Don’t make Affiliates parties to the agreement

It 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]

An 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.

IP 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?