Category Archives: Contract drafting

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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Where do you find good drafters?

IP Draughts wishes to offer thoughtful commentary but not to offend. Postings are works in progress, drafted in a few hours, rather than polished publications. On this occasion, the post prompted some discussion and reflection, as a result of which he has decided it would be best to delete it. He may return to the subject at a later date.

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Choice of contract law in light of Brexit

IP Draughts has just returned from a pleasant few days spent in Paris, where he chaired the third annual meeting of BioLawEurope FmbA, a not-for-profit association of specialist life science lawyers across Europe, who mostly work in small firms. In the last 3 years, we have referred dozens of projects between members of the association. IP Draughts’ firm is currently working on a regulatory matter that was referred to us by the German member of the network, and a commercial matter referred by the Danish member.

During our annual conference we have presentations on various topics. One that has stuck in IP Draughts’ mind this year was on choice of law and jurisdiction. When negotiating parties are based in different jurisdictions, they often need to find a compromise jurisdiction on which both of them can agree. Apparently, English law and jurisdiction has been a popular compromise choice, but is currently less popular for some of the BLE members, due to uncertainty over Brexit. Specifically, will there be mutual recognition of judgments between the UK and EU countries after Brexit?

IP Draughts thinks it is likely that the UK and EU will negotiate mutual recognition as part of the Brexit negotiations. Although the UK government is playing its cards very close to its chest, there is some ‘mood music’ to suggest that it recognises the importance of maintaining the reputation of England and Wales as a jurisdiction of choice. This seems to be a relatively uncontroversial topic where common sense would suggest that arrangements similar to those currently applicable (under Rome and Brussels regulations) will be agreed.

However, just because something makes sense and is uncontroversial is no guarantee that it will be negotiated, given the extraordinary times in which we live, so IP Draughts understands the short-term concerns that were expressed at our Paris meeting.

Part of our discussion was about the features of litigation in different jurisdictions. This discussion left IP Draughts feeling that, recognition issues apart, England and Wales had much to recommend it, including:

  1. A summary judgment procedure to get rid of spurious cases (unlike, it seems, France).
  2. Disclosure (also know as discovery) procedures to obtain access to the internal documents of the other party (unlike most civil law jurisdictions).
  3. Oral advocacy and cross-examination of witnesses, which tests the strength of the case in court, rather than relying mostly on written submissions (unlike in most civil law jurisdictions).
  4. A judiciary made up of experienced advocates, rather than career judges.
  5. A system of ‘without prejudice’ communications that are not disclosed to the court, and which facilitate freer communications in negotiations (unlike, it seems, Austria).
  6. The winning party usually gets a court order that most of its legal costs must be paid by the losing party. Apparently, in Austria, Germany and some other countries there is a tariff system which pays only a small proportion of the costs actually incurred. At the same time, for smaller cases in the Intellectual Property Enterprise Court, in London, there is a cap on legal costs of £50,000.

Other issues that we discussed included whether a non-English court would be willing to conduct the case in the English language, if the parties agree to do so. Apparently this is possible in Denmark but not in many civil law jurisdictions, where every document relied on must be  translated into the local language and certified to be an accurate translation, which can add considerably to a party’s costs.

Increasingly, IP Draughts is wondering whether Ireland might be an answer to some of these issues, bearing in mind that its legal system shares many features with that of England and Wales, particularly if the mutual recognition point is not dealt with in a timely manner.

But IP Draughts is crossing his fingers in the hope and expectation that all will turn out well in the next couple of years.

 

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Indemnities are often misconceived

When will we three meet again:
cause, remote and mitigate?

Why are there so many contracts in circulation that include indemnities?

The short answer may be that the drafter thinks they are expected, and doesn’t want to be criticised for omitting them.

But too often the wording seems misconceived, as if the drafter doesn’t really understand the principles behind them, or just has a vague idea that they somehow provide greater protection than a contract that merely has warranties and other obligations.

The classic way of looking at indemnities is to say that they provide stronger protection to the beneficiary of the indemnity than a contractual obligation on the other party. For example, being entitled to an indemnity against third party claims for IP infringement may provide greater protection than being the recipient of a warranty that no third party IP is infringed. This argument assumes that the indemnity provides, in effect, a “blank cheque” for the amount of any damages or settlement payment to the third party IP owner. By contrast, if there is merely a warranty, the recipient of the warranty can only recover if the “holy trinity” of contract claims are satisfied, namely:

  1. Causation. The loss suffered must have been caused by the breach of warranty.
  2. Remoteness. The loss must not be too remote from the breach.
  3. Mitigation. The recipient of the warranty must take reasonable steps to mitigate, or minimise, the loss.

There is some case law that suggests that mitigation, at least, may be required, even in the case of an indemnity. But, in general, drafters feel that an indemnity of this kind may provide stronger protection than a warranty, and in some types of negotiation a possible advantage is enough to justify including a clause, even if the precise extent of that advantage in an individual case is not clear.

While this argument is understandable using the above examples, there are many other examples, seen in practice, where the argument is much less clear. Sometimes, an indemnity is given against breach of warranty. Adapting the previous examples, a party warrants that no third party IP is infringed, and indemnifies the other party against its breach of warranty.

In this example, it is much less clear that the indemnifier is giving a blank cheque to the other party. The party asking for the indemnity is, no doubt, hoping that the indemnity will provide greater protection than the warranty, otherwise what is the point of the indemnity? But are they clear in their mind what that greater protection is? Are they expecting that the court will say that, because an indemnity against breach of contract is given, the party in breach no longer has the protection of causation, remoteness and mitigation?

In IP Draughts’ view, the case law on this point is far from clear. See further Wayne Courtney’s excellent book, Contractual Indemnities, for a discussion of the case law.

Even if it might be possible to persuade a court that an indemnity against breach strips away the protection of causation, remoteness and mitigation, why would the party in breach want to agree to removing their rights under contract law, which arguably provide a reasonable balance between the interests of the parties?

This type of indemnity, which has gradually crept into many English contract templates from overseas, notably from the USA, is arguably misconceived and should be avoided. Of course, the counter-argument is that it depends on which party you are acting for, but we shouldn’t just put stuff in contracts because others do, and where the rationale is not clear.

Once you start including this type of indemnity, the next question and area of confusion is whether liability under the indemnity should be limited. If the indemnity is viewed as a bolster or flying buttress for a breach of contract claim, then yes, liability probably should be limited in the same way that the contract typically limits liability for breach of warranty. But if the indemnity is designed for a different purpose, namely to allocate responsibility for third party claims (as in the first example given above) then different considerations apply. Some of this confusion can be avoided if the indemnity is drafted not as an indemnity against breach of contract, but as an indemnity against a third party claim.

Or the contract might not need any indemnities. In IP Draughts’ view, the contract drafter should start from the assumption that no indemnities are needed, then add them if there is a good reason to do so, rather than the other way around.

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