (“Affiliates” as of the time transfer, or as of the time that the contract is entered into?), err on the side of being explicit:

The Company shall not transfer any Shares to any Person that, as of immediately prior to such transfer, is an Affiliate of the Company.

 

5) Do not use more than one defined term per concept.

Do NOT do the following:

“Company” or “Verbiage Co.” means Verbiage Company, a Colorado corporation.

In the interest of brevity, just pick one. Remember, unlike other forms of writing, with contract drafting, we’re concerned about functionality, not rhetoric or how “nice” a given term “sounds” in a given context.

 

Feel free to disagree (bonus points if you use one or more defined terms in conveying your contention) and to pass along tips of your own.

 

Drafting Points Quiz (and Access to Webinar)

Posted in Miscellaneous

On Thursday, February 20, from 1 p.m. – 2:30 p.m. EST, I will be co-presenting a webinar for Strafford Webinars on certain provisions in private M&A agreements. I’ve got 10 free passes to give away. I’ll give them to the first 10 people who email me the correct answers to the following questions on contract drafting and interpretation. Answers are due by 7 p.m. EST on Wednesday. Good luck!

 

1) Which of the following sentences best conveys an obligation?

 

a) The Contract shall be drafted by the Attorney.

b) The Attorney must draft the Contract.

c) The Attorney shall draft the Contract.

d) The Attorney will draft the Contract.

e) The Contract shall be drafted.

 

2) In the post “The Battle of ‘Notwithstandings’ (Using Provisions from Bert and Ernie’s Sublease),” what drink did Bert ultimately decide to indulge in after dealing, yet again, with Ernie’s frustrating banter?

 

3) Which of the following is not a contract-interpretation principle noted in the updated A Guide to Contract Interpretation (October 2013) that Mike Zitelli and I co-authored?

 

a) The same words used in different parts of a writing have the same meaning.

b) The terms of the contract should be “harmonized” and read in context.

c) If the provision is ambiguous, then the parties’ intent becomes a question of fact.

d) A contract should be construed liberally, unless otherwise provided in the contract.

e) Parol evidence cannot be used to create an ambiguity.

 

4) In May 2013, Ken Adams posted his draft of an Irreparable Harm provision. I responded in this post with a draft of my own. What is the fifth word in my draft of an Irreparable Harm provision?

 

5) Last and final question: What’s the “last and final” stop of my morning commute?

Upcoming CLEs: February 2014 – July 2014

Posted in Miscellaneous

For those of you who need CLE credit (or who are otherwise just interested in contract drafting or M&A), below is a list of some upcoming CLEs that I’ll be giving during the first half of 2014. (Note: The availability of CLE credit for these programs is subject to rules of the applicable jurisdiction.) Check back to this list from time to time for updates (or you can click here for a complete list of my speaking engagements), and feel free to contact me should you have any questions. If it’s been made available, you can click on the applicable link to be directed to the venue’s web site for a description of the course and to register.

 

February 5, 2014, 1 p.m. ET – 2:30 p.m. ET Commercial Law WebAdvisor (Webinar) Written Representations in M&A Contracts

 

February 13, 2014, 1 p.m. ET – 2:30 p.m. ET Commercial Law WebAdvisor (Webinar) Fundamental Concepts in Drafting Contracts: What Most Attorneys Fail to Consider

 

February 20, 2014, 1 p.m. ET – 2:30 p.m. ET Strafford Webinars (Webinar) Private Company Acquisitions: Drafting Reps, Warranties, Covenants and Closing Conditions – Leveraging Current Market Trends in Deal Terms When Negotiating Key Contract Provisions

 

February 26, 2014, 6 p.m. ET – 9 p.m. ET New York City Bar Association (NYC – Live at the NYC Bar Association) Fundamental Concepts in Drafting Contracts: What Most Attorneys Fail to Consider

 

March 4, 2014, 1 p.m. ET – 2:30 p.m. ET Commercial Law WebAdvisor (Webinar) Essential Concepts in Drafting Contracts: Using Language to Ensure Desired Outcomes

 

March 18, 2014, 9 a.m. ET – 12:15 p.m. ET Practising Law Institute (NYC – Live at PLI) Fundamental Concepts in Drafting Contracts: What Most Attorneys Fail to Consider

 

March 20, 2014, 1 p.m. ET – 2:30 p.m. ET Commercial Law WebAdvisor (Webinar) Select Issues in Contract Drafting: Formulas, Attachments, Ambiguities, and More

 

April 2, 2014, 1 p.m. ET – 2:30 p.m. ET Commercial Law WebAdvisor (Webinar) Drafting Contract Boilerplate: Standard Provisions That Work for Your Client

 

June 12, 2014, 6 p.m. ET – 9 p.m. ET New York City Bar Association (NYC – Live at the NYC Bar Association) Intermediate Concepts in Drafting Contracts

 

July 21, 2014, 9 a.m. ET – 4:30 p.m. ET New York State Bar Association (NYC – Live at The New York Hotel Pennsylvania) The Nuts & Bolts of Contract Drafting

The Quarks of a Contract

Posted in Categories of Contract-Drafting Language

Just like matter can be broken down into molecules, atoms, sub-atomic particles, and quarks, so too can a contract be described in various levels of hierarchy: articles, sections, clauses, sub-clauses, and categories of language. This post addresses the quarks of contract drafting.

While browsing the web for contract-drafting-related articles (yes, I do that), I came across this article by Lori Johnson at UNLV on the “building blocks” of a contract. After a hearty conversation with Lori on the topic, I’m still left wondering: what makes a “building block” a building block?

Ken Adams’s A Manual of Style on Contract Drafting initially inspired me to think about the clauses in contracts as belonging to one—and only one—category of contract-drafting language. These categories form the foundation of expression in contracts. They are a contract’s building blocks. Components of the whole that enable the drafter to clearly convey substance.

There are various categories that Lori, Ken, Tina Stark, and I (and others) have identified. Currently, I include the following as the categories of contract-drafting language:

  • language of performance
  • language of obligation
  • language of discretion
  • representations and warranties
  • acknowledgments
  • language of policy

Ken has some new categories in his most recent edition of A Manual of Style for Contract Drafting, which I need to explore further. And he has also voiced his opinion that “warranties” really don’t constitute a separate category of contract-drafting language and that representations and acknowledgments are two sub-types of a more general category: language of declaration. Other authors seem to refer to “rights” as a separate category. (To my mind, rights are not a separate category of contract-drafting language; rather, they derive from other categories.)

 

So what is a “category of contract-drafting language”?

I tend to think (for now…) that a category of contract-drafting language exists if it serves a unique function that you can express in plain english. For example, for each of the categories above, here’s how I think of them:

  • language of performance: something that’s happening by virtue of entry into the contract
  • language of obligation: what the parties have to do or are prohibited from doing
  • language of discretion: what a party is permitted to do (but, as I’ll discuss in a future post, I view language of discretion as really just an exception to an express or implied prohibition imposed by law or by a contract)
  • representations and warranties: statement of something that is (or will be…) true. I’m debating with myself as to whether “warranties” constitute a distinct category or whether they should be included at all. (I’m winning the debate.)
  • acknowledgements: something that a party is openly setting forth in writing that the party is accepting as true (whether or not that thing is actually true)
  • language of policy: the “rules of the contract”; this is the trickiest category of contract-drafting language for me

In addition to the categories noted above, there are two other types (I hesitate to call them “categories”) of contract-drafting language that can serve to qualify the nature of a given category of contract-drafting language:

  • language of exception and subordination: language that serves as either absolute or a degree of exception to a given clause
  • conditional language: language that qualifies the the extent to which a given clause applies

 

Those are the quarks that I work with to draft my contracts. As I routinely trumpet when giving CLEs (and in prior blog posts), in order to successfully draft a contract, you need to know—for each clause—which quark you’re dealing with and how that quark functions. Only then can you properly assemble the atoms, molecules, and complex compounds that comprise a contract.

The Battle of “Notwithstandings” (Using Provisions from Bert and Ernie’s Sublease)

Posted in Exceptions and Subordindation, Specific Words and Phrases

Yesterday, in this post, I addressed some of the virtues and vices of “notwithstanding.” Here’s a bit of Friday fun for you to highlight the problem that you can run into with competingnotwithstandings in a contract:

 

The Sublease

 

SUBLEASE

This Sublease, dated as of November 1, 2013, is made between Bert and Ernie.

Section 1.1. Ernie shall not annoy Bert.

Section 7.10. Notwithstanding anything to the contrary in this Sublease, Ernie is permitted to yell at Bert before 7 a.m. on Christmas morning if there are presents under the tree.

Section 12.3 Notwithstanding anything to the contrary in this Sublease, Ernie shall not converse with Bert before Bert has finished Bert’s first cup of morning coffee.

 

The Scenario

It’s 6 a.m. on Christmas morning. Ernie arises to find presents under the Christmas tree. Bert is drinking his first cup of morning joe in the kitchen. A dialogue ensues:

 

Ernie [yelling]: “Bert! Bert! There are presents under the tree! Come here, Bert! You’ve gotta see this!”

Bert [whining]: “Ernie, you know that you’re not supposed to annoy me. It says so in our sublease.”

Ernie [still yelling]: “But Bert: look at all those presents! And besides, Section 7.10 of our sublease says that I can yell at you in this circumstance, even if it’s annoying.”

Bert [getting mad]: “First of all, I’m surprised that you actually read the sublease. But I guess you didn’t read the whole thing. Section 12.3 says that you can’t talk to me before I’ve finished my first cup of morning coffee, notwithstanding anything to the contrary in the sublease. This is my first cup, and I’m not done, so put a lid on it!”

Ernie: “Gee, Bert: Section 7.10 says that, too. I’m allowed to yell aloud at you—that’s a homophone, Bert—in this case, notwithstanding anything to the contrary in the sublease.”

Bert: “Well this is just wonderful. Now we’ve got two conflicting provisions in the sublease. Who drafted this thing, anyway.”

Ernie: “It was Elmo, Bert. He jointly represented us.”

[Muted trumpet plays that “wah-wah” noise. Bert furrows uni-brow and pours a scotch.]

 

The Vices and Virtues of “Notwithstanding”

Posted in Exceptions and Subordindation, Practicalities, Specific Words and Phrases

A contract that I recently analyzed and a blog post that I recently read gave me inspiration to do a post about notwithstanding. On a fairly regular basis, I encounter and employ notwithstanding in contracts. What does this potentially daunting word mean? I think of it as meaning “despite.” Notwithstanding is used to create exceptions to rules in a contract or to circumstances or events. So, for example, suppose we have the following provisions in a sublease between Bert and Ernie:

Section 1. Ernie shall not annoy Bert.

Section 2. Notwithstanding Section 1, Ernie is permitted to annoy Bert on Christmas morning.

Here, the general rule is set forth in Section 1. Section 2, however, subordinates that general rule in certain cases (namely, on Christmas morning). Section 2 does this by using Notwithstanding. The provision is telling the reader (colloquially): Despite what I said in Section 1, here comes an exception.

There are other ways to convey exceptions in contracts (e.g., except and subject to), but I’ll save the larger topic of exceptions generally for another blog post. For now, I’d like to discuss the virtues and vices of notwithstanding. Let’s start with the vices.

 

The Vices

 

1) Confusion as to its meaning

The first issue with notwithstanding is its tendency to confuse readers. This is just about as lawyerly a word as you can get in contract drafting without straying into Latin. Ipso facto, it tends to confuse readers. I think it took me about two years of practicing law to be able to come across this word and not have to access the recesses of my brain to figure out what I was reading. Many people, in fact, confuse notwithstanding (which subordinates the text that immediately follows it) with its polar opposite, subject to (which elevates the text that immediately follows it).

 

2) It tends to subordinate rules that are not always readily identifiable

In our example above, it’s clear which rule notwithstanding is subordinating because that rule is specifically referenced. But notwithstanding is often coupled with anything to the contrary in this Agreement. In other words, it often serves as an all-encompassing rule that trumps all. The “contrary” provision could be located in the immediately prior provision. Or it could be located 80 pages away.

Moreover, using notwithstanding in this context begs the question: what exactly in this Agreement is “contrary”? This issue arises with respect to exceptions generally (and will be the subject of a future blog post). But, when coupled with a broad notwithstanding anything to the contrary in this Agreement, the issue becomes magnified. The drafter had better have a firm understanding of what provisions are or might be contrary, or else be comfortable that the “trumping” rule being implemented really should trump all.

 

3) The battle of the notwithstandings

A related issue is that, in the throes of negotiating a 90-page document (or several 90-page documents), you end up with more than one all-encompassing notwithstanding rule. The question then arises as to which notwithstanding “wins.” I’ll post an example of this tomorrow, using our friends Bert and Ernie…

 

4) The problem of the foregoing

Notwithstanding also often gets coupled with the foregoing, as in: Notwithstanding the foregoing, the Seller is permitted to disclose the transaction to Bob. The foregoing means, more or less, “that which came before” or “the thing mentioned before.” This can cause trouble in its own right, but is a pitfall that often arises when used with notwithstanding. For example:

Bill shall not disclose the existence of the time machine. Bill shall not disclose where Bill has been on Wednesday. Notwithstanding the foregoing, Bill is permitted to tell Ted that he has been to England.

Suppose that Bill visits medieval England on Wednesday. He can tell Ted that he’s visited England on Wednesday. But can he tell Ted that he visited England in 1431 using his time machine? The last sentence wouldn’t necessarily permit that conclusion; it’s unclear “how far back”the foregoing”reaches.”

 

The Virtues

Notwithstanding my commentary under the heading “The Vices” (see what I did there?), notwithstanding has its virtues. I’ve separated those out below in separate points, but the benefits are all interrelated and each has to do with practicalities rather than pure logic and precision. And each involves coupling notwithstanding with anything to the contrary in this Agreement when your client is the party that is the beneficiary of the trumping rule.

As such, Notwithstanding anything to the contrary in this Agreement can be useful in the following situations:

 

1) Your client needs a broad rule

In an ideal world, you’d know your contract inside and out. The contract would be free from ambiguity and would be perfectly easy to read. Moreover, all parties would have a clear understanding of how all of the provisions of the contract interact. While we strive for these characteristics in drafting, the practicalities of the day creep in and do so pretty quickly. We don’t always have the time or money to analyze each provision of a contract or of multiple contracts to determine whether that provision should or should not be subordinated. And we might have a pretty clear directive that the exception is meant to be all-powerful. For example, if my client tells me that, above all else, the company cannot be liable for more than $50 million under the contract or with respect to matters relating to the contract, you can bet that I’ll drop in a Notwithstanding anything to the contrary in this Agreement-type provision implementing that concept.

 

2) You know which provisions should be subordinated…and there are many of them

Suppose that you want to implement a trumping rule in your contract. Suppose, also, that you do in fact know your contract inside and out and have identified 23 provisions that need or might need to be subordinated, depending upon the circumstances. Rather than separately stating the 23 discrete provisions that should be subordinated, a Notwithstanding anything to the contrary in this Agreement might do the trick, especially if your client is the beneficiary of the trumping rule.

 

3) You’ll likely need to subordinate additional provisions as negotiations proceed

If you know that more provisions are forthcoming in your contract and that those provisions will likely need to be subordinated to the general rule, then, rather than providing “subject to [trumping rule]” as each new provision is inserted, you might simply want to make your trumping rule apply notwithstanding anything to the contrary in the contract. Moreover, you might want to do this to also avoid a negotiation with your counterparty as to whether a given provision does or does not require subordination. And, as a practical matter, once you’ve gone the route of using subject to to subordinate provisions, it might be difficult later on to reverse course and implement a notwithstanding anything to the contrary in this Agreement approach.

 

The Conclusion

In the end, I tend to stay away from notwithstanding. It’s more verbose than other methods of subordinating language, and, when coupled with anything to the contrary in this Agreement, it can affect provisions without warning. Moreover, it can give rise to ambiguities. That being said, I do tend to use notwithstanding from time to time. But I do so consciously and for practical purposes. Specifically, notwithstanding anything to the contrary in this Agreement can be particularly useful if your client is the beneficiary of the trumping language, if you and your client are confident that the trumping language should apply in all cases, and if you are concerned about not “catching” one or more provisions that should be subordinated.

A Guide to Contract Interpretation (October 2013)

Posted in Contract Interpretation and Construction

In February of this year, my colleague, Michael Zitelli, and I published a Reed Smith white paper entitled A Guide to Contract Interpretation. The guide includes a brief introduction on our philosophy regarding contract interpretation, a flow chart that illustrates the typical contract-interpretation process, and an outline of excerpts from recent opinions rendered by New York and Delaware courts (which form the basis for the contract-interpretation principles that we set forth in the guide).

The guide was well received, and I’m happy to announce that we’ve now published an updated version. You can obtain a copy by clicking on the following link:

A Guide to Contract Interpretation

The updated features of the guide include the following:

  • our analysis takes into account New York and Delaware court opinions from July 2012 to July 2013, as well as some additional case law;
  • added depth to certain sections to provide a more nuanced treatment of how courts approach interpretive issues;
  • new sections discussing both interpretive issues and certain types of contracts and contractual provisions that merit special attention; and
  • an updated flow chart, which organizes the interpretive concepts in the guide in a linear fashion.

Additionally, Mike and I would like to thank Jordan M. Hook and Tom James for their assistance in preparing the guide.

Please feel free to send me any questions or comments that you might have on the guide or on contract interpretation generally.

Penn Station: “Last and Final” Stop

Posted in Contract Interpretation and Construction

I take the Long Island Railroad to and from work each day. Every now and then, I’ll hear a conductor trumpeting one of my pet peeves (I have many): “Penn Station: last and final stop.” This grates on me like fingernails on a chalkboard. The “last and final” cadence is an example of a couplet. And many couplets are redundant, articulated for rhetorical purposes. The more-savvy conductors simply say “last stop” or “final stop.” There’s no point to using both “last” and “final.” (Could there be a “last and penultimate stop”? How about a “last and somewhat final” stop? Maybe, if you consider “the yard” a stop…)

Couplets can also be found in contract drafting. Not the kind of “couplet” found in poetry. (Although, how cool would it be if attorneys were required to draft contracts in verse?) Rather, I’m referring to a pairing of terms with commonly understood definitions that overlap to a large extent. And sometimes the overlap is so large that one term subsumes the other or is completely coextensive in definition with the other, at least when ordinary-sense definitions are applied.

One problem with couplets in contract drafting is that they are evidence of rhetorical emphasis, which has no place in writing that is meant to govern the relationship between two or more persons. You might as well say: “Last and final stop. Seriously, guys. I’m not kidding. That’s why I said both ‘last’ and ‘final.’ ”

But a more pernicious problem is one of contract interpretation. One principle of contract interpretation is that a court will attempt to give different meanings to different terms, even if those terms ostensibly would otherwise cover the same concepts. For example, if in your contract you refer to terms and conditions, a court might be inclined to interpret terms to have one meaning and conditions to have another. That’s not always problematic. But issues can arise where, for example, you simply use the word terms (i.e., without conditions) elsewhere in the contract; the court might reason that terms means something less than one would ordinarily think the word terms means.

Here are some classic contract-drafting couplets (or triplets) and my suggested replacements:

  • null and voidvoid
  • covenants and agrees to – shall
  • covenants, agrees, and undertakes to – shall
  • cease and desist – cease (or another verb, depending upon the context)
  • by and betweenbetween
  • true and correctaccurate
  • terms and conditions – terms

There are many other examples. (You’ll note that I did not attempt to tackle the hotly contested represents and warrants or indemnify, defend, and hold harmless. Perhaps I’ll weigh in on those another day…)

And I should also mention that there are some instances in which I don’t have the time or inclination to consider whether two terms constitute a true couplet, i.e., such that their ordinary-sense definitions completely overlap or that one term subsumes the other. For example, when representing a buyer in an M&A deal, I tend to throw in the kitchen sink in my definition of Lien rather to try to negotiate against the other side, my colleagues, my client, and myself as to whether there is a distinction between pledge and encumbrance.

And now I need to close. I’m writing this post as I’m riding the LIRR and we just reached the last and final stop.

Don’t Purport to Bind Third Parties to Your Contract

Posted in Categories of Contract-Drafting Language

Picture the following: you’re walking down the street, minding your own business, maybe eating some ice cream. All of a sudden — bam! You’re hit with an obligation. You didn’t even know it was coming. Before you know it, Big Brother just contractually bound you to an indemnification obligation under a contract that you didn’t even sign.

And then you wake up in a cold sweat. It’s ok. It was all just a bad dream. Imagine what life would be like were your nightmare to be reality.

Yet this is what I see all too often in contracts: the parties purporting to bind to their contract individuals or entities that haven’t signed that contract. Here are some examples:

 

  • The Accountants shall deliver a report no later than 60 days after the Closing Date. What if the Accountants shalln’t? You can’t sue them under the terms of the purchase agreement in which this sentence is contained. Obligate the Accountants to produce and timely deliver their report under an engagement letter, not a purchase agreement that the Accountants didn’t sign.

 

  • The Company’s board shall meet each Tuesday at 10 a.m. Let’s suppose that this purported obligation is contained in a joint venture contract, not the bylaws of a corporation. Unless the board members are signing that contract, don’t purport to obligate them to meet. (Exception: there’s law out there that says that managers of a Delaware LLC are bound by the terms of the LLC’s operating agreement. This might be true in other contexts as well.)

 

  • The Company, the Company’s affiliates, and the representatives of each of the foregoing shall not disclose any Confidential Information. Ok for the Company; not ok for the Company’s affiliates and representatives. Here’s an example of where you might want to use conditional language: if any of the affiliates or representatives discloses Confidential Information, then the Company is on the hook for damages or must take actions to stop that disclosure from continuing to occur.

 

The problem of “cause”

If you’re trying to solve these kinds of problems, don’t fall into the trap of solving the problem by obligating a party to “cause” another person that that party doesn’t control to take or not take action. That won’t completely work unless (1) that party can actually control the actions of the other person (e.g., a parent company controlling its subsidiaries) or (2) you include a concept in your contract of what the obligation to “cause” someone to do something means (e.g., the party must exercise that party’s rights under its contracts with the other person to seek recourse against that other person).

Some examples:

 

  • The Company shall not engage (and shall cause the Company’s affiliates not to engage) in any Competing Activities. The Company will not be able to exercise control over those entities that it does not control (e.g., parent companies and “sister” affiliates). There of course might be other bases for bringing action if sister entities engage in Competing Activities. For example, if the entities share common officers and directors, the beneficiary of that non-competition obligation might be able to bring some sort of action. (I leave the details of that claim to you litigators.) But any such action would be extra-contractual and I would not rely on it as a basis for breach of contract.

 

  • The Company shall cause the Company’s suppliers to timely deliver all Raw Materials. There are probably arguments that you could make as to what “cause” means here, i.e., the Company has to take some degree of action to try to get its suppliers to deliver Raw Materials on time. But I’d want to flesh out exactly what the Company has to do (or at least include a non-exhaustive list of actions that the Company is required to take).

 

What to do

There are a couple ways to plug these third-party gaps. Consider using one or more of the following:

 

  • Have the person that you want bound sign the contract, even if it’s for only limited purposes.

 

  • Have a party “cause” the third party to take action; just be sure that you define what “cause” means or are comfortable with the potential ambiguity that comes along with that concept given the context.

 

  • Include a “trigger”—a consequence under the contract if the third party takes unwanted action or fails to take required action—that will be binding on the parties to the contract.

 

So each time you try to create an obligation under a contract, just be sure that the person that you want to obligate is signing on the dotted line. Our wonderful freedom-of-contract world is not suited for Orwellian notions of spontaneous obligations.