Legal requirement as a negotiating position

The forward-defensive shot

Most experienced contract negotiators have encountered it.  The deadbat response to a request to change a contract term: we can’t change that, it’s a legal requirement.  The responder usually then goes on to explain that the term (or sometimes, the deal structure) is required by competition laws, tax, statutory warranties, industry regulation, or some other aspect of commercial law.

Sometimes, the response is legitimate.

For example, a licensor of intellectual property may want to own any improvements to the licensed IP that are generated by his licensee while working the licence.  This may be perfectly understandable from a commercial perspective.  However, if the licence agreement is subject to European competition laws – in particular Article 101 of the Treaty on the Functioning of the European Union – such a provision is likely to be problematic.  Assignment-back clauses are outside the scope of the EU Technology Transfer Block Exemption Regulation (TTBER).  The European Commission seems to be tightening up this area of law, rather than relaxing it, if one considers their proposed revisions to the TTBER, the current version of which is due to expire next year.

Even with this example, it might be argued that an assignment-back clause is not per se illegal, as evidenced by the fact that it is not a hardcore or black-listed provision under the TTBER and instead is grey-listed (under Article 5).  But most well-advised parties are likely to avoid such a provision in light of Article 5 of the TTBER.  So a cry of it’s a legal requirement to justify a non-exclusive licence back of licensee improvements, rather than an assignment back, has some legal merit.

On other occasions, the response has some basis in law, but there is more than one way of addressing the issue.  For example, it might be argued in negotiations that a contract clause excluding all liability would be unenforceable under the Unfair Contract Terms Act 1977.  This might well be true, depending on the detailed facts of the case.  But a slightly different clause with ‘safety valve’ wording, making clear that the clause does not attempt to exclude liability for death or personal injury caused by negligence, might be acceptable.  In this case, an objection to a clause based on it’s a legal requirement might be true but not provide the complete picture, and a skilled negotiator might find a satisfactory way around the objection.

A variant on this type of response is where a party has a company policy of including a clause to address a real legal issue, but it is not strictly necessary to have that clause.  For example, US parties often include template clauses addressing issues such as export controls and corrupt practices.  Within Europe, large organisations sometimes include lengthy clauses in contracts dealing with data protection issues.  These clauses are often designed to demonstrate to legal authorities that the party who drafted the clause is doing its best to comply with the laws in question, and putting an onus on the other party to comply with those  laws and cooperate with the drafting party.  In practice, these clauses tend to be a ‘one-size-fits-all’ approach to addressing the legal issues and they are not always appropriate  for the facts of the individual contract.  Ultimately, though there may be a legal requirement, it is not necessary to address it in the way proposed.  However, the drafting party’s company (commercial) policy may make it very reluctant to change the wording.

On yet other occasions, the response is merely an attempt to bamboozle the other party and win a negotiating point, knowing that the other party’s negotiator is not a lawyer and not involving one in the negotiations.  One way of calling the responder’s bluff in this situation is to ask them for a full citation of the law – most laws can readily be found on the internet nowadays.  If the point seems to be a valid one, legal advice can be sought on how to address it.

 

The seventh Python

As most fules kno, Monty Python’s Flying Circus was a TV comedy series in the 1960s and 1970s that spawned several films and, in 2005, a stage musical called Spamalot.  So ingrained is Python in the public consciousness that (according to Wikipedia) questions about it feature in the examination for would-be British citizens.

When the TV show first appeared in 1969, IP Draughts’ mother didn’t allow him to watch it, but he heard about it at school.  Phrases such as “and now for something completely different” and “nobody expects the Spanish inquisition” became part of the playground banter in Newton Mearns, a pleasant suburb of Glasgow.  At around the same time, in the town of Lewes, near the South coast of England, the Draughtatrix received a Monty Python Christmas Annual, which she still possesses.

There were originally six members of the Python team, some of whom went on to become household names for their later work.  John Cleese co-wrote and starred in one of the most successful TV comedies of all time, Fawlty Towers.  After many years of travel programmes, Michael Palin is now a national treasure.  Eric Idle, whom IP Draughts thought one of the strongest presences on the Python TV programmes, seemed to disappear from public view (other than in the Python films) until resurfacing in 2005 as the writer and driving force behind Spamalot.

It is strange, to say the least, to encounter the Python team as witnesses in a High Court trial.  The case, Forstater v Python (Monty) Pictures Limited [2013] EWHC 1873 (Ch), published yesterday, concerns the 1975 film, Monty Python and the Holy Grail (the Grail), and a dispute over entitlement to royalties from Spamalot, which was inspired by the film. The case is interesting because of the people involved and the facts; from a legal perspective it is rather unimportant.

The claimant in the case, Mark Forstater, was hired by the Pythons to be the producer of the Grail.  He was entitled, under a written agreement with the first defendant dated 25 April 1974, to a percentage of certain profits from the film, including, in the words of the third schedule to this agreement, ‘any and all so-called “merchandising” and other “spin-off” rights arising therefrom.’  The dispute concerned (among other issues) whether  Mr Forstater was entitled to a percentage of the royalties accruing from Spamalot, and what that percentage should be.

Mr Forstater was rather unwise in the way he presented his claim.  The judge reported that Mr Forstater had dug a deep pit for himself by claiming to be the seventh Python, which infuriated the surviving Pythons.  He then tried to backtrack and clarify that he only meant for financial purposes and was not claiming a creative role.

The case report describes a long and complex factual history.  The judge, Norris J, was prepared to rectify (ie rewrite) a term of the agreement based on the evidence before him.  It is quite unusual, in IP Draughts’ experience, for judges to rectify the terms set out in a signed, written agreement, but then the way in which the parties in this case went about taking decisions was also highly unusual.

The Pythons were not the only prominent people to feature in the case.  Mr Simon Olswang is a solicitor who founded the London firm that bears his name; Olswang is now a leading media law firm with offices in seven countries.  According to his blog, Mr Olswang is now “enjoying an active retirement from a mango fruit farm overlooking the Sea of Galilee”.  According to the judge, he gave evidence “in a rather casual way” by mobile phone and video link from Israel.  It seems he was responsible for drafting the agreement and failed to incorporate an agreed provision; hence the need for rectification.  But as the drafting work was done 40 years ago, there is unlikely to be any recourse against him or his firm at that time (Brecher & Co); the limitation period for claims has long since expired.

Several of the Pythons gave evidence to the court.  As is usual in court judgments nowadays, the judge stated whether he found each witness’s evidence trustworthy and reliable.  So, for the record:

Michael Palin: “a balanced and trustworthy witness.”

Terry Jones: “a trustworthy witness, though …his evidence was suffused with a sense that Mr Forstater had done very well out of his brief connection with the Pythons.”

Eric Idle: “he expressed the hope that in his evidence he was being honest and that his dislike [of Mr Forstater] did not affect his honesty. I think he largely achieved that aim so far as conscious effort could take him. He undoubtedly regarded Mr Forstater as ungrateful.”

Terry Gilliam and John Cleese: “gave written evidence but did not attend for cross-examination. I do not place much weight on their evidence on that account.”

The case report reveals the Pythons’ concern with retaining copyright in their creative work, which might suggest a good business approach.  However, other aspects of the way they worked seemed highly disfunctional.  Michael Palin’s evidence hints at frequent arguments among the Pythons.  They apparently had a “chaotic” approach to management and decision-making, relying on a succession of individuals of varying qualifications and experience to handle the business side of their activities, including important but mundane activities such as negotiating contracts and giving instructions to solicitors.  There seem to have been many fallings-out with these individuals over the years, including someone who might have been a key witness in the case, Anne Henshaw.

As he read the case report, IP Draughts reflected on the best way to manage the business and legal affairs of creative artists.  Even highly intelligent people such as the Pythons – most of them were from an Oxbridge background, and John Cleese obtained a 2:1 in law from Cambridge – seem to be unable, or unwilling, to engage with the business side.  It is not surprising that some artists are ripped off by their managers or have dark, strange relationships with them, as in the case of Elvis and Colonel Tom Parker.

IP Draughts’ experience of advising ‘creatives’ is more limited than it is of advising scientists and academics.  His experience tells him that advising artistic people can be very rewarding, but sometimes it requires the adviser to have a very thick skin.  Perhaps that is not so different from dealing with any driven, highly-talented individuals.  Last December a client of IP Draughts who is a novelist told him he knew “sod all” about the matter on which he was advising (she apologised later), while some years ago a client who is a leading academic surgeon and knight of the realm told him that he was “killing patients” with each day of delay in reaching agreement on the terms of a licence agreement (he didn’t apologise).  Maybe there isn’t any real difference between the artistic and scientific worlds!

Don’t come to me, if the product I sell you infringes IP

Disclaimers can take many forms…

The title of this post is almost poetic.  Recently, IP Draughts was asked for advice on the sale of products by an overseas company to purchasers in the UK.  The products were to be sold to retail businesses, who would resell to consumers.

The question that was raised was whether the contract terms between the client and the retailer could include a provision by which the client excluded liability if the retailer were sued by a third party for IP infringement.

Any such provision would face some legal obstacles.

Section 12 of the (UK) Sale of Goods Act 1979 (SGA) implies into contracts for the sale of goods, in summary:

1. A condition that the seller has the right to sell the goods; and
2. A warranty that the buyer will enjoy “quiet possession” of the goods.

In Microbeads v Vinhurst Road Markings [1975] 1 All ER 529 (CA), Lord Denning MR discussed that either or both of the above implied terms could be breached if the buyer were sued for patent infringement by a third party.  In that case, on the facts, a breach of the first of these terms could not be established, but a breach of the quiet possession warranty was established.  The latter is an ongoing warranty that continues while the buyer remains in possession of the goods.

Lord Denning also discussed the earlier Court of Appeal case of Niblett v Confectioners Materials [1921] 3 KB 387 (CA), in which a similar point was discussed in relation to trade mark infringement.  In the latter case the products in question were tins of condensed milk marked with the name Nissly, to which Nestle (pronounced ness-lay) not surprisingly objected.

These are the only two cases of prominence that IP Draughts is aware of, in this field.  The SGA and its predecessors date back to the nineteenth century.  In 1975, in the Microbeads case, Lord Denning described the infringement issue in relation to section 12 as a “new and interesting point”.

If one accepts that the law is this area was settled by the Microbeads case, the next question is whether a seller can avoid liability for IP infringement by the buyer through the use of suitable contract terms.  Unfortunately for sellers, there is another legal obstacle.  Section 6(1)(a) of the Unfair Contract Terms Act 1977 (UCTA) states that liability for breach of section 12 of the SGA “cannot be excluded or restricted by reference to any contract term.”

So, the short answer seems to be that a seller is liable if the buyer is sued by a third party for IP infringement.  No doubt there are special cases where this might not be so.  For example, sections 12(3) and (5) of SGA limit the implied terms of title where “there appears from the contract or is to be inferred from its circumstances an intention that the seller should transfer only such title as he or a third person may have”.  And section 26 of UCTA disapplies certain of UCTA’s prohibitions in the case of “international supply contracts”.

Moreover, if the buyer provides a detailed design and specification for the product, and the seller simply follows the buyer’s instructions, common sense might suggest (although IP Draughts hasn’t yet worked out whether the law follows common sense on this point) that the buyer should not able to rely on section 12.  Or perhaps section 12(3) then applies.

Has any reader encountered this legal issue under English or other laws?  If so, what conclusions did you reach?

Clients who agree fancy deal terms: when should you pour cold water?

An easy way of ‘getting a rise’ out of IP Draughts (one of many) is to comment in his hearing that lawyers like to make things complicated.  No they don’t, he is likely to reply, in a style that has been compared to Hillary Rodham Clinton answering a Republican question at a Congressional enquiry.  It is clients who make things complicated, with their innovative deal structures.  If only they stuck to ‘plain vanilla’ deal terms, the contract drafting would be so much easier, and the bill so much smaller.

This thought crossed IP Draughts’ mind more than once in recent weeks.  The deal that prompted it related to an early-stage technology company that was ‘boot-strapping’ with a modest loan and the goodwill of some individuals who were not being paid for their services.

These individuals were to receive some ‘sweat equity’ as compensation for their past efforts, and some further shares that were to be linked to the future performance of the company.  The conventional way of structuring the latter would be to issue share options whose exercise is conditional upon future performance.  In the UK, share options typically have tax advantages for the individuals who receive them, compared with a simple issue of shares.

For reasons that are entirely understandable, the parties to this transaction did not agree on share options.  Instead, they agreed that the individuals would receive shares now, which would be returnable to the company if performance targets were not met.  This is known as a share ‘buy-back’ arrangement.  The company’s chairman, who negotiated the basic deal structure, had experience of such an arrangement in previous transactions.

Until fairly recently, it was very difficult for a UK company to buy-back its own shares.  While it is now easier to do so, company law has required the parties to go through additional corporate procedures before such an arrangement is valid.  The tax treatment of such an arrangement has its own complexities that need to be considered.  Moreover, as the individual owns the shares, additional steps need to be taken to ensure that the company can recover them in situations where they are forfeited.

As if this did not add enough complexity to the transaction, there was also complexity in the performance targets and the precise number of shares to be forfeited if they were not met.  While it was fairly simple to describe the arrangement in high-level terms, the detailed drafting took several hours to get right to our satisfaction.  When we showed the drafting to colleagues they scratched their heads until we explained the deal to them.  At that point they said they thought the drafting worked and was clear and accurate, which was reassuring.  But we were left wondering whether it was right for parties to enter into arrangements so complex that the drafting cannot be immediately understood by an experienced corporate lawyer.

Naturally, we pointed this concern out to our clients and suggested a more simple structure.  However, the negotiations were too far advanced to make changes.  The clients’ response, once they had reviewed the detailed wording, was that both parties were “very pleased” with the drafting and that they recognised that the deal terms were “logically complex”.

In the end the deal (which had other elements to it, not mentioned here) required us to prepare 29 separate documents for signature.  Once signature had taken place, the client thanked us for our efforts and suggested that the deal structure would be “an interesting exam question for company secretaries and corporate lawyers”.

IP Draughts agrees that there is an exam question (or several) in this deal.  The question could focus on how to structure and document the transaction.  But a more interesting question would be what the role of the lawyer should be when faced with such a deal structure.

How far should the lawyer interfere in a structure that apparently experienced and sophisticated parties have agreed?  Should he make clear his reservations and then get on with making it happen?  Or should he devote a considerable amount of time into trying to persuade the parties to think again and come up with a simpler structure?

What do you think, dear reader?