Why is M&A contract drafting so bad?

Before we get to that question, here are some others: why do people called Wood start insurance businesses, and what makes them so good at it that they become millionaires?

Back in the 1980s, Peter Wood set up Direct Line, an insurance company whose advertising was famous for featuring a red telephone handset on wheels. He later started another successful insurance business, eSure. Sir Peter Wood, as he is now called, is said to be worth about half a billion pounds.

When IP Draughts first read the Supreme Court’s judgment in the case of Wood v Capita Insurance Services Ltd [2017] UKSC 24 (29 March 2017), he assumed this was another Peter Wood venture. But in fact, the person selling an insurance business in this case was a Mr Andrew Wood. According to the case report, he received 94% of £7,681,661, or about £7.2M, from the sale of Sureterm Direct Limited to Capita Insurance Services Limited. Plus possibly some deferred consideration, the amount of which is not stated in the judgment. Impressive, but not on the same scale as his namesake.

General approach of the English courts to conctract interpretation

The Wood v Capita judgment is interesting mainly because the court was required to interpret a badly-constructed indemnity clause. It also includes some comments on contract interpretation generally, but as Lord Hodge, who gave the sole judgment (with which all the other justices – including Lords Neuberger and Sumption – agreed), stated:

It is not appropriate in this case to reformulate the guidance given in Rainy Sky and Arnold; the legal profession has sufficient judicial statements of this nature. But it may assist if I explain briefly why I do not accept the proposition that Arnold involved a recalibration of the approach summarised in Rainy Sky.

Regular readers of this blog will be aware that we have briefly commented on the Rainy Sky and Arnold cases in the past. For a more detailed and considered view of these and other recent cases on contractual interpretation, and how they should be applied to the facts of IP transactions, readers are directed here. This link is to the abstract of an article Contract Law for Intellectual Property Lawyers, which IP Draughts and his colleagues Lisa Allebone and Mario Subramaniam have recently written for the Journal of Intellectual Property Law and Practice, and which should appear in the print version of the Journal in the next few months. For what it is worth, the article agrees with Lord Hodge’s assessment of the impact of Arnold on Rainy Sky.

Analysis of the indemnity clause

Thus, the main interest of Wood v Capita is in how the court applied the existing law on contractual interpretation to the facts of a specific indemnity clause. In the 3 months or so since the judgment was published, many law firms have written articles summarising the case. IP Draughts will take a slightly different approach, by focussing more on the wording and what it says about the state of M&A drafting.

Here is the clause that was in dispute:

The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service. [emphasis added by IP Draughts]

The facts, very briefly stated, were:

  1. Allegations were raised about the conduct of the business prior to its sale to Capita. In essence the allegation was that, after a customer had obtained an online quote, and had been put in touch with a member of the Sureterm sales team, they were quoted a higher premium, which had in effect been made up by the sales person without reference to the underwriter, simply to increase the sales commission.
  2. Capita notifed the Financial Services Authority (FSA), who required Capita to implement a compensation scheme to customers.
  3. Capita claimed under the indemnity for the costs of the scheme and various other costs, totalling about £2.4M.
  4. Wood argued that he wasn’t liable under the indemnity, as there had been no “claims or complaints registered with the FSA” (see wording of indemnity above).

Readers will see that the above-quoted clause has numerous components, whose relationship to one another is unclear. The court broke these components down, and added numbering to aid discussion, as follows:

The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against

(1)       all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and

(2)       all fines, compensation or remedial action or payments imposed on or required to be made by the Company

(A)      following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other authority against the Company, the Sellers or any Relevant Person

(B)      (i) and which relate to the period prior to the Completion Date (ii) pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.

In IP Draughts’ view, this breakdown is not entirely helpful, as it makes some assumptions about the relationship of each component with each other. He prefers to do so as follows:

  1. The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against
  2. all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and
  3. all fines, compensation or remedial action or payments imposed on or required to be made by the Company
  4. following and arising out of claims
  5. or complaints
  6. registered with the FSA, the Financial Services Ombudsman or any other Authority
  7. against the Company, the Sellers or any Relevant Person and
  8. which relate to the period prior to the Completion Date
  9. pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.

Some remarkable arguments and comments were made about the relationship of these items to one another. Using IP Draughts’ numbering system, Lord Hodge notes that:

  • the parties agreed that item 3 is already covered by the wording of item 2, and so is “otiose” (or redundant to you and me), and was included “for the avoidance of doubt”.
  • Capita argued that items 4 to 7 qualified item 3 but not item 2 (which is difficult to reconcile, as the judge noted, with the previous bullet point), but that items 8 and 9 qualified both 2 and 3.
  • Wood argued that items 4 to 9 qualified both 2 and 3 (but see below).
  • Wood argued that a comma should be inserted after item 4, so that it was not qualified by item 6, but was qualified by item 7. In other words items 5 and 6 should be rolled into one.

Various other technical arguments were made on the drafting, including the potential tautology of using the word “claims” in both item 2 and item 4. Ultimately, the court had to decide whether a customer had to make a claim or complaint in order for the indemnity to be triggered. The 5 justices in the Supreme Court said yes, as did the 3 judges in the Court of Appeal, but the respected judge in the High Court said no.

IP Draughts’ first reaction to this case is to wonder what the drafter was thinking, when allowing such a poorly structured clause to be included in the agreement for which he or she was responsible. Then he has second thoughts, and wonders what pressures the drafter was under to produce wording of such low quality, and what training he or she had in contract drafting.

Clearly, a major issue in this case is that there were at least 9 separate components in the clause (IP Draughts has now spotted some more), and the drafter had not clearly established the relationship between them. This allows numerous interpretations, only some of which were explored in the present case. To some extent this can be fixed by including numbering, as the judge in this case did.

But the clause breaks so many other basic rules of contract drafting that it is difficult to know where to start. In no particular order, some significant issues are:

  • No contract needs a sentence of 119 words.
  • Rather than simply indemnify the buyer, the seller is required to “undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer”. This drafting approach appears to IP Draughts to be M&A industry practice, perhaps just UK M&A practice. He sees obligations to pay rather than indemnities (though here the two concepts seem to have been combined). IP Draughts understands that “covenants to pay” were originally used instead of tax indemnities in M&A transactions because tax indemnities had certain undesirable tax consequences under applicable legislation. They are, he understands, thought to be stronger than warranties in that they are a simple debt and not subject to the rules on causation, remoteness and mitigation. Thus, a practice has developed in M&A contracts of stating obligations to pay as a substitute for indemnities. He is not aware of any case law that supports this approach, and he has always put the practice down to the inward-looking “group think” of the M&A legal community. But he is happy to be corrected.
  • On pure drafting grounds “undertake to pay” is bad drafting. Why not just “shall pay”?
  • Item 2 in IP Draughts’ list mixes up various types of claim with various types of financial category (damages, costs, etc). He finds this confusing and his indemnities tend to separate out these two categories.
  • In what sense is a claim “suffered”? This is such an old-fashioned word, and is used in different ways – sometimes it means “allow” as in “suffer little children to come unto me” (Luke 18).

On the positive side, at least we have avoided “hold harmless and defend” in the above wording. IP Draughts hopes that somewhere in the agreement the seller is given conduct of any claims in respect of which the indemnity applies.

Seeing this clause feeds IP Draughts’ prejudices about the lack of interest in contract drafting among M&A practitioners. But he isn’t smug about the IP community either, as his recent article about the wording of a FRAND licence agreement demonstrates.

There’s a lot of it about…

 

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