Creative and Legal Communities

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1 AIPLA Mergers & Acquisition Committee Year in a Deal Lecture Series Beyond the Four Corners: A Discussion of the Impact of the Choice of New York, Delaware, Texas, and California Law in Contracts Carey Jordan, Vorys, Sater, Seymour and Pease Lacy Kolo, Squire Patton & Boggs LLP Serving the Creative and Legal Communities

2 The terms forum selection clause and choice of law clause are commonly used, their differences are not always appreciated. FSC = agreed upon personal jurisdiction and venue, usually always enforceable CLC = agreed upon law that will govern disputes about the agreement Contractual choice-of-law provisions are not as unassailable as forum selection clauses Enforceability depends on state -- many states, including California, Ohio, Pennsylvania, Washington and Texas, follow the rules set out in section 187 of the Restatement of Law 2d (1971) 561, Conflict of Laws, and will enforce the parties choice-of-law clause, unless either: (1) no substantial relationship to the parties or the transaction, or (2) contrary to a fundamental policy of a state which has a materially greater interest Other states like NY follow a substantial relationship test, which omits the Restatement s first prong The choice of governing law need not be the same as the forum of choice. Absent a choice of law clause, courts may rely on territorial rules, such as lex loci contractus or the place of contracting rule, and more recently, rely on an interest-based analysis reflected in the RESTATEMENT (SECOND) OF CONFLICTS OF LAW 188 (1971) to determine which law to apply.

3 The Tango of FSC and CLC Be aware of permissive and mandatory language When selecting a forum, keep in mind that the forum s rules will apply as to whether the choiceof-law in the contract will be enforced. Be aware of integration and merger clauses Ethics: What happens when a choice of law in an agreement you are negotiating and drafting changes to a jurisdiction in which you are not licensed?

4 and now for the real fun Scenario 1: You are reviewing a settlement for a patent litigation, which includes a clause that shortens the statute of limitations for breach to 1 year. Is this clause valid? Texas New York Delaware Statutory SOL 2 years 6 years 3 years Can you contract around it? No contracted SOL shorter than 2 years unless clear, reasonable, and no fraud Exception: sale of business entity for aggregate value of not less than $500k Can contractually shorten the SOL if clear and explicit Cannot contractually lengthen the SOL Can contractually shorten the SOL if clear and explicit Can contractually lengthen the SOL sometimes

5 Scenario 2: Your target has two agreements with another party: a distribution agreement signed 2 years ago and a no-cost license signed last year. The license states: Now, therefore, for the mutual covenants set forth herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows. No other consideration is in the license. Is the license binding? California CA Evidence Rules states that facts in a contract are presumed true, but this rule does not apply to a recital of consideration Even with the above statement, the parties can later present evidence to show no consideration and no contract New York Other good and valuable consideration creates presumption that such consideration is supplied by the mutual promises in that agreement Texas A recital of consideration in a contract will raise a presumption that the consideration for a contract was sufficient, the presumption may be rebutted

6 Scenario 3: Your company acquired another entity that is party to a litigation settlement and license agreement. It appears from the record that the parties had a complicated negotiation, and several times they changed the meaning of key terms. In other words, there s a messy record. Can you use parol evidence later to dispute the term meaning? California Maybe CA. is more liberal than most states in allowing parol evidence If there in an integrated clause, PE admitted only if language in question is ambiguous If contract is unambiguous on its face, parol evidence still admitted to find if the contract reflects the party s true intent Texas Merger/Integration clause gives presumption agreement is complete. Parol evidence generally not admissible, but may be admissible if needed for interpretation. New York Parol evidence rule strictly applied, whether or not a merger clause is present Delaware Parol evidence prohibited if contract language is clear and unambiguous

7 Scenario 4: You are conducting due diligence on a potential target, and review a joint venture agreement to develop a new formulation for a known pharmaceutical. The agreement states that the parties have to use best efforts for R&D and product distribution. How should you interpret best efforts?

8 California Specific Provisions CA law is still somewhat unsettled. CA law allows courts to imply best efforts into contracts, but there is no set standards on how to determine (i) when a court must imply best efforts, or (ii) what standard a court is to use in examining whether or not a party has met a best efforts obligation. Some courts equate best efforts to good faith efforts, while others give these terms different meanings. Given the diversity of judicial views and the absence of a set standard in this area, you should check for: o specific performance metrics o statements re expectations o express consequences for non-performance, such as liquidated damages and termination rights

9 Texas Specific Provisions Interpretation of Best Efforts or Best Endeavors Clauses: Texas courts and the U.S. Court of Appeals for the Fifth Circuit have set forth a clear set of rules to use in enforcing best efforts clauses in some contracts, such as oil and gas contracts. To be enforceable, a best efforts contractual provision must set some kind of goal or guideline against which best efforts may be measured. o If such guidelines exist, the contracting party that meets that goal or guideline, or performs within its scope, fulfills the contract without regard to the quality of its efforts.

10 New York Specific Provisions The terms best efforts and reasonable efforts are used interchangeably. Generally, New York courts find best efforts means: o taking an action or inaction that is in good faith and to the extent of a party s own total capabilities, and like an average prudent performer Delaware Specific Provisions It is unsettled in Delaware the exact meaning of the terms such as best efforts, best endeavors, reasonable efforts One Delaware Court did find that reasonable best efforts is clearly understood by transactional lawyers to be less than an unconditional commitment and that best efforts is a more rigorous standard than reasonable best efforts

11 Scenario 4: How should you interpret best efforts? California Unsettled law no set standard for best efforts, but courts have to imply best efforts in certain types of contracts (probably not this one) Texas Clear set of rules in enforcing best effort clauses in some contract. Generally need guideline against which to measure best efforts against New York Means taking an action or inaction in good faith, to the extent of one s own capability, and like a prudent performer Delaware Unsettled law but some cases distinguish between best efforts and reasonable best efforts

12 Scenario 5: Your target currently is entering into a litigation over a non-compete agreement. The choice of law is California, but a suit is brought in New York. Your business partners want to know if New York will follow California law.

13 California Specific Provisions Non-compete agreements are generally unenforceable under CA law, based on a strong, fundamental public policy that promotes freedom of competition. Exceptions: Sale of a business. CA Code Section states that when someone sells the goodwill of a business, they can agree to refrain from carrying on a similar business within a specified geographic area in which the business so sold has been carried on, so long as the buyer, or any person deriving title to the goodwill from the buyer, carries on a like business therein. Partner can agree not to compete in anticipation of dissolution of partnership. CA courts have consistently rejected the inevitable disclosure doctrine, which would allow an employer to seek an injunction to prohibit former employees from working for a competitor because the former employees will necessarily rely upon knowledge of the former employer s trade secrets in performing their new job duties. This doctrine is deemed contrary to public policy in creating an after-the-fact covenant not to compete restricting employee mobility. See: Schlage Lock Co. v Whyte, 101 Cal. App. 4 th 1443 (2002).

14 New York Specific Provisions Generally, New York courts enforce choice of law clauses as long as the chosen law bears a reasonable relationship to the dispute; the result is not illegal or contravene some fundamental principle of justice, some prevalent conception of good morals, some deep-rooted tradition of the common weal. Covenants Not to Compete: New York generally allows covenants not to compete if it is reasonable. A reasonable restriction 1. is no greater than is required for the protection of the legitimate interest of the employer, 2. does not impose undue hardship on the employed party, 3. is not injurious to the public New York courts have refused to enforce CNCs for other states if that state prohibits courts from considering the harm or hardship to the employee

15 Scenario 5: Two parties entered into a non-compete agreement. The choice of law is California, but a suit is brought in New York California every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void. This provision is reinforced by a strong, fundamental public policy that promotes freedom of competition and is typically interpreted broadly. Thus, under California law, such clauses are generally unenforceable with some exceptions. New York NY courts can ignore parties choice of law if against public policy of NY. California noncompete law against public policy of NY. Use NY law to adjudge dispute.

16 Scenario 6: You run across a distribution agreement where Party A is the sole provider of a very rare mineral that Party B (your target) uses for their electronics. The supply agreement has a $6m liquidated damages provision. Party A breaches. $6m was reasonable at time of contract, but now it is not because other suppliers are now on the market. Actual damages are $1m at the time of breach. Will a court in California or Texas be more likely to enforce the $6m liquidated damages clause?

17 California Specific Provisions Liquidated Damages Clauses: The Cal. Civ. Code, Section 1671(b) provides, subject to certain limited exceptions: a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made. In other words, court looks to the time the contract was made, and liquidated damages clauses are generally presumptively valid in business contracts.

18 Texas Specific Provisions Liquidated Damages Clauses: Reasonableness of the liquidated damages provision is viewed at the time of breach for enforcement. To enforce a liquidated damages clause, Texas courts examine 1. whether the harm caused by the prospective breach of the contract is incapable or difficult of estimation, and 2. whether the amount of liquidated damages called for is a reasonable forecast of just compensation. If the liquidated damages are proven to be disproportionate to the actual damages, the liquidated damages will be declared a penalty, and recovery will be limited to actual damages. The burden of proving a penalty defense is on the party challenging the liquidated damages clause.

19 Scenario 6 Summary: Party A is the sole provider of a very rare mineral that Party B uses for their electronics. The supply agreement has a $6m liquidated damages provision. Party A breaches. $6m was reasonable at time of contract, but now it is not because other suppliers are now on the market. Actual damages are $1m at the time of breach. Will a court in California or Texas be more likely to enforce the clause? California Texas Courts look to time of contracting for determining reasonableness for enforcing liquidated damages clauses. Courts look to time of breach and actual damages to determine reasonableness.

20 Scenario 7: A settlement agreement lacks a provision for attorney fees in an event of a dispute. Choice of law is Texas. You are looking to acquire Party A, who you think will prevail at court. Can you get attorney fees?

21 Texas Specific Provisions Attorneys' fees: Even without an attorneys-fees clause in a contract, a party that successfully sues to enforce its rights under an oral or written contract is entitled to recover its reasonable attorneys fees, in addition to the amount of the claim and costs. See TEX. CIV. PRAC. & REM. CODE (8). o The Texas Supreme Court has held that this right of recovery extends to a party suing for breach of warranty, not just breach of contract. This right of recovery does not include a party that successfully defends against a breach-of-contract suit; for that, the contract would have to include a prevailing-party attorneys-fees clause. Delaware, New York, California No (with some exceptions).

22 A few other state considerations to think about

23 New York Specific Provisions Automatic renewal rules: In New York, a party must give notice of termination for provisions that automatically extend the contract term for more than one month for contracts for the service, maintenance or repair to or for any real or personal property. The notice must be at least 15 days and no more than 30 days before the time when the service provider must provide notice of its intent not to renew.

24 California Specific Provisions Consequential Damages: Under CA law (Cal. Com. Code, Section 2719), a consequential damages exclusion in a contract will not be enforceable if the exclusive or limited remedy agreed upon by the parties fails for its essential purpose. It is not necessary to establish bad faith or procedural unconscionability.

25 Texas Specific Provisions Notice requirements for damages claims: Under Section of the Texas Civil Practice & Remedies Code, "[a] contract stipulation that requires a claimant to give notice of a claim for damages as a condition precedent to the right to sue on the contract is not valid unless the stipulation is reasonable. A stipulation that requires notification within less than 90 days is void." Consequential Damages: Consequential damages are recoverable in Texas if foreseeable and not speculative. Lost Profits: Under Texas law, lost profits may be deemed direct damages or consequential damages, depending on the nature of the loss. To recover consequential damages like lost profits, a party must demonstrate that the damages were foreseeable (and not speculative) and directly traceable to the wrongful act.

26 Texas Specific Provisions Exemplary Damages (with Breach of Contract): In Texas, [a] breach of contract alone will not support punitive damages in Texas; the existence of an independent tort must be established. Two basic requirements: 1. a party must be awarded actual damages other than nominal damages -- actual damages sustained from a tort must be proven before punitive damages are available. 2. once actual damages have been established, a party also must prove, by clear and convincing evidence, the existence of fraud, malice, or gross negligence. Further, exemplary damages are capped to the greater of: (a) two times the amount of its economic damages, plus up to $750,000 of any noneconomic damages found by the jury; or (b) a maximum of $200,000 if the total of the calculation under (a) above is below $200,000.

27 Texas Specific Provisions Disclaimer of Warranties, Exculpatory Clauses, and Limitation of Liability Clauses: As a general rule, exculpatory clauses and limitation of liability clauses and not favored and are therefore strictly construed against the party seeking the benefit of the clause. Accordingly, any waiver of warranties, limitation of remedies, or limitation of liability should be stated in the contract in conspicuous language such as ALLCAPS and/or bold lettering. See TEX. BUS. & COM. CODE 1.201(10) which defines conspicuous.

28 Texas Specific Provisions DTPA - Deceptive Trade Practices Act The Texas DTPA is a consumer-protection statute that provides for up to treble damages in cases of 'knowing' and/or 'intentional' unfair practices (section contains a laundry list), including among other things breach of warranty. A successful plaintiff is also entitled to recover attorneys' fees. To be eligible for DTPA protection, consumers must follow a demand procedure.

29 Any Questions?