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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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The Supreme Court of Texas is considering whether to grant a petition for review to establish whether, in Texas, an indemnity provision covers only third-party claims, not first-party claims, unless the provision unequiv­oc­al­ly states otherwise. (This seems to be the case in some other states such as New York.) The case is Claybar v. Samson Exploration LLC, on appeal from a decision by the Texas Court of Appeals in Beaumont.

Mr. Claybar entered into a contract allowing Samson Exploration to drill for oil and gas on Claybar’s property.  An equipment failure allegedly caused damage to the property; Claybar alleged that the failure was due to neg­li­gence by Sam­son’s contractor, Kinder Morgan.  Claybar settled with Kinder Morgan, but kept going in his lawsuit against Samson, claiming that Samson was con­tract­ually required to indemnify Claybar for the attorney’s fees and costs that Claybar had incurred in pursuing his negligence claim.

As quoted by the court of appeals, the indemnity provision stated:

[Samson] shall indemnify [Claybar] against any claims, damages, demands, liabilities, and costs (including reasonable attorneys’ fees) to the extent arising from or related to the negligence or misconduct of [Samson] or its employees, agents, contractors, or invitees in the course of their exercise of rights granted by this instrument, but not to the extent caused by [Claybar], or its employees, agents, contractors, or invitees.

(Emphasis added.)  The appeals court, affirming summary judgment, held that:

The plain language of the indemnity provision does not show that the parties intended for Samson to indemnify Claybar for attorney’s fees and costs in pursuing claims against Samson and Kinder Morgan for damages to Claybar’s property.

If Samson and Claybar had intended to include claims between them, they would have had to specifically add such language to the Agreement.

We hold that there is no specific language in the Agreement that would overcome the general rule that indemnity agreements do not generally apply to claims between the parties to the agreement.

(Citations omitted, extra paragraphing added.)

The appellant’s brief and respondent’s brief in the Texas supreme court contain extensive citations.

It seems possible that the supreme court might deny the petition, because in another provision in the contract, Claybar granted a release for any damage caused to his property:

Except as otherwise set forth herein, the consideration paid hereunder includes payment for all damages to the Lands, and Grantor hereby acknow­ledges receipt and sufficiency of said payment as full and com­plete settlement for and as a release of all claims for loss, damage, or injury to property arising out of the operations contemplated hereunder.

(Quoted in Samson’s brief at 6; emphasis added.)

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Many arbitration agreements adopt the American Arbitration Association’s rules, especially the AAA’s Commercial Arbitration Rules. In those rules, Rule R-7(a) explicitly gives the arbitrator “the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim.” (Emphasis added.)

The likely upshot of a unanimous decision of the U.S. Supreme Court is that, if parties adopt rules such as AAA Rule R-7, and those rules “clear[ly] and un­mis­tak­abl[y]” delegate arbitrability determinations to the arbitrator, then all demands for arbitration must be run through the arbitration process at least to determine arbitrability — even if a particular demand for arb­i­tra­tion seems clearly excluded by the language of the arbitration provision it­self. See Henry Schein, Inc. v. Archer & White Sales, Inc., No. 17-1272 (U.S. Jan. 8, 2018), reversing 878 F.3d 488 (5th Cir. 2017).

In Henry Schein, the arbitration provision in the contract expressly ex­clu­ded demands for injunctive relief:

Disputes. This Agreement shall be governed by the laws of the State of North Carolina. Any dispute arising under or related to this Agreement (except for actions seeking injunctive relief and disputes related to trademarks, trade secrets, or other intellectual property of [Schein]), shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association [(AAA)].

Id., slip op. at 2 (citation omitted, italics added).

One of the parties sued the other in court, demanding injunctive relief (among other things) The defendant moved to compel arbitration.

A magistrate judge ruled that the arbitration provision’s incorporation of AAA rules had the effect of clearly delegating the arbitrability decision to the arb­i­tra­tor. The district judge reversed, however, and the Fifth Circuit affirmed the district judge’s ruling, on the basis that the injunctive relief carve-out in the arbitration provision made the arbitration demand “wholly groundless.” See 878 F.3d at 491.

But then, in an opinion by Justice Kavanaugh, the Supreme Court unan­i­mous­ly vacated and remanded the Fifth Circuit’s decision. While the Court ex­pressed no view whether the contract actually did delegate arbitrability de­ter­min­a­tions to the arbitrator, see slip op. at 8, it held that the “wholly ground­less” ex­cep­tion cited by the Fifth Circuit was inconsistent with the Federal Arbi­tra­tion Act. See id at 5.

(The Court was untroubled by the prospect of the case being ping-ponged between arbitration and litigation. See id. at 7.)

Drafting lesson: If your arbitration provision adopts rules that delegate arb­i­tra­bil­i­ty de­ci­sions to the arbitrator, then you might want to consider whether that’s what you want — and if not, then stating explicitly in your arbitration provision that the court, not an arbi­tra­tor, is to determine whether particular claims are arbitrable.

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Contract management can be expensive, but lack of it can be even more costly.  General Nutrition Centers (GNC) was given a painful lesson in this truth to the tune of a $1.1 million jury verdict — which could have been much higher.

In Olive v. General Nutrition Cen­ters, Inc., No. B279490 (Cal. App. Dec. 27, 2018), the plaintiff, a model and actor, appealed the damage award for being too low; the appeals court affirmed the judgment below, and also affirmed denial of the plaintiff’s claim for attorney fees. The case arose because GNC’s outside photographic agency shot photos of some 16 models that GNC used in an ad cam­paign. Among the models was one Jason Olive, who was paid $4,000 for a three-hour photo shoot and for the right to use his likeness for one year (a “model release”), with GNC also having an option to extend the model release for one additional year.

In a classic example of things falling through the crack, GNC did not keep track of when the model releases expired; neither did GNC’s photo­graphic agency, which by then was no longer doing work for GNC.  Con­se­quent­ly, when GNC’s ads continued to feature the likenesses of sev­er­al of the models, including Mr. Olive, it was for longer than the agreed period covered by the model releases.

GNC settled with the other models for between $5,000 and $32,000 each in exchange for five-year extensions of their model releases; Mr. Olive, how­ever, held out for more. Rejecting an eventual GNC offer of $150,000, he sued GNC, under a California statute, for mis­ap­pro­pri­­a­tion of his likeness.

GNC admitted liability; the lawsuit was about the proper measure of dam­ages. Mr. Olive initially asked for some $55 million, but the jury awarded him a total of $1.1 million. This was far less than what Mr. Olive had sought, but it was still far more than what GNC had paid any of the other models — and far less than GNC might have paid if it had insisted on the perpetual right to use the models’ likenesses, as pointed out by Santa Clara Law professor Eric Goldman, who explains the case in detail at his Technology and Marketing Law blog.

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In a case involving a software sale gone wrong, the federal district court in Min­ne­sota provides a nice recap of how courts analyze whether or not a given soft­ware-license transaction is governed by Article 2 of the Uniform Com­mer­cial Code (which covers sales of goods):

<BEGIN QUOTE>

Article 2 of the UCC applies to “transactions in goods.”  Under Illinois law, whether a sale of software constitutes a “transactions in goods” depends on various considerations.

One consideration is the rights conferred to the purchaser by the Agreement. A transaction that nominally involves a mere license to use software will be considered a sale under the UCC if it involves a single payment giving the buyer an unlimited period in which it has a right to possession.

Another consideration is whether the components of the software package were developed from scratch.  Off-the-rack software is almost always a good. Customization or modification of a standard software product is generally considered the manufacture of a good rather than a service.

Additionally, contracts for the sale of software often include provisions of services, such as training and technical support. Where there is a mixed contract for goods and services, there is a transaction in goods only if the contract is predominantly for goods and incidentally for services.  Article 2 applies to sales of software where the ancillary services offered are similar to those generally accompanying sales of computer systems, such as installation, training, and technical support.

Here, the Agreement is the sale of software that has been customized for Prairie River’s business.

  • First, Prairie River purchased a perpetual enterprise license, meaning that Prairie River has a non-transferable right and license to perpetually access and use the Software.
  • Second, the Complaint and the Agreement suggest that the Software is a standard Procura product. Customization of the Software is considered the manufacture of the Software in this case.
  • Third, the ancillary services provided in the Agreement are the sorts of services — installation, training, and technical support — expected to accompany a sale of software.

Accordingly, the Court concludes that the Agreement governs a sale of goods subject to Article 2 of the UCC.

<END QUOTE>

Prairie River Home Care, Inc. v. Procura, LLC, No. 17-5121 (D. Minn. July 30, 2018) (denying defendant’s motion to dismiss) (cleaned up, bullets added).

Hat tip:  Richard Raysman and Elliot Magruder, Potentially Unconscionable Warranty Precludes Licensor’s Motion To Dismiss (Mondaq.com Oct. 5, 2018).

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