Definitions clauses for contracts

△ Consider going along with this term if (i) you want your affiliated companies to have specific rights under the Agreement, and/or (ii) you want the other side’s affiliated companies to have specific obligations under the Agreement.

▽ Consider objecting to this term if you want to keep tight control over which corporate entity is entitled to be “the other side” of your contract.

This definition seems to have its roots in language found in U.S. securities laws such as Rule 501(b) of SEC Regulation D, 17 C.F.R. § 230.501(b). It’s pretty typical in how it puts fences around the concept of affiliation by requiring at least 50% stock ownership to establish a “control” relationship.

• Think about what would happen if one of the other side’s existing or future affiliates turned out to be a competitor, or some other person or organization that you would just as soon not do business with.
• Consider specifying, elsewhere in the Agreement, just what would happens in case of loss of affiliate status. For example, suppose that (1) that a software license agreement permitted the licensee’s affiliates to use the software, and (2) that a particular affiliate were later to lose its status as such because of a corporate divestiture. It could be disruptive if the affiliate were required immediately to stop using the licensed software.

For purposes of subdivision (b) of this section, the Minimum Voting Percentage is as stated.

The listed group(s) of Persons, if any, are deemed Affiliates of each other regardless of control.

For the avoidance of doubt, for purposes of this section, “control” of an organization does not arise solely from a requirement that a particular type of decision by the organization be approved by a specific class of shares or of comparable voting interests.

For the avoidance of doubt, for purposes of this section, control of an organization is not to be deemed to arise solely from a requirement that a particular type of transaction or decision by the organization must be approved by a supermajority vote of the organization’s board of directors, shareholders, members, etc.

For purposes of determining Affiliate status, “control” of an organization also includes the power to direct or cause the direction of the management and policies of the organization, by contract or otherwise.

△ Consider proposing this clause if you think someday there might be a controversy about which documents were or were not intended to be part of the Agreement.

Some critics rail against the use of and/or as allegedly being a crutch for the lazy. For example, one judge, evidently no slave to brevity, remarked that a drafter “could express a series of items as, ‘A, B, C, and D together, or any combination together, or any one of them alone.“‘ Carley Foundry, Inc. v. CBIZ BVKT, LLC, No. 62-CV-08-9791, slip op. at 8 (Minn. Ct. App., Apr. 6, 2010) (italics added). Um, sure, your honor. Certainly the world needs more sticklers for proper language. But and/or, thoughtfully used, is a perfectly serviceable shorthand; language was made for man, not man for language.

See generally the materials cited in the Wikipedia entry for the term “and/or.”

The definition of this term should be reviewed in the context of the substantive clause(s) that use the defined term. Consider a couple of typical hypothetical situations:

• Suppose a company fails to make X happen after agreeing to use its best efforts to do so. The other side might well claim that this failure was a breach of contract. Almost surely, the company would respond that it made its best efforts to do X, just as the contract required, and so there was no breach.

Just as surely, however, with 20-20 hindsight, the other side’s lawyer will think of some things the company supposedly could have done — but didn’t — to make X happen. That means (or so the other side’s lawyer argues) that by definition the company didn’t use best efforts, and therefore the company should indeed be held liable for breach of contract.

A court very likely would hold that a jury must decide whether or not the company used best efforts, and therefore would refuse to grant a motion to dismiss the case. That of course would increase the expense and uncertainty of the litigation for all concerned.

• Or suppose there’s a catastrophic delay: The company does get X done, but by then it’s too late, at least in the view of the other side. Something like that happened in the Fifth Circuit’s Hermann Holdings case. See Herrmann Holdings Ltd. v. Lucent Technologies Inc., 302 F.3d 552, 556-57 (5th Cir. 2002) (reversing in pertinent part district court’s dismissal of lawsuit).

In the Herrmann Holdings case, Lucent Technologies acquired a company in an all-stock deal; that is, Lucent paid for the acquired company with newly-issued shares of Lucent’s own stock nominally worth $438 million. Under the contract, Lucent was required to use its “reasonable best efforts” to file an S-3 registration statement with the SEC “as promptly as practicable.” Id. at 556 (emphasis added). That filing would allow the sellers to liquidate their Lucent stock by selling it in the stock market.

Unfortunately for the sellers, it took Lucent six weeks to file an S-3, which the SEC approved ten days later. By then, the market price of Lucent’s stock had dropped by 30%, meaning that the sellers were out something like $131 million. Not surprisingly, the sellers filed suit. The appeals court noted that Lucent’s obligation was not merely to file an S-3, but to make its “reasonable best efforts” to do so “as promptly as practicable.” Whether Lucent had complied with this obligation, said the appeals court, could not be determined on a motion to dismiss (meaning in effect that the question was for a jury to decide). See id. at 559-61 (citing cases).

Courts sometimes have difficulty coming to grips with a best-efforts obligation. Does the term mean all efforts short of bankruptcy? Or just “diligent” efforts? Or merely “reasonable” efforts? For that matter, is a best-efforts obligation, without more, so vague that it’s simply unenforceable?

• A California appeals court reviewed case law and concluded that when the contract does not define “best efforts,” the term requires the diligence of a reasonable person under comparable circumstances, not the diligence of a fiduciary:
  

  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. Rather, it requires a party to make such efforts as are reasonable in light of that party’s ability and the means at its disposal and of the other party’s justifiable expectations. ¶ … Diligence is certainly required, but the obligation is framed within the bounds of reasonableness.

  California Pines Property Owners Association v. Pedotti, No. C066315 (Cal. App. May 24, 2012) (affirming judgment after trial to the court) (citations, internal quotation marks, and alteration marks omitted).

• Reviewing case law, the Fifth Circuit noted that in Texas, a best-efforts obligation is unenforceable unless the contract sets out a goal or guideline against which best efforts can be measured. The court held that, on the facts of the case, a contract’s best-efforts obligation was so indefinite as to make it unenforceable; as a result, the defendant could not be held liable for allegedly entering into the contract with no intent to perform. Kevin M. Ehringer Enterprises, Inc., v. McData Serv. Corp., No. 10-10197 (5th Cir. Jul. 11, 2011) (reversing and remanding judgment on jury verdict of fraudulent inducement).

It would probably be better for drafters to use the term diligent efforts instead of best efforts. But for better or worse, best efforts has entered the drafter’s lexicon and is likely to remain there.

If your opposite number demands that your client agree to a best-efforts obligation, consider proposing “diligent efforts” or “commercially reasonable efforts” intead. That should provide you with a little more flexibility in actual operation.

If you still can’t avoid a best-efforts obligation, see my blog posting, Best-efforts obligations: Six negotiation tips, for suggestions about negotiating the language. In summary:

• Try to define “best efforts” and “reasonable efforts” conservatively;
• Help keep disputes from arising by forcing the parties to talk regularly and to escalate disputes to higher management;
• Require early neutral evaluation (ENE) of best-efforts disputes;
• Create a financial incentive to settle;
• Require micro-arbitration of best-efforts disputes; and/or
• Agree to refer best-efforts disputes to a special master.

See generally:

• The definition of reasonable efforts
• A useful 2007 Jones Day memo by Shawn C. Helms, David Harding, and John R. Phillips, Best Efforts and Endeavours—Case Analysis and Practical Guidance Under U.S. and U.K. Law
• A blog posting by Ken Adams and the extensive comments following it (including my own comments): What the Heck Does “Best Efforts” Mean?, Jan. 23, 2008 (accessed Apr. 1, 2009)
• Akash D. Sethi, Derrick Carson, and Brad L. Whitlock, Boilerplate Provisions, 44 Tex. J. Bus. L. 157, 168 & n.37 (2012) (citing cases)

The party subject to the best-efforts obligation is to leave no stone unturned in making reasonable efforts to achieve the stated objective.

In theory, it could be open to factual disputes as to whether, on a given day, banks are closed in the applicable location. A 2004 memo by the Jones Day law firm notes that the traditional definition refers to days on which banks in the applicable location are required or permitted by law to close, but re­search into New York and Texas law found no such requirement nor permission. See Paco Villamar, Not Business as Usual (2004). Villamar’s memo suggests that, for a given contract, it might make more sense to define business day as something more-readily verifiable and/or more appropriate for the specific transaction; for example:

• Days on which the Federal Reserve Bank in the relevant [U.S.] location is closed
• Days on which the Securities Exchange Commission (SEC) does not accept filings.

Many contracts include provisions requiring one party to defend and/or indemnify another party from various types of claims by third parties. An archaic approach to drafting these provisions is, each time, to repeat a laundry list of such variations. This definition allows drafters to forego such a laundry list.

The definition draws on ideas set out in an article by D. Hull Youngblood, Jr. and Peter N. Flocos, Drafting And Enforcing Complex Indemnification Provisions, The Practical Lawyer, Aug. 2010, p.21, at 27.

Sometimes contract drafters don’t want to try to define exactly what a party is supposed to achieve, for example, in promoting sales of a new product. So instead, they might say that “Party A will make commercially-reasonable efforts to promote sales.”

This definition expressly requires assessing the obligated party’s level of effort from the point of view of a reasonably-experienced business person.

The illustrative example in subdivision (a) implicitly incorporates the definition of reasonable efforts, which potentially requires consideration of more than just purely-business issues.

The “potential cost and potential return” language in subdivision (b) is adapted from a comment by Janet T. Erskine in Best Efforts versus Reasonable Efforts: Canada and Australia (Nov. 30, 2007; accessed Aug. 12, 2012).

See the definition of best efforts and the associated commentary.

This clause could offer a way to mitigate a party’s concern that the other side might make a sudden, unexpected move that affects the business relationship.

Consent requirements can be problematic: Suppose that a customer were concerned that its service provider might suddenly replace a key person assigned to doing a customer’s work. In contract negotiations, the customer’s sledge-hammer reaction might be to demand that the service provider agree to obtain the customer’s prior consent before taking such an action.

The prov­id­er, though, likely will push back against such a consent re­quire­ment. The prov­id­er will usually be reluctant to give the customer a veto over how it runs its business. More­over, it could be a management burden for the provider to have to check every customer’s contract to see what internal management decisions required prior customer approval.

Consultation as a compromise: As a compromise, the service provider might be willing to commit to consulting with the customer before taking a specified action that couild cause heart­burn for the customer. That way, the customer would at least get notice, perhaps an explanation, and an opportu­ni­ty to be heard. This could ease the resulting stress on the parties’ business relationship.

A contract for ongoing sales or goods or services will sometimes lock in the pricing for years, subject to periodic increases by X% per year (let’s say) or by the corresponding increase in CPI, whichever is greater (or sometimes, whichever is less).

• Depending on the industry, CPI-U might or might not be the best specific index for estimating how much a provider’s costs have increased. This is explained in the FAQ page of the Bureau of Labor Statistics (accessed Aug. 16, 2012).
• Prohibiting a provider from increasing its pricing by more than the increase in CPI or X percent per year, whichever is less, would force the provider to ‘eat’ any increases in its own costs that exceeded the increase in the particular index chosen.

See also Provider.

This definition is stated here to make it available for possible use in various other provisions relating to (for example) limitations of liability, arbitration, etc.

The definition of this term should be reviewed in the context of the substantive clause(s) that use the defined term.

The definition of this term should be reviewed in the context of the substantive clause(s) that use the defined term.

This definition makes it easy to say (for example): No Press Release Without [Party X] Approval, Deemed Granted In 10 Business Days.

The definition of this term should be reviewed in the context of the substantive clause(s) that use the defined term.

See also the Good Faith Requirement definition.

Some contracts say that a party can do X (or decline to do X) “in its sole and unfettered discretion.” In some jurisdictions, though, the law might impose an implied covenant of good faith and fair dealing, even on a discretionary decision, unless the parties had expressly agreed otherwise. The prospect of such judicial second-guessing likely would lead to (expensive and time-consuming) discovery as each side tried to convince the court that a party had or had not exercised its discretion “fairly” or “in good faith.” The provision in the main text tries to avoid this burden by disavowing any putative standard of reasonableness, good faith, etc.

See generally the Wikipedia article, Implied covenant of good faith and fair dealing.

This definition eliminates the need to repeatedly write (and read), for example, “by way of example but not of limitation.” It’s not uncommon in contracts, and generally uncontroversial.

For an overview of generally accepted accounting principles, see the Wikipedia article of the same title, which also links to a discussion of International Financial Reporting Standards (IFRS), which according to some are beginning to replace the U.S.-oriented GAAP.

This language draws on the definition of Taxing Authority in section 3.5(f) of the Asset Purchase Agreement between Piper Jaffray Companies and UBS Financial Services, available at the SEC’s EDGAR Web site and reproduced in David Zarfes & Michael L. Bloom, Contracts and Commercial Transactions (Wolters Kluwer Law & Business 2011).

In contract disputes, the concept of gross negligence normally comes into play in connection with risk-shifting provisions, such as:

• limitations of liability;
• indemnity obligations;
• clauses exculpating parties from liability for their future actions or omissions.

Such risk-shifting provisions sometimes include an exception (commonly referred to as a carve-out) for cases in which gross negligence is proved.

For example, a limitation clause that caps a vendor’s liability for damages at a stated dollar amount might contain an exception for cases in which the vendor was grossly negligent.

In some U.S. jurisdictions, however, if “gross” negligence was involved, then applicable law might disregard such risk-shifting provisions, as a matter of public policy, no matter what the contract said.

Different U.S. states define gross negligence differently. Moreover, some non-U.S. jurisdictions apparently have not settled on a view whether gross negligence can be distinguished from ordinary negligence.

A contractual definition of gross negligence might therefore be helpful or even essential to determining whether a risk-shifting clause should be pierced. The above definition might applies a fairly-restrictive “New York” standard, in contrast to the arguably-fuzzier and more plaintiff-friendly “California” standard (explained in the blog post cited under “Further reading” below).

Whether a given court would give effect to the definition might depend on whether public policy required a specific definition of gross negligence and precluded parties from agreeing to a different definition.But there is at least a chance that a court might hold that public policy did not bar the parties from agreeing to their own definition of that term.

So all in all, including a definition of gross negligence in a contract is probably worth the effort.

For more details and case citations, see my blog posting, Defining gross negligence in a contract.

The very-real conceptual distinction between hold harmless and indemnify seems to be more academic than practical. Con­seq­uent­ly, in the interest of reducing uncertainty and following what seems to have become conventional practice, this definition unilaterally declares the two terms to be synonymous — forcing them onto a Procrustean bed, so to speak — on the theory that if the parties intend otherwise, they can simply draft their contract language accordingly.

This approach fits in with the tendency of some leading authorities to treat the two terms as being practically synonymous, even though ordinarily courts construe contracts so as to give effect to each provision. See, for example, an opinion by Vice Chancellor Strine of the Delaware Court of Chancery in Majkowski v. American Imaging Management Services, LLC, 913 A.2d 572, 587-89 (Del. Ch. 2006):

As a general matter, Majkowski is correct that courts attempt to interpret each word or phrase in a contract to have an independent meaning so as to avoid rendering contractual language mere surplusage. But …

The terms “indemnify” and “hold harmless” have a long history of joint use throughout the lexicon of Anglo-American legal practice. The phrase “indemnify and hold harmless” ap­pears in countless types of contracts in varying contexts.

The plain fact is that lawyers have become so accustomed to using the phrase “indemnify and hold harmless” that it is often almost second nature for the drafter of a contract to include both phrases in referring to a single indemnification right.

Indeed, were I to hold for Majkowski in this case, I imagine many transactional lawyers would be quite surprised to learn that by using the phrase “indemnify and hold harmless,” they had all along unwittingly been creating mandatory advancement rights.

As a result of its traditional usage, the phrase “indemnify and hold harmless” just nat­ur­al­ly rolls off the tongue (and out of the word processors) of American commercial law­yers. The two terms almost always go together.

Indeed, modern authorities confirm that “hold harmless” has little, if any, different mean­ing than the word “indemnify.” Black’s Law Dictionary in fact defines “hold harmless” by using the word “indemnify.” It defines “hold harmless agreement” as a “contract in which one party agrees to indemnify the other.” In defining “hold harmless clause,” it simply says “[s]ee INDEMNITY CLAUSE.”

Id., 913 A.2d at 588-89 (holding that indemnity- and hold-harmless provision did not entitle protected person to advancement of expenses in lawsuit against him by promisor) (extra paragraphing added). (Hat tip: Ken Adams, who usefully summarizes some relevant authorities in the Revisiting “Indemnify” posting at his Koncision contract-automation site.)

Equating the hold harmless with indemnify also fits in with the fact that the hold-harmless language of UCC § 2-312(3), concerning infringement warranties, appears to have been treated by courts as simply an indemnification obligation. See generally the cases cited in Charlene M. Morrow, Indemnity Ex­clu­sions for Goods Made According to Specification or Industry Standard, parts I-B and I-G (2009)

Still, the conceptual distinction between the two terms is worth pondering. The term indemnify is more-or-less universally understood as a commitment by the promisor to reimburse the protected person for stated losses or liabilities. The term hold harmless, on the other hand, has been treated by some courts as amounting to an advance waiver, release, or exculpation, by the promisor, of stated claims against the person held harmless. For example:

• In its 2012 Morrison opinion, the Idaho Supreme Court considered a release form that had been signed by an employee of a private university in conjunction with the employee’s participation in a team-building exercise. In essence, the release form exculpated the university, in advance, from any injury that the employee might suffer (and in fact the employee did suffer serious injury in falling from a climbing wall). The court referred to the release form, and to similar language in other contracts, as a “hold harmless agreement.” Morrison v. Northwest Nazarene University, 273 P.3d 1253 (Id. 2012) (affirming summary judgment dismissing injured employee’s claim against university).
• In the Queen Villas Homeowners Association case, a California court of appeals, after reviewing (and in some cases distinguishing) California case law, articulated what Ken Adams calls a fab­ri­ca­ted distinction: “Are the words ‘indemnify’ and ‘hold harmless’ synonymous? No. One is offensive and the other is defensive — even though both contemplate third-party liability situations. ‘In­dem­nify’ is an offensive right — a sword allowing an indemnitee to seek indemnification. ‘Hold harm­less’ is defensive: The right not to be bothered by the other party itself seeking in­dem­nif­ic­a­tion.” Queen Villas Homeowners Ass’n v. TCB Prop. Mgmt., No. G037019, slip. op. at 9-10 (Cal. App. Mar. 29, 2007) (reversing summary judgment in favor of defendant; emphasis in original).

Vice-Chancellor Strine, though, is probably right: As a practical matter, for better or worse, lawyers and judges have come to equate hold harmless with indemnify. If parties negotiating a contract believe that the two terms ought to have different meanings, they should draft their contract language accordingly, so as to be clear about their intentions.

This definition eliminates the need to repeatedly write (and read), for example, “including without limitation.” It’s not uncommon in contracts, and generally uncontroversial.

This is a “comfort” clause that should reassure a drafter who thinks the other side might try to argue that incorporated by reference means something other than the accepted meaning.

The language of this definition is adapted from Clauses Incorporated by Reference in the Federal Acquisition Regulations, set forth in the Code of Federal Regulations at 48 C.F.R. § 52.252-2.

(1) Except as provided in subdivision (3) below, the Indemnity Group of the specified party additionally includes the successors and assigns of each individual and organization coming within the scope of the definition of that term.

(2) For the avoidance of doubt, IF: The Agreement requires a member of the Indemnity Group to obtain the consent of another party before assigning the Agreement (or otherwise assigning its right to indemnification); THEN: (i) This option does not in itself constitute such consent; and (ii) If such consent was not obtained, then the indemnifying party is not obligated to indemnify the putative assignee.

The Indemnity Group of the specified party additionally includes the subcontractors (at any tier) of that party.

The Indemnity Group of the specified party additionally includes the customers of that party.

Goodwill is significant in connection with trademarks and service marks. a mark’s legal significance is that it symbolizes the pubilc “goodwill” associated with a product or service that originates with, or is sponsored or endorsed by, the owner of the mark. If the mark owner purports to assign the right to use the mark apart from that goodwill, it can destroy the owner’s rights in the mark. See generally Irene Calboli, What If, After All, Trademarks Were “Traded in Gross”?, 2008 Mich. St. L. Rev. 345.

This definition is adapted almost verbatim from subdivision (b) of UCC § 1-202.

Other subdivisions of UCC § 1-202 are not incorporated into this definition; some of those other subdivisions define “notice” and specify default rules for when an organization has knowledge or notice of a fact, which might conflict with the notice provisions of the Agreement.

Merger- and acquisition (M&A) agreements often contain definitions of knowledge (sometimes much more elaborate than this one). Such definitions seem to be less common in contracts for commercial transactions.

This definition does not impose a duty of inquiry.

It’s always possible that a “creative” counsel might try to claim that some form of government requirement did not constitute “law” in connection with a contract provision. This definition is intended to forestall such an attempt.

This is a convenience definition

The language of this definition is adapted from UCC §§ 1-201(25) and 1-201(27).

The language of this definition is adapted from UCC § 1-201(27).

See also Customer.

Contract drafters not-infrequently resort to stating that a party will make “reasonable efforts” to achieve something, instead of imposing an absolute obligation to do so. This definition attempts to give some predictability to the quoted term. See also the definition of best efforts and the associated commentary, which contains citations to court cases and links to further reading.

Undue hardship — subdivision (c): This language is adapted from a comment by Janet T. Erskine, Best Efforts versus Reasonable Efforts: Canada and Australia (Nov. 30, 2007; accessed Aug. 12, 2012).

The language of this definition is adapted essentially verbatim from UCC § 1-205.

This definition is a combination of (i) the definitions of signed and writing in UCC §§ 1-201(37) and 1-201(43); and (ii) the definitions of electronic signature and electronic record in the [U.S.] Electronic Signatures in Global and National Commerce Act (“E-SIGN”), 15 U.S.C. § 7006. The definition also draws on the definition of writing in proposed Rule 1.00(v) of the 2010 proposed amendments to the Texas Disciplinary Rules of Professional Conduct [for lawyers]. (Those proposed amendments were rejected, for unrelated reasons, in a referendum of the State Bar of Texas.)

The language of this definition draws on:

• Contract language quoted by the Court of Appeals of New York in Innophos, Inc. v. Rhodia, S.A., 10 N.Y.3d 25, 27-28 (2008). In that case, the state of New York’s highest court upheld a summary judgment that a $20 million-plus water usage charge, levied by a Mexican government entity, was a “tax” within the meaning of the contract’s laundry-list definition; and
• Section 3.5(e) of the Asset Purchase Agreement between Piper Jaffray Companies and UBS Financial Services, available at the SEC’s EDGAR Web site and reproduced in David Zarfes & Michael L. Bloom, Contracts and Commercial Transactions (Wolters Kluwer Law & Business 2011).

The language of this definition draws on the definition of Taxing Authority in section 3.5(f) of the Asset Purchase Agreement between Piper Jaffray Companies and UBS Financial Services, available at the SEC’s EDGAR Web site and reproduced in David Zarfes & Michael L. Bloom, Contracts and Commercial Transactions (Wolters Kluwer Law & Business 2011).

Portions of this definition are adapted from proposed amendments to Rule 1.00(u) of the 2010 proposed amendments to the Texas Disciplinary Rules of Professional Conduct [for lawyers]. (The proposed amendments were rejected in a referendum for unrelated reasons.)

The definition of “workmanlike” here is my own coinage; it draws on concepts in various definitions I found on-line.

Portions of this definition are adapted from proposed amendments to Rule 1.00(v) of the 2010 proposed amendments to the Texas Disciplinary Rules of Professional Conduct [for lawyers]. (The proposed amendments were rejected in a referendum for unrelated reasons.)

This is a fairly conventional “usages” provision.