Parties to acquisition agreements typically agree to limit the survival of certain or all of the representations and warranties made in the agreement to a period shorter than the applicable jurisdiction’s statute of limitations. Generally, such provisions governing the survival periods of representations and warranties are also understood by the parties to limit the period during which a claim may be brought for a breach or failure of a representation or warranty. However, the U.S. Court of Appeals for the Ninth Circuit recently held in Western Filter Corp. v. Argan, Inc. (9th Cir. August 25, 2008) that contractual language limiting the survival period of representations and warranties may not be construed to also limit the period during which a claim may be brought for a breach of the same in the absence of explicit language intended to shorten the claims period. Although it remains unclear whether the court’s decision in Western Filter will be followed by other courts, practitioners should ensure that any acquisition or other agreement governed by California law explicitly states the parties’ intentions with respect to both the survival period for representations and warranties and whether such period shall also constitute the period during which a party may file a claim relating to a breach of the same, notwithstanding any applicable statute of limitations.

Background

On October 30, 2003, Western Filter Corporation and Argan, Inc., entered into a Stock Purchase Agreement (the Purchase Agreement) pursuant to which Western Filter acquired all of the outstanding shares of Puroflow, Inc., a wholly owned subsidiary of Argan, for $3.5 million. Section 8.1 of the Purchase Agreement provided that “[t]he representations and warranties of [Western Filter] and [Argan] in this Agreement shall survive the Closing for a period of one year, except the representations and warranties contained in Section 3.1(a), (b), (c) and (f) and 3.2(a) and (b) shall survive indefinitely.”

Following the consummation of the acquisition, Western Filter allegedly discovered that the value of Puroflow’s inventory was substantially less than had been represented. In September 2004, Western Filter sent written notice to Argan claiming that Argan had grossly misrepresented the financial condition of Puroflow and claiming damages in the amount of $2,002,850. In its notice, Western Filter offered to immediately settle its claims for $700,000 in order to avoid protracted litigation. In late September 2004, Argan responded to Western Filter’s notice and indicated that the issues could be solved without the involvement of counsel, and in late October 2004 Western Filter confirmed with Argan that the $300,000 escrow would be retained pending resolution of the dispute. However, six months later, on March 22, 2005, Western Filter filed suit in Los Angeles County Superior Court against Argan, claiming, among other things, breach of contract and intentional misrepresentation. The case was later moved to federal court, upon which Argan filed for summary judgment.

The federal district court granted Argan’s motion for summary judgment, holding that Western Filter’s claims were barred by the survival period limitations set forth in the Purchase Agreement. The court concluded that the plain meaning of the provisions of Section 8.1 of the Purchase Agreement clearly indicated that a claim could only be filed for the breach of certain representations and warranties within one year of the consummation of the acquisition. However, as more than one year had passed since that date, the court held that Western Filter’s claim was barred.

Ninth Circuit Decision

On appeal, the Ninth Circuit reversed the district court’s holding, concluding that the language in the Purchase Agreement relating to the survival of the representations and warranties was ambiguous and did not explicitly serve to limit the period during which a claim for a breach of a representation or warranty could be made. The court based its holding in part on its view that California law favors strict construction with respect to contractual provisions that purport to reduce the statute of limitations in regard to the right to sue against the party seeking to invoke the limitation. The court drew a distinction between the survival point for representations and warranties and the period during which a claim can be made. The court noted that while the provisions of Section 8.1 of the Purchase Agreement explicitly addressed the period during which the representations and warranties survived, the period during which a claim for damages arising from or relating to such a breach could be brought was not explicitly limited. As a result, the court concluded that Western Filter filed its claim within California’s four year statute of limitations for contract claims and that the breach of the representations and warranties underlying the claim had occurred prior to the expiration of the survival period delineated in the Purchase Agreement.

Conclusion

The implications of the decision for practitioners are clear. Acquisition and other agreements governed by California law that contain survival provisions should clearly and explicitly express the parties’ intent in regard to (i) the survival period for the representations and warranties and (ii) the period during which claims for the breach of such representations and warranties may be brought. An example of such a survival provision is the following:

The representations and warranties of Target contained in this Agreement, the Target Disclosure Schedule, the other Transaction Documents to which Target is a party and the certificates of Target delivered pursuant to this Agreement shall survive the Closing and remain in full force and effect, regardless of any investigation or disclosure made by or on behalf of any of the parties to this Agreement, until the close of business on the one-year anniversary of the Closing Date (the “Expiration Date”). The parties to this Agreement further agree that notwithstanding any provision of applicable Law to the contrary, any action, claim or proceeding relating to the representations and warranties of Target contained in this Agreement, the Target Disclosure Schedule, the other Transaction Documents to which Target is a party and the certificates of Target delivered pursuant to this Agreement must be brought, filed or noticed, as applicable, on or prior to the Expiration Date.

Based on the Ninth Circuit’s decision in Western Filter,parties should pay careful attention to the language used in an agreement’s survival provision, which can no longer be considered boilerplate.