Affiliate definition notes
May 4, 2008
Why “affiliate” is often a defined term
Some contracts give “affiliates” of parties some of the same rights and/or obligations as the parties themselves (for example, some license agreements). Other contracts require parties to make representations and warranties not only about themselves but about their affiliates as well (for example, some merger agreements). This sample clause is a fairly typical definition of affiliate, mirroring definitions found in U.S. securities laws such as Rule 501(b) of SEC Regulation D, 17 CFR § 230.501(b).
Heads-up: Could competitors be affiliates?
Conceivably, one of the other side’s existing (or future) affiliates could turn out to be one of your competitors, or some other person or entity you’d just as soon not do business with. Ask yourself whether it would cause you any heartburn if such an affiliate were to have the rights (and/or obligations) of an affiliate under the Agreement.
Heads-up: Less than 50% ownership for “control”
Some contracting parties may ask for a lower percentage than 50% to establish "control": They may have subsidiaries in which they own less than a majority of the stock, but they feel they still have de facto voting control. Counterparties might not be comfortable with less than 50% control, however. For those situations, consider specifying particular non-controlled organizations that are to be deemed affiliates even in the absence of a control relationship.
Heads-up: Loss of affiliate status
It might be appropriate to provide in the Agreement, in case of loss of affiliate status, for the orderly phase-out of specific rights and obligations. For example, suppose that (1) a software license agreement permitted the licensee’s affiliate to use the software, and (2) that an affiliate were to lose its status as such because of a corporate divestiture. It could be quite disruptive if the affiliate were required immediately to stop using the licensed software.
Heads-up: Affiliate “control” through power to direct management
Some contracting parties want their “affiliates” to include companies that they control through, for example, “the power to direct or cause the direction of the management and policies of the organization, directly or indirectly, whether through ownership of voting securities, by contract or credit arrangement, as trustee or executor, or otherwise.” This language is modeled on text found in the U.S. securities laws (for example, in Rule 1-02(g) of SEC Regulation S-X), and for regulatory purposes such language may be all well and good. But this kind of definition of “control” were to be used in a contract, it’s not hard to imagine how, in later litigation, the parties might have to engage in extensive — and expensive — discovery about who has what management power. In some circumstances, it may be sufficient to state that certain specified companies will be deemed “affiliates,” even though the specific legal relationships in question don’t qualify as "control."
Contracts should explain their terms as necessary
May 2, 2008
I couldn’t disagree more strongly with my friend Ken Adams’s comment that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.” That’s way too categorical a statement for my taste. Contracts are read and followed by people, not by computers, and people sometimes need to be persuaded to do the things they’re theoretically supposed to do. That’s where it can be extremely helpful to record reasons and explanations into a contract.
Suppose Company A signs a contract requiring it to do X. It won’t necessarily happen that way automatically. One or more people need to make X happen, and those people might balk at doing so:
- Company A’s management might decide they want the company to do Y instead of X because of changed circumstances.
- Or it might be that Alice at Company A negotiated the contract, but her colleague Allen is now responsible for making X happen, and Allen thinks doing X is a bad idea.
If Company A’s lawyer can think of even a faintly-plausible rationale for not doing X, the odds are that the company will simply fold its arms and say “nope.” (I speak from hard experience on this score.)
That’s where reasons and explanations can come in handy: If the contract explains the business reasons that Alice committed the company to doing X, there’s a better chance that Allen will understand her reasoning and go along with her commitment.
The same is true in contract litigation: Judges sometimes need to be persuaded too. This is especially true if there’s more than one way to read the contract — again, this is where reasons and explanations can come in very handy.
Nonreliance
April 16, 2008
The Pactix entire-agreement clause disavows reliance on representations extrinsic to the contract. This provision is intended to forestall claims of fraudulent inducement. See generally R. Bruce Wallace and Christie Matthews, Using Non-Reliance Clauses in Defense of Fraud Claims (accessed Oct. 15, 2007).
Attorneys’ fees - notes
April 16, 2008
Prevailing-party attorneys’ fees
Some people view a prevailing-party allocation (sometimes called the loser-pays rule, or the everywhere-but-America rule) as fundamentally fair: If you lost a case, presumably you were responsible for the case having to be litigated, so you should pay the attorneys’ fees and expenses that you made the winner spend.
Big companies, however, sometimes regard legal fees in litigation as a cost of doing business — and once in a while, they might consciously want to use their superior financial strength as a litigation advantage over adversaries with fewer resources.
Attorneys’ fees for motion practice, etc.
Motion practice and other preliminary proceedings account for much of the expense of litigation. A contract drafter might want to include a clause allowing the parties to agree to a prevailing-party allocation not just for the final outcome, but for preliminary proceedings as well, in the interest of promoting reasonableness by litigants and their counsel.
Of course, there’s a potential problem with such a clause: If bad blood exists between the parties (and/or between their lawyers), the winner of every little motion is likely to demand to recover its attorneys’ fees for the motion. That would be a waste of resources for all concerned.
To discourage this, a motion-practice attorneys’ fees clause can require a showing of good cause. It can also make an award subject to the tribunal’s discretion.
American-rule attorneys’ fees clause
In many U.S. jurisdictions, there’d be no need for a clause stating that each party must pay its own attorneys’ fees, because that would be the default rule in any case. In Texas, however, a party that successfully enforces a claim on an oral or written contract (but not a party that successfully defends against an enforcement action) is entitled to recover attorneys’ fees. See Tex. Civ. Prac. & Rem. Code § 38.001. Consequently, if a party thinks it is more likely to be the defendant in a contract case than the plaintiff, that party might want to affirmatively include an American-rule, pay-your-own clause in the contract, in the hope of cutting off the plaintiff’s statutory right of recovery in such a jurisdiction.
Accepting goods or services
April 12, 2008
The Uniform Commercial Code’s acceptance rules for sales of goods
In a nutshell, UCC article 2, part 6 provides in part that:
• Failure to reject goods within a reasonable time after delivery constitutes acceptance, provided that the buyer has had a reasonable opportunity to inspect the goods. 2-602(1), 2-606(1)(B). A rejection must state the reason(s) for rejection with particularity (subject to certain limitations). 2-605.
• After acceptance, the buyer must pay for the goods. 2-607(1). It can still exercise any warranty rights it might have, 2-607(2), although it must bear the burden of proof that the goods were deficient. 2-607(4). If the buyer establishes a breach of warranty, it is entitled to recover “the difference at the time and place of acceptance between the value of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount.” 2-714.
• Alternatively, the buyer can revoke acceptance, subject to certain limitations, 2-608, in which case it can “recover so much of the price as has been paid.” 2-711(2)(a).
Confidential information notes posted
April 3, 2008
I just posted a long article with general notes about confidentiality clauses.
Contract creation - an industry, not a craft
August 27, 2007
We contract drafters and -reviewers tend to strive for perfection. We’ve been trained to craft language that gives our clients as much of an "edge" as possible. We can cite compelling ethical reasons for doing so; we also have reputational pressures and other institutional incentives that move us in that direction. And many wordsmiths (like many computer programmers) are secretly convinced, in the depths of their souls, that "I can do it better."
But in the bigger picture, we may be doing more harm than good that way.
The forceps experience
I was struck by an analogous "case study" in the world of medicine, described by surgeon and Harvard Medical School assistant professor Atul Gawande (who is also a Rhodes Scholar and a 2006 "genius grant" MacArthur Fellow).
Gawande reports that obstetricians began questioning their use of forceps and other techniques for handling difficult deliveries, as well as their preference for avoiding surgical Cesarean-section deliveries where possible. Their questioning was motivated in part by their competitive desire to improve their newborns’ Apgar scores (and doubtless also by the threat of malpractice liability).
The obstetricians knew that, in the hands of skilled practitioners, forceps can produce fine results. But they also recognized that the proper use of forceps is based largely on feel, which is very hard to learn (and to teach). And improper use of forceps can seriously injure both child and mother. In contrast, while Cesarean-section surgery is surgery, and thus has inherent risks, it also is readily capable of being taught (because the instructor can observe and coach the new doctor in real time).
So the obstetrical profession found itself having to decide whether occasional terrible results from the use of forceps were an acceptable price to pay for the quest for perfection, viz., the avoidance of C-section surgery:
If medicine is a craft, then you focus on teaching obstetricians to acquire a set of artisanal skills—the Woods corkscrew maneuver … , the Lovset maneuver …, the feel of a forceps for a baby whose head is too big. … You accept that things will not always work out in everyone’s hands.
But if medicine is an industry, responsible for the safest possible delivery of some four million babies a year in the United States alone, then a new understanding is required. The focus shifts. You seek reliability.
You begin to wonder whether forty-two thousand obstetricians in the Unites [sic] States could really safely master all those techniques. You notice the steady reports of terrible forceps injuries to babies and mothers, despite all the training that clinicians received.
After Apgar, obstetricians decided they needed a simpler, more predictable way to intervene when a laboring mother ran into trouble. They found it in the Cesarean section.
Atul Gawande, Better: A Surgeon’s Notes on Performance, at 192 (Henry Holt & Co. 2007) (emphasis and extra paragraphing added).
A baseball analogy
You could think of delivering babies in baseball terms. Obstetricians knew that, in the clutch, their leading players could regularly "hit home runs" by using forceps. But not all their players could do this when needed, especially the rookies.
The obstetricians realized that their collective clutch performance was not what they wanted. So team-wide, they de-emphasized swinging for the fences, i.e., using forceps, in problem situations. Instead, they began stressing doing what it takes to just "get on base," i.e., C-sections.
Contract creation is likewise an industry, not just a craft
We contract creators can take some lessons from the obstetricians’ experience. Many of us tend to think of contract creation primarily as a craft: within the constraints of professional ethics, we focus almost entirely on achieving the best result for this client. We sometimes secretly take pride in fashioning (what we imagine is) the best possible contract language for the situation. We inculcate this ethos into our junior professionals, both expressly and by subtle cues.
But contract creation is an industry, too. This means we professionals must also think in terms of achieving the safe and healthy "delivery" of thousands of new business relationships every year.
And therein lies a problem: Fashioning the best possible contract language, like using forceps (or hitting clutch home runs), is tough to learn and to teach. Doing it wrong can lead to significant complications. Moreover, many of those complications are hard to predict in advance even for seasoned pros — yet much of everyday contract creation is done by junior professionals who have not always had the requisite experience.
Just as obstetricians found themselves rethinking their use of forceps, we may have to rethink our emphasis on custom-crafting the language of each contract. As Dr. Gawande notes about delivering babies (see id. at 192), sometimes reliability is more important than "the possibility of occasional perfection."