On Contracts

This week, Washington state’s supreme court decided Nelson v. P.S.C., Inc., which turned on whether a state statute’s reference to “within three years of the marriage” required a specified event to occur:

• during the three years before the marriage; or
• no later than the three years after the marriage.

The details aren’t important, only that the case had to be litigated — thanks, legislative drafters!

In the Contract Drafting course that I teach at the University of Houston Law Center, I stress a number of real-world rules designed to help get workable contracts to signature sooner and keep clients out of trouble. Here are some of those rules (adapted from a published article):

1. Clients prize speed to signature.
2. Other things being equal, a short, simple contract that can be reviewed and signed quickly might serve the client’s short-term and long-term desires far better than the opposite.
3. Short paragraphs are almost always better — avoid walls of words.
4. Single-topic paragraphs are always better.
5. Contract length isn’t as important as paragraph length.
6. D.R.Y.: Don’t repeat yourself — e.g., the $693,000 drafting error in a bank guaranty
7. Steer well clear of ambiguity:
   • A.T.A.R.I.: If a term is even arguably subject to multiple interpretations, Avoid The Argument: Rewrite It.
   • W.I.D.D.: When in doubt, define.
8. Make contracts understandable to future readers — such as jurors.
9. Remember that contracts will usually go back into the jury room as “real” evidence, whereas the same might not always be true for lawyer-prepared demonstrative exhibits. Take advantage of that to create your own trial exhibits:
   • Use tables where appropriate.
   • Use illustrative examples and sample calculations.
   • Consider drafting explanatory footnotes — the other side might not ask to delete them, in which case the footnotes might someday become part of a trial exhibit.
10. Other things being equal, try for “Seneca terms”: Treat your inferior as you would wish your superior to treat you.
11. A friendly, balanced contract can signal your client’s reliability as a business partner and get you to signature sooner.
12. Don’t leave out something that you know the other side will ask for — it’s better to include a safe version that you know your client can live with.  (It’s foolish to hope that the other side’s contract reviewer won’t know what to ask for — if you leave out a provision that you know she’ll want, she might ask for a version that your client will hate.)
13. R.O.O.F.: Root Out Opportunities for F[oul]-ups — don’t assume perfect performance by either party.
    • What might fall through the cracks?
    • Personnel changes can happen — reassignments, new jobs, promotions, retirements, deaths (the Mack Truck Rule of Contract Drafting).
    • Build in sensible default values, e.g., a specific date & location for performance unless otherwise agreed.
    • Be practical: E.g., don’t insist on too-short a time frame, notice period, etc.
14. Don’t assume people will want to keep their promises (that includes your client).
15. Try to put the monkey on the other party’s back, e.g., your client will do X upon written request.
16. Use time limits – earliest date (“sunrise”), latest date (“sunset”) — or from Neil Wertlieb: “Always address timing!”
17. Consider expressly specifying Plan-B remedies, to be easily understood by business executives — and judges and jurors. For example:  “If Provider fails to fix the problems on time, then Customer may hire another contractor to finish the job, at Provider’s expense.”
18. As a drafter, don’t assume you must go it alone: When in doubt, A.T.P. (Ask The Partner) or A.T.C. (Ask The Client).
19. Consider making the other party earn what they get (or what they want to keep). EXAMPLE: Tie the other side’s exclusive rights to its meeting specific performance goals.
20. Be sure the other side has the financial- and other wherewithal to perform:
    • Due diligence
    • Financial covenants
    • Backup funding sources, e.g., insurance, guaranties, standby letters of credit, escrow
21. “You get what you inspect, not what you expect” (this is a saying from the nuclear Navy). So:
    • Insist on your client’s getting the information it needs / wants from the other side.
    • Do due diligence, possibly including getting third parties involved (e.g., a mechanic to inspect a used car)
    • Confirm your understanding & assumptions with reps and warranties
    • Audit provisions
22. Humans can be “funny” — see behavioral economics. Some examples follow.
23. Incentives matter — Charlie Munger (vice-chairman of Berkshire Hathaway). 
24. Many people care most about their own careers.
25. Buyer’s remorse can be a problem, especially if a better offer comes along — and competitors might do that intentionally to try to steal a deal away.
26. People are great at rationalizing doing what they want to do.
27. People don’t like to be told what they can and can’t do.
28. Memories can be plastic — and sometimes “motivated.”
29. People might cut costs to meet their KPIs, resulting in dangers or disasters. Example: PG&E criminal trial in SF over gas pipe exploding in 2010.
30. People tend to point fingers to shift blame — and lawyers can be a favorite target.
31. Don’t forget Hanlon’s Razor: Never attribute to malice that which can be adequately explained by stupidity — but don’t rule out malice.
32. “Absent reasonable objection, we are allowed to do X” might be better than “Mother May I?”
33. Plan for transition after termination; for example:
    • Consider a phase-out period.
    • Transition of customer’s business to another vendor
34. When you can’t just say no in a contract negotiation: Creative compromises
    • Non-discrimination language
    • Advance-warning or advance-consultation requirement
    • Transparency requirement
    • Cap the financial exposure for the onerous provision
    • Package the onerous provision as part of a premium offering
35. Negotiate limitations of liability risk-by-risk, not one-size-fits-all

In the previous post, my initially-published version (which went out to this blog’s email subscribers but which I subsequently revised) blamed the Bayer and Merck lawyers for the wall-of-words paragraphs reproduced in the Delaware chancery court’s opinion in Merck v. Bayer. The actual version of those contract sections contract, as filed at the SEC’s EDGAR Web site, includes somewhat-shorter paragraphs.

But the language could still have been pretty-drastically simplified. And for that we should indeed blame the lawyers — especially the lawyers for Buyer, likely at the Sullivan & Cromwell firm, according to the Notices section of the contract.

Example: Section 2.6 from the SEC version is as follows:

2.6 Assumption of Liabilities.

Effective as of the Closing, neither Seller nor any of its Affiliates shall have any liability or obligation with respect to, and Buyer shall assume and thereafter pay, perform and discharge when due, all liabilities and obligations of Seller and its Affiliates, whether relating to periods prior to, on, or after the Closing, to the extent related to or arising from, the Transferred Consumer Care Assets, the Consumer Care Business, the Transferred Rx Product Assets, the Rx Product Business and/or the Conveyed Sites, other than the Retained Liabilities (collectively, the “Assumed Liabilities”) (provided that, notwithstanding anything to the contrary in this Section 2.6, (i) any liabilities or obligations of the Companies or any of their Subsidiaries shall not constitute Assumed Liabilities, it being acknowledged and agreed that such liabilities or obligations (other than Retained Liabilities) shall remain the liabilities or obligations, as applicable, of the Companies or their applicable Subsidiaries immediately after the Closing, and (ii) nothing in this Section 2.6 shall affect Buyer’s rights pursuant to Article X), including, without limitation: … [subdivisions (a) through (f) omitted]

Here’s a possible (partial) rewrite that follows the SSRP Rule: Short, Single-Subject Paragraphs:

2.6 Assumption of Liabilities.

(a) Effective as of the Closing, Buyer will assume all “Assumed Liabilities,” defined in subdivision (c) below.

(b)  Without limiting Buyer’s obligation under subdivision (a), Buyer will take any and all action required to ensure that neither Seller nor any of its Affiliates have any liability or obligation with respect to the Assumed Liabilities.

(c)  Definition: The term “Assumed Liabilities” refers to all liabilities and obligations of Seller and its Affiliates — except as subdivision 2.6(e) — whether relating to periods prior to, on, or after the Closing, to the extent related to or arising from one or more of the following:

      (1)  the Transferred Consumer Care Assets;

      (2)  the Consumer Care Business;

      (3)  the Transferred Rx Product Assets;

      (4)  the Rx Product Business; and/or

      (5)  the Conveyed Sites.

(d)  The term “Assumed Liabilities” includes, without limitation:

      (1) all obligations and liabilities under the Material Contracts to which any member of the Seller Group is a party or by which it is bound, to the extent relating to the Consumer Care Business;

      (2)  [for subdivisions (2) through (7), add the text of exceptions listed in the original version’s subdivisions 2.6(b) through 2.6(g)]  …

      (8)  the obligations and liabilities set forth in Section 2.6(d)(8) of the Seller Disclosure Schedule.

(e)  Exception: The term “Assumed Liabilities” does not include any of the following:

      (1)  any liabilities or obligations of the Companies or any of their Subsidiaries;

      (2)  the Retained Liabilities.

Much more readable, no?

Sure, it’d take a few more minutes of lawyer time to follow the SSSP Rule (again: Short, Single-Subject Paragraphs). 

But that extra cost would undoubtedly be “couch change” compared to the overall legal costs of doing the asset sale that was the subject of the contract.

And:

• Which version would be signed sooner, because it could be more-quickly reviewed and, if necessary, negotiated and revised?
• Which version would the clients’ business people prefer to read?
• Which version would a judge or law clerk prefer to read?

There’s only one reasonable answer.

Get a load of the long, complex contract clauses “reproduced” in this week’s Merck v. Bayer decision concerning whether talc-litigation liabilities were transferred in Merck’s 2014 asset sale of its Claritin, Coppertone, and Dr. Scholl’s product lines for some $14 billion. The Delaware chancery court concluded that the relevant contract provisions were “clear and unambiguous” and that Bayer’s interpretation was “the only reasonable one” (slip op. at 2). But that’s sure as hell not obvious at a glance from the court’s reproduction of the language in question, copied from the court’s opinion:

2.6. Assumption of Liabilities. Effective as of the Closing, neither Seller nor any of its Affiliates shall have any liability or obligation with respect to, and Buyer shall assume and thereafter pay, perform and discharge when due, all liabilities and obligations of Seller and its Affiliates, whether relating to periods prior to, on, or after the Closing, to the extent related to or arising from, the Transferred Consumer Care Assets, the Consumer Care Business, the Transferred Rx Product Assets, the Rx Product Business and/or the Conveyed Sites, other than the Retained Liabilities (collectively, the “Assumed Liabilities”) (provided that, notwithstanding anything to the contrary in this Section 2.6, (i) any liabilities or obligations of the Companies or any of their Subsidiaries shall not constitute Assumed Liabilities, it being acknowledged and agreed that such liabilities or obligations (other than Retained Liabilities) shall remain the liabilities or obligations, as applicable, of the Companies or their applicable Subsidiaries immediately after the Closing, and (ii) nothing in this Section 2.6 shall affect Buyer’s rights pursuant to Article X), including, without limitation: . . . (e) any obligations or liabilities to the extent relating to the Consumer Care Business in connection with any Litigation, other than Retained Liabilities; . . . and (h) the obligations and liabilities set forth in Section 2.6(h) of the Seller Disclosure Schedule.

2.7. Retained Liabilities. Seller shall, without any further responsibility or liability of, or recourse to, Buyer, or any of Buyer’s directors, shareholders, officers, employees, agents, consultants, representatives, Affiliates, successors or assigns (including the Companies and their Subsidiaries), absolutely and irrevocably assume and be solely liable and responsible for the following obligations and liabilities (the “Retained Liabilities”); it being understood that nothing in this Section 2.7 shall affect Buyer’s rights pursuant to Article X: (a) all obligations and liabilities to the extent relating to or arising out of the Retained Assets; (b) any Taxes for which Seller is responsible under Section 6.1 of this Agreement; (c) all obligations and liabilities for which Seller or its Affiliates are made responsible pursuant to the terms of this Agreement or the Ancillary Documents; (d) the obligations and liabilities set forth in Section 2.7(d) of the Seller Disclosure Schedule (the “Section 2.7(d) Liabilities”); and (e) the China Obligations.

And for the retained liabilities, in Section 2.7(d) of the Seller Disclosure Schedule:

1.  Any product liability or similar claim for injury to a Person or property that allegedly arises out of or is based upon any express or implied representation, warranty, agreement or guaranty made by the Transferred Business, Seller or its Affiliates, or any of the Companies or their Subsidiaries, or by reason of the alleged improper performance or malfunctioning of a product, improper design or manufacture, failure to adequately package, label or warn of hazards or other related product defects of any products at any time manufactured, marketed or sold by the Companies or their Subsidiaries or otherwise in connection with the Transferred Business, in each case to the extent arising out of or relating to periods prior to the Closing.

2.  Any liability or obligation of the Transferred Business, Seller or any of its Affiliates, or any of the Companies or their Subsidiaries, which is related to or associated with the failure, alleged failure or purported failure of a product to comply with applicable labeling, false or misleading advertising or consumer protection Laws, including California’s Proposition 65 (California Health & Safety Code Section 25249.6 et. seq.), in each case to the extent arising out of or relating to periods prior to the Closing.

What a godawful mess.

In contrast, the drafters of the contract had used (relatively) short, single-subject paragraphs.