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When drafting a services agreement, it can be a big mistake for a customer to fail to establish clear lines of responsibility about who will obtain any third-party authorizations that might be needed. A California business owner got an expensive lesson on that subject when he hired a Web developer to revamp the business’s Website. The revamped Website included three copyrighted photographs that had been taken, and were owned, by a professional photographer, who filed suit for copyright infringement.

The business owner claimed that he had thought that the Web developer would take care of obtaining any necessary copyright clearances.  Evidently, however, the trial judge and jury were not impressed: the jury found the business owner liable for contributing to the copyright infringement and awarded maximum statutory damages of $150,000 for each of the three photographs, plus attorney fees and other amounts, for a total of more than $636,000; the appeals court affirmed the judgment.

The case: Erickson Productions, Inc. v. Kast, No. 15-16801 (9th Cir. Apr. 16, 2019); proceedings below, e.g., No. 5:13-cv-05472-HRL (N.D. Cal. May 21, 2018).

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When you draft an exclusion of consequential damages, do you exclude “lost profits”?  In a Seventh Circuit case, a manufacturer’s contract with a distributor contained just such an exclusion of lost profits — but it did not specify that this referred to lost profits from collateral business transactions. As a result, the court affirmed a judgment that:

  1. under the circumstances of the case, lost profits were the only remedy available for breach (because the defendant manufacturer had so argued and thus had waived any contention otherwise);
  2. the exclusion of lost profits therefore caused the contract’s limited remedy to fail of its intended purpose; and so,
  3. under Wisconsin’s arguably-outdated interpretation of the UCC, all remedies under article 2 (sales) were therefore available to the plaintiff.

Sanchelima Int’l, Inc. v. Walker Stainless Equipment Co., No. 18-1823, slip op. (7th Cir. Apr. 10, 2019).

The Seventh Circuit did not address case law from other jurisdictions, e.g., New York, where courts held that lost profits from the contemplated transaction were direct damages, not consequential damages, and thus were not encompassed by an exclusion of lost-profits consequential damages. See, e.g., Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 22 N.Y.3d 799, 11 N.E.3d 676, 988 N.Y.S.2d 527 (2014), where New York’s highest court held that, on the facts of the case, “lost profits were the direct and probable result of a breach of the parties’ agreement and thus constitute general damages” (emphasis added, citations omitted), and thus were not barred by a limitation-of-liability clause.  (For additional citations, see the Common Draft commentary on that point [self-cite].)

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From the Illinois supreme court in 1550 MP Road LLC v. Teamsters Local No. 700, 2019 IL 123046 (Mar. 21, 2019): A landlord sued its defaulting tenant, a union local. The landlord won a $2.3 million judgment against the union in the trial court, only to see the award thrown out in the state supreme court. Why? Because in signing the lease, the union official had not complied with the requirements of a state statute that authorized unincorporated associations to lease or purchase real estate in their own names.

The statute required an unincorporated association to submit a proposed real-estate lease to vote of the membership, after advance written notice. The statute also required the lease to be signed by both the president and the secretary of the association. Neither of those requirements were met.

Holding that the lease was void ab initio, the supreme court reversed a judgment of $2.3 million in favor of the landlord and remanded with instructions to enter a take-nothing judgment in favor of the union.

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From IBM Corp. v. Lufkin Industries, LLC, No. 17-0666, slip op. (Tex. Mar. 15, 2019): IBM told Lufkin that IBM could adapt a particular software system to Lufkin’s needs.  The project turned out badly, and Lufkin sued IBM for fraudulent misrepresentation, but a reliance disclaimer in the contract ruled out the fraudulent inducement claim.

So what did IBM do wrong, exactly? According to the Texas supreme court:

IBM made numerous representations about its Express Solution that turned out to be false.

  • IBM represented that the Express Solution was a preconfigured system that could be implemented for Lufkin within four to six months and meet eighty percent of Lufkin’s requirements without any enhancements.
  • IBM knew, however, that its Express Solution would require extensive customization before it could meet most of Lufkin’s needs.
  • Yet IBM continued to represent the Express Solution as a “fit” for Lufkin, hoping it could land the sale and then figure out how to provide what Lufkin needed.

In September 2009, IBM presented a demonstration of the Express Solution for Lufkin.

  • During this demonstration, IBM’s representatives again represented that the Express Solution would meet eighty percent of Lufkin’s needs without any customization.
  • In fact, the representatives knew that Express Solution was designed for much smaller operations and could not meet Lufkin’s requirements without extensive and costly enhancements.

Relying on IBM’s misrepresentations, Lufkin agreed to a written contract with IBM in March 2010. The contract— called the “Statement of Work,” or “SOW”—gave IBM about a year to finalize and implement the system, projecting that Lufkin could “go live” with IBM’s Express Solution system on March 1, 2011.

The implementation did not go well. …

Id., slip op. at 2-3 (extra paragraphing and bullets added).

What saved IBM from a $21 million verdict for fraudulent inducement was the following reliance-disclaimer language:

In entering into this SOW, Lufkin Industries is not relying upon any representation made by or on behalf of IBM that is not specified in the Agreement or this SOW, including, without limitation, the actual or estimated completion date, amount of hours to provide any of the Services, charges to be paid, or the results of any of the Services to be provided under this SOW.

This SOW, its Appendices, and the Agreement represent the entire agreement between the parties regarding the subject matter and replace any prior oral or written communications.

Id., slip op. at 6 (extra paragraphing added).  The supreme court said:

… we hold that contractual disclaimers bar the buyer from recovering in tort for misrepresentations the seller made both to induce the buyer to enter into the contract and to induce the buyer to later agree to amend the contract.

Id., slip op. at 1.

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It’s not exactly breaking news, but there are still useful lessons to be had in a Delaware chancery court case, Zayo Group, LLC v. Latisys Holdings, LLC,:

  • Latisys Holdings (the “target company”) put itself up for sale, and ul­ti­mate­ly sold itself to Zayo Group (the “buyer”)
  • The M&A agreement included a “rep” (a representation and warranty) that none of the target company’s key customers “intends to cancel, terminate, materially modify or refuse to perform” their contracts.
  • The target company failed to disclose to the buyer that some of the target company’s key customers were refusing to renew their expiring contracts without significant changes in pricing.
  • The buyer’s original draft of the rep would have required disclosure of the non-renewing customers. But during negotiation of the M&A agreement, the target company’s counsel redlined the draft agreement to delete the “refuse to renew” language, and the buyer accepted the deletion.

The court ruled that the language of the rep was ambiguous, so it looked to the negotiation history for clarification — and found that the buyer’s ac­cept­ance of the deletion of “refuse to renew” amounted to a meeting of the minds about the meaning of the remainder of the rep:

Zayo returned the redline to Latisys—accepting Latisys’ change to Section 4.12(b). …

[FN90] Because Zayo returned the redline with no changes or comments to Zayo’s deletion of “‘refuse to renew,” the parties assume, as do I, that Zayo accepted the change and there was a meeting of the minds that the phrase would not be included. * * *

The SPA [i.e., the M&A agreement] drafting history makes clear that Latisys made no commitment to inform Zayo if existing customers will or will not renew their expiring contract. To the contrary, Latisys expressly declined to make that commitment when Zayo proposed it during the course of negotiations. Zayo did not object and the parties executed the SPA without the “refuse to renew” language in the Material Contracts representation and warranty.

The fact that Zayo inserted this added language in its proposed SPA reveals that Zayo, like Latisys, believed that “refuse to renew” had a different meaning than the language already included in Section 4.12(b)—i.e., “terminate,” “cancel” and “refuse to perform.”

Zayo Group, LLC v. Latisys Holdings, LLC, No. 12874-VCS, slip op. at 17-18 & n.90, 36-37 (Del. Ch. Nov. 26, 2018) (footnote omitted, emphasis and extra paragraphing added). The court found (i) that the target company didn’t breach the rep, and (2) in any case, the resulting financial harm to the buyer didn’t exceed the agreement’s “basket” threshold for liability.

In a discussion at the redline.net lawyer forum (membership re­quired), Sean Hogle suggests that “the court undoubtedly placed too much em­pha­sis on the removal of the clause in question”; he quotes a blog post by “the always-awesome Glenn West” for the proposition that (in Glenn’s words):

… as deal lawyers know well, another possible explanation is that the buyer’s counsel thought (ill-advisedly as it turns out) that the buyer was already covered by the other redundant words and decided not to push the issue.

After all, if the words that were already there basically were all various ways of saying “terminate” or “come to an end,” isn’t one way that a con­tract comes to an end the expiration of its term without being renewed?

(Emphasis and extra paragraphing added.)  This is one of the rare occasions where I find myself disagreeing with Sean and Glenn; let me explain.

Lessons:  There are a couple of lessons here for contract negotiators:

  1. Whenever “The Other Side” asks for a change in contract language, assume that there might be a substantive reason — and consider asking questions. As we see from the above case, it can be dangerous to assume that The Other Side’s contract reviewer was concerned solely about drafting style. (Keep in mind that we don’t know whether the buyer’s counsel made that mistake in the Zayo Group case.)
  2. A corollary: If you’re reviewing a draft contract, then to keep the neg­o­ti­ation moving (and to avoid coming across as a nitpicker): Don’t ask for purely-stylistic changes; instead, for the most part stick to sub­stan­tive mat­ters, with the exceptions discussed just below.

There are a couple of exceptions to the don’t-ask-for-stylistic-changes corollary in item 2 above:

  • Exception 1:  Whenever you encounter a long, “wall of words” pro­vi­sion while re­view­ing a contract draft, then break up the wall of words into short, single-subject paragraphs, for two reasons:
    • First, you want to make the provision easier for your client to review.  I’ve never had an opposing counsel complain about my breaking up a wall of words when I’ve preemptively noted this in a comment at the beginning of my redline.
    • Second, you want to avoid the MEGO Factor (Mine Eyes Glaze Over).  You can’t rule out that The Other Side might have inten­tion­al­ly written a wall of words in the hope that you’ll miss some­thing important.
  • Exception 2:  A style problem can create an ambiguity, in which case it’s usually better to fix the ambiguity right away.  Other things being equal, it’s generally better to raise potential disputes and get them out into the open before the parties get too far down the road.  That’s why it’s usually good to follow the A.T.A.R.I. Rule:  Avoid The Argument: Rewrite It!
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