Mergers and acquisitions agreements almost always include a provision stating that the representations and warranties in the agreement survive the closing of the transaction for a set time period. These provisions are often heavily negotiated and are critical to the allocation of risk between the parties. A recent decision by a three-judge panel of the Ninth Circuit Court of Appeals has an important impact on the interpretation of those survival clauses and serves as a reminder to M&A parties in all jurisdictions to draft with specificity when crafting survival clauses in M&A agreements.
Western Filter Corp. v. Argan, Inc. (9th Cir. 8/25/2008)
Western Filter Corp. competed with Pureflow, Inc. in the industrial aerospace and automotive filter business. Western Filter decided to acquire Pureflow from its parent company, Argan, Inc. As is typical, Argan made representations and warranties about Pureflow in the Stock Purchase Agreement (SPA) that governed the transaction. The SPA contained a survival clause that provided that certain of the representations and warranties "shall survive the Closing for a period of one year..."
After acquiring Pureflow, Western Filter discovered that Pureflow's inventory was allegedly worth significantly less than Argan represented in the SPA. Eleven months after the closing, Western Filter sent Argan a written notice claiming that Argan had "grossly misrepresented" the financial condition of Pureflow, and that Western Filter was "fully prepared to assert its claims in court, if necessary." Six months later, after the one-year survival period had expired, Western Filter filed suit against Argan, alleging breach of representations and warranties in the SPA. On summary judgment, the district court concluded that Western Filter's claims were barred by the one-year survival limitation in the SPA.
Ninth Circuit Decision
On appeal, the Ninth Circuit considered whether the one-year survival clause in the SPA served as a contract to shorten the longer statute of limitation period otherwise applicable under California law. Reversing the district court's decision, the Ninth Circuit held that the SPA's survival clause, as drafted, did not shorten the limitation period to one year.
The court reasoned that although contracts to shorten a statute of limitation period are generally valid, the survival clause in this case did not do so because it did not unambiguously state that it was meant to shorten the statute. According to the court, the most reasonable interpretation of the survival clause is that it "serves only to specify when a breach of the representations and warranties may occur, but not when an action must be filed." It noted that California law, like that of many states, disfavors contracts to shorten a statute of limitation period, requiring them to be "construed with strictness against the party invoking them."
Some commentators have criticized the Ninth Circuit's decision because its conclusion differs from the common understanding of survival clauses held by most M&A lawyers. Future court cases might clarify or overturn the Ninth Circuit's holding, but in the meantime, parties involved in drafting M&A agreements should carefully craft the survival provisions. In most cases, that means an M&A agreement should provide:
- That representations and warranties of the seller speak only as of the time of execution of the agreement and as of the closing;
- That the survival clause is intended to shorten the period otherwise provided by law during which claims for breach of representations and warranties can be made, and that such claims must be asserted within the applicable survival period or be forever barred;
- A procedure describing how such a claim for breach of representations and warranties should be made, for example, by written notice to the other party or by filing a complaint in court; and
- That indemnity is the sole remedy available for breach of representations and warranties.