Hello Entrepreneurs!
Below is an example of an ambiguous “term” provision in a Confidentiality Agreement. The provision doesn’t distinguish between the “Disclosure Period" and the “Obligation Period”. The Disclosure Period is the time period during which disclosures (of secret information) are made by the Disclosing Party (the owner of the secret information) to the Receiving Party (the contract party that receives the secret information from the Disclosing Party). The "Obligation Period" is the time period during which the Receiving Party must comply with its obligations of confidentiality and non-use.Good hunting!
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]]>In the next few columns, I'll examine a couple of approaches contract parties take to structure the term provisions of NDAs to take into account these concepts.
Good hunting.
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]]>Again, here is the hypothetical non-compete provision.
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
Today, let's look at an commonly found alternative to Choice C (discussed in my previous column).
Here is Choice C.
Choice C - “If a court of competent jurisdiction finds any provision of this Agreement to be unenforceable, then such provision remains in full force to the extent not held invalid or unenforceable.”
Here is the alternative (let’s call it Choice D), which can be placed directly at the end of the non-compete provision.
“In the event a court finds this non-compete provision unenforceable as to geographic scope or duration, then the court has the power to reduce the geographic scope or duration to the extent necessary to render the provision enforceable.”
Like Choice C, Choice D also works to salvage the non-compete provision if a court finds it to be overreaching in scope (that is, in duration or geographic scope). And Choice D similarly allows a court to easily substitute a shorter duration if it finds that three years is too long. It can replace “three (3)” years with, for example, “two (2) years” without changing the sentence structure. If the court finds that 15 miles is too large in geographic scope, then it can replace “15 miles” with, for example, “5 miles”. If you look closely, however, Choice D doesn’t cover the situation where the non-compete overreaches in terms of the scope of activity or other problems that a court may find with the non-compete provision. Keep in mind also that Choice D is typically found directly in the non-compete provision (because it's intended to cover only problematic non-competes). You’ll still need to have severability language in the boilerplate section of the agreement to cover the rest of the agreement. Make sure your attorney confirms to you that the severability provision (typically one of Choice A, Choice B or Choice C) in the boilerplate section isn’t internally inconsistent with the Choice D language in the non-compete provision.
Good hunting.
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In this series of columns, we're looking at the impact of including severability language on a non-compete provision. In my hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to a non-compete provision in the asset purchase agreement (APA). In the first of these columns (October 1st column), I present a choice of three severability provisions - Choice A, Choice B and Choice C. In the October 2nd column, we looked at the impact of Choice A. In the October 3rd column, we looked at the impact of Choice B.
Today, let's look at Choice C, as follows...
Choice C - “If a court of competent jurisdiction finds any provision of this Agreement to be unenforceable, then such provision remains in full force to the extent not held invalid or unenforceable.”
Again, here is the hypothetical non-compete provision.
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
Of the three choices, Choice C is the best choice to salvage the non-compete provision if a court finds it to be overreaching in scope (that is, duration, scope of restricted activity, geographic scope). Choice C allows a court to easily substitute a shorter duration if it finds that three years is too long. It can replace “three (3)” years with, for example, “two (2) years” without changing the sentence structure. If the court finds that 15 miles is too large in geographic scope, then it can replace “15 miles” with, for example, “5 miles”.
The above underlined portions of the non-compete provision, dealing with duration, scope of restricted activity and geographic scope, are the parts that are the most likely to be challenged by the parties being restricted, and therefore the most likely to be scrutinized by the court. Therefore, be proactive with your attorney to make sure that your non-competes are drafted in a way that a court can easily replace the offending words without having to restructure the sentence. A good test of this is to imagine that the court has a “find” and “replace” program like most word processing programs. If you can “find” three (3) years, and “replace” it with “two (2) years”, and the resulting sentence still makes sense (doesn’t have to be rewritten grammatically), then your non-compete provision stands a good chance of making the cut even in a blue-pencil jurisdiction.
Tomorrow, I’ll present a commonly used alternative to Choice C that also works to repair broken non-competes.
Good hunting.
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In this series of columns, we're looking at the impact of including severability language on a non-compete provision contained in an asset purchase agreement (APA). In my hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to a non-compete provision. In the first of these columns (October 1st column), I present a choice of three severability provisions - Choice A, Choice B and Choice C. In yesterday’s column, we looked at the impact of Choice A.
Today, let's look at Choice B, as follows...
Choice B - “If any provision of this Agreement is unenforcable, then the entire Agreement is no longer in effect and no party has the right to enforce any provision of this Agreement.”
Again, here is the hypothetical non-compete provision.
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
Truth be told, an asset purchase agreement is not the best hypothetical to use for Choice B because the sale of a business is not an on-going transaction. Except for the non-compete, maybe a brief consultancy period, the survival of certain indemnities, and confidentiality obligations, the Seller and the Purchaser pretty much go their separate ways after the closing. Choice B would have the court unravel the entire transaction if it finds any part of the non-compete unenforceable. A court-ordered unravelling (in legal parlance, a "recission") of the asset purchase agreement (where the court makes Fred buy the business back) is highly unlikely, and in fact may not be desired by either party.
Choice B is not a great solution in general. Here's why... most contracts have provisions that remain in effect (in legal parlance, "survive") after the contract's termination or expiration. In fact, I've listed above some of the surviving post-closing provisions of the asset purchase agreement - things like confidentiality, etc. Confidentiality is the kind of obligation most businesspeople want to maintain even after a business relationship is terminated (or gets unravelled). So, the mostly negative impact of Choice B can best be summed up by this rhetorical question - do you really want your severability provision to undo the entire agreement, even provisions like confidentiality, which were meant to survive no matter what?
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]]>In yesterday’s column, I offered three possible choices of severability language to include in a hypothetical asset purchase agreement. In the hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to the following non-compete provision…
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
Let’s say that within 1 and 1/2 years, Fred starts another clothing retail store within 12 miles of the Retail Store. You go to court to enforce the non-compete. As luck would have it, now that Fred’s taken your money, he and his attorney will try to argue that the non-compete is not enforceable. A court could agree; it could find any number of legal problems with the non-compete provision. First, three (3) years might be too long. And while the restriction against activities in clothing retail seems reasonable, the case law in your particular jurisdiction may favor less stringent geographic restrictions, for example, a 5 to 10 mile radius (maybe even 1 mile for dense urban areas). In other words, there’s a chance the court might rule that the 15 mile radius is overly aggressive and not enforceable.
What is the impact of including severability provision Choice A in the agreement?
“If any provision of this Agreement is unenforceable, the balance of this Agreement remains in full force.”
By adding Choice A, you are inviting the court to completely sever (akin to physically redacting) the offending provision from the contract, and to enforce the balance of the Agreement.
If the court ultimately rules that the 15 mile radius is unenforceable, and agrees with the parties’ stated intent as reflected in severability provision Choice A, then it would treat the non-compete provision as though it was not in the APA, and enforce the rest of the APA. You could try to argue that the balance of the APA should not be enforced either (i.e., that the entire contract should be void), but a court probably won’t buy that argument unless you can convince the court that striking the non-compete undermines the main purpose of the deal. This is a bit of a stretch, but maybe you can attempt to argue that voiding the non-compete messes up the purchase price allocation of the APA for tax purposes, but I think most people who buy and sell small businesses do so for strategic, rather than purely tax purposes. Note that it's a business decision, of course, whether you'd want to go for a rescission (i.e., an unraveling of the entire transaction) - except for the non-compete issue, things may be going very well for you with your new business. In any event, it’s been a whole year and a half, so it’s not likely the court would rescind (unravel) the transaction and make Fred buy the business back.
Bottom line - With Choice A, Fred stands a good chance of being able to set up shop and compete despite the non-compete provsion.
We’ll examine Choice B and Choice C in upcoming columns.
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In yesterday’s column, I started my discussion of severability provisions. These are typically found in the boilerplate or miscellaneous provisions section of the agreement, and unfortunately are mostly overlooked by businesspeople (and even lawyers) during business contract negotiations.
As discussed, severability clauses are useful to salvage contracts that have unenforceable, illegal or invalid provisions. One area where the issue of severability comes up frequently is non-compete provisions.
Let’s say that you are negotiating an asset purchase agreement (APA) to purchase a one-store clothing retail business from Fred. You want to include a non-compete provision in the agreement, which will prevent Fred from competing against you for a certain period of time after the closing. Fair enough. In fact, non-competes can be found in most sale of business agreements, and in concept are enforceable.
Acquisition agreements like APA are typically drafted by purchaser’s counsel. This means that the purchaser’s lawyer prepares the first draft; the seller and its attorney review and make comments and the parties go back and forth, but the purchaser’s counsel “controls” the master copy in his or her computer and makes the agreed to changes.
Let’s put aside all other APA issues, including what portion of the purchase price will be allocated to the non-compete for tax purposes. Let's say you want to max out because you don’t want Fred anywhere near clothing retail for a good long time; you figure why not?… you’re paying good money for his business. You want Fred to stay away from all retailing for 10 years anywhere in the world. Your attorney correctly tells you that the case law in this area is not clear cut as to the upper limits of duration and geographic scope, but that your proposal sounds “over-the-top”, and is most likely not enforcable. You and your attorney finally agree to pare the restriction down a bit in an attempt to ensure its enforceability.
Here is the resulting provision…
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
Your attorney is still concerned about the impact of the non-compete on the enforceability of the entire agreement, so he or she inserts one of the following severability provisions into the agreement.
Choice A - “If any provision of this Agreement is unenforceable, the balance of this Agreement remains in full force.”
Choice B - “If any provision of this Agreement is unenforcable, then the entire Agreement is no longer in effect and no party has the right to enforce any provision of this Agreement.”
Choice C - “If a court of competent jurisdiction finds any provision of this Agreement to be unenforcable, then such provision remains in full force to the extent not held invalid or unenforcable.”
In upcoming columns, I’ll discuss the pros and cons of each of the above, and perhaps other solutions to this problem.
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]]>In a contract negotiation, there's a fine line between aggressively negotiating contract provisions that serve your interests, and stepping over legal limits. This is especially true when negotiating certain types of provisions that courts have historically very closely scrutinized - for example, contract provisions dealing with non-competition, choice of law and exclusivity.
One way contract parties have tried to work around this issue is to include a severability provision (sometimes called a seperability provision) in their business contracts, which allows a court to "sever" offending (that is, unenforcable) provisions in order to salvage the rest of the contract. Depending on the jurisdiction and the situation, not to mention the kind of severability provision in the contract, a court may employ several approaches to "right" the situation. Some courts sever (that is, drop) the entire offending provision and enforce the rest of the contract. Some courts try to salvage the provision by removing/replacing the offending words or phrases without changing the provision's sentence structure (blue pencil approach). Other courts save the provision by making relatively extensive changes to right the offending provision (rule of reasonableness approach).
In the next few columns, we’ll dig a little deeper into how severability provisions work.
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]]>Had the protagonist included such language in its business contract, it might have staved off at least the claim for consequential damages.
]]>Yesterday, we asked what might happen if the parties to a contract agree to a liquidated damages provision. The label doesn't matter. It could be a termination fee, a deal kill fee, a commitment fee, a fee to be charged for each day of performance delay or default, basically any pre-agreed monetary amount to be paid that gives a contract party the right to walk away or "breach" the contract without further liability. In this case, let's keep it simple and say that the liquidated damages provision calls for a flat fee to be paid by Party A to Party B each time Party A breaches a particular provision.
In this hypothetical, the parties are working off a contract form from another transaction, and they neglect to carefully review the boilerplate section, which contains various and sundry "miscellaneous" provisions, including the following cumulative remedies provision.
“All rights and remedies provided in this Agreement are cumulative and not exclusive of any other rights or remedies that may be available to the parties, whether provided by law, equity, statute, in any other agreement between the parties or otherwise.”
Somewhere down the line, Party A breaches the contract and forks over the liquidated damages fee to Party B. Party A returns to business as usual, thinking that this episode is done. One week later, it receives a letter from Party B demanding additional monetary damages, plus lost profits caused by Party A's breach. Perplexed and angry, Party A calls Party B to find out why it sent the letter when the parties clearly agreed to the "exclusive remedy" of liquidated damages. And what's the deal with the lost profits? Party B responds that it's entitled to the additional damages because of the cumulative remedies provision. As far as the lost profits, explains Party B, these are consequential damages, which the parties did not specifically exclude in the contract. The parties proceed to litigation. No lawyer can predict with certainty how a court would rule in a case like this. That depends on the detailed facts of the case, plus the governing law of the contract, plus where the litigation takes place, etc.
That being said, Party B will still try to exploit the ambiguity in the contract to its advantage, if not only to extract additional cash or perhaps concessions on another deal point.Regardless of the intent of the parties, the contract is ambiguous. On the one hand it provides for the exclusive remedy of liquidated damages. On the other hand, it contains a boilerplate cumulative remedies provision authorizing all remedies - it's there in black and white; a court cannot simply ignore it.
A little more care in reviewing the contract at the outset might have helped to avoid this situation. One possible work-around could be to add the underlined language to the cumulative remedies provision.
"All rights and remedies provided in this Agreement are cumulative and not exclusive of any other rights or remedies that may be available to the parties, whether provided by law, equity, statute, in any other agreement between the parties or otherwise. However, the [Liquidated Damages provided for in Section __ of this Agreement] is Party B's exclusive remedy for Party A's breach of Section __ of this Agreement."
This means that Party B is not entitled to relief for the specified breach beyond the agreed to liquidated damages. Keep in mind that both parties are still entitled (under this language) to cumulative remedies for other types of breaches. If the parties want to carve out other exclusive remedies, they'll need to consider the same drafting approach outlined in this column.
In the next column, I'll talk about consequential damages.
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]]>A possible work-around in this situation is to:
This way, the seller won't risk making a misrepresentation, but nevertheless agrees to bear the risk of environmental problems by agreeing to indemnify you for environmental law violations, clean-ups, etc. as though it was making a flat or unqualified representation.
This is just a hypothetical fact situation, and the work-around can be applied to other representations as well. In other words, I'm certainly not advocating using a work-around to handle something as potentially devasting as an environmental problem. In real life, it's up to you and your advisors to determine the pros and cons of doing a work-around, versus sticking to your guns (and walking away from the transaction in case you don't get your way). Hey, maybe the risk of a potential misrepresentation lawsuit is just the kick in the pants the seller needs to go the extra mile to do a really good investigation and preemptive clean-up so that he delivers you a clean piece of property.
]]>In this example, let's say that because the seller hasn't owned the business for very long (having acquired it only a few years ago) he's reluctant to make unqualified or "flat" representations about the business. So he negotiates aggressively to add a knowledge qualifier or a materiality qualifier to most of the representations. You review his draft of APA, looking at all the qualifiers he's added, trying to figure out which ones you can live with and which ones you have to have "flat". In particular, you're flabbergasted that he inserted a knowledge qualifier to the representation that there are no environmental law violations with respect to the property. (You're not surprised either, given the potential devastating financial impact of an environmental law violation.)
During the ensuing negotiations, he explains that as much as he'd like to, he can't take the chance of making the environmental rep flat. He says that as a short-term owner, he's just not confident that there aren't any problems, and as a matter of principle, he can't make a flat representation that may very well turn out to be untrue.
You explain that you empathize with his situation and appreciate his honesty, but can't accept the knowledge qualifier because he'd be off the hook as long as he didn't know, and you'd be left holding the bag. You're not real thrilled with the materiality qualifier either because you want him (as the seller) to bear the entire risk of environmental problems. This risk shift or risk allocation is a central tenet of contract representations.
Sellers won't necessarily shoot down the risk allocation argument. You may find that the main reason for his refusal to make an unqualified representation is that he doesn't want to be liable for misrepresentation, including the stigma associated with a misrepresentation lawsuit. If that's the case, maybe there's another way to tackle this issue. More on that in my next column.
]]>“The Manufacturer shall deliver to the Company the Prototype no later than June 30, 2009.”
Once again, as revised…
“The Manufacturer shall use good faith efforts to deliver to the Company the Prototype no later than June 30, 2009.”
We discovered how "good faith efforts" only requries the obligor to make an honest effort to meet its obligation. There is no requirement to even put in a "reasonable effort" to meet the deadline - click here to see my column on "reasonable effort" .
Today, let’s take a look at what happens if the Company successfully negotiates to insert a “best efforts” qualifier instead. (Note how unlike in the other columns, I say if the "Company" successfully negotiates, instead of the if the "Manufacturer" successfully negotiates... read on to see why...)
“The Manufacturer shall use best efforts to deliver to the Company the Prototype no later than June 30, 2009.”
To the layperson, "best efforts" sounds alot like the "good faith efforts" advice a coach would give to a young ballplayer - "Just do your best." But "best efforts" and "good faith efforts" are not the same. In fact, many lawyers would place them at opposite ends of the spectrum.
Of the three qualifiers discussed (i.e., good faith efforts, reasonable efforts, and best efforts), best efforts is the strictest. It requries the obligor (in this example, the Manufacturer) to meet its obligation even if it has to pay more to do so. Let's say that because of internal delays, the Manufacturer can't ship the Prototype until the day before the deadline. Many lawyers would argue that "best efforts" would require the Manufacturer to ship the Prototype using overnight delivery service, even if the cost of doing so would wipe out the planned profit margin for the transaction.
To summarize,
Unqualified - “The Manufacturer shall deliver to the Company the Prototype no later than June 30, 2009.” - There is an absolute obligation to deliver by the deadline.
Qualified language -
Best efforts qualified language - “The Manufacturer shall use best efforts to deliver to the Company the Prototype no later than June 30, 2009.” This is the strictest of the qualified choices.
Reasonable efforts qualified language - “The Manufacturer shall use reasonable efforts to deliver to the Company the Prototype no later than June 30, 2009.” This the next on the spectrum.
Good faith efforts qualified language - “The Manufacturer shall use good faith efforts to deliver to the Company the Prototype no later than June 30, 2009.” This is the most lenient standard.
]]>
“The Manufacturer shall deliver to the Company the Prototype no later than June 30, 2009.”
Once again, as revised…
“The Manufacturer shall use reasonable efforts to deliver to the Company the Prototype no later than June 30, 2009.”
Today, let’s take a look at what happens if the Manufacturer successfully negotiates to insert a “good faith efforts” qualifier instead.
“The Manufacturer shall use good faith efforts to deliver to the Company the Prototype no later than June 30, 2009.”
This is a dream come true for the Manufacturer because all it has to do to fulfill its obligations is to make an honest attempt to meet the deadline. That’s it. It doesn’t matter if a reasonable person under similar circumstances would have taken a couple of extra steps to try to meet the deadline. As usual, no language, no matter how one-sided, is a vaccine against costly litigation – in a contract dispute, the Company will likely try to couch the facts in a way to show that the Manufacturer did not, in fact, exercise good faith efforts.It’s a good idea for a contract obligee* to reject any attempt by the contract obligor* to weaken the obligor’s obligations with a good faith efforts qualifier, especially if the obligation is important or key to the transaction. This is common sense. An obvious example… a manufacturer shouldn’t grant exclusive distribution rights to a distributor who won’t agree to exercise anything more than good faith efforts to meet minimum purchase targets.
In my next column, I’ll discuss the “best efforts” qualification.* In contract parlance, the obligor is the party with the duty to perform. The obligee is the party with the right to receive performance.
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