Risk Allocation in Commercial Contracts:
Indemnity, Reps and Warranties, Termination,
Damages Provisions
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.
THURSDAY, FEBRUARY 28, 2019
Presenting a live 90-minute webinar with interactive Q&A
Amir Azaran, Partner, Loeb & Loeb, Chicago
Mark Cohen, J.D., LL.M., Attorney, Boulder, Colo.
Tips for Optimal Quality
Sound Quality
If you are listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory, you may listen via the phone: dial
1-866-570-7602 and enter your PIN when prompted. Otherwise, please
send us a chat or e-mail [email protected] immediately so we can address
the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
FOR LIVE EVENT ONLY
Continuing Education Credits
In order for us to process your continuing education credit, you must confirm your
participation in this webinar by completing and submitting the Attendance
Affirmation/Evaluation after the webinar.
A link to the Attendance Affirmation/Evaluation will be in the thank you email
that you will receive immediately following the program.
For additional information about continuing education, call us at 1-800-926-7926
ext. 2.
FOR LIVE EVENT ONLY
Program Materials
If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the ^ symbol next to “Conference Materials” in the middle of the left-
hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides for today's program.
• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
FOR LIVE EVENT ONLY
Risk Allocation in Commercial Contracts:
Indemnity, Reps and Warranties, Termination,
and Damages Provisions
Mark Cohen, J.D., LL.M.
Amir Azaran – Loeb & Loeb LLP
Strafford CLE Webinar
February 28, 2019
6
Risk Allocation – Types of Risk
•Risk of non-performance
•Risk of flawed performance
•Risk of foregone opportunities
•Risk of change circumstances--------------------------------------------
(And I would add risk of poor drafting)
7
Risk Allocation – Considering Risk
• What are the client’s expectations?
• What damages will the client incur from non-performance or
flawed performance?
• What possible remedies are available?
• What is the risk that circumstances will change?
• What is the risk that the client could get a better deal elsewhere?
• What are the opportunity costs?
8
Risk Allocation – Two Functions of a Contract
A typical contract serves two functions:
1. Clarify and Express Expectations. Who will do
what, by when, in what manner, and how will the
results and proceeds of their efforts (risks, losses,
gains) be allocated; and
2. Dealing with Disruption. The contract should
simplify and stream how the parties manage
disruptive change and disagreement – how issues
are identified, how parties are notified, and how the
conflict is engaged and resolved.
Linda Alvarez, Discovering Agreement, American Bar Association, 2016.
9
Drafting and Litigation:
The Three Main Causes of Contract Disputes
• AmbiguityWhen an ambiguity is found to exist and cannot be resolved by reference to other
contractual provisions, extrinsic evidence must be considered by the trial court in
order to determine the mutual intent of the parties at the time of contracting. Pepcol
Mfg. Co. v. Denver Union Corp., 687 P.2d 1310 (Colo. 1984).
• InconsistencyWhere it is impossible to reconcile conflicting clauses of a contract, it is proper to
receive extrinsic evidence for the purpose of determining the intent of the parties.
Ryan v. Fitzpatrick Drilling Co., 342 P.2d 1040 (Colo. 1959).
• Failure to address an issue altogetherSilence on a matter in a contract creates an ambiguity when it involves a matter
naturally within the scope of the contract. Cheyenne Mtn. Sch. Dist. #12 v.
Thompson, 81 P.2d 711 (Colo. 1993). Extrinsic evidence is admissible to
determine the intent of the parties.
10
Drafting and Litigation:
Questions of Fact and Questions of Law
• Whether a contract is ambiguous is a question of law. Pepcol
Mfg. Co. v. Denver Union Corp., 687 P.2d 1310 (Colo. 1984)
• However, once a court determines that a contract is ambiguous,
the meaning of the ambiguous term is a question of fact.
Dorman v. Petrol Aspen, Inc., 914 P.2d 909 (Colo. 1996)
• Once a court determines that a contract is ambiguous, the intent
of the parties is question of fact. Metropolitan Paving Co. v. City
of Aurora, 449 F.2d 177 (10th Cir. 1971)
11
Drafting and Litigation:
Questions of Fact and Questions of Law
And If a Question of Fact Exists…
NO SUMMARY
JUDGMENT
12
Drafting and Litigation:
The Parol Evidence Rule
• In the absence of allegations of fraud, accident, or mistake in the
formation of the contract, parol evidence may not be admitted to
add to, subtract from, vary, contradict, change, or modify an
unambiguous integrated contract. Boyer v. Karahenian, 915 P.2d
1295 (Colo. 1996)
• Terms used in a contract are ambiguous when they are
susceptible to more than one reasonable interpretation. B&B
Livery, Inc. v. Riehl, 960 P.2d 134 (Colo. 1998)
• An integrated contract is one that contains all the terms the
contracting parties agreed to. Harmon v. Waugh, 414 P.2d 110
(Colo. 1966)
13
The Main Risk Allocation Provisions
• Representations and Warranties
• Indemnification
• Limitation of liability
• Termination
• Exculpatory clauses
Practice tip → reps/warranties, indemnification and
limitation of liability provisions form the “core” risk
allocation provisions of a contract, and are often “linked”
in subtle ways
14
Representation and Warranties
• Representations and warranties are different than contract
covenants
• Covenant – a promise to perform an obligation
• Representation – a statement of fact as of the time the contract
is formed
• Warranty – a guarantee that a certain fact will remain true for
the term of the contract
• Generally, a breach of a representation or warranty allows
the aggrieved party more ways to recover
• Fraudulent misrepresentation
• Ziff-Davis Rule – a warranty is a promise of indemnity if a
statement of fact is false
• CBS Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496 (1990)
15
Representation and Warranties
• Common representations and warranties in contracts
• Authority to enter contract
• Properly organized and in good standing
• Compliance with law / all required consents
• No conflicts with other contracts
• Ability to perform
• More “specialized” representations and warranties
• Ownership / original work
• No viruses or other harmful code
• Pass through of third party warranties
16
Representation and Warranties
• Implied warranties
• UCC Article 2 – implied warranties of merchantability and
fitness for a particular purpose
• Many contracts will seek to disclaim implied warranties,
and limit warranties only to those expressly stated in the
contract
• Practice tip → watch for warranty disclaimers that go too
far
• Party A’s performance hereunder is “as is” and “with all faults”
17
Indemnification
• Indemnity clauses essentially place the entire burden of a
given circumstance on the indemnifying party
• Practice tip → an indemnity is appropriate where one party is able to
minimize or control for a risk, and it would be difficult or impossible for
the other party to do so
• Often coupled with a duty to defend the other party
• “Party A shall indemnify, defend, and hold harmless Party B against all
damages, losses, costs, and expenses (including reasonable
attorneys’ fees) resulting from…”
• Common indemnity clauses
• Failure to comply with law
• Gross negligence or willful misconduct
• Breach of (certain) representations and warranties
18
Indemnification
• More specialized clauses
• Third party claims of IP infringement
• Costs related to a data security breach
• Drafting considerations
• Precisely define the breadth of indemnified parties
• Affiliates, officers, directors, etc.
• Usually drafted to protect against third party claims
• What is a “first party” indemnity?
• Define circumstances where the indemnity will not apply
• Use of the other party’s materials
• The other party’s alteration of improper use of the indemnifying
party’s technology
19
Limitation of Liability
• Limitation of liability clauses generally have three
components:
• Exclusion of consequential damages
• Cap on direct damages
• Carve-outs to each of the above
• Exclusion of consequential damages
• Hadley v. Baxendale, 9 Exch. 341 (1854): damages awarded for
breach only if it was foreseeable at the time of contracting that the
type of damage being sought would result from the breach
• In most contracts, the parties seek to remove the uncertainty of what
is “foreseeable”, and exclude consequential, indirect, punitive, and
other similar kinds of damages
20
Limitation of Liability
• Cap on direct damages
• Goal is to rationally tie a party’s liability for breach to the economic
value of the contract
• Common formulation:
• “Party A’s aggregate liability in connection with this Agreement will be limited
to the greater of (i) the amounts paid by Party B hereunder during the [X]
months preceding the event giving rise to such liability, and (ii) [$Y]”
• Carve-outs
• In certain circumstances it is appropriate to “carve out” certain types of
damages from the exclusion of consequential damages and cap on
direct damages
• Common examples
• Breaches of confidentiality
• Indemnification obligations under the contract
• Gross negligence or willful misconduct
21
Term and Termination
In general, if a transaction is high risk, clients prefer a
short contract term so they are not stuck with a bad deal
for a long time.
However, if a contract requires the client to make
significant investment, the client may prefer a longer
term to allow time for it to recoup its investment.
22
Term and Termination
• Term of the Contract
• Specified term versus a contract that continues until
terminated.
• Automatic renewal unless notice of intent not to renew
provided by a specified date.
• Contract ends on a specified date, but there is an option to
renew if notice of intent to renew is provided by a specified
date.
• Rights to terminate allow a party to mitigate contract risk
23
Term and Termination
• Categories of Termination Rights
• For cause
• Material breach
• Defined circumstances – e.g., “persistent” service level violations
• Convenience
• Often heavily negotiated
• Amount of notice is frequently an issue
• May require payment of a termination fee to compensate a party for
upfront costs
• Others
• Material adverse change
• Financial stability of counterparty
• Change in control of counterparty
24
Term and Termination
• Consider the financial impact of termination
• May not easy to exit a deal from an operational perspective
• Significant transition-out costs
• Consider whether a transition assistance provision is
needed
• Upon a party’s election to terminate, certain transition-related
or “disentanglement” obligations are undertaken
• Can allow a party to delay the termination date (extend the
term) in order to “keep the lights on”
• Survival – specify what provisions continue to apply after
termination
• Confidentiality
• Indemnification and limitation of liability
• Boilerplate provisions
25
Exculpatory Clauses
• An exculpatory clause is any provision that limits a party’s
damages or the range of remedies that are available
• Examples
• Limitation of liability provisions
• Liquidated damages
• Identifying defined remedies as a party’s “sole and exclusive”
remedies for breach
• Force majeure clauses
26
Force Majeure Clauses
Is a Force Majeure Clause necessary?
The law offers two doctrines that will excuse a party’s obligations
when an unanticipated, supervening event fundamentally alters the
nature of the parties’ contract: (1) impossibility / impracticability,
and (2) frustration of purpose. For a general discussion of these,
see Seaboard Lumber Co. v. U.S., 308 F.3d 1283 (5th Cir. 2002).
27
Force Majeure Clauses
Defining what constitutes a Force Majeure event versus not defining it.
Not Defined:
• “To the extent caused by force majeure, no delay, failure, or default willconstitute a breach of this Agreement.” See, David W. Tollen, The TechContracts Handbook, American Bar Association, 2010.
The danger of attempting to list every possible Force Majeure event lies inthe doctrine of Expressio Unius Est Exclusio Alterius.
• If your clause says, “Acts of God, fire, or flood,” but doesn’t say“earthquake,” you may have an issue. An alternative might be:
Each party will be excused from performance under this Agreement while and tothe extent it is unable to perform for unforeseen cause beyond its reasonablecontrol. This does not include x, y, and z. This provision does not excuse anyparty from making timely payment of any amount due under this Agreement.
28
Force Majeure Clauses
Other Issues with Force Majeure clauses:
• Is the non-performing party’s performance excused temporarily or
permanently? If temporary, for how long is performance excused?
• Must the event be unforeseen? Must the event be beyond the control of
the non-performing party?
• See, Perlman v. Pioneer Ltd. Partnership, 918 F.2d 1244 (5th Cir. 1990)
(Where contract did not require the event be unforeseen or beyond control of a
party, trial court erred in reading those terms into the contract).
• Obligation of the non-performing party to give notice of Force Majeure
event within a specified time.
• Non-performing party’s duty, if any, to attempt to respond to Force
Majeure event.
• Right of a party to terminate contract if Force Majeure event continues
for specified time.
29
The more important the relationship is to the
parties, the more willing they will be to be flexible
in addressing their changing needs.
Change as an Element of Risk
30
Change as an Element of Risk
Factors in Determining Importance of the Relationship
• Importance of the transaction to the parties
• Alternatives available to the parties
• Potential for future transactions with the other party
• The other party’s ability to help develop new customers
31
Change as an Element of Risk
We tend to think there is tension between flexibility and
predictability (stability) in contracts, but if the
relationship is important, flexibility may promote long-
term stability in the relationship.
See, Flexibility And Stability In Contracts, Thomas D. Barton, Helena Haapio,
Tatiana Borisova, 2 Lapland Law Review 8 (2015).
32
Change as an Element of Risk
The less likely there is to be significant unforeseen change, the less risk there will be
associated with a longer contract term
33
Change as an Element of Risk
Some Commons Types of Change:
1. Force Majeure Events.
2. Changes in business / market conditions.
3. Changes of law.
4. Changes in key personnel.
34
Change as an Element of Risk
Changes in Business / Market Conditions
Changes in costs or taxes will generally not be
considered Force Majeure events unless the contract
specifically states otherwise.
See, e.g., Kyocera Corp. v. Hemlock Semiconductor, LLC, 886 N.W.2d 445 (Mich. Ct.
App. 2015) (China‘s imposition of tariffs was not a Force Majeure event).
35
Change as an Element of Risk
Changes in Business / Market Conditions
Government policies that affect the profitability of a contract but do not preclude
performance should not be considered “acts of government” for force majeure
clause purposes. See, e.g., Langham–Hill Petroleum, Inc. v. S. Fuels Co., 813 F.2d
1327 (4th Cir.1987) (rejecting claim for relief under force majeure where the
government of Saudi Arabia acted to cause a collapse in world oil prices, making a
contract unprofitable for one party); N. Ind. Pub. Serv. Co. v. Carbon County Coal
Co., 799 F.2d 265 (7th Cir.1986) (holding that a government order denying a request
from a utility to pass increased coal prices along to its customers did not excuse
utility from a long-term contract to buy coal even though contract was unprofitable).
“A force majeure clause is not intended to buffer a party against the normal risks of
a contract. The normal risk of a fixed-price contract is that the market price will
change.” N. Ind. Pub. Serv. Co., 799 F.2d at 275.
36
Change as an Element of Risk
Changes in Business / Market Conditions
In Kyocera, the Court wrote:
“Plaintiff opted not to protect itself with a contractual limitation on
the degree of market price risk that it would assume. It cannot now,
by judicial action, manufacture a contractual limitation that it may in
hindsight desire, by broadly interpreting the force majeure clause to
say something that it does not.”
37
Change as an Element of Risk
Changes in Business / Market Conditions
Compare: Associated British Ports v Tata Steel UK Ltd[2017] EWHC 694
(Ch).
The license agreement provided that after the midway point of the license,
“… in the event of any major physical or financial change in
circumstances … either party may serve notice on the other requiring the
terms of this Licence to be renegotiated …. The parties shall immediately
seek to agree amended terms reflecting such change in circumstances
and if agreement is not reached within a period of six months from the date
of the notice the matter shall be referred to an Arbitrator…”
The Court held this provision was not uncertain and was enforceable.
38
Change as an Element of Risk
Changes in Business / Market Conditions
Possible Solutions to Unforeseen Changes in Business / Market
Conditions
1. Triggers. If X occurs, then Y. Y could be a pre-determined price
increase, a renegotiation, termination of the contract, or something
else.
2. Indexing. Contract price tied to an inflation index and adjusted
periodically or tied to the cost of a key material or component and rises
when the cost of the material or component reaches a specified level.
(Be specific about which index).
3. Renegotiation.
39
Change as an Element of Risk
Renegotiation
Types of Renegotiation:
1. Post-Deal. Takes place when contract expires.
2. Intra-Deal. Takes place while the contract is in force, according
to predefined conditions.
3. Extra-Deal. Takes place in the absence of a specific clause
authorizing renegotiation due to imperfections in the contract or
changed circumstances.
Salacuse, Renegotiating Existing Agreements – How to Deal with “Life Struggling Against Form”,
Negotiation Journal, Vol. 17, Number 4 (October 2001).
40
Change as an Element of Risk
Renegotiation
Causes for Extra-Deal Renegotiation:
1. An imperfect contract. (Failure to predict events or conditions thatmay impact the transaction).
2. Changed circumstances. A change in circumstances usually increases the deal's costs or reduces its benefits for one side. When that party concludes that the cost of complying with a contract is greater than the cost of abandonment, it usually abandons the deal or demands renegotiation.
Salacuse, You Cut A Bad Deal. Now What. https://hbswk.hbs.edu/archive/you-cut-a-bad-deal-now-what
41
Change as an Element of Risk
Differences Between Initial Negotiation and Renegotiation
1. The parties know more about each other.
2. The parties know more about the transaction.
3. As a result of the investment in the initial transaction, the cost of
refusing to renegotiate is higher than the one of walking away
initially.
42
Change as an Element of Risk
Sample Renegotiation Clause
After (date), either party may serve on the other a request to renegotiate
specific provisions in this agreement. The notice must specify the
provisions the party serving the notice wants to renegotiation, the reasons
for the request, and that party’s proposal for new provisions. The parties
must meet within thirty days of the notice to negotiate. If the parties are
unable to reach agreement within ninety days of the notice…
• the party serving the notice may terminate the agreement for
convenience on X day’s notice.
• the parties will participate in non-binding mediation.
• the parties agree to submit to binding arbitration.
A party may not request renegotiation more than once in any X month
period. A party may not request renegotiation of these provisions (specify).
43
Change as an Element of Risk
Changes in Law
There is a difference between changes in law that make a contract
provision illegal (in which case the parties look to the severability
clause) and changes in law that simply render a transaction less
favorable for one party such as laws that increase one party’s costs.
44
Change as an Element of Risk
Sample Change in Law Clause
If any legislative, regulatory, or judicial action materially affects the
ability of a party to perform any material obligation under this
Agreement, the party affected may request renegotiation pursuant to
Article X of this Agreement.
45
Change as an Element of Risk
What Not to Do
• Avoid agreements to agree later.
• Avoid vague agreements to negotiate in good faith due to
changed circumstances.
• Avoid purposely being ambiguous just because change is
possible.
Questions?
Amir Azaran – Loeb & Loeb LLP
(312) 464-3330
Mark Cohen, J.D., LL.M.
(303) 638-3410