Category Archives: Contract drafting

Most interpretation clauses are a waste of time

masculineMany contracts have them. The clause that informs the reader that the singular includes the plural, the masculine embraces the feminine, and similar nonsense. Some lawyers like to put these provisions ‘front and centre’ in the contract, immediately after the definitions, in clause 1.2.

It has always amazed IP Draughts that lawyers would want to make these turgid provisions so prominent. His instinct is to hide them at the back of the contract, if he includes them at all.  Putting them at the beginning  forces the reader wade through them before they get to the heart of the contract. It feels like the drafter is showing off their legal expertise, signalling that contracts need formulaic legal language, which only lawyers can fully understand.

To illustrate the point, IP Draughts has reproduced below some clauses from the first contract he found in his files. The contract was drafted by a well-known UK national law firm within the last 10 years, and appears to be based on one of their templates. The clauses appeared at the beginning of the contract, after the definitions. There were 16 sub-clauses in the original, but only a few are reproduced below, and with different numbering.

  1. contextIn this Agreement the masculine includes the feminine and the neuter, and the singular includes the plural and vice versa, as the context admits or requires.
  2. References to a statute or statutory provision include, unless the context otherwise requires, a reference to that statute or statutory provision as from time to time amended, modified, extended, re-enacted, consolidated and all statutory instruments, orders, by-laws, directions and notices made pursuant to it whether made before or after the date of this Agreement.
  3. Any reference to a “month” is a reference to the period of a calendar month.
  4. Any phrase in this Agreement introduced by the term “include”, “including” “in particular” or any similar expression will be construed as illustrating and will not limit the sense of the words preceding that term.

These clauses seem to track a couple of statutory provisions. Section 61 of the Law of Property Act 1925  (LPA) provides:

Construction of expressions used in deeds and other instruments.

61. In all deeds, contracts, wills, orders and other instruments executed, made or instrumentcoming into operation after the commencement of this Act, unless the context otherwise requires—

(a)“Month” means calendar month;

(b)“Person” includes a corporation;

(c)The singular includes the plural and vice versa;

(d)The masculine includes the feminine and vice versa.

While the Interpretation Act 1978 includes the following provisions:

17 (2)Where an Act repeals and re-enacts, with or without modification, a previous enactment then, unless the contrary intention appears,—

(a)any reference in any other enactment to the enactment so repealed shall be construed as a reference to the provision re-enacted;

23 …in the application of section 17(2)(a) to Acts passed or subordinate legislation made after the commencement of this Act, the reference to any other enactment includes any deed or other instrument or document.

Perhaps there is an argument that the contract clauses quoted above are wider in scope than the above legislation. It is unclear, for example, whether there is any kind of territorial limitation on the scope of section 61 of LPA, given that the LPA was mainly designed to consolidate land law in England and Wales.

Note: a different fabulous five sat in the Supreme Court in the Rainy Sky case

Note: a different fabulous five decided Rainy Sky

Typically, the justification is that interpretation clauses provide a safety valve, to avoid too narrow an interpretation. But this type of argument is based on a false premise about how the courts interpret contracts. The statutory provisions quoted above come from an era when contracts tended to be interpreted in a very narrow and precise way, similar to the method of interpreting legislation. Since the 1970s, the senior English courts have gradually relaxed the rules on interpreting contracts, and the process has accelerated in the last 10 years. See, for example, Lord Clarke’s discussion in the Rainy Sky case (2011) of the principles to be followed, including when it is possible to apply commercial common sense. The case was briefly discussed on this blog here.

So, to the extent that the interpretation clause is seeking to avoid an unduly narrow interpretation by the court, it is probably unnecessary. Courts don’t usually interpret contract wording that way, nowadays. This probably means that clause 1 above is not needed.

Clause 2 is wordy but could be viewed as useful.  Sometimes it is helpful to know whether references to statutes are fixed in time or change when the statute changes. For example, some contractual definitions of group companies make use of statutory definitions, so it could be important to know whether the contractual definition changes if the statutory definition changes. Before including clause 2 in the contract, the drafter should check whether the contract has any references to statutory provisions. If not, the clause is clearly redundant. On low risk contracts, the drafter may think it is sufficient to rely on the provisions of the Interpretation Act.

Clause 3 echoes section 61(a) of LPA. But what does it mean? IP Draughts understands the statutory definition to be clarifying that months are not to be understood as lunar months. While this may be an important point to address when dealing with some countries that still use a version of the lunar calendar, in the UK it has not been a credible point of doubt for a very long time. Apparently, during the Napoleonic wars, the British navy paid its sailors by the lunar month.

Clause 4 seeks to disapply the eiusdem generis (of the same kind) rule of interpretation, under which, if  a general principle is followed by examples, the examples may narrow the scope of the general principle. There is some old case law  to this effect. It is doubtful whether this is a significant issue in the modern approach to contract interpretation.

An alternative justification for these and other interpretation clauses is that they serve to clarify the interpretation of the contract for the parties, without the need for recourse to statutory provisions. That may sometimes be true, for example with clause 2.

confusedIt is less clearly a justification in the other cases, and clause 3 might positively confuse the lay reader, and some lawyers, into thinking that a calendar month runs only from the first of the month to the last of the month, just as many people understand a calendar year to run from 1st January to 31st December. But this would be a wrong assumption. If, for example, a contract requires a party to give 3 months notice of termination, and the above clause clarifies that months are calendar months, notice given today (15 August 2015) will expire on 15 November 2015, and not on 30 November or at the end of any other month.

Enough, already. IP Draughts tries to minimise the number of interpretation clauses that he includes in a contract, and to bury them at the back of the contract.

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Insurance obligations in commercial contracts

lloydsTemplate agreements – particularly those designed for larger transactions such as manufacturing, product trials, distribution or licensing – often include obligations on a party to have insurance against commercial risks.

General approach

Typically, the insurance clause will appear after a clause dealing with liability and indemnities. Faced with such a clause in a contract that you are reviewing, some of the obvious alternative ways of dealing with the clause are:

  1. To say to your client “ask your insurers whether you comply with the clause”. Depending on the answer, and on the wording of the clause, it may be safe to leave the clause as drafted.
  2. To say to the other party in the negotiations “here are details of our current insurance; we are not going to change our insurance, nor are we going to promise that we have particular insurance” and modify the clause accordingly.
  3. To delete the insurance clause, eg on the grounds that the scale of the deal does not justify the inclusion of an insurance obligation.

Getting advice from the insurer

Sometimes, where advice is sought from the insurers, the lawyer is then asked to review the answer. Depending on the scale and risks of the deal, it may be more important to know the correct answer than just have someone to blame if they gave a wrong or misleading answer. Possible points to consider include:

  1. Is the answer from the insurance underwriter (ie the party to the insurance contract) rather than the insurance broker (a middle-man)? If it is from the broker, is he taking responsibility for the answer (ie you can sue him if he is wrong) or just giving an opinion?
  2. Does it directly answer the question?
  3. car insuranceDoes the answer give the impression that the person answering it understood the question? Sometimes, the individual you deal with at an insurer or broker is a liaison person. He may not have a deep understanding of commercial liability issues, which are at the complex end of the spectrum of insurance questions, compared with say questions about the costs of repair to the CEO’s company car.
  4. In some situations, insurance may be a regulatory requirement, or there may be a code of conduct within an industry that a particular form of insurance will be maintained. The contract may require a party’s insurance to comply with such a regulation or code of conduct. This may lead to supplementary insurance questions of the insurer.

Drafting issues

Insurance clauses sometimes raise drafting issues, including the following:

  1. Sometimes, the wording uses US insurance industry jargon, which doesn’t work when dealing with UK insurance policies and industry practice.
  2. An example of the above is that US contracts sometimes refer to the other contracting party being “named” on the policy of the party that is required to insure. This may not be acceptable to a UK insurer. At most, he may be willing to “note the interest” of the other party on the policy. The lawyer should probably not attempt to second-guess what the insurer will say on this issue, and instead should defer making changes (other than perhaps deleting the obligation to name) until the insurer has commented.
  3. The clause may state that insurance must be maintained for several years after the contract comes to an end. This is because some policies provide cover on what the insurers call a “claims made” [during the year of the policy] basis while others provide cover on a “claims arising” basis. If liability results, for example, from a party’s negligence or breach of contract, litigation to establish that liability may be started several years after the end of the contract. Typically, the time limit under English law is 6 years from the date of the breach of contract. If the policy only covers claims made during the year of the policy, it may be necessary to continue cover for 6 years after the contract comes to an end. The contract drafter may wish to establish with the insurer whether post-contract insurance is needed in respect of the types of liabilities that the insurance clause requires, and modify the clause accordingly.
  4. In very heavyweight insurance clauses, there is sometimes an obligation on a party to get its insurers to notify the other party if cover is ended or the terms of the policy are changed. There is likely to be a cost associated with such a service, if the insurer is even willing to do it. In many cases, if faced with such an obligation, a first response may be to seek to delete it from the contract.
  5. Sometimes, the clause will use wording requiring a party to have insurance against all risks arising from the contract. This is probably an impossible obligation to meet, as all insurance is limited in scope, subject to conditions and subject to a financial cap. At the very least the obligation should be reduced to one of obtaining insurance that is reasonably available at a reasonable cost, and ideally one would be more specific as to the types, amount, etc.

Standing back from the contractual obligation

no riskContracts impose obligations. If a contractual obligation is not met, a party may suffer loss and may seek to recover its loss from the party that breached the obligation. Some contracts specifically address the question of losses arising from breach, eg by including indemnities. Bringing a claim for breach of contract, or under an indemnity, will be pointless if the breaching party doesn’t have the resources to meet the liability. Those “resources” might include having insurance.

Insurance can, therefore, be a useful way of mitigating contractual risk, and contractual obligations to insure can part of a package of risk management measures. Sometimes, though, contractual obligations to insure are excessive for the scale and risk of the contract. IP Draughts has an impression that sometimes insurance clauses are included in a contract because they were in the template that the drafter used when preparing the contract, rather than because the commercial manager who is responsible for the deal really thinks the obligation is important.  In such cases, it may not take much effort in negotiations to agree to remove the insurance clause from the draft contract.

 

 

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Learning transactional skills

middleIt has been a busy week. IP Draughts’ client work on Monday and Friday seemed like light relief compared with the three middle days, which were spent running a new training course. Three days in a row “on stage”, using untested material, is rather demanding!

The course was for LLM (Master of Laws) students at University College London. The subject was transactional skills. The course tutors (mainly Jelena Madir and IP Draughts, but with support from a new Anderson Law associate, Francis Davey, on day 3) introduced students to some of the issues that they would face when they started work in a law firm.

45 students signed up for the course. They were mostly from outside the UK. Colombia, Cyprus, Germany, India, Russia and Ukraine were some of the countries that were mentioned by students.

The topics that were covered on days 1 and 2 included the role of the lawyer in commercial transactions, the typical sequence of events in a large commercial deal, the structure of a contract, contract drafting techniques and techniques for clear legal writing generally. On day 3, students elected to work on an international financing deal with Jelena, or on an international technology collaboration with IP Draughts, and this day included sessions when the students were divided up into teams to negotiate the deal.

new york barFor IP Draughts, the most interesting aspect of the course was meeting the students and hearing their views on various topics. In the previous week he had participated in a discussion of the English Law Society’s strategy, in which it had been suggested that the UK was losing out in a race with the USA to attract overseas law students and to get overseas lawyers to become dual-qualified. It was good to hear the students explain this subject. It seems that US universities are even more expensive than those in the UK (it apparently costs £19,000 for an overseas student to take an LLM course at UCL) but it is easier to obtain the New York Bar qualification while doing a postgraduate US law degree than it is to qualify as a UK solicitor. The immigration rules are currently stricter in the UK than they are in the USA.

Note: IP Draughts does not wear a bow tie when lecturing.

Note: IP Draughts does not wear a bow tie when lecturing.

IP Draughts’ previous experience of teaching on an LLM course had been that many of the overseas students sat passively in the audience. In the absence of a well-established ‘Socratic method’ in UK law schools (we tend not to pick on students and demand answers to questions, in the way that is apparently done in the USA – think Professor Kingsfield in the Paper Chaseit is too easy for students to keep their heads down and say nothing. In the announcements for this course we had emphasised that students would be expected to contribute to the discussions, and thankfully most of them did.

IP Draughts was impressed by the quality of the students in last week’s course, and their willingness to engage with the topics that were being taught. We should encourage people like them to contribute to life in the UK, and not make it difficult for them to do so through the blunt instrument of immigration policy.

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Post-expiry royalties: what’s the problem?

weirdThere are some weird terms in US licence agreements. Let’s leave aside the general peculiarities of US contract wording. Examples such as “indemnify, hold harmless and defend”, “represents, warrants and undertakes”, “successors and assigns”, and a host of other excrescences, appear in many types of commercial agreement and not just IP licences. Instead, let’s focus on wording that deals with the duration of royalties in licence agreements. This issue came into sharp focus last week, with the decision of the US Supreme Court in the case of Kimble v Marvel Entertainment, LLC.

More on that case later. The general issue, in the US and internationally, is whether it is appropriate to require a licensee of IP to pay royalties after the IP has expired, been revoked, or otherwise ceased to exist. A generation or two ago, there seemed to be a consensus among legislators and the courts that it was not appropriate. This attitude could be seen, for example, in:

  • the US Supreme Court case of Brulotte v Thys Co, a 1964 decision that was discussed and followed in the Kimble case linked above. In Brulotte, the court decided that a contractual obligation to pay patent royalties after the patents had expired was “unlawful per se“.
  • the UK Patents Act 1977, which included a provision in section 45, since repealed, that: “Any contract for the supply of a patented product or licence to work a patented invention, or contract relating to any such supply or licence, may at any time after the patent or all the patents by which the product or invention was protected at the time of the making of the contract or granting of the licence has or have ceased to be in force, and notwithstanding anything to the contrary in the contract or licence or in any other contract, be determined, to the extent (and only to the extent) that the contract or licence relates to the product or invention, by either party on giving three months’ notice in writing to the other party.”
  • the 1984 EC Block Exemption Regulation for patent and know-how licences, which black-listed a provision whereby: “the licensee is charged royalties on products which are not entirely or partially patented …without prejudice to arrangements whereby, in order to facilitate payment, the royalty payments for the use of a licensed invention are spread over a period extending beyond the life of the licensed patents …” Recital 22 to the Regulation clarified that this spreading of payments referred to “spreading payments in respect of previous use of the licensed invention” – ie use during the period when the patents were in force.

A possible solution to this issue is to grant a mixed patent and know-how licence, in which royalties can be charged for use of know-how in circumstances where there are no patents, eg because they have expired or not been applied for in a particular country.

While this solution may work in many countries, there has clearly been a strand of opinion that, in the USA, a more nuanced approach to royalty terms is required. It seems to be thought by some that the licence agreement should state separate royalty rates for use of patents and for use of know-how. Presumably this makes it easier to show that there is no disguised patent royalty after the patents have expired. This approach is consistent with a comment from Kagan J in the Kimble case. She said:

That means, for example, that a license involving both a patent and a trade secret can set a 5% royalty during the patent period (as compensation for the two combined) and a 4% royalty afterward (as payment for the trade secret alone).

IP Draughts has seen some very strange royalty terms that try to finess this issue, eg providing separately for X% for use of patents and another royalty of X% for use of know-how, but stating that for as long as both patents and know-how protect the product, only the patent royalty applies. After the patent expires, only the know-how royalty of X% applies. Hey presto, X% applies both before and after the patent expires! IP Draughts has severe doubts about the effectiveness of this type of legal engineering.

More conventional, in IPDraughts experience, is a clause that sets the royalty at X% and reduces it to 50% of X in any country where there is no valid patent.

Ley lines

Ley lines

IP Draughts’ impression is that economists and competition (or in the USA, antitrust) authorities are no longer as concerned about post-expiry royalties as they once were. For example, the European Commission’s 2014 Guidelines on Technology Transfer Agreements state, at paragraph 187:

Notwithstanding the fact that the block exemption [for technology transfer agreements] only applies as long as the technology rights are valid and in force, the parties can normally agree to extend royalty obligations beyond the period of validity of the licensed intellectual property rights without falling foul of Article 101(1) of the Treaty. Once these rights expire, third parties can legally exploit the technology in question and compete with the parties to the agreement. Such actual and potential competition will normally be sufficient to ensure that the obligation in question does not have appreciable anti-competitive effects.

Kimble

In Kimble, the parties had settled patent litigation on terms that the inventor, Kimble, assigned a patent to Marvel in return for royalties. The parties set no end-date for the payment of royalties. Some years later, Marvel “stumbled across Brulotte” and sought and obtained a declaratory judgment that it could cease paying royalties at the end of the patent term. On appeal, the Supreme Court upheld the award of the declaratory judgment. In passing, one wonders how such a defective settlement agreement could have been drafted. Presumably the parties were advised in their patent litigation and settlement negotiations by lawyers who held themselves out as specialists in US patent law.

The majority of the justices in Kimble appeared to recognise that the current thinking of economists (and therefore antitrust authorities) does not object to post-expiry royalties. As the majority judgment put it:

A broad scholarly consensus supports Kimble’s view of the competitive effects of post-expiration royalties, and we see no error in that shared analysis.”

However, that consensus was irrelevant, according to the majority, as the issue before them was one of interpreting statutory patent law, and not antitrust law. The Supreme Court was bound by the principle of stare decisis to follow the decision in Brulotte. If the case had been properly considered as an antitrust case, they might well have been prepared to decide Kimble differently.

IP Draughts found this part of the Kimble decision surprising. Though he has no expertise in US laws, he had always understood the general issue, at least as it is understood in the UK and Europe, to be one of competition (antitrust) law.

The 3 minority justices in Kimble also saw things differently. They commented that the earlier Brulotte case “was an antitrust decision masquerading as a patent case”.

stare decisisGood old stare decisis. IP Draughts remembers being taught about the English version of the rule in his first term as an undergraduate law student, in 1979. Courts are sometimes bound by earlier court decisions on points of law. The English rule is not so constraining as the US one, it seems. The UK House of Lords (now the UK Supreme Court) simply announced in 1966 that it would no longer consider itself bound by its previous decisions.

IP Draughts is left feeling perplexed by the decision in Kimble. It is concerned only with a narrow point on the duration of patent royalties. But on that narrow point, US licensing practice and to some extent (because of the strong, international influence of the US) non-US licensing practice, is frozen in time by the opinions and decisions of an earlier generation of US judges. It matters not whether the decision is based on statutory interpretation or antitrust laws, the practical effect is the same.

Practitioners advising on licence agreements that have a US element to them must consider carefully how the royalty duration is expressed. Many of IP Draughts’ licence agreements provide for royalties to be paid, on a country-by-country basis, for the longer of (a) the duration of the licensed patents, or (b) in the case of know-how, for a period (often 10 years) from the first commercial sale of licensed products. At first glance, this would appear to address the issue. What is troubling IP Draughts is whether the agreement needs to go further, in light of this US case law, and have separate royalty rates for patents and for know-how, as some US templates for patent licence agreements seem to prefer. Readers – do you think this is necessary?

 

 

 

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