Monthly Archives: February 2012

One-sided contract term of the day (4): warranting a ‘good deal’

We continue our series highlighting IP Draughts’ “favourite” one-sided provisions in contracts.  These provisions are often found in contracts where there is an imbalance of power between the parties, and where the party with the power (let us call him the “Patron”) seeks to reduce a sometimes theoretical risk by imposing it on the other party (the “Supplicant”).

Today’s one-sided term is:

The Supplicant is not aware of any fact or matter not disclosed in writing to the Patron which directly affects the Business, the disclosure of which might reasonably affect the willingness of a reasonable institutional investor to apply for shares in the capital of the Company or the price at or terms on which an institutional investor would be willing to subscribe them.

This warranty appeared in a draft investment agreement that IP Draughts recently reviewed, in respect of a university spin-out company.

The warranty is very broad and general.  In effect, it is asking the warrantor (the Chief Executive of the Company) to bear the risk that the investor has made a bad investment decision.

There is no safe way of disclosing against this warranty, other than a Joe-90 style brain dump of all information known to the Warrantor.

In IP Draughts’ view, the correct response to this warranty is to delete it, and not to attempt any finessing or fine-tuning of the words.  In agreements where such a warranty appears, there are likely to be plenty of other, more specific warranties that the investor can rely on.

IP Draughts’ scoring for extremeness: 10/10

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Using US contract templates outside the US: it can be a bad mistake

US business practices dominate international contract negotiations.  This sometimes results in US contract templates being used for contracts that are not made under US laws.  While this may be okay for some of the more ‘commercial’ clauses in a contract, it can be a bad mistake to use US wording in liability clauses, when the contract is made under another country’s laws.

A case decided last week in the English Commercial Court illustrates the problems that can arise.

In Air Transworld Limited v Bombardier Inc [2012] EWHC 243 (Comm), an Angolan resident, Mr Antonio Mosquito, purchased a Challenger 605 private jet aircraft from a well-known Canadian manufacturer, Bombardier.  In his claim, he stated that the jet was for his personal use.  The contract was initially in the name of an Angolan company controlled by him, but was later assigned to a Gilbraltar company.  The contract was made under English law.

Plenty of room for Mosquitos

The detailed facts need not concern us, but there was a problem with the aircraft’s hydraulics which resulted in an emergency landing in Algeria.  The claimant purported to reject the aircraft on the grounds that it did not meet its description, was not of satisfactory quality and was unfit for purpose, in breach of implied terms under sections 13 and 14 of the English Sale of Goods Act 1979.  For the benefit of US readers who have similar implied terms in their legislation, the phrase “satisfactory quality” was substituted for “merchantable quality” by an amendment to the English legislation in the 1990s, but it is not thought that any substantive change was made by this modernisation of the wording.  The phrase “merchantable quality” was used in earlier versions of the same legislation, dating back to at least the nineteenth century.

Bombardier sought to rely on the following clause in the contract:

4.1 THE WARRANTY, OBLIGATIONS AND LIABILITIES OF SELLER AND THE RIGHTS AND REMEDIES OF BUYER SET FORTH IN THIS AGREEMENT ARE EXCLUSIVE AND ARE IN LIEU OF AND BUYER HEREBY WAIVES AND RELEASES ALL OTHER WARRANTIES, OBLIGATIONS, REPRESENTATIONS OR LIABILITIES, EXPRESS OR IMPLIED, ARISING BY LAW, IN CONTRACT, CIVIL LIABILITY OR IN TORT, OTHER OTHERWISE, INCLUDING BUT NOT LIMITED TO A) ANY IMPLIED WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR A PARTICULAR PURPOSE, AND B) ANY OTHER OBLIGATION OR LIABILITY ON THE PART OF SELLER TO ANYONE OF ANY NATURE WHATSOEVER BY REASON OF THE DESIGN, MANUFACTURE, SALE, REPAIR, LEASE OR USE OF THE AIRCRAFT OR RELATED PRODUCTS AND SERVICES DELIVERED OR RENDERED HEREUNDER OR OTHERWISE.

If effective, this wording would have excluded the implied terms under section 14 of the Sale of Goods Act.

Unfortunately for Bombardier, there is a long line of English case authority, discussed at length in Cooke J’s judgment, stating that in order to exclude section 14, it is necessary to state explicitly that one is excluding the “conditions” of merchantability (now satisfactory quality) and fitness for purpose.  It is not enough to state that one is excluding “warranties”.  This is because the Sale of Goods Act makes a clear distinction between promissory conditions (breach of which entitle the party suffering from a breach to terminate the contract) and warranties (breach of which only entitle that party to claim damages).

There is a strong commercial argument that this technical distinction between conditions and warranties has outlived its usefulness, does not reflect modern commercial practice, and should no longer form part of English law.  In one of the cited cases, Rix LJ (a very senior, current English judge specialising in commercial law) made comments to this effect, but felt bound by House of Lords (now Supreme Court) authority.

Be that as it may, a well-drafted English law disclaimer would include the word “conditions” in the long list of words that appears in lines 4-5.

Reading Cooke J’s judgment, one senses that he was trying to find a way of ensuring that Bombardier did not lose on this point as a result of a legal technicality.  In the event, he decided that some of the other wording of the clause, including the reference to other obligations and liabilities “of any nature whatsoever” meant that he could construe the disclaimer as applying to implied conditions, even though the word “condition” was not used.

IP Draughts has several thoughts about this case:

  1. The judge was stretching a point in order to do justice in the case. It will be interesting to see if the decision is appealed and, if so, whether the Court of Appeal agrees that this wording is sufficiently different to that in the earlier cases cited in his judgment, that it can be given a different meaning.
  2. The wording of clause 4.1 is quite clearly from a US, or North American, template.  There are plenty of clues that this is the case, including the fact that the above-quoted clause is in block capital letters – see our earlier blog posting which discusses this point.  It refers to merchantability when an English clause would refer to satisfactory quality.  Another clue is in the choice of law clause which stated “This Agreement shall be governed by and interpreted in accordance with the internal laws of England and Wales, excluding any conflicts of law provisions thereof.”  The reference to conflict of laws is a distinctly US feature of choice of law clauses, and is not really relevant under English law.  Wherever possible, parties should ensure that the warranty, liability and indemnity clauses (but not only these clauses) have been drafted by a lawyer who is qualified in the country or state whose law is to apply to the contract.
  3. Sometimes, commercial parties treat the choice of law as a minor negotiating point, perhaps at a similar level to whether payment is to be made within 30 or 45 days of the date of the invoice.  In IP Draughts’ view, it is one of the more important terms of the contract, and should not be traded lightly.

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Incorporation by Royal Charter: more classy than a conventional company

IP Draughts’ attention has recently been brought to a fascinating document: a complete list of the bodies incorporated by Royal Charter in the United Kingdom, as set out on the Privy Council website.  Thanks to Sean Cummings of Keltie and Tom Sharman of Reddie and Grose for pointing out this list.

Sir Anthony Denny, Henry VIII's Groom of the Stool and member of his Privy Council: he was pleased to take c*** from his boss!

To his shame, IP Draughts was surprised to discover that the Privy Council has a website, and even more surprised to find that it provides commercially-useful information in a convenient, spreadsheet format.  In IP Draughts’ mind, the Privy Council is associated with the court of Henry VIII or Elizabeth I.  It jars to think of such an august and ceremonial body making use of modern technology

The information is not as arcane as it may seem. Most, if not all, of our UK university clients are incorporated by Royal Charter.  When entering into a contract, it is important to identify the parties and their legal status.  In recent years, Companies House has included charter bodies in their free, searchable index of companies.  As Companies House is not responsible for the incorporation of charter bodies, they have presumably used information from the Privy Council in their index.  There is a nice legal point as to whether one can rely on either the public Companies House list or the Privy Council list when identifying a party in a contract, or should one consult the Royal Charter of the body concerned?  IP Draughts would be interested to hear readers’ views.

The list is in the form of an Excel spreadsheet, with the charter bodies listed in order of incorporation.  A second list (or is it the same list?) claims to show all bodies that have received a Royal Charter since the thirteenth century, whether or not still active.

William Hogarth: South Sea Bubble

After the University of Cambridge in 1231, and the University of Oxford in 1248, come a variety of guilds, livery companies, colleges and schools, including Giggleswick School in 1553.  Other notable entries include the Royal Society in 1662, the South Sea Company in 1711 (remember the South Sea Bubble?), Royal Bank of Scotland Limited in 1727 (but probably don’t use this RBS company if you want to contract with them!), and McGill University in 1821.  Surprisingly, IP Draughts was not able to find King’s College, which subsequently became Columbia University, despite the Columbia University website claiming that it obtained a Royal Charter in 1754.

Among the most recent entries is the Chartered Institute of Legal Executives, in 2011.

On a different topic, IP Draughts is intrigued to see, on the Privy Council website, the oath that must be made by new Privy Councillors:

You do swear by Almighty God to be a true and faithful Servant unto The Queen’s Majesty as one of Her Majesty’s Privy Council.  You will not know or understand of any manner of thing to be attempted, done or spoken against Her Majesty’s Person, Honour, Crown or Dignity Royal, but you will lett and withstand the same to the uttermost of your power, and either cause it to be revealed to Her Majesty Herself, or to such of Her Privy Council as shall advertise Her Majesty of the same.  You will in all things to be moved, treated and debated in Council, faithfully and truly declare your Mind and Opinion, according to your Heart and Conscience;  and will keep secret all matters committed and revealed unto you, or that shall be treated of secretly in Council.  And if any of the said Treaties or Counsels shall touch any of the Counsellors you will not reveal it unto him but will keep the same until such time as, by the consent of Her Majesty or of the Council, Publication shall be made thereof.  You will to your uttermost bear Faith and Allegiance to the Queen’s Majesty; and will assist and defend all civil and temporal Jurisdictions, Pre-eminences, and Authorities, granted to Her Majesty and annexed to the Crown by Acts of Parliament, or otherwise, against all Foreign Princes, Persons, Prelates, States, or Potentates.   And generally in all things you will do as a faithful and true Servant ought to do to Her Majesty

SO HELP YOU GOD

Should this be redrafted in plain English, or is it in a similar category to the letters patent for a Duke, ie largely ceremonial?  IP Draughts does not know whether the above confidentiality and fidelity obligations are intended to be legally enforceable.  Perhaps a Privy Councillor who breaches them is handed a loaded revolver and told to go into the next room…?

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One-sided contract term of the day (3): grossing-up of withholding tax

We continue our series highlighting IP Draughts’ “favourite” one-sided provisions in contracts.  These provisions are often found in contracts where there is an imbalance of power between the parties, and where the party with the power (let us call him the “Patron”) seeks to reduce a sometimes theoretical risk by imposing it on the other party (the “Supplicant”).

Today’s one-sided term is:

If any withholding tax is levied on the Payments, then Supplicant shall increase the sums paid to Patron so that the amount received by Patron after the withholding tax is deducted is the full amount Patron would have received if no withholding or deduction had been made.

This term differs from some of the others in the series in a number of ways.  First, it is focussed on an IP issue, or rather an IP tax issue – withholding tax.  Some of the other terms in the series could be found in many types of commercial agreement and are not specific to IP transactions.

Secondly, the presence or absence of the term doesn’t depend entirely on who has the bargaining power, although this has a part to play.  Instead, the use of such a term seems to reflect practice in particular industry sectors.  Thus, IP Draughts sees the term used frequently in software supply agreements, but very rarely sees it in biotech licence agreements.

What is withholding tax?

Many countries’ tax laws, including those in the UK, start from the assumption that where IP royalties are paid, tax should be deducted by the payer (ie the licensee) from the amount of the royalty, and paid to the tax authorities in the licensee’s country.  The net amount, less the tax, can then be paid to the licensor.  In some situations, reliefs and exemptions may be available that allow the payment to be made gross, ie without deduction of tax.

It is important to stress that what is being deducted is an advance payment of the licensor’s tax.  Typically, basic rate income or corporation tax (the name varies between jurisdictions) is deducted. Thus the licensee is acting as an unpaid tax collection agent for tax that has nothing to do with him.

While this tax system may be unfamiliar to many people, you may be more familiar (at least in the UK) with the fact that, on an interest-bearing bank account, your bank deducts basic rate income tax on interest payments, and sends you a certificate of tax deducted at the end of the year.  You include this certificate in your annual income tax submission and the tax authorities take it into account when calculating the tax due.  Essentially, the deduction at source of tax on interest is the same system as applies to royalty payments, and for that matter dividends on shares.

This withholding of tax at source is commonly known as withholding tax.

Deduction of tax on royalties at source can cause several problems for the licensor.  If he is not a taxpayer, or is not a taxpayer in the licensee’s country, it may be difficult for him to recover the tax, or (even if he can recover the tax) he may suffer a short-term cash flow disadvantage.  If he is a taxpayer in another country, he may find himself being taxed twice on the same income in two countries.  This is known as double taxation.

To mitigate the effect of double taxation, most countries of the world have entered into bi-lateral double tax treaties with most other countries of the world.  The terms of those treaties vary, but over time as they are periodically renewed, many are being redrafted to conform with an OECD model.  This is gradually removing some of the quirks of some of the treaties.  For example, while many treaties allow 100% relief from basic rate tax in the licensee’s territory if certain conditions are met, some of the treaties with Far Eastern countries have historically allowed only 50% relief.  During the 1990s, IP Draughts was involved in helping a UK biotech company that was prejudiced by the fact that the UK:Japan treaty only allowed 50% relief.  IP Draughts understands that the latest UK:Japan treaty allows 100% relief from withholding of tax.

Typically, to obtain the relief, the licensor must obtain evidence from the tax authorities in his home territory showing that he is a taxpayer in that territory.  That evidence is given to the licensee, who shows it to the tax authorities in the licensee’s territory and seeks permission to make the royalty payments gross, ie without deduction of tax.

Addressing the withholding tax risk

In biotech licence agreements (to take one of the examples given earlier), IP Draughts has typically seen wording such as the following:

The Payments shall be made without deduction of income tax or other taxes charges or duties that may be imposed, except insofar as the Licensee is required to deduct the same to comply with applicable laws.  The Parties shall cooperate and take all steps reasonably and lawfully available to them, at the expense of IP Owner, to avoid deducting such taxes and to obtain double taxation relief.  If the Licensee is required to make any such deduction it shall provide IP Owner with such certificates or other documents as it can reasonably obtain to enable IP Owner to obtain appropriate relief from double taxation of the payment in question.

The above wording provides that the parties will try to avoid withholding of tax, but ultimately if the licensee is required to deduct tax he may do so.  This is a tax issue for the licensor and ultimately, in the above wording, the risk is borne by the licensor.

The “one-sided” wording quoted at the beginning of this piece takes a different approach.  It requires the licensee to “gross up” the amount of the payment so that, after deduction of tax, it is the same amount as was originally agreed to be paid.  With this approach, the risk is passed to the licensee.

Who bears an individual risk in a contract is ultimately a matter for commercial negotiation, and the answer to this question may be affected by industry practice and the relative bargaining power of the parties.  In some cases, the risk may have been factored into the price.  It is for the parties  to decide what deal terms they want to agree, and IP Draughts claims no superior knowledge to tell them differently.

Standing back from market practice, though, it does seem strange to IP Draughts that a licensee should have to bear a risk that he cannot control, and where the nature of the risk may depend on the structure of the licensor organisation (eg whether he has a trading subsidiary in the licensee territory that can offset the tax against profits) and its current tax status.

IP Draughts’ scoring for extremeness: 6/10

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