Category Archives: Contract drafting

Remedies for breach of warranty

Beware of Daphne, bearing grease...

Beware of Daphne, bearing grease…

At one level, the case of Idemitsu Kosan Co Ltd v Sumitomo Corporation [2016] EWHC 1909 (Comm) (27 July 2016), reported on BAILII last week, is of limited interest. It is only a hearing of an application for summary judgment, before a deputy judge.

Nevertheless, it is a decision of the Commercial Court, and is a useful reminder of several points:

  1. That parties will argue obscure legal points if enough money is at stake, or if their “normal” legal remedies are time-barred (in this case there was a time limit of 18 months from completion for any warranty claim to be brought).
  2. That High Court judges can and will come up with different answers to those obscure points, and if there is not a good Court of Appeal authority on them, the chances of an unpredictable outcome are increased.
  3. That the issue of whether a party can bring a claim in tort for misrepresentation as well as, or instead of, one for breach of contract, is alive and kicking and can take many forms. It does not depend solely on whether the parties used the phrase “represents and warrants” in their contract.

The parties in this case were two Japanese companies who entered into a share sale agreement. A subsequent dispute with a third party resulted in the buyer suffering loss. The buyer was unable to bring a claim for breach of warranty because the agreed time period for bringing such a claim had expired. It argued that it also had a right to claim for misrepresentation, which was not time-barred. In other words, the buyer argued the same set of facts that caused it a loss gave rise to parallel claims for (a) breach of contract and (b) misrepresentation under the law of tort.

This was not a case where the argument was based on lead-in wording in the relevant clauses that the seller “represents and warrants” a series of statements. The clause in this case started with the following words:

Each of the Sellers warrants to the Buyer in respect of itself and its Relevant Shares in the terms of the Warranties in paragraphs 1 and 2 of Schedule 4

The buyer nevertheless argued that the matters warranted were also representations that were actionable under tort laws, including the Misrepresentation Act 1967.

This was despite the presence of another clause in the agreement which read:

The Buyer acknowledges and agrees with the Sellers that:

(a) it has not relied on, or been induced to enter into, this Agreement by any representations, warranties or undertakings of any kind other than the Warranties (as modified by the Disclosure Letter); and

(b) the Sellers shall not be liable to the Buyer (whether in equity, contract, tort or under the Misrepresentation Act 1967 or otherwise) for any warranty or undertaking which is not set out in this Agreement and the Buyer shall not be entitled to terminate or rescind this Agreement as a result of a breach of this Agreement, including the Warranties (for which the Buyer’s only remedy shall be in damages for breach of contract).

The buyer argued that the Warranties (as set out in Schedule 4 to the agreement) should be treated as representations as well as contractual promises and therefore the above clause did not prevent it from bringing a claim for misrepresentation.

The judge was referred to conflicting authorities on this point, namely:

  1. The decision of Arnold J. in Invertec Ltd v (1) De Mol Holding BV, (2) Henricus Albertus de Mol [2009] EWHC 2471 (Ch) which supported the proposition that a claim for misrepresentation could be brought.
  2. The contrary decision of Mann J. in Sycamore Bidco Ltd v (1) Sean Breslin, (2) Andrew Dawson [2012] EWHC 3443 (Ch).
Arnold J and Mann J have a disagreement

Arnold J and Mann J disagree

In the words of the deputy judge in the present case, “Mann J. gave fully reasoned consideration to the question, and to the decision of Arnold J. in the earlier case. He refused to follow Arnold J., not on the basis that there was any room to distinguish between the contractual wording in the two cases but because he disagreed with Arnold J.’s view as a matter of principle.” The deputy judge agreed with Mann J’s view on this point.

It seems that it was not entirely clear to the deputy judge whether the buyer’s argument was based on the idea of a prior representation made prior to signing the share sale agreement, that induced the buyer to enter into the share sale agreement, or of a representation that was made as part of the share sale agreement. Either way, the claim failed.

One of the deputy judge’s many stated reasons for coming to this view was that there was no express statement that the warranties were also to be treated as representations:

In some cases that problem is solved by an express provision making certain contractual statements representations. In such a case the parties have agreed as to their nature and how they should be treated. However, that is not the present case.

IP Draughts is disappointed by this last comment, which is a little glib and was not considered in detail. It suggests that the judge might have accepted the buyer’s argument if a formula such as “represents and warrants” had been used. That is far from a foregone conclusion, in IP Draughts’ view, though he is aware than many practitioners in the M&A field have a similar view to the judge on this point.

IP Draughts hopes that this topic will get an airing at the UCL panel discussion to be held in London on 8 November, Dysfunction in Contract Drafting, at which Ken Adams, Mr Justice Flaux, Kate Gibbons of Clifford Chance, and Kristin McFetridge of British Telecom’s legal department will be speaking. So far, 169 people have booked their (free) tickets for this event. Don’t miss out on what will be an interesting and lively occasion!169

 

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Contract drafting: grabbing the nearest document

kw hoursVia Ken Adams’ excellent blog, comes news of a very interesting article, The Inefficient Evolution of Merger Agreements. Written by two associate professors at US law schools, Robert Anderson and Jeffrey Manns, it describes and comments on an empirical legal research project.

The authors analysed the text of over 12,000 merger agreements that had been filed with the Securities and Exchange Commission by publicly-listed corporations between 1994 and 2014. US-listed corporations are required to provide copies of their material contracts to the SEC, which places them on its EDGAR online database.

EDGAR is a very useful source of examples of agreements, though it can be time-consuming and frustrating to find what one is looking for. Anderson (no relation to IP Draughts) and Manns used computer programs to automate their searches and to analyse the results.

edison lightThe purpose of this research was “to explore whether transactional drafting is a driven by a rational process that minimizes the cost of deal documentation and risk to clients or by an ad hoc process that increases billable hours and risk.” Guess what they found?

By comparing the wording of the agreements and using a technique known as Levenshtein distance, or edit difference, they were able to map the extent to which major US law firms used a template (precedent) when drafting a merger agreement or just grabbed a document from a recent transaction that the law firm associate thought suitable.

Their maps included those shown below. Where agreements are drafted from a single source, such as a firm precedent, the map will show lines radiating from that source. The authors’ research revealed very little of that radiation. Instead, there was evidence of documents being several generations away from an official firm precedent. For example, below is the map of contracts drafted by Sullivan & Cromwell.

sully

The authors also included a map of contracts drafted by Davis Polk, which was similar to the map shown above. In the case of one law firm, Cooley Godward, there was one clear focus point of radiation, but also a lot of non-radiation.

cooley

IP Draughts finds this paper fascinating for several reasons. First, it echoes his experience of how some clients work, when drafting IP-related agreements. They use a document that is loosely based on their official template agreement, but includes some deal-specific terms from previous transactions, which may or may not be suitable for the present transaction. Even if the added terms are desirable in principle, they were probably drafted in haste in the pressure of negotiations, or reflect a pragmatic compromise (taking account of the quirks of the person they were negotiating with) rather than an ideally-drafted clause. Over time, by starting with a document from a previous transaction, rather than going back to the official template, the documents that they use become corrupted with junk.

light bulbIt is very interesting to see major law firms, which trade on their reputation, doing exactly the same thing. The authors discuss the dynamics within law firms, including ridiculous time pressures, which may lead to an associate grabbing a familiar document rather than an official precedent. One point that is not mentioned in the article, but which IP Draughts thinks may also be relevant, is the extreme length and complexity of many agreements nowadays, which may make it difficult for a busy associate to understand fully the terms of his firm’s precedents. It may be tempting to use a document that he recently worked on; he spent many late nights negotiating that document, so there may be a comfort factor that he understands at least some parts of that document better than the official precedent.

(This is not a good excuse, by the way, for avoiding precedents that IP Draughts has drafted, which try to be concise and clear!)

The other point that IP Draughts finds very interesting in this article is its discussion of the fact that “there has been amost no empirical work on the legal drafting process in transactional law”, and that “the deal drafting process has been all but ignored by legal scholars”. IP Draughts agrees with these statements, and has ambitions to bring this type of subject to the UCL Faculty of Laws. Research at the boundary between doctrinal law and legal practice is an under-developed area, particularly in relation to commercial transactions. He has had exploratory discussions with the faculty about establishing a Contracts Institute (or similar) there, which would do a mixture of research, teaching and public engagement.

bulb dollarIf any reader knows anyone who might be interested, in principle, in funding such an initiative, (eg a major law firm, alumnus/alumna, or other benefactor) he would be very glad to hear from them. This idea is at too early a stage for us to have established structures for funding. But by way of comparison, the sponsorship opportunities for UCL’s Institute of Brand and Innovation Law can be found here.

A small example of the type of work we might do in this institute is the panel discussion that UCL will be hosting in November. See here for details.

 

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Brexit clauses in contracts

brexitIt takes time to adjust to a major shock: to recover, to process the information, and to recalibrate. Three weeks after the UK electorate voted, unexpectedly, to leave the European Union, IP Draughts is starting to think more clearly about the implications of the vote for IP practice. To do so, we have to leave behind the lies, the half-truths, and the stirring of ugly emotions in the referendum campaign, in some ways very different to the political process of a general election, and instead focus on the practical.

Some plain talking is now required. Many readers of this blog will fall into a category of people who benefit from international trade, who embrace the cultures of others, and who are prosperous in absolute terms (however much we struggle to pay a large mortgage or look enviously or competitively at others who are doing better than us). We work and often socialise with others who share this perspective, both in our own country and in other countries.

To many people with this mindset – let us give them a name and, for want of a better, use one that was used disparagingly in the referendum campaign, “metropolitan elite” (otherwise known as the London and South East “bubble”) – it is unthinkable that the UK would want to leave the European Union. It would not be in our economic, security, cultural or social interests to do so.

schockBut vote to leave we have, and in processing this information we need to understand the perspectives of those who formed the majority. Of course, there is no single group of Brexiteers. But generalising helps us to focus on what needs to be done. There are the social conservatives, the older generations, the people whose lives are not international. There are those who have been suffering from stagnant salaries over the last decade, combined with worsening conditions of employment. There are those who can’t get access to good medical services or good schools.

In other words, the people that are left behind, through choice or circumstance, in the noisy, difficult, competitive but satisfying ‘global’ world that the metropolitan elite inhabits.

The UK’s new Prime Minister recently made a speech in which she recognised the concerns of the Brexiteers. We should be spending more money on new schools, hospitals and infrastructure. We should be increasing the salaries of public sector workers. In short, we should take steps that are other times would be called left-wing.

Coming back to IP (at last), IP Draughts was at a business dinner this week, sitting next to a senior German IP practitioner. The conversation naturally turned to Brexit. IP Draughts’ dinner companion was sanguine about the prospects for the EU doing a deal with with the UK that was in both parties’ interests. Yet, when pressed, he thought that free movement of people was a non-negotiable issue – it was a subject on which many Germans and other EU nationals felt very deeply. IP Draughts thought and said that this probably meant that a deal was unlikely, as control of immigration was a central theme of the Brexit campaign.

IP Draughts was left with several thoughts. First, there is the (perhaps obvious) point that IP practitioners, and professionals generally, may have more in common with their counterparts in other countries than they do with their fellow citizens who have been left behind by globalisation. Second, and more interesting, that while the metropolitan elite in the UK have had a rude shock and become more aware of the large body of people who don’t share our global perspective, our colleagues in other countries may not be so aware of this issue. This has been noticeable in some of the “advice” that Continental Europeans have given to the UK in IP Draughts’ Twitter feed. It is not that we need to think outside the box; we need to think outside the bubble.

futureTurning to IP contracts, IP Draughts and his colleagues have been thinking about how contracts might be affected by Brexit, and what terms might be included to address this issue. Of course, we don’t yet know what form Brexit will take, as it depends on a negotiation that has not yet started. But contracting parties may want to think through the range of possible implications for their contract of Britain leaving the EU, and perhaps even include a clause or two to address the issue. IP Draughts has previously mentioned on this blog some of the possible situations where contractual terms may need to be revisited. He now wonders whether we need a standard clause to address the variety of issues, many of them not easy to foresee or plan for, to address this issue in more general terms. Such a clause might, for example, provide that:

  1. If performance or interpretation of contractual obligations is substantially affected by the fact of Brexit, or by changes in law arising from Brexit, or by the actions of persons or institutions arising from Brexit or in contemplation of Brexit, then a party can notify the other party that it wishes to renegotiate or terminate the contract to take account of this.
  2. If renegotiation occurs, the objective should be (unless the parties agree otherwise) to put them in as close a position to that in which they would have been if the Brexit-related action or event had not occurred. If they can’t agree, the matter can be referred to an adjudicator who will decide on the appropriate adjustments, or conclude that there are no reasonable adjustments to take, in which case termination may be the agreed outcome.

IP Draughts has not yet drafted such a clause, but it sounds a bit like a combination of a force majeure clause and a severance clause, combined with a mechanism for referring a dispute to an expert or arbitrator under a simplified (quick and cheap) process.

As ever, readers’ thoughts on this subject are welcomed.

 

 

 

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Smart contracts and blockchain technology

hypallageCan contracts be smart or dumb? Isn’t this just hypallagic nonsense?

According to Wikipedia:

Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract, or that make a contractual clause unnecessary. Smart contracts usually also have a user interface and often emulate the logic of contractual clauses. Proponents of smart contracts claim that many kinds of contractual clauses may thus be made partially or fully self-executing, self-enforcing, or both. Smart contracts aim to provide security superior to traditional contract law and to reduce other transaction costs associated with contracting.

Wikipedia gives the following examples of smart contracts:

Digital rights management schemes are smart contracts for copyright licenses, as are financial cryptography schemes for financial contracts. Admission control schemes, token bucket algorithms, and other quality of service mechanisms help facilitate network service-level agreements.

In other words, we are dealing with a buzz-phrase whose meaning can vary, depending on the context. If you follow social media, you may have noticed an upsurge in references to smart contracts and blockchain technology (more on which, below) in recent weeks.

Sometimes, the buzz-phrase refers to a method of making contracts. The “smart” part is the use of computers to automate the contracting process. Typically, computers are used to authenticate the parties’ approval of the contract, using encryption technology, or to implement the obligations under the contract, eg by automatically transferring ownership of shares and the payment for those shares.

At other times, the term “smart contract” is misleading (at least in the minds of contract lawyers), and “smart transaction” might be a better (and broader) term. IP Draughts has noticed that many of the articles and comments about this subject seem to be written by computer specialists rather than lawyers, and sometimes the references to contracts are surprising from a lawyer’s perspective. For a good introduction to blockchain technology and its application to transactions, written by commercial lawyers, see this paper by the Australian law firm, Allens.

edi.So far, we could be talking about ideas that have been around for decades. IP Draughts recalls reading articles in computer law journals in the mid-1980s about the use of electronic data interchange, or EDI, as a method of entering into contracts, with digital signatures used to authenticate the transaction. See further, chapter 31 of our book, Execution of Documents (Anderson & Warner, Law Society Publishing, 3rd edition 2015).

blockchainIn its current manifestation, the idea of smart contracts tends to be linked with the technology of “distributed ledgers”, and in particular those which use blockchain technology. One of the best known uses of blockchain technology is the cryptocurrency known as Bitcoin.

Distributed ledgers provide a new way of storing information on computer networks. The technology is still in its early days, and requires a huge amount of computing power. Potentially, it could revolutionise the way in which information is stored and used electronically. For example, if (in future) your medical records are stored in this way, it should be possible for you to see instantly which doctors have accessed your records, and by withdrawing permission (or breaking the chain) you can instantly remove access to your records. The records would no longer exist in the computer network of the doctors or health service.

In relation to commercial contracts, one of the examples quoted earlier was digital rights management schemes for copyright works. IP Draughts has previously joked on this blog about receiving £0.37 (less commission of 9.75%) from the Authors’ Licensing and Collecting Society for the photocopying of our book, Drafting Confidentiality Agreements by the British Library. If we, the ALCS and the British Library were connected via a blockchain network, and the right set of “contract” terms were established, those royalties could be transferred automatically by the British Library (or even by the person who asked for the copy to be made) into our bank account as soon as the photocopying is done, and without the need for ALCS to check the sums, prepare a statement and send us a payment.

bank codeThe most obvious applications for smart contracts arise where there is currently a cumbersome, often manual, process that involves several parties. For example, if you as a UK customer make an online payment to a UK supplier, currently it may be necessary to wait for up to 5 days before your bank and the supplier’s bank confirm that the payment has been made. If the payment is made to someone in another country, the delay may be longer. Our firm used an Australian web designer to create the latest manifestation of our website. Paying the designer online seemed to be rather a complex, slow process, and the bank charges were disproportionately large.

Many of the examples that are given of smart contracts are concerned with financial transactions. Generally, the advantages of smart contracts seem more obvious where the transaction is simple to describe but the process for implementing it is currently complex. The benefits are less obvious where the contract is one that has many complex obligations that cannot be simply reduced to a computer code.

Even if the transaction is simple, there remains the issue of whether the parties fully understand it and should be bound by it. Automating the implementation of a contract may remove or reduce opportunities for a party to hold their hand up and say “no, this is not what I meant”. The current litigation in the English High Court between the Libyan Investment Authority and Goldman Sachs is said by some to illustrate this point. See the recent news item by Bloomberg, Blockchain Company’s Smart Contracts Were Dumb.

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