The Art of Contracting - Association of Corporate Counsel · reasonable bestefforts 345 0 ......

The Art of ContractingTools and Tips for Identifying and Avoiding Common

Traps in Commercial Contracts

July 13, 2016

Crowell & Moring LLP590 Madison Avenue, 20th Floor

New York, NY 10022‐2544www.crowell.com

© 2016 Crowell & Moring LLP

How are various efforts standards interpreted?Efforts

What is material?Materiality

What claims are covered? Are there limitations?Indemnification and Limitation Liability

How to handle disputes under the contract?Dispute Resolution

What is the effect of force majeure provisions?Force Majeure or Impracticability

Overview of Today’s Workshop

2© 2016 Crowell & Moring LLP

STANDARDS OF EFFORT


Phrase # of Contracts Using

# of Contracts Defining

best efforts 627 1

commercially reasonable efforts 425 1

reasonable best efforts 345 0

reasonable efforts 307 0

good‐faith efforts 58 0

commercially reasonable best efforts 46 0

diligent efforts 23 0

good‐faith best efforts 8 0

every effort 5 0

commercially reasonable and diligent efforts 3 1

What Standards of Effort Are Used

“Understanding ‘Best Efforts’ And Its Variants,” Kenneth A. Adams, The Practical Lawyer, 2004


Opening Thoughts

Language may drive conduct even if its enforceability is questionable.

Negotiating history may matter.

Strive for consistency and clarity.


» Heavily negotiated– Contract lawyers often use more than one standard in any given contract.

– Avoids naked obligations and is especially useful when performance of the obligation is not entirely within the performing party’s control.

» Frequently litigated …

» … to unpredictable results.

Why the Focus on Efforts Clauses?


» Obligates performing party to use some levelof diligence to accomplish a contractually assigned duty.

Example: Contract obligates distributor to use best efforts to promote and sell manufacturer’s products.

What Does Best Efforts Mean?


» Delaware: Promisor must undertake its contractual obligations diligently and with reasonable effort.”

» California: Best efforts does not mean every conceivable effort. It does not require the promisor to ignore its own interests, spend itself into bankruptcy, or incur substantial losses to perform its contractual obligations.”

See Cal. Pines Prop. Owners Ass’n v. Pedotti, 206 Cal. App. 4th 384, 387 (2012); Crum & Crum Enters., Inc. v. NDC of Cal., L.P., 2010 WL 4668456, *5 (D. Del. Nov. 3, 2010)

Interpreting Best Efforts Clauses


“I can’t agree to use best

efforts! That would

require me to bankrupt

my company!”

Debunking the New York Myth


Level of effort required is murky : » due diligence

– Van Valkenburgh, Nooger & Neville v. Hayden Publ. Co., 30 N.Y.2d 34, 45 (N.Y. 1972)

» all reasonable methods– Town of Roxbury v. Rodrigues, 716 N.Y.S.2d 814, 815 (N.Y. App. Div. 2000)

» reasonable efforts– Timberline Dev. LLC v. Kronman, 702 N.Y.S.2d 237, 239 (N.Y. App. Div. 2000)

» genuine effort– Foster Wheeler Broome Cnty., Inc. v. County of Broome, 713 N.Y.S.2d 92, 94 (N.Y. App. Div. 2000)

See also Ashokan Water Servs., Inc. v. New Start, LLC, 807 N.Y.S. 2d 550, 553 (N.Y. Civ. Ct. 2006) (summarizing prior interpretations of “best efforts” standards)

So, What Does NY Case Law Actually Say?


» No case identified requiring a performing party to “spend itself into bankruptcy.”

» The Second Circuit has held that New York law does not require a party performing under a “best efforts” standard to “spend itself into bankruptcy.”

Bloor v. Falstaff Brewing Corp., 601 F.2d 609, 614 (2nd Cir. 1979)

Bankrupting the Company


» “Practitioners . . . tend to view all the other phrases, while perhaps not being too different from each other, as being definitely different from “best efforts.”

Lou R. Kling & Eileen T. Simon, Negotiated Acquisitions of Companies, Subsidiaries and Divisions,§13.06

n.3.2 (2003)

Best Efforts vs The Rest


Because recent case law suggests that best efforts incorporates the concept of reasonableness,

unless a contract definition provides otherwise, “reasonable best efforts,” “reasonable efforts” and “commercially reasonable efforts” are likely to be interpreted to mean the same as “best efforts.”

Interpreting the Variants


“The standard imposed by a ‘reasonable efforts’ clause such as that contained in section 7.01 of the Agreement is indisputably less stringent

than that imposed by the ‘best efforts’ clauses contained elsewhere in the Agreement.”

In re Chateaugay Corp., 198 B.R. 848, 854 (S.D.N.Y. 1996), aff’d 108 F.3d 1369 (2d Cir. 1997)

Inconsistency


» Fact‐specific inquiry with unpredictable results – other than expensive litigation

» Courts will look to promises or projections made in negotiation, industry standards, prior conduct, etc.

The Aftermath – Litigating Disputes

See Samica Enters., LLC v. Mail Boxes Etc., 637 F. Supp. 2d 712, 717 (C.D. Cal. 2008): whether a defendant used best efforts under the circumstances is a

factual question usually reserved for the jury.


At least one NY court refused to enforce an undefined best effortsstandard.

See Timberline Dev. LLC v. Kronman, 702 N.Y.S. 2d 237, 239 (N.Y. App. Div. 2000)

Consider your audience:– A former D.A., now judge, may have no idea what

commercially reasonable best efforts are. Describe the applicable standard of conduct:

– “level of effort customarily employed by a reasonable venture capitalist”– “level of effort used to sell your own products”– set minimum thresholds

Provide illustrative examples.

Drafting Considerations


What does “material” really mean?


“obtain all material

consents” “Assigned Assets include

all material assets used

in the business”

“terminated only in the

event of material

breach”

“Vendor may use

subcontractors only to

perform non-material

obligations.”

“in the event of a

material delay”

How is “material” really used?


Is of such a nature that knowledge of the item would affect a person’s decision‐making process (Delaware; Blacks Law Dictionary)

Goes to the root of the agreement between the parties(New York)

Affects a party’s decision as to whether or not to enter into the contract (California)

Common Definitions


» Many jurisdictions use the deal‐breakerdefinition:

– Question: Would the innocent party have agreed to enter the contract without the inclusion of the disputed clause?

Most Common Definition

Material = so substantial as to defeat the purpose of the entire transaction.


– (a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;

– (b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;

– (c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;

– (d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;

– (e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.

New York Courts – Restatement of Contracts § 241 Factors


Use materiality consistently throughout the contract.

Evaluate the purpose of using materiality.

Use dollar thresholds instead of materiality.

Specifically identify which provisions or obligations are material.

Use terms other than materiality where other terms might provide a more clear meaning.

Practice Tips


RISK ALLOCATION


Reps / Warranties

Indemnity

Limitation of Liability

Stipulated Damages

Elements of Risk Allocation


LIMITATION OF LIABILITY


» Limitation of liability provisions limit a party’s exposure in the event of a dispute.

» Parties may limit:

» Total amount of damages

» Types of damages (e.g., consequential or punitive damages)

» Nonmonetary relief

Preventing Excessive Exposure


Limitation of Liability.

Each party’s liability, whether in contract, tort, otherwise, arising out of or in connection with this Agreement … shall not exceed the amount of the License Fee.

IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR ANY SPECIAL, INCIDENTAL, PUNITIVE, CONSEQUENTIAL (INCLUDING LOST PROFITS) OR TORT DAMAGES ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT...

Example


» Courts generally enforce liability limitations in claims for breach of contract and negligence.– May not be enforced for intentional torts– Limitations for “gross negligence” subject to challenge

Compare City of Santa Barbara v. Superior Court, 41 Cal. 4th 747, 758 (2007) and ABRY Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006).

– NY courts define gross negligence more like intentional misconduct.

» The language of the limitation is “strictly construed.”

» Litigation often results over the language used.

Enforceability


» There are essentially four types of damages:

–Direct

–Consequential / Special– Incidental

–Punitive

» All four types can be limited.

Primary Types of Damages


» Direct damages “follow from the type of wrong complained of.”

– Black’s Law Dictionary 446 (9th ed. 2009).

» Courts generally uphold caps on direct damages to the amount paid under the contract.

– Markborough v. Superior Court, 227 Cal. App. 3d 705 (1991) (limiting recovery to the amount of the consulting fee paid to the defendant).

» Caps of less than the amount paid under the contract may also be upheld.

– See, e.g., Sch. Dist. of the City of Niagara Falls v. CrossPointe, LLC, 2011 U.S. Dist. LEXIS 143739 (W.D.N.Y. 2011) (limitation on damages to annual service fee presumed valid); Rob‐Win, Inc. v. Lydia Sec. Monitoring, Inc., 2007 Del. Super. LEXIS 421, *20‐21 (Del. Super. Ct. 2007) (upholding cap of $250 for security alarm monitoring).

Limiting Direct Damages


» Limitation on direct damages upheld for intentional breach of contract.– Example: in a services agreement, the limitation of liability is $100,000. The

cost to perform increases by more than $100,000. The vendor stops performing.

– Result: Customer’s direct damages limited to $100,000.

– Caution: The contract may also include a specific performance clause, which could also be invoked.

Intentional Breach

An “economically motivated decision cannot, as a matter of law, rise to the level of malice or intentional wrongdoing necessary to invalidate” a limitation of liability provision. See Net2Globe Int’l, Inc. v. Time Warner Telecom, 273 F. Supp. 2d 436, 451 (S.D.N.Y. 2003).


» Consequential damages are “[l]osses that do not flow directly and immediately from an injurious act but that result indirectly from the act.”

– Black’s Law Dictionary 446 (9th ed. 2009).

» Courts generally uphold limitations on consequential damages.

» Consider whether to define direct or consequential damages.

Consequential Damages


» The line between what is a direct damage and what is a consequential damage is blurry, at best.

» One way to avoid ambiguity is to clearly define direct damages:

– For the avoidance of doubt, the following shall be considered direct damages and Vendor shall not assert that they are indirect, incidental, consequential or special damages to the extent they result from Vendor’s failure to perform in accordance with this Agreement: (a) commercially reasonable costs and expenses of restoring or reloading any Client Data that is lost, stolen or damaged due to Vendor’s failure to safeguard the Client Data and (b) reasonable expenses incurred by Client, including overhead allocations for employees, wages and salaries of employees, travel expenses, overtime expenses and similar charges, due to a failure of Vendor to provide all or a portion of the Services.

Avoiding Ambiguity


Are “lost profits” consequential or direct damages?

Are “lost profits” consequential or direct damages?

Key Question


» Lost profits may be categorized as either consequential damages or direct damages, or both.

» A contract that does not cap direct damages but excludes consequential damages invites litigation over the availability of lost profit damages.

– See Coremetrics, Inc. v. AtomicPark.com, LLC, 2005 U.S. Dist. LEXIS 40484, *8 (N.D. Cal. 2005) (lost profits recoverable despite exclusion of consequential damages).

Lost Profits


Limitation of Liability.

Vendor’s liability for all damages, whether in contract, tort or otherwise arising out of or in connection with this Agreement, including from any and all claims related to the breach of this Agreement or nonperformance by Vendor. . . shall not exceed the amount of the License Fee.

Without limiting the foregoing, in no event will Vendor be liable for any lost or prospective profits, indirect, incidental, consequential, special, exemplary or punitive damages, arising out of or in connection with this Agreement . . .

Revised Contract Language


Consider whether to include a direct damage cap. Choose a reasonable amount for the cap. Define lost profits as either direct or consequential damages.

Ensure that the limitation of liability covers all available forms of potential liability.

Consider whether there are any claims (such as indemnifiable third party claims or breaches of confidentiality) that should be outside the limitation of liability.



INDEMNIFICATION


A promise by the indemnitor to safeguard or hold the indemnitee harmless against existing or

future loss or liability, or both.

Definition


Is one party likely to create risk or liability for the other party?

What would be the result in the absence of an indemnity?

If not, the risk should be shifted to the liability‐creating party.

Is that the “fair” result?

Decision Path


» Third party claims only or all losses?» What losses are covered?» Indemnify v. defend» Indemnification procedures» Effect of indemnification on other provisions» Is indemnity an exclusive remedy?

» Liability caps and other limitations

Common Negotiation Points


» Indemnify –– to reimburse someone for a loss suffered and paid by that person – after‐the‐fact

» Defend –– to take actions to protect someone against a loss– ongoing obligation

» Hold Harmless –– A court may construe a “hold harmless” obligation to be more

broadly defined than intended.

Indemnify v. Defend


» Notice and remedies for untimely notice» Conflicts of interest» Cooperation and assistance

– Internal costs / out‐of‐pocket costs» Reporting to (and participation of) the other party

– Approval rights or notice only?» Approval of settlements

– Indemnified Party should have right to approve any settlement that involves anything other than a payment of money by the Indemnifying Party.

Indemnification Procedures


Control of Defense


» First party claims v. third party claims only– Does the indemnity cover losses incurred by the counterparty?

– Consider limiting indemnification obligations to third party claims only.

– Counterparty may still be able to sue for breach of contract –if there is a representation or covenant breached.» Practice Tip: Include both a representation AND an indemnity obligation.

» Caution: Breach of representation may not be available if it is qualified by knowledge or if indemnity is the exclusive remedy.

What is a Claim?


» What losses are covered?– Costs of internal investigations?– Taxes or similar charges, interest or penalties? – Costs of attorneys’ fees and expert witnesses?– Losses incurred by customers or end users?– Arbitration fees? Court costs?

» Practice Tip: Indemnifying Party may want to try to limit losses to finally adjudicated or settled amounts payable to third parties only:

– indemnify the Indemnified Party against any Losses finally awarded against such party to a third party making such Claim, by a court of competent jurisdiction or agreed to in settlement and actually paid to such third party.

Scope of Losses


» Time Limitations– Consider including time limitations for the indemnitee to bring a claim.

» Cap– Consider including an overall limit of liability.– Consider excluding certain types of damages.

» Consider making indemnity the sole and exclusive remedy.

Limitations


Time limitations (e.g., duration of rep and warranty survival)

Dollar limitations (caps, baskets and offsets) Effects on other remedies

Should the liability cap cover indemnifiable claims?

How long should the indemnity claims survive? Control and ability of indemnifying party to participate in defense of claims

Choice of law / forum



DISPUTE RESOLUTION


» Escalation/Mediation

» Arbitration

For Discussion Another Day

50

» Choice of forum/Choice of law» Jury Waivers

» Attorneys’ fees provisions

Provisions We’ll Discuss


» Executive‐to‐Executive meetings

– Can be very effective tool– Cooler heads; greater perspective on relationship

» Mediation

– As a mandatory step, not always effectiveSophisticated parties know how to settleCan devolve into litigation strategy discovery

– Choose mediator qualifications wisely

(Don’t forget the statute of limitations)

Escalation and Mediation Steps


Court Arbitration

Judge is generally assigned, not chosen Can choose arbitrator qualifications and number; can include non‐lawyers with special expertise

Jury is available No juryForum may be unattractive Can specify situsTime to result may be unpredictable or uncontrollable

Can dictate time to result

Full discovery is available Can limit discoveryRight to appeal from errors Very limited ability to appealPresumptively public; precedential Can be private

Should We Agree to Arbitrate?


Important Choices

53

Arbitration Arbitration


» Some … or all … disputes?– Interpretation and performance of the contract?– Arising out of or related to the contract?– Arising between the parties?– Teensy ones? Huge ones?

» Shall … or may?

Choice #1: Scope


» Presumption in favor of arbitrationmeans that courts interpret clauses broadly.

» The magic words “arising out of or relating to the agreement” constitute “the broad clause”– Often interpreted to include tort and other noncontractual claims.

Some law on scope


Any controversy or claim arising out of or relating to thiscontract, or the breach thereof, shall be settled by arbitrationadministered by the American Arbitration Associationin accordance with its Commercial [or other] ArbitrationRules [including the Optional Rules for Emergency

Measures of Protection], and judgment on the awardrendered by the arbitrator(s) may be entered in any courthaving jurisdiction thereof.

Any controversy or claim arising out of or relating to thiscontract, or the breach thereof, shall be settled by arbitrationadministered by the American Arbitration Associationin accordance with its Commercial [or other] ArbitrationRules [including the Optional Rules for Emergency

Measures of Protection], and judgment on the awardrendered by the arbitrator(s) may be entered in any courthaving jurisdiction thereof.

AAA Model Clause


»AAA »JAMS

»Other

»Ad hoc

Choice #2: The Administration


» Can be industry or dispute‐type specific» Can include special rules for:

Complex disputesExpedited proceduresEmergency measures

Appeal

» Be familiar with AAA, JAMS Rules

» Can also decline to specify applicable rules

Choice #3: The Rules


3 or 1? Qualifications?Selection process

Choice #4: The Arbitrators


» Yes or No?

» How much?

» What type?

» Time frame?

Choice #5: Discovery


» Be realistic, in light of your process» Consider expedited procedures for certain types of claims

Choice #6: Speed


» Not a foregone conclusion» Sample language:

Except as may be required by law, neither a party nor an arbitrator may disclose the existence, content, or results of any arbitration hereunder without the prior written consent of both parties.

» May elect to restrict only certain types of information (e.g., trade secrets)

American Arbitration Association, Drafting Dispute Resolution Clauses: A Practical Guide (2007).

Choice #7: Confidentiality


» Ordinarily not a reasoned award unless all parties request it

» Sample language: “The award of the arbitrators shall be accompanied by a reasoned award”

» May undermine the finality of the decision

Choice # 8: Reasoned Award


1. I DON’T WANT TO ARBITRATE AFTER ALL.

2. We can’t agree on an arbitrator.

3. The arbitration is slow and costing me a

fortune.

4. The award takes forever.

5. I hate the award.

6. I AM GOING TO IGNORE THE AWARD.

What Can Go Wrong


» Waive it» Find a different contract» File a pre‐emptive lawsuit

– Maybe seek just interim relief» Craft your claim around the scope» Allege fraud» Allege unconscionability (if you are a consumer)

» Refuse to respond to demand

End‐Runs Around Arbitration


Force Majeure or Impracticability


“Force Majeure”

“Act of God” or “Vis Major”

“An event or effect that can be neither anticipated nor controlled.” – Black’s Law Dictionary (9th ed.)


Common Litigation IssuesIs event expressly listed in the contract?Unforeseeable?

Beyond party’s reasonable control?Causation: did the event really prevent or delay performance?

Which party bears the risk of the event at issue?

…Let’s explore through Kel Kim Corp. v. Central Markets, Inc., 519 N.E.2d 295 (N.Y. 1987).


Is claimed force majeure event listed?“If either party to this Lease shall be delayed or

prevented from the performance of any obligation through no fault of their own

by reason of labor disputes, inability to procure materials, failure of utility service, restrictive

governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar

causes beyond the control of such party,

the performance of such obligation shall be excused for the period of the delay.”


Did event prevent or delay performance?

“If either party to this Lease shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes

beyond the control of such party, the performance of such obligation shall be excused for the period of

the delay.” © 2016 Crowell & Moring LLP 70

What Happens Next?

Effect of the force majeure

– Excuse for failure to performAllow a party to delay payment or performance

Allow a reduction or extinguishment of particular obligations

– Frustration of the whole contractAllow a party to exercise its termination rightExtend the term of the agreement based upon the duration of the force majeure


Practice Tips If you want only protection against truly unforeseeable

and uncontrollable events, consider whether default defenses are sufficient.

If using a force majeure clause, expressly state whether only unforeseeable events are covered to avoid later conflict.

If you have something in mind, be specific, and expressly state force majeure conditions need not be unforeseeable.

If you want protection against changes in economic conditions, be explicit.

Do you want force majeure events to excuse both parties? 72


Representations, warranties and covenantsConsents and discretionRecitals

Agreements to agreeTerm v. Termination

Waiver/Estoppel

Choice of forum and law provisions; jury waivers; attorneys fees

Topics for Future Presentations


Ed BaumPartner‐Litigation

Crowell & Moring LLP

Paul Pollock

Partner‐Corporate


Alan Howard

Partner‐Litigation


Ilana Lubin

Counsel‐Corporate


Robert Smits

Executive Vice

President, General Counsel

GBG USA Inc.


[email protected] [email protected] [email protected] [email protected]

The Art of Contracting - Association of Corporate Counsel · reasonable bestefforts 345 0 ......

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Transcript of The Art of Contracting - Association of Corporate Counsel · reasonable bestefforts 345 0 ......