Many of us have unfortunately experienced the perils and pitfalls that follow when imprecise terms and definitions appear in deal documents. The risks of imprecision are especially acute in the area of indemnities, representations and warranties. While a breach of warranty typically occurs at the time of the transaction, a breach of a covenant may occur at a later date. Given the significance of this distinction for statute of limitations purposes, all too often a single omitted word or misplaced phrase causes a provision that was intended by the parties as a promise to perform to be interpreted later as a warranty, leading one party to prevail on an unintended limitations period defense to a claim for breach of the “warranty.” To avoid such pitfalls, deal lawyers and litigators must carefully review boilerplate definitions in closing documents and consider how each word specifically applies to the deal or could be misinterpreted and lead to these unintended but entirely preventable consequences.
At the deal negotiation stage, lawyers can never be too vigilant in reviewing representations and warranties and should provide specific meaning to each and every term on the face of the deal documents. Lawyers must also consider the consequences of each word or phrase, and must undertake to strike any term that was cut-and-pasted from an agreement for a prior, unrelated deal that has no applicability to the deal at hand. Any ambiguity in these critical provisions must at the same time be resolved in a manner that ensures the deal aligns with the parties’ expectations and avoids future disputes. In this crucial exercise, bedrock principles of contract interpretation serve as important guides for lawyers to protect against unclear or undefined terms and to dramatically reduce the chances of a court turning to extrinsic or parol evidence and fashioning its own interpretation that could be at odds with the intention of the parties.
Lawyers may also reduce the risk of inaccurate representations or warranties by including so-called anti-sandbagging provisions in deal documents. Anti-sandbagging affirmatively requires one party to inform the other of anything it believes to be a misrepresentation or breach of warranty before the deal closes. Sellers may desire anti-sandbagging protection where the purchaser is considerably larger and has great buying power. In such instances, sellers may seek to avoid the situation where purchasers learn about an inaccuracy before the deal closes but do not disclose it until after deal closes and sues for breach of the inaccurate representation and warranty.
Whether a party is on the purchasing or selling side, careful attention must therefore be paid to the anti-sandbagging terms and also to the choice of law provision that applies in the event of a dispute. By way of example, purchasers may opt for a pro-sandbagging choice of law like Delaware to try to reduce or eliminate any early reporting obligation to sellers. On the other hand, sellers may negotiate for an anti-sandbagging jurisdiction like California where several courts have strictly required buyers to report any information found to be false or inaccurate during the pre-closing, due diligence period. New York is another option that may be palatable to both sides because it is generally pro-sandbagging but several courts have nonetheless imposed reporting obligations on sellers who specifically learned through their own due diligence that a warranty or representation was not accurately stated.
Indemnity clauses are another fertile area for post-deal disputes when due care is not taken to clearly define the scope and limits of any contractual obligation to indemnify. While the purchase and sale environment typically calls for some sort of shifting of loss from one party to another, the circumstances of when and how much loss is shifted can vary greatly. Particular focus must be directed on the various indemnity limits appearing in deal documents in order to eliminate ambiguity and protect against unintended indemnity claims or defenses. Defining in crystal clear terms the monetary amount that must be reached before an obligation to pay is triggered and the recovery limits in the event of a loss or breach, commonly referred to “baskets and caps,” is one way to guard against future disputes. Other limitations on the right to indemnity, such as anti-reliance provisions and fraud carve-outs, must also be closely reviewed during the negotiation stage and unequivocally stated in the final deal documents. A thorough review and understanding of the stated indemnity obligations is essential to prevent, for example, any post-deal surprises for an out-of-luck party who chose to rely on the other party’s misstatements about indemnification that nowhere appear in the closing documents or who incorrectly assumed an insurer will provide indemnity coverage if the other party engages in any and all types of fraud. Particularly with the latter, ensuring the indemnity agreement carefully defines those categories of conduct that constitute “fraud” and spells out all pre-requisites for when an insurance claim may be tendered must occur so that all agreed upon indemnity limits—e.g., waiver of reliance, monetary caps, and time limits for bringing claims—are not inadvertently or intentionally undermined after the deal closes.
Special attention also should be paid to waiver of reliance clauses, as the parties should carefully consider the appropriate choice of law. Here, a party may opt to specify a jurisdiction like New York or Delaware that favors enforcement of language disclaiming reliance on extra-contractual statements or, alternatively, California, which views anti-reliance clauses not as a bar to such statements but rather as evidence that a party’s reliance was unreasonable. Also, ensuring that any reliance waiver language in the agreement is sufficiently specific and clear is of utmost importance and using actual provisions that have been upheld by courts is recommended. See, e.g., Prairie Capital III, L.P v. Double E Holding Corp., C.A. No. 10127-VCL (Del. Ch. Nov. 24, 2015) (language must add up to a “clear anti-reliance clause” to defeat extra-contractual fraud claim). In this important respect, attorneys must avoid using standard integration clauses which many courts have held do not apply to exclude a party’s reliance on representations that are made outside of the contract. Similarly, while parties are generally free to specify shorter or longer contractual limitations and notice periods for asserting claims, they are well-advised to take extra caution and confirm that any extension of the statute of limitations will be upheld by courts in the selected jurisdiction and not struck down as invalid or limited in any way.
In sum, careful consideration of the language used in deal documents---particularly with regard to representations, warranties and indemnities—is of paramount importance. Deal lawyers are encouraged to consult with their litigation colleagues sooner rather than later and undertake a thorough and collaborative review of these critical provisions to help protect against post-deal disputes over the scope and meaning of these provisions. Through this joint effort, attempts by clever litigators to re-write or re-interpret items like anti-sandbagging, waiver of reliance, and indemnity “basket and cap” provisions can be greatly curtailed, if not altogether eliminated.