Don’t make Affiliates parties to the agreement

creepingIt has been creeping into agreement templates for several years.  If you search on the internet for the phrase “together with its affiliates”, you will find plenty of examples of agreements that lump affiliates into the party definitions.

At the beginning of an agreement, typically the full legal name and status of each party is given.  In addition, the parties are typically given short code-names that are used in the rest of the agreement.  These code-names are usually abbreviated versions of the party’s name (eg GSK for GlaxoSmithKline plc) or names based on the party’s status (eg Contractor).  So far, so good.

Increasingly, affiliates of a party are included in the definition using a formula such as the following:

Mega Corporation, Inc., incorporated in the State of Alabama (together with its Affiliates, “Mega“)

Affiliates are usually defined in the agreement as (in summary) members of the same corporate group.  The definition typically refers to majority shareholding or control.

This is sometimes followed, several pages later, by a signature block that reads:

For and on behalf of Mega

________________

signed [etc]

This practice is encountered in many types of commercial agreement, including corporate and IP agreements.  In IP Draughts’ experience it is usually a terrible idea to include affiliates in an agreement in this way.

Let’s take the example of a patent and know-how licence agreement, where Mega is the licensee.

It is understandable, from the licensee’s perspective, to want the licence to extend to affiliates (ie group companies) of the licensee.  There are several ways in which this can be done, which will be discussed below.  Lumping affiliates into the definition of the licensee may seem superficially attractive – a quick fix – but presents several difficulties.

First, there is the question of whether the affiliates are made parties by this method.  Is that the intention, or is there some lesser intention of somehow sweeping up affiliates without making them formally parties?  In IP Draughts’ view, the natural conclusion is that they are being made parties, particularly if the signature block just refers to “Mega”, or refers to “Mega Corporation Inc and its Affiliates”, and does not say “Mega Corporation Inc.”  IP Draughts dislikes signature blocks that use abbreviated party names and prefers to see the parties named explicitly.

If the natural conclusion is that affiliates are being made contracting parties, this raises several further questions, including:

  1. Does the person signing have authority to sign on behalf of each affiliate?  By signing on behalf of them, the individual who signs is implicitly representing that they have authority to do so.  If they don’t have such authority, who is liable for the misrepresentation, the (main) contracting party or the individual?
  2. Which of the group companies (ie the named party and its affiliates) is liable for performing Mega’s obligations under the agreement?  Are all the group companies jointly and severally liable for such performance?  What assets do the affiliates have to meet any liabilities and should there be a parent company guarantee?
  3. If Mega is giving knowledge-based warranties, are they made by reference to the knowledge of all of the affiliates?
  4. If Mega is a licensee and is obliged to pay royalties, is the licensor required to deal with each affiliate separately, and does it have a contractual right to deal only with the main contracting party?
  5. If the licensor is in breach of contract, is it liable to each of the affiliates separately?
  6. If company X is an affiliate at the date of signing but ceases to be an affiliate thereafter, does it cease to be a party to the agreement?  How does this work?
  7. If company Y is not an affiliate at the date of signing but becomes one thereafter, does it become a party to the agreement?  In IP Draughts’ view, probably not, but the agreement will need to be closely scrutinised before coming to any views on this point.
  8. If one of the affiliate-parties is in breach, is the licensor able to exercise remedies (eg termination) against all of the licensee-parties or only against that affiliate?

In other words, joining affiliates in as parties is likely to create a nasty mess, which can be dealt with by detailed contract language (eg dealing with points 1 to 8 above) but often isn’t.

So, how should a licensee seek to extend the benefit of its licence to its affiliates, without making them parties to the agreement?  One way that is seen, is to modify the grant clause so that it refers to affiliates, as in the following example:

Patent Owner hereby grants to Mega and its Affiliates an exclusive, worldwide licence [etc]

cryAn objection might be made to this formula that the affiliates are not parties to the agreement and therefore cannot benefit from a clause drafted in this way.  A possible way of dealing with this point, under English law and the law of some US states, is to include a “third party rights” clause that states, in effect, that the affiliates may enforce the grant clause as if they were a party. Advice should be sought as to the effectiveness and wording of such a clause under the law of the contract.

But even if this is done, some of points 1-8 above will still need to be addressed in the contract, eg who does the licensor look to for royalties, and is it clear that royalties are payable on sales by affiliates?

From a licensor’s perspective, it may be preferable to deal with one contracting party as licensee and avoid some of the complications mentioned above.  On that basis, it may be preferable to allow the licensee to sub-license its affiliates, rather than giving the affiliates automatic licence rights under the main licence agreement.  Some licensees are happy with this solution. It may be necessary to address the question of royalties on sales by affiliates differently to royalties on sales by independent sub-licensees, but this is an issue that may arise anyway, whether affiliates are treated as sub-licensees or as direct beneficiaries of the main licence under the agreement.

pierceIP Draughts has a suspicion that the practice of lumping affiliates into the party definition may be based partly on a hazy idea that all group companies are somehow treated as a single entity.  Perhaps the legal position is different in some jurisdictions, but in England and Wales the courts are usually very reluctant to “pierce the corporate veil” (to use a quaint expression that the courts have used for over a century on this point) and treat group companies as one.

Do readers agree?  Are there any circumstances in which you consider it appropriate to include affiliates in a definition of a contracting party?

8 Comments

Filed under Contract drafting

8 responses to “Don’t make Affiliates parties to the agreement

  1. Mark’s concerns are, of course, valid but they are not limited to license agreements. Most transactional templates used by multinational corporations, such as master supply agreements, contain broad language for Affiliates and are subject to the vagaries that Mark identifies. About the only form of precision one ever sees is in the very definition of Affiliate, often (but not always) in terms of 51% ownership by a parent. I have seen hundreds of agreements executed by two multinationals, and I can’t remember a single occasion when one of Mark’s concerns was raised during negotiation. I believe the lawyers involved know that the approach to Affiliates is imprecise but they prefer to focus their energies on other topics during drafting and negotiation — and to let the courts sort it out, if a dispute arises over Affiliate language. In a transactional agreement where buyer and seller each has 50 or more subsidiaries around the world, with the number of country-pair combinations reaching into the hundreds, attempting to nail down all the potential problems could be quite time-consuming and perhaps inconclusive.

    • Interesting to hear of your experience with this one. I wonder whether this formula has become “part of the furniture” in US agreements, a bit like references to “hold harmless”, and is not queried for that reason.

  2. I can’t argue with the logic or the concerns expressed, but does anyone have experience with real world problems of unintended consequences that have arisen from being overly inclusive? It occurs to me that in most instances, if the concerns are expressly addressed, the results would be the same. Usage and royalty should certainly be clear. In my experience, business disputes are generally not that nuanced.

    • Jim, thanks for providing a counter-argument. It would be great if more people did that in response to articles on this blog.

      I don’t have an example of where this particular formula caused problems, but I have seen plenty of reported cases on the general question of when the courts are prepared to “pierce the corporate veil” and make one company liable for the actions of another. Eg see this very recent English Court of Appeal case which also discusses differences between English and New York law on this subject: http://www.bailii.org/ew/cases/EWHC/Comm/2013/2767.html#para206

      I agree that many business disputes are not nuanced. Many are based on simple issues like non-payment, or seem to rely more on personalities and commercial fire-power than legal niceties. However, even the most gung-ho businessman should want to know how the contract would be interpreted if the issue in dispute came to court. This knowledge won’t stop more basic commercial considerations coming into play, but it will provide a legal context. For example, I am reminded of the case of Cambridge Antibody Technology v Abbott Laboratories, which concerned the interpretation of a royalty-stacking clause. http://www.bailii.org/cgi-bin/markup.cgi?doc=/ew/cases/EWHC/Patents/2004/2974.html&query=title+%28+cambridge+%29+and+title+%28+antibody+%29+and+title+%28+technology+%29+and+title+%28+v+%29+and+title+%28+abbott+%29&method=boolean This case concerned the interpretation of detailed wording. The English High Court came down clearly in favour of CAT, but the parties subsequently struck a deal to settle the dispute that arguably recognised Abbott’s greater commercial firepower.

  3. Mark, excellent article and I completely agree with your comments. I have never been able to think of a good reason to define a contracting party as including affiliates and I will always cross such drafting out. Keep up the good work on the blog. All the best for 2014, George

  4. theContractsGuy

    Mark: Thanks for the words of caution. I see this approach often in confidentiality agreements, also. It’s always made me uncomfortable, because it’s unclear what the implications are.

    • Brian, yes and if the NDA is for really important trade secrets, it is questionable whether disclosure across an international group should be allowed anyway, rather than making relevant group companies parties to the NDA.

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