Common Contract Clauses: Part 2-Module 4 of 6

IV. Common Clauses: Part 2

Disclaimers and Compliance Clauses

Disclaimers and “As Is.” “Disclaimers” in contracts are for the purpose of avoiding liability on the subjects of the disclaimers. As companies today have learned to go to great lengths to avoid liability through their contractual relationships with their customers, contractually-based disclaimers have become quite popular and numerous. They also are made orally. For example, one can hardly watch a television commercial or read a magazine advertisement for a pharmaceutical product without being subjected to as much or more communication on the subject of disclaimers as on the subject of the drug itself. Disclaimers are generally very specific to the precise subject matter of the agreement. The disclaimer clause below is, for that reason, quite generic. While the “as is” idea also is meant to avoid liability, it is accomplished simply by the use of phrase “as is” and by providing the purchaser with a reasonable opportunity, pre-sale, to inspect that which is being purchased. In this way, the “as is” clause does an end run around the idea of “implied warranty of merchantability.” Further, in most states a provision of the Uniform Commercial Code grants legal effectiveness to the “as is” idea.

          In Roberts v. Lanigan Auto Sales, 406 S.W.3d 882 (Ct. of App. Ky. 2013), a car buyer bought a used car through a contract containing an “as is” provision and then, when the vehicle purchased had problems, sued the car dealer arguing that the “as is” provision in the contract did not cover fraud. The court disagreed, quoting from the Kentucky UCC and its accompanying comments. “An ‘as is’ clause in a sales contract is ‘understood to mean that the buyer takes the entire risk as to the quality of the goods involved.’ KRS 355.2–316 official cmt. 7 (2008). The rationale was further explained: ‘A valid ‘as is’ agreement prevents a buyer from holding a seller liable if the thing sold turns out to be worth less than the price paid, because it is impossible for the buyer’s injury on account of this disparity to have been caused by the seller and the sole cause of the buyer’s injury is the buyer himself or herself (emphasis supplied by the court). Thus, by agreeing to purchase something ‘as is,’ a buyer agrees to make his or her own appraisal of the bargain and to accept the risk that he or she may be wrong, and the seller gives no assurances, express or implied, concerning the value or condition of the thing sold.”

Sample disclaimers and “as is” clause: The party to this Agreement providing goods and services does so without at the same time providing any warranties of any kind. To the fullest extent permissible under applicable law, all such warranties, express or implied, including, but not limited to, warranties of merchantability, fitness for a particular purpose, non-infringement, accuracy, freedom from errors, suitability of content, or availability are hereby disclaimed. All goods purchased under this Agreement are sold “as is,” carry with them no express warranties, and all implied warranties, including any warranty of merchantability and warranty of fitness for a particular purpose, are hereby disclaimed.

          Discrimination. This is a very controversial subject. Nondiscrimination clauses are required in most every contract nowadays where a company is supplying goods or services to a government entity. Where the contract, however, is between private parties, the party paying for the goods and/or services often wants such a provision included in the contract. The reasons for this are too complex to be addressed here. Whether to include such a clause and its particular language can be the subject of heated negotiation resulting in no contract being executed. It is not so much that any party wants to discriminate as it is that many parties do not like to be told how to handle their internal affairs by another company, especially in a time when discrimination allegations are so prevalent and troublesome.

Sample discrimination clause: During the term of this Agreement, the [performing party] agrees as follows: a) In the hiring of any employees for the manufacture of supplies, performance of work, or any other activity required under this Agreement, the [performing party] shall not by reason of gender, race, creed, or color discriminate against any person who is qualified and available to perform the work to which the employment relates; b) The [performing party] shall not in any manner discriminate against or intimidate any employee involved in performance of any work or any other activity required under this Agreement on account of gender, race, creed or color; and c) The [performing party] shall establish and maintain a written sexual harassment policy and shall inform its employees of the policy, and the policy must contain a notice that sexual harassment will not be tolerated and that employees who practice it will be disciplined.

          Environment, Health and Safety. A clause relating to this subject matter would not be applicable to every kind of contract, but it is applicable where any of these subjects reasonably could become an issue. In today’s world, there is a great deal of litigation on these subjects, and parties to contracts want to avoid liability on these subjects if at all possible. Contractually agreeing not to violate environment, health and safety standards can be tricky, especially where such violations would include violating regulations that come into effect after the contract in question has been formed. See also Compliance with Law and Regulations.

Sample environment, health and safety clause: The [performing party] is in compliance with and shall remain in compliance with during the term of this Agreement all applicable requirements of all laws and regulations relating to public health and safety, worker health and safety, and protection of the environment. In relation to this Agreement and in relation to the environment, health, and safety, the [performing party] possesses all required government permits and has appropriately filed all notices and/or applications required thereby.

Escrow Provisions

          Escrow. Escrow is the principal method contracting parties use to reduce the idea of “trust” to workability. It is a very effective way to avoid litigation that could result where one party does not think the other party has lived up to the agreement. For example, party A has contracted with party B to create proprietary software. Before Party A makes its final payment to party B for the software, party A wants the code and wants to make sure the software is appropriately executable. Party B, on the other hand, does not want to transfer the code and an executable version of the software to party A without receiving its final payment. An escrow clause referring to a full escrow agreement that is an exhibit to the contract is the simple solution to this “lack of trust.” Escrow agents must follow the escrow agreement explicitly or be liable in damages for any breach of the escrow agreement.

          In Gomez v. Huntington Trust Company, N.A., 129 F.Supp.2d 1116 (N.D. Ohio 2000), the escrow agent entered an escrow agreement with a seller of securities which called for the escrow agent to retain the funds for all securities sold until sales reached a certain level by a certain date. If the goal was met by the securities seller, all the transactions would be valid and the escrow agent would release the funds to the securities seller and the securities to the respective purchasers of them. When the magic date came and went, the escrow agent did not return the funds to the putative purchasers of the securities, after which one such person sued the escrow agent for the return of his funds and for attorney fees and costs. The court denied the escrow agent’s summary judgment motion and allowed the matter to proceed to trial.

Sample escrow clause: The parties agree that the final deliverable (“Final Deliverable”) which is the subject matter of this Agreement and the final payment therefor (“Final Payment”) shall be delivered to the Trust Department of Escrow Bank & Trust (“Escrow Agent”) by [date]. The exchange of Final Payment and Final Deliverable shall be accomplished pursuant to the escrow agreement (“Escrow Agreement”) attached to this Agreement as Exhibit A and hereby made a part hereof for all purposes. The Escrow Agreement requires that [payor] have reasonable opportunity to satisfy itself that Final Deliverable is acceptable to it. If, in its reasonable business judgment, Final Deliverable is acceptable, Final Deliverable will be released by Escrow Agent to [payor] and Final Payment will be made to [payee] by Escrow Agent, reasonably simultaneously. Notwithstanding anything to the contrary contained in this Agreement, the Escrow Agreement governs over this paragraph should there be a conflict between the two.

Force Majeure Clause

          Force Majeure. Sometimes, a party’s performance of a contract is not within its control no matter how much the party wishes to perform the contract as written because outside events have rendered performance impossible. When that happens and to avoid the resulting breach of contract, the parties can benefit greatly from contract language that defines force majeure events and sets forth what is to happen when such an event occurs. The term force majeure is French, dates from the late 19th century, and, literally translated, means “superior strength.” While such events can be referred to as “acts of God,” force majeure is much broader, including, as it does, both natural events and political events. The term “force majeure” has little meaning in and of itself, instead deriving its meaning from the meaning given to it in the contract in which it is contained. Any gaps left in the contractual definition used may be filled in by a court through applicable caselaw, but contracts usually spell out exactly what the term is to mean in the context of the performance of that particular agreement. See Sun Operating Ltd. Partnership v. Holt, 984.W.2d 277 (Ct. of App.—Amarillo 1998).

Sample force majeure clause: With respect to the performance obligations of this Agreement, where there occurs any prevention, delay or stoppage due to strikes, lockouts, labor disputes, acts of God, inability to obtain services, labor, or materials or reasonable substitutes therefor, governmental actions, civil commotions, fire, flood, civil commotion, riot, war (declared and undeclared), revolution, or embargoes and other causes beyond the reasonable control of the party obligated to perform (a Force Majeure event), the affected party’s failure to perform shall be excused for the duration of such event and for such a time thereafter as is reasonable to enable the parties to resume performance under this Agreement; provided however, that reasonable mitigation efforts by the non-performing party shall be required, if mitigation is possible, and provided, however, that in no event shall such time extend for a period of more than one hundred eighty (180) days, at which time either party may terminate its further obligations under this Agreement except for the payment of any money due the other party at the time of termination and not reasonably related to the Force Majeure event.

Governance and Headings Provisions

          Governance. Where the parties to the contract are located and incorporated or organized in the same state and where all the work to be performed will take place in that same state, a “governance” clause probably is not necessary (but often is included anyway). It simply states that the law of that state will apply to the contract (which it very likely does anyway). It is unlikely that the law of another state would be allowed by a court to apply to such a situation regardless of the fact that the contract calls for the law of the foreign state to apply. Where, however, there is diversity in location, organization, or performance, a governance clause is quite useful. Almost all of them nowadays indicate that the chosen state’s conflict of laws rules do not pertain because those rules might dictate whether that state otherwise could govern the contract. (The subjects of jurisdiction and venue are treated in their own section.)

Where the contract contains no governance clause, and the law of more than one state, under the circumstances, could apply: “[I]t is well settled by the decisions of the United States Supreme Court that a contract is governed by the law with a view to which it is made; and it is to be presumed, in the absence of any express declaration or controlling circumstances to the contrary, that the parties had in contemplation a law according to which their contract would be upheld, rather than one by which it would be defeated.” Green v. Northwestern Trust Company, 150 N.W. 229, 237-38 (Minn. 1914).

Sample governance clause: This Agreement is governed by the law of [state] without regard to its conflict of laws rules.

          Headings. For convenience of reference, most longer contracts contain a label preceding each major section of the contract and a label for each specific topic at the place where that topic begins to be addressed. Because these labels might not exactly comport with or describe the language that follows, it is a good idea to state in the contract that the “headings” contained in the contract do not form a part of the contract and therefore have no force or effect. On the other hand, “headings” in a contract can have a very specific and controlling meaning.

          In ENI Technology, Inc. v. United States, 641 F.Supp.2d 1337 (C.I.T. 2009), the issue was the classification of certain imported goods as the classification would determine the duty-free status of goods. The goods were classified under certain headings in the Harmonized Tariff Schedule of the United States (“HTSUS”). “In interpreting classification terms contained in the HTSUS, the General Rules of Interpretation (“GRI”) to the HTSUS direct the court’s de novo review. Specifically, GRI 1 states: ‘The table of contents, alphabetical index, and titles of sections, chapters and sub-chapters are provided for ease of reference only; for legal purposes, classification shall be determined according to the terms of the headings and any relative section or chapter notes and, provided such headings or notes do not otherwise require, according to the following provisions....’ This rule ‘is intended to make it quite clear that the terms of the headings and any relative Section or Chapter Notes are paramount, i.e., they are the first consideration in determining classification. 1 World Customs Org., Harmonized Commodity Description & Coding Sys., Explanatory Notes 1 (3d ed. 2002).’ Thus, interpretation of tariff headings, and the court’s analysis, originate in the headings, subheadings, section notes and chapter notes of the relevant parts of the HTSUS.”

Sample headings clause: The headings contained in this Agreement are for convenience of reference only, form no part of this Agreement, and have no force or effect whatsoever.

Damages and Collections

Liquidated Damages. Many contracts that involve the exchange of money for performance have a liquidated damages clause for the purpose of establishing a predetermined sum that must be paid if the performing party fails to perform as promised. Damages can be liquidated in a contract when the injury is either “uncertain” or “difficult to quantify,” when the amount is reasonable and considers the actual or anticipated harm caused by the contract breach, the difficulty of proving the loss, and the difficulty of finding another, adequate remedy, and when the damages are structured to function as real damages and not as a penalty. Any liquidated damages clause not meeting these rules generally would be void and unenforceable. Though the liquidated damages concept is viable, courts long have been uneasy about the whole idea, as illustrated by the following “close-call” case.

In Barrie School v. Patch, 933 A.2d 382 (Md. 2007), the issue was whether the non-breaching party had a duty to mitigate damages where the contract contained a valid liquidated damages clause. It is well-settled law that the non-breaching party has a duty to mitigate its damages. Here, the parties had signed an agreement whereby a student was to attend a private school. The contract specified liquidated damages where notice of non-attendance was given past a date certain. The breaching party argued that, notwithstanding the liquidated damages clause, the non-breaching party should have mitigated its damages by seeking another student to fill the slot. The Court ruled that, in the circumstance of a valid liquidated damages clause, there was no duty to mitigate. A vigorous dissent was filed.

Sample liquidated damages clause: In the event of delay in [type of project] completion, the [performing party] shall pay liquidated damages to [the owner] in the amount of [dollar amount per day/week, etc.] [or] ["X" percent of the total contract price per day/week, etc.]. The parties agree that liquidated damages as described in this Agreement are a genuine estimate of [the owner’s] foreseeable damages and are [the owner’s] sole remedy for such delay. Delays caused by Force Majeure events or by actions of [the owner] shall not constitute a delay resulting in the payment of liquidated damages.

Indemnification. Indemnification generally means that party A agrees to pay any damages party B may be liable for because of something party A unreasonably did or unreasonably did not do. Here’s an example. A songwriter writes a song and conveys the copyright to a music publisher in a contract that contains an indemnification provision. As it turns out, in the song conveyed, party A has infringed the copyright of a third party (C) to another song. C sues party B, the copyright owner, and wins a judgment. Party B turns to party A for payment of the judgment because party A agreed to indemnify party B for just such claims. That is a “normal” indemnification situation. However, in the last 15 to 20 years, indemnification clauses have found their way into contracts whereby party A is indemnifying party B for such as acts of negligence committed by party B against a third party. Here’s an example. Party A is a drilling fluids company working under contract on an oil-well drilling site controlled by an oil company, party B. Party B orders the delivery of additional drilling pipe from a third-party company (C). When that truck arrives, an employee of party B commits an act of negligence that injures C’s driver. Because party A has agreed in its contract with party B to indemnify party B in this very situation, party A must indemnify party B though it had nothing to do with the accident. Generally, courts allowing such contract provisions require that they be stated in BOLD AND CONSPICUOUS language.

Indemnification can be a very confusing construct, even to judges, to the point that some attorneys argue it is sometimes better to have no indemnification clause at all rather than to have one that is difficult to understand (and therefore at risk of ambiguity and all that follows). In Investors Savings Bank v. Waldo Jersey City, LLC, 12 A.3d264 (N.J. Super. Ct. 2011), the appellate court stated: “The trial judge…concluded that if the counterclaim-waiver provision were not enforceable, the indemnification provision of the loan agreement required dismissal of the counterclaim. We find this holding to be erroneous as well. It is axiomatic [citation omitted] that an indemnification agreement must be based upon ‘the indemnitee’s claim to obtain recovery from the indemnitor for liability incurred to a third party’ [citations omitted]. Accordingly, the indemnity provision here has no application when presented as a shield against claims asserted against the indemnitee by the indemnitor. It is only when the indemnitee is found liable to a third party that the indemnification agreement may be triggered. The judge mistakenly viewed the indemnity provision as having a greater scope than it literally or logically possessed.”

Sample indemnification clause: [Party A] shall indemnify and hold harmless [party B] and its directors, officers, employees, agents, stockholders, affiliates, subcontractors and customers from and against all allegations, claims, actions, suits, demands, damages, liabilities, obligations, losses, settlements, judgments, costs and expenses (including without limitation attorney fees and costs) which arise out of, relate to, or result from any act or omission of party A concerning the subject matter of this Agreement.

          Insolvency and Bankruptcy. When one company enters into a contract with another, the expectation is that the company contracted with is a going, viable concern. Entering into a contract with a company that then becomes insolvent and/or takes bankruptcy can be very damaging to the performance of the contract, and the non-bankrupt party can end up with significant losses. A contract’s relationship to bankruptcy can be quite complex and highly frustrating to the company having to deal with its contract partner having gone bankrupt. Therefore, “termination on insolvency/bankruptcy” clauses are quite common, but there is a big problem with them that many contract drafters are unaware of, which is that the federal bankruptcy code makes many of these clauses unenforceable.

          In In re 4Kids Entertainment, Inc., 463 B.R. 610 (S.D.N.Y. 2011), the court quoted, with seeming approval, an email in which one attorney stated to an opposing (foreign) attorney: “Given the threatening position of ADK’s U.S. lawyer, 4Kids has had no choice but to consult outside litigation and bankruptcy counsel.... 4Kids would be obligated to try to stop the termination of the [2008 Agreement].... [and] would have to prepare for a bankruptcy filing in New York because of the serious harm to 4Kids’ business.... Notwithstanding the clause in the 2008 [Agreement], permitting termination on bankruptcy of either party, as we discussed last night, under U.S. bankruptcy law such clause would not be enforced....”

Sample insolvency and bankruptcy clause: This Agreement shall terminate, without notice, (i) upon the institution by or against either party of insolvency, receivership or bankruptcy proceedings or any other proceedings for the settlement of either party’s debts, (ii) upon either party making an assignment for the benefit of creditors, or (iii) upon either party’s dissolution or ceasing to do business.