Non-disclosure agreements (NDA)

Non-disclosure agreements (NDA) facilitate the exchange of ideas and confidential or proprietary information by (i) limiting the permitted purpose for which such disclosed information may be used, and (ii) imposing secrecy obligations on the receiving party. If both parties are exchanging confidential information, a non-disclosure agreement would be ‘mutual’. Otherwise, an NDA may be one-sided, usually drafted by the disclosing party and protecting the latter against misappropriation of its disclosed confidential information.

A Non-disclosure agreement is often also referred to as a Confidentiality agreement or a Secrecy agreement (or the abbreviation NDA or CDA).

Protection of confidential information

A Non-disclosure agreement enables parties to protect their know-how and technology against misappropriation or abusive use by the other party. It is legally difficult to protect ideas, concepts, know-how, general technology and many software functionalities because these elements fall outside of the standard categories covered by intellectual property law, such as, copyrighted works, patented inventions, and certain designs.

Intellectual property rights in NDA’s
The Model Contract contains a simplified provision regarding the intellectual property rights of the disclosing party: any improvement of the disclosed information, even when proposed or suggested by the receiving party, will be owned by the disclosing party. This prevents claims to co-inventorship, co-ownership and other related complications.

Avoid negotiation of Non-disclosure agreements

A non-disclosure agreement should be signed soon after the contact between the parties starts in order to facilitate disclosure and further the effective negotiations concerning the main contract. The non-disclosure agreement should therefore not contain significant areas of negotiation.

The “Purpose” in a non-disclosure agreement

One of the key clauses is the formulation of the defined term “Purpose”. The Purpose of a non-disclosure agreement determines what a receiving party may and may not do with the disclosed confidential information. The Purpose should be formulated accurately and in a sufficiently narrow manner. A narrow definition prevents that the receiving party uses the confidential information for competitive aims, for conducting a fishing expedition into product specifications with the aim of developing the same technology itself or with another party, or any other undesired purposes.

An appropriate Purpose could be, for example:

“discussing the feasibility of jointly developing product X to be used in market A and exchanging information about certain proprietary, secret technologies, including the possible terms and conditions of a joint development project”

“assessing the attractiveness of entering into a contractual alliance related to entering into the market of country B, including discussion on the possible terms and conditions of a contractual alliance”

“Investigating the appropriateness of entering into a long-term supply agreement in relation to products Y and Z to be sold in the region of South East Asia, including discussion on the possible terms and conditions of a long-term supply”

Not for pre-patent purposes

The Model Contract is not intended for use where patentable inventions are involved because more care is desired in order to prevent claims of co-inventorship or ‘prior use’. Nonetheless, if certain materials (or software source code) are disclosed for testing purposes, it is desirable to expressly provide that the materials or source code may not be analysed or re-engineered (unless analysis or re-engineering is the Purpose of the non-disclosure agreement).

Confidential information and competition law

Due care must be exercised in the disclosure of confidential information which triggers concerns from an antitrust or competition law perspective. Although development of (new) technology is usually exempted, this is usually not the case with respect to information regarding market shares, sales figures or cost price elements (or the parties’ intentions or plans to develop markets, to change pricing or to improve cost price). It is a gross violation of antitrust or competition law to enter into a non-disclosure agreement in the context of price-setting arrangements, competing procurement/tender processes and similar acts.

Duration of confidentiality

Depending on the Purpose of the non-disclosure agreement, the term during which confidential information must be kept secret and treated confidentially with due care might range from (usually) six months (in case of simple product development or assessing a long-term supply relationship) to eight or ten years (in case of joint technology development).

Letter of intent (LOI) or Memorandum of understanding (MOU)

A letter of intent (LOI) or Memorandum of Understanding (MOU) is used for establishing the intentions or mutual understanding between two or more parties concerning their forthcoming main agreement. It is a pre-agreement; a document reflecting the parties’ intentions and (partly) non-binding commitments may be equally called a “Letter of Intent” (also commonly referred to as an “LOI”), “Memorandum of Understanding” (or “MOU”), “Heads of Agreement” or “Term Sheet”, depending on industry practice and on the parties’ preference to express a binding or less-binding commitment.

Why using a letter of intent (LOI)?
When is a Letter of Intent useful? There may be many reasons for using a letter of intent (LOI), for example:

1. The transaction is too complex or too large to negotiate in one single phase;
2. The parties are not yet aligned on the structure or nature of a transaction (i.e. crucial deal elements remain to be determined);
3. Discussions may have reached a stage where outlining a number of mutually acceptable principles and procedures is possible; or
4. Certain binding obligations can only be agreed on after preliminary hurdles are overcome, certain milestones have been achieved, or if a prototype has been delivered and accepted.

In particular, an agreement concerning a contractual alliance, a (corporate) joint venture or the manufacturing of a complex product may well be preceded by an MOU. But typically, a (very) large transaction is often also preceded by a letter of intent: it helps shaping the negotiations, by first straighten the main (intended or desired) course of action of such transaction. The Model letter of intent of sample MOU or LOI shared by us on this website can be particularly useful in the context of such transaction.

Letter of Intent – How to avoid binding obligations

Most (if not all) MOU’s are intended to be non-binding, with a limited number of binding terms. The applicable law, however, may impose liability on a party if it terminates negotiations that have become somewhat binding (or if a party could, in good faith, reasonably anticipate that a contract would result from the negotiations). The party terminating such negotiations in bad faith can be held liable for damages vis-à-vis the other party (‘precontractual liability’). This liability may stem from a document such as an LOI or MOU if it contains binding, unconditional obligations.

The extent to which the terms or conditions in MOU’s are binding or non-binding depends on a number of factors. You can make a letter of intent non-binding by being express and clear on:

• conditions or requirements set out in the sample LOI (see Article 2);
• whether the commitments are dependent on:
  • permits or clearances (see paragraph 2.1.1 of the model LOI),
  • funding or subsidies (see paragraph 2.1.2 of the model LOI),
  • a satisfactory outcome of further investigations (see paragraph 2.1.3 of the Letter of Intent example),
  • “subject to contract” (such as a Definitive Agreement – see paragraph 2.1.5 of the MOU) or “subject to approval” (see paragraph 2.1.4 of the MOU);
• whether certain (crucial) terms or conditions are specifically mentioned to be pending negotiations and subject to prior agreement (see Section 3.1 of the MOU); and
• generally, also considering other circumstances, the binding wording of the provisions in the MOU.

Letter of intent as a roadmap

Negotiation time schedule and action list. A letter of intent or MOU (such as the sample template letter of intent shared by Trader Options Investing Platform) will often also contains provisions addressing the anticipated procedure for negotiations:

• a time-table with deadlines (e.g. for delivering (first draft) contracts, specifications or factual details – Article 4 of the MOU); and
• optionally, a period of time during which the parties will negotiate on an exclusive basis (Article 5 of the MOU).

Alliance or collaboration agreements

Alliances and collaborations: strategic aims
The basic aim of an alliance, collaboration agreement or a joint venture is strategic: activities that are of significant importance to an organisation’s core business and that cannot be performed at the required quality level or with the necessary efficiency by the company itself ‘must’ be partnered (unless cooperation is a first step towards divestment of certain existing business, starting with the joinder of a fifty percent ‘partner’ and followed by a full-swing sale of the other fifty percent to that party).

If the required activities are not a company’s core business and if (i) undertaking such activities does not add significant value, or (ii) the core business is not crucially dependent on the activities, a company should not enter into cooperation but instead consider outsourcing.

In one way or another, cooperation may facilitate any of the organisation’s (core) activities: the (joint) purchasing of raw materials, inventories or services, the outsourcing of a key discipline to a partner, the development of new technology or products, a joint exploration or exploitation of a market segment, territory or product market.

Also, an alliance may provide access to the partner’s network or technology, create learning opportunities (e.g. as regards the partner’s way of working), allow for cost savings (e.g. joint purchasing, joint production), result in risk sharing, or grant access to new markets and to establishing a distribution channel (e.g. expansion of the customer base).

Terminology
An alliance or joint venture may be given various titles. It may be created under the name ‘joint venture’, ‘collaboration’, ‘consortium’, ‘teaming’, ‘cooperation’, ‘joint development’, ‘joint operation’, ‘joint exploration’, or even ‘partnership’. Its legal qualification, as well as the accentuation in legal consequences or prerequisites, will always be made on the basis of the actual setup.

Contractual collaboration or alliance, or incorporated joint venture?

The choice in favour of a contractual alliance, instead of an (incorporated) joint venture, as discussed in another chapter, is often based on one or more of the following considerations:

• Informal character – a contractual alliance structure is more informal than an incorporated joint venture with its mandatory management organisation and formal decision-making requirements. In addition, setting up or dissolving a legal entity involve the satisfaction of various formalities.
• Taxation and accounting treatment – fiscal transparency: in a contractual alliance or partnership, each partner fully consolidates the alliance results in its financial results.
• Limited scope or duration – by its informal character, the alliance is typically also easier to terminate and unwind, and therefore more suited for collaboration with limited duration.
• Limitation of liability being less relevant – a corporate structure might be preferable if the alliance should deliver products or provide services to third parties.
• No joint (cash) investments to be made – when the alliance can operate without (cash) investments by a party in a jointly owned business, a contractual setup may be preferable. However, an incorporated joint venture may be preferable when two parties jointly enter a national market in which neither of them is present and establishing a legal entity is desirable, for example in view of taxation.
• No creation or acquisition of joint property – but if a new product is developed, its joint exploitation may be easier in an incorporated joint venture.
• No realistic profit-making potential of the venture – if cooperation is a cost-factor and not profitable, its costs and losses can be fully consolidated by both parties if it is set up as a contractual alliance or as a partnership.

The above considerations are mere indicators. Recent legislative developments and the increasing number of tax treaties between countries have lessened the differences between informal contractual alliances and incorporated joint ventures.

In each case, it may be important to provide for an appropriate exit scenario in case of deadlock once considerable efforts have been made. If know-how and intellectual property are involved or created, it is essential that the entitlement to such know-how and intellectual property rights are clear.

Interchangeability of provisions
It is important to note that all the provisions in the ITC’s model alliance contract are well suited to be copied into the ITC model corporate joint venture agreement. This applies in particular to the following articles:

• Article 1 (objectives and key principles for future decision making)
• Article 4 (joint projects, for exploring new business opportunities)
• Article 6 (intellectual property rights)
• Article 7 (preferred supplier arrangements)
• Article 8 (secondment of the parties’ personnel to the alliance)

Transaction documents in alliance and collaboration agreements

Alliances and joint ventures will typically require more than just one contract (i.e. one document). Once the main principles of the collaboration are agreed, it may be worthwhile to involve more people from both parties’ organisations and work on the various aspects involved. If the alliance or joint venture is complex or somewhat voluminous, consider starting with a letter of intent (LOI) or memorandum of understanding (MOU) setting forth the high-level principles of the collaboration.

The various documents that result from those preparatory discussions will be included in the alliance contract or joint venture agreement, which will then contain one or more schedules. Using more than one document makes it easier to separate facts and ‘legalistics’, or the involvement of different disciplines (each working on their own document).

If the alliance or joint venture triggers several legal relationships then it is important to establish each of them in their proper contract. For example:

• A joint venture agreement will typically include one or more business arrangements – such as a technology or trademark licence, a long-term supply of or a general purchasing agreement for products or raw materials – in addition to a (one off) contribution to the joint venture itself. Each can be reflected in its own contract, and all of them should be attached to the main joint venture agreement.
• A joint development agreement may require that one party provides certain tools or equipment on loan, in which case the goods on loan will be dealt with in a separate contract.
• An alliance aimed at the joint development of a product, service or technology typically contains a statement of work or ‘SOW’ (i.e. a technical document specifying various aspects of the work to be developed, such as for example the product specifications, testing criteria and acceptance procedures, deliverables and milestones, go/no-go decision-making points, budget allocations, persons involved in the various stages). See also the remarks on the ITC Model international supply of services contract (Article: Services agreements).
• A joint venture agreement will typically contain a description of the joint venture’s business. As sharpening the scope of the business does not require a full document to be circulated each time, separating this into a one-page schedule may facilitate the discussions.

Similarly, a joint venture agreement will normally contain a business plan for the collaboration. The business plan may be a PowerPoint presentation or an Excel spread sheet (depending on the kind of persons who are responsible for preparing the business case). A contract, however, should not contain spread sheets or presentations.

Alliance or collaboration agreements further explained

A contractual alliance contract is a framework for an alliance or a collaboration agreement between two or more parties where no separate, jointly owned, corporate entity is created. The alliance or collaboration agreement is based solely on contractual arrangements between the parties.

Required tailoring
Each contractual alliance or collaboration is different, and the ITC Model international contractual alliance contract therefore provides a series or a “menu” of possibilities, depending on the purpose of the alliance. Of course, provisions that are not relevant to the particular alliance should be deleted. Moreover, if the context of the contemplated collaboration makes it desirable to provide for a different arrangement, then this different configuration should be negotiated or adopted. After all, contract law facilitates flexibility and autonomy for the parties to tailor their relationship.

Costs and benefits
The ITC Model Contract anticipates that the two parties will share pro rata in the costs of the alliance. It is important to establish what types of costs are to be shared, especially to the extent that this would require cash payments from the parties. If a party is to be paid for its work or other contribution, the basis for remuneration should be clearly established – either at the outset or through the management committee.

Appropriate compensation schemes can be: time-based (i.e. per hour, day or month), fixed pricing (e.g. one lump sum compensation or divided into milestones), a commission or a pro rata sharing of revenues (e.g. a percentage of turnover or net sales). It is recommended that you be explicit about costs and cash benefits.

Organisation and decision making
The ITC Model Contract envisages the formation of a management committee, on which the two parties are jointly represented. In this regard, it may be appropriate in some cases to (i) spell out the authority of particular individuals or subcommittees, or (ii) ensure that certain “reserved matters” require unanimous decision.

See also the related provisions in the ITC Model international corporate joint venture agreement (Articles 6, 7 and 8). It is important that issues involving ownership, (strategic) business scope, non-compete and intellectual property rights remain subject to consensus (i.e. unanimity). If more parties are involved, these issues might be subject to a veto or qualified vote.

Party contributions
In the ITC Model, Article 3 contemplates that each party will have areas of responsibility to contribute towards the success of the alliance. In some cases, these will be expressed in general terms – and not involve formal legal commitment (see examples in Article 3.3.1, 3.2.1 and 3.3.2). In other cases, specific legally-binding commitment will be appropriate.

Especially in larger or complex alliances, it is common to subdivide the agreements: the alliance agreement becomes an umbrella for adjacent (project) agreements. Article 3 would refer to those agreements, which are attached as a schedule. For example:

• Commitments related to promotion and sales of alliance products could be based on the ITC Model Contracts international commercial agency or international distribution of goods.
• Commitments to supply certain goods to the alliance (or to another party) can follow the format of the ITC Model international long-term supply of goods or Trader Options Investing Platform’s General purchasing agreement.
• The provision of services, the joint development of a ‘work’, product or component can be inspired by the ITC Model Contract international supply of services.

Other important clauses in alliances or collaboration agreements

Joint development
If the alliance is a joint development agreement, Article 4 (‘joint projects’) is helpful: the ‘organisation’ established in Article 2 is attributed the authority to define and monitor the joint development work, and the parties commit to fund such joint projects. In many cases, it is indispensable to specify technical requirements, technical tolerances of results and external licences in a separate ‘statement of work’ to be attached as a schedule, as well. If the joint activities include an exchange of staff or key personnel, Article 8 establishes a few safeguards.

Intellectual property rights (IPR)
Article 6 sets out provisions for a relatively straightforward sharing of know-how and technical development. The ITC Model Contract provides a framework of key points. It envisages that specific IPR developed under the alliance will be jointly owned and that “going to market” will require the consent of both parties. Clarity is important regarding rights after termination of the alliance. In many cases, more detailed licence agreements will be appropriate to cover the IPR arrangements, particularly where one party’s IPR is made available for use by the other party under the alliance.

Preferred supplier
In many cases, one of the parties is likely to be appointed a preferred supplier or distributor of products developed under the alliance. In such cases, the ITC Model’s Article 7 may inspire such an arrangement, which typically grants a first opportunity (or, alternatively, a right of first refusal) to one party to supply the other party, subject to price, specification, quality and delivery times being agreed and no less favourable than other potential and comparable suppliers.

It must be noted that preferred supplier arrangements may constitute an infringement of competition law in the countries where the party-suppliers are established or where the alliance will become operative.

Non-compete clause
Many alliances contain a clause restricting the parties’ freedom to undertake activities competing with those of the alliance. This may take the form of a non-compete clause (see Article 10.1 of the ITC Model Contract), as well as a certain level of exclusivity of the cooperation (Article 10.2).

Usually, the scope and duration of these clauses are heavily negotiated. It is therefore important to be accurate as to what is prohibited and what is permitted. It is common (and generally not subject to competition law restrictions) to provide for a non-solicitation clause as well: Article 10.3 prohibits the partners from enticing away each other’s (key) employees.

The duration of such restrictions is often extended beyond the term of the alliance agreement. The prevents one party from opportunistically terminating the alliance when it appears that cooperating requires the efforts of a struggling marriage, but key skills or learning points of the other party seem replaceable. While a post-termination continuation of a non-compete is justifiable for the viability of an alliance, competition law also limits how long that continuation may last.

Duration
Establish the duration of the alliance. Most alliances are related to the term of a certain project. Once the project has been completed or when the results appear unachievable, the parties may (freely) either consider extending the scope of the initial project or go their own ways. In the ITC Model, Article 12 provides for the case where the alliance will continue indefinitely subject to a party’s right to terminate – either unilaterally by giving notice or in specified circumstances. Alternatively, the alliance parties might agree on a specific term with subsequent renewal requiring mutual agreement.

One termination ground is particularly common for alliances and close cooperations: termination on the ground of a ‘change of control’ over the other party. The reason behind it is based on the personal nature of cooperation and the mutual trust required in collaborations. This mutual trust would typically be diminished if the partner has been taken over by a competitor or if the commitment of the partner’s management is in doubt following replacement of the people most directly involved.

Tax and liability implications
A contractual alliance does not usually involve the creation of a separate, profit-making business in which the parties share profits as well as costs. If the arrangements do involve income or profit-sharing, it is important to note the potential liabilities that might arise. An alliance might fiscally or legally be qualified as a ‘partnership’ that:

• triggers tax filing obligations and specific tax treatment; and
• entails the considerable risk that, especially if the alliance operates vis-à-vis third parties, each party could become jointly liable to third parties for any claims arising out of the activities of either party in the alliance.

Formalised partnership status
If the venture does involve a separate profit-making business, this will normally require a more formal ‘partnership’ agreement or the creation of a corporate joint venture. Such a formal partnership agreement can be based on the ITC Model international corporate joint venture agreement (where the terms ‘shareholder’, ‘director’ and ‘JVC’ should be replaced, respectively, by the terms ‘partner’, ‘managing partner’ and ‘alliance’.

Joint venture agreement (JVC)

It is common to talk in terms of a ‘joint venture agreement’ when partners incorporate their alliance or cooperation into a legal entity (other than a general partnership) and to refer to the joint legal entity as the ‘joint venture’ (or ‘JVC’). Most of what is discussed in connection with contractual alliances and collaboration agreements and the strategic rationale for seeking a collaboration also applies to joint ventures.

The ITC Model Contract for an international corporate joint venture provides a general framework for a joint venture that is to be jointly owned by two parties. A more extensive model joint venture agreement (for incorporated JV’s) is from Trader Options Investing Platform (available from our model contracts platform). Of course, joint ventures may well be entered into by multiple parties – it would require more attention in finetuning the dispute resolution mechanism (but with multiple parties its might also be easier to solve any disagreements).

It is almost without exception that a joint venture agreement will have a number of related project agreements attached to it, so as to organise the various relationships and qualities of each joint venture partner vis-à-vis the JVC. Examples of such project agreements could include:

• Reseller or distribution agreements between the JVC and each JV-partner (if the partners or the JVC will act as a distributor for the other)
• Sales agreements, Long-term supply agreements or General purchase agreements between the JVC and each JV-partner (to provide for the terms and conditions on which a partner will supply the JVC, or vice versa)
• A Joint development agreement between all partners and the JVC (to organise any jointly undertaken R&D work, and to allocate any IP rights resulting from it)
• Licence agreements between the JVC and each of the JV-partners (if any technology must be licensed by a partner to the JVC, or vice versa)
• Contribution agreements or subscription agreements between the JVC and each JV-partner (setting forth the terms and conditions for such JV-partner’s cash contribution or contribution-in-kind in exchange of receiving its shares in the capital of the JVC)
• An agreed form of the articles of association (or deed of incorporation) for the joint venture company
• …

These project agreements can be straightforward versions of a model reseller, distribution, sales, long-term supply agreement etc. Reflecting such relationships in separate agreements (that will be attached as a schedule or annex to the joint venture agreement and thereby be made an integral part of it) makes drafting, negotiations and managing a joint venture much easier. Do not try to arrange for everything in one single JV agreement. Consider using this model joint venture agreement that already anticipates attaching such project agreement.

Joint venture agreements and the JVC

Equality or majority
The ITC Model Joint venture agreement is designed for 50 /50 participation by two parties. Occasionally, for psychological, tax or accounting reasons, the parties may need to establish a 49/51 or 48/52 percent participation share. The ITC Model Contract can also be used for those cases. If there are more than two parties, or if one is to have an articulated majority share, the provisions will need to be adapted. In multi-party joint ventures, the dynamics of JVC management, decision making, deadlock resolution and termination differ considerably.

The JVC business and joint venture business plan
Establishing a JVC requires a match of objectives among the parties, most importantly regarding its financial and business aspects. Although mutual trust between the parties is an essential element for successful cooperation, it is crucial to align on business aims and intentions, as well. The parties should carefully determine the scope of the JVC. A few guidelines:

• Identify the business: the nature of the JVC’s business, its commercial environment (e.g. internet-related, target groups), specific products or services, and production methods;
• What falls within the JVC’s scope, perhaps by clearly identifying what is outside its scope (competitive business, competitors, excluded business);
• The functionality of the JVC business and application of the joint venture production processes and products;
• The JVC’s field of activities, which can be delimited geographically as well as by sector or industry;
• How synergetic effects are expected to be realised;
• Various temporal effects: how can or should the JVC develop or vary over time – relevant factors may include (i) targets reached, (ii) changes in market circumstances, (iii) discontinuance of any activities by the parties, and (iv) new technologies.

For clarity about the development of the JVC’s business, it is good practice to agree on a business plan at the outset. A business plan can take any form: from a PowerPoint presentation to a simple Excel sheet with forecasted sales projections. The business plan could be attached to (or at least identified in) the joint venture contract.

Conditions in a joint venture agreement
In the context of a joint venture contract, certain ‘conditions precedent’ may need to be satisfied before the collaboration can actually be launched. Such conditions may include regulatory approvals (e.g. from competition authorities or other market supervisory bodies), the establishment of the JVC (legal) entity, or the grant of government subsidies (see the ITC Model Contract, Article 3).

Establishment of the JVC
A corporate JVC must be formed in a particular jurisdiction. Usually, this will also determine the governing law of the joint venture contract. It will be necessary to prepare articles of association, bylaws or other constitutional documents in that jurisdiction, and these documents must be consistent with the joint venture contract. It is good practice to ensure that the joint venture contract addresses key items as a matter of contract between the parties.

If there are conditions to be satisfied, or if the JVC will be established after the joint venture contract is signed, a number of actions must be postponed. To avoid a renegotiation of terms, the key aspects of such actions should be agreed and listed in the contract. While the actual establishment of a JVC is called ‘closing’ or ‘completion’, such a list is often referred to as the ‘closing agenda’ – see Article 4 of the ITC Model.

Joint venture party contributions and management of the JVC

Contributions in kind
Many joint ventures involve a contribution by a party of assets, property, technology or services, or associated distributorship or supply arrangements. These will often require “ancillary contracts” to spell out detailed terms (e.g. price, specification, limitation of liability). In a simple, lean joint venture, contributions ‘in kind’ can be included in the joint venture agreement (see the ITC Model Contract, Article 9). However, in most cases, it is more appropriate to provide for these in separate contracts, (and other ITC Model Contracts can be used for this purpose).

If a postponed closing or completion is planned, it is important to agree on (the key items of) such ancillary contracts at the time of signing the joint venture contract (and attach them in ‘agreed form’ – see the ITC Model Contract, Article 4.4). The JVC and the appropriate party or parties will then sign on the closing date.

Cash contributions
In many JVC’s, each party makes an initial financial contribution to the capital of the JVC. The amount may differ per party: a large contribution in kind by one party can be balanced by additional cash from the other party. It is important to stipulate whether or not a party will have any subsequent obligation to provide further finance to the JVC. Article 5 envisages that any future finance requires mutual consent.

JVC management
Overall direction and management of the JVC is usually in the hands of the JVC board of directors: an executive team of representatives from each of the joint venture partners. They will (attempt to) manage any conflicting interests among the partners and ascertain that the partners do what they have agreed to do. They coordinate the parties’ performance, represent their appointing party within the JVC, and manage the JVC (like a business unit of a company). This list of responsibilities makes it clear that the board of directors has a complex task.

Decision making in joint ventures
Obviously, it is impossible (if even desirable) to foresee in advance and include in the joint venture contract everything that will eventually need to be settled. Nevertheless, it is important to clarify at the outset the balance of decision-making power. Decision making within a JVC affects: (a) the parties as shareholders, (b) the board, and (c) individual executives of the JVC. It is common to specify that certain “Reserved Matters” will require the mutual consent of the parties, either as shareholders or on the board.

Business-related matters are not necessarily the subject of decision making by the shareholders, but this is almost inevitably the case for actions or policies affecting:

• the financial commitments and obligations of each party (including applicable accounting policies, especially if the JVC is consolidated in the accounts of one or both parties);
• the creditworthiness of the JVC;
• the shareholding percentage;
• the freedom of a party to compete and the freedom of the JVC to enter new markets and territories;
• litigation (affecting the name or reputation of a party);
• key employee related aspects; and

the JVC’s freedom to merge, take over other companies, initiate reorganisations and to apply for insolvency proceedings.

Termination of the joint venture agreement and the JVC

Overview. Most joint ventures will cease to exist within the first year of their existence. The main reasons for this include the incompatibility of the parties’ organisations or operational functioning, differences in internal (decision-making) culture, a change of strategy by one of the parties, a material breach of contract or even a dispute regarding interpretation of contractual obligations. A sale by a party of its shares in the JVC can, under the ITC Model Contract, only be made with mutual consent.

Termination grounds affecting mutual trust will typically lead to a deadlock in decision making. Therefore, it is appropriate not to include an exhaustive list of possible termination situations but simply to provide for ‘deadlock’ as a ground for termination. If a party wishes to bring the joint venture to an end, this usually requires mutual agreement. In the ITC Model, Article 14.3 contemplates that (after a reasonably lengthy procedure) a party can nevertheless call for a winding up of the JVC in certain circumstances of breakdown or deadlock.

Russian roulette, Texas shoot-out etc. It is not uncommon to provide for an alternative termination mechanism. In many joint venture configurations, the sale of JVC shares to a third party or to only one of the parties is not acceptable. Sometimes, the parties may foresee which of the two would be the most appropriate acquirer of the JVC shares. The key issue in such cases is the valuation of the shares at a reasonable price. The contract clauses providing for a valuation or acquirer-appointing mechanism have been given exotic names such as ‘Russian roulette’ or ‘Texas shoot-out’. It is beyond the scope of this book to elaborate on all the ins and outs of such clauses, but a brief description of three common mechanisms is given below.

1. Russian roulette (two-party JVC’s). When it is uncertain who will buy out the other party, a common mechanism provides for an internal auction (also called Russian roulette).[1] Both parties should indicate whether they want to buy or sell, and at what price. If one party wants to sell and the other wants to buy, then the latter must buy at the price proposed by the former party. If both parties want to sell, then the highest bidding party must buy at the lowest offered price (and vice versa in case of two willing buyers). The combination of these two outcomes embodies an implicit incentive for the willing seller to offer at an appropriate price (i.e. if it offered at a too high price, it would become the buyer; and there is no reason to anticipate an offer at a below-value price).
2. Texas shootout (multiparty JVC’s). When it is uncertain who will buy out the other party, another common mechanism can be applied in a multi-party JVC (it is known as a Texas shootout). An independent person who will facilitate the process must propose a share price for the JVC. All parties will indicate whether they are willing to buy or sell at that price. The indicated sellers will sell at that price; if more than one party wants to buy, the process is repeated among the willing buyers at a bid price increased by five or ten percent, until there is one buyer left. If at some point all the remaining willing buyers turn into willing sellers, the price is decreased by 1 percent (and goes down until there is one buyer). The prices to be paid by the buyer will be the prices at which the relevant seller was still willing to buy. If the first round provides only sellers, instead of increasing, the price will decrease by 5 or 10 percent (and while the reference price goes down each time, the mechanism works mutatis mutandis the same).
3. One pre-appointed acquirer. If one particular party must eventually acquire all the shares, the bidding mechanisms described above do not work. Instead, the valuation must be more adequate. A termination mechanism would require each of the parties to propose a valuation of the JVC shares (including a breakdown and explanation as to how the valuation has been calculated. If there is a difference between them, the parties will discuss both valuations and deviations. If after a period of (for example) 60 days no consensus is reached on the price, each party may require the appointment of an independent accountant, and it is therefore important that the joint venture agreement provides for an appointing authority in case the parties fail to agree on one person or firm. The appointed independent accountant will establish the price at which the prospected seller must sell and the anticipated buyer must acquire. The mechanism might contain instructions as regards the valuation method (but in many cases, it is best not to include such instructions).

This mechanism matches the auction principle developed by Nobel Prize winner William Vickrey.

Completing your joint venture agreement

The provisions in the ITC model Corporate Joint Venture Agreement may be added to the Alliance or collaboration agreement:

• Article 5 (capital and further finance)
• Article 6 (directors and management)
• Article 7 (reserved matters for important decisions)
• Article 9 (additional contributions)
• Article 13 (restrictions on the parties)
• Article 14 (deadlock and termination)

Sales agreements explained

Sales agreements are the cornerstone of almost every business. A sales contract requires tailoring for the particular product or goods, the locations of the seller and purchaser, how delivery must take pace, (if applicable) any after-sales servicing, and probably some requirements under the applicable law. This paragraph discusses the general framework of sales agreements by reference to ITC’s Model Contract for international sales of goods. For own use, the parties should adapt the sales contract developed by the ITC.

In this chapter, contracts for one-off sales transactions are discussed (one single sales transaction); for recurring sales transactions the chapter on long-term supply agreements (or manufacturing or distributorships) is more appropriate.

Scope of sales agreements

While there is largely freedom of contract, a well-structured sales agreement contain the substantive rules for an international sales or purchase transaction, i.e. the main rights and obligations of the parties, the remedies for breach of contract by the buyer; the remedies for breach of contract by the seller; and general rules that apply equally to both parties. Both sales agreements also contain the boilerplate clauses common in international commercial contracts.

Four parts of sales contracts
Therefore, the ITC Model sales agreements can be divided into four parts:

1. Key obligations related to the goods: delivery term, price, payment conditions, and documents to be provided;
2. Remedies of the seller in case of non-payment at the agreed time, the remedies of the buyer in case of non-delivery of goods at the agreed time, lack of conformity of goods, transfer of property and defects;
3. Avoidance or termination of contract and damages: termination grounds, avoidance procedure, effects of avoidance, restitution, damages and mitigation of harm; and
4. Standard (boilerplate) provisions – for more about these clauses, see the various subchapters here on Hardship (change of circumstances), Force majeure, the ‘miscellaneous’ or boilerplate clauses, choosing the applicable law, and on the various aspects of dispute resolution.

CISG-based
The ITC Model sales agreements are greatly influenced by the United Nations Convention on Contracts for the International Sale of Goods (CISG, the “Vienna Convention” of 1980), widely accepted by lawyers of different traditions and backgrounds (we also explain why you should probably not exclude application of the CISG). The Model Contract articulates practical requirements arising from commercial practice within the general rules of the Vienna Convention – for the Vienna Convention see elsewhere in this book.

Sale of perishable goods
The sales agreement may not be suitable for the sale of perishable goods. Apart from the fact that perishable goods are often sold by reference to branch-established trading terms and conditions, such goods require a different (and more concise) conformity criterion, short periods of time for notifying non-compliance, and a specialised quality-inspection procedure.

Short vs. standard version
The ITC Model Contract for the international commercial sale of goods is presented in two versions – the ‘standard’ version and a ‘short’ version. The standard version contains definitions of relevant notions (e.g. lack of conformity), special comments (e.g. on the notice of non-conformity), explanations and warnings to the parties (e.g. on the limitation of the seller’s liability or on the validity of the agreed interest clause). The short version is more practice-oriented, covering the main rights and obligations of the parties with no special explanations. In addition, the short version contains only selected boilerplate clauses, whereas the standard version provides all the relevant boilerplate clauses included in the other ITC Model Contracts.

Key clauses in sales agreements

Delivery term (INCOTERMS)
Many cross-border sales transactions require transportation. Questions then arise as to which party should do what, who should bear the risk of the various means of transportation, who should arrange for insurance and for customs clearance. This introduces a wide range of possible combinations of responsibilities, but in practice the parties will seek a combination in which those risks and responsibilities match. Commonly used combinations are reflected in the ‘Incoterms’.

Payment conditions
In cross-border sales where the parties do not hand over the goods, payment also entails an allocation of risk. Banks play an important trade-facilitating role in such cases. The parties may opt for various payment mechanisms, each of which presents a different allocation of risks for non-compliance. The allocation of risk may also engage the bank or banks involved, which affects the cost of the payment mechanism. Common payment mechanisms, provided for in the ITC Model Contract, are:

• Payment in advance: the buyer pays (part of) the purchase price into the seller’s bank account;
• Documentary collection, involving documents against payment (D/P) or documents against acceptance (D/A): a simple mechanism, suitable if the buyer considers the seller to be a trustworthy party, and if the seller would probably be able to sell the delivered goods to third parties in case of fundamental breach;
• Irrevocable documentary credit, pursuant to a letter of credit (L/C), under the UCP600: this mechanism provides optimum security for both parties;
• Payment supported by a bank guarantee; or
• Another specified payment mechanism (or combination of mechanisms).

More about this in our dedicated subchapter on payment mechanisms.

Documents required by international sales agreements
When a party arranges for transportation, insurance or customs clearance, it receives documentary evidence: those documents should be identified, and the desired contents may also be specified, in the sales contract. Article 5 of the ITC model sales agreement serves as a stepping stone for such specifications.

Even when a seller draws up a document alone they must not omit information required to be reflected in that document. The information may be relevant for subsequent parties in the transportation and delivery chain. For example, the invoice may need to reflect the VAT amount (otherwise the buyer may not be able to reclaim VAT or apply for exemption), and levies charged in connection with exportation may be recoverable under international treaties.

Furthermore, a bank engaged in an L/C payment will not verify if the goods are indeed the ones agreed in the contract, but it will investigate whether the certificate of origin, a certificate of inspection or a date of shipment are reflected the way the parties agreed in the contract. Types of commonly agreed documents are:

• commercial documents (e.g. invoice, packing list)
• shipping or transport documents (e.g. bill of lading (ocean or multi-modal or charter party), airway bill, lorry or truck receipt, railway receipt, forwarder cargo receipt);
• official documents (e.g. customs documents, import permits, export permits, license, embassy legalization, certificate of origin, certificate of inspection, phytosanitary certificate);
• financial documents (e.g. bill of exchange, co-accepted draft);
• insurance documents (e.g. insurance policy or certificate).

Under a UCP600-governed L/C-payment transaction, the standard of examination to be applied by a bank is elaborated in UCP600 articles 18 to 28. These Articles provide, for example, that:

• The start date of an insurance policy must be no later than the date of shipment, unless it is clear that the insurance coverage is retroactive (article 28(e)).
• A bill of lading may be given any title (article 20(a)) but must indicate, inter alia, the name of the vessel (article 20(a)(ii)) and contain terms and conditions of carriage, even though the bank will not examine such terms and conditions (article 20(a)(v)).
• An invoice must be expressed in the currency of the L/C (article 18(a)(iii)).

Breach of a sales contract (and remedies)

Late payment (interest)
Obviously, a seller would like to ensure that the buyer will pay its invoice in due time. Although the applicable law may provide for an entitlement to interest, it is psychologically stronger to be able to refer to precise contract terms stating that interest will accrue on late payments. Moreover, the statutory interest rate may be too low to justify collection proceedings in court.

In the ITC Model, Article 6.2 provides for the seller’s right to demand interest on late payments. However, it is important to note that an interest rate per day or per month will also be ‘compounded’ daily or monthly (quickly resulting in interest over interest and hence in a rapidly increasing percentage per year). Because this effect may be very excessive over a relatively short period of time, many courts are inclined to adjust (or even set aside) an exaggeratedly high interest rate. If the applicable law nullifies excessive interest rates, a court will likely also disregard a stipulation such as “unless the applicable law prohibits such interest rate, in which case the highest permitted rate will apply” (for its opportunistically attempting to take a benefit over the inadvertent buyer).

The specified interest rate should at least cover the interest that the seller would pay if it had to borrow the same amount from a bank.

Delayed delivery (penalty or liquidated damages clause)
The buyer may also wish to agree on a firm incentive for the seller to perform in a timely manner. Article 7.2 of the ITC Model Contract provides an option to include such an incentive in the form of a penalty or liquidated damages clause. To be valid and fully enforceable, the agreed amount of liquidated damages should roughly correspond to the damages likely to fall upon the buyer. As liquidated damages are a type of estimated damages, the actual (exposure to) damages must be sufficiently uncertain at the time of contracting to warrant this option.

In common law contracts, the term “penalty” should be avoided. The enforcement of this term would require an equitable order of specific performance. Courts deciding in equity, however, will seek to achieve a fair result and therefore not enforce a term that leads a priori to an unjust enrichment of the enforcing party. The proper term under common law is “liquidated damages” and justified by clarifying that it is an incentive to perform duly and timely (and that the amount of the liquidated damages are an “accurate estimate of the damages” in case of undue or late performance).

Because a penalty or liquidated damages clause contains only an estimate, the actual damages suffered by the buyer may be much higher. Both under common law and in other jurisdictions, however, including a specified penalty excludes the right to claim actual damages (and in some jurisdictions even the right to invoke other remedies). It is therefore important to add a phrase such as “without prejudice to the Buyer’s right to claim damages” or wording of similar import.

Lack of conformity
The ITC Model Contract adopts the CISG concept of lack of conformity or non-conformity. This concept is wider than the concept of material defects (traditionally adopted in civil law countries) and includes differences in quality, as well as differences in quantity, delivery of goods of different kinds, and defects in packing. Nevertheless, specific cases of non-conformity defined under the Vienna Convention largely correspond to how material defects are defined in civil law countries. Such cases include unsuitability of the goods for their ordinary purpose or for a particular purpose, as well as non-conformity with a sample or model.

The liability of the seller for non-conformity under the Vienna Convention is dealt with almost identically under most national rules dealing with liability of the seller for material defects. Furthermore, in the Vienna Convention, “non-delivery” and “lack of conformity” are strictly separate forms of breach of contract. The same system is adopted in the ITC Model Contract, specifying:

1. special rules on the remedies of the buyer in case of non-delivery at the agreed time;
2. special rules on the remedies of the buyer in case of non-conformity of goods; and
3. general rules on avoidance due to non-performance of contractual obligations.

Expertise procedure
To mitigate the risk of lasting controversies about an alleged non-conformity in the quality of delivered goods, the parties could provide for an expertise procedure. This procedure prevents such controversies from becoming ‘endless’, and ensures that one party will not engage a third-party expert whose expertise or independence may be questionable. Article 9 of the ITC model sales agreement provides for this kind of expert procedure.

Warranty disclaimer
Instead of the Model sales agreement’s Article 8 (lack of conformity), a seller may propose a limited warranty and complete disclaimer of any implied or express properties of the goods sold under the contract. An example of such a disclaimer is:

The Goods are provided “AS IS” and the Seller makes no other warranties regarding the Goods. The Seller expressly disclaims all representations and warranties, express and implied, including any warranties of merchantability, fitness for a particular purpose and non-infringement of any third-party rights.

If this choice is made, the provision should in particular replace Sections 8.1 to 8.3. Obviously, including this kind of disclaimer reduces to a minimum the scope and relevance of (negotiations on) Sections 8.4 to 8.5.

Transfer of property
The ownership of goods transfers in accordance with the law applicable to the transfer of movable goods. In most jurisdictions, in the absence of express stipulations otherwise (e.g. a retention of title clause), ownership transfers when the seller ‘delivers’ the goods to the buyer because the risk transfer to the buyer. In cross-border sales transactions, this would be at the moment (and the place) determined by the agreed Incoterm: under Ex Works, for example, ownership transfers at the door of the premises of the seller; but under FOB, the seller only delivers once the goods have actually been loaded on board the vessel selected by the buyer.

Retention of title clause
A seller with some negotiating power will ensure that ownership of the delivered goods does not transfer to the buyer before the purchase price has been paid (see optional Article 10.1 of the ITC model sales agreement). A transfer of ownership obviously reduces the seller’s right to reverse the sales transaction in case the buyer goes bankrupt or enters into suspension-of-payment proceedings.

Ownership might also transfer by mixing the goods delivered with similar, other goods (e.g. if the sale concerns generic products such as bricks, steel bars, pencils, raw materials, or components). Therefore, it is important to complement a retention-of-title clause with an obligation to keep the goods under contract separate from the buyer’s other goods.

Various clauses in the sales agreements explained

Avoidance (termination) in the ITC Model sales agreements
The ITC model sales agreements use the term “avoidance” of contract, also taken from the Vienna Convention (CISG), to mean contract termination. It adopts the Vienna Convention concept of fundamental breach of contract, but with significant modifications. First, the ITC sales agreements define cases that constitute a breach of contract (where a party fails to perform any of its obligations under the contract, including defective, partial or late performance). Next, and on that basis, the ITC sales agreements establish rules for two different situations:

• Fundamental breach. A breach of contract amounts to a ‘fundamental breach’ in cases where strict compliance of the obligation that has not been performed is of the essence under the contract, or where non-performance substantially deprives the aggrieved party of what it was reasonably entitled to expect. The ITC Model Contract allows the parties to specify cases that are to be considered as a fundamental breach (e.g. late payment, late delivery, non-conformity). In case of fundamental breach, the ITC Model Contract allows the aggrieved party to declare the contract void, without fixing an additional period of time to perform what is specified in the contract.
• Other (material) breaches of contract. In all other situations, where a breach of contract does not amount to a fundamental breach, the aggrieved party is obliged to fix an additional period of time for performance. Only when the other party fails to perform the obligation within that period, may the aggrieved party declare the contract void. The ITC Model Contract adopts the following CISG rule: a declaration of avoidance is effective only if made by giving notice to the other party.

“Material breach” of a sales contract as ground for termination
Many contracts provide for a termination right in case of a (persistent) material breach. In this context, courts will give the term “material” a meaning corresponding to “significant from the perspective of the aggrieved party”. This implies an assessment as to whether the breach in question has a serious adverse effect on the party that has been deprived of performance or compliance with the contract. The assessment does not require such a breach to be fundamental, but the effect may well be the same.

Given that providing for an assessment leaves uncertainty about what kind of breach will be deemed “material”, it is worth considering whether to expressly identify the specific breaches that will give rise to a right to terminate (as opposed to generic wording that each delay in payment or delivery, or every non-compliance with specifications, is material).

Restitution
Once a sales contract is avoided (terminated), the parties’ performances (if any) must be reversed. Obviously, given that the transaction crossed borders, there may be practical implications and additional costs to be incurred by either party. In the ITC model sales agreement, Article 13 provides for restitution that can be adjusted to meet the particularities of the case.

‘Minor’ details not to forget in a sales agreement

Damages
Article 14 of the ITC model sales agreement contains an elaborate arrangement for claiming damages in case of non-performance (which includes non-conformity of delivered goods). First, paragraph 14.1 states the general principle that, except for cases of force majeure, any non-performance entitles the aggrieved party to damages.

Second, the damages eligible for compensation are limited to those reasonably foreseeable at the time of contracting (“which the breaching party ought to have foreseen”). In case of avoidance, such damages will be calculated by reference to the replacement costs of the contract goods, increased by any additional expenses incurred (paragraphs 14.2 to 14.5). This provision substantially reflects articles 74 to 76 of the Vienna Convention.

Limitation of liability
The ITC model sales agreement does limit the extent of liability by specifying the type of damages. The effect is that the buyer faces a discussion as to what “ought to have been foreseen” by the seller. This eliminates opportunistic claims, and the uncertainty introduces a certain “nuisance value” (as a probable complex discussion of foreseeability may discourage the buyer from submitting a claim).

In practice, the parties may seek more certainty: the seller will exclude its liability, and the parties will negotiate a limitation of liability that matches the circumstances. For a more detailed discussion of and the dynamics of such negotiations, see the subchapter addressing limitations-of-liability clauses.

Mitigation of harm
In the ITC model sales agreement, Article 15 expresses a general principle of law: even an aggrieved party must take such measures as may reasonably be expected in the circumstances to prevent that any damages or losses unnecessarily increase (also in CISG article 77, and the same principle is expressed in Unidroit Principles article 7.4.8.)

The scope and extent of such measures must be proportionate to the harm suffered if the measures are not taken. Potentially, this may even require the aggrieved party to incur considerable costs. Those expenses are recoverable, however, as part of the damages.

Applicable law
Article 23 of the ITC Model Contract is specific to the international commercial sale of goods. It stipulates that questions not regulated by the contract itself are governed by the Vienna Convention; and questions not covered by the Vienna Convention are governed by the Unidroit Principles; and to the extent that such questions are not covered by the Unidroit Principles, they are governed by reference to the national law chosen by the parties. The parties may agree on rules that modify, replace or supplement those of the Vienna Convention or the chosen applicable law.

Regulatory framework
The main sources of uniform contract law that were used in drafting the ITC Model Contract are the:

• Vienna Convention (CISG);
• Uniform Law on the International Sale of Goods (ULIS);
• Unidroit Principles (you can read and download the Unidroit Principles for International Commercial Contracts here (available in numerous, some versions with black-letter text only (without the explanatory notes or illustrations));
• Principles of European Contract Law (PECL); currently extended as the European Draft Common Frame of Reference (DCFR).
• ITC model contract for the international commercial sale of perishable goods;
• ICC Model International Sale Contract – Manufactured Goods Intended for Resale.

Long-term supply agreements

If parties enter into a continuous relationship for the supply of goods, it is helpful to reflect this in a long-term supply agreement or strategic purchasing agreement (aka general purchase agreement). You may benefit from the extensive model General purchase agreement also available on the Trader Options Investing Platform website.

The ITC Model Contract is less extensive and intended for use in connection with manufactured goods, rather than commodities, which have their own special features and are often sold on standard forms provided by associations of producers or dealers. The Model Contract on the international long-term supply of goods by the ITC is not intended for use in cases where goods are supplied for resale by a distributor (for those cases, see the ITC Model Contract for the international distribution of goods).

What is the purpose of long-term supply agreements?

While a contract for a long-term supply of goods would mainly be a sales contract, the parties can focus on various additional relational elements to improve the quality of logistics, delivery and of the supplied goods themselves (as regards such joint development between the customer and its supplier, Trader Options Investing Platform’s model General purchasing agreement contains various useful sample clauses). The larger contracted sales volumes give the parties more freedom to tailor their relationship.

The purpose of such a long-term supply agreement is not only to arrange for the sales related aspects, but also to improve the supply relationship by providing for:

• ensuring continuity of supply
• logistical aspects of supply aimed at a shortened lead time (the time between order and delivery)
• improvement of product quality
• continuity in product specifications (and a mechanism for changing product specifications in case of technical developments, a change in raw materials or other developments)
• flexibility in modifying the applicable Incoterm
• fluctuations in purchase prices (including price developments related to raw materials or components)
• flexibility as regards payment (i.e. no costly L/C or other payment mechanism is required)
• a limitation of liability by reference to the (long) duration of the contract
• permissible events of force majeure, tailored to the particularities

How to decide: Supply or manufacturing?
A supplier may or may not be the manufacturer of the goods under contract. If the manufacturing aspect is predominant, it is recommended to use the ITC model international manufacture agreement.

Key clauses in long-term supply agreements

Change of specifications (‘variation‘ or ‘change requests‘)
In a long-term supply relationship, it is probably inevitable that each party should have a right to change the specifications of the goods. The customer may need such changes to fit them into its own products (which may be subject to change) or to meet the end-users’ desire to buy a state-of-the-art product.

The supplier may require flexibility because it might need to shift to other suppliers, have to cope with a varying quality of raw materials or components, or want to cease old production methods or processes. In the ITC Model long-term supply agreement, Articles 1.2 and 1.3 provide for a mechanism to change the product specifications, subject to reasonable notice and price adjustments. The parties may even agree on a product ‘roadmap’ reflecting improvements to be made to the contracted goods.

Minimum volume commitment
The more volume (i.e. certainty) a customer can commit to in its estimated purchases, the higher a discount a supplier can offer. This is reflected in minimum purchase commitments (see the ITC Model Contract’s optional Article 1.4).

For large customers, such commitments effectively imply more exclusivity (and less opportunism) regarding the supplier that will be chosen. A long-term supply relationship allows the parties to alleviate any undesired effects of minimum volume commitments: circumstances of force majeure and shortfalls in any year can be compensated in subsequent years.

Framework-character and ordering
A long-term supply agreement is normally a framework agreement: the framework for ordering and delivering the goods is established in the contract, but actual deliveries are subject to a purchase order that must be accepted by the supplier.

This mechanism does not reflect the contract formation procedure of the Vienna Convention (see Article 14-24 about offers, counteroffers, modified-acceptance and similar negotiation stages): rather, it is meant to ascertain that the customer is firm in its wish to purchase a certain quantity and quality of goods, to ensure that that the supplier has received such an order, and to fix the moment in time as of which both parties are bound to a single delivery of goods. The (software) accounting and enterprise resource planning (ERP) systems work this way.

Order forecasting
Especially in cases involving complex products, a supplier needs to purchase raw materials and components, and manufacturing may depend on the availability of (fine-tuned) production lines. For those purposes, to optimise the production process for the supplier, and allow it to acquire raw materials or components at a discount, the ITC Model Contract contains a so-called forecasting mechanism.

For a lawyer, a forecasting mechanism is a strange animal: every month, quarter or year, the customer is requested to submit a good faith estimate of its product requirement for the forthcoming periods, without being bound to actually purchase such estimated volume.

Inventory management and discontinuation of products
The advantage of a forecasting mechanism is that it enhances a supplier’s ability to improve the product lead time – the time between receipt of a purchase order and delivery of the ordered goods. Although reflected weakly, the ITC Model Contract’s Article 2.9 provides that the supplier will make commercially reasonable endeavours to meet its obligations (expeditiously).

The same Article provides for a discontinuation of goods if technological developments, decreasing order volumes or other efficiency-decreasing factors force a supplier to stop supplying a product. In such cases, the supplier must give written notice (allowing the customer to submit an ‘end-of-life purchase order’).

Intellectual property rights
If the contract triggers or involves the creation or divulgence of any intellectual property rights or know-how, it is strongly recommended that this issue be addressed in the long-term supply agreement. By default, intellectual property rights are owned by the creating party; if the creation was partly or entirely paid for by the other party, a reallocation of ownership or the grant of a licence may be necessary.

Note that the ITC Model Contract for international manufacture agreement serves a similar purpose but focuses on product and manufacturing process improvement; various Articles from that contract can be used in a long-term supply agreement.

Flexibility in pricing
Not only may a change of specifications lead to an increase (or decrease) of purchase prices; other circumstances may also require price adjustments. The ITC Model Contract provides for a few options (in Article 3.3 and 3.4) to adjust purchase prices following considerable cost-price increases. Obviously, the question of whether to include these clauses is typically subject to heavy negotiation, in connection with which objective standards would be introduced to protect the interests of the customer.

One objective reference could be a national price index or other indicator of inflation. It is appropriate to provide for a minimum notice period and to subject any purchase price increase to a stipulated maximum. Any excessive price increase should entitle the customer to terminate the long-term supply agreement.

Mitigated exclusivity (price comparison)
Contractual devices that can strengthen the customer’s loyalty and order volume for products include, for example, an exclusive purchase arrangement, a minimum purchase volume commitment, volume discounts and improved supply chain arrangements.

However, such devices demand a certain freedom for the customer to benchmark the prices imposed by the supplier. In the ITC Model Contract, optional Article 3.5 provides the customer with a right to compare prices offered by competitors.

Standard clauses in long-term supply agreements

Warranties: No third-party rights
Of course, the supplier must deliver goods free from third-party ownership rights (reflected in the warranty in Article 5.1.1). But consistent with the Vienna Convention (Article 42), the delivered goods should also not infringe the intellectual property rights of third parties: this would make the goods useless for the customer.

In various industries, it is practically impossible to avoid all infringements (and fortunately, in those industry sectors, monitoring of infringements is often limited to successful products only). The parties may compromise by starting the warranty in Article 5.1.2 with the phrase “to the supplier’s knowledge after due and careful investigation” or, even less strictly: “to the supplier’s knowledge” (see also section 5.2(f)).

Limitation of liability
The ITC Model long-term supply agreement does not contain an extensive limitation of liability for the supplier. Article 7 optionally excludes the supplier’s liability for any indirect, consequential losses or damages (but product-liability-related claims resulting in death or personal injury are not excluded). Especially in long-term relationships, a broader limitation of liability would be very appropriate.

Duration
The ITC Model Contract also addresses the duration or term of the long-term supply relationship. As so many considerations could be taken into account, it is not possible to provide for all possibilities. Commonly, a contract of this type will cover several years, sometimes including the right of one party or both parties to terminate early either for convenience, breach of contract or insolvency of the other party.

A maximum period may be imposed by applicable law, depending on circumstances (see Article 8). Also, a maximum duration – with express extension being required – of up to five years may be required by virtue of competition law (if the supplier or the customer is in a dominant market position with, roughly, a market share in excess of thirty percent).

Consequences of termination
In cases involving termination of a long-term supply agreement, both parties have an interest to provide for the period after termination: the supplier may want to dispose of excess inventory (or even raw materials, components and spare parts); while the customer may wish to avoid a situation where such goods are dumped by the supplier at market-deteriorating prices.

Miscellaneous provisions and no-subcontracting
Standard provisions have been included in the ITC Model Contract, including change of circumstances (Hardship) (Article 9), and force majeure (Article 10).

Article 15 is worth mentioning separately: in a long-term supply agreement, the customer relies on a relationship with the supplier and will therefore prohibit that the supply as agreed in the contract (i.e. whether or not it includes manufacturing) be subcontracted or (partly) delegated to third parties. For more elaborate discussion of these type of clauses, see elsewhere.

General terms and conditions
In some cases, a long-term supply agreement is used in connection with the supplier’s standard terms of sale or with the customer’s standard terms of purchase. In cases where these do not exist or are not intended to apply, the ITC Model Contract includes a set of simple additional terms of supply (schedule 4).

Manufacturing agreements

Main idea of manufacturing agreements: This section presents the ITC model Manufacturing agreement that provides a framework for a so-called international contract manufacture agreement. It is only a general framework and must be tailored to specific circumstances.

The ITC model Manufacturing agreement provides a series or “menu” of possibilities depending on the background and the nature of the production. Many provisions may not be relevant to a particular contract and should of course, if not relevant, be deleted.

Manufacturing vs. long-term supply
The setup and outline of the manufacturing ITC Model Contract differ from the ITC Model international long-term supply agreement. Although the two ITC Model Contracts are very similar, in the long-term supply agreement the emphasis is on improvement of the product supply chain: ordering, forecasting, quality assurance, adjustability of specifications and (some) flexibility of pricing. Furthermore, the long-term supply agreement can be used for non-manufacturing related purposes, as well. In the ITC Model international contract manufacture agreement, the emphasis is on design and on improvement of the manufactured product and the manufacturing process. Both contracts enable the client to integrate the delivered goods into its own final products or services.

Manufacturing services vs. supply (sales)
The legal characterisation of a manufacturing agreement requires an assessment:

1. does it entail a sale or supply of goods? or
2. is it effectively the provision of a services?

Most manufacturing contracts are a mixture of both. When the manufacturer is primarily the party responsible for acquiring raw materials and components, and is also responsible for the adequate quality (‘conformity’) of those raw materials or components, then the manufacturer assumes the risks and obligations of a seller/supplier. However, if the customer procures those raw materials and components, and requires from the manufacturer only to perform its ‘manufacturing trick’, manufacturing must be qualified as a service. Some legal systems recognise that a manufacturing agreement may have a mixed character, leading to a differentiated approach regarding each party’s rights and obligations.

Unless otherwise specified or agreed, the distinction between manufacturing as sales/supply versus manufacturing as a service can be made as follows:

Manufacturing as a service

Manufacturing as a sale

Obligation to make best efforts. The client is responsible for timely delivery of raw materials or components. Prices for raw materials and components are for the risk and account of the customer. The client is responsible for the conformity of raw materials and components. IPR in the product is owned by the client. Implied warranty of good and professional workmanship. No great level of uniformity in applicable laws worldwide.

Obligation to deliver a result. The manufacturer is responsible for timely ordering of raw materials or components. Prices for raw materials and components are for the risk and account of the manufacturer. The manufacturer is responsible for the conformity of raw materials and components. IPR in the product is owned by (or licensed to) the manufacturer. Implied warranties of fitness for ordinary purpose and conformity. (Potentially) the Vienna Convention applies.

Toll manufacturing
In practice, a manufacturing services arrangement (i.e. where the service element predominates) is sometimes also referred to as ‘toll manufacturing’. Although ‘tolling’ is a term of art in several industries, across industries there is no common understanding as to what this term actually means.

Interchangeability of contract clauses in manufacturing agreements
Despite the different focus, mentioned above, in the ITC model long-term supply agreement (ordering, lead-time and logistics optimisation) as compared to the manufacturing agreement (joint product or production process improvement with emphasis on IP rights), several contract clauses are interchangeable between the two models. If that may result in a joint patent, you might benefit from our uploaded clause for managing the patent‘s registration. The following ITC model international long-term supply agreement clauses can be copy-pasted into the ITC Model international contract manufacture agreement:

• ordering and forecasting (Article 2):
  • order acceptance
  • changes to orders
  • flexible Incoterm choice
  • import/export clearance
• price flexibility and volume discounts (Articles 3.2.2 to 3.4).

The following ITC Model international distribution of goods contract clauses can be copy-pasted into the ITC Model international contract manufacture agreement:

• exclusive, sole or non-exclusive appointment restricting the use of certain developed technology (or the supply of certain manufactured goods) to a:
  • territory
  • market segment
• training and support (Article 8)
• retention of title (§ 4 of Schedule 4)

Note that upon copy-pasting, the term Supplier must be changed to “Manufacturer”; and the term Distributor to “Client” (or “Customer”).

Goods on loan
Many manufacturing agreements require specialised equipment or tooling to be used during the manufacturing process. The ITC model manufacturing agreement provides for the case that such equipment or tooling is made available by the client to the manufacturer. Obviously, in such cases, the client will require a higher level of skill and care as regards the treatment of its equipment or tooling. This possibility of ‘goods on loan’ is provided for in Article 1.5. Consider attaching a schedule with a more elaborate, dedicated goods-on-loan agreement (a model is uploaded onto our platform here).

Provision of know-how – responsibility for technology level
The ITC model manufacturing agreement provides for a basic scheme founded on the assumption that the manufacturer is fully equipped and has the technology to produce conforming goods, in its position as most specialized party. But the model manufacturing agreement also provides optionally for cases where the client has to transfer parts of its own technology to the manufacturer to enable it to finalize the products (Article 1.4).

Samples and models
In addition, the Model agreement covers the optional situation where the parties have agreed that the manufacturer shall submit samples before (mass) production is launched (Article 1.6).

Quality assurance
The desired level of quality for the goods produced by the manufacturer is ascertained in several ways. First, the manufacturer must warrant that the goods comply with the warranties stipulated in Article 4.1 of the ITC model manufacturing agreement (compliance to the written specifications of Schedule 1; free from defects in design, workmanship and materials; and compliance with applicable laws and regulations) during a warranty period to be agreed under 4.1.2. Second, the client is given the right to audit the premises of the manufacturer, its permitted subcontractors and its storage warehouses (see Article 4.3). Third, the manufacturer undertakes to indemnify the client against third-party claims (see Article 4.4).

Intellectual property aspects
Articles 1.4, 5 and 6 of the ITC model manufacturing agreement deal with issues related to intellectual property. It is assumed that the relevant intellectual property rights are properly protected by appropriate registration. Moreover, Article 9 imposes a duty of confidentiality upon both parties, which should provide additional protection, in particular if know-how is communicated by one party to the other. It is best to verify that the regime for improvements set out in Article 6 is acceptable in view of any applicable competition (‘antitrust’) law.

As mentioned above, if the contract triggers or involves the creation or divulgence of any intellectual property rights or know-how, it is strongly recommended that this be addressed in the contract. By default, intellectual property rights are owned by the creating party, in cases involving manufacturing, this will often be the manufacturer. If the creation was partly or entirely paid for by the other party (the client), a reallocation of ownership or the grant of a licence is necessary.

Cooperation on improvements
Especially in long-term relationships (such as manufacturing contracts) the parties will evaluate each other’s performance on a regular basis – depending on the type of goods: annually, quarterly or monthly. The evaluation includes the improvement of the goods (i.e. a product roadmap) and the efficiency or effectiveness of the manufacturing process.

In the ITC model manufacturing agreement, Article 6.4 provides that (IP rights in) further improvements will be owned by the client. This is because, most often, such improvements will be driven by the efforts of the client. Also, when a client sources its goods from various manufacturers worldwide, all the manufacturers benefit from improvements achieved by any manufacturers engaged by their client.

Duration
For manufacturing, the parties may establish a contract of long duration. The effect may be that each party must take into account the other party’s reasonable interests. Furthermore, a party cannot freely terminate a contract of long duration without an appropriate termination notice period, especially if the terminated party has made client-specific investments in its equipment and production installations, and the terminating party was aware of these client-specific investments.

In such cases, the client can be liable for compensating (the remaining economic value of) the investments. It is therefore important to establish the duration of the agreement (see Article 7.1). Another common option (not addressed in the model manufacturing agreement) could be to give the contract a specific term with subsequent renewal requiring mutual agreement. Note, however, that if the manufacturer or the client has a dominant market position, this kind of automatic extension may not in the aggregate exceed five years.

Distribution agreements

Distribution agreements cover (part of) a sales or distribution channel of a company, usually limited to a certain geographical territory or market segment. In addition to the company’s own sales activities, it may engage a commercial agent or sell to a distributor, a reseller, in order to increase its turnover.

A main reason to appoint a distributor or agent is that the supplier is unable to carry out distribution or sales in the particular territory or market segment alone, or is unwilling to invest in the infrastructure required for distribution. A distribution agreement can assure that the sales and distribution of the supplier’s goods is undertaken in an efficient and vigorous manner. In this chapter, we discuss aspects of a distributorship on the basis of the ITC Model International Distribution Agreement (PDF). But you may as well use Trader Options Investing Platform’s model distribution agreement as a useful sample.

(Commercial) agency vs. distribution agreements – what to choose?

It is extremely important to distinguish between (commercial) agency, on the one hand, and distributorship, on the other hand. A (commercial) agent is a representative of its principal (who sells to the customers found by the agent), whereas a distributor buys the goods from the supplier and resells them (for the risk and at the account of the distributor itself) to its customers (who are often also the end-users).

Commercial agency	Distribution agreements
Differences:
An agent does not buy or sell. An agent acts for risk and account of its principal. A termination indemnity is based on the volume of generated business and goodwill.	A distributor buys and resells. A distributor is a sales channel for the supplier, acting for its own risk and account. Termination is ‘free’, unless the distributor made investments in reasonable reliance on continuation.

 

Similarities:
An agency is a sales channel for the supplier. An agency can be exclusive, sole or non-exclusive. An agency must follow the instructions of the principal (legal duty, contractually reconfirmed). An agency must use advertisement materials as indicated by the principal.	A distributorship is a sales channel (resale) for the supplier. Distribution agreements can be exclusive, sole or non-exclusive. A distributor must (or should) follow certain instructions of the principal (contractual basis). A distributor should use advertisement materials as indicated by the principal.

Key clauses of distribution agreements

Appointment for a territory or market
The appointment of an agency or distributor is usually limited to a certain geographical area (i.e. a country or part of a country), a specific market segment (e.g. supermarkets, fitness centres, swimming pools, shopping malls, petrol stations), or a type of promotion or customer channel (e.g. general consumers, tv-broadcasting, printed magazines, luxury brand shops). Note that from a competition (antitrust) law perspective, it is not permitted to restrict a distributor from selling passively to customers from outside the appointed territory, and it is also not permitted to forbid a distributor to sell through the internet.

It is important to note that the principal/supplier may wish to exclude certain key customers which have their main place of business outside the territory from the scope granted to the agent or distributor. Especially in commercial agency contracts, it is possible that the principal does not want the agent to conduct sales activities with (affiliated companies of) such key customers (and become entitled to commission). This is because decisions to buy from a supplier are often made on corporate (holding) level; whereas the sales activities are focused on that level, it would be inappropriate to reward sales locally (i.e. pay commission to the agent because incidentally, the formal buying entity was in its territory).

Exclusivity of appointment
An agent or a distributor will be appointed “exclusively”, “non-exclusively” or as “sole” representative for the principal/supplier. “Exclusive” means that neither the principal/supplier nor a competitor of the agent/distributor is entitled to (be appointed for and) conduct sales activities in the agreed territory, market segment and customer channel. The distributor or agent will usually seek assurances that its efforts will be protected in some way, possibly by being appointed as the sole or the exclusive distributor, in a given territory. Conversely, a supplier may wish to ensure that the distributor’s efforts are concentrated in only the granted territory (Article 1).

Sole appointment (‘sole distributorship’)
If the appointment concerns a ‘sole’ agency or distributorship, the principal/supplier agrees not to appoint another agent or distributor for the same territory, market segment or customer channel. Nonetheless, the principal/supplier itself remains entitled to sell into that area. In other words, the appointed agent or distributor will be the only (sole) agent or distributor for that area, but will be operating alongside the principal/supplier.

Important incompatibilities
Both exclusive and non-exclusive arrangements may severely restrict the freedom of the principal or supplier in undertaking sales activities or appointing potentially more successful agents or distributors, because:

• The appointment of an exclusive distributor for a certain market segment prohibits the subsequent appointment of a non-exclusive distributor in the same territory for a broader market.
• The appointment of a non-exclusive agency for a certain territory prohibits the subsequent appointment of an exclusive agent in that same territory (even though the former is not de facto active in the market segment or customer channel covered by the latter). In such cases, the second appointment must contain a carve-out permitting the agent appointed first to continue its activities.
• If an agent is appointed with an exclusivity arrangement for a term of five years and the agent does not generate any sales, the territory and market segment for which the agent is appointed will effectively be ‘blocked’ for alternative sales efforts during that period of five years.

Interchangeability of contract clauses
Some clauses in the ITC Model international distribution of goods contract can be used in the ITC Model international commercial agency contract, and vice versa. You could essentially copy-paste the following Articles from the distribution of goods Model into the commercial agency Model:

• Article 7 (actions to be taken by the distributor);
• Article 8 (support and training); and
• Article 9 (intellectual property rights).

In such case, the term Distributor from this Distribution agreement must be changed to “Agent”; and the term Supplier to “Principal”.

(Commercial) agency agreements

In (commercial) agency agreements, the principal party, as supplier of goods or services, appoints an agent for a certain territory, market segment, or product or customer channel. The agent will conduct business development work, market the principal’s goods and facilitate sales contracts with the principal. Note the term “with the principal”: when a sales contract is facilitated by an agent (under an agency agreement), it is not the agent who enters into the contract with the customer; it is the principal (represented by the agent) who enters into the sales contract with the customer.

In addition to business development, marketing and closing the deal, an agent’s activities may also include after-sales services, customer care, any product-related servicing, as well as the collection on behalf of the principal of payments by the customer.

Applicability of the ITC Model Contract
The ITC Model international commercial agency contract is intended for use in connection with the introduction, promotion, negotiation and conclusion of sales of products or services by an independent agent on behalf of a principal, within a defined territory or market. A main reason to appoint an agent is that the principal is unable to carry out by itself the introduction, promotion, negotiation and conclusion of sales of products or services in that particular territory or market, or is not prepared to make the necessary investments required. On this website, a model commercial agency agreement (basic) can be downloaded.

The commercial agent may be a physical person or a company. If the agent is a physical person, under no circumstances can it be considered as an employee of the principal. When an agency contract applies to products, the principal may or may not be the manufacturer of these products. The principal may instead be, for example, a distributor.

Key clauses of a (commercial) agency agreement

Activities on behalf of the principal
Although the sales contract is clearly between the principal and the customer, sometimes (but not always) the principal requires that its agent:

• negotiates and signs the sales contract on behalf of the principal:
• takes care of any delivery and installation work;
• collects the purchase price on behalf of the principal; and
• takes care of various kinds of aftersales servicing (including complaints handling).

In such cases, the agent may almost seem like an employee of the principal: it represents the principal vis-à-vis the customer.

Exclusivity
As with distribution contracts, the commercial agency contract may provide that a self-employed agent shall have sole, or exclusive, or sole and exclusive trading rights in a particular territory (see the ITC Model Contract, Article 1). In this context, the character of the agency is territorial, not personal. The parties may wish to limit the scope of the agency contract to certain categories of customers.

Commission
The agent is normally paid commission on all sales emanating from his territory, whether procured by efforts of his own or of others. The commission is usually based on the price of the goods sold by or through him, sometimes augmented by bonuses or commissions.

Various clauses in the ITC model (commercial) agency agreement

In the ITC Model (commercial) agency agreement, several points require particular attention and should be dealt with in the contract in precise terms, as follows.

Minimum volume commitment
The more volume (i.e. certainty) a customer can commit to in its estimated purchases, the higher a discount a supplier can offer. This is reflected in minimum purchase commitments (see the ITC Model Contract’s optional Article 1.4). For large customers, such commitments effectively imply more exclusivity (and less opportunism) regarding the supplier that will be chosen. The long-term character of a supply relationship allows the parties to alleviate any undesired effects of minimum volume commitments: circumstances of force majeure and shortfalls in any year can be compensated in subsequent years.

Commission on orders received directly by the principal
The agent is entitled to commission if the transaction concerned is the direct result of its efforts. The agent cannot claim commission if a customer places an unsolicited order with the principal, or if the order has been obtained by the principal himself or other agents. These rules are frequently modified by contract parties or a custom of the trade, which may provide that the agent shall be entitled to commission on all transactions emanating from his territory. That arrangement is particularly frequent when an agent is appointed as exclusive agent for a defined territory.

Repeat orders
Parties often arrange that commission shall be payable on repeat orders. If parties fail to make an express provision on this point, the principle that applies is that if the first order was the result of the agent’s efforts, the agent is entitled to commission on repeat orders (because they have to be considered as the continued effect of his or her original efforts). It is irrelevant whether these repeat orders are placed with the agent or with the principal directly.

Reimbursement of the agent for expenses
The self-employed sales agent abroad who solicits orders for an exporter cannot claim his trading expenses from the principal, unless this was expressly agreed upon in the contract. If the agent, with the approval of the principal, incurs liabilities in the courts of the country where the customer resides, he is entitled to be indemnified for any losses sustained or liabilities incurred.

Web shops and internet-sales
The increasing importance of electronic commerce is a further aspect of distribution that needs to be dealt with in the contract (see the ITC Model Contract Article 6).

Del credere agency
In a del credere agency, the agent may be responsible for assessing the creditworthiness of the customer and even for payment of the sales price. A del credere agent can be held liable for non-payment, depending on the contract, for amounts up to:

• the sales price;
• the commission; or
• part of the commission.

Termination: Payment of goodwill
The agent’s strength lies in its contacts with customers, and its weakness derives from the fact that its customers ‘belong to’ the principal. This explains why, in many countries including the EU Member States, public policy laws aim to protect the agent’s rights, especially upon the termination of the contract.

Applicable law (and local mandatory law)
The parties are indeed subject to mandatory legal provisions of public policy that may apply regardless of the applicable law chosen by the parties. The background of this is that an agent may need a level of protection similar in scope and nature as that granted to an employee. Such provisions are binding, meaning that the parties cannot ignore or decide not to apply them. These provisions may restrict the validity of certain provisions in the contract, and may allow a court to reduce or extend the obligations of the parties. Before any discussion takes place between the parties, it is therefore strongly recommended to check whether the foreseen agency contract will be impacted by such laws.

Quick overview of obligations
The main purpose of a commercial agency contract is to establish the level of each party’s obligations towards the other, such as the authority of the agent:

1. to commit the principal (Article 2.2),
2. to receive payments on their behalf (Article 2.3),
3. the obligation for the principal to accept the orders transmitted by the agent (Articles 3.4 and 3.5),
4. the information that the principal should pass on to the agent, such as the minimum overall orders, any change in the range of products or services, price, etc. (Articles 3.3 and 3.7),
5. minimum orders (Article 4),
6. advertising, fairs and exhibitions (Article 5),
7. internet sales (Article 6),
8. non-competition (Article 7),
9. trademarks and property rights (Article 9),
10. exclusivity (Article 10),
11. commissions (Articles 11 and 12),
12. consequences on termination (Articles 14 and 15), and
13. assignment and appointment of sub-agents (Article 19).

A commercial agent’s obligations and duties
If the agent is an individual or a small company that is not necessarily involved in the granted market fully or on a daily basis, it is common to include a detailed list of activities that the principal expects the agent to undertake. A detailed list of a commercial agent’s obligations and duties would reflect the entire sales cycle as is characteristic for the product or service, and the particular market of the commercial agent.

For example:

General responsibilities. Agent shall be free to organise its time and its activities pursuant to this Agreement. Agent shall make best efforts and devote such time, manpower and other resources as are necessary or helpful to promote, market, sell and maintain for Principal, and where required cooperate in the conclusion and completion of substantial sales of Products to the Market in the Territory.

…If desired, in view of the experience of the appointed agent, the specificity of a product’s or services’ sales cycle and required business development work a clause listing in more detail what an agent must do (or omit):

Specific responsibilities. Without limiting the generality of Section [General responsibilities], Agent shall:

As regards marketing, business development and sales:

1. regularly (as often as is suitable) visit Customers and follow up on all leads and prospects provided by Principal, except that Agent shall not solicit sales from Key Customers;
2. reply to all requests of Customers for quotations and shall pass on all orders for Products promptly upon receipt to Principal and has no authority to commit Principal in any manner. Quotations that are given, orders that are recorded and agreements that are negotiated by Agent shall reflect that they remain subject to the agreement of or a written order confirmation by Principal;
3. refer promptly to Principal all enquiries for the purchase of Products received from persons operating inside or outside the Territory or the Market but for sale outside the Territory or the Market;
4. keep Principal informed of any changes in the prevailing market conditions and shall periodically supply general and specific market reports relating to the Product and the Product’s equivalents, including: (A) information regarding Customers and general complaints from Customers, (B) details with regard to market shares and prices in the Market in the Territory, (C) promotional or other activities in the Market in the Territory, (D) technical information which can be considered to be relevant to the marketing and sale of the Products, and (E) information on Customers’ wishes for improvements of the Products. Agent shall, if so requested, actively assist Principal in its market research; and
5. submit to Principal, at least [annually, by the end of November of each calendar year] a sales plan to be implemented by Agent, with target sales figures for each Product, for the following year, so as to allow Principal to schedule the manufacturing of the Products.

As regards its business operations:

1. describe itself as an agent of Principal in all correspondence, letterheads, business cards, telephone directories, advertising materials and other external communications;
2. conduct its business in accordance with proper business standards, in good faith and not commit any act which would adversely affect Principal or its Products, business, integrity or reputation;
3. comply with all laws and regulations to which it is subject (including VAT, tax and social security) and avoid all unethical or misleading business practices, and keep Principal informed about (any changes in) the laws, regulations or requirements that (are to) apply in the Market and the Territory and to which the Products must conform;
4. engage resources as are necessary for the efficient and effective performance of its obligations under this Agreement; and not engage in any other activities that would detract Agent from or hinder Agent in the performance of its obligations under this Agreement without the prior written consent of Principal, which consent shall not be unreasonably withheld or delayed; and
5. at its own expense, attend and participate in trade fairs, industry meetings, conventions and other sales exhibitions (pre-approved by Principal), and attend meetings at Principal’s request with Customers and with representatives of Principal.

As regards support services:

1. provide Customers with adequate after-sales servicing of all Products for Principal and address and resolve Customer complaints, breakdowns, off-specification deliveries of Product;
2. subject to Section 2.4, refer promptly to Principal all contacts or inquiries by a Key Customer with respect to the Products;
3. notify Principal of each complaint, breakdown or off-specification delivery with full particulars of the nature of the problem, the actions taken by Agent in response to the problem, the recommendations suggested by Agent, and such information as Principal may reasonably require; and
4. provide Principal upon its first request with assistance in relation to handling of complaints and claims from Principal’s customers where it relates to (Principal’s operations) in the Market and the Territory.

As regards financial matters:

1. not transmit orders from potential Customers of which Agent knows (or ought to know) that they are in a critical financial position, without informing Principal in advance of such fact; and actively support Principal in its assessment of Customers’ (ongoing) financial capability to fulfil their financial obligations duly and timely;
2. not be authorised to collect or accept payments on behalf of Principal, but shall, when so requested by Principal, provide credit control and solvency review assistance on Customers (including follow-up of outstanding invoices and, where so requested, support in the collection of debts);
3. [Agent shall be liable, up to the amount of the commission, for the solvency, capacity and willingness of the Customer to pay for the Product that such Customer ordered from Principal as a result of the activities of Agent under this Agreement, unless Principal has changed the delivery or payment conditions without Agent’s consent; and]
4. provide Principal upon its first request with assistance in relation to invoicing to and debt collection from Customers.

Pricing and GTCs. Agent shall offer the Products for sale to the Customers as per the then current price lists, the volume discount schemes (if applicable) and the General Sales Conditions. Agent shall make no warranty or representation concerning the Products or their delivery other than those expressly made by Principal in its then current sales materials or otherwise authorised by Principal in writing.

It is important to note that national laws on agency agreement may impose restrictions on the agent’s involvement or responsibility (in terms of liability and risk) regarding financial matters. The above clause listing obligations of a commercial agent is also shared on our model contracts platform (in Word-format).

Miscellaneous clauses
Standard provisions have been incorporated into the ITC Model (commercial) agency agreement, including the financial responsibility of the agent (see optional Article 13), force majeure – excuse for non-performance (Article 16) and change of circumstances (hardship) (Article 17).

Conversely, you might want to use the following agency clauses in a distribution contract:

• Article 4 (minimum orders); and
• Article 5 (advertising, fairs and exhibitions).

In such case, when using the ITC model distribution agreement, the term Agent must be changed to “Distributor”; and the term Principal to “Supplier”.

This paragraph discusses the general framework of commercial agency agreements by reference to ITC’s Model Contract for international commercial agency. For own use, the parties should adapt the sales contract developed by the ITC.

Trademark license agreements

Trademark license agreements are for the licensing of a trademark used in connection with certain products. A trademark may be any distinctive, identifying wordmark, symbol, logo or other indicator of a product or service. In most cases, trademark licence agreements are part of another arrangement such as a franchise agreement, distribution agreement or manufacturing agreement. A good example of a trademark licence agreement can be downloaded (for non-commercial use) on our platform elsewhere on this website.

Scope of Trademark License Agreements
Trademark license agreements grant the licensee a right to use a certain trademark on certain (agreed) products and to manufacture, promote, import, distribute and sell such products in an agreed territory or market segment (or a market segment within an agreed territory).

• Sub-licences and exhaustion. Although the licence may exclude the right to grant sub-licences, if the licensee is the seller of the products carrying the trademark, a right to sub-license for such purpose is unnecessary: upon the sale and delivery of the product, the trademark protection is ‘exhausted’. This means that further resale of the products is not considered infringements on the trademark. It is therefore important to be clear, precise and specific about the scope of sub-licensing rights.
• Sub-licensing to affiliates and sub-contractors. The licence may be extended to companies affiliated with the licensee, as well as suppliers (of components or spare parts) of the product, or sub-contractors (e.g. responsible for assembling the product for the licensee). The Model Contract contains a number of options to ensure that the scope of sub-licences is not unnecessarily broad.
• Exclusivity. The granted licence can be non-exclusive, sole or exclusive (as regards the territory and market segment). Non-exclusivity means that other persons may be granted a licence as well. A sole licence is where the licensor itself is entitled to use the trademark within the agreed territory or market, next to the licensee. Exclusivity means that also the licensor is not entitled to use the trademark for the agreed products in the agreed territory and market segment.

Trademarked products vs. services
The trademark licence agreement is aimed at a trademark used in relation to a product. For services provided under a trademark, in the Model Contract, references to the “Product” must be replaced by the “Service”. Certain provisions typically related to products, product manufacturing, testing or product modifications may be redundant. Instead, it would be desirable to specify the quality level and the way in which licensed services are to be performed.

Royalties
Although the Model Contract may be royalty-free or fully paid-up (in which case the articles on royalties and payment can be limited or deleted altogether), most licences provide for a recurring licence fee in the form of a royalty. The Model Contract contains a framework for this.

Usually, the royalty (or licence fee) is linked to the volume of products sold after deducting certain costs which are unrelated to the relevant sale. Sales to affiliated companies, so-called ‘captive sales’, should be excluded (but the sales by those affiliated companies to third parties must be included). Also, the effect of taxes, import duties and other levies should be excluded.

If you want to learn more about trademarks as an intellectual property right, check out the chapter dedicated to it.

Brand manual and trademark usage guidelines
It is important that a trademark owner continuously uses the trademark and is vigilant concerning possible infringements, misuse or genericising signals. One powerful instrument to achieve this is by adopting the trademark owner’s brand manual or trademark usage guidelines:

• Detailed instructions as to how and where on the product the trademark must be printed or presented
• What type of (advertisement) materials are permissible
• Which photographs must be used
• What the surrounding style, class or ambience any communication must include
• Which particular colours (RGB or hex), typefaces (fonts) and shapes must be used
• Which quality requirements apply to packaging materials or materials on which the trademark is permitted to be printed

A trademark licence agreement should include the requirement of strict compliance with the brand manual or trademark use guidelines. The agreement could attach the manual or guidelines as of the date of the agreement as an annex (and permit updates from time to time), refer to a website from which the manual or guidelines can be retrieved, or require the licensor’s approval of any product or material before it is produced.

The licensee should comply with future changes of the manual or guidelines, at least within a reasonably short period of time. Obviously, as long as the trademark is being ‘developed’, requiring prior approval for any type of use (i.e. design of merchandising, advertising materials and other communication means) is probably the only practicable way to ascertain a consistent, distinctive trademark development.

Benefit
A trademark licensor should ensure that ‘use’ of the trademark inures to the benefit of the owner. If that would not be the case, a licensee who is the only party using the licensed trademark in a territory would (e.g. after five years of being licensed) be able to terminate the licence agreement and prohibit the licensor to use the trademark because it had not used the trademark for five years and that conversely, the licensee should be treated as the trademark owner in that territory because it had used it.

Although this seems absurd, the general principle is that the party claiming the infringement must use the trademark. Therefore, in many countries, including all EU member states, use of the trademark by a licensee (or with the consent of the trademark owner) is deemed to constitute ‘use’ by the trademark owner. It is helpful to express this in the trademark licence agreement.

The designations TM and ® in connection with a trademark
Generally, it is not necessary to highlight a trademark by the superscripted letters TM (for non-registered trademarks) or the sign ® (for registered trademarks). The background of this is that some jurisdictions used to distinguish between intentional (or wilful) and unconscious use of a trademark. In those jurisdictions, if the copied trademark is marked by a designation TM or ®, intent on the part of the infringer would be presumed.

In that case, the trademark owner would not need to give a prior warning or notice of infringement before it takes action against the infringement. Case law has developed in a less formalistic and a more internationally uniform direction, such that a court will decide on intent with regard to infringement on the basis of the factual circumstances.

Miscellaneous aspects of trademarks license agreements

Antitrust considerations regarding trademark licence agreements
Competition (antitrust) laws may considerably restrict a licensor’s freedom to control or influence a licensee. Such restrictions apply in particular to the pricing of the products sold under the trademark. Furthermore, competition law may set aside a contractual limitation of the licensee’s freedom to challenge the validity of the trademark or nullify a contractual prohibition of the licensee’s ability to market, sell and deliver products to customers (immediately) outside the agreed territory.

Infringement of trademarks
A party using a trademark without a licence might well infringe the trademark. Whether or not there is an infringement, however, is not always clear. The allegedly infringing products may be sold in a different (or merely adjacent) market or the allegedly infringing products might be remotely similar. Relevant criterion is whether the allegedly infringing product or service causes confusion of the targeted buyers.

In assessing an alleged infringement, a court will consider:

• The strength of the trademark
• Proximity of the products or services
• Whether the trademark is not identical or the further similarity of the trademarks
• Evidence of actual confusion
• Product markets and marketing channels used
• Type of products and the degree of care likely to be exercised by the consumer (or professional buyer): ‘purchaser sophistication’
• The (alleged) infringer’s intent in selecting the mark
• Likelihood of expansion of either party’s product line

Licences and infringement
A trademark licensor will typically require that the licensee promptly notifies it of any infringement which comes to its attention. The reasons for this include that:

1. The licensor might not immediately be aware of infringements in various places or countries
2. Once the infringing mark is established, the original trademark may lose its distinctiveness (i.e. become genericised and therefore lose protection)
3. The licensor may prefer to act itself and not leave the legal case to be dealt with by the licensee (who might choose a less informed lawyer or make an undesirable argument)
4. Taking prompt action increases the chance to win the case

Conversely, also a licensee of a trademark will typically require that the licensor take prompt action against any infringement. If the licensor would not act (promptly or adequately), the trademark may lose its distinctiveness or goodwill in the market, and the customer might lose its willingness to pay a higher price.

Act promptly vs. defence of laches
It is important to act promptly against any infringement. Prompt action improves the possibility to prevent sales of infringing products, reduces damages to the goodwill in the trademark, limits the risk of price erosion in the market, and may facilitate the recoverability of damages. More importantly, if the action for trademark infringement is started only after an unreasonable (unnecessary) delay, the trademark owner (or licensee) may have lost all its rights to stop the infringement (based on ‘laches’).

Such a defence of laches may be successful in case of a delay of even a few days. In many legal systems, a court will balance the interests of the trademark owner against those of the alleged infringer. If the trademark owner failed to respond promptly against an infringement and the alleged infringer has (in good faith) invested in its mark, many courts will reject a claim to prohibit use of an ‘infringing’ mark. The law tends to protect the vigilant, rather than the sleeping party.

Counterfeit products
Counterfeit consumer products (informally also known as knock-offs) are products that inherently infringe the rights of a trademark owner by displaying a trademark which is either identical to a protected trademark or by using an identification mark which cannot be distinguished in its essential aspects from the trademark.

Producing, importing or selling counterfeit products is illegal and countries impose increasingly high penalties on such criminal activities. Countries have become increasingly active in fighting counterfeit trade.

Useful trademark license clauses from other model contracts
The Model Contract can be expanded with provisions from other ITC Model Contracts. For example, if a licensor intends to provide training (e.g. on marketing and sales), or customer support related to the products (see Article 8 of the ITC Model Contract for the International Distribution of Goods).

• If a licensor wishes to ensure that the quality of a product is sufficiently high and adequately controlled, or if extensive provisions regarding changes of the product specifications are desired, examples can be found in Sections 1.2 and 1.3 of the ITC Model International contract for the long-term supply of goods or Section 1.6 of the ITC Model International contract manufacture agreement.
• If a licensor wishes to be more closely involved in the promotion, marketing and sales, specific obligations can be included (see Section 7.3 ITC Model Contract for the International Distribution of Goods).
• If the development of the trademark and products is undertaken in collaboration with a licensee, a provision addressing implementation of improvements and modifications can be desirable (see Article 6 of the ITC Model International contract manufacture agreement).

If the trademark is (or will become) part of a larger framework resembling a franchising network, the Model Contract and the ITC Model Contract International contractual alliance could be combined. Also, relevant provisions from the ITC Model Contract can be inserted in the Model Contract. This might apply, for example, to Articles 1 (Objectives and key principles), 2 (Management Committee), 3 (Contributions of the Parties), 4 (Joint Projects), 5 (Alliance costs), 7 (Preferred supplier/distributor), 8 (Secondments and personnel) and 10 (Restrictions on the Parties) of the ITC Model Contract International Contractual Alliance.

Amendment agreements, supplements and addenda

Amendments or amendment agreements are agreements by which the parties’ original contract are modified. The common terminology refers to an amendment and to amend a contract. However, there is nothing wrong with modification and to modify. The terminology adjustment and to adjust should preferably be used in the context of numbers, percentages and amounts.

Supplements and addenda
It may well be that the parties do not intend to amend a contract but rather desire to expand it in scope or nature. This is done by way of a supplement or supplement agreement. Although supplements will often also amend existing arrangements between the parties, their main purpose is to add something to an existing arrangement. From a legal point of view, you may equally call a supplement an addendum.

Settlement agreements
Although a settlement agreement is typically drafted in the context of (the settlement of) a dispute, the outline and clauses are largely similar to those of an amendment. If a settlement agreement relates to a dispute under an agreement, the parties can settle by simply amending the provisions that require amendment. In a settlement agreement, the recitals would express the background of the dispute or the uncertainties amongst the parties, and the provisions in the body text should be pragmatically dry and factual. It is strongly recommended not to restate both parties’ positions in the dispute but to use objectivity and to refrain from emotionally charged statements.

Format and contents
An amendment, supplement, addendum or settlement preferably takes a format and structure similar to the amended or supplemented contract. In the body text, the parties add, remove or replace definitions, obligations or other statements by new ones. Removed sentences can be identified by the first and the last words of the sentence (together with the section number). Inserted or amended text can be marked in italics, to clarify what precisely is being inserted or amended. It is not common for an amendment agreement to expressly eliminate provisions, which have been executed or performed already. There is no need to agree that such provisions have ceased to be effective.

Restated agreements
Sometimes, often after many years, the parties desire to continue an existing relationship but with certain amendments of the existing contract (e.g. in order to adapt the contract to newer standards of compliance, to align the contract better to the actual practice of doing business or to take out established ambiguities). In such case, the entire contract may be replaced by a restated and amended contract. This would only be visible in the title of the contract, probably the whereas clause and an entire agreement clause (i.e. which terminates the old contract).

Best practices relating to amendment agreements
One of the general drafting principles is to ‘be accurate’. It implies that when an amendment involves adding, deleting or replacing less than an entire provision (a word or two, a phrase, a sentence, or perhaps an enumerated clause), the drafter generally has two options. First, the original clause can be amended by specifying only the exact change being made. Second, the drafter can restate the entire provision.

For example, the original agreement provides in section 6.1 that: this Agreement shall take effect from the Effective Date and continue into force until 31 December 2022. If the parties agree to amend the Agreement, the two approaches could result in the following amendment clauses:

In the Agreement, “31 December 2022” is replaced by “30 June 2023”.
The first sentence of section 6.1 is amended to read: this Agreement shall take effect from the Effective Date and continue into force until 30 June 2023.

The first approach is more concise and has the advantage of being specific about the change that was made. The disadvantage would be that amendment is presented out of context, placing the burden on the reader to consult the underlying agreement as well. The second approach, restating the amended provision in its entirety, avoids that problem. A middle ground approach would be to describe the amendment in the recitals.

Defined terms in amendment agreements
In an amendment (or supplement or addendum) it is common practice to adopt the defined terms of the Agreement:

Unless otherwise defined in this Amendment, a capitalised term has the meaning ascribed to it in the Agreement. In addition, in this Amendment:

Do not copy, summarise or restate a defined term for no reason. Be accurate in the use of defined terms. For example, if the amended agreement uses definitions in connection with certain (not amended) concepts or covenants and the amendment introduces a new concept (without affecting the concepts or covenants used in the amended agreement), do not amend a defined term in such manner that the definition as used in the amended agreement is also changed. In such case, it is appropriate to emphasise that the redefined term only applies in the amendment:

For the purpose of this Amendment only, Technology means…
For the purpose of this Amendment, Products include…

Confirm validity of the rest
It makes sense to express, as a miscellaneous provision of the amendment agreement, that the remainder of the agreement is unaffected (and, for people who fear the force of oral or accompanying promises, some ‘entire agreement wording’):

Except for this Amendment, the Agreement remains unchanged. The validity of all terms and conditions not expressly amended by this Amendment remain unaffected. This Amendment constitutes an integral part of the Agreement, sets forth, together with the Agreement, the entire agreement between the Parties in respect of the subject matter of this Amendment and the Agreement, and supersedes all discussions or understandings between the Parties relating to this Amendment and the Agreement.

Do not exaggerate with your amendment agreement
In many cases, a simple e-mail by a person authorised to represent a party to the representative of the other party will be adequate evidence of an extension of the contractual term. The general drafting principle to be accurate does not, however, impose a level of precision as follows. In the example, an enumerated paragraph would be added at the end of the existing enumeration in the Agreement:

The Agreement is amended as follows:
(a) paragraph 10.2(l) is renumbered as 10.2(m).
(b) after paragraph 10.2(k), following provision is inserted as paragraph 10.2(l): “enter into, amend or terminate any management agreement, partnership, joint venture agreement or any other agreements other than in the ordinary course of business;”
(c) the word “or” at the end of paragraph 10.2(j) is deleted.
(d) in Sections 4.3 and 6.2, the cross references to (Section) “10.2(k)” are replaced by “10.2(l)”.

Needless to say, this example is somewhat overly detailed. Try to catch (a), (c) and (d) in one sentence: In the Agreement, paragraph 10.2(l) is renumbered as 10.2(m); and in Sections 4.3 and 6.2, the cross references to (Section) “10.2(k)” are replaced by “10.2(l)”. Similar cases of excessive detail would be to identify how, in case the last or the penultimate enumerated clause is deleted, a semicolon is replaced by “; or” and a full stop inserted.

Shareholder and board resolutions and powers of attorney

First of all, choose a title that identifies the type of resolution. If a shareholder resolution prominently presents the name of the shareholder (e.g. because it is the first entity referred to and printed in bold), it is desirable to make it equally prominently known that it is not the shareholder but the company to which the resolution relates.

Recitals
A resolution should preferably address all those elements that are necessary to ascertain its validity and enforceability. As a matter of good practice, the resolution contains a preamble explaining the background of the resolution. Therefore, a resolution should confirm the title, authority and presence of the persons who should decide, as well as the fulfilment of procedural aspects for the relevant resolution.

Listing prerequisites
Mentioning the fulfilment of procedural aspects serves as a reminder that all those aspects have been taken into account, as a failure could have the effect of the resolution being declared void or even null from the outset. The procedural aspects that could be addressed may include:

• a statement that each director and all holders of non-voting shares have received notice and were (therefore) given a reasonable opportunity to attend and advise the general meeting of shareholders;
• if the resolution relates to the approval or fixation of the annual accounts, preferably a statement that the company’s auditor has received notice and was given a reasonable opportunity to advise the general meeting of shareholders;
• if there are holders of pledge with the right to vote, a reconfirmation of this (and the relevant holder of pledge should sign, preferably with the statement that the shareholder itself had received notice and was given a reasonable opportunity to advise the holder of the pledge);
• if the articles of association contain specific requirements for shareholder or board resolutions, a reference to the relevant provisions in the articles of association and a brief synopsis of those requirements;
• if the resolution is required under the applicable law, a reference to the relevant statutory provisions and a brief synopsis of requirements or the qualifying facts;
• if the resolution relates to a resolution by another body or organ of the company, a reference to such other resolution (i.e. the title, such body or organ and the date of the resolution);
• a confirmation that any required approvals or advice from works councils and other employee representative bodies and employee unions, if relevant, were given.

The company resolves
Please note that, from a legal point of view, depending on the applicable law, it may be the company that decides, even though the company does so by virtue of a decision by the shareholder. In other words, where for instance the articles of association require that a shareholder resolution is adopted in connection with a sale of important assets, it may be the company that adopts such resolution by virtue of the fact that the shareholders duly exercise their voting rights.

Minutes, not resolutions
In several jurisdictions, resolutions are embodied in minutes of a shareholders or board meeting, as the case may be. In such case, a rather absurd story is conveyed of a meeting that has never taken place. The minutes explain that the chairman opened the meeting, established those aspects that would otherwise be included in a mere resolution, this followed a phantom agenda including items such as “what comes up for discussion” and -any other matters. The minutes should of course contain the above elements for a resolution.

Where such a procedure is not necessary, the “words of resolution” (i.e. the lead-in to the individual resolutions) could explicitly address this as follows:

NOW THEREFORE, the undersigned, constituting all the members of the Company’s management board, acting by written consent instead of in a meeting, resolve as follows:

Or, more simply, since the authority to bind the company can be verified in the Trade Register (or Companies Register) and is therefore redundant:

NOW THEREFORE, the Company resolves as follows:

Lead-ins. It is recommended to enumerate each individual resolution and precede the enumeration by a lead-in phrase such as:

The Company hereby resolves to:

Instead of such lead-in, U.S.-style resolutions sometimes precede each enumerated resolution by the word RESOLVED. This is similar to using WHEREAS in each recital of U.S.-style agreements and is (for the same reason) redundant. As with recitals, it is unnecessary to start each resolution as a strict grammatical continuation of the lead-in, especially if the enumerated clauses are somewhat more extensive than one or two lines. It is recommended to adopt the best practice rules for recitals and for enumerations in resolutions.

Adopt or ratify
Corporate resolutions are effective as of the moment that the resolution is actually adopted or ratified. The distinction between adopting or ratifying a resolution or act is that a ratification confirms or repairs the validity of an otherwise invalid, inexistent or defective act or resolution. It would be correct to express this by using the word ratify instead of adopt but be aware that, in English, ratify is also used to simply express the adoption of the resolution.

Hereby is or be
An archaic way of drafting is the use of the legalese be, and hereby is. The background of this combination of verbs is grammatical and would distinguish between the resolution being adopted with a view to something happening in the future and something taking place concurrently. The wording might be correct in its most strict grammatical interpretation. It ignores the fact that statutory laws are generally geared towards repairing or reducing any nullities or invalidities; failure to ascertain that both be and is hereby apply (i.e. the adoption of the resolution permitting something to happen concurrently or in the future, as the case may be) does not mean that the drafter intended the failing variant to apply. Correct wording is:

…the Attorney is hereby authorised to
…the Attorney be authorised to

Dating
Note that for the validity of the resolution, a resolution has effect as of the moment that all formalities for the resolution have been fulfilled. Depending on the strictness of the applicable law, that could be the mental consent amongst the persons whose consent is required followed by a confirmation of the consent in writing; but could also be that, in addition, each of those persons (and not merely the majority, have actually signed the document. It is good practice that instead of dating the resolution as such, each signatory is encouraged to write down the date of signature.

Contract clauses explained

Best practices of definitions, conditions, warranties, indemnities, limitations of liability, subcontracting, boilerplates, force majeure and negotiated alternatives.

Definitions in contracts – 22 best practice rules

Defined terms and definitions in contracts are a powerful tool to improve the readability of a contract. At the same time, it is a contract drafting discipline in which almost invariably mistakes or drafting flaws are found. Thanks to M&A practice, several best practice rules can be identified for drafting and using definitions and defined terms. Those principles are discussed in this section.

One of the final drafting steps before circulating a first-draft document (or a mark-up) is to check whether all defined terms are indeed used. If a term is defined but not used, it may trigger the inclusion of contract clauses or subjects that the drafter probably tried to avoid.

Similarly, the drafter should verify that there are no terms that are used but never defined. This error occurs when a definition is deleted but not all references to the term are removed, or when text containing a defined term is copy-pasted from another document (without copying the definition).

My terminology
In the following best practice principles, a strict terminology can be identified: definition refers to the description, or object, of what is defined; defined term refers to the (capitalised) word or words chosen to refer to the definition. In common parlance, both are somewhat interchangeably referred to as definitions. The body text refers to the preamble, warranties, conditions, covenants and contract clauses other than the definitions article.

Principles related to the use of defined terms in contracts

1) Defined terms and definitions must be used to make the interpretation of a contract easier: they make contract provisions concise; whereas the use of defined terms should at all times reduce any risks of ambiguity.

This is the overriding principle that must be taken into account when deciding whether and how to define a term. In interpreting the contract, the defined term must be substituted by the definition of that term.

A defined term should not include “(s)”: where defined, a defined term is either singular or plural. In the body of the contract, both the singular and plural can be used interchangeably regardless of whether the definition refers to the singular or plural term.

Licence Agreements mean collectively, the Trademark Licence and the Technology Licence; and Licence Agreement means either of them.

Realise that the plural encases the risk of ambiguity, so the singular would be preferable (see paragraph 1.1(d)).

2) The first letter of the defined term should be capitalised. If a defined term consists of more words, each word should be capitalised, except for its conjunctions and prepositions (e.g. and, but, or, on, in, under, beside, of, by, for, with, as, about).

This best practice rule is well-established and prevents that more clarification of how defined terms and definitions work. For example:

• Seller hereby sells the Goods and undertakes to provide the Services…
• Within ten Business Days after each calendar quarter, the Management Board shall…
• Each party may terminate this agreement upon a Change of Control over the other party.

The defined terms are underlined for the sake of clarity only. When a reference is made to an article or section of a statute, regulation or to another contract, write ‘article’ or ‘section’ (without capital).

Defined terms should not be in all-capitals, unless this is desirable in view of the language (e.g. the German language capitalises all nouns, which may justify a full-capitalisation of defined terms).

If a name or reference, such as an institution, report or statute, that is usually written with a first capital (or all caps) is not defined as such in the contract, it should be clear that the term is not a defined term. This may be achieved by printing the reference in italics. Note the ‘break’ between the reference to the institute and its rules in the following example:

All disputes in connection with this Agreement, or further agreements resulting from this Agreement, shall be finally settled in accordance with the Arbitration Rules of the Netherlands Arbitration Institute.

When a reference is made to an Article or Section of a statute, regulation or another contract, write “article” or “section” (without capital). For example:

Unless explicitly stated otherwise in this Agreement, the Parties waive their rights, if any, to annul, (partly) rescind, (partly) dissolve or cancel this Agreement, or to request annulment, (partial) rescission, (partial) dissolution or cancellation of this Agreement after Completion on the basis of articles 228 or 265, book 6 or title 7.1 of the Dutch Civil Code.

3) A defined term must be used in the body text (or in definitions) by capitalising the term as defined.

The contractual provision must be interpreted by substituting the definition for the defined term. If the drafter intentionally avoids the definition, the capitalisation should also be avoided (but mistakes are made all too often); in view of this error sensitivity, the drafter may prefer to use a synonym where the defined term is meant to be avoided. Here is an example of correctly using a defined term in combination with an undefined (similar) word:

Distributor shall not sell any products that are equal to or fulfil a similar function as the Products.

In the body contract text the defined term should not be underlined or printed bold (except where it marks the immediately preceding definition – see best practice rule 13).

4) Do not create a defined term if its plain-language meaning is clear and unambiguous.

Especially in transactions in which no sharp line is intended to be drawn between concepts that could either fall within or outside the definition, it is often better to leave the term undefined. Consistent with the overriding drafting principle that contracts must use plain language (and not business jargon or legalese), the same applies to defining terms.

For example, in most contracts it will be superfluous to define what a ‘third party’ is (e.g. whether it includes legal entities that form part of a contracting party’s group), what is captured by clauses referring to a ‘person’ (e.g. in addition to legal entities, does it also include governmental agencies?) or ‘business hours’ (if ‘response time’ or ‘availability of service’ would not affect the economics of the underlying transaction).

Similarly, defining the terms ‘Parties’, this ‘Agreement’ (or ‘Contract’) is generally unnecessary. But it must be admitted that in the specific case of Parties and Agreement, this best practice principle is often ignored.

5) Create only one defined term for each definition, and never use a synonym where the defined concept, word or expression is meant to apply.

This best practice rule overlaps with best practice rule 6. For example, do not define a contracting party as

(the “Company” or “Trader Options Investing Platform”)

For another example, do not refer both to ‘Product’ and to ‘TV Sets’, if they are both defined as “tv sets as specified in Annex 1”. If a defined term originates from and refers to exactly the same definition in another (related) contract or document, refer to that contract or document (“TV Sets as defined in the Distribution Agreement”); you should not repeat such definition.

6) Use the defined term each time the definition is meant to apply, and avoid creating a defined term if it will be used only once.

It is confusing if a word or concept is defined (e.g. the Goods sold under the agreement are “all products listed in the annex”) and the agreement would ‘refer’ to it by using similar words or concepts. For example, it is confusing if the agreement would interchangeably refer to “Goods”, “the products listed in the annex” and “the goods contemplated by this agreement”. Confusion gives rise to ambiguity and interpretation questions.

In case a word or concept would be used only once in the contract, it is sufficient clarifying that word or concept in a subsequent sentence or paragraph. After all, defined terms and definitions are used to make the interpretation of a contract easier.

Occasionally, it may be helpful to define a term if it improves the interpretation of the provision. In such case, the definition should be placed in that section. For example:

In this article, “Encumbrance” means any right of pledge, mortgage, attachment, bla bla bla.

7) If a term is defined, do not repeat a part of its definition in connection with the use of the defined term.

For example, do not refer to the “Management Board of the Company” in the contract provisions if the “Management Board” is already defined as “the management board of the Company”. When substituting such incorrectly used defined term, the result would read “the management board of the Company of the Company”. In other words, the principle of substituting a definition into the defined term must be applied strictly.

8) A term defined in the body text should not be used before it is defined.

Principles related to the place and presentation of defined terms

9) If a contract uses more than one defined term in several places and the contract is more than six or seven pages long, bring the definitions together in one article.

Normally, definitions would be listed in the article 1 of a contract. It aligns with best practice rule 8, that defined terms must not be used in the body text before they are defined. The lead-in of the definitions article could be:

In this Agreement:…

If a definition is used in only one article, consider inserting one, initial section in that article for that definition. The lead-in could be:

For the purpose of this Article,…

If the defined terms and definitions are presented in the format of a table, you may prefer to use the following lead-in: “In this Agreement, the following capitalised terms have the meanings ascribed opposite to them:”

Many contract drafters prefer to bring the definitions together at the backend of the contract or in a separate schedule. This prevents the somewhat inconvenient reading a contract (to first go through a list of definitions before reading the core provisions).

If one defined term is used in the recitals, it should be followed by “(as defined in article 1)“. If more than one defined term is used in the recitals, the text after the first defined term should be “(capitalised terms are defined in article 1)” or “(a capitalised term has the meaning ascribed to it in article 1)“.

If a term is defined in a separate contract or document, use the defined term (capitalised) and add “(as defined in…)” immediately following the first instance where the defined term is used. Refer to the contract or document only, not to the article or section of that contract or document (provided that the definition can be traced easily upon a prima facie reading) of such contract or document.

For contracts longer than about nine or ten pages, it is recommended that the terms defined in the body of the contract are referenced in the definitions article. The referencing text should refer to the section number in which the definition appears (and the referencing text must be consistent):

Product has the meaning ascribed to it in Section 3.4.

10) In the definitions article, order the defined terms alphabetically together with its definition, a paragraph for each.

If the definitions are defined in a dedicated definitions article, they are invariably ordered alphabetically. In the definitions article, the defined terms should not be numbered (a), (b), (c), or 1.1, 1.2, 1.3 etc. As they are ordered alphabetically, it does not make sense to enumerate the list as well.

Sometimes, the defined terms and definitions are placed in a table, visually distinguishing the defined term (in the left column) from its definition (placed in the right column opposite that defined term).

11) A term defined in the definitions article must not be preceded by an article or a preposition and should be followed, consistently, by the word ‘means’.

If the defined term is a verb and may be confused with a noun, exceptionally, the defined verb can be preceded by “to”, which should not be printed bold and should be placed outside the quotation marks (if used at all).

Note that grammatically, ‘shall’ exclusively refers to an obligation (an action by a person). Accordingly, ‘shall mean’ would be incorrect. A correct example is:

“Products” means the products listed in Annex 1.

12) In the definitions article, never repeat a part of a term that is already defined in the body text and never summarize or rephrase such a definition.

For example, do not use “Management Board means the management board of the Company” together with a section “4.1. The Company shall be managed and represented by the management board (the Management Board).” What happens in such combination of ‘definitions’ within one contract is that there are two definitions of the same defined term, and both are ascribed a (fundamentally) different meaning. Although the draftsperson may not intend to differentiate, the defined term is anyhow ambiguous.

It would be even worse to use the following definition in combination with such section 4.1: “Management Board means the Company’s formal body, collectively responsible for the day-to-day affairs of the Company.” Where in the previous example the definition aimed at different elements for identifying the Management Board, in this example, the definitions even collide.

A term should be defined completely. Sometimes, it is unavoidable or more convenient to work with a definition defined in the body text. In several jurisdictions, it is common practice to define terms as much as possible in the body text rather than in the definitions article.

Do not re-define or refer to the “Parties” or “Agreement” in the definitions article, provided that the terms are defined (or, for example in the case of a separate schedule identifying each party, referred to) in the initial contract line and parties block. Sometimes, but wrongly, a clause is added to the definition of Agreement, modifying its ordinary meaning or limiting its scope to the body text (or expanding its meaning to schedules and annexes). Such modifications should be addressed in a separate interpretation section (e.g. section 1.2) or in the miscellaneous provisions.

13) A term defined in the body text should (a) be placed immediately following the concept it defines, (b) be placed between brackets together with an article, (c) be distinguished clearly from the other text, and (d) be marked consistent with the terms defined in the definitions article.

A defined term is clearly distinguishable when printed bold, but traditionally, the term is also put between “double quotation marks” (it is odd to use ‘single quotes’). It is common practice to mark the defined term in bold where it is defined. For example:

…(the Products).

The article “the” is not part of the defined term. For example, do not define products as (“the Products”) but instead write (the Products), or (the “Products”) if quotation marks are used. It is unnecessary to indicate that a term is defined elsewhere in the body text, by also inserting words such as ‘hereinafter’, or ‘hereinafter referred to as’.

It is unnecessary (and old-fashioned) to indicate that a term is defined elsewhere in the body text, whether in the parties block, the preamble or the definitions section, by also inserting between the brackets words or phrases such as hereinafter, or hereinafter referred to as.

In letters (and letter agreements) it is common to use quotation marks only and not to print the defined term in bold or all-caps.

14) A term defined in the body text must be placed immediately after the definition (taken in its entirety).

The defined term should not be placed halfway through the description it intends to cover. This creates ambiguity. Consider the different scopes of definition of when a notice qualifies as an “Option Notice” in the following examples:

• …Purchasers, shall give Seller a notice in writing referring to this Agreement and this Article (an “Option Notice”), specifying the precise nature, background and details of the Triggering Event and the date on which the Triggering Event occurred, as well as the date on which Purchaser anticipates that the effect of the Triggering Event may reasonably result in…,
• …Purchasers, shall give Seller a notice in writing referring to this Agreement and this Article, specifying the precise nature, background and details of the Triggering Event and the date on which the Triggering Event occurred, as well as the date on which Purchaser anticipates that the effect of the Triggering Event may reasonably result in… (such notice, an “Option Notice”).

By the placement of the defined term, the scope of the captured definition differs: in the first example, a mere written notice by the Purchaser to the Sellers pointing at its option under the referred-to Article will already qualify as an Option Notice, with all the effects stipulated in the agreement (for example, the right to exercise the agreed option right may lapse permanently within a stipulated period of time after the Option Notice, or uncertainty may exist regarding the question whether there was a Triggering Event at all).

Occasionally, the defined term precedes the object it defines. This is especially the case for listings of items: termination events such as bankruptcy, suspension of payment proceedings, change of control and material breach or assets to be sold (or excluded from sale). For example:

For the purpose of this Article 7, a Triggering Event means the occurrence of any of the following facts or events:

Principles related to drafting the text of a definition

15) The defined term should correlate with the concept of the definition.

In interpreting the contract, the meaning of the definition (substituted into the defined term) prevails over the (plain-language meaning of) the defined term. Use a term that is concise and yet informative. The choice of the defined term should preferably reflect what is relevant, to distinguish it from other defined terms. Keep the defined terms short (like captions).

When substituting the definition in the body text for the defined term, the meaning of the sentence should be the same and no grammatical errors should occur. For example, the defined term ‘Bicycle’ would not be suitable to include ‘cars, buses, trains and motorcycles’ as part of its definition (in such case, rather use ‘Means of Transportation’).

Terms that are somewhat characteristic for certain kinds of agreements are of­ten given the same defined term. Examples for an asset purchase agreement are Assumed Liabilities, Receivables, Excluded Assets, Contracts and Payables. In credit agreements, examples would be Indebtedness, Maturity Date, Guarantors and Majority Lenders. The advantage of using such defined terms is that an experienced reader will understand immediately what is being re­ferred to without having to go to the definitions article each time. If there is no such ‘term of art’, choose a defined term that helps the reader by signalling what it means.

Conversely, if you use a commonly used defined term that has a generally accepted meaning (such as Net Sales or Taxes) but ‘redefine’ it in a somewhat unorthodox way, consider modifying the defined term appropriately (e.g. to Adjusted Net Sales or Income Taxes).

16) Never include obligations, conditions or warranties in a definition.

This is an important best practice principle. Ignoring this rule frustrates the principle of substituting the defined term by its definition, with all negative consequences. The inclusion of obligations, conditions or warranties creates ambiguity when interpreting the body text in which the defined term is used. A common flaw of such ‘error’ is, for example:

Specifications means the technical design and related specifications, which shall be developed and owned by Licensor and which are to be provided to the Manufacturers that wish to manufacture the Product meeting those specifications.

Such definition will be problematic when the contract would furthermore stipulate:

“Technical designs and related specifications developed by Licensee in connection with the Specifications will be owned by Licensor.”

The complications triggered by including an obligation in the definition are difficult to oversee (and any right to compensation or payment problematic): the definition includes an obligation on the part of Licensor, the contract provision contains an entitlement of Licensor to Licensee’s contributions; but what happens if the Licensee requires the Licensor to further develop its design (e.g. to match the requirements of Licensee’s technical designs)?

The proper way to redraft the above sample definition would be to take out the circumstantial and descriptive language. The word shall creates ambiguity in that it may refer to a future fact without further obligatory intentions, or imply an obligation (for the Licencee to transfer ownership or not to claim ownership). If necessary at all, references to development and ownership, to the process of handing over to Manufacturers (qualifying in terms of their ‘wish’) should be moved to the body text and be rephrased there in the form of actual obligations, whether or not qualified or conditioned, or to the warranties (without obligatory phrases).

This best practice rule is important; let’s repeat it: never include an obligation, a condition or a warranty in the definition.

17) Define a term as precise and narrowly as possible; it must be capable of substitution everywhere it is used.

Expansion of the scope of the definition may be included as part of the appropriate substantive provision, warranty or condition. If accordingly, such additional text is repeated several times, consider creating an additional defined term that embeds the narrowly-defined defined term.

Do not use adjectives in the body text to distinguish, qualify or limit certain defined concepts from concepts covered by the same definition, unless substituting the definition into the defined term fits entirely (and without overlap) in the intended meaning of that defined term.

For example, do not use “…draft Financial Statements…” if the Financial Statements are defined as “the published financial statements from time to time as certified by the Auditor and approved by the Annual General Meeting”.

18) A definition may include a defined term (defined elsewhere).

This is phenomenon is referred to as nesting or embedded definitions. Because definitions are ordered alphabetically in the definitions section, do not ‘clarify’ (e.g. “(as defined below)”) that such nested defined term is defined later in that section.

If, exceptionally, a term is defined within the definition of another defined term (and provided that the definition is in the list of defined terms and not in the body text), the embedded defined term should be listed separately in the alphabetical order and refer to the definition:

Confidential Information means the written information disclosed by one Party (the Disclosing Party) to the other Party (the Receiving Party) and marked ‘confidential’ or ‘proprietary’;

and (in alphabetical order):

Disclosing Party has the meaning ascribed to it in the definition of Confidential Information.

These definitions cross-referring to other definitions are often omitted.

19) Never create circular definitions.

A circular definition is a term directly or indirectly defined by reference to that same term. Circular definitions occur in case of nested definitions or when several defined terms are intertwined.

For the sake of clarity, this best practice rule does not apply to the inclusion of the non-capitalised term in the definition. For a correct example:

Licence Agreement means the licence agreement attached as Schedule 3.

Such use of the term rather emphasizes that the defined term is well chosen.

20) To exclude a concept that may ordinarily be within the scope of a definition, the defined term, or a part of it, should be followed by ‘excludes’.

Similarly, some drafters believe that if a definition is not intended as an exhaustive description, the defined term should be followed by ‘includes’ (and not ‘means’). For example:

“Fruits” means all fruits commercialized by Seller, including mini tomatoes and olives.

“Products” means all fruits commercialized by Seller. “Products” exclude peppers, cucumber, peas, string beans, eggplants, avocados, corn, zucchini and beans.

Note that botanically, both the included and the excluded vegetables are actually fruits. Especially if there can be discussion about the scope of the contracted goods, the clarification is helpful. Such discussion may be relevant if also a non-compete clause or exclusivity is

21) If a definition must also capture any future, yet unknown version, value or amendment, it must qualify the relevant concept by the words “from time to time”.

The relevant date as of which such version, value or amendment will apply, should be clear from the definition or the context in the body text. The addition from time to time clarifies that the version, value or amendment in force on a date of delivery or performance, rather than on the effective date of the agreement, should apply. For example:

REACH means EC Regulation No. 1907/2006 on Registration, Evaluation, Authorisation and Restriction of Chemicals, as amended from time to time.

Another example: a deed of pledge could refer to the defined terms in the underlying credit agreement. This would ensure that the definitions in the two agreements are exactly the same. If the scope of the pledge must ‘follow’ any amendments, supplements and addenda of the credit agreement, the reference to the contract should not prevent this. Inserting from time to time avoids ambiguity.

22) The definition of a (signed) ‘contract’ should identify the title of that contract, its date, the parties and the amendments (if any).

If the contract is attached as a schedule, there is no need to include more than a reference to the schedule and, if desired, the title or type of contract (not capitalised).

If more than one name can be attributed to the contract, the title as it appears most prominently on the first page, including any subtitles, should be used.

If a contract refers to several dates (e.g. because each signatory wrote down a different date of signature), the printed date should be used and failing such date, the first date on which the first signatory of the last signing party should be used. The names of each party should include the type of entity (e.g. GmbH, N.V., Sàrl). In the case of one or more amendments, supplements or addenda, only the dates of those documents should be included (e.g. “as amended on 18 June 2021 and 14 July 2022”).

Some drafters precede the contract title by the useless and non-specifying words that certain. Omit them. It should be sufficient to simply refer to a contract in order to give the terms of that contract their effect: it should be effective as per its terms (emphasised by its reference). Accordingly, do not include legalese such as “the terms and conditions are herein incorporated by reference“.

23) The definition of a person, legal entity or organization should be consistent with the details provided for the parties.

If a person, legal entity or organisation is referred to in relation to an obligation to be fulfilled by it or otherwise as a subject of an obligation, condition or warranty, it is recommended that it be identified accurately and consistently with other references to persons or entities in that contract. Omit the details if their inclusion serves no useful purpose.

Standard words and phrases ‘defined’

Many large agreements devote the second part of the interpretation article (where the first part contains the definitions) to commonly used phrases and address how certain standard words and phrases are to be defined. (In such case, the header of article 1 is often renamed Definitions into Interpretation).

This paragraph addresses these provisions and criticises how useful they are. In a European style contract (but likely also in a U.S. style contract), none of these interpretation guidelines are crucial; only a few of them are somewhat useful; and most of them are redundant. Finally, a few of them even disturb a reader by being exaggerated or legalese, or by addressing the obvious.

Written.
Many contract provisions require a notice to be given in writing. The obvious intention of the requirement is to require that a party is firm and accurate as regards its intentions. A party who needs to notify an event of force majeure will prefer to do so informally rather than putting everyone on the side of the other party in a position in which a formal response becomes inevitable (e.g. a firm and final warning with a deadline for remedy). In joint ventures, informal communications between the partners are the rule. A question that may arise is whether communications by e-mail or fax are in writing (and satisfy the criterion provided in a contract clause). In view of modern practice, it would be hard to argue that this is not the case, but avoiding any discussion may still be helpful:

A reference to a communication in writing shall be construed so as to include any communication in the written form, whether by letter, fax or a scanned and signed document sent by e-mail;

Singular and plural.
Even though an agreement should be interpreted as a normal and reasonable person would read it, some drafters believe that a normal and reasonable person could say (after reading a contract provision that talks about one person required to do or omit something) that the contract provision does not apply to cases where two or more persons would omit or do what is written in it. They alone will need the following clause (for their comfort):

A reference in this agreement to the singular includes the plural and vice versa.

In order to avoid (risks of) ambiguity, as explained in paragraph 1.1(d), draft as much as possible in the singular.

Gender.
The following phrase would allow a drafter to use gender-specific language in a contract without running the risk of a court holding that, for example, use of only masculine pronouns in that contract excludes corporations from the scope of certain provisions.

References to words importing one gender include both genders and the neuter.

You might agree that the phrase is rather funny and fairly redundant, in particular in commercial agreements where the parties are legal entities (referred to as “it”).

Article and Section references.
A meticulous contract drafter may refer to the articles and sections of the agreement by adding of this Agreement or above or below, as the case may be, or hereof to each such reference. There might theoretically be confusion about whether the reference may accidentally point to a provision outside the body of the agreement. To ensure () that this is only the case for non-capitalised references include the following:

References to Articles, Sections, Annexes, and Schedules are references to articles or sections of, or annexes or schedules to this Agreement.

Clause headings and captions.
A drafter may sometimes want to ascertain that contractual provisions cannot be summarised in the two or three words of an article heading or the caption immediately preceding a contract section. Although it is difficult to argue that one party misunderstood a contract clause because the caption or article heading gave it a certain meaning, the following clause would attempt to diminish such argument:

Headings in this Agreement and captions to Sections are provided for convenience only and do not affect its meaning.

Hereof, thereof, everywhereof.
See also elsewhere in this online book about:

The words hereof, herein, hereunder; and hereby refer to this Agreement as a whole and not to any particular provision of this Agreement.

Amendments, supplements and addenda.
A written amendment of an agreement will almost inevitably state that as of such amendment, supplement or addendum the agreement needs to be read in the amended, supplemented or extended manner. Some people feel more comfortable if the agreement itself anticipates its amendment:

A reference to an agreement means that agreement as amended or supplemented, subject to any restrictions on amendment in that agreement or any restrictions in such amendment or supplement, as the case may be.

Applicable laws and regulations.
When a party warrants that it is not in breach of a particular statute or undertakes to continue acting in compliance with a particular act or regulation, the other party may want to ascertain that such non-breach or compliance is measured against that statute, act or regulation as it is in effect at the time in question. This provision would allow a drafter to accomplish that without adding as amended or supplemented or from time to time after each reference to such a statute, act or regulation.

Except as provided otherwise, a reference to a statute or regulation means that statute or regulation as amended or supplemented from time to time.

Times and time zones.
In a multinational context it may be helpful to specify which time zone should be referenced in case the parties failed to identify it.

Except as provided otherwise, a reference to a time of day is a reference to the time in Amsterdam, the Netherlands.

Actions on non-business days.
If a contract provision identifies several periods of time within which a certain action needs to be taken, there is a possibility that such action will be required to be taken at a weekend or on a public holiday. The following provision creates an allowance for taking such action on the immediately following business day.

If any date specified in this agreement as a date for taking action falls on a day that is not a Business Day, then that action may be taken on the next Business Day.

Modified following adjusted clause.
A similar provision, slightly more advanced, is the ‘modified following adjusted‘ clause used in loan agreements.

If a payment under this Agreement is due on a day which is not a Business Day, the “modified following adjusted” convention shall be applied such that the due date for that payment shall instead be the next Business Day unless this day falls in the next calendar month, in which case the due date for payment of such sum shall be the immediately preceding Business Day. During any extension of the due date for payment of any principal amount under this Agreement, interest is payable on that principal amount at the rate payable on the original due date.

The Notary.
A person who is qualitate qua careful and continuously in search of a maximum level of security, is a notary. In order to prevent a notarial deed not being able to be executed due to the notary being appointed personally (and him/her being absent on the desired date of execution), the following clause provides for a discretionary right of substitution:

A reference to the Notary must be construed as a reference to the person named in this Agreement as civil law notary or, if applicable, any other civil law notary working with [notary firm name] and any of their deputies;

Person.
What about the following? Is it really necessary to make sure that if you refer to a third party, this is substituted by the defined term Person, defined as:

an individual, a corporation, a partnership, a limited liability company, a joint venture, a joint stock or other company, an association, a trust or other entity or organisation, including a local or national government or an agency, institute or instrumentality thereof?

The elements that might trigger some uncertainty, if any, are probably the inclusion of (informal) partnerships and various governmental bodies. Rather than the use of a definition, a clarification in the interpretation section would be more appropriate. But reconsider first: if a warranty states that neither Seller nor Target received a notice of any Person relating to the status of X, would you consider that there is a likelihood that, whilst a local governmental authority might fail to qualify as a ‘person’ within the strict meaning of the word, a liability claim will fail (if Target actually did receive a warning notice) on the ground that the warranty did not specify the authority as such ‘Person’?

Assignees and successors.
Particularly in U.S. style contracts, it seems, the drafter may want to ascertain that a reference to a person includes such person’s assignees (or other successors in title). In legal systems where a right of ownership transfers in its entirety, the following clause is redundant:

A reference to any Person is to be construed to include that Person’s successors and assigns.

Negotiated terms.
As discussed elsewhere in this online book, a party might fear that a court will say that the contract is not a negotiated agreement but rather a set of general terms and conditions (the interpretation of which could potentially be scrutinised and interpreted against the drafter). The following may be included to reduce such risk (albeit that its effect may be very limited):

Each party has participated in negotiating and drafting this agreement, so if an ambiguity or a question of intent or interpretation arises, this agreement is to be construed as if the parties had drafted it jointly, as opposed to being construed against a party because it was responsible for drafting one or more provisions of this agreement.

Conditions in contracts

A very important subject is the use of conditions in contracts. Below, legal and practical aspects of conditions will be explained in detail, several common condition-related provisions will be addressed, a set of best practices will be formulated, followed by some examples (or checklists) for conditions.

General observations about conditions in contracts

Conditions precedent (cp’s) and conditions subsquent are of great importance because their effect can be drakonic. If a condition is not satisfied, the related rights or obligations either fall away or, depending on the formulation, become effective. This may even apply to the enforceability of the entire agreement.

Examples of conditions are a financing clause for the sale of a house, financial credibility (solvency) conditions for (revolving) credit facilities, a required shareholder approval for major (M&A) transactions or clearance by competition law authorities.

The law. Many national laws address the effects of a condition being satisfied, as does the DCFR:

III. – 1:106: Conditional rights and obligations

1. The terms regulating a right, obligation or contractual relationship may provide that it is conditional upon the occurrence of an uncertain future event, so that it takes effect only if the event occurs (suspensive condition) or comes to an end if the event occurs (resolutive condition).
2. Upon fulfilment of a suspensive condition, the relevant right, obligation or relationship takes effect.
3. Upon fulfilment of a resolutive condition, the relevant right, obligation or relationship comes to an end.
4. When a party, contrary to the duty of good faith and fair dealing or the obligation to co-operate, interferes with events so as to bring about the fulfilment or non-fulfilment of a condition to that party’s advantage, the other party may treat the condition as not having been fulfilled or as having been fulfilled as the case may be.
5. When a contractual obligation or relationship comes to an end on the fulfilment of a resolutive condition any restitutionary effects are regulated by the rules in Chapter 3, Section 5, Sub-section 4 (Restitution) with appropriate adaptations.

VIII. – 2:203: Transfer subject to condition

1. Where the parties agreed on a transfer subject to a resolutive condition, ownership is re-transferred immediately upon the fulfilment of that condition, subject to the limits of the re-transferor’s right or authority to dispose at that time. A retroactive proprietary effect of the re-transfer cannot be achieved by party agreement.
2. Where the contract or other juridical act entitling to the transfer of ownership is subject to a suspensive condition, ownership passes when the condition is fulfilled.

One may bear in mind, that a lawyer may have two roles relating to conditions prece­dent: negotiating them and making sure that they are satisfied.

Conditions as an exit. In many cases, the contracting parties may believe that the execution of an agreement con­cludes the deal, whereas in many cases there is still a lot of work to be done before the transaction is completed.

The negotiations of conditions precedent sometimes bring key interests of the parties to light. One party may have a great interest in the quick closure of the deal, whilst the other will probably need to receive more information on the object of the transaction. This is why conditions in contracts often serve as a leverage to renegotiate key deal terms (i.e., in such case, despite the drakonic effect, a condition precedent is not intended as an exit but rather as a protection of one party against ‘hidden defects’).

For example, if an ‘unsatisfied’ condition requires that the acquired company has a certain mini­mum amount of cash flow during, the purchaser may insist that the purchase price be reduced. At the same time, arguments to object to a proposed condition may be that satisfying such condition is onerous, expen­sive or not customary. In all cases, a condition should not permit a party a discretionary freedom to walk away from the deal after signing the agreement. (Explained in legal concepts: the ‘free will’ of a party or the ‘mutual consent’ of both parties should not in fact mean that one party may effectively still freely make up its mind.)

Terminology and cp’s versus conditions precedent. In somewhat unusual terms, the DCFR distinguishes between ‘suspensive conditions’ and ‘resolutive conditions’. More common is a distinction between conditions precedent (also called cp‘s) and conditions subsequent: conditions precedent, on the one hand, address conditions that should be satisfied before a right, obligation or contractual relationship comes into existence. On the other hand, conditions subsequent describe facts or events pursuant to which a right, obligation or contractual relationship may be terminated. Nevertheless, the term condition subsequent is not common parlance (if known at all); therefore, it strongly recommended that simple conditional wording is used such that “if ABC occurs, Party 1 may terminate this agreement”.

Conditions relate to future or uncertain facts or events. The DCFR on conditions in contracts requires that a condition refers to a future or uncertain fact or event. This distinguishes conditions from the legal concept of mistake (Irrtum, erreur, dwaling). The concept of mistake implies that an agreement, entered into on the basis of an incorrect assumption, is voidable (or otherwise subject to termination) if the agreement had not been entered into but for that assumption being incorrect (subject to tests of reasonableness and proportionality of termination).

To include a condition that refers to an unknown but existent fact or event (or to a fact or event that is uncertain for the parties but certain for others) is therefore not so much a question of conditionality of the agreement but rather an agreement between the parties that the referenced fact or event is important enough to trigger a termination. Nevertheless, if a straightforward condition is satisfied but for some apparently insignificant facts or events, the rights or obligations that are the subject of the condition will not come into force.

Potestative conditions. Effectively, such ‘subjective condition’ implies that the party has never been truly bound to the ‘agreed’ transaction (since that party has always been free to terminate ‘at will’); in fact it is questionable whether there was mutual consent or a meeting of offer and acceptance as regards the object of the agreement).

On the European continent, potestative conditions are invalid or ineffective. Depending on the contents of the condion, the principle of good faith would impose legal consequences that may for instance range from complete ineffectiveness of the condition, to a more objective (and reasonable) test whether the condition is satisfied, or even to an obligation on a party to make best efforts in order to ascertain that the condition be satisfied.

The potestative nature of a condition is not always apparent. For example, the following conditions contain a prevailing subjective element:

…Borrower has delivered its financial statements, in form and substance satis­factory to Lender.

…Purchasers having completed a due diligence review of the business, assets, contracts, tax and financial condition of Acquired Com­panies, being satisfied in all respects with the outcome of the review.

…The Parties having entered into a joint development agreement, allocating each Party’s entitlement to intellectual property rights in a mutually satisfactory manner.

The questionability of overly subjective conditions can be remedied in several ways. The inclusion of a standard of reasonableness in each of those conditions would mean that the beneficiary of the condition cannot avoid a closing by a simple statement that the condition is not satisfied (timely). The standard of reasonableness implies an objective test or at least a duty to explain (on reasonably understandable grounds) why the condition is not satisfied. Similarly, the conditions could be phrased more objectively.

For example, the condition could refer to market standards or customs of the market or even to the internal policies generally used by the beneficiary in similar circumstances. Alternatively, it is a good option to leave the determination whether the condition is satisfied open. Finally, the condition related to the joint development agreement could be elaborated by attaching an agreed framework or the main terms of such agreement. Obviously, time restraints or other circumstances may make this ap­proach impractical.

Topics adjacent to conditions

Conditions reasonable efforts and good faith. Most conditions in contracts require that one party undertakes to achieve a certain fact or event. This would imply that that party also has the power to prevent the satisfaction of a condition. That’s is not true: European legal systems impose the principle of good faith (or a similar concept – e.g., not to abuse a right) on such party requiring it to make reasonable endeavours in achieving the stipulated results. The specific effects of this general principle and the particular actions required in the context largely depend on the circumstances of the case. It is clear, however, that a party cannot sit and await the lapse of time: a condition that was dependent upon the efforts made by the party that is entitled to invoke it, is valid and enforceable only if that party is able to show that it has done what could reasonably be expected from it to have that condition satisfied.

Because by its nature the principle of good faith depends on the particularities of the case, it is not always possible to foresee what level of efforts actually is required. This does not take away that the parties may well be able to prescribe what minimum level of efforts is expected or which specific actions must be undertaken by a party in order to allow it to invoke the condition. Therefore, a generic contract clause providing that the parties will make best efforts to have the conditions satisfied (within an agreed period of time) is as such redundant: it does not add anything to what the law imposes. This is different if the parties also provide what such ‘best efforts’ means or if they prescribe the contents and any monetary implications of any required actions.

Note that reasonable efforts to have a condition satisfied is something else than a condition that reasonable efforts are made to attempt to achieve something. Compare the following two examples:

This Agreement is conditional upon Employee having made reasonable endeavours to obtain a waiver from his current employer regarding the non-compete obligation in their employment agreement.

This Agreement is conditional upon Employee having obtained a waiver from his current employer regarding the non-compete obligation in their employment agreement. Employee shall make reasonable endeavours to obtain such consent as soon as practicable.

In the first example, the condition would be satisfied if the employee has made several serious requests even if they were rejected, whereas in the second example, the condition is not satisfied until the waiver is actually obtained.

Satisfaction of the conditions (and closing agenda). After signing the agreement, the closing conditions must be satisfied. The question whether a condition is satisfied is after all a matter of interpretation, the scope and extent of matters or efforts required depend on what the parties (or the lawyers on their behalf) agreed.

Usually, the parties’ lawyers take the lead in identifying all work that needs to be done before completion can take place. This requires foresight, organization and attention to details. The first step is usually the creation of a “closing list” or “closing agenda”, a document or spreadsheet listing all of the (closing) conditions in each of the transaction documents, as well as all actions on the closing agenda. In the table, for each item ownership (i.e., responsibility) is allocated, the current status and the action required from time to time. This closing agenda is a roadmap to closing and neither a negotiation document nor a document that requires drafting skills. It is typically shared openly amongst all the lawyers involved in the transactions. Despite the typical lack of professional project management skills of a lawyer, the lawyers involved in the transaction take a lead and take care of satisfaction of the conditions and the fulfilment of all other actions required for closing. At the closing the closing schedule or action list serves as the guide to tick off each closing document.

Whilst a condition provides for an exit right for one party in case of non-fulfilment, the opposite is often true as well. For example, if the closing of a transaction is conditional upon certain conditions being satisfied and both parties fulfil all the closing actions, the closing itself implies a waiver of any pending conditions. This would be the effect of the Lex Mercatoria principle that “no-one may set himself in contradiction to his own previous conduct (non concedit venire contra factum proprium)”[1]. Clearly, if a party pursued the closing on the pretext of the other party’s statement that all conditions were satisfied and it appears that a material adverse change has occurred (triggering a MAC-condition not to be satisfied), the legal concept of fraud or even mistake would imply a right to reverse the closing and to claim damages. This is generally addressed in the lead-in to the conditions, where it stipulates that:

each of the following conditions be satisfied or waived.

Although generally there is no need to express this ‘waiver effect’, it may well trigger a contract party to require a positive statement (in the US context often called a “certificate”) confirming that a fact or an event (as foreseen in the condition) is absent or has not taken place, respectively.

This generally recognised principle is included under No. I.7 in the CENTRAL list of Lex Mercatoria principles, rules and standards (click here for the full list of the principles). The list is included in Willem Wiggers, International commercial law – source materials, Kluwer 2006.

Best practices on drafting conditions in contracts – intro and overview

Best practice rules. Below are best practice principles and rules of good practice related to drafting conditions in contracts, conditional clauses and triggering events. Where a reference is made to a “condition”, the same applies to triggering events and, albeit to a slightly lesser extent, to conditional clauses. The best practice rules refer to conditions being ‘satisfied’ or not; no difference in meaning is intended where the word ‘fulfilled’ is used and the same principles apply to conditions that should not be fulfilled in order for the object of that condition to have its effect.

1) The object of the condition, conditional phrase or triggering event should be clearly defined.

The object of a condition is what is made conditional: the right or obligation that comes to life or ceases to exist when the condition is satisfied (or fails to be satisfied). Make sure that it is clear what exactly is conditional.

For example, in a share purchase agreement, conditions precedent can be formulated in several ways. Consider the following examples:

Purchaser’s obligations are subject to each of the following conditions being satisfied:
The Closing is subject to each of the following conditions being satisfied:

The obligations in this Agreement are subject to each of the following conditions being satisfied:

This Agreement is subject to:

Obviously, the first condition is very one-sided and Purchaser-friendly; the second condition is probably the most reasonable and adequate; and although the third condition is more specific than the last, the effect of both is that various provisions will cease to be effective (e.g. notably on confidentiality, applicable law and dispute resolution).

The object of a condition can be anything which the parties agree, but would typically range from:

• the agreement (as a whole): this is dangerous since (strictly speaking but probably not intended) the non-fulfilment of a condition also drags along the binding nature of a choice of law and the provisions on dispute resolution and confidentiality.
• a closing or completion of the transaction: this is a common provision in financial and M&A transactions.
• a right or obligation of a party: the conditionality of a right or obligation is often indicated by the words provided that or a mere unless or if. All rights and obligations can be subject to certain conditions being fulfilled. For example, a right to an indemnity will typically be subject to the condition that the party seeking the indemnity makes full disclosure of relevant facts and gives the indemnifying party full control and authority to conduct the defence.
• the completion (or waiver) of the last closing step: if several steps must be taken either consecutively or concurrently, for example during the closing of a transaction, the parties often agree that all steps are conditional upon the last step being completed. Obviously, the effect of this will be that all steps take effect (and become unconditional) in the split second of fulfilment of the last step.
• certain events taking place: for example, a revolv­ing credit agreement permits multiple borrowings, requiring a complete set of closing conditions in respect of the ini­tial draw-down or closing and an additional, separate (usually shorter) set of conditions that must be satisfied by the borrower at the time of each draw-down (i.e. with the lapse of time).

2) Bring conditions that relate to the same object together in one article or section of the agreement.

This best practice rule is consistent with the general drafting technique of grouping exceptions to a rule together (see paragraph 1.3(b) on ambiguity). The legibility of conditions improve if they are separated out of the object to which they relate. A similar technique is used when a definition is lifted out of a contractual provision or the text of another definition (i.e. by creating a new defined term and substituting this term in the overly complex provision or definition, respectively).

Alternatively the contractual provision may have the following pattern: there is a general obligation, which contains a few objects; each of those objects is phrased generally but requires to be refined by exceptions, qualifications, limitations or conditionality. Now, to prevent accurate drafting efforts resulting in an unclear provision, it is helpful to untangle all those objects and to connect the right conditions with the right objects.

An illustration of this is a licence provision: the licence clause itself lists the elements of exclusivity, geographical scope, sub-licensability, assignability, and its royalty-bearing character, whilst the exceptions, qualifications, limitations and conditions to each of those elements are usually elaborated in the subsequent sections.

Where to locate conditions? If conditions affect various articles of an agreement, list the conditions in a separate article; if conditions or triggering events affect various elements of a section, separate them out in the same section or in a separate section of the same article.

3) Divide conditions in contracts clearly, subject-by-subject and consider enumerating them.

Because the effect of a condition can be very important to the parties (since potentially the entire agreement is at stake), it is strongly recommended to formulate and present each condition in a clear and unequivocal manner. For example, a drafter should prevent two conditions becoming confused and interpreted as one consisting of two sub-conditions (each of which must be met).

Example (triggering events). An example is the following clause taken from an escrow agreement in which the escrow agent should be able to apply clear and strict criteria:

The Escrow Agent shall release the Technology and Know How to Customer immediately:

(a) upon receipt of a joint written instruction to that effect from Supplier and Customer, stating the deposit code and date;
(b) upon receipt of a notice that Supplier shall be dissolved or liquidated, is declared bankrupt or otherwise insolvent pursuant to the laws and regulations of a jurisdiction to which Supplier is subject;
(c) in the event that Supplier is in material breach of its obligations arising from the Principal Agreement, upon receipt of a copy of Customer’s notice of default to Supplier, provided that if the Escrow Agent deems that such breach was capable of being remedied, a reasonable term for remedy permitted in such notice has also expired.

The Escrow Agent may deem:

(i) a breach by Supplier to be “material” if Supplier failed to deliver the Product ordered by Customer (X) within the period specified in the purchase order or Statement of Work, or (Y) strictly in accordance with the agreed specifications, as stated in the notice of default.
(ii) a period for remedy of any breach to be “reasonable” if it is no less than 30 days;

(d) in the event that a court judgment has become final and conclusive or has become provisionally enforceable, resulting in the Escrow Agent being obliged to deliver the Material to Customer.

Ordering the conditions in contracts. As is the case for enumerations generally, the legibility of conditions improves if they are listed subject-by-subject. Apply a logic to the order of the conditions. An exception to this can be that the legibility of a listing of items, one of which is verbose and the other just a few words, may require that the short conditions are listed first and the lengthier ones thereafter.

Sentence structure. Often, conditional clauses are placed together at the beginning of a sentence. However, it is recommended to follow the general drafting principles of the left-right principle: make the reader comfortable by first driving your point home (and start with the main principle, followed by the conditions).

Enumerated conditions. If you do enumerate the conditions or triggering events, apply enumeration principles.

4) Each condition and each conditional clause should be formulated such that it is capable of being either ‘satisfied’ (or ‘fulfilled’) or not.

This is the same best practice rule as applies to drafting warranties where each warranty should be capable of being either correct or incorrect. Conditions in contracts and triggering events in clauses are important components of a contract. Especially where a condition contains a subjective element, the trigger as to whether it is satisfied or not becomes fluid.

Text interpretation required. The more questionable the satisfaction of a condition is, the more likely it is that only one party determines whether or not it is satisfied. In that case, the condition may qualify as a potestative condition and be invalid or inoperative. Also, if the parameters for satisfying a condition are vague, the ‘reasonableness factor’ of invoking the condition becomes more important. After all, from a legal point of view, whether or not a condition is satisfied (or fulfilled) or not remains a matter of interpretation.

Conditions vs. obligations. Mixing up conditions and obligations is a source of ambiguity. This is particularly sensitive if you explore the dividing line between a condition, on the one hand, and an obligation depending on the performance of another obligation on the other hand. For example, compare:

If Purchaser becomes aware of a matter which is likely to give rise to a Warranty Claim, Seller shall not be liable in respect of such Warranty Claim unless Purchaser has given notice of the relevant facts to Seller promptly after becoming aware of the matter or such facts.
If Purchaser becomes aware of a matter which is likely to give rise to a Warranty Claim, Purchaser shall give notice of the relevant facts to Seller promptly after becoming aware of the matter or such facts.

In the first example, a right to an indemnification exists (with the condition that the claim which gives rise to the indemnification is notified promptly); whereas in the second example, which is not a condition, such right to an indemnification is not affected if no prompt notice has been given. The second example is in fact a lex imperfecta in that the breach of the obligation to notify (promptly) remains a priori without consequences.

The failure to satisfy a condition results in the non-existence of a right or obligation to which the condition pertains; the failure to perform an obligation upon which another obligation or a right depends results in a claim for restitution, a right to suspend performance or a claim for damages.

Grammatical recommendations. As a consequence of the rule that conditions should be capable of being correct or not, it is recommended that you use the present tense in all conditions. The present perfect is also acceptable if the condition represents a preliminary question that needs to be settled (as opposed to a matter that needs to be negotiated and agreed on). Therefore, it is recommended to avoid the use of shall (or will).

5) Never include a warranty, an obligation or other operative clause in a condition.

A condition is a hard and fast statement. By including an obligation, warranty or other operative provision in a condition, the condition (and its strong effect) may easily become ambiguous or even lose its character of conditionality. For example:

The Licence is subject to the condition that Licensee is at all times in full compliance with Licensor’s Trademark Guidelines and, if it is not, it shall remedy such non-compliance within ten business days after Licensor notifies Licensee of such non-compliance.

Do you agree that in this example the conditionality of the licence (and therefore the strength of the trademark) has disappeared or at least become negotiable? What do you think will happen if the licencee is able to remedy non-compliance at once but takes the full ten business day period? Or if during the ten business days an event of force majeure occurs (permitting the remedy only after a few more business days?). How alert will the licencee be in preventing any non-compliance?

At the very least, a drafter should distinguish the obligation from the condition by clear conditional wording (e.g. provided that, unless, if) or by inserting the condition in a separate sentence. If there are more than two conditions or if a condition is rather wordy, it is recommended to bring all obligations (and warranties or other operative clauses) that relate to the satisfaction of a condition into a separate section of the contract.

6) Distinguish exceptions from conditions.

‘Exceptions’ pertain to a ‘rule’ (or, equally, a right or an obligation) and might be governed by their proper rules (or not be governed by any particular principle). ‘Conditions’ trigger the application or the applicability of a rule, a right or an obligation. Two examples to illustrate the difference:

If Purchaser becomes aware of a third party claim which gives rise to a Warranty Claim, it shall give prompt notice of the relevant facts to Seller, except that any failure shall not affect the rights of Purchaser unless Seller can demonstrate that such failure prejudiced Seller’s ability to successfully defend the matter giving rise to the Warranty Claim.

Seller shall indemnify Purchaser against each third party claim which gives rise to a Warranty Claim, provided that Purchaser shall give prompt notice of the relevant facts to Seller…

In common law jurisdictions, the distinction between exceptions and conditions may be relevant in view of the remedies that may be invoked. Those remedies may restrict a party in the legal actions it is able to invoke. For example, in case of an exception to a licence grant (e.g. a licence under a patent or copyrighted work) the granted right does exist but using the right as exempted would result in a breach of contract; whereas in case of a condition to a granted right remaining unsatisfied, the granted right itself has not come into existence, which entitles the owner of the right to start an action for infringement. As a starting point the remedy for breach of contract is a claim for damages; in case of infringement of a right, the owner of the right may also claim that the infringing acts stop (which might be extremely disruptive) and claim the benefits or profits derived from the act of infringement (which might well exceed the plaintiff’s damages). This distinction does not necessarily work out the same way in all common law jurisdictions, but from a legal-traditional point of view the unavailability of a remedy might alert the drafter to choose for either an exception or a condition.

A provision is clearer and more comprehensible if it distinguishes between the rule and the exceptions to that rule, than if the rule is formulated such that the exceptions become conditions for the inapplicability of that rule. Conditions may give rise to further distinctions or to their own contractual regime, which may become a source of wordy clauses.

7) Do not phrase the key obligation of an agreement as a condition.

For example, it is nonsense to stipulate that the transfer and delivery of the Shares would be a condition to closing. This is because despite all exclusions or limitations of liability, if one party is unable to perform its key obligation, no law would protect such party against the other party deferring the performance of its obligation. Similarly, making the transaction subject to a condition that the key obligation is performed is like repeating the law of contracts.

The obligations of Seller in connection with the Closing are subject to the following conditions being satisfied:
…
(e) all Share certificates and the shareholder registers of the Acquired Companies required to complete the Transaction shall be delivered to Seller.

Exception. The best practice rule must be distinguished from a conditionality that does make sense. This might be the case if the key obligation must be performed by more than one party (e.g. several sellers who should each hand over their own shares) or if the object of the transaction consists of various objects (e.g. the shares of several companies are to be transferred). In those cases, it is appropriate that a purchaser requires that no shares are deemed to be transferred (and no part of the purchase price is available to any seller) unless all shares are actually transferred. For example:

Purchaser shall not be required to purchase or acquire any of the Shares unless all of the Shares are sold and transferred.

8) Conditions referring to the absence of a fact or the non-occurrence of an event require a statement in writing that such fact is absent or that such event has not occurred.

Obviously, in most transactions, the purchaser of a business (or a bank providing a loan or credit facilities) will not be in a position to establish whether a condition that something did not happen before the closing of a transaction has been satisfied. At the same time, pursuing the closing could legally operate as an implicit waiver of the condition. The effect of a waiver is obviously to the detriment of the other party (e.g. the purchaser or bank) because the deal-breaking impact of a condition would disappear completely. For example:

The obligation of Purchaser to consummate the transactions to be performed by it in connection with the Closing is subject to satisfaction of the following conditions:
(a) no legal proceeding shall be pending at any court or quasi-judicial or administrative agency of any jurisdiction which may possibly result in an unfavorable order or judgment that would (i) prevent consummation of any of the material transactions contemplated by this Agreement, (ii) cause any of the transactions contemplated by this Agreement to be rescinded following consummation, (iii) affect adversely the right of Purchaser to own any of the Shares or to control the Acquired Company, or (iv) affect adversely the right of Company to own its assets and to operate its business (and no such order or judgment shall be in effect); and
(b) Seller shall have delivered written confirmation to Purchaser that any and all consulting agreements it may have with the Acquired Company are terminated and no fees pursuant to those agreements are due or payable.

Despite the implicit waiver of the condition as a consequence of closing, it would be appropriate to convert the condition into something with a strong legal effect: if the seller (or borrower) must hand over a written statement that ‘the something’ has not happened, the written statement would imply a warranty by the seller (or borrower) that such ‘something’ is absent. If that would be incorrect, the burden of proof that the seller (or borrower) was not aware of the incorrectness of its statement would shift to the seller. Also, being required to provide such a statement would prompt the seller (or borrower) to inquire actively whether its statement is indeed correct, in order to avoid the purchaser (or bank) alleging that it ought to have been aware of the ‘something’.

9) Do not include a best efforts provision in connection with a condition, unless it specifies a required (i.e. a particular or preferred) course of action in a meaningful manner.

In European continental legal systems, the general principle of good faith requires that the parties make best efforts in order to have each condition satisfied in due course. This means that, in connection with the conditions, upon entering into an agreement there is an implicit presumption that all internal approvals required for the consummation of the transaction are obtained as soon as possible after signing of the agreement; that merger filings are made (and all answers to any competition authority’s questions are given) in due course; and that any adverse events are dealt with in such manner that damages are minimised for the purchaser (i.e. between signing and closing, the seller would act in a trustee-like role vis-à-vis the purchaser).

In a European context, it would be redundant or even exaggerated to provide:

Subject to the terms and conditions in this Agreement, Purchaser and Principal Seller shall, and Principal Seller shall procure that the Company shall, use commercially reasonable efforts to take promptly, or cause to be taken promptly, all actions, and to do promptly, or cause to be done promptly, all things reasonably necessary, proper or advisable under applicable laws and regulations to satisfy the conditions to the other Parties’ obligations to consummate the Acquisition and to remove any injunctions or other impediments or delays, legal or otherwise, in order to consummate and make effective the transactions contemplated by this Agreement. Each Seller will use its commercially reasonable efforts to cause the other Seller to fulfil such other Seller’s obligations under this Agreement.

If the parties are able to provide how a certain course of action must be undertaken by a party, it makes sense to specify those actions. In such case, the best-efforts obligation is partly turned into a results-oriented or milestone-driven obligation. For example, a purchaser (who would normally coordinate the preparation of merger filings) could be obliged to propose antitrust remedies before the appropriateness of such remedies would even be addressed by the competition authorities.

10) Conditions are for the benefit of both parties, unless otherwise specified.

For example, in respect of a choice of court, one party may need to prevent its being effectively unable to take recourse on the other party as a consequence of complications in the enforcement of a (favourable) court decision:

Section 11.2 is for the benefit of the Pledgee only. For the avoidance of doubt, subject to the applicable law, the Pledgee may initiate concurrent proceedings in any number of jurisdictions.

Obviously, the benefit of a condition is often determined by the context in which the condition applies. A technique to identify the beneficiary of a condition is to use the active tense, to personalise (or to ‘de-nominalise’) the related obligation or right.

In large transactions with several conditions, a separate section can be included to identify which conditions are for the benefit of which party (or both parties). The identification would also specify that the relevant party is solely entitled to waive the condition. For example:

Benefit. The Conditions under 2.1(a), (e), (f) and (g) are for the benefit of Purchaser and may be waived by Purchaser. The Condition under 2.1(b) is for the benefit of Sellers and may be waived by each Seller. The Conditions under 2.1(c) and (d) are for the benefit of all Parties and may be waived by Purchaser and a Seller acting jointly.

Note how any practical complications of having more than one seller (each of whom would need to waive its right) are avoided by establishing the authority of each seller to bind all.

11) Include a deadline before which all conditions must be satisfied.

A deadline is a relatively strong incentive for a party to have the conditions satisfied as soon as reasonably practicable. Obviously, a deadline provides a certainty about the rights and obligations of both parties. Such deadline is usually called a ‘long stop date’ or ‘drop dead date’.

It is recommended to provide for a deadline, that is realistic in view of what must happen or can happen during the period when not all conditions in the contract are satisfied. For example, it does not make sense to agree on a long stop date which precedes the day on which a competition authority would be required to make a decision on the proposed merger transaction (where a positive decision or the lapse of a statutory period to make the decision implies the satisfaction of a condition). But obviously, if the long stop date does cover such period, the non-satisfaction of the condition would be caused by a failure to submit the merger filing in a timely fashion.

12) Specify the effects of non-fulfilment of a condition.

If one or more of the conditions will not be satisfied, the disappointed party may want to claim the pre-contractual liability of the other party. Also, several actions might have been taken in anticipation of the completion of the agreement or the satisfaction of the condition and such actions may have an irreversible aspect or may require efforts or costs to achieve reversal.

Typically, the non-fulfilment of a condition results in the right of either or both parties to terminate the agreement without any liability towards other parties involved in the transaction. For example:

If the Conditions are not satisfied or waived on or before the Long Stop Date, each Party may terminate this Agreement and the other Party shall not have any claim against the Party so terminating this Agreement as a result of such termination. Following termination, this Agreement shall cease to have effect, except for this Section and Articles [confidentiality, notices, costs, applicable law and dispute resolution], and except furthermore that such termination shall not affect any rights or liabilities of either Party in respect of any preceding breach of this Agreement.

Do not repeat the law. It is unnecessary to provide that the right to terminate cannot be invoked by a party who caused the non-fulfilment of a condition (whether this is the consequence of a party’s failure to make sufficient efforts to have a condition satisfied or to start making such efforts in a timely fashion). This is because the law will not permit such termination right to be exercised.

Examples of conditions in contracts

Depending on the nature of the contract, different types of conditions are called for. M&A transactions require different conditions than loan facility agreements. In the ordinary course of business contracts, conditions are rarely found, except that individual contract clauses may well be ‘conditional’. A party with strong bargaining power may require the satisfaction of many condi­tions before becoming obliged to perform itself.

M&A transactions.
Some typical conditions for large M&A-transactions are:

• Internal approvals. Large companies have typically established internal contract approval policies: before a transaction may be consummated, an internal body must have approved it.
• Competition clearance. Transactions of a certain size often trigger a regulatory requirement to obtain clearance by national or European competition authorities.
• Other regulatory approvals. If the transaction contemplated by the agreement requires a governmental approval, neither par­ty will want to be obligated to close unless the approval is ob­tained.
• Third party consents. Similarly, both parties will want all ma­terial consents from third parties to be in hand before closing.
• No breach or MAC. Performance is not required if the business has been affected by a truly major event (a MAC, material adverse change or, in other words, a material adverse event). Such material adverse change would be negotiated to be something coming from outside the business with a very large impact (measured against the value of the business) on the acquired business. A stronger purchaser might be able to negotiate that performance is not required if the other party has breached its covenants or representations.
• Bringdown of warranties. Warranties first made at signing may be required to be repeated (‘brought down’) at closing. This is often an implicit effect of the warranty provision, but sometimes a seller is required to submit a written statement expressly confirming that the warranties are still ‘valid’.
• Legal opinions. These are letters from counsel to one party ad­dressed to the other party, stating legal conclusions relevant to the transaction.
  Certified organisational documents. Entities will often be re­quired to deliver copies of their certificates of incorporation, by-laws or other organisational documents, certified as accurate by an official in the jurisdiction of the organisation or by an officer of the entity.

U.S. particularities.
In the U.S., certain closing conditions in contracts are very standard, which are highly unlikely to appear in EU-sourced agreements. For example, agree­ments to which a company or other legal entity is a party may require the following closing documents (in the U.S., such documents are often referred to as “certificates”):

• The certificates of incorporation, certified by the secretary of state of the jurisdiction where the company or legal entity is incorporated.
• The company’s by-laws, certified as accurate by the corporate secretary.
• A statement of good standing issued by the secretary of state of the (U.S.) state of incorporation and certificates from other (U.S.) states indicating that the company or legal entity is entitled to do business in those states.
• A board resolution of the acquired company or legal entity’s board of directors authorising the transaction, certified by the corporate secretary.
• A statement of the corporate secretary certifying the signatures and incumbency of the officers who are signing the transac­tion documents.

Whereas a European lawyer (of the purchaser) will ascertain that the local equivalents of the above items are in order; a purchaser’s interest in such documents is normally limited, given the scope of the First E.C. Company Directive on the representation of companies. Nevertheless, any complications that might arise are best identified early. In particular, conditions that re­quire a lengthy process to be completed or the consent of a third party are two potential closing condition pitfalls. For instance, if a condition requires the delivery to the other party of a satisfactory environmental report, a transaction lawyer should initiate the preparation of the report as soon as possible following signing of the transaction.

Closing certificates.
It would appear, especially in U.S. originating M&A agreements, that closing conditions in contracts often require the delivery of a certifi­cate executed by the seller of shares or a complete business, stating that all the warranties made by the party are correct. Such a certificate adds nothing to what is already reflected in the agreement.

The rationale behind this practice is that requiring an individual to sign a formal-looking doc­ument induces a normal person to double-check the correctness of the warranties (or other certified matters). This is different in revolving credit facilities, which invariably require that the borrower, at the end of a term of loans drawn under the facility, delivers a certificate confirming that certain warranties are (still) correct and that the borrower is in full compliance with certain financial covenants.

The title ‘certificate’ is more commonly used in U.S. legal practice than it is in a European context. A ‘certificate’ is in fact nothing more a simple document signed by an individual, in which statements of fact are made.

Legal opinions.
The requirement for legal opinions at a transaction’s closing deserves special mention. A legal opinion is a written statement of legal consequences of the agreement, delivered by one party’s lawyer to the other party. Especially in financing transactions, legal opinions are common practice.

Most law firms have a review process be­fore legal opinions bearing the firm’s name may be delivered. If the parties agree that certain legal opinions be provided, the lawyers involved will focus on the scope of the opinion and the necessary legal conclusion that must be reached. Accordingly, a condition requiring the delivery of an opinion “in form and substance satisfactory” to the other party may be inca­pable of being fulfilled. Therefore, it is recommended to agree on the scope and conclusions of the opinion in advance and at­tach them as an exhibit.

Licensing intellectual property

The owner of an IP right may grant licences to third parties to use those IP rights in one way or another. In such licences, a licensee sometimes has the right to grant sublicences. In this section, licensing of IP rights such as a trademark, copyrighted work, patent or software application will be discussed.

Core licence clause

The essence of a licence is usually reflected in one key licence provision and, if necessary, elaborated in subsequent clauses. In the licence clause, probably more than in any other type of agreement, the key elements of the agreement are identified.

Subject to the terms of this Agreement, Licensor hereby grants Licensee, and Licensee hereby accepts a perpetual, non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to use the Licensed Trademark in the Territory in connection with Licensed Products only.

The core licence clause (whether included in a Trademark licence agreement, Patent licence agreement, Software licence agreement or other IP-licence) would contain the following elements:

• Licence grant. The wording reflects the grant of licensed rights (“hereby grants”, “hereby accepts”). The word hereby is essential since it prevents that an additional written licence grant must be signed (as is typically required in connection with intangible rights);
• The licensed object. For example a trademark, patent, copyrighted work, know-how, software;
• The scope could include:
• type of use (e.g. manufacture, import, export, market, sell, distribute, use);
• territory restrictions (this could be a specified region, country, or worldwide);
• exclusivity (sole or non-exclusive);
• market segment restrictions (e.g. fitness-shops, shopping malls, supermarkets, webshop);
• the right to grant sub-licences; and
• duration (perpetual or irrevocable, or a specified time limit).
• Licence fees (i.e. royalty bearing, royalty-free or fully paid-up).

Differentiation in licensed uses. If the licence differentiates for the various uses, the above core licence clause becomes a matrix of several licences, each of which apply to a different scope and each subject to varying conditions. For instance, the above example could differentiate between the types of permitted uses as to degree of exclusivity, geographical reach, right to sub-license and royalty:

Licence. Subject to the terms of this Agreement, Licensor hereby grants to Licensee and Licensee hereby accepts:
(a)  a non-exclusive, royalty-free licence, without the right to grant sub-licences, to demonstrate the Licensed Trademark in connection with Licensed Products only; and
(b)  an exclusive, royalty-bearing licence, with the right to grant sub-licences, to make and have made the Licensed Trademark in connection with Licensed Products only.
(c)  a non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to market, have marketed, offer for sale, have offered for sale, sell, have sold, or otherwise distribute or have distributed, the Licensed Trademark in the Territory in connection with Licensed Products only.

Note that the verb “to use” is omitted in all subparagraphs. Instead, each subparagraph includes a specific type of ‘use’. Item (c) demonstrates that the possible differentiation in licensed uses might be very specific.

Licence elements

Geographical and market-related scope. A licence involving the sale of a patented product or a product or service under a trademark licence agreement is often limited to a certain geographical area (i.e. a region, a country or part of a country), and sometimes also to a specific market segment (e.g. supermarkets, petrol stations, bars or restaurants), or a type of promotion or customer channel (e.g. general consumers, tv-broadcasting, printed magazines, or luxury brand shops). See also sections 2.4, lead-in, (a) and (b).

As regards patents, the licence should not cover geographical areas in which no patent was granted. Furthermore, a licence must be considered to be a technology licence. However, the licensee may argue that the licensor failed to deliver what was agreed: a patented invention.

Exclusivity. A licence is either ‘exclusive’ or ‘non-exclusive’. “Exclusive” means that nobody is entitled to use the licensed IP in the agreed territory, market segment and customer channel, not even the licensor. If the licence is a sole licence, the licensor may not grant a licence to another in the same territory, market segment or customer channel. Nevertheless, the licensor itself remains entitled to distribute in that area. In other words, the licensee will be the only (sole) licensee for that area, operating alongside the licensor. See also sections 2.4, lead-in, (a) and (b).

Important incompatibilities. Both an exclusive and a non-exclusive arrangement may severely restrict the freedom of the licensor in its freedom to undertake sales activities or to appoint other potential licensees who may be more successful:

• The appointment of an exclusive licence for a certain market segment in a certain territory prohibits the subsequent appointment of a (even non-exclusive) licence in the same territory for a broader market.
• The appointment of a non-exclusive licence for a certain territory prohibits the subsequent appointment of an exclusive licence in that same territory (even though the former is not de facto active in the market segment or customer channel covered by the latter). In such case, the second licence must contain a carve-out permitting the first licensee to continue its activities.
• If a licensee is appointed with an exclusivity arrangement for a term of five years and the licensee does not generate any sales, the territory and market segment for which the licensee is appointed will effectively be ‘blocked’ for alternative sales efforts during those five years.

Temporal scope. Most licences are either perpetual or have a specific term. If the licence clause includes the word “perpetual”, there is no further need to provide for a termination mechanism. A term licence would be limited by the time period of the agreement. It is uncommon to address this in the licence clause and is usually stipulated in an article on ‘term and termination’. The agreed term should enable the licensee to recover its investments made in relation to the licensed IP (and make profit).

Occasionally, a licence is granted for the duration of a project. For example, if a party agrees to provide certain services with which it makes use of proprietary technology of the customer or a supplier of the customer, the service provider would need a licence to carry out the agreed services. Similarly, if parties enter into a joint development agreement, one or both parties might need a licence to complete their part of the agreed development work. Such licence might be implied by the scope of the agreement, but an express project-licence emphasises the proprietary nature of the IP involved and might bring to light which limitations ought to apply to such project-licence.

Right to sub-license. In some cases, a right to grant sub-licences is desirable. For example, if the licensee is granted a licence in respect of a territory whilst it cannot (or will not) exploit the full capabilities of the licensed IP alone. In such case, whilst the licensee might be in a better position to obtain the maximum potential of the market, it would be appropriate to grant sub-licensing rights. In sub-licensing, the licensor usually requires the licensee to assume a larger responsibility in case of IP infringements by third parties in that territory.

More common situations in which sub-licences are necessary, relate to the use of the IP by (a) companies affiliated to the licensee, and (b) subcontractors of the licensee. An example of a clause permitting such sub-licences:

Permitted sub-licences. Subject to the limitations applicable to Licensee, Licensee is entitled to grant sub-licences to:
(a)  its Affiliates, which are not also an Affiliate of a third party, with the limited right to [use] the Trademark, provided that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such sub-licensed Affiliate ceasing to be an “Affiliate” of Licensee;
(b)  its suppliers and subcontractors, with the limited right to use the Trademark for Licensee’s exclusive benefit, provided that the sub-licence shall be no more extensive than is strictly required for providing such subcontractor’s services to Licensee, and provided furthermore that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such subcontractor ceasing to be a subcontractor of Licensee for the sub-licensed type of services. Each sub-licence as referred to in this paragraph (b) shall be subject to the prior written approval of Licensor, which approval shall not unreasonably be withheld or delayed.

Competition law restrictions. In patent and know-how licence agreements, the parties should be free to compete with their own developed products, improvements or new applications of the technology to the extent that these are independent from the licensee’s initial know-how. It is permitted to oblige the licensee to grant a non-exclusive licence to the licensor for improvements and new applications of the licensed technology. For important prohibitions, see section 5.6(b).

Irrelevant licence elements. In the core licence clause, it is generally not necessary to stipulate matters which are otherwise implied by (contract or IP) law. Such words, as they are occasionally used, include:

• Non-transferability or non-assignability of the licence: the general contract law principles for transferability of the licence agreement apply. This means that, in order to be legally effective, such a transfer requires the consent of all the parties to the licence agreement. This means that the licensor has the right to refuse and thereby prevent any transfer.
• Irrevocability of the licence: general contract law provides that contracting parties are bound by the terms of their agreement. Revocation of the licence is only possible on grounds provided by the applicable law which justify a term licensor for improvements inaction of the licence (e.g. rescission in case of material breach or termination by a receiver in bankruptcy) or grounds expressly stipulated in the licence agreement (e.g. in cases of material breach, bankruptcy or change of ownership over the licensee).
• Personal nature: this is the same as the non-transferability of the licence and a statement that the licence is personal is therefore redundant. Every contract is personal to the parties involved.

Royalties

Licences are fully paid-up, royalty-free or royalty-bearing. A royalty-free licence is common in joint development projects and for service providers in the context of their provided services. Also, the right to give demonstrations or to hand out free (complimentary or testing) samples of a product is often free of charge.

Fully paid-up. If the licence is fully paid-up, it means that the licensee acquires the rights to use, as stipulated in the licence agreement, after a one-off (lump sum) payment. This licence fee structure is usually applied if the parties want to materialise the licence in one settlement, or more commonly, if the payment in periodical instalments is impracticable (e.g. in case of a broadly defined patent, if the licensee is active in a different industry and not amongst the usual customers of the licensor) or if the collection of licence fees is undesirably burdensome (e.g. in case of consumers or large numbers of users).

Royalty-bearing. Royalty-bearing licences take countless forms. A royalty implies the payment of a (recurring) licence fee, the amount of which is often dependent on the volume of “net sales” (turnover) of the product in which the IP is used or applied. It is important to define what the royalty amount covers. A common reference figure is a percentage of the net sales of the products on which the trademark is used or for which the manufacture of the licenced patent or know-how is used:

Net Sales definition. In patent or technology licences:

Net Sales means the aggregate amount of sales prices of the Products received by the Licensee and its affiliated companies, excluding:
(a)  taxes and duties paid by the Licensee for the sale of any Products;
(b)  insurance, packaging and transportation expenses of Products;
(c)  deliveries of Products to Licensee’s affiliated companies to the extent that such deliveries are also included in such affiliated companies’ aggregated sales prices; and
(d)  normal discounts, returns and rebates to Licensee’s customers.

In trademark licences, the above item (c) should be replaced by:

(c)  deliveries of Products to Licensee’s affiliated companies for internal use by such affiliated companies only;

In both definitions, certain product-unrelated pricing elements, relating to delivery, logistics and insurance, are taken out of the net sales definition. The two definitions are different:

• In patent and technology licences it is important to capture (in case of a process-related patent) all processes where the licensee applies the patented invention or (in case of a product-resulting patent) all products sold by the licensee and its affiliates (even if there is no sub-licensing right). Any captive product sales (i.e. internally to affiliated companies) should be included at the Net Sales amounts received by that affiliated company from its customers (deducting the captive transfer price) but should be calculated at an arm’s length price.
• In trademark licences, internal sales are irrelevant and only the sales realised by the licensee and its affiliated companies vis-à-vis their customers is relevant. The brand does not operate as a particular unique selling point.

A percentage of net sales results in zero (nil) royalties if the licensee makes no sales efforts at all. Therefore, in many turnover-related licences, the licensor requires a minimum sales effort from the licensee by agreeing on a minimum royalty commitment: regardless of whether the licensee achieves the agreed minimum level of net sales, it must still pay for it (‘take or pay’).

NRE. In some industries, it is common to pay a part of the licence fees in an upfront lump sum amount. Such non-recoverable or non-recurring engineering fee is also known as “NRE”. This is useful if the licensor has to undertake development work in order to fit its product with the licensed IP into a given environment. The results of the development can be licensed to other parties as well. The possibility to relicense the IP justifies that the licensor assumes the costs of the investment, whilst the upfront payment is a way of financing the development work.

Royalty reporting. If any part of the licence fees is directly linked to (sales) amounts realised by the licensee, it is inevitable that the licensee reports on its sales. Accordingly, the licensor will require that the licensee maintains accurate bookkeeping and its records must enable the calculation of royalties by reference to the sales. In other words, the licensee must be able to account for the precise number of products in which the licensed IP was used (and the sales prices received for each product).

It is common to require quarterly reporting, although monthly reporting (in case of questionable debtors or high volumes of sales) and annual reporting (in case of low sales volumes or long lead times) also are agreed on. Royalty reports should be submitted within a few days after the end of the reporting period. Payment of the royalty should be made shortly thereafter (sometimes after the issuance of an invoice).

Royalty audits. If royalties are dependent on a variable, such as fluctuating sales amounts, it is appropriate to provide for an audit right: a right of the licensor (or its independent auditing firm) to verify the accuracy of the licensee’s royalty reports. In many industries, a royalty audit is considered to be a step-up to terminating the licence. Nonetheless, an audit clause usually addresses the maximum frequency of permitted audits (if previous audits revealed no irregularities), that an audit must be announced in advance, that it must take place during working hours, as well as a ‘penalty’ mechanism for settling misreported royalties. An example of a royalty audit clause is included in Model international trademark licence agreement (Section 6.6).

Covenants in contracts vs obligations

What is a covenant? Broadly speaking, ‘cov­enants’ are the contractual devices ensuring that a party receives the benefits that it negotiated for in the business deal. In other words, covenants support the achievement of the purpose implied by the key provisions characterising the transaction.

In this section, a brief comparison will be made between covenants as opposed to conditions, various examples of typical covenants in different types of contracts will be discussed (one subparagraph will address M&A-related convenants and another subparagraph will address covenants in financial agreements). This section will finally address how a contract drafter can smoothen the effects of a covenant.

Covenants vs. conditions

Unlike conditions (and warranties) – which are statements of fact as at a specific point in time – covenants are ongoing promises by one party to take or not to take certain actions. But covenants and conditions are more related than it may seem at first sight. Compare the following examples:

1. Seller shall sell and deliver the Products to Purchaser, subject to the condition that Purchaser has paid the Purchase Price.
2. Seller hereby sells and delivers the Products to Purchaser, subject to the condition that Purchaser shall pay the Purchase Price within five days after the Signing Date.
3. Seller hereby sells and shall deliver the Products to Purchaser within five days after the Signing Date, subject to the condition that Purchaser has paid the Purchase Price.
4. Seller hereby sells the Products to Purchaser and Purchaser hereby purchases the Products against payment of the Purchase Price. Seller shall deliver the Products within five days after the date of this Agreement.

Example 1 does not contain an ‘act of purchase’ by the Purchaser and does not contain an unequivocal link between the Purchase Price being a “purchase price” and the sales. Example 2 has the same defects; the strict wording would not grant the Seller an action for performance against the Purchaser (i.e. the Purchaser could argue that despite Seller’s act of sale, the Purchaser’s act of purchase remains open until the Purchaser so decides). Example 3 is the same as example 2, except that the required order of performance of payment and delivery are changed. Example 4 is a proper sales provision without any explicit conditions (i.e. one may well argue that the sale is subject to the implied condition that the Purchase Price be paid).

Based on the wording used or missing in the examples (i.e. a reference to a “Purchase Price” and a failure to reflect that the products are “hereby purchased”, respectively) examples 1 to 3 may well need improvement. Whether they are more obligatory than a precise lawyer would prefer is a matter of (reasonable) interpretation. If they were written by a non-lawyer for a simple transaction between two individuals, it is quite possible that a court would determine that the main intentions of the parties as expressed in the examples are all the same: one party sells and the other party buys, against payment of a purchase price. If an amount has been paid and the Products have been delivered, a court will probably not invalidate the sale. Nonetheless, it emphasises the importance of drafting straightforward obligatory provisions in the active tense.

The relationship between conditions and covenants can also be explained in a different way. First, although a condition is not, as such, a ‘promise to act’ in a certain way, the stipulation of a condition often implies that the parties use reasonable endeavours that the condition will be satisfied in such manner that the object of that condition takes its anticipated effect. Accordingly, a condition may a contrario imply an obligation (i.e. a covenant) imposed on the party who is able to influence the satisfaction (positively or negatively) of that condition. Similarly, a covenant is not a key obligation and therefore many courts will refuse to permit a complete suspension or postponement of performance by the beneficiary of an obligation if the obligor fails to perform according to the covenant.

Second, if contractual obligations are drafted in the passive tense (i.e. without an actor or obligor being appointed) the distinction between covenants and conditions becomes fluid. This becomes clear when reading the American Restatement of Contracts:

“If in an agreement words that state that an act is to be performed purport to be the words of the person who is to do the act, the words are interpreted, unless a contrary intention has been manifested, as a promise by that person to perform the act. If the words purport to be those of a party who is not to do the act they are interpreted, unless the contrary intention has been manifested, as limiting the promise of that party by making performance of the act a condition.”

Although the distinction might not be of great relevance from a contract-drafting or even a practical perspective, it is important to be aware how conditions and obligations interact with each other.

Covenants in various contracts

Covenants in IP-related agreements. In a patent transfer agreement, the transferring party will transfer its invention. However, the transferee would like to maximise its use of the patented invention and also be made familiar with all technology know how connected to the patented invention.

Also, a transferor may want to avoid any infringement claims for the use of any remote elements in the patent that do not relate to the transferee’s business but was covered by the patented invention (as the patent was applied for in view of the transferor’s business): the transferor may seek a non-assertion or licence-back in connection with the transferred patent. Similarly, a licensor of trademarks or other intellectual property rights often requires from its licensees that they notify the licensor promptly of any infringements identified in the market of such licensee. Such stipulations are covenants.

Covenants in Lease or loan agreements. In a manufacturing equipment lease, the main objective of the lessor is to ensure that the lessee pays the rent timely and that it returns the equipment at the end of the lease. However, a lessor may want the lessee to operate and store the equipment in accordance with lessor’s instructions, to maintain the leased assets, to keep it insured and to allow periodical inspections by the lessor. The lessor, in addition to its concern regarding the value of the equipment, will want to prevent that the lessee will be unable to pay the rent timely. Likewise, the lessor might require that the lessee provides an ongoing security for the lease

The lessor, in addition to its concern regarding the value of the equipment, will want to prevent that the lessee will be unable to pay the rent timely. Likewise, the lessor might require that the lessee provides an ongoing security for the lease instalments. If the lease has a potentially significant impact on the lessee’s business, the lessor may even require periodical information about the lessee’s financial capability to continue paying the rent.

Each of the above examples of deal-related or unrelated purposes is accomplished by covenants that prescribe what the transferor or lessee must do, and cannot do, in respect of the transferred patent or leased equipment.

Covenants in M&A transactions

In M&A transactions, covenants will protect the purchaser’s interests prior to completion (i.e. covenants force a seller and the acquired companies to conduct the business in the ordinary course and to obtain the purchaser’s approval for important or extraordinary matters), as well as its commercial deal after completion in an active sense (i.e. the seller is required to take care of transaction-related interests or to continue to disentangle the acquired business) and in a passive sense (i.e. the seller should refrain from using its knowledge or business relationships to compete with the business it sold).

Disentanglement covenants. In addition, various matters related to the historic positioning of the acquired companies as part of seller’s group need to be addressed. The disentanglement is usually not completed on the closing date. For that reason, the following matters are commonly provided:

• Financial disentanglement: all securities, suretyships and collateral granted by the acquired companies for the benefit of the seller’s group and vice versa should be terminated (and replaced). This includes financial arrangements of any kind: cash pooling arrangements with the bank, security rights under credit facilities, currency exchange swaps or foreign currency hedge arrangements, surityship undertakings and parent guarantees by the selling shareholder, credit arrangements with suppliers that service both the sold companies and the remaining subsidiaries of the seller etc.
• Employee’s rights: although the position of employees does not change as a direct consequence of a change of control, many selling companies would like to ascertain that the employees will indeed keep their employment. Also, employee codetermination laws and regulations (or the mere existence of a works council) have had the effect that a seller and purchaser often agree on a certain (or an unchanged) level of employment after closing of the transaction. A covenant could therefore address matters such as:
  • the number of FTE during the next few years;
  • the continuous availability of certain specific facilities of the seller (e.g. an employee mobility centre);
  • the replacement of an employee share or option participation scheme by a reasonable alternative;
  • certain minimum requirements for the benefit of senior staff (who are not covered by a collective labour agreement);
• Pensions: whilst the pension rights of employees are also well-protected under European legislation, it is sometimes recommended that a purchaser takes over certain pension arrangements of the seller or arranges for a pension scheme that is substantially similar to that of the seller (e.g. defined benefit scheme, defined contribution scheme, capital contribution policy).
• Intellectual property rights: if IP does not constitute a significant part of the M&A transaction, some more basic aspects are dealt with in the covenants:
  • the cessation of the use of seller’s trademarks and trade names in the acquired companies business (i.e. usually such use is allowed until three months after closing) including the removal of nameplates and logos, and, less typical but for a sense of mutuality, of the acquired companies’ trademarks, trade names and logos by the seller;
  • the transfer of certain domain names and trade mark registrations (i.e. such transfer could be formalised on closing but the actual transfer registration process takes some time and is so different from country to country with so little interest by either party to have it done on closing that filling out the forms is typically a post-closing affair if it happens at all);
  • an undertaking not to permit the lapse of any IP-registration.
• Insurances: a seller will sometimes want to ascertain that certain business risks of the sold companies continue to be covered by insurance.
• Authorisations: in multi-party agreements, covenants may consist of authorisations or a (conditional) power of attorney to undertake certain actions on behalf of one or more parties.
• Taxation: Although often addressed in a separate schedule or tax agreement, tax matters obviously require a sort of ‘covenant’ in the context of an M&A transaction. Matters that may need to be addressed include the seller’s and acquired companies’ respective liability for any taxes, a termination of regional tax unities, the entitlement and reimbursement of tax benefits, communications with tax authorities and the conduct of any tax-related disputes.
• Intra-company agreements: in order to ascertain that the purchaser does not acquire a loss-making business because the seller has arranged highly unfavourable terms and conditions for itself, the ordinary course supplies by the acquired companies to the seller’s other subsidiaries are often terminated. Please note that these agreements contribute to the value of the acquired companies and are not, as such, of a transitional nature.
• Transitional services: the sold companies are often highly dependent on the availability of various services and facilities provided by their former holding company. To a lesser extent, this may also apply to services or facilities (if only in certain countries) hosted by the sold companies for the benefit of their former affiliated companies. For that purpose, a share or asset purchase agreement will typically contain a transitional services agreement that provides for an uninterrupted continuation of various services. The typical aspects to be addressed are the legal entities that are formally entitled to (responsible for) the service, the duration of each such service (i.e. not all services can be terminated easily), the service fee, payment and invoicing arrangements, particularities related to the service and the contact persons after closing. For ICT matters, which might include the availability of enterprise software systems, more elaborate arrangements are often necessary.

Pre-closing covenants. During the period between the signing and the closing of the transaction, the business of the acquired companies would typically be continued in the ordinary course of business. Anticipated investments (e.g.the renewal or maintenance of equipment and production installations) may or may not continue as planned. The purchasers will likely want to prepare, to reconfirm or to further elaborate their business plan for the acquired companies. Also, suppliers and customers contact their counterparts in the sold business asking for a clarification of the transaction (and certainty about their ongoing position). Some contracts contain change-of-control provisions, which may even trigger renegotiation of the pricing or other terms and conditions. As with everything in life, issues arise in the ordinary course of business. Because each such issue might affect the value of the acquired companies or the possibility of integrating the acquired business into the business of the purchaser, pre-closing covenants would be agreed, probably with some involvement of the purchaser. Such pre-closing covenants might address, for example:

• Access to facilities and information rights. Whereas competition laws prohibit the implementation of various (irreversible) measures, a purchaser would like to have some access rights to the acquired companies’ manufacturing facilities or offices and to certain (non-strategic) information. The seller will want to make sure that the purchaser does not interfere with the business activities and that the purchaser will comply with all security and safety measures.
• Undertaking to conduct the business in the ordinary course. It is appropriate for a seller to procure that the acquired companies undertake their business as usual.
• Approval rights. Various matters will be subject to the purchaser’s prior approval. They may include:
  • entering into agreements (distinguishing between ordinary course contracts, non-ordinary course contracts, unusual contracts or commitments under atypical terms and conditions, and contracts with a conflict of interest);
  • matters related to the acquired companies’ assets (i.e. no disposals or grants of pledges other than in the ordinary course of business and no unanticipated deviation from capital-expenditure-related investment plans);
  • matters related to the corporate structure, taxation and finance (including financial reporting), preventing a transfer of any entities, any amendments to corporate constitutional documents, tax-revaluations etc.;
  • employment-related matters, such as a change of the terms of employment (including of any collective labour agreements), the removal of (key) employees other than for urgent cause, or the employment of additional personnel;
  • IP-related matters (if not addressed otherwise);
  • an undertaking not to enter into, amend or terminate any joint ventures, partnerships, licences or important lease agreements.
  • settlement of claims and disputes and the conduct of any pending litigation.
• A duty to inform. Obviously, between signing and closing, the purchaser wants to be informed about all matters that might affect the value of the acquired companies, any of the warranties becoming incorrect and generally any business decisions by the acquired companies. It will also want to receive periodical management reports and quarterly or annual financial statements.

Credit-facility-related covenants

In credit facilities and loan agreements, as in M&A transaction agreements, covenants can similarly be divided into three categories:

• Covenants requiring action (i.e. promises to take a specified action);
• Negative covenants (i.e. promises not to take specified actions); and
• Financial covenants (i.e. promises to maintain certain levels of financial performance or not to take specific actions unless certain levels of fi­nancial condition or performance exist at the time).

Negative cove­nants are also referred to as restrictive covenants, because they restrict or prohibit certain actions (i.e. not permitting the creation of pledges over any assets of the borrower, or the undertaking not to grant any higher-ranking security rights over its assets compared to those of the lender).

Financial covenants. In their financing practice, banks have been developing great insight into the need to monitor their customers’ businesses. Those needs are satisfied by adequate financial covenants. Financial covenants restrict a borrower’s freedom to engage in activ­ities that may worsen its financial condition. These activities include the following:

• Incurrence of debt. More debt means more interest and princi­pal payments, implying a greater impact on the company’s cash flow.
• Creation of encumbrances (‘negative pledge’). The more assets are pledged or otherwise collateralised, the fewer assets are available to be used to satisfy the borrower’s unsecured claims and general obligations in the event of insolvency.
• Line of business. Especially in leveraged finance, finance agreements will require that the borrower does not change the essential scope or nature of its business activities.
• Sale of assets. Loss of income-generating assets could adversely affect the lessee’s cash flow. Sometimes also the assignment of receivables (factoring arrangement) is restricted or prohibited.
• Dividend distributions (‘leakage prevention’). Each euro distributed as dividend to share­holders reduces cash available for payment of rent. Also, intra-company transactions with affiliates that do not participate in the financial arrangement may endanger the leakage of valuable assets or cash out of the reach of the lenders.
• Investments. From a lender’s standpoint, cash spent on investments would be better spent on repaying amounts due to the lender.

Financial ratios in credit agreements. Financial covenants that require the covenanting party to periodically meet certain financial ratios are also used to ad­dress credit concerns. These ratios are set at levels de­signed as an ‘early warning signal’ in the event that the borrower is facing financial difficulties. Financial ratios are aimed at balancing the business decisions of a company’s management, in that the ratio established by a covenant requires that the company will at all times be capable of paying its debts, as should be determined on the basis of the company’s cashflow to debt ratio, a profitability (EBIT or PBIT) to interest indebtedness ratio, a current ratio (i.e. current assets to current liabilities) or a solvency ratio (e.g. borrowed money set off against equity). Such financial covenants will often also require that the borrower is of a certain ‘minimum net worth’.

Carve-outs and baskets: exceptions to covenants

The scope of a covenant can be limited or qualified in a few respects. The most important one is to create exceptions or to be specific regarding its scope. Two basic types of exceptions can be distinguished and will be addressed in this paragraph: carve-outs and baskets.

Carve-outs. A carve-out is formulated as an exception and functions as a removal, or carve-out, of part of the restriction imposed by the covenant. For example:

Borrower shall not sell any of its assets, except for any equipment that has reached its end-of-life status or a status of technical obsolescence.

Baskets. A basket, on the other hand, is an allowance that establishes the right to deviate from the covenant’s restrictions by some specified amount. The purpose of a basket is to give the restricted party a limited ability to deviate from a covenant’s restrictions. The above exception could be converted into a basket, as follows:

Borrower shall not sell any of its assets, except for any equipment that has reached its end-of-life status or a status of technical obsolescence up to an aggregate amount not exceeding EUR 15,000,000.

Similar baskets are found in the pre-closing covenants in share purchase agreements, where the purchaser requires the seller to obtain prior approval for certain types of transactions. The example shows that further distinguishing between the nature of the underlying transaction is helpful in finding a middle ground:

Except to the extent provided in a budget of Acquired Companies that has been fairly disclosed to or approved by Purchaser, Seller shall not permit Acquired Companies to do any of the following pending the Closing without the prior written approval of Purchaser (which approval shall not be unreasonably withheld or delayed):

(a) enter into an agreement or a series of related agreements which are in the ordinary course of business for an aggregate amount in excess of EUR 250,000;

(b) enter into an agreement or a series of related agreements which are not in the ordinary course of business for an aggregate amount in excess of EUR 50,000;

(c) enter into any abnormal or unusual agreements or commitments, including any which (i) are unlikely to become profitable, (ii) are of an unusually long-term nature or which cannot be terminated within 24 months, (iii) contain a payment term or potential liability exposure deviating significantly from Acquired Companies’ contracting policy as at the Signing Date, or (iv) would otherwise likely have a financial impact after the (initial) term of the contract;

(d) enter into any agreement in which a member of Seller’s Group has an interest.

Remedies for breach of a covenant. In most agreements that are subject to a European continental law, it is unnecessary to include a remedy in a covenant. Unlike in civil law jurisdictions, the default remedy under common law for breach of contract is that the harmed party is entitled to damages but not a priori to specific performance, which is an equitable remedy granted at the discretion of the court. In the European continental legal systems, the opposite applies (see paragraph 2.2(a)): by default, a party can ask for specific performance (and if that is not practicable or adequate, damages can be claimed). Because an entitlement to damages often does not protect the harmed party’s interests adequately, an agreement that is drafted in view of the law of a common law jurisdiction usually provides for specific remedies in the event of a breach of a covenant.

Representations and warranties – sense and all nonsense

Warranties, also referred to as representations (but see below), are statements of fact. At least, as a matter of best practice, representations and warranties should be statements that are either true or not true. Warranties are made by one party (e.g. a seller, service provider, borrower or licensor) to the other party, typically as at a particular moment in time. The purpose of a warranty is (a) by way of promise about the future post-signing, to confirm or stand in for the warranted facts and events, as those may be important to the other party’s expectations, and (b) to encourage (but in common law, this is called a representation) its business decision to enter into the transaction (on the agreed terms of the contract).

If warranties are incorrect, this would result in rights or remedies under the contract. For a distinction between representations vs. warranties (as is made in common law) this is essential. Below, we will address various aspects of warranties and best practices.

Introduction to warranties

Like recitals, warranties are statements of fact. Someone can ‘breach’ a contractual obligation or covenant, but not a statement of fact. A properly drafted warranty is either true (or correct) or not. There should be no room for something in-between. Of course, a warranty can be partially incorrect, but this implies that also the warranty in its entirety is incorrect. In the English language, it is also appropriate to stipulate that a warranty is ‘accurate’ (or ‘inaccurate’).

Smoking out the facts. The process of asking and negotiating warranties should trigger the disclosure of facts and events that might not otherwise become known. In this respect, warranties spur the seller on to discharge its ‘duty to inform’, whilst at the same time the purchaser effectively conducts its ‘duty to investigate’. Asking and negotiating the warranties is therefore a natural outflow of the due diligence investigation. (Ideally, a purchaser’s due diligence questionnaire will match the set of model warranties, which a purchaser would require if it had full bargaining power. At the same time, since such a set is likely ‘complete’, a seller would organise its data room consistent with such model warranties.)

For example, a purchaser will ask the seller of a company to make the following warranty:

Except as disclosed in Schedule 11, there have not at any time been any Spills or Contaminations on or from the Production Site.

When the seller receives this warranty as part of the first draft set of warranties, it has several options:

1. refuse to make the warranty (either in general terms “take a closer and critical look at what you are asking” or more specifically “we are unwilling to make this warranty”). In this last case, the suggestion arises that the seller hides environmen­tal contaminations, and the purchaser will want the warranty even more;
2. qualify and limit the warranty to the seller’s knowledge, so that the warranty is only incorrect if the seller fails to disclose relevant facts actually known to it. (Often, reference is made to the seller’s best knowledge: the qualification is non-sense because someone either ‘knows’ or ‘does not know’.) In many cases, the responsible former and current managers are named to further limit the scope of seller’s knowledge, imposing a necessity to scrutinise them about the warranties qualified as such.
3. make the warranty, as well as a disclosure of all facts or events of which it is aware.

Allocation of risk. A warranty removes legal issues related to attributability (and partly also of causation) of damages if the warranted facts or events appear to be incorrect. The result is that a warranty operates as a risk allocation mechanism. The party making a warranty assumes the risk that if the warranty is incorrect, the other party will have a claim against it or another appropriate remedy under the agreement. Depending on the interpretation of the warranty, a failure in the contractual object may fall within the scope of the warranty (and therefore the customer can make a claim) or it may not (and accordingly, the risk remains for the customer). It may well be that neither party knows whether a warranty is correct, even after comprehensive investigations and testing. Having the seller, service provider, borrower or licensor make the warranty is a simple allocation of risk.

Representations or warranties, in common law and elsewhere

Warranties, not representations and warranties. The word warranties is very often coupled with representations, in that the parties do not merely warrant, they would represent and warrant. Many people argue that ‘representation’ and ‘warranty’ signify the same legal concept, and that the use of the one or the other is interchangeable. While this is true for all non-common law systems (where warranties do not have a distinct meaning), within common law – most evidently under English law – the two terms relate to fundamentally different concepts.

Representations under common law. Under English common law, a representation is a statement of fact made by one party to induce the other party to enter into the contract. Being a statement of fact means that it can relate (and must be drafted to relate) to past or present facts or circumstances only. As in many other legal systems, a misrepresentation (a ‘breach’ of a representation), by consequence, affects (the appropriateness, validity or cause of) the transaction.

A misrepresentation operates the way the legal concept of ‘mistake’ (erreur, Irrtum, dwaling) works in non-common law jurisdictions. Accordingly, the default remedy is (and as codified for English law in the Misrepresentation Act 1967 indeed is) that the induced or misled other party may rescind the contract if the misrepresentation so justifies. An immediate consequence would then also be that, rather than a (contractually qualified or limited) claim under ‘contract’, such other party would claim in ‘tort‘ or ‘unjustified enrichment’.

Although one may reflect the representations in the contract, by a representation’s very nature (as an inducement to enter into the contract) such written reflection is not necessary: whether the remedy (rescission of the contract) is justified will be determined regardless of whether the representation was in writing. Having the representation in writing is of course good evidence.

Warranties under common law. The term warranty has a slightly different meaning: it reflects the promise about (the effects of) the contemplated transaction made by one party to the other, so about what such other party might expect from performance under the contract. If a warranty appears to be incorrect, the remedy under common law is: damages (and not rescission). If the incorrectness is fundamental, the contract can be terminated. However, the default remedy under common law is the payment of damages resulting from the warranty being incorrect.

Unlike a representation, the contract is not undone as though it never existed. A warranty should be drafted such that one can say that it is ‘correct’ or ‘incorrect’. Accordingly, like representations, semantically, a warranty takes the ‘structure’ of a statement of (past, current or future) facts. Whilst representations refer to the particular facts as they are (or would be) at the time of contracting, a warranty must be presumed to address a promised future fact, benefit or circumstance measured as of the moment such a warranty is made.

On similar grounds, warranties imply a contractual risk allocation mechanism, which is – in view of the remedy (rescission) – not the case with a representation. Having pointed out these notions of warranties vs. representations, it must be admitted that many common law lawyers are unaware of the distinction.

Reps and warranties in the rest of the world. On the European continent, one would expect that representation is the preferred wording. At least from a semantic point of view, the well-known concept of a ‘juridical act’ (being something like ‘a statement or declaration, which has legal effect as such’) seems to match better with that terminology (whereas a warranty has no specific legal meaning). Regardless of this somewhat arbitrary argument, European contract laws are conceptually built on notions such as the parties’ (mental, psychological) consent, their free (subjective) mutual will, or the meaning that a reasonable person would (objectively) attribute to what the parties expressed as their agreement.

Because of such notions, the English-language distinction is not so obvious that using one word or the other is of any decisive relevance. What is relevant is that one party makes a statement of fact and that the party relying on that statement may or may not invoke a contractual or statutory right when that statement happens to be incorrect.

Guarantee? Some European originating contracts may use the term guarantee (i.e. the verb) or guaranty (i.e. the act as such). This can be explained from the translated concept (e.g. ‘garantie’ (French), ‘Garantie’ (German), ‘garantie’ (Dutch)). Still, in the common law, the concept guarantee is much more closely related to a suretyship, the undertaking by one person to stand in for the due and timely performance by another person. In Black’s Law Dictionary’s explanation:

guarantee, vb. (18c) 1. To assume a suretyship obligations; to agree to answer for a debt or default. 2. To promise that a contract or legal act will be duly carried out.

Best practices of warranties

Best practice – written as a statement of fact. A representation and a warranty must be drafted as a statement of fact. A properly drafted warranty is either true (or correct) or not. There should be no room for something in-between. Of course, a warranty can be partially incorrect, but this implies that the warranty in its entirety is also incorrect. In the English language, it is also appropriate to stipulate that a warranty is ‘accurate’ (or ‘inaccurate’).

Best practice – never include obligations. Like recitals and definitions, a warranty should never contain obligations, remedies or other operative provisions. If the drafter wants to provide for an obligation or a remedy in the case a warranty is incorrect, or for any consequences depending on the degree of ‘incorrectness’ of a warranty, this should be addressed in a separate provision: a separate article, section or at least its own sentence.

Hindsight effect of obligations. If a party wants to ascertain that the other party has been acting as if the obligations had been agreed earlier in time, this should be achieved by a warranty, not by an obligation. It is simply impossible for a party to undertake that it would not have acted or would not have omitted to act in a certain manner in respect of a period preceding the date of execution of the agreement. This is because no-one can reverse time or step into a time machine in order to perform an obligation.  A party should only warrant that it did act (or did omit to act) in a certain manner up to the present date.

For example, a confidentiality agreement that should have retroactive effect must be phrased in the following way:

6.1       Preceding Disclosures. The Receiving Party hereby confirms that Confidential Information already disclosed in relation to the Purpose and any discussions already held between them, from 15 March 2020 and thereafter, shall be subject to this Agreement.
6.2       Warranty. The Receiving Party warrants that during the period between the date in Section 6.1 and the date of this Agreement, it has not disclosed, done or omitted anything that would have constituted a breach of this Agreement, if this Agreement had been in entered into immediately preceding such period of time.

Warranties in all-caps: ‘conspicuousness’ ? Many contract drafters believe that a disclaimer or limitation of liability must be printed entirely in capital letters. The requirement to capitalize can be found in the United States Uniform Commercial Code (UCC) and only applies to a few nominal types of contracts – the sale of goods, the licence of software, a lease or a warehousing contract. In such contracts, a seller of a product can disclaim implied warranties and limit its exposure to liability conspicuously. The UCC defines the conspicuous requirement as something written (printed) such that a reasonable person ought to have noticed it.[1]

Language would be considered conspicuous if it is in a larger font or other contrasting type or colour (for sales contracts, a broader definition applies). The UCC does not require all-capitals. Whether or not the text is considered conspicuous is for the court to decide. Finally, since the requirement of conspicuousness is based on the UCC, it applies only if the contract is governed by the laws of a U.S. state. Almost no other country adopted such a conspicuous requirement.

Warranties in ordinary course business contracts

Fitness for purpose and merchantability. In day-to-day business contracts, warranties related to fitness for a particular purpose and ascertaining the merchantability of the products are very common. Also the opposite, that such warranties are specifically disclaimed, is common practice.

What do they mean? Most legal systems require that a sold product must generally be fit for the ordinary purpose for which such products are to be used (and the meaning of which depends on the particular context). If not, the seller would be selling defective products and would rely on a disclaimer allowing it to be in material breach without any remedy or penalty. People call that deceit.

Should the parties agree on a warranty that the products are delivered “AS IS” (and that any other warranties are disclaimed), a purchaser should inform itself more careful as to whether the sold goods meet its expectations. However, even such limited ‘warranty’ does not permit the seller to deliver crap or even something of which it actually knows that it does not meet the purchaser’s expectations at all (unless the purchaser actually assumed the risk that the seller’s performance could potentially lead to no result at all). Non-performance is something else than performing with no guarantee of success.

Sometimes, a seller disclaims that a product is “fit for a particular purpose”. Such disclaimer attempts to avoid that a seller is held to deliver according to l is therefore ineffective if it allows the seller to deliver defective products. The trick is in the specificity of the purpose and in the extent to which the product should meet the purchaser’s personal intentions (i.e. those particular purposes on top of what may generally be expected).

In connection with a warranty of fitness for a particular purpose, the U.S. Uniform Commercial Code requires that (a) at the time of entering into the contract, the seller must have reason to know the purchaser’s particular purpose (i.e. the purchaser must have told or informed the seller in a somewhat deliberate way for what purpose it would use the goods), (b) the seller must have reason to know that the purchaser is relying on the seller’s skill or judgement to deliver suitable products, and (c) the purchaser must – in fact – rely upon the seller’s skill or judgement.

Disclaiming the merchantability of a product refers to the freedom of the purchaser to sell the product to third parties (and such third parties’ freedom to use it without infringing another person’s rights). Normally, this is not problematic at all. When the product is subject to a limited licence or if the use of the product independently or in combination with another product infringes the (intellectual property) rights of a third party, however, the product is not merchantable. The same applies if the product is subject to encumbrances or if it cannot be delivered because of any litigation, seizure or embargo.

Generally, merchantability is something that a seller should warrant. However, the complication in relation to intellectual property is that a seller is not always capable of knowing which IP-rights its competitors own (or in which jurisdiction they apply). Furthermore, it disregards another aspect of merchantability: the seller does not necessarily know how its product will be processed and probably the product is subject to additional regulatory requirements under any local law (e.g. export or import restrictions, registration requirements or specific permits or authori­sations). In the U.S. Uniform Commercial Code[2], ‘merchant­ability’ is equivalent to fitness for ordinary purpose.

Warranty of specifications. A warranty requiring that a product meets the ‘specifications’ may trigger the purchaser to clarify for which purpose it will use that product. Because this can be very subjective (and probably also subject to changes) it is risky for a seller to make warranties that the product is fit for the particular purpose for which the purchaser will use it.

Capitals. Many contract drafters believe that in international commerce, a disclaimer or limitation of liability must be printed in capital letters. For example:

THE PRODUCT IS PROVIDED TO PURCHASER “AS IS” WITHOUT ANY WARRANTIES OF ANY KIND. SELLER EXPRESSLY DISCLAIMS ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NON-INFRINGEMENT OF INTELLECTUAL PROPERTY RIGHTS. SELLER SHALL HAVE NO LIABILITY TO PURCHASER OR ITS AFFILIATES OR ANY THIRD PARTY FOR ANY DAMAGES, INCLUDING DAMAGES RESULTING OR ALLEGED TO RESULT FROM ANY DEFECT, ERROR OR OMISSION IN THE PRODUCT, ANY USED THIRD PARTY PRODUCTS OR AS A RESULT OF ANY INFRINGEMENT OF INTELLECTUAL PROPERTY OF ANY THIRD PARTY. IN NO EVENT SHALL SELLER BE LIABLE FOR ANY INCIDENTAL, INDIRECT, SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS) SUFFERED BY PURCHASER OR ITS AFFILIATES OR ANY OTHER THIRD PARTY ARISING OUT OF OR RELATED TO THIS AGREEMENT EVEN IF SELLER HAS ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.

Background: ‘conspicuousness’. The requirement to capitalise only applies to a few nominal types of contracts. They can be found in the Uniform Commercial Code (UCC) related to the sale of goods, the licence of software, a lease or warehousing contract: a seller of a product can disclaim implied warranties and limit its exposure to liability conspicuously. The UCC defines[3] the conspicuous requirement as something that is written (i.e. printed) in such a way that a reasonable person against whom it is to operate ought to have noticed it. Language in the body of a contract would be conspicuous if it is in a larger font or other contrasting type or colour (for sales contracts, a broader definition applies). The UCC does not require all-capitals. Whether or not text is conspicuous is for decision by the court. Finally, since the requirement of conspicuousness has its origins in the UCC, it applies only if the contract is governed by the law of certain U.S. states, where such a requirement is also adopted. This is the case only in a limited number of states.

Disclosures against warranties – strategy and best practices

Triggering disclosure and clarification. In major transactions, warranties serve to smoke out the facts. The process of asking and negotiating warranties should trigger the disclosure of facts and events that might not otherwise become known. In this respect, warranties spur the seller on to discharge its ‘duty to inform’, whilst at the same time the purchaser effectively conducts its ‘duty to investigate’. Asking and negotiating the warranties is therefore a natural outflow of the due diligence investigation. (Ideally, a purchaser’s due diligence questionnaire will match the set of model warranties which a purchaser would require if it had full bargaining power. At the same time, since such a set is likely to be ‘complete’, a seller would organise its data room consistent with such model warranties.)

Example and strategy. For example in the context of a sale of a chemical business, the buyer most probably wants to know whether there are any environmental contaminations for which the target company may be held liable at some point in time. The potential purchaser will ask the seller of a company to warrant the following:

Except as disclosed in Schedule 10, there have not at any time been any Spills or Contaminations on or from the Production Site.

To continue the example, the seller may have carried out environmental investigations providing a minimum of comfort that there are no environmental complications. However, there may have been hazardous spills that were not accurately reported in the records and not discovered in the soil investigation.

When the seller receives this warranty as part of the first draft set of warranties, it has several options:

1. refuse to make the warranty (either in general terms stating “take a closer and more critical look at what you are asking” or in more specific terms stating “we are unwilling to make this warranty”). In our example, refusal may imply that the seller is hiding environmental contaminations, and the purchaser will want the warranty even more;
2. qualify the warranty by the words to the seller’s knowledge, so that the warranty is only incorrect if the seller fails to disclose relevant facts actually known to it. (Often, reference is made to the seller’s best knowledge: the qualification best is nonsense because someone either ‘knows’ or ‘does not know’.) In many cases, the responsible former and current managers are named to further limit the scope of seller’s knowledge, imposing a necessity to scrutinise them about the warranties qualified as such;
3. limit the scope of the proposed warranty. A mark-up of the above example could state that the seller has always had adequate waste spill reporting policies in place in accordance with the best industry practices at such moment in time, and that it has conducted adequate soil investigations;
4. make the warranty, as well as a disclosure of all facts or events of which it is aware.

The best approach to negotiating warranties depends on several circumstances:

• the negotiating power and leverage of the disclosing party,
• the sensitivity of the negotiations generally (e.g. the level of mutual trust or confidence of the parties),
• the time of internal discovery of ‘defects’ in warranties (i.e. disclosure letters tend to be prepared and handed over after the warranties have been negotiated, at least to some extent),
• the disclosing party’s liability exposure in view of thresholds and baskets,
• the disclosing party’s general approach to being complete and comprehensive (or not),
• the willingness to address (highly) sensitive subjects (e.g. potential antitrust issues).

Disclosures may also be made by excluding, or carving out, the incorrect facts or events otherwise covered under the warranty. This is appropriate if the exception is rather extensive as opposed to the scope of the warranty against which it is disclosed.

The disclosing party should realise in advance that proposing a dis­closure may in turn trigger a buyer to require specific indemnities separate from the warranties (and excluded from the warranty-related limitations of liability). Such a specific indemnity may take many forms: from a specific indemnity limited in scope, time and amount to remedial action taken by the seller (or under its supervision and at its costs).

Disclosures – best practice rules. Like warranties, disclosures are statements of facts or events. Therefore, disclosures must not contain obligations, promises or undertakings of any kind. Like warranties, disclosures may refer to annexes attached to the disclosure schedule, which annexes may list, describe or otherwise report the disclosed facts or events.

It is good practice to organise meetings with the senior employees who should potentially have any knowledge of possible warranty breaches. In other words, when a disclosure letter is to be drafted, the disclosing party’s lawyers should meet with each such employee (or small group of employees). They should explain the impact of a warranty breach (i.e. being somewhat different from ordinary course warranties), the thresholds above which a warranty breach is likely to become an issue, and explain word-by-word what is meant by a warranty. Each employee should be encouraged to give as much information as possible. After that, he or she may well be requested to sign off on the reflection in the disclosure letter, or to document any disclosure. Subsequently, it should be the negotiation project team that decides whether or not making the disclosure is appropriate.

General vs. specific disclosures. The party that prepares the disclosure letter will try to avoid the disclosure of information that is publicly available (e.g. in public registers, such as for companies, for ownership rights of real estate, or for patents or trademarks). Obviously, the work related to making such disclosures can be enormous (with a risk of missing certain specifics), whilst the information itself may not be very useful (other than having an aggregated list of items that will be transferred).

Similarly, the disclosing party will prefer to refer to existing and readily available documents, such as the transaction’s information memorandum and (the Powerpoint handouts of) management presentations, as well as any disclosed financial statements and management reports. For this reason, a first draft disclosure letter will likely attempt to include all information that is generally available to the public or otherwise available to the other party. The part of the disclosure letter that addresses these disclosures is referred to as general disclosures (as opposed to specific disclosures that are prepared in view of a certain warranty).

In an M&A-transaction a seller will try to elaborate on the opportunities that were given to the purchaser and its advisers to undertake an (extensive) due diligence investigation. Accordingly, the seller will attempt to have the complete dataroom considered to be a disclosure against all warranties.

Numbering of disclosures. It is recommended that the numbering of individual disclosures match the numbers of the warranties. Accordingly, the disclosed item gets a number that corresponds to the warranty in connection with which it is primarily included.

Disclosure against what? Because a warranty will typically have a great level of overlap with matters addressed in other warranties, the related disclosures will inevitably need to be either repeated or a statement be included that the disclosures are deemed to be made against each of the warranties (and that grouping them is for convenience only). This also implies that the party seeking the disclosure may fail to recognise its impact, whilst at the same time, the opposite approach would lead to unnecessarily extensive and repetitive disclosure letters.

Warranties in large transactions (M&A or financing)

Below, we will address a few other particularities of warranties and limitation of liability as they are used in the context of major transactions (e.g. M&A or financing transactions).

Sandbagging and warranties. Negotiating for contractual provisions that create burdens to actually receiving compensation is referred to as ‘sand-bagging’. Sand bags are used to protect against invasions and may indeed imply the impossibilities associated with battles taking place in the trenches. Sand-bagging behaviour obviously insinuates that a seller is creating contractual burdens and is overly complicating a purchaser’s ability to recover damages. As Dutchmen, however, we should emphasise that sand-bagging is also a modest alternative to a dike and yet is a proper means to prevent a flood.

Making incorrect warranties. In line with the principle of allocating risk, some people consider that it is appropriate for a seller of a company to make warranties about information which it already knows to be incorrect, without making (or even attempting to make) disclosures against such warranties. Such behaviour may be questionable in the event that such incorrect warranty substantially impacts the purchaser’s ability to recover damages under any other warranties, because of the agreed limitations on liability claims (i.e. the ‘cap’).

It is inappropriate if a seller does not answer questions during a due diligence exercise, anticipating a subsequent first draft of warranties in which the subject matter will most likely be addressed (and also anticipating that it will be able to stay away from making such warranties during the negotiations). Conversely, a seller may expect that if a data room is not as such a disclosure against warranties and it contains important information that clearly and materially contradicts a warranty, such information should be addressed during the negotiations rather than that the purchaser raises it as a warranty claim immediately after the closing of the transaction.

Categories of M&A-warranties. Warranties commonly made in the context of an M&A transaction can be classified in three basic categories:

• Warranties about the transaction as such. The first category includes warranties related to the transaction. The purpose of these warranties (also known as enforceability warranties) is to ascertain that the party making them has the contractual capacity and authority to enter into the agreement, and that the contract is enforceable and does not violate a law or regulation. These are standard warranties. Under EU member state laws they are often also largely (if not entirely) redundant since modern legal systems will most likely protect the other party against such warranties being incorrect (in any respect). Therefore, enforceability warranties rather serve information purposes. They are rarely negotiated, except that a purchaser may try to extend their scope to subject matters in the second category.
• Subject matter warranties. A second category of warranties relates to the subject matter of the transaction. These warranties are made to en­sure that a party is acquiring what it agreed to and may reasonably expect, and are tailored to the specific context of the transaction. Some examples:

*   an ordinary sales agreement may include warranties that the products are unused, of good workmanship and free of any material defects;
*   a software licence would include warranties that the software will be free of worms and viruses and will not perform any operation other than specified in the Specifications;
*   a business and asset purchase agreement will include warranties that the sold property is free from encumbrances;
*   a patent licence contains warranties by the licensor that the patent is properly registered and does not infringe other (pre-existent) patented technologies;
*   a share purchase agreement includes warranties that the target company has withheld all taxes required to be withheld and paid all taxes in a timely manner.

• Warranties about the parties. Many contracts require the parties to make warranties about themselves. These are desirable if a party must be (and remain) able to perform its contractual obligations. Examples relate to the financial condition of the party, and in particular its creditworthiness.

To ‘bring down’ warranties. Warranties are made as of a particular moment in time. That moment can be the signing date of the contract, the closing date of the transaction or any other date provided for in the contract. Without further specification, a warranty will be deemed to be made on the date that the relevant product is delivered. Warranties that are deemed to be repeated on a later date are referred to as being brought down.

Bringing down warranties is usually required at times when a significant event occurs under an agreement. For example, a share purchase agreement may provide for completion of the transfer only after the required approvals are obtained; the pur­chaser will require the seller to bring down its warranties at the closing. This bring-down implies an extra incentive for the seller to make sure that the quality of the transferred business remains as it was at the signing date by leaving any deterioration for the account of the seller.

Warranty bring-downs are also found in other types of agreement. In master sale agreements with ongoing deliveries of products pursuant to purchase orders, the purchaser needs the warranties to be made as of each delivery date. Similarly, a borrow­er is required to bring down its warranties to the lender each time it draws under a loan or credit agreement.

If a warranty in a credit agreement provides that all of borrower’s subsidiaries are listed in a schedule, the bring-down of that warranty may become impossible (and rightfully so): when new subsidiaries are created or acquired, the creditworthiness of the borrower will probably change. In such cases, additional drawings cannot be made without violating the warranty, unless a specific waiver is obtained or an appropriate amendment made to the schedule. Obviously, such waiver or amendment will trigger the lender to scrutinise the creditworthiness of the borrower after creating or acquiring the subsidiaries.

Survival of warranties. Other than the bringing down of warranties at some future moment in time, there is also the concept of warranties ‘surviving the closing of a transaction’. Survival of the warranties in fact refers to the right of the purchaser to claim under those warranties.

Normally, the seller will limit this right by stipulating that all claims related to a warranty being incorrect must be made (or made known) within a certain period of time. In such case, it is appropriate to distinguish between the various types of warranties. Accordingly, short periods would apply to running business and tangible assets, whilst warranties related to real estate and environmental contamination would probably be subjected to longer periods. Warranties related to taxation are often subject to the statutory period during which tax authorities may continue to impose taxes related to the period before closing of the transaction.

[1]  UCC, Article 1, General provisions, Section 1-210 (10).
[2]  UCC § 2-314(2).
[3]  UCC, Article 1, General provisions, § 1-210(10).

Limitations of liability in contracts

Limitations of liability (and exclusions of liability) are almost invariably found in contracts. In addition to limitations on the warranty period to claim under the warranties, a supplier will normally limit its risks and exposure to liability in various other respects:

• the damages eligible for compensation: excluding indirect (consequential) damages, only damages individually exceeding a de minimis threshold and furthermore damages that are not remedied by the purchaser;
• matters affecting the purchaser’s compensation (i.e. scope of damages): aspects of own fault, mixed causation, claim-related benefits, recourse rights on third parties (e.g. suppliers);
• causation: limiting eligible damages to those being the immediate and adequate consequence of a warranty being incorrect;
• aspects managing the claim process: a purchaser’s ‘own risk, also known as a basket, which has to filled before a first claim can be made;
• (notification and) handling of third party claims that may give rise to a warranty claim;
• procedures for making warranty claims must be followed (e.g. not mere notifications of claims interrupting the contractual period of limitation but requiring that a claim is initiated).

Providing for a ‘cap’. Many contracts contain a monetary limitation of liability (a ‘cap‘). For M&A-agreements, such a cap is typically defined as a percentage of the (preliminary or adjusted) purchase price or simply a fixed amount (agreed by the same token). Normally, a cap should not apply to matters relating to ownership or entitlement to sell because it affects the entire sales transaction (and more).

For commercial contracts, such reference is not always readily determinable or the parties may have reasons to vary. Commonly used caps or limitations of liability are:

(a) a simple amount (perhaps relating to the amount ordinarily received under a purchase order);
(b) the amount of the purchase order (under which the defective products were delivered);
(c) the amount actually paid under the agreement during a period of time preceding the claim;
(d) a percentage of the amount under (c);
(e) the higher of (i) a simple amount, or (ii) a reference such as under (b), (c) or (d). The background of this is to provide substance during the initial period of time or in case of irregular deliveries; or
(f) the lower of the two references mentioned under (e). The background is of course to provide the widest possible approach to the conditions.

Any cap established in accordance with one of the above referenced amounts, will nevertheless be subject to further discussions. Solutions to overcome such discussions is to further distinguish for the risks involved (and not apply the standard one-size-fits-all clause). An example of such distinction was proposed by D.C. Toedt III:

A damages cap distinguishing the types of risk involved could be, for example:

(a) three times X for any damages that arise during the first 3 months after the later of the Signing Date or Milestone 1 having been delivered and accepted;
(b) two times X during the 9 months thereafter; and
(c) one time X thereafter until the later of 24 months after the Signing Date or 12 months after Milestone Y having been delivered and accepted.

In this example, the factor X could be:

(i) a fixed amount;
(ii) defined as the amount actually paid by customer to service provider during the 24 months preceding any claim; or
(iii) defined in any other convenient way.

In many commercial contracts in which intellectual property rights are at stake, the limitation of liability clause contains a carve-out or exception for breach of the confidentiality provision and for IP infringement claims. A very common (and between equal parties, often accepted) reference is:

…the amounts actually received by Seller under this Agreement during the twelve months period preceding the event or circumstances giving rise to a claim.

Note that in case of a claim, the customer will typically cease payment of its invoices (and in many industries, a seller will nevertheless continue its supplies, at least for a certain period of time), which makes twelve months preceding the claim relevant. Arguments to come to a higher amount (beyond one purchase order or the scope of the contract) are often established by reference to the amount that the parties order annually: in a good commercial relationship, a purchaser expects that for determining a cap on liability other supplies between the parties are also taken into account (i.e. no limitation merely to amounts paid under the agreement, let alone under a purchase order).

Carve-out cyber-security breach. A further carve-out is often made for cyber-liability: damages resulting from failing IT-security, poor software (being hacked or otherwise resulting in a data breach), poor security practices by the seller, etc. While a properly organised supplier should have this in order, the liability exposure (risk impact) is both significantly higher and the insurability under a cybersecurity insurance well-possible and common.

Indemnity clauses (for infringements)

Many contracts include an indemnity clause. Indemnity clauses entitle one party (the indemnified party) to be indemnified by its supplier (the indemnifying party) against damages resulting from a claim made by a third party and caused by the product or service delivered by that supplier.

Two indemnification clauses are commonly provided. First, the indemnity can relate to infringement of third party intellectual property rights resulting from the use of rights or technology licenced from the supplier. Secondly, an indemnity can relate to claims by customers of the indemnified party resulting from the use of contaminated raw materials or incorporation of defective half-products in the end-products supplied by the indemnified party; the indemnity is in fact the extension of a warranty that comes to life later in the supply chain.

Procedural law aspects. The scope and nature of such indemnification varies considerably from jurisdiction to jurisdiction. In some countries, the indemnity can be invoked in court proceedings by such third party claimant, following which, the party providing the indemnity would step into the position of the party with the benefit of the indemnity. In other countries, civil procedural law does not provide for such right (or obligation) of substitution but requires the indemnified party to continue the court proceedings notwithstanding its right to take recourse against the indemnifying party.

Indemnity clauses – addressed aspects. The indemnification provision should address the key elements:

• the subjects of the indemnity: who is entitled to be indemnified (this may include affiliates and subsidiaries of the indemnified party, as well as customers of the party that is contractually entitled to the indemnity);
• the object of the indemnity: which claims and which damages can be reimbursed or compensated and which claims are exempted;
• the conditions for indemnification: freedom to negotiate and settle, maximum amount of the indemnity;
• procedural aspects: prompt notice of the claim, responsibility to act or respond, required prior approvals or consent by the indemnified party;
• remedies: apart from a monetary settlement of the claim, other remedies are often possible (or should be provided for within a certain time frame);
• a counter-indemnity: claims that are exempted from the indemnity should be borne by the indemnified party (i.e. in case the claim is also made against the indemnifying party).

The wording indemnify and hold harmless is a doublet that originates from the Viking era in England. A purchaser-friendly indemnity for infringement of intellectual property rights could for example be as follows:

8.1 Supplier shall defend and indemnify Customer against all losses, damages and expenses incurred by Customer which arise out of or in connection with a claim or proceeding alleging that the manufacture, sale, importation, use or disposition by Customer or any of its customers of a Product or any part thereof, or of equipment incorporating such Product, directly or indirectly infringes Intellectual Property Rights, trade marks or trade secrets of a third party (a “Claim“).

8.2 In the event of a Claim, Customer shall:
(a)  notify Supplier of the Claim;
(b)  grant Supplier the authority to either settle or defend such Claim with counsel of its choice, provided that any settlement does not impose liability on Customer; and
(c)  cooperate and provide reasonable assistance in the defense of the Claim, at Supplier’s expense.

8.3 In connection with a Claim, Supplier may, at its expense, procure for Customer and its customers the right to continue all acts in relation to the Product, or if a procurement of such right is not a reasonable or viable option, (a) replace existing Products or parts thereof and (b) replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (c)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.

8.4 If a Product is held to infringe and its manufacture, sale, importation, use or disposition is enjoined, Supplier shall, at its discretion and expense, either procure for Customer and its customers (i) the right to continue all acts in relation to the Product, or (ii) replace the Product or part thereof and replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (ii)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.

A supplier (or licensor) geared indemnification will likely exclude various aspects. Although this may well be self-evident, being explicit in case of an overlap or division of responsibilities between the contracting parties is recommended. For example, the above section 8.2 can be continued as follows:

Supplier has no obligation or liability to Customer in connection with any Claim:
(a) to the extent that such Claim is attributable to specifications, designs or instructions provided by Customer; or
(b) to the extent that the Claim is based on any prototypes, risk production units, or disabled parts of the Product, the use of which has not been expressly permitted; or
(c) for any unauthorised use or disposition of the Product beyond the Specifications; or
(d) to the extent that the Claim arises from (i) a modification of the Product and the infringement would have been avoided without such modification, or (ii) the combination of the Product with any other product, service or technology, or (iii) the use of the Product or any part thereof in the practice of a process if Customer does not incorporate the Product into a device of which the end-user is a consumer; or
(e) to the extent a Claim arises from Customer’s continued manufacture, use, sale, offer for sale or other disposition or promotion after Supplier’s notice to Customer that Customer must cease such activity, provided such notice shall only be given if the Product is, or is likely to become, the subject of such a claim of infringement; or
(f) for any costs or expenses incurred by Customer without Supplier’s prior written consent.

Hardship clauses – Changed circumstances or imprévision

The legal context of hardship clauses addressing changed circumstances.
An area of the law that divides the legal traditions is visible in the concept of force majeure. During the late 19th century, the French Cour de cassation (‘supreme court’) established the overriding principle that contractual provisions are recognised as a strong force of law. Unless the parties provided for exceptions in the case of hardship or force majeure, the principle ‘contract is contract’ (pacta sunt servanda) prevails. This principle of “you have to deliver what you promised” is also essential in common law.

Nevertheless, some circumstances that go beyond the reasonable expectations of the parties may call the binding nature of a contract into question. The occurrences of life are infinite and, accordingly, upon the occurrence of unforeseen circumstances, a contract or a rule of law might provide an unjust result. It makes a hardship or force majeure provision of great importance[1].

Examples of hardship cases (where changed circumstances were acknowledged).
A change of circumstances triggering a renegotiation or change of an agreement should be highly exceptional. Cases in which such renegotiation or change would be appropriate could be:

• inflation of over 100 percent per day or per week (e.g. as happened in Zimbabwe (2008), Germany (1923), Greece (1944), Yugoslavia (1994)) whilst the contract was entered into during relatively stable economic circumstances (of low inflation);
• a collapse of the real estate market (price drops by over 95 percent in a few days), whilst the affected contractual obligations were non-speculative nature, unrelated to real estate market developments;
• a pricing formula linked to an electricity price index, which price index increases significantly (e.g. effectively turning the index from a ratio of less than 1 (one) into a factor in excess of 1 (one); in other words, changing a mathematical divider into a multiplier);
• a purchase price expressed in a currency that has become subject to extreme fluctuations whilst the contract was entered into during a period of relatively stable exchange rates;
• delivery requirements for countries that have become inaccessible due to political reasons or because of international trade embargo;
• minimum purchase requirements or exclusivity arrangements in long-term agreements, where the product (or a key component of it) has been abandoned due to technological developments.

The examples that might justify an amendment of the contract are highly exceptional. Courts are very reluctant to step into such revision. Obviously, whilst a hardship clause as such can be desirable, providing for changes of circumstances also lowers the threshold for a party to call upon it.

ITC Model contracts on hardship in contracts

The ITC Model Contracts provide for a contractual device applicable in exceptional cases of a change of circumstances. Those exceptional cases would typically include changes of circumstances or cases of hardship that (a) the parties did not already (implicitly) incorporate in the contract by way of risk allocation, (b) should not remain for the risk and account of the affected party (e.g. because the occurred change of circumstance is part of its business), or (c) could not be influenced by the affected party. For example the international long-term supply contract:

9. Change of circumstances (hardship)
   9.1          Where the performance of this contract becomes more onerous for one of the Parties, that party is nevertheless bound to perform its obligations subject to the following provisions on change of circumstances (hardship).
   9.2          If, however, after the time of conclusion of this contract, events occur which have not been contemplated by the Parties and which fundamentally alter the equilibrium of the present contract, thereby placing an excessive burden on one of the Parties in the performance of its contractual obligations (hardship), that party shall be entitled to request revision of this contract provided that:
   9.2.1 the events could not reasonably have been taken into account by the affected party at the time of conclusion of this contract;
   9.2.2 the events are beyond the control of the affected party; and
   9.2.3 the risk of the events is not one that, according to this contract, the Party affected should be required to bear.
   9.3          Each party shall in good faith consider any proposed revision seriously put forward by the other party in the interests of the relationship between the Parties.

Interference by a third person. The idea behind the clause is that the parties should be free to consult each other in the event of a major change in circumstances − particularly one creating hardship for a particular party. However, a company should only include the option at the end of Article 9.4 (right to refer to the courts/arbitral tribunal to make a revision or to terminate the contract) if (a) the company considers that it is not likely to be used against that party’s interests by a party in a stronger tactical position or (b) the right to refer to a court/tribunal is already an existing right under the applicable governing law in the event of hardship.

9.4          If the Parties fail to reach agreement on the requested revision within [specify time limit if appropriate], a party may resort to the dispute resolution procedure provided in Article 18. The [court/arbitral tribunal] shall have the power to make any revision to this contract that it finds just and equitable in the circumstances, or to terminate this contract at a date and on Terms to be fixed.

DCFR on hardship in contracts

The Draft Common Frame of Reference (DCFR) provides for a mechanism that is inspired by the approach of the Dutch Civil Code (art. 6:258) and the Italian Civil Code (art. 1467 (eccessiva onerosità)):

III. – 1:110: Variation or termination by court on a change of circumstances
(1)  An obligation must be performed even if performance has become more onerous, whether because the cost of performance has increased or because the value of what is to be received in return has diminished.
(2)  If, however, performance of a contractual obligation or of an obligation arising from a unilateral juridical act becomes so onerous because of an exceptional change of circumstances that it would be manifestly unjust to hold the debtor to the obligation a court may:
(a) vary the obligation in order to make it reasonable and equitable in the new circumstances; or
(b) terminate the obligation at a date and on terms to be determined by the court.
(3)  Paragraph (2) applies only if:
(a) the change of circumstances occurred after the time when the obligation was incurred;
(b) the debtor did not at that time take into account, and could not reasonably be expected to have taken into account, the possibility or scale of that change of circumstances;
(c)  the debtor did not assume, and cannot reasonably be regarded as having assumed, the risk of that change of circumstances; and
(d) the debtor has attempted, reasonably and in good faith, to achieve by negotiation a reasonable and equitable adjustment of the terms regulating the obligation.

Unidroit Principles on hardship in contracts

The Unidroit Principles address the issues related to hardship and probably provide for a more sophisticated framework, consistent with the ITC Model Contracts’ solution, permitting the parties to find a solution:

SECTION 2: HARDSHIP
Article 6.2.1 (Contract to be observed)
Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.

Article 6.2.2 (Definition of hardship)
There is hardship where the occurrence of events fundamentally alters the equilib­rium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and
(a)  the events occur or become known to the disadvantaged party after the conclu­sion of the contract;
(b)  the events could not reasonably have been taken into account by the disadvan­taged party at the time of the conclusion of the contract;
(c)   the events are beyond the control of the disadvantaged party; and
(d)  the risk of the events was not assumed by the disadvantaged party.

Article 6.2.3 (Effects of hardship)
(1)  In case of hardship the disadvantaged party is entitled to request renegotia­tions. The request shall be made without undue delay and shall indicate the grounds on which it is based.
(2)  The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
(3)  Upon failure to reach agreement within a reasonable time either party may resort to the court.
(4)  If the court finds hardship it may, if reasonable,
(a)  terminate the contract at a date and on terms to be fixed, or
(b)  adapt the contract with a view to restoring its equilibrium.

Because courts would be very reluctant to step into the position of a contracting party, the solution of a case of hardship would apply only in highly exceptional, special circumstances. Especially in common law and in French law, this principle is taken rather strictly. In the Germanic legal tradition, such force majeure or hardship provision is not a must-have. This is because the court will take an objective (more reasonable) approach as regards the question of whether a party is excused from performance given the occurrence of exceptional circumstances.

[1]  A comprehensive study of the scope and effect of unforeseen circumstances (and hardship, mistake and force majeure) in the European Union countries is: Ewoud Hondius & Hans Christoph Grigoleit (Eds.), Unexpected circumstances in European contract law, The common core of European private law, Cambridge University Press 2011, 692 p. (In the book, Willem Wiggers reported on the laws of The Netherlands.)

Force majeure clauses

Many suppliers are exposed to the risk that an event of force majeure prevents timely delivery or performance of their obligations. Force majeure clauses organise what happens if such circumstances (a ‘force majeure event’) occur.

Force majeure and business operations. Whether or not to include a force majeure clause, its wording and the definition of what entails an event of force majeure largely depends on the position of the contract drafting party. Force majeure clauses either favour the side where a force majeure event will typically occur (e.g. manufacturer, service provider, seller) or the side of the customer. It is typically the first group that wishes to provide for a force majeure clause.

A manufacturer would expand the scope of force majeure and increase its flexibility to remedy a force majeure event, including its consequences. The manufacturer, service provider or seller will tie in subjective elements, such as a strike by its own employees, interruptions in its supply-chain (including delays in delivery of raw materials), transportation difficulties, industrial disputes and other developments influencing any part of the supply chain, as well as circumstances that may be avoidable, such as the breakdown of equipment or any machinery. On the other hand, the customer will go for highly exceptional examples, which are objective, ‘completely’ unforeseeable and generally out of the control or manageability of the other party.

The above considerations imply that including a force majeure clause would be more appropriate in contracts governed by French law and furthermore depends on the position of the contract drafting party. A manufacturer, service provider or seller will likely include a provision as follows:

Notification of Force Majeure. A Party prevented from fulfilling its obligations duly and timely because of an event of Force Majeure shall inform the other Party without undue delay and make reasonable efforts to terminate the Force Majeure as soon as practicable. The Parties shall consult with each other in order to minimise all damages, costs and possible other negative effects.

For the purpose of this Section, Force Majeure means any and all circumstances beyond the reasonable control of the Party concerned, including acts of God, earthquake, flood, storm, lightning, fire, explosion, war, terrorism, riot, civil distur­bance, sabotage, strike, lockout, slowdown, labour disturbances, accident, epidemic, difficulties in obtaining required raw materials or labour, lack of or failing transportation, breakdown of plant or essential machinery, emergency repair or maintenance work, breakdown of public utilities, changes of law, statutes, regulations or any other legislative measures, acts of governments, supranational organisations or other administrative or public agencies, orders or decrees of any court, acts of third parties, delay in delivery or defects in goods or materials supplied by suppliers or subcontractors or an inability to obtain or retain necessary authorisations, permits, easements or rights of ways.

Effects. The Party prevented from fulfilling its obligations shall not be required to remove any cause of Force Majeure or to replace or provide any alternative to the affected source of supply or the affected facility if that would require additional expenses or a departure from its normal practices, or to make up for any quantities not supplied. If an event of Force Majeure has occurred, the Party prevented from fulfilling its obligations is entitled to allocate, in a manner it considers reasonable, the available quantities of Products amongst its customers and its own requirement.

Obviously, the customer will seek a different type of wording:

Notification of Force Majeure. A Party prevented from fulfilling its obligations duly and timely because of an event of Force Majeure shall promptly inform the other Party specifying the cause of Force Majeure and how it may affect its performance, including a good faith best estimate of the likely scope and duration of interference with its obligations, and shall make best efforts to terminate or avoid the Force Majeure circumstances as soon as practicable. The Parties shall consult with each other in order to minimise all damages, costs and possible other negative effects.

For the purpose of this Section, Force Majeure means unforeseeable and unavoidable circumstances entirely beyond the control of the Party concerned, such as acts of God and wars.Effects. The Party other than the Party prevented by a Force Majeure event shall be released from performing any of its obligations for the duration of the Force Majeure event. Furthermore, if an event of Force Majeure continues for more than 60 days, such latter Party shall be entitled to terminate this Agreement or any purchase order or part of a purchase order, with immediate effect and without liability to the Party prevented by the Force Majeure. Upon remediation of the Force Majeure event, the Party prevented by the Force Majeure shall promptly resume performance on all purchase orders of the other Party (which have not been terminated).

Note that you can download our model Force majeure clause customer-friendly from our model contracts platform. Our model Force majeure clause supplier-friendly is also shared on the platform.

Force majeure clauses. The middle ground is somewhere in between. An event of force majeure should be reasonably unforeseeable, out of the debtor’s control and reasonably unavoidable. Once an event of force majeure has occurred, whether contractually excusable or not, it is often possible to solve its consequences or at least to establish an appropriate way forward.

In such circumstances, it may well be important for the customer to receive all relevant information promptly and probably also to be involved in choosing the remedies. In view of the consequences and entitlement to stay involved, even a buyer or contractor may prefer to widen the scope of the force majeure situations and get an informed, preferred customer position.

Legal context of force majeure. An area of the law that divides the European legal traditions is visible in the concept of force majeure. In short, the background of this division goes back to the legalistic era of the late 19th century. At the time, the French Cour de cassation (French ‘supreme court’) established the overriding principle that contractual provisions are recognised as a strong force of law. Unless the parties provided for exceptions in the case of hardship or force majeure, the principle ‘contract is contract’ or ‘a contract serves as the law between the contracting parties’ (pacta sunt servanda) prevails.

In the Germanic legal tradition, such provision is not a must-have. As explained in connection with contract interpretation and legal cultures this is because the court will take an objective (more reasonable) approach as regards the question of whether a party is excused from performance given the occurrence of exceptional circumstances. Still, also in Germanic traditions, ‘contract is contract’.

Confidentiality clauses

Confidentiality clauses are commonly inserted in any kind of contract. They are quasi-miscellaneous provisions.

Still, a contract drafter should establish whether a confidentiality clause is indeed desirable. In contracts for the sale of bulk products, a confidentiality provision may well be excessive. In product development arrangements (sometimes as part of a sales contract), the developer may prefer to remain free to operate making use of information about the products or product applications of its customer. A confidentiality clause in a patent licence may obstruct registration of the licence in national patent registers (making the licence potentially invalid if the patent is sold and transferred to another party or if the patent owner goes bankrupt).

Define the scope of information. The scope of a confidentiality clause requires some care. It is essential to capture the right information. Some parties prefer to be rigorous and require that information is only considered Confidential Information if it is marked as such (and furthermore, in case of oral information, the confidential information must be put in writing and communicated within 30 days of the oral presentation to be covered by the confidentiality provision). A court should be suspicious of whether such a strict approach was indeed intended by the parties. Many companies are less formal; for them:

Confidential Information means any information of a non-public, confidential or proprietary nature; whether of a commercial, financial or technical nature; customer, supplier, product or production-related; and otherwise all information exchanged between the parties in the context of [the Purpose][this Agreement][the Project] shall be deemed to be ‘confidential’.

Of course, the definition can be extended by adding appropriate examples of confidential information, which may include samples, information relating to raw materials, formulae, recipes, specifications, software source code, patent applications, process designs, process models, catalysts and processed materials. Such additions should be product, sector or industry specific.

Note that the definition of Confidential Information is generic. It does not state that the information is owned by one party. This means that the body text should clarify which party may or must do what, and what rights apply upon disclosure.

Marking obligations. The ‘relaxed’ approach to defining confidential information is often complemented by an undertaking to mark information as confidential, for example:

Each Party shall use its best efforts to mark the Confidential Information which is disclosed in writing as being confidential. Failure to do so, however, shall leave the other Party’s obligations set forth in this Agreement unaffected.

The second sentence in this example is sometimes replaced by the more burdensome statement that orally disclosed information is only deemed to be confidential if it has been identified as such or summarised in a written document (with typically the requirement that it be sent to the Receiving Party within 30 days after the disclosure).

Scope of use (the “Purpose”). The scope of use of confidential information needs to be properly restricted. The two main provisions of a confidentiality agreement or clause address the disclosing party’s right to select or deny a disclosure to the receiving party, and the receiving party’s obligation to use disclosed information for a limited purpose only and furthermore to keep it confidential, as follows:

No obligation to disclose. Each Party may furnish Confidential Information to the other Party as it deems necessary or helpful for the Purpose. [to be used in mutual NDA’s]

No obligation to disclose. Each Party may furnish Confidential Information to the other Party as it deems necessary or helpful for [the completion of the Project] [the performance of the Services] [that Party’s performance]. [to be used in contracts]

Restrictions on use. A Receiving Party shall not use Confidential Information of the Disclosing Party for purposes other than in direct relation with the Purpose. The Receiving Party shall treat the Disclosing Party’s Confidential Information with at least the same degree of care as it would use in respect of its own confidential information of like importance, but in any event a reasonable level of care.

If a higher level of care would be more appropriate, it may be necessary to provide specific guidelines for protecting know-how. A disclosing party should in any case be entitled to rely on a higher level of care professed by the receiving party.  Please note the non-capitalisation of confidential information in the penultimate line, above.

Expanded scope to affiliated companies and employees. Because confidentiality obligations are normally assumed by two or a limited number of formal entities, it is important to expand the scope of confidentiality to people related to those entities. Furthermore, the receiving party should limit such expressed expansion only to the extent necessary (albeit that in practice ‘everybody’ will be aware that the parties are exchanging confidential information).

Related Parties. The Receiving Party shall disclose Confidential Information to its group companies (including subsidiaries and affiliates), directors, officers, employees or other representatives only on a need-to-know basis. Prior to the disclosure of the Disclosing Party’s Confidential Information to such persons, the Receiving Party shall inform each such person of the confidential nature of the Confidential Information and shall expressly require that the person agrees to treat the Confidential Information as is provided in this Agreement. Notwithstanding due observance of these requirements, the Receiving Party shall be liable for any breach of the provisions of this Agreement by such person.

Note that subsidiaries and affiliates are not covered, unless they qualify as a group company (normally meaning entities that are fully consolidated in the financial accounts and hence under full control of the receiving party). Employees are, in most jurisdictions, subject to statutory duties of confidentiality, but even when they are subject to such obligations by virtue of their employment conditions; it would be unusual not to expressly refer to their obligations.

Directors and officers are mentioned separately from employees because in most jurisdictions they are not an ‘employee’ of the company they serve. It is appropriate to stipulate that employees will receive confidential information on a need-to-know basis only, which makes it easier for the disclosing party to question unnecessary internal disclosures (and require a higher level of care).

Finally, because all these individuals are not themselves contracting parties and probably not even capable of bearing the consequences of a breach, it is important to attribute any such breach to the receiving party (even if the receiving party has implemented proper measures to prevent disclosure).

Exceptions to confidentiality. A properly drafted confidentiality clause also addresses the exceptions, even though they may be presupposed or raised as a defence against a claim for breach.

Special exception: intellectual property rights. If disclosures are made in connection with research or development projects or service agreements, and intended to be protected under intellectual property rights, it is important to regulate the input or suggestions for improvement. Intellectual property laws protect the creator or inventor for his or her own ideas, if, whilst presenting inventions to an adviser or interested customer, that customer gives feedback on the ideas, the latter may claim co-ownership or co-inventor rights. Such effect, co-ownership or co-inventorship merely resulting from feedback is often undesirable (but it is the legal consequence of a failing contractual arrangement to the contrary).

If the receiving party (i.e. the adviser or potential customer) refuses to waive ownership rights on any feedback given, and the disclosing party nevertheless desires to make the disclosure, it may be important to agree on a protocol allocating time and opportunity to make a disclosure in full or to give feedback, respectively. Examples can be found in most software licences or online Q&A’s, where modifications and suggestions for improvement or additional functionalities are gratefully appropriated by the licensor.

Subcontracting clauses in contracts

Many no-subcontracting clauses in contracts for provision of service or supply of goods prohibit subcontracting, either in the miscellaneous chapter or under the article on contract scope:

No subcontracting. No obligations under this Agreement or a Statement of Work, which may cause Customer, any of its subcontractors or customers (including end-users) to infringe upon third party’s Intellectual Property Rights shall be sub­contracted, unless it is approved by Customer, which approval shall not be unreasonably withheld or delayed. Service Provider shall procure that:
(a)  Article n [on quality, compliance and audit rights] shall extend to each sub­contractor and their subcontractors; and
(b)  each subcontractor shall comply in all respects with the provisions of this Agreement (as if it is Service Provider itself).
Supplier shall remain the primary debtor and be responsible for the due and timely performance by any subcontractor.

The practical merits of no-subcontracting clauses in contracts are not as severe as it may appear. The background of this is certainly not limited to a desire to understand or manage a service provider’s costs accumulating in the supply chain. Responsible business parties wish to be fully aware of the identity of all their suppliers in the supply chain. A customer often wants to make sure that know-how required for, or developed in connection with, the services obtained from a service provider does not become diluted over an extensive chain of subcontractors. Also, responsible business parties cautiously monitor the supply chain for generally unacceptable matters, such as child labour, remarkably bad working conditions or environmentally hazardous production methods.

Although some variations amongst national laws are likely to exist, communis opinio may tend to allow subcontracting, as the Common Frame of Reference shows:

1. C. – 2:104: Subcontractors, tools and materials
   (1)  The service provider may subcontract the performance of the service in whole or in part without the client’s consent, unless personal performance is required by the contract.
   (2)  Any subcontractor so engaged by the service provider must be of adequate compe­tence.
   (3)  The service provider must ensure that any tools and materials used for the performance of the service are in conformity with the contract and the applicable statutory rules, and fit to achieve the particular purpose for which they are to be used.
   (4)  Insofar as subcontractors are nominated by the client or tools and materials are provided by the client, the responsibility of the service provider is governed by IV.C. – 2:107 (Directions of the client) and IV.C. – 2:108 (Contractual obligation of the service provider to warn).

In many cases, the no-subcontracting clause merely triggers an information requirement to the customer, who does not intend to reject a request to have certain of the supplier’s obligations performed by a third party. Note however, that the prohibition does imply a ‘veto right’ and if the customer established a (dual) supplier policy, the agreed performance is likely assumed to be personal. In that case, the subcontracting clause will be enforced (or result in the ongoing evaluation of the subcontractors).

Amendments clause

An amendments clause should address two elements. First, an amendment should be in writing in order to ascertain that both parties understand the scope and nature of any contract changes and to be able to keep track of the status of the contract. Secondly, it should not be possible to amend a contract inadvertently, binding a party to the informal promises of a junior sales representative, and should therefore be considered (and accepted) only by the persons authorised to act on behalf of the relevant party. Consider the following amendment clause:

Amendments. No amendment of this Agreement shall bind a Party unless it is in writing and duly signed by the Parties.

The inclusion of this amendments clause attempts to prevent a business representative of one party making promises they cannot uphold and to prevent such promises from becoming binding because the other party acted in reliance of them. The amendment clause builds in the certainty that the management of a company and not an arbitrary employee is responsible for any assurances made by the Company.

The scope of an amendments clause is not as firm and certain as it appears, because if the same employee starts to repeat his promises and if the company appears to support this (or somehow acts accordingly), the company may nevertheless be bound. The Common Frame of Reference reflects this subtle distinction:

1. – 4:105: Modification in certain form only
   (1) A term in a contract requiring any agreement to modify its terms, or to terminate the relationship resulting from it, to be in a certain form establishes only a presumption that any such agreement is not intended to be legally binding unless it is in that form.
   (2) A party may by statements or conduct be precluded from asserting such a term to the extent that the other party has reasonably relied on such statements or conduct.

Because the law does not always uphold the strict enforcement of formal requirements, a company or its legal department should educate employees as regards the consequences of their informal and promissory behaviour.

Announcements clauses

In a so-called announcements clause, many companies, and particularly those that are subject to regulatory requirements on disclosure of inside information, keep some control over (public) announcements made by their partners, suppliers, customers etc.

The following announcements clause is rather restrictive, but in practice it does not seem to lead to significant problems. Like all contractual prohibitions, they force one party to obtain the waiver or approval of the other party and, similarly, they trigger transparency rather than non-cooperative responses.

Announcements. This Agreement and its contents shall be considered confidential by the Parties. Neither Party shall make any announcement with respect to the transactions contemplated by this Agreement or any ancillary matter without the prior written approval of the other Party.

The announcements clause is often inserted as part of the article on confidentiality but may well be positioned as a section in the miscellaneous article.

Often, a party wants to avoid the purchase price being disclosed. In such case, the buyer may need a carve-out for disclosures vis-à-vis the banks providing its financing. In private equity transactions, the buyer will likely require the following exception:

Notwithstanding the previous sentence, the Purchaser shall be entitled to disclose information relating to the purchase price under this Agreement to the limited partners of its parent entity, to potential limited partners of its parent entity and to banks and other institutions interested in providing financing, without the prior written consent of Seller.

Assignment or no-assignment of contracts?

Many contracts will provide for a prohibition to assign the rights and obligations under the agreement – so-called assignment clauses. Normally, each party should be able to negotiate that the approval of the other party to an assignment will not be unreasonably withheld or delayed:

Assignment. No Party shall assign its rights or obligations under this Agreement in whole or in part, without the prior written approval of the other Party, which approval shall not be unreasonably withheld, conditioned or delayed.

Carve-outs allowing assignment. In many cases, the parties would like to make an extra carve-out for intra-group restructurings of activities or the performance under the contract by an affiliate, whether for tax or other geographical reasons. This would be the typical example for the applicability of shall not be unreasonably withheld.

However, contracting parties may seek more certainty. Uncertainty becomes particularly problematic when a party prepares a divestment of the business. Obviously, when the new investor in such business is a competitor of the customer, the latter’s refusal to unconditionally approve assignment is reasonable. In other cases, the parties want to be free to assign the agreement (i.e. the rights and related obligations) as part of a sale of the entire business to which such agreement relates. The uncertainty may be covered by a specific exception:

…, except that Seller may assign its rights and obligations under this Agreement in connection with a sale of all or a substantial part of its business to which such rights and obligations pertain.

The more complete version will also require a re-assignment in case of divestment of the Affiliated Company and have an additional provision:

Seller shall procure that an assignee Affiliate assigns back the assigned rights and obligations, immediately prior to such assignee ceasing to be an Affiliate of it.

Personal nature of the contract. The exception and related assign-back provision can, of course, accommodate both parties. Note, however, that there is a greater logic that a purchaser does not want to source from its competitors or from suppliers with a questionable background (e.g. suppliers obtaining products manufactured by children or in an environment-polluting way) than vice versa. Child labour or pollution of the environment are matters that a company would typically want to control upwards the product chain and not down. For a discussion of the wording shall not be unreasonably withheld, conditioned or delayed, click here.

Assignment and transaction financing (pledge). In case of private equity and other leveraged transactions, the purchaser may need to be able to assign its rights (and obligations) freely under the share purchase agreement, in order to be able to obtain financing more easily. In such case, the seller would keep some control over the financing parts of the transaction by a restrictive assignment clause.

The caveat that assignment shall not unreasonably be withheld or conditioned will give the seller at least the opportunity to review the financing obligations and analyse the potential consequences of an assignment of the rights (and obligations) under the share purchase agreement to the banks and other lenders involved. A relaxed assignment clause facilitating the purchaser would be as follows:

Assignment. No Party may assign or transfer any of its rights or obligations under this Agreement without the prior written approval of the other Party, except that:
(a)  each Party may assign any of its rights under this Agreement to its Affiliates; and
(b)  Purchaser may assign any of its rights under this Agreement to any of its lenders or to any person acquiring all or substantially all of the rights or assets of Target after the Completion Date,
provided, however, that no such assignment shall relieve an assigning Party of its obligations under this Agreement.  For the avoidance of doubt, Purchaser may grant security interests in its rights under this Agreement to its lenders.

Note that an assignment clause does not relieve the parties to an assignment from fulfilling the requirements of the applicable law to such assigned rights and obligations. In order to give an assignment of rights its full effect (i.e. enforceability against the debtor and an obligation on the debtor to perform vis-à-vis the assignee only) most jurisdictions require a (written) assignment notice to the debtor.

Contract law and assignment of obligations. An assignment of obligations would usually be subject to the consent of the debtor although under English law a distinction is drawn between novation and the assignment of a contract; whereby the latter does not require consent although will only be effective so as to assign the ‘benefit’ and not the ‘burden’ of the contract.

See CFR Section III.5.1 (Art. III. – 5:104 ff.) and compare the U.N. Convention on the Assignment of Receivables in International Trade (12 December 2004).

Counterparts

The counterparts clause is one of the most remarkable miscellaneous provisions of modern common law practice. Although it has almost completely lost its necessity over the past century, it is still inserted into most contracts originating from those jurisdictions. For European continental legal systems, the clause is dispensable.

Background. What is the background of a counterparts provision? In common law countries[1], a defendant in court may require from a plaintiff that it provides evidence of the existence of a valid contract by handing over the original documents. If an original with the signatures of both parties or a counterpart with the signature of the other party could not be shown, 350 years ago, a court would have decided that no valid or enforceable contract was entered into. At that time, halfway the 17th century, contracts were drawn up in either of two manners: either as one document reflecting both parties’ rights and obligations and signed by each of them (and each party would receive an equal copy and both such copies would be considered to be an ‘original’); or as the combination of one document reflecting the rights of the lessor or seller (which document was called the ‘original‘) and one document reflecting the remaining rights and obligations (which document was called the ‘counterpart‘). The terminology refers to the physical presentation of contracts: the original and the counterpart were separated by a perforation for detaching the two counterparts. Each party would sign the other party’s counterpart (on which its obligations were reflected). At the turn of the 19th century, contracts were typed on paper with carbon copies behind it: the carbon copies were the counterparts of the one original. In those ages, something like a statutory countersigning requirement was understandable to prevent fraud.

It would suffice to hand over an original executed by the other party if the contract contains a counterparts clause:

Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, and all of which together shall constitute one and the same agreement.

Current necessity. Obviously, over the past centuries, common law courts have created numerous caveats and exceptions to the burdensome countersigning requirement. The idea behind the requirement was that under the (common law) Statutes of Frauds, strict formal requirements apply to the validity and enforceability of certain types of contract. To understand these requirements better, compare the formalities applicable on the European continent for vesting a right of mortgage or incorporating a company, which are subject to the notarial form. Because not all Statutes of Frauds have been modernised and case law is still relatively scarce, there is still no 100 percent certainty that courts will reject a party’s claim in court that there is no properly executed counterpart. Since a few decades, copiers and printers produce originals and their counterparts as if both are an original. This is when the counterparts clause became completely preposterous.

Even nowadays, American contract drafting books can spend pages on the uncertainties that various wording embody. When contracting with an American or common law party the advice is: insert the above simple clause and if the clause is marked up, accept it as amended.

More specifically, under the ‘Statute of frauds‘ of those countries ….

Entire agreement clauses

An entire agreement clause aims at organising the status of preceding negotiations. Often, a contract will replace a preceding contract, a letter of intent or a mere exchange of e-mails in which the basics of a possible transaction are fine-tuned. Also, a contract is in many cases the end-result of what started with an information memorandum, a ‘binding bid’ or one or more (product or business) presentations. Furthermore, during the negotiations, the parties will likely have expressed their intentions as to how they would perform in certain specific cases or how they would generally behave in a certain context.

When it comes to important or otherwise key issues of the transaction, the parties will include these in the final contract. At the same time, the parties will generally have acted in a promotional mood to get the deal done, without necessarily assuming all promises made. Eventually, they will write down in their contract the minimum of what is important or necessary and, later on, they will probably perform, formally committed or not, also in light of the other party’s behaviour. This is why contracting parties limit their contractual obligations to what is negotiated and written in the contract itself and why they wish to exclude preceding communications and arrangements. Obviously, what will be carved out by the arrangement should be limited to what needs to be carved out (and not also cover unrelated or adjacent arrangements).

If a term sheet or letter of intent needs to terminate, this should preferably be done explicitly (by identifying the term sheet or LOI and stating that it ceases to be effective). Strictly speaking, this needs to be done by the relevant party to any such letter of intent in order to achieve full certainty but in real life no one will bother if an affiliated company does so.

Entire Agreement. This Agreement constitutes the entire agreement between the Parties on the subject matter of this Agreement and supersedes any preceding agreement between the Parties on the subject matter of this Agreement only. In particular, the Letter of Intent on the Acquisition of all Shares in Johnson Distribution Services Holding GmbH dated 18 May 2008 between [A] and [B] is hereby terminated.

Limited legal effectiveness. The binding effect of an entire agreement clause remains somewhat uncertain and always subject to interpretation. Whether a boilerplate-type of clause must have the drakonic effect of its wording may well be questioned. The European Member State laws somehow accommodate the above considerations, given the following provision in the Draft Common Frame of Reference (DCFR), an authoritative preparatory work for a European Civil Code:

Art. II. – 4:104: Merger clause
(1)  If a contract document contains an individually negotiated clause stating that the document embodies all the terms of the contract (a merger clause), any prior statements, undertakings or agreements which are not embodied in the document do not form part of the contract.
(2)  If the merger clause is not individually negotiated it establishes only a presumption that the parties intended that their prior statements, undertakings or agreements were not to form part of the contract. This rule may not be excluded or restricted.
(3)  The parties’ prior statements may be used to interpret the contract. This rule may not be excluded or restricted except by an individually negotiated clause.
(4)  A party may by statements or conduct be precluded from asserting a merger clause to the extent that the other party has reasonably relied on such statements or conduct.

Best practice on entire agreement clauses. If mutual trust and cooperation are important characteristics of a transaction, the contracting parties should be reluctant to insert an entire agreement clause in their contract. This may be particularly sensitive if extensive discussions between them have led to various arrangements, which have not necessarily been incorporated in the transaction agreements. Of course, if arrangements in a letter of intent have been renegotiated or were the subject of giving and taking of other benefits, the exclusion of a specific document is recommendable: that is what the entire agreement clause is for. A drafter should consider the impact of emails and other arrangements in the block notes of one party.

No general conditions to apply

In some contracts, in particular operational contracts (e.g. sales, purchase, services), a drafter sometimes includes a miscellaneous provision explicitly excluding the applicability of general terms and conditions. For example:

No General Conditions apply. The use of either Party’s standard forms, including any purchase order or order confirmation forms, shall not affect any rights or obligations under this Agreement. Any general conditions appearing on or referred to in such forms shall not apply, except to the extent that they specify information required to be furnished by either Party.

The background of this clause is the obvious practice deployed by many enterprise software applications to print such general terms and conditions by default on the back, or even in the body, of a purchase order. It may be difficult to change those standard texts, given the approval procedures that such enterprise software applications sometimes impose. Also, parties that (are presumed to) have been doing business over a long period of time under general business conditions and convert their business relationship into a custom contract, should apply the agreed terms.

It may well be academic to expect that in a worst case scenario a court would accept a party’s claim that its general conditions apply; but this provision makes sure the negotiated terms and not those general terms and conditions, apply.

Independent contractors (‘no partnership established’)

Although the categorisation of a contract or contractual obligation is a matter of law,  in certain contracts originating from a common law environment there may be disclaimers such as:

Independent contractors. The Parties are independent contractors. Nothing in this Agreement shall be deemed to constitute a partnership or joint venture between the Parties or constitute any Party to be the agent of the other Party for any purpose.

The purpose of the clause is to avoid the consequences of an unwanted legal relationship. For example, if a contract, obligation or ‘legal act’ would entail a certain level of dependency, partnership or joint venture; in common law countries, such circumstances may create an unwanted legal structure with undesired (financial or tax) obligations. This imposes important ‘duties of loyalty’ upon the fiduciary, such as a duty to disclose all conflicts of interest and a duty to subordinate the fiduciary’s own interests in favour of those of the other party. However, a contractual denial of the existence of such relationship or facts is not likely to be determinative of the legal effect, at the same time, consider whether the unwanted relationship is realistic at all.

No authority. A more valuable miscellaneous clause would be to provide expressly that the contract does not implicitly grant a power or authority of one party to act on behalf of the other party. This is because the agency doctrine of ‘apparent authority’ may apply. Under this doctrine, a person becomes bound by the acts of someone else, its agent, if after becoming aware of those acts, the former, as (apparent) principal, has been behaving in an acquiescent manner or must otherwise be deemed to have (tacitly) accepted the consequences of such acts (by its apparent agent). An argument to support the opposite intentions is reflected in the following sentence of an ‘independent contractors’ clause. Note, however, that since such provision is not also addressed to unrelated third parties acting in reliance on the representative’s acts, its effectiveness is limited to the internal relationship between the ‘apparent principal’ and its ‘agent’:

No Party shall have any authority to act for or bind the other Party in any way, or to represent that it has such authority.

Typically, a miscellaneous clause on ‘independent contractors’ is dispensable. A stipulation that one party shall not represent the other is of limited use.

Language clauses (translations)

If a contract is translated into another contract language, inserting a language clause is important. Such language clause avoids the ambiguity that inevitably results from rewriting the contractual rights and obligations in a second contract language.

Translating a contract may be mandatory, for example, because the local law requires that contracts are drawn up in an officially recognised language in order for the contract to be valid and enforceable. To avoid ambiguity, it is important to recognise this and to determine which language version or translation will prevail in case of inconsistencies or contradictions between the two. An example of a language clause providing for the prevailing version in such circumstances is as follows:

Contract language. This Agreement has been drawn up in the English language. In case of discrepancies between the English text version of this Agreement and any translation, the English contract language version prevails.

The first sentence, establishing that the contract language is English, may sound superfluous, but a translator should not translate the word English into (the characters saying) “Chinese”. In that case, the reader of the Chinese version must be alert that another text version might be slightly different. Rather, supposedly, a translator will translate English into its translated equivalent and the meaning stays the same (ceci n’est pas en français).

Notices clauses

Notices clauses serve various purposes, for example, they state where the addressee wishes to receive the execution copies of the contract, and identify the corporate departments for various types of notices in connection with the contract performance (e.g. account manager, quality complaints, product delivery, claims, IP-infringement). Normally, contact persons know how to find their day-to-day contacts (and otherwise, there is always a website with phone numbers); they will probably consult their internal predecessor rather than the contract itself for contact details of the other party in a certain case.

On to the use of indentation, inserting the addresses is often a messy affair. Also, putting the parties underneath each other makes the clause span over various pages (with arbitrary page breaks) and an inefficient flow of information. The best way is to use a table (without showing the table borders in the printed version):

In respect of Trader Options Investing Platform, to: P.O. Box 12345 1070 AB  Lutjebroek The Netherlands

In respect of Willem Wiggers, to: Vondelstraat 11H-4a 1054 GC  Amsterdam The Netherlands

Time of satisfaction. From a legal point of view, the time of fulfilment of the notice requirement is relevant. Where the timing of a notice is of the essence, it does make sense to stipulate that a notice shall be deemed to be delivered upon the notice being delivered to a courier service of international repute, provided that the notice was also faxed or sent as a scan attached to an e-mail. What matters is whether the applicable law follows the ‘receipt theory’ or the ‘dispatch theory’ to determine if a message was on time. The Common Frame of Reference adopts the receipt theory:

1. – 1:106: Notice

(1)  This Article applies in relation to the giving of notice for any purpose under these rules. “Notice” includes the communication of a promise, offer, acceptance or other juridical act.
(2)  The notice may be given by any means appropriate to the circumstances.
(3)  The notice becomes effective when it reaches the addressee, unless it provides for a delayed effect.
(4)  The notice reaches the addressee:
(a)  when it is delivered to the addressee;
(b)  when it is delivered to the addressee’s place of business, or, where there is no such place of business or the notice does not relate to a business matter, to the addressee’s habitual residence;
(c)   in the case of a notice transmitted by electronic means, when it can be accessed by the addressee; or
(d)  when it is otherwise made available to the addressee at such a place and in such a way that the addressee could reasonably be expected to obtain access to it without undue delay.
(5)  The notice has no effect if a revocation of it reaches the addressee before or at the same time as the notice.
(6)  Any reference in these rules to a notice given by or to a person includes a notice given by or to a representative of that person who has authority to give or receive it.
(7)  In relations between a business and a consumer the parties may not, to the detriment of the consumer, exclude the rule in paragraph (4)(c) or derogate from or vary its effects.

You may need to give some practical consideration to what you require in the notices clause. When a notice is urgent, a phone call is much more efficient than initiating communication by sending printed letters, which is often required to be sent by registered mail or overnight courier. Please note that in many jurisdictions, the registration of registered mail ends after crossing the national border. This makes a requirement to use registered mail useless. In other cases, the national and traditional post appears to be slower than going there by bicycle. Further, an overnight courier implies 24 hours delivery service but is still five to ten times more expensive than the regular 48 hours delivery service. Whilst an attorney-at-law may be concerned that, in case of claims, the other party sticks to the strict wording of the notices clause; can you imagine a court disregarding the fact that complaints were subsequently reported by phone (answered by the right person) and by e-mail (between the account managers) in addition to a formal notice being served (signed and attached as pdf to an email) because the contract required overnight courier services if the notice was not handed over in person?

Many addressees and many disciplines involved. In a framework of several interrelated contracts, it may be worthwhile creating a notices schedule to the agreement, in which the names of the contact persons of the disciplines involved are collected.

More persons on one side. In M&A transactions it is often desirable to stipulate that all purchasers or all sellers act in concert, or that notice by one of them shall be deemed to constitute a notification on behalf of all the others. This places the responsibility for communications with one party and prevents the other party being burdened by a variety of different positions and statements none of which is conclusive. This can be achieved by:

A notice by Seller to any or all Purchasers shall be deemed given upon the receipt by any one of the Purchasers. A notice given by any Purchaser to Seller shall be deemed to be the joint notice of all Purchasers. In case of several notices given by several Purchasers, Seller may deem the first notice received by it to constitute the joint notice of all Purchasers.

Severability

Severability clauses generally. The quick drafter will try to avoid that if a contract clause appears to be null or ‘void’ for whatever reason the remainder of the contract remains unaffected. Such attempt may well overlook the actual consequences and the fact that, typically, European member state laws will provide a much more thoughtful solution.

The law on nullities. The actual consequences may well be that the contract becomes unattractive or even loss generating. A thoughtful solution would address the reverse side. See for example the Draft Common Frame of Reference (DCFR), extensively providing that (a) the nullity of a contract must be reduced to the very minimum of what is absolutely necessary to give effect to the infringed statutory principle; and (b) the effects of such nullity must be minimised, with the power granted to the court to impose a remedy that is an appropriate and proportional response to the infringement, having regard to all relevant circumstances (see DCFR Art. II.7:301 ff.).

Section 3: Infringement of fundamental principles or mandatory rules
II. – 7:301: Contracts infringing fundamental principles
A contract is void to the extent that:
(a)  it infringes a principle recognised as fundamental in the laws of the Member States of the European Union; and
(b)  nullity is required to give effect to that principle.

1. – 7:302: Contracts infringing mandatory rules
   (1)  Where a contract is not void under the preceding Article but infringes a mandatory rule of law, the effects of that infringement on the validity of the contract are the effects, if any, expressly prescribed by that mandatory rule.
   (2)  Where the mandatory rule does not expressly prescribe the effects of an infringement on the validity of a contract, a court may;
   (a)  declare the contract to be valid;
   (b)  avoid the contract, with retrospective effect, in whole or in part; or
   (c)   modify the contract or its effects.
   (3)  A decision reached under paragraph (2) should be an appropriate and proportional response to the infringement, having regard to all relevant circumstances, including:
   (a)  the purpose of the rule which has been infringed;
   (b)  the category of persons for whose protection the rule exists;
   (c)   any sanction that may be imposed under the rule infringed;
   (d)  the seriousness of the infringement;
   (e)  whether the infringement was intentional; and
   (f)   the closeness of the relationship between the infringement and the contract.
2. – 7:303: Effects of nullity or avoidance
   (1)  The question whether either party has a right to the return of whatever has been transferred or supplied under a contract, or part of a contract, which is void or has been avoided under this Section, or a monetary equivalent, is regulated by the rules on unjustified enrichment.
   (2)  The effect of nullity or avoidance under this Section on the ownership of property which has been transferred under the void or avoided contract, or part of a contract, is governed by the rules on the transfer of property.
   (3)  This Article is subject to the powers of the court to modify the contract or its effects.

The root cause of a contract provision being null or void typically relates to fundamental matters of a regulatory nature such as competition law or matters of quality, safety, health or environment. If solving the nullity affects the pricing or other essentials of the contract, it impacts the entire contract and the parties may well prefer to be able to renegotiate or terminate their arrangement. If a nullity applies to only one jurisdiction, this will not necessarily affect the applicability in another jurisdiction. Look at the following example of a severability provision:

Severability. If any provision of this Agreement is found to be invalid or unenforceable in any jurisdiction:
(a) the validity or enforceability of such provision shall not in any way be affected in respect of any other jurisdiction and the validity and enforceability of the remaining provisions shall not be affected, unless this Agreement reasonably fails in its essential purpose; and
(b) the Parties shall replace such provision by one or more valid and enforceable provisions approximating the original provision as closely as possible.

You will probably note two significant elements that are not necessarily addressed under a national law. First, there is a cross-border element that may be present in a contract but typically not in a national civil code. Second, it is helpful to provide for an active obligation to negotiate a an appropriate and proportional replacement clause. For more observations on severability clauses see Drafting International Contracts by Marcel Fontaine and Filip De Ly[1].

Arbitration clause. If the entire contract ‘falls away’ because a key provision becomes null or void, all modern arbitration laws will deem an arbitration provision to be ‘several’ (valid and enforceable) anyhow. Hence, no need for specific stipulations in that respect.

[1] Marcel Fontaine and Filip De Ly, Drafting International Contracts – An analysis of contract clauses, p. 167 ff., reflecting the work of the Groupe de travail contrats internationaux (an international Working group on international contracts).

No termination or dissolution

In major transactions, the parties, and in particular a seller in the case of a business sale, will exclude the possibility of reversing the transaction. A reversal or rescission of a contract may be sought if a party claims misrepresentation or suffers under a material breach or claims a material lack of conformity of the acquired business (i.e. the business is allegedly not fit for ‘its purpose’).

This refers to three legal concepts the applicability of which would need to be excluded. In the case of mistake, the applicable law may provide that a reversal has its effect ab initio: in such legal system, the deal is declared null and void (and will be deemed never to have existed from a legal point of view). Accordingly, instead of excluding annulment (in a document which will in the end be deemed not to have had legal force and effect), the parties should agree not to request an annulment in court. This is reflected in the following miscellaneous clause:

No termination or anulment. Unless explicitly allowed or stated otherwise in this Agreement, the Parties waive their rights, if any, to (partly) terminate, (partly) annul, (partly) dissolve this Agreement or claim lack of conformity, and agree not to request (partial) annulment or cancellation of this Agreement.

Time is of the essence

Time is of the essence clauses. The qualification as breach of contract should be preceded by (or happen concurrently with) the default of a party. Whether a party is in default is not always clear: obviously, if the party must deliver a work or product that will be used for the Olympics, then an agreed deadline is unequivocally triggering the default when delivery does not take place by then. Many contracts do not relate to the Olympic Games.

A provision that ‘time is of the essence’ is sometimes included to emphasise that the debtor is in default upon its failure to meet a certain deadline for delivery. A fairly imprecise clause is:

Time is of the essence. Supplier shall adhere to the time schedule in the Statement of Work. All dates specified in the Statement of Work are of the essence, unless the context clearly and unequivocally allows otherwise. The Parties will notify each other promptly of any circumstances that may adversely affect the time schedule in the Statement of Work, specifying the causes of delay and expected duration of it, as well as all proposed measures to reduce the delay as much as practicable.

Where all delivery dates are identified to be of the essence, it is possibly nothing more than a superfluous statement. Whether or not in the particular circumstances a timely delivery is indeed ‘of the essence‘ is rather a factual question and subject to qualification by operation of law.

Of course, in a commercial services agreement agreed in the context of a larger project, meeting the contractual milestones may well be essential. It is recommended that you ensure that this is understood from other facts than a boilerplate provision. In common law jurisdictions time is of the essence often means that delayed performance permits the affected party to terminate the contract.

A useful element in the same provision is the agreed remedy in case a delivery date cannot be met. In ongoing relationships, the persons involved will contact each other and explain regardless. Without a contractual remedy, however, it may well be more difficult to be notified promptly, let alone to require a collaborative approach from the defaulting party.

If time is really of the essence, it makes a lot of sense to provide for in-between (performance, progress or performance) evaluation meetings, and make those periodical meetings not only compulsory to attend, but also to include some obligatory wording in the agreement to be bound by and act upon the outcomes of such evaluation meeting.

Waiver clauses

Most European member state laws provide that the failure of a party to claim or enforce its rights does not automatically qualify as a waiver of such rights. Also, if a party does ‘waive’ its rights in a certain situation, member state laws will not easily presume a blanket waiver.

Waivers. A failure of a Party to enforce strictly a provision of this Agreement shall in no event be considered a waiver of any part of such provision. No waiver by a Party of any breach or default by the other Party shall operate as a waiver of any succeeding breach or other default or breach by such other Party. No waiver shall have any effect unless it is specific, irrevocable and in writing.

The above clause specifies what may or may not be the consequence of a party’s behaviour or (informal) remarks.

Applicable law clauses

Most contracts contain a provision on the applicable law. The effect of a choice of law is that, in principle, the contract is governed by the law chosen. (If a contract has never been signed but the choice of law has not been disputed either, the Rome Convention provides that the agreed choice of law will apply.) The standard and sufficient pattern of a choice of law provision is:

Applicable law. This Agreement is governed by the laws of Switzerland.

The effect of the choice of law is that the chosen law applies to the agreement. Although, the parties may be unable to avoid certain mandatory law provisions of the contracting parties’ national laws (i.e. under the Rome Convention).

Fields of law not covered by a choice-of-law clause. By operation of the applicable conflicts of law provisions, a distinction must be made in relation to:

• Certain non-contractual fields of law. Subject matters which qualify as a category of private international law for the parties cannot choose another law other than the lex causae. This may be the case in connection with the transfer of ownership of real estate, movable property in a foreign jurisdiction, aspects of company law, insolvency law, securities law, competition law etc.;
• Super-mandatory socio-economic laws. Subject matters which are covered by a scope rule (i.e. a ‘super-mandatory’ rule that applies regardless of the law governing the contract), usually matters of employment law or employee codetermination law;
• Regulatory law. Regulatory matters, including matters of public policy: examples include regulatory matters designed to protect a local market, such as food, feed and pharmaceutical regulations, regulations relating to the registration or authorisation of chemical substances, laws and regulations relating to the financial markets, insurances and provision of financial advice, telecom and energy laws etc.;
• Arbitration law. The applicable arbitration law (or other law of civil procedure): an arbitration is governed by the law of the agreed place of arbitration (‘seat of arbitration’), whereas a choice of court implies a choice for the civil procedural laws applicable in the chosen jurisdiction. If exceptionally, the parties wish to agree on a particular other arbitration law, they may do so explicitly;
• Employment and consumer law. In the case of employment agreements and consumer contracts, different choice-of-law rules apply in order to protect the interests of the weaker party.

The law applicable to the listed subject matters is determined on the basis of different provisions of private international law (or public international law, as the case may be) than those of contractual obligations. Of course, they might well be subject to the law chosen by the parties, but that would be for the reason that the relevant provisions point to the same legal system. In the following paragraphs, a few particularities of legal practice are discussed.

Depeçage. In principle, the chosen law applies to the contract in its entirety. The parties are free, however, to identify specific parts of their contract (or agreements attached as a schedule or annex) and submit those parts to a different applicable law. This phenomena is called ‘depeçage‘. In this respect, it is worth mentioning supranational rules and regulations such as the Incoterms and UCP600. The legal status of these rules is not always clear; in some jurisdictions they are considered ‘contractual arrangements incorporated into the contract by reference’, whereas in other contracts they are seen as a separate body of law. In such case, a reference to such rules and regulations would qualify as depeçage and be valid and enforceable.

International nature and choice of law

In order for a choice-of-law clause to be effective, a contract must be ‘international’. If a contract is not ‘international’, the effect of the choice-of-law clause is that only the supplementary law (ius dispositivum) from the local law of the contracting parties is replaced by the chosen law; the mandatory law of the contracting parties’ jurisdiction cannot be contracted away.

A contract is ‘international’ if there is an element of some significance in the agreement that points to a jurisdiction other than the law which would otherwise be assumed to apply in the usual course of things. This is most obvious if the two parties are established in different jurisdictions but also when both contracting parties are from the same jurisdiction and delivery of the goods takes place abroad; a sales contract is generally considered to be ‘international’. It is not clear in all jurisdictions when a contract becomes ‘international’ but the prevailing opinion is that the criteria are relatively easily met.

Dispense with “…excluding its conflicts of law provisions”

Choice-of-law clauses regularly contain the phrase excluding its conflicts of law provisions (or, equally, …excluding its private international law rules). It is used so often and yet is so useless that a clarification is desirable.

Obviously, the phrase excluding its conflicts of law provisions attempts to exclude the private international law provisions of the law chosen under that same choice-of-law clause. (Conflict of laws is an area of private international law, which deals with determining the applicable law, as may be appointed by a choice-of-law clause.) The phrase excluding its conflicts of law provisions is meaningful only if the private international law rules of the chosen law would ‘refer’ the same matter to another law. This is only possible under the (private international law) concept of ‘renvoi‘.

Renvoi (private international law). Many systems of private international law reject renvoi, which is understandable because renvoi is a source of legal uncertainty, potentially leading to circular or endless referrals. Moreover, renvoi would not necessarily provide a solution, which is by definition unequivocally acceptable. Finally, many legal systems reject renvoi because it may introduce inefficiencies in the case at hand. Countries that do accept renvoi normally reduce its scope to a minimum. Areas typically excluded from the working sphere of renvoi are contractual obligations and areas that permit broad party autonomy (ius dispositivum). In essence, the applicability of renvoi in the case of a choice-of-law clause, and hence the phrase excluding its conflicts of law provisions, seems rather exceptional and academic (if not ridiculous).

In order for the words excluding its conflicts of law provisions to be meaningful, the following criteria should be met cumulatively:
1.     neither the private international law rules of the chosen law nor those of the lex fori (i.e. the law of the country where the court is located) may reject application of the private-international-law-concept of ‘renvoi’. If the private international law rules of the lex fori do, the court will, after applying its own private international law rules, refuse a renvoi (if any) by the private international law rules of the chosen law;
2. the applied private international law rules should not permit contracting parties to choose the applicable contract law themselves because if they do, such a choice-of-law clause would already be conclusive, and
if these two criteria are met, the court must take a major step of sidepassing the parties, by not determining that they actually intended to apply the chosen law (e.g. because they wrote this down) or that they had a legally valid other justification for the chosen law.

Do you see how highly exceptional if not completely hypothetical the facts of a particular contract must be in order for the words excluding its conflicts of law provisions to make any sense?

Exclude the applicability of the Vienna Convention?

Many contracts exclude the applicability of the ‘Vienna Convention‘. Most lawyers do this ‘because everyone does’ and many opt out even if the convention is not even applicable.

Scope of CISG

The scope of the Vienna Convention is well defined. It is limited to international sales contracts only. Accordingly, it is nonsense to exclude its applicability in licences, service contracts, manufacturing agreements or loans. Furthermore, the convention excludes certain sales contracts because of its purpose (i.e. consumer contracts), its particular nature (i.e. sales by auction, on execution or otherwise by operation of law) or because of the nature of the goods (i.e. shares, investment securities, negotiable instruments, money, ships, aircraft or electricity). Therefore, a share purchase agreement does not need to contain an exclusion of the Vienna Convention, simply because the convention would not be applicable anyway.

The Vienna Convention is most widely ratified

Considering the number of ratifications, the Vienna Convention is a great success. The convention is ratified by some 70 countries worldwide. Important countries that have not ratified the convention (yet) include: the UK, India, South Africa and several countries in the Middle East. An up-to-date map can be found on or via the websites of Uncitral or legacarta.net/maps.

If you wish to exclude the convention, you may do so as follows:

The Convention on the International Sale of Goods (Vienna 1980) does not apply.

Exclude the Vienna Convention? (No)

Is it important to exclude its application? Probably not, the law on the (international) sale of goods is one of the bodies of law, which have become harmonised considerably over the past centuries. (Its being predictable has always been an important factor for trading companies to do business.) Even the legal concepts under sales contract law are similar or equal under the various legal systems. The Vienna Convention is not really different in this respect.

A court will not likely answer important questions relating to ‘fitness for purpose,’ ‘conformity,’ ‘free from liens’ or ‘merchantability’ differently under the Vienna Convention as opposed to under the applicable national law. In many cases, the handbooks on the Vienna Convention provide more details on the case law developed in the various national courts than the national case law is reasonably capable of addressing.

It is commonly considered that opting out of the applicability of the Vienna Convention has to do with getting ‘cold feet’.

Choosing court or arbitration in contracts?

Court or arbitration in contracts? Many contract drafters base their choice on hearsay or one or two bad experiences in arbitration. There are important factors that should drive your decision, however. But not myths. The principal question is whether disputes should be settled in court or by means of arbitration.

Decisive factors for choosing court or arbitration

The important decisive factors for arbitration instead of public court proceedings are:

• Enforceability of a decision. Arbitration is almost inevitable if there is no treaty between the countries in which the final decision must be executed and the country of an agreeable court (e.g. a convention for the enforcement of foreign judgments, such as the Convention of Lugano or the ‘Brussels Regulation’). The New York Convention of 1958, facilitating the enforcement of arbitral awards, has been ratified by an impressive number of countries.
• Confidentiality. In arbitration, even the existence of a dispute is secret. If this is important, it may be desirable to provide that the arbitration institute will not publish the arbitral award (or at least not any identifying elements of the case).
• Greater expertise of arbitrators. The parties may provide for effective appointing rules to establish the arbitral tribunal. Even if the parties did not provide anything on the nomination or appointment of arbiters, an arbitration institute will likely consider the desirability of bringing a true expert ‘on board’.
• ‘International’ approach of a dispute. In court procedures, the foreign party will likely feel uncomfortable and uncertain about the somewhat patriotic or chauvinist attitude the court may take vis-à-vis its local counterpart. Also, in arbitration, the tribunal may be more receptive to international quality standards or service levels and transnational best practice rules (e.g. Lex Mercatoria) and less amenable to formalities required by the applicable law.
• Speed, although arbitration is sometimes slower. This argument is often misplaced. It is not generally true that arbitration is slower than court proceedings. On the contrary, in some countries civil procedures are considerably slower or much more burdensome.
• Adaptability of the arbitral procedure.

Whatever the parties agree, they should certainly not provide for arbitration and a choice of court at the same time. Also, if the choice is made for arbitration, it is highly unusual to provide for a right of appeal (not even in a court) and the decision not to choose arbitration should not be driven by the lack of such right of appeal.

Choice of court clauses

Policy decisions. If the decision to prefer court or avoid arbitration proceedings is made, a choice of court provision is appropriate. In essence, the ‘political’ questions asked in connection with a choice of court provision in commercial contracts are:

• What is the best choice in order to ascertain the continuation of business as much as possible?
• Should we discourage court proceedings by providing for an unattractive procedure? Alternatively, do we need to have an expeditious court decision?
• Is a carve-out for certain action desirable (e.g. the right to seek protection under applicable intellectual property laws in a different jurisdiction)?
• Where should we engage a law firm?

The answers will probably follow from some very general observations of each party’s probable interests and power to settle disputes amicably. A Dutch in-house legal counsel will probably find that a counterparty will be inclined to compromise on German or French courts (as if a football team were sentenced by the UEFA to play its home matches outside its home country).

Exclusive jurisdiction in a choice-of-court clause.
A choice of court is typically made under the assumption that the choice excludes the international jurisdiction of other courts. Making this explicit is not necessary: both the Brussels Regulation and the Lugano Convention (i.e. the regulation’s counterpart for non-EU member states) determine that in the absence of such an express stipulation jurisdiction of the appointed court over any dispute is exclusive. Since U.S. courts do not recognise the scope of the Regulation or the Convention and it requires only one word, including the word exclusive is recommended.

Relative jurisdiction and choice-of-court clauses.
Normally, it is not necessary and potentially a source of confusion to express which level of court jurisdiction (relative competence) applies. It is unnecessary because local civil procedural law will determine what relative jurisdiction applies (and it does not always permit the choice); it can be a source of confusion if at the time of a dispute it appears that the drafter did not intend to choose the relative jurisdiction but rather was trying to be too clever. The parties might find themselves having precluded a right to appeal (e.g. because they appointed a Court of Appeals).

U.S. particularities and choice of court.
If a U.S. court is appointed, there exists a possibility that court proceedings could be initiated in a federal court instead of a state court. In short, federal courts may have jurisdiction in matters where (federal-U.S.) interstate aspects come into play and, amongst others, in matters related to bankruptcy or intellectual property rights (both these legal areas are subject to federal legislation).

Another particularity would be to exclude the right to demand a jury trial. This right might also be invoked in other jurisdictions, depending on national law. The arguments in favour of arbitration (see the preceding paragraph (a)) apply here as well, especially when it comes to speed of the procedure and expertise (quod non) of the jury. Note that under several U.S. state laws, such exclusion must be made conspicuously (i.e. printed in all caps), because it is a deviation of each person’s constitutional right to have a jury try the facts of a dispute (and not the court itself). An example of such waiver is:

EACH OF THE PARTIES HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHTS TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATED TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT.

Or with more certainty that the waiver is effective:

EACH PARTY ACKNOWLEDGES AND AGREES THAT ANY CONTROVERSY WHICH MAY ARISE UNDER THIS AGREEMENT IS LIKELY TO INVOLVE COMPLICATED AND DIFFICULT ISSUES, AND THEREFORE EACH SUCH PARTY HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVES ANY RIGHT SUCH PARTY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY ACTION, SUIT OR PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AGREEMENT, OR THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT. EACH PARTY CERTIFIES AND ACKNOWLEDGES THAT (i) NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF SUCH ACTION, SUIT OR PROCEEDING, SEEK TO ENFORCE THE FOREGOING WAIVER, (ii) EACH PARTY UNDERSTANDS AND HAS CONSIDERED THE IMPLICATIONS OF THIS WAIVER, (iii) EACH PARTY MAKES THIS WAIVER VOLUNTARILY, AND (iv) EACH PARTY HAS BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.

Arbitration or expert determination in a contract?

It is important to distinguish dispute settlement by arbitration from expert-determination proceedings. Arbitration is suitable when the parties have a true dispute, in terms of differing opinions on the interpretation of a contract, disputes as to whether one party can be held liable or if there is a deadlock in decision making. In the last case, a more sophisticated mechanism such as mediation or a dispute board would probably be more desirable. Expert determination proceedings are relevant in relation to matters that require the establishment of facts. Accordingly, many argue that arbitration rather relates to legal issues whereas expert determination relates to a matter of fact. Of course, the parties may be in dispute on the establishment of a certain value, amount or quality level and most disputes can be traced back to questions of how much a party should pay. In practice, it is often best to determine the appropriate procedure based on the issue at hand.

The appropriateness of expert determination is often overlooked. Typical examples of matters that can be subjected to expert determination are:

• the determination of the final purchase price (and purchase price-related elements) under a share or business purchase agreement;
• the question of whether or not the delivered products or services meet the agreed product specifications;
• the determination of the amount of damages;
• the determination of a root cause of certain damages (e.g. whether a defect in a delivered product was caused by a hidden defect in the product itself or by external circumstances);
• the valuation of important assets or of a business or legal entity in the event of an exit procedure (e.g. if a party terminated a joint venture or if a partnership share needs to be bought out);
• if it is undesirable that a party gets access to confidential information of the other party (e.g. determinative sales or turnover figures in connection with a royalty audit).

The questions for the expert must be rather straightforward and should not involve assessments that may trigger elaborate discussions between the parties or a judgement as to what is ‘reasonable’ or ‘appropriate’ under the circumstances. This does not mean, of course, that an expert should not be reasonable or should disregard all circumstances. It also does not mean that an expert’s opinion may not contain any speculative elements. Furthermore, a careful expert is likely to give each party an opportunity to explain the case (and respond to the explanations of the other party) before reaching a final determination.

What is important in the case of expert-determination clauses is that:

• the expert’s involvement is triggered on the basis of clear (objective) criteria;
• the expert’s independence from both parties is properly secured, although the expert who is engaged for an audit of the other party’s books and records would only need to be reasonably acceptable;
• the expert’s appointment should take place expeditiously, implying that the contract should provide for clear deadlines to object or agree on a proposed appointment and, failing consensus, for (the chairman or president of) a named authoritative expert institute that will make the appointment in case of disagreement;
• high-level expert-determination principles, the failure of which may give rise to disputes between the parties, are clarified beforehand (and ideally in the contract itself);
• the expert should have adequate access rights to the information needed for its determination, subject to such information being kept confidential (including, in some instances, vis-à-vis the other party). Such information or access should be given promptly;
• it may be desirable to provide for an allocation of the costs of the expert, depending on the outcome of the expert’s determination. In case of a royalty audit, it would be appropriate to allow for a threshold for any excusable misstatements or relief.

In case of an audit right, it would be appropriate to limit the frequency of subsequent audits if a preceding audit did not reveal any significant irregularities. It is common to provide that such audit should take place during normal business hours and, depending on the nature of an audit and the matters to be audited, to require reasonable prior notice.

Arbitration clauses; arbitration institute or ad hoc arbitration?

Once it is decided to go for arbitration, the parties should decide to submit to ad hoc arbitration or choose an appropriate arbitration institute. And in the last case, as is strongly recommended, which arbitration institute to choose?

If the potential disputes under a contract are likely to be ‘simple’ or capable of being resolved relatively easily, it could be perfectly fine to provide for ad hoc arbitration. In that case, the arbitration law of the place of arbitration will determine how the arbiter or arbitral tribunal will be appointed, unless the parties have provided for their own appointment mechanism. But in most cases, it is unlikely to be that simple of easy.

Which arbitration institute to choose?

Normally, the parties will agree on an arbitration institute to administer their arbitration. Which arbitration institute should be chosen? Arguments of particular expertise or location of the institute’s principal office, as well as a link with the applicable law, might influence the choice.

A contract drafter will encounter competition amongst the major arbitration institutes: ICC, AAA, LCIA, the Stockholm or the Swiss chambers of commerce, the NAI, CEDR, ‘Singapore’ or CIETAC each have their particular benefits. It may be helpful if you establish a contracting policy as regards the arbitration institute you appoint when the agreement ‘moves out of your jurisdiction’. Although the differences between the main arbitration institutes fades, historically, some aspects may have coloured their reputation:

• Often, for contracts with a link to Eastern Europe or Russia, arbitration is sought under the rules of the Stockholm Chambers of Commerce.
• ICC has the reputation of being expensive but an arbitral award will likely not be voidable as this is specifically double-checked as part of the ICC arbitration procedure, and the ICC is at least clear about the costs, which is not necessarily the case for other arbitration institutes.
• Sometimes, for Asian parties, arbitration under the Singapore SIAC rules may be preferred.
• In China, it may well be that you end up litigating under the rules of the CIETAC (China International Economic and Trade Arbitration Commission).
• Note that NAI is a highly respected international institute, due to a long tradition of well-known arbitrators.
• But there are similar arguments in favour of LCIA, its competitor in London.
• In the U.S., one would often choose either the ICC or ICDR (International Centre for Dispute Resolution), the international division of the AAA (pronounced: ‘triple A’).
• Finally, especially in connection with mediation, CEDR administers arbitrations.

Which arbitration clause? After choosing an arbitration institute, it is strongly recommended that you include the model arbitration clause of the elected institute in the contract. When you switch from arbitration institute during contract negotiations, the arbitration clause should be amended according to the agreed institute’s model clause. The background of this is that arguments about the meaning or scope of an arbitration clauses has typically been tested in the past, and the arbitration institute will likely have ‘off-the-shelf answers’ to arguments questioning their model clause.

Points of attention in drafting an arbitration clause

All model arbitration clauses provide for some options. Normally, it is advisable to include them:

1. You should agree on a place of arbitration. Although the arbitration rules will provide for a solution, identifying a venue improves the enforceability of an arbitral award. Although the arbitral proceedings would normally be held in the chosen city, this is not a must (the parties may always agree on other places). You should know that all arbitral institutes will allow you to compromise on any place of arbitration.
2. You may agree on the number of arbiters that the tribunal should consist of. Many arbitration laws require that this must be an odd number (one or three).
3. Be aware that in the absence of a choice of law clause the arbitral tribunal may sometimes be entitled to “decide ex aequo et bono“. This depends on the applicable arbitration law, which is that of the jurisdiction of the place of arbitration. Since virtually all arbitration laws are highly flexible, there is no need to explicitly stipulate that another arbitration law applies. Parties might, however, desire to determine that the arbitral tribunal “shall decide in accordance with the rules of law” or “as amiable compositeurs“.
4. You may want to provide a customised mechanism for appointment of the arbitral tribunal. Each arbitration institute has its own rules, but all institutes require that the arbitral tribunal is independent from both parties (even though the parties might have nominated their own ‘representatives’ on the tribunal).
5. Most arbitration institutes provide for adequate access to summary proceedings and provisional measures. If not, the applicable arbitration law will probably allow for it. Nevertheless, you might exceptionally want to say something about such a possibility.

ADR: mediation, dispute boards and escalation in contracts

While court proceedings and arbitration are a hard-cut way of solving disagreements, a more sophisticated way is alternative dispute resolution (ADR). ADR may consist of mediation (aka conciliation), an escalation of disputes to the parties’ CEO’s or senior management, or, in case of complex relationships or projects, dispute boards.

Mediation. Once it comes to litigation, the termination of the contract is almost inevitable. Therefore, in complex or relational contracts in which unwinding the contract may give rise to  another source of dispute, providing for mediation (also known as conciliation) may be desirable.

It is a matter of best practice to link the mediation and arbitration provisions to each other. Normally, you would probably want to have the mediations coordinated and administered by the same institute as a subsequent arbitration (if any). Each arbitration institute mentioned above also provides for ADR (‘alternative dispute resolution’) procedures (see their respective websites for text model clauses). One institution deserves special mention because it has partly evolved from mediation practice and provides advanced professional mediation training programmes: CEDR. Many people believe that mediation has no reasonable chance of success if one of the parties does not sincerely wish to settle the dispute. Therefore, a mediation clause is primarily a voluntary procedure, albeit that the admissibility of an obligatory mediation clause before arbitration may vary. This subtlety depends on the actual wording of the provision.

Dispute boards. Recent developments have led the ICC to establish a standard dispute board procedure for preventing major disputes under medium- and long-term contracts or under project-related agreements. The idea is that dispute boards are set up at the outset of a contract term and remain in place and are remunerated throughout its duration.

The dispute board is a kind of ‘supervisory board of the contract’. Comprising one or three members thoroughly acquainted with the contract and each party’s performance, the dispute board informally assists the parties, if they so desire, in resolving disagreements arising in the course of the contract. Depending on the setup, the dispute board may make recommendations or even decisions regarding disputes referred to it by any of the parties. A similar service is provided by CEDR (in several degrees of involvement, as ‘early neutral evaluation’ or ‘adjudication’). A dispute board should be established at the outset of the parties’ project, as all parties must agree to submitting their disputes and disagreements to such board. In addition to an extensive set of rules and regulations for dispute resolution boards, it has also drafted model clauses for appointing and ‘operating’ dispute boards.

Escalation clauses. In contractual relationships between major parties that regularly do business with each other, an ‘escalation clause’ providing for the escalation of a dispute to the principal executive officers would be another means of dispute settlement. The idea behind an escalation clause is that the party who threatens the relationship between the parties should subsequently face internal discussions as to whether and how the senior executives must be involved (i.e. including the career-limiting effects of such involvement). In other words, both parties will go up the hierarchical ladder of their organisation upon the occurrence of the contractual triggering event.

The senior executives selected should not have been directly involved in the dispute, but need to have the authority to bind the party they represent.The escalation clause contains several incentives; the persons directly involved in the dispute may be reluctant to escalate given the ‘shameful’ aspect that they were not able to settle the matter themselves, whereas the senior executives may spend only such time on the matter as the (financial) interest justifies and they will settle as quickly and pragmatically as possible. Such escalation would be more effective if they must consider the higher desirability of all relationships between the parties or if they can compromise on other disputes or irregularities as well.

Contract law explained

Intellectual property law, sales law (CISG), Incoterms, letters of credit (L/C) and concepts such as Good faith and freedom of contract

What is a contract?

What is a contract? A contract is an agreement between two or more parties determining their enforceable rights and obligations under a certain (one-off) transaction or in their (ongoing) relationship.

A contract will often include any conditions for such rights or obligations to become effective or for its termination, any covenants (and contractual prohibitions) enabling each party to enjoy the full benefit of their agreement, any warranties ascertaining that each party will receive what the other party has promised, and the effects (remedies) in case of a breach of contract. Other chapters here explain what these legal concepts (conditions, covenants, warranties, limitations of liability, indemnities and various related contract clauses) mean.

Oral or written?

Most contracts do not need to be in writing to be enforceable in court. Contracts that are by law required be in writing typically relate to the sale of real property or to the grant of licences under intellectual property (copyright, use of trademark or patent). Apart from those, a mere oral agreement is equally binding than written agreements, although an oral agreement may be difficult to prove and introduces a considerable uncertainty regarding its precise scope and interpretation.

Written contracts may be given an ‘official’ look and feel, following a common structure, or be presented more informally, as a letter agreement. Normally, courts will accept an exchange of e-mails as evidence of a contract, but typically, e-mails are not written with the greatest accuracy and discipline and may easily leave important aspects of the parties’ agreement unaddressed. Therefore, in cross-border context, it is strongly recommended that a contract is in writing.

Requirements for validity?

Some legal systems – including many common law systems – require that the parties intend to enter into the contract (where the intention is a requirement on its own), but the threshold will be met easily. In common law, this intention to be bound is demonstrated by the existence of ‘consideration’: the fact that every party committed itself vis-à-vis the other by assuming an obligation of any (not illegal) kind. In practice, this requirement is easily met (the symbolic one Dollar or Pound sterling). Other legal systems – notably the Roman (French law-inspired) legal systems – require that the contract is not for an illicit cause (a negative criterion).

When is a contract binding?

A contract is ‘entered into’ (and becomes ‘binding’ between the parties) once they reach consensus, agreement. In somewhat abstract terms, when one party makes an ‘offer’ and the other ‘accepts’ it. Under common law, a contract must have ‘consideration’ (any counter-obligation, however small) and the parties must have the intention to be bound (which can be implicit). In a supermarket, ‘offer and acceptance’ works simple: the supermarket offers its products (for sale) by allowing consumers to pick them from the shelves; and the customer’s handing it over at the cashier constitute acceptance; once paid, the transaction is complete (ownership shifted, warranties apply, etc.). When offer and acceptance do not readily match, the other party may make a counteroffer (and this may go back and forth). This process of offer-counteroffer-counteroffer-acceptance is negotiation.

As with contracts, offer and acceptance are not subject to formalities: the context, circumstances, customs and stipulations can take any form. Therefore, professional parties who make an offer will also clarify that it is subject to (conditional upon) agreement in writing. On the other hand, if a party starts performing its presumed obligations, this will likely a proof of its ‘acceptance’ (of the other party’s last counter-offer – see section 5.1(c)). So, if one party sends the other an e-mail unconditionally outlining or proposing the parameters of a transaction (or even a collaboration) without any reservation as to its being non-binding (not marked “for discussion purposes only” or “subject to contract” or “subject to board approval”), that e-mail may well constitute an offer that can be accepted by the other.

One-off transactions and ongoing relationships

Contracts can address the parties’ single transaction (a simple sale of a product or batch of goods, or the provision of a certain service), as well as establish the parameters of their ongoing relationship. This may change the characteristics of the arrangement:

• In a one-off transaction, the rights and obligations focus on the specifications of the product or service, on the (timely) delivery and who-does-what in respect of transportation, the payment of the purchase price or service fee, and what happens if something goes wrong. Examples of such contracts are the ITC Model Contracts for the International sales of goods, and for the International provision of services.

• In an ongoing relationship, these are less urgent as such relationship is partly built on mutual trust; the contract will then provide for procedures (for forecasting, ordering and joint product development), the establishment of a relational framework (establishing the governance and evaluation of the relationship) and the formalisation of continuing rights (in the use of trademarks, know-how, and training). Examples are the ITC Model Contracts for International distributorships, Commercial agency, Long-term supply of goods, Manufacturing, as well as the ITC Model Contractual alliance and (incorporated) joint venture.

Importance of a contract

Does it matter if there would be no ‘formal contract’ between the parties? Maybe not. But if a seller has not limited its liability to a certain maximum amount (as is often appropriate and acceptable) then if there is a defect in its supplied goods, all damages must be borne by the supplier. Conversely, if a customer did not stipulate that purchased goods had not been manufactured in violation of laws and regulations, then the delivery of those goods might not be objected (and the customer may even be held liable for undertaking or facilitating illegal activities).

Applicable law and dispute resolution

In a cross-border contract, it is very important to provide for an appropriate dispute resolution mechanism, and to determine which national law will govern the contract. In many international transactions, (mediation combined with) arbitration is inevitable.

‘Contract’ or ‘agreement’?

There is no fixed terminology for referring to a contract, agreement or (contractual) arrangement. Most lawyers will understand a ‘contract’ to be the written reflection of a business transaction or legal relationship; but many will argue that an ‘agreement’ does the same. Moreover, the term ‘agreement’ is commonly understood to reflect the (mental) being in agreement, the having achieved consensus (on all details of) a transaction. Regardless of these somewhat arbitrary approaches, most English-language contracts are entitled as ‘agreement’ (not ‘contract’).

Practices and usages in contracts

General. In general, contract parties are bound by practices and usages that they have established among themselves or that are widely known and generally accepted in the industry concerned:

Article 1.9 (Usages and practices)

(1)  The parties are bound by any usage to which they have agreed and by any practices which they have established between themselves.

(2)  The parties are bound by a usage that is widely known to and regularly observed in international trade by parties in the particular trade concerned except where the application of such a usage would be unreasonable.

Practices between the parties. A practice established between the parties is automatically binding, except where the parties have expressly excluded its application. Whether a particular practice must be considered to be ‘established’ between the parties depends on the circumstances. Obviously, behaviour in the context of only one preceding transaction will not normally suffice.

Illustration 1 (usually permitted claim period in excess of the agreed term).

S, a supplier, has repeatedly accepted claims from C, a customer, for quantitative or qualitative defects in the goods as much as two weeks after their delivery. When C gives another notice of defects after a fortnight, S cannot object that it is too late since the two-weeks’ notice amounts to a practice established between S and C which will as such be binding on S.

Agreed usages. The parties may specify all the terms of their contract or for certain questions simply refer to other sources, including usages. In the itc model contract for the international commercial sale of goods, this applies in particular where references are made to the Incoterms and to international trade usages as regards letters of credit (ucp600), standby practices (isp98) or demand guarantees (URDG).

Other applicable usages. Concerning the applicability of other trade usages, it is important that the usage is “widely known to and regularly observed […] by parties in the particular trade concerned”. The additional qualification “in international trade” means that usages confined to domestic transactions should not also be invoked in transactions with foreigners. Only exceptionally should usages of a purely local or national origin be applied without any reference thereto by the parties. For example, usages existing on certain commodity exchanges or at ports should apply, provided that would regularly be the case with respect to foreigners. Another exception concerns businesses that have already completed a number of similar contracts and that might be deemed to have become aware of the usages within that country for such contracts.

Illustration 3 (usages in a port).

A, a terminal operator, invokes a particular usage of the port where it is located vis-à-vis B, a foreign carrier. B is bound by this local usage if the port is normally used by foreigners and the usage in question has been regularly observed with respect to all customers, irrespective of their place of business and of their nationality.

Illustration 4 (applicability of local discount usages).

A, a sales agent from Country X, receives a request from B, one of its customers in Country Y, for the customary 10 percent discount upon payment of the price in cash. A may not object to the application of such a usage on account of its being restricted to Country Y if A has been doing business in that country for a certain period of time.

Application would be unreasonable. A usage may be regularly observed in a particular trade sector, but its application in a given case may nevertheless be unreasonable. Particular conditions within which a party operates, or the atypical nature of a transaction, may lead to such a conclusion. In that case, the usage should not apply.

Illustration 5 (adjusted warranty claim right if quality inspection is unreasonably burdensome).

A usage exists in a commodity trade sector according to which the purchaser may not rely on defects in the goods if they are not duly certified by an internationally recognised inspection agency. When A, a buyer, takes over the goods at the port of destination, the only internationally recognised inspection agency operating in that port is on strike and to call another from the nearest port would be excessively costly. The application of the usage in this case would be unreasonable and A may rely on the defects it has discovered even though they have not been certified by an internationally recognised inspection agency.

Contract interpretation and legal culture

A drafter should be well aware of the contract interpretation or meaning that will be attributed to contract wording once it comes to court proceedings. International legal cultures as well as some contract interpretation guidelines will be discussed in the light of contract drafting and interpretation. The purpose of this chapter is to increase awareness of the background of different opinions and practices, styles and cultures of contract drafting.

Legal cultures and determinative interpretation factors

Three main legal traditions. Three approaches to legal practice can be distinguished, each representing the characteristics of the legal culture behind it:

• The Roman legal culture;
• The Germanic legal tradition; and
• most visibly impacting the size of a contract, the common law.

Other legal families. Also other cultures can be identified, such as the Scandinavian ‘family’, the (former) socialist countries, Arab (or Islamic) legal culture, the Hindu tradition and various mixtures: the Scottish and South African legal systems are somewhat of a mixture between common law and civil law; Japanese law has been influenced by both U.S. common law and German law; Turkish law by the Swiss codification of around 1900; Russian law by several European legal systems including the Dutch re-codification of 1992.

Roman and Germanic traditions. In both legal cultures, courts will come to their decisions by reverting to systematic codifications of the law (i.e. a civil or a commercial code), the meaning of which is elaborated on in parliamentary materials, doctrinal opinions and case law. These codifications have a rather abstract character, building on general principles such as ‘good faith’, ‘reasonable’, ‘fair dealing’, ‘justifiable’, ‘duty to co-operate’, which are familiar tools for each lawyer. These principles require that a party exercising its rights under a contract observes standards of proportionality and subsidiary.

In the Roman and Germanic legal traditions, courts are not strictly bound to their precedents and, exceptionally, even able to set aside unfair consequences of a law or regulation. Lawyers from common law jurisdictions would probably reject such source of uncertainty about explicit provisions, but the practical consequences are not as sweeping as it may seem. Remedies in case of breach of contract are not limited and will typically include specific performance or an otherwise effective remedy.

The two legal traditions are fundamentally different as regards contract interpretation (although the difference may seem to be of a philosophical, academic nature rather than of practical meaning). In the Roman legal culture, the rather subjective consensus between the parties is determinative for the scope and nature of the parties’ mutual obligations. This means that not the written contract but the mental, ‘common intentions’ are relevant and that a written agreement is rather a welcomed (but important) piece of evidence.

In the Germanic legal tradition, an objective approach prevails in the interpretation of contracts and legal acts: important is what, under the circumstances, a reasonable and informed person in the same position would deem reflects most accurately how the parties are bound. Also in this approach, the written contract is a good starting point.

Efforts to articulate a common core of European contract law resulted in the following general principle of contract interpretation (CFR):

1. – 8:101: General rules
   (1)  A contract is to be interpreted according to the common intention of the parties even if this differs from the literal meaning of the words.
   (2)  If one party intended the contract, or a term or expression used in it, to have a particular meaning, and at the time of the conclusion of the contract the other party was aware, or could reasonably be expected to have been aware, of the first party’s intention, the contract is to be interpreted in the way intended by the first party.
   (3)  The contract is, however, to be interpreted according to the meaning which a reasonable person would give to it:
   (a)  if an intention cannot be established under the preceding paragraphs; or
   (b)  if the question arises with a person, not being a party to the contract or a person who by law has no better rights than such a party, who has reasonably and in good faith relied on the contract’s apparent meaning.
2. – 8:102: Relevant matters
   (1)  In interpreting the contract, regard may be had, in particular, to:

(a)  the circumstances in which it was concluded, including the preliminary negotiations;
(b)  the conduct of the parties, even subsequent to the conclusion of the contract;
(c)   the interpretation which has already been given by the parties to terms or expressions which are the same as, or similar to, those used in the contract and the practices they have established between  themselves;
(d)  the meaning commonly given to such terms or expressions in the branch of activity concerned and the interpretation such terms or expressions may already have received;
(e)  the nature and purpose of the contract;
(f)   usages; and
(g)  good faith and fair dealing.

(2)  In a question with a person, not being a party to the contract or a person such as an assignee who by law has no better rights than such a party, who has reasonably and in good faith relied on the contract’s apparent meaning, regard may be had to the circumstances mentioned in sub-paragraphs (a) to (c) above only to the extent that those circumstances were known to, or could reasonably be expected to have been known to, that person.

The above CFR articles give a well-balanced principle of contract interpretation, which would even encompass English law. It is fair to say that each European jurisdiction is somehow represented in the expressed concepts and that none is contradicted. Note that the literal meaning of contractual words is not necessarily decisive.

Common law. In the common law systems, vast codifications of private law have never been developed or, at least, they never achieved an authority given to it on the European continent. For the U.S., for example, codifications have been made for corporate law, partnership law, various types of transactions in movable property (embodied in state codifications of the Uniform Commercial Code) and federal topics such as competition law, intellectual property law, arbitration, securities laws and regulations and bankruptcy law (‘Chapter 11′). Subject matters that are not covered by these codifications have often been developed in the common law (i.e. case law). Accordingly, legal concepts such as ‘mistake’ or ‘set-off’ are based on court precedents.

The influence of legal doctrine is, at least in the U.S. state laws, very limited if relevant at all. To state that legal concepts such as ‘good faith and fair dealing’ can be excluded contractually is exaggerated, but to say that the typical common law attorney is well able to appreciate its scope often contradicts practical experience.

Other than in the Roman and Germanic traditions, the default remedy in common law systems is payment (in cash) of damages. Whether or not an injunction or specific performance may be awarded may depend on the adjudicated court, except that parties can always contractually provide for remedies.

Although this is not the place to elaborate on differences between legal systems, it may be helpful to cite a few relevant provisions of the U.S. Restatement (Second) of Contracts, an academic reflection of the mainstream U.S. principles of contract law.

• 201. Whose meaning prevails
  (1)  Where the parties have attached the same meaning to a promise or agreement or a term thereof, it is interpreted in accordance with that meaning.
  (2)  Where the parties have attached different meanings to a promise or agreement or a term thereof, it is interpreted in accordance with the meaning attached by one of them if at the time the agreement was made:
  (a)  that party did not know of any different meaning attached by the other, and the other knew the meaning attached by the first party; or
  (b)  that party had no reason to know of any different meaning at­tached by the other, and the other had reason to know the meaning attached by the first party.
  (3)  Except as stated in this Section, neither party is bound by the meaning attached by the other, even though the result may be a failure of mutual assent.
• 202. Rules in aid of interpretation
  (1)  Words and other conduct are interpreted in the light of all the circum­stances, and if the principal purpose of the parties is ascertainable it is given great weight.
  (2)  A writing is interpreted as a whole, and all writings that are part of the same transaction are interpreted together.
  (3)  Unless a different intention is manifested:
  (a)  where language has a generally prevailing meaning, it is interpret­ed in accordance with that meaning;
  (b)  technical terms and words of art are given their technical meaning when used in a transaction within their technical field.
  (4)  Where an agreement involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection is given great weight in the interpretation of the agreement.
  (5)  Wherever reasonable, the manifestations of intention of the parties to a promise or agreement are interpreted as consistent with each other and with any relevant course of performance, course of dealing, or usage of trade.

Of course, U.S. state laws may deviate on details, but the key message here is that the differences with European contract laws are not as significant as it may seem.

Statutory guidelines on contract interpretation

Lawyers like to provide certainty on how a contract must be (and will be) interpreted. For them, several legislatures have provided guidelines for interpreting contracts (or legal acts). Despite the broad consensus that such guidelines are not determinative for a case at hand and no more than some hints for a court, lawyers (and typically from other jurisdictions) have anticipated that the guidelines could nevertheless be detrimental and should therefore be excluded explicitly.

Contra proferentem. The CFR provides guidelines for contract interpretation. This is in particular consistent with the civil codes of France, Italy, Spain and Belgium[11], albeit that all EU member states apply such principles. The main interpretation principles have been stated in the previous paragraph; another well-known one is:

1. – 8:103: Interpretation against supplier of term or dominant party
   (1)  Where there is doubt about the meaning of a term not individually negotiated, an interpretation of the term against the party who supplied it is to be preferred.
   (2)  Where there is doubt about the meaning of any other term, and that term has been established under the dominant influence of one party, an interpretation of the term against that party is to be preferred.

Even though the authoritativeness may be questioned, the Restatement (Second) of Contracts explains that a similar principle applies in mainstream U.S. contract law:

• 206. Interpretation against the draftsman
  In choosing among the reasonable meanings of a promise or agreement or a term thereof, that meaning is generally preferred which operates against the party who supplies the words or from whom a writing otherwise proceeds.

The lead-in of the first paragraph of Art. II.8:103 (and Restatement § 206) typically refers to the interpretation of general conditions rather than to ordinary course contracts. The second paragraph of Art. II.8:103 emphasises this, where it introduces a preference in case any negotiations were mainly determined by an economically strong party (vis-à-vis a weak counterparty).

Despite this context specific application, the principle has invited many drafters to include a provision expressing that “the parties reviewed and negotiated the entire contract in all its respects” (and accordingly stating or implying that “no provision should be interpreted against the party who drafted it”). Such approach fails to address the real issue: the interpretation rule would first of all only apply to stipulations where there is a (reasonable) doubt about the actual meaning of them.

If there is no such doubt, the stipulation would be enforced. Whether such doubt could exist may well be measured against the main rule: for instance, the fact that the parties are business people and advised by professionals who would be keen to understand each oddly phrased provision. Secondly, the principle effectively says that where two interpretations compete, the party who created the ambiguity should not have the benefit. The phrase is to be preferred emphasises that the drafter may well explain why a certain meaning should prevail (and ´win’ the interpretation discussion).

Similar arguments can be made about a dominant party who drafted a contract provision: such party would insist on the inclusion of a particular provision, notably as regards disclaimers or limitation of liabilities. In those cases, there may also be a hint of abuse of power, which is not supported by the law. Art. II. 8:103 section (2) balances out this dominance: a dominant party should contractually express its impositions carefully. Moreover, the provision may well be seen as the complement of section (1), as it would likely apply to circumstances in which the dominant party even refused to talk about an issue.

Drafting technique: introduce mutuality. The interpretation rules suggest that a very one-sided contract may be highly susceptible of being interpreted against the drafter. A technique to diminish this is to improve the sense of mutuality of the contract provisions. The most obvious example is probably the confidentiality provision in most contracts: despite a clear one-party geared interest in continuing confidentiality, typically, this provision is drafted to apply mutually. Well-known other examples of mutuality are force majeure clauses: although the party that can be affected by an event of force majeure is foreseeably only one of the two, the text of the provision often suggests fairness for both.

Rules prioritising contract interpretation

A few provisions of the CFR clarify that negotiation of a provision increases its enforceability. This is understandable because the more comprehensive discussions about the ins and outs of a provision were, all the more reluctant a court must be in attributing a meaning, which is not at once apparent. Another important interpretation rule (Art. II. 8:106) is that presumably a contract provision was given a meaning or intended effect. If a provision is ambiguous or contains errors, the mere reliance on such ambiguity or error without further merit should not be protected if another interpretation puts a meaning on it.

1. – 8:104: Preference for negotiated terms
   Terms which have been individually negotiated take preference over those which have not.
2. – 8:105: Reference to contract as a whole
   Terms and expressions are to be interpreted in the light of the whole contract in which they appear.
3. – 8:106: Preference for interpretation which gives terms effect
   An interpretation which renders the terms of the contract lawful, or effective, is to be preferred to one which would not.

The Restatement (Second) of Contracts emphasises other aspects of contract interpretation. Interesting enough, the written terms are not necessarily determinative:

• 203. Standards of preference in interpretation
  In the interpretation of a promise or agreement or a term thereof, the following standards of preference are generally applicable:
  (a)  an interpretation which gives a reasonable, lawful, and effective meaning to all the terms is preferred to an interpretation which leaves a part unreasonable, unlawful, or of no effect;
  (b)  express terms are given greater weight than course of perfor­mance, course of dealing, and usage of trade, course of performance is given greater weight than course of dealing or usage of trade, and course of dealing is given greater weight than usage of trade;
  (c)   specific terms and exact terms are given greater weight than general language;
  (d)  separately negotiated or added terms are given greater weight than standardized terms or other terms not separately negotiated.

Altogether, the importance of one interpretation rule or another is yet a matter of judgement and is not inevitably part of the reasoning a court gives. Where the principles revert to different standards, their actual significance may well differ from country to country or even from judge to judge. Again, this probably also appeals to contracting styles: European versus U.S. style.

Signing a contract, notarisation, legalisation and apostilles

Who should be signing a contract and how to reflect this? The signature block should identify the name of the signatory and, preferably, the legal position of the signatory. This position is important in order to be able to establish whether or not the contract party was duly represented at the time of entering into the agreement.

Defects in the representation of a company can often be repaired by a board resolution of the quasi-represented party in which the entering into of the agreement is ratified. (Since the First European Directive on company law determines that only the represented company can invoke undue representation, such ratification merely protects the representative and may be of convenience for the other party.) Obviously, agency law related to the question of whether a company has been bound by an agreement may well protect the counterparty against undue representation and it is good practice to reflect this under the signatory line (i.e. the signatory should himself or herself be liable if the description is untrue).

Mentioning a signatory’s function or title. The wording identifying the signatories’ respective legal position should be consistent with the requirements for representing the company. Normally, the articles of association of the companies involved establish how the relevant company can or must be represented. If the articles require that only the president or chief executive is authorised, the signature block should reflect this. If the articles authorise each managing director, the signature block could refer to the signatory as the managing director as well as to his or her specific position as chief executive or president.

Powers or attorney and internal contract approval policies. If the agreement is executed by a person authorised on the basis of a power of attorney, the signature block should identify the signatory as Attorney-in-fact. In many companies, there are contracting policies in place authorising business line managers to enter into less significant contracts; such policies should be set out in a power of attorney. In such cases, the authorised person is often identified by reference to the business position rather than as an attorney-in-fact.

(Limited) partnerships. If a partnership is a party to the agreement, the signature block should clarify how and by whom the partnership is represented. As with corporate legal entities, the signature block should identify the quality (or legal position) of the signatory. After all, the signature block should establish how the contracting party is represented. This can be done by embedding an extra line in the signature block identifying the representing entity. Such signing particularity could also be ‘announced’ in the parties block on the first page.

Similarly, if a company must be represented by another legal entity (i.e. because the managing director is itself a legal entity), the signatory line should identify both the name of the latter legal entity and the name of the person authorised to represent that legal entity.

Each party a signature block. If a contract is entered into between more parties (e.g. a loan facility agreement between financing parties on the one hand and various affiliated borrowing (or guaranteeing) parties on the other hand, each such party should have a signatory line even where several entities are represented by one individual.

A signature schedule. If an agreement is between many contracting parties the execution of the agreement may logistically be burdensome and it can be useful to provide for a separate signature schedule. Accordingly, the concluding clause should refer to the schedule in which the signature blocks are included and the signature schedule should identify the agreement to which it relates (as well as a phrase ascertaining that execution of the schedule has the effect of executing the agreement). This has the same effect as a deed of adherence, by the execution of which a person adheres to an existing agreement.

Attach no powers of attorney or other evidence. It is uncommon to attach evidence of each party’s signatory’s authority to represent the contract party in the ordinary course of business contracts. Moreover, it seems common practice that both parties rely on the other party’s proper entering into the agreement. In major corporate transactions (in which a law firm is involved), the contract binders often contain a final chapter in which copies of all powers of attorney and corporate resolutions are gathered.

A wife or husband’s consent. Under the laws of several EU member states, statutory provisions exist requiring that the partner of a natural person who is married in a ‘community of property’ must give his or her consent to important transactions by the partner (e.g. a transfer of shares or securities in a company or granting a guarantee on behalf of a company owned by that other partner). If the consent is missing, the transaction is null and void. In practice, such consent is typically placed underneath the signature blocks (and obviously requires the signature of the partner). In the Netherlands, there is important case law confirming that this principle also applies to securities in investment funds (e.g. established in relation to life insurance policies or mortgage-related financial products).

Initialling contract pages

In many jurisdictions, it is common practice that all pages of a contract are initialled; the question is ‘why?’ Initialling contract pages appears to be something that is not found in US commercial legal practice, whilst in Spanish and Dutch legal practice, initialling each page is common.

In the Netherlands, it is common practice to initial all pages (including a cover sheet). On the signature page, the initialling person (who is not necessarily the signatory of the contract) would place his or her initial next to the legal entity for which the document was initialled. As in Spain, this applies both to M&A and ordinary course business transactions.

Legal prerequisite? Is there a statutory requirement for this? We are not aware of such requirement. In particular contexts or for certain specific types of contracts, it may have been in the past. Apart from very specific cases, initialling pages is probably nowhere required in order for the contract to be valid or enforceable.

Purposes of initialling contract pages. In an M&A context, even the pages of the schedules and annexes (including those attached to a disclosure ‘letter’) would be initialled. For ‘Agreed Form’ agreements attached as schedules, often, a reference is made in the definition of Agreed Form that they are initialled for identification purposes (meaning that “this is substantially the text we agreed”). After closing, they would probably be replaced in the binders by their executed final form versions. Usually, the lawyers (i.e. the junior associates of the law firm’s partner involved) would do the initialling. The main idea would probably be to be able to identify the documents in their entirety; and certainly not as a representation by the law firm that the document is complete.

For ordinary course agreements, initialling the pages serves an additional purpose: in several companies, there is a compliance policy rule saying that the contract be reviewed (and approved) by in-house legal counsel. The authorised signatory (often: the two signatories) would sign only if legal counsel has initialled the pages as a sign of approval.

In both contexts, initialling serves the purpose of a final check whether the agreement is complete, properly dated and undone from square bracketed texts. Typically, it happens that annexes with technical spec sheets, the general terms and conditions or even the list prices have not yet been attached.
By way of conclusion: the initialling lawyer serves as a gatekeeper of the contracting process. Introducing initialling as a safeguard in the process improves transaction quality, increases certainty and hence reduces risks.

Although this is not a matter of contract drafting, knowing what notarisation, legalisation and apostilles entail, is very helpful. The signature block often starts by saying that the contracting party is duly represented by its signatory. There is no need to explicitly state this; if the signatory is not authorised (whether in accordance with the statutory rules or under case law) the represented party would not be bound by the contract and the signatory would be personally liable vis-à-vis the other party.

When the other party insists that a signatory’s due authorisation is formally confirmed, then in most cases a copy of the signatory’s passport (or other appropriate ID) would be acceptable. If a party requires a higher level of certainty, also an extract from the commercial register or court registry would be required. The highest level of certainty is typically sought by a notary (who needs to execute a notarial deed) or by a public official since they must exclude the chance of fraud. Instead of a ‘copy passport’ the ‘legalisation’ of the other party’s authorisation would need to be established. Such legalisation requires an apostille.

Apostille on a contract

In short, an apostille is the French word for a certification commonly used to refer to the legalisation of a document for use in another jurisdiction. The apostille or legalisation ascertains that the signature of the legalised document is authentic. Such ‘legalised documents’ must be accepted in the countries that have signed the Hague Convention. Where the apostille-issuing country is not a party to the Hague Convention, usually an additional diplomatic or consular confirmation of authenticity is necessary.

Legalisation and notarisation of contracts

In practice, an apostille is not much more than an extra page (attached to the legalised document) with a stamped legalisation statement (as required by the Hague Convention) and, in some jurisdictions, one or more colourful stamps (for the taxes and levies paid), signed by an official. The official is normally a consul, a court or other public official who ‘legalises’, by means of the apostille, the authenticity of the signatory of another official, typically a civil notary. The latter has actually investigated and ascertained what needs to be established in the relevant context the formalities up to the notary’s signature, are sometimes called ‘notarisation’.

What to legalise? In relation to the execution of an agreement, the legalised document should establish: (i) the names of the persons who are duly entitled to represent the relevant contracting party; and (ii) whether that representative (and not another person) has indeed signed the legalised document.

Example. For example: in many continental European jurisdictions, the transfer of shares requires a notarial deed of transfer; because of this formality, a transfer is often done on the basis of a power of attorney. In order for the power of attorney to be a valid proof of authority, the notary will ascertain that the seller is validly transferring the shares (and the same applies to the acquisition by the purchaser). Therefore, the notary needs to establish both:

1. who is duly entitled to represent the seller; and
2. whether that representative (and not another person) has indeed signed the relevant power of attorney.

Accordingly, the notary needs to have a statement under the law governing the internal affairs of the selling entities (i.e. that according to the articles of association, the seller can be represented in a certain manner), as well as a statement that the person who signed the power of attorney is indeed the representative (i.e. the signatory needs to go to a notary who will establish his or her identity on the basis of a valid ID and witness signature of the power of attorney).

Although the legalisation of a party’s legal acts would typically be certified by one and the same certification of a notary (and subsequently the court), it may well be that two apostilled documents are delivered depending on where the representative actually is i.e. one ascertaining how the party can be represented and one stating that the signature is actually that of such duly authorised representative.

INCOTERMS explained

Incoterms (‘international commercial terms’) are a series of pre-defined set of rules related to the delivery of sold products and are published by the International Chamber of Commerce (ICC), where full text and explanations can be purchased in print or as an app. Incoterms are usually abbreviated to three letters (e.g. FOB, CIF, DDP, EXW). Incoterm rules are generally accepted worldwide for the interpretation of most commonly used sets of terms and conditions, and are primarily intended to clearly communicate:

1. the tasks, costs and risks associated with the transportation, and
2. point of delivery of goods.

An Incoterm operates as a set of predefined parameters related to transportation, transfer of risk, insurance and delivery of sold products. While usually found in sales agreements (strategic or long-term supply or one-off sales), it may well be that if tangible goods are to shipped in the context of providing service such shipment is arranged by reference to the Incoterms. A contractual reference to an Incoterm implies the incorporation (by reference) of the parameters of the chosen Incoterm into the sales contract. There is no need to expressly stipulate that the Incoterm rules are indeed incorporated by reference, as that is how this is commonly understood. While non-English contracts might use translated wording for the selected Incoterm, it is strongly recommended not to abbreviate the such translated wording but to refer to the official (English) three-letter abbreviation. For example, while a French contract might refer to Coût Assurance Fret for Incoterm Cost Insurance Freight, do not refer to CAF but instead use CIF.

If the parties provide differently as regards one or more of those parameters, this would be deemed to ‘overrule’ the relevant parameters of the Incoterm. For example, the retention of title that ownership passes upon payment overrides the Incoterm’s parameter that risk passes upon handing over the sold goods at a port of shipment.

Delivery and risk-passing. A key characteristic requirement of the Incoterms is to give a precise definition of the contractual place of delivery of the sold products. Under the Incoterms, the place of delivery is also the place (under the sales contract) where the risk of loss of or damage to the goods transfers from the seller to the buyer. Paragraph A4 of each Incoterm specifies the place of delivery.

Point of delivery. By incorporating an Incoterm into a sales contract, the parties clarify precisely where the seller performs its obligation to deliver the goods. For an Incoterm to work properly, it is essential to identify a precise location as the place of delivery. Do not stipulate a point of delivery that does not fit the selected Incoterm: it makes no sense to agree on EXW (Ex Works, delivery at the warehouse of the seller) and provide for a location in the buyer’s country – rather, that gives rise to disputes.

Under most Incoterms, delivery takes place where the goods are handed over, not directly to the buyer, but to a third party (e.g. a carrier) at a pre-determined place. The practicalities for handing over goods to carriers may vary, depending on the location. Clearly identifying the place of delivery will make it impossible for different possible applicable laws to assign the passage of risk to multiple locations.

Cost implications. Choosing an Incoterm determines not only the transportation and delivery obligations of the parties, but also the answer to the question: “Who bears which costs?” Accordingly, to the extent that the seller takes responsibility for transportation and delivery costs, those costs are presumed to be incorporated into the purchase price of the goods.

Application. The Incoterms have traditionally been used for international sale contracts even though some geographical areas, such as the European Union (or even the WTO), have minimised import formalities. Incoterms 2010 can now also be used for domestic sales. This change may encourage greater use of the Incoterms in the U.S.

History of the Incoterms

Versions. The idea for the Incoterms goes back to 1921, and the International Chamber of Commerce published the first set in 1936. The current version is Incoterms 2010, published on 1 January 2011, which updates (albeit to a limited extent) Incoterms 2000.

Refer to the right version. Because changes are made to Incoterms from time to time, it is important to ensure that an express reference is made to the then-current version of the Incoterms wherever the parties incorporate Incoterms into their contract. This may easily be overlooked when, for example, a reference has been made to an earlier version in standard contract forms or in order forms used by merchants. A failure to refer to the current version may then result in disputes as to whether the parties intended to incorporate that version or an earlier version into their contract. Merchants wishing to use Incoterms 2000 should therefore clearly specify that their contract is governed by “Incoterms 2000”.

Incoterms 2000, 2010 and 2020. Incoterms 2010 defined 11 rules (down from the 13 used in Incoterms 2000), introducing two new rules (“Delivered at Terminal”, DAT; and “Delivered at Place”, DAP), which replace four rules in Incoterms 2000 (i.e. “Delivered at Frontier”, DAF; “Delivered Ex Ship”, DES; “Delivered Ex Quay”, DEQ; and “Delivered Duty Unpaid”, DDU). By way of clarification, in Incoterms 2020, the term DAT was renamed to DPU (“Delivery at Place Unloaded“).

Incoterm delivery obligations of the parties visualised

The differences among Incoterms are best understood when depicted in a table. The table below shows which action (if applicable) must be undertaken by the seller and which by the buyer. Obviously, this is a cost/price influencing element. However, the choice of one or another Incoterm is often determined by the more practical question: which party is more used to arranging for transportation or insurance, the availability of warehousing to the buyer, or more familiar with local transportation particularities.

Note that the above and below tables relate to Incoterms 2010 (DAT is now called DPU).  The transfer of the risk regarding the sold goods somewhat deviates from the overview of obligations to be performed by which party, as shown below:

Structure of the Incoterms

Categorisation of Incoterms according to the letter. In Incoterms 2000, a categorisation was made based on the place of delivery. Although this approach has now been abandoned, the categorisation still helps in distinguishing the Incoterms from one another.

The “E”-term (‘departure contracts’) is the term under which the seller’s obligation is at its minimum: the seller has to do no more than place the goods at the disposal of the buyer at the agreed location – usually a distribution centre or the factory or assembler of the seller.

The “F”-terms (‘main carriage unpaid contracts’) require the seller to deliver the goods for carriage as instructed by the buyer. The delivery point under FOB is the same under CFR and CIF.

The “C”-terms (‘main carriage paid contracts’) require the seller to contract for carriage on usual terms at its own expense. Therefore, a point up to which he would have to pay transport costs must necessarily be indicated after the respective “C”-term.[1] Under the CIF and CIP terms, the seller also has to take out insurance and bear the insurance cost. The “C”-terms contain two ‘critical’ points (not one, as opposed to the other Incoterms): one indicating the point to which the seller must arrange and bear the costs of a contract of carriage, and another indicating the point for transfer of the risk. A characteristic of the “C”-terms is that the seller is relieved of any further cost and risk once it has discharged its obligations by contracting for transportation, handing over the goods to the carrier, and, in case of CIF or CIP, by providing for insurance. Accordingly, adding obligations of the seller to the “C”-terms, which extend its responsibility beyond the point of transfer of the risk, requires great caution.

The “D”-terms (‘arrival contracts’) are essentially different from the “C”-terms, because under the “D”-terms the seller is responsible for the arrival of the goods at the agreed place (or at a destination at the border or within the country of import). The seller must bear all costs and risk in bringing the goods there. Hence, the “D”-terms signify arrival contracts, while the “C”-terms denote departure (shipment) contracts.

Categorisation in Incoterms 2010. In Incoterms 2010, the 11 Incoterms are subdivided into two categories based only on method of delivery. The larger group of seven rules applies regardless of the method of transport, but the smaller group of four is applicable only to sales that solely involve transportation over water.

Subdivision of Incoterms from A1 to B10. Each Incoterm is systematically structured, dividing all the elements of delivery into ten numbered entries, each of which is sub-labelled “A” for the seller’s obligations or “B” for the buyer’s obligations. Accordingly, each Incoterm contains the following captions:

A1                – Provision of goods in conformity with the contract
B1                – Payment of the price
A2 & B2        – Licences, authorizations and formalities
A3 & B3        – Contracts of carriage and insurance
A4                – Delivery
B4                – Taking delivery
A5 & B5        – Transfer of risks
A6 & B6        – Division of costs
A7                – Notice to the buyer
B7                – Notice to the seller
A8 & B8        – Proof of delivery, transport document or equivalent electronic message
A9                – Checking – packaging – marking
B9                – Inspection of goods
A10 & B10    – Other obligations

Incoterms for any mode of transportation.

The seven rules defined by Incoterms 2010 for any mode(s) of transportation are:

EXW: Ex works (named place of delivery)
The Ex Works Incoterm is typically used in an initial quotation for the goods without any costs included. The seller makes the goods available at its premises. This term places the maximum obligation on the buyer and minimum obligation on the seller. EXW means that on the agreed date, the seller makes the goods available at its premises (factory, warehouse, plant). To put it simply, the seller opens the doors of its premises. The buyer pays for transportation and bears the risks for taking the goods to their final destination. The seller does not load the goods on collecting vehicles and does not clear them for export. If the seller does load the goods, it does so at the buyer’s risk and cost. If the seller should be responsible for loading the goods on departure and bear the costs and risk of such loading, this must be made explicit in the sales contract.

FCA: Free carrier (named place of delivery)
The seller hands over the goods, cleared for export, putting them at the disposal of the first carrier (named by the buyer) at the named place. The seller pays for carriage to the named point of delivery, and risk passes when the goods are handed over to the first carrier.

CPT: Carriage paid to (named place of destination)
The seller pays for carriage. Risk transfers to the buyer upon handing goods over to the first carrier.

CIP: Carriage and insurance paid to (named place of destination)
CIP is the containerised transport or multimodal equivalent of CIF. The seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier.

DPU: Delivered at place unloaded (named terminal at port or place of destination)
The seller pays for carriage to the terminal, except for costs related to import clearance, and assumes all risks up to the point that the goods are unloaded at the terminal. Note that DPU is renamed from Incoterms 2010 term DAT.

DAP: Delivered at place (named place of destination)
The seller pays for carriage to the named place, except for costs related to import clearance, and assumes all risks prior to the point that the goods are ready for unloading by the buyer.

DDP: Delivered duty paid (named place of destination)
The seller is responsible for delivering the goods to the named place in the country of the buyer, and bears all the costs in bringing the goods to the destination, including import duties and taxes. This Incoterm places the maximum obligation on the seller.

Incoterms for sea and inland waterway transport.

The four rules defined by Incoterms 2010 for international trade where transportation is entirely conducted over water are:

FAS: Free alongside ship (named port of shipment)
The seller must place the goods alongside the ship at the named port. The seller must clear the goods for export. FAS is suitable only for maritime transport but not for multimodal sea transport in containers. This term is typically used for heavy-lift or bulk cargo.

FOB: Free on board (named port of shipment)
The seller must load the goods on board the vessel named by the buyer. Cost and risk shift to the buyer once the goods are actually loaded on board the vessel (this clarification is new). The seller must clear the goods for export. The term is applicable for maritime and inland waterway transport only but not for multimodal sea transport in containers. The buyer must instruct the seller as to the details of the vessel and the port where the goods are to be loaded, and there is no reference to, or provision for, the use of a carrier or forwarder. This term has been greatly misused over the past three decades, ever since Incoterms 1980 explained that FCA should be used for container shipments.

CFR: Cost and freight (named port of destination)
The seller must pay the costs to transport the goods to the port of destination. The risk transfers to the buyer once the goods are loaded on the vessel (this is a ‘clarification’ of Incoterms 2000). Maritime transport only and insurance for the goods is not included. This term is formerly known as CNF (C&F).

CIF: Cost, insurance and freight (named port of destination)
The term is same as CFR, except that the seller must in addition arrange (and pay) for insurance.

[1]       Since the point for the division of costs is fixed at a point in the country of destination, the “C”-terms are frequently mistakenly believed to be ‘arrival contracts’, in which the seller would bear all risks and costs until the goods have actually arrived at the agreed point. It must be emphasised, however, that the “C”-terms are of the same nature as the “F”-terms: the seller fulfils the contract in the country of shipment or dispatch.

A few particularities

Ship’s rail as delivery point. In Incoterms 2010, the “ship’s rail” as the point of delivery has been omitted in favour of the goods being considered as delivered when they are “on board”. This more accurately reflects commercial reality and avoids the rather dated image of the risk transferring across an imaginary line.

Terminal handling charges. The carriage costs sometimes include handling and moving the goods within a port or container terminal facility. The carrier or terminal operator may well charge these costs to the buyer who receives the goods. In these cases, the buyer must not be obliged to pay twice for the same service: once to the seller (as part of the total selling price) and once independently to the carrier or the terminal operator. The Incoterms 2010 rules seek to avoid this by clearly allocating these costs in paragraphs A6/B6 of the applicable Incoterm.

E-mails, etc. Articles A1/B1 of Incoterms 2010 give electronic means of communication the same effect as paper communication, as long as the parties so agree, or where such communication is customary.

 

Unidroit Principles of International Commercial Contracts

The Unidroit Principles of International Commercial Contracts set forth general rules basically conceived for ‘international commercial contracts’. The concept ‘international’ should be given the broadest possible interpretation, so as to exclude only those contractual relationships where no international element is involved at all. The term ‘commercial’ is intended to exclude so-called ‘consumer transactions’, aimed at protecting the consumer (i.e. a person who enters into a contract other than in the exercise of a trade or a profession).

The Unidroit Principles chosen as the applicable law

Given that the Unidroit Principles embody a system of principles and rules of contract law common to existing national legal systems or best adapted to the special requirements of international commercial transactions, there might be good reasons for the parties to choose them expressly as the rules of law governing their contract. In so doing, the parties may refer to the Unidroit Principles exclusively or in conjunction with a particular domestic law that applies to issues not covered by the Unidroit Principles (see an explanation of the model clauses here – as also referred to in the footnote to the second paragraph of the Preamble).

The Model Clauses can be divided into four categories depending whether their purpose is to:

1. Choose the Unidroit Principles as the (rules of) law governing the contract (see model clauses 1 below).
2. Incorporate the Unidroit Principles as terms of the contract (see model clause 2 below).
3. Refer to the Unidroit Principles to interpret and supplement the CISG (Vienna Convention on the International Sales of Goods) if CISG was chosen by the parties (see model clauses 3 below).
4. Refer to the Unidroit Principles to interpret and supplement the applicable national law (incl. any international uniform law instrument incorporated into that law (see model clauses 4 below).

Unidroit Principles in arbitration

Some (public) courts might consider that freedom to choose the applicable law is a matter of national law. Therefore, it is recommended that parties who wish to choose the Unidroit Principles as the rules of law governing their contract combine this choice of law with an arbitration agreement. Since the Unidroit Principles could be considered a mere set of rules, the law applicable to the contract would still have to be determined on the basis of private international law rules. In such approach, the Unidroit Principles would bind the parties only to the extent that they do not affect mandatory law.

This is different in arbitration. Arbitrators are not necessarily bound by a particular domestic law. This is self-evident if they are authorised by the parties to act as amiable compositeurs or ex aequo et bono. Moreover, the parties are generally permitted to choose “rules of law” other than national laws, on which the arbitrators must base their decision. Accordingly, the parties would be free to choose the Unidroit Principles as the “rules of law” according to which the arbitrators must decide a dispute.

Unidroit Principles and Lex Mercatoria

Parties to international commercial contracts who cannot agree on the choice of a particular domestic law as the law applicable to their contract sometimes provide that it shall be governed by “general principles of law”, by the “usages and customs of international trade”, or by the Lex Mercatoria. In such cases, it might be advisable to submit to the Unidroit Principles. The Unidroit Principles can be considered to reflect the Lex Mercatoria (if any such body of law can be identified at all) and certainly reflect the usages and customs of international trade.

Throughout this book, many generally accepted principles of international contract law – rules of the Lex Mercatoria, so to speak, or usages and customs of international trade – have been discussed with reference to specific Unidroit Principles. In this paragraph, a few high-level concepts underlying international trade will be addressed by referring to the Unidroit Principles. These general concepts include:

• Freedom of contract
• The principle of good faith and fair dealing
• Practices and usages of international trade (but see also the chapter on Incoterms or on payment devices)

A rich source of materials, cases and arbitral awards related to a ‘codification’ in 130 principles of the Lex Mercatoria (and referring also to the Unidroit Principles) has been collected by Prof. Klaus Peter Berger. The collection is available on the Trans-Lex website.

Applying the Unidroit Principles on your contracts or dispute

Depending on the context, Unidroit recommends using the following model clauses for invoking and applying the Unidroit Principles to your contract or dispute:

1.   Model clauses choosing the Unidroit Principles as the rules of law governing the contract

1.1    Model clauses choosing only the Unidroit Principles

(a)    Model Clause for inclusion in the contract

“This contract shall be governed by the Unidroit Principles of International Commercial Contracts (2016).”

(b)    Model Clause for use after a dispute has arisen

“This dispute shall be decided in accordance with the Unidroit Principles of International Commercial Contracts (2016).”

1.2    Model clauses choosing the Unidroit Principles supplemented by a particular domestic law

(a)    Model Clause for inclusion in the contract

“This contract shall be governed by the Unidroit Principles of International Commercial Contracts (2016) and, with respect to issues not covered by such Principles, by the law of [State X].”

(b)    Model Clause for use after a dispute has arisen

“This dispute shall be decided in accordance with the Unidroit Principles of International Commercial Contracts (2016) and, with respect to issues not covered by the Principles, by the law of [State X].”

1.3    Model clauses choosing the Unidroit Principles supplemented by generally accepted principles of international commercial law

(a) Model Clause for inclusion in the contract

“This contract shall be governed by the Unidroit Principles of international Commercial Contracts (2016) and, with respect to issues not covered by such Principles, by generally accepted principles of international commercial law.”

(b) Model Clause for use after a dispute has arisen

“This dispute shall be decided in accordance with the Unidroit Principles of International Commercial Contracts (2016) and, with respect to issues not covered by such Principles, by generally accepted principles of international commercial law.”

2.  Model clause incorporating the Unidroit Principles as terms of the contract

“The Unidroit Principles of International Commercial Contracts (2016) are incorporated in this contract to the extent that they are not inconsistent with the other terms of the contract.”

3.   Model clauses referring to the Unidroit Principles as a means of interpreting and supplementing the United Nations Convention on Contracts for the International Sale of Goods (CISG) when the latter is chosen by the parties

(a) Model Clause for inclusion in the contract

“This contract shall be governed by the United Nations Convention on Contracts for the International Sale of Goods (CISG) interpreted and supplemented by the Unidroit Principles of International Commercial Contracts (2016).”

(b) Model clause for use after a dispute has arisen

“This dispute shall be decided in accordance with the United Nations Convention on Contracts for the International Sale of Goods (CISG) interpreted and supplemented by the Unidroit Principles of International Commercial Contracts (2016).”

4.   Model clauses referring to the Unidroit Principles as a means of interpreting and supplementing the applicable domestic law

(a) Model Clause for inclusion in the contract

“This contract shall be governed by the law of [State X] interpreted and supplemented by the Unidroit Principles of International Commercial Contracts (2016).”

(b) Model Clause for use after a dispute has arisen

“This dispute shall be decided in accordance with the law of [State X] interpreted and supplemented by the Unidroit Principles of International Commercial Contracts (2016).”

 

Freedom of contract in the Unidroit principles

A fundamental principle in international trade. The principle of freedom of contract is of paramount importance in international trade. The principle embodies the freedom to decide to whom a company will offer its goods or services and by whom it wishes to be supplied, as well as the terms and conditions of the related transactions. This is inherent to an open, market-oriented and competitive international economic order.

Exceptions and limitations. Regarding the freedom to conclude contracts with any other person, certain economic sectors are in the public interest excluded from open competition (e.g. military goods and materials, nuclear products, technology, raw materials or ingredients that might be used for chemical or biological weapons). In such cases the goods or services can only be ordered from selected suppliers, subject to terms and conditions consistent with the public interest.

Limitation by mandatory rules. Freedom of contract, to the extent that it relates to the subject matter of an agreement, is further limited by mandatory law: laws and regulations from which the parties may not derogate. Such mandatory law is of a national nature and applies by operation of the conflict of laws principles. Although the contracting parties have a great discretion to avoid mandatory law by making a choice of law for a jurisdiction which is more favourable or familiar to them (or whatever other justification, if any, the parties may have), the rules of private international law may qualify specific laws and regulations to prevail despite such choice of law (e.g. laws

Practices and usages in contract performance

Contract parties are bound by practices and usages in contract performance as they have established among themselves or that are widely known and generally accepted in the industry concerned:

Article 1.9 (Usages and practices)
(1)  The parties are bound by any usage to which they have agreed and by any practices which they have established between themselves.
(2)  The parties are bound by a usage that is widely known to and regularly observed in international trade by parties in the particular trade concerned except where the application of such a usage would be unreasonable.

Practices between the parties. A practice established between the parties is automatically binding, except where the parties have expressly excluded its application. Whether a particular practice must be considered to be ‘established’ between the parties depends on the circumstances. Obviously, behaviour in the context of only one preceding transaction will not normally suffice.

Illustration 1 (usually permitted claim period in excess of the agreed term).
S, a supplier, has repeatedly accepted claims from C, a customer, for quantitative or qualitative defects in the goods as much as two weeks after their delivery. When C gives another notice of defects after a fortnight, S cannot object that it is too late since the two-weeks’ notice amounts to a practice established between S and C which will as such be binding on S.

Agreed usages. The parties may specify all the terms of their contract or for certain questions simply refer to other sources, including usages. In the ITC model contract for the international commercial sale of goods, this applies in particular where references are made to the Incoterms and to international trade usages as regards letters of credit (UCP600), standby practices (ISP98) or demand guarantees (URDG).

Other applicable usages in contract performance

Concerning the applicability of other trade usages, it is important that the usage is “widely known to and regularly observed […] by parties in the particular trade concerned”. The additional qualification “in international trade” means that usages confined to domestic transactions should not also be invoked in transactions with foreigners. Only exceptionally should usages of a purely local or national origin be applied without any reference thereto by the parties. For example, usages existing on certain commodity exchanges or at ports should apply, provided that would regularly be the case with respect to foreigners. Another exception concerns businesses that have already completed a number of similar contracts and that might be deemed to have become aware of the usages within that country for such contracts.

Illustration 3 (usages in a port).
A, a terminal operator, invokes a particular usage of the port where it is located vis-à-vis B, a foreign carrier. B is bound by this local usage if the port is normally used by foreigners and the usage in question has been regularly observed with respect to all customers, irrespective of their place of business and of their nationality.

Illustration 4 (applicability of local discount usages).
A, a sales agent from Country X, receives a request from B, one of its customers in Country Y, for the customary 10 percent discount upon payment of the price in cash. A may not object to the application of such a usage on account of its being restricted to Country Y if A has been doing business in that country for a certain period of time.

Application would be unreasonable. A usage may be regularly observed in a particular trade sector, but its application in a given case may nevertheless be unreasonable. Particular conditions within which a party operates, or the atypical nature of a transaction, may lead to such a conclusion. In that case, the usage should not apply.

Illustration 5 (adjusted warranty claim right if quality inspection is unreasonably burdensome).
A usage exists in a commodity trade sector according to which the purchaser may not rely on defects in the goods if they are not duly certified by an internationally recognised inspection agency. When A, a buyer, takes over the goods at the port of destination, the only internationally recognised inspection agency operating in that port is on strike and to call another from the nearest port would be excessively costly. The application of the usage in this case would be unreasonable and A may rely on the defects it has discovered even though they have not been certified by an internationally recognised inspection agency.

Inconsistent behaviour (venire contra factum proprium) and contracts

A general principle of contracting that can be considered as an application of good faith and fair dealing, is the requirement that parties should not act inconsistently with an understanding that is implied in the contract (Unidroit Principles Article 1.8):

Article 1.8 (Inconsistent behaviour)

A party cannot act inconsistently with an understanding it has caused the other party to have and upon which that other party reasonably has acted in reliance to its detriment.

This general manifestation of the principle of good faith is called (non) ‘venire contra factum proprium’. In other words, a contract imposes a responsibility on each party not to occasion detriment to another party by acting inconsistently with an understanding concerning their contractual relationship that it has – explicitly, implicitly or by its mere behaviour – caused that other party to have, and upon which that other party has reasonably acted in reliance.

How an understanding reasonably relied upon comes to existence. A party may cause the other party to have an understanding concerning their contract, its performance or enforcement, in many ways. For example, the understanding may result from a representation made, from conduct, or from silence when a party would reasonably expect the other to speak to correct a known error or misunderstanding that was being relied upon.

Effect of the principle. The prohibition in Article 1.8 might result in the creation of rights, or in the loss, suspension or modification of rights, deviating from those expressly agreed by the parties. This is because the understanding reasonably relied upon may itself be inconsistent with the agreed or actual rights of the parties.

Because its impact is rather large, there is an important prerequisite for invoking this principle: the understanding must be one on which, in view of all the circumstances, the other party can and does reasonably rely. Whether such reliance is reasonable (and must be given effect) depends, in particular, on the communications and conduct of the parties, on the nature and context of the parties’ dealings, and on the expectations they could reasonably have with regard to each other. This is best illustrated by examples:

Illustration 1 (letting the other party take destructive steps in anticipation of a contract that is not entered into).

A and B have spent lengthy negotiations over a lease contract relating to B’s land under which B is to demolish a building and construct a new one to A’s specification. A communicates with B in terms that induce B reasonably to understand that their contract negotiations have been completed, and that B can begin performance. B then demolishes the building and engages contractors to build the new building. A is aware of this and does nothing to stop it. A later indicates to B that there are additional terms still to be negotiated. A will be precluded from departing from B’s understanding.

Illustration 2 (failing to warn that expected performance should be different).

B mistakenly understands that its contract with A can be performed in a particular way. A is aware of this and stands by while B’s performance proceeds. B and A meet regularly. B’s performance is discussed but no reference is made by A to B’s mistake. A will be precluded from insisting that the performance was not that which was required under the contract.

Illustration 3 (denying that payment is due, now that an affiliate ordered the work).

A regularly uses B to do sub-contract work on building sites. That part of A’s business and the employees involved in it are taken over by A1, a related business. There is no change in the general course of business by which B obtains its instruction to do work. B continues to provide sub-contract services and continues to bill A for work done believing the work is being done for A. A does not inform B of its mistake. A is precluded from denying that B’s contract for work done is with it and must pay for the work done.

Illustration 4 (requiring penalties notwithstanding accepted delays in deliveries).

Because of difficulties it is experiencing with its own suppliers, A is unable to make deliveries on time to B under their contract. The contract imposes penalties for late delivery. After being made aware of A’s difficulties, B indicates it will not insist on strict compliance with the delivery schedule. A year later B’s business begins to suffer from A’s late deliveries. B seeks to recover penalties for the late deliveries to date and to require compliance with the delivery schedule for the future. It will be precluded from recovering the penalties but will be able to insist on compliance with the schedule if reasonable notice is given that compliance is required for the future.

Illustration 5 (failure to claim payment does not preclude a later claim to be paid).

B is indebted to A in the sum of AUD 10,000. Though the debt is due A takes no steps to enforce it. B assumes in consequence that A has pardoned the debt. A has done nothing to indicate that such actually is the case. It later demands payment. B cannot rely on A’s inaction to resist that demand.

Detriment and preclusion. Contracting parties must avoid detriment being occasioned in consequence of reasonable reliance. This principle does not necessarily lead to a prohibition or preclusion to act in the detrimental way. Depending on the circumstances, there may be other reasonable means available that can avert the detriment. For example, unreasonable detriment can be diminished by giving reasonable notice before acting inconsistently (see Illustration 4), or by paying for costs or losses incurred by reason of reliance.

Illustration 6 (compensation of non-commissioned but performed work).

A and B are parties to a construction contract which requires that additional works be documented in writing and be certified by the site architect. A’s contract manager orally requests B to do specified additional work on a ‘time and materials basis’ and assures B it will be documented appropriately in due course. B commissions design works for the additional work at which stage A indicates that the work is not required. The cost incurred in commissioning the design work is far less than the cost that would be incurred if the additional work were to be done. If A pays B the costs incurred by B for the design work, B cannot then complain of A’s inconsistent behaviour.

Illustration 7 (continued request for performance precludes a termination right for breach of contract).

A fails to meet on time a prescribed milestone in a software development contract with B. B is entitled under the contract to terminate the contract because of that failure. B continues to require and pay for changes to the software and acts co-operatively with A in continuing the software development program. A’s continued performance is based on B’s conduct subsequent to the breach. B will in such circumstances be precluded from exercising its right to terminate for the failure to meet the milestone. However, under the Unidroit Principles B will be able to allow A an additional period of time for performance (see Article 7.1.5) and to exercise its right to terminate if the milestone is not met in that period.

Introduction to CISG (Convention on contracts for the international sale of goods)

One of the most important treaties (or, equally, conventions) in international commerce is the United Nations Convention on Contracts for the International Sale of Goods. It was prepared by UNCITRAL and adopted in Vienna in 1980.[1] In common parlance, the convention is referred to as the “Vienna Convention” and in publications often abbreviated as “CISG”.

The CISG is a success. Considering the number of ratifications, the Vienna Convention is a great success. The text has been ratified by over 75 countries worldwide. Important countries that have not (yet) ratified the CISG include the UK, India, Portugal, South Africa and several countries in the Middle East.[2] An up-to-date map can be found on or through the websites of uncitral and legacarta.net/maps.

Accessibility and supporting materials. The vienna convention has been translated into the six official u.n. Languages, as well as (inter alia) into german, italian and portuguese. This makes the cisg widely accessible. Moreover, there is an abundance of materials explaining the scope and application of the Vienna Convention.[3] a brief presentation is given below.

[1]           U.N. Convention on Contracts for the International Sale of Goods, Vienna, 1 April 1980. It entered into force on 1 January 1988.
[2]       Note that for the Convention to be applicable, it is sufficient that only one contracting party has its place of business in a contracting State and that the rules of private international law lead to the application of the law of a contracting State (Article 1).
[3]       See in particular: Commentary on the Draft Convention for the International Sale of Goods, prepared by the Secretariat (document A/Conf.97/5), dated 14 March 1979, available at: www.cisg-online.ch.

 

Scope of CISG and its general provisions explained

The scope of the United Nations Convention on Contracts for the International Sale of Goods (aka “CISG” or “Vienna Convention”) is well defined. It is limited to international sales contracts only. It does not apply to licences, service contracts, manufacturing agreements or loans, except to the extent that such contracts contain provisions related to the sale of movable goods. Furthermore, the CISG excludes certain sales contracts because of purpose (i.e. consumer contracts), particular nature (i.e. sales by auction, on execution or otherwise by operation of law) or the nature of the goods (i.e. shares, investment securities, negotiable instruments, money, ships, aircraft, or electricity). Therefore, it is nonsense to exclude its applicability in any of those cases.

Certain matters fall outside the Vienna Convention’s scope, such as for example the validity of the sales contract, and (passing of) ownership of the goods sold. These matters are typically covered by the law chosen in the sales contract. Whether that is indeed true is a question of ‘private international law’ (more adequately called ‘conflict of laws’ – see section 4.9). In any case, the Vienna Convention applies if the law of a contracting State[1] is chosen.

CISG and fundamental principles of contract law

Party autonomy. A key aspect of the Vienna Convention is the recognition of ‘freedom of contract’ or ‘party autonomy’. The parties are free to exclude the application of the Vienna Convention and to modify the scope or effect of any of its provisions. The parties do not have to derogate explicitly from the Vienna Convention: they may instead provide a different rule from the corresponding provision found in the Vienna Convention.

Interpretation of CISG. The Vienna Convention was written to be as clear and easy to understand as possible. In cases involving disputes as to its meaning and application, courts and arbitral tribunals are admonished to observe its international character, to promote a uniform application and to observe good faith in international trade. Nevertheless, the Vienna Convention will respect (i) the statements and conduct of a party in the context of the formation of the contract or its implementation, (ii) usages agreed to by the parties, (iii) practices they have established among themselves, and (iv) industry usages and good practices (think of Incoterms or the UCP600 in support of L/Cs, Letters of Credit).

Legal ‘form’ of a contract. The Vienna Convention does not require that a sales contract be expressed in a certain form. A sales agreement can be entered into orally, in writing, by e-mail or in any other form. Accordingly, any amendment of the agreement does not require a certain form – except, if the contract itself requires that an amendment or a termination be notified in writing, such requirement prevails.[2] The only exception would be that a party may be precluded by its conduct from asserting such requirement to the extent that the other party has relied on that conduct.

Formation of a sales contract. The second part of the Vienna Convention deals with the formation of the contract, which is concluded by the exchange of offer and acceptance. It is outside the scope of this book to discuss aspects of ‘business proposals’, ‘withdrawal or revocation of offers’, ‘rejection of an offer’, ‘counteroffers’, ‘modified acceptance’, ‘acceptance’ and related topics, and aspects of the applicability of ‘general terms and conditions’ (also referred to as ‘general business terms’ or any other recombination of these words).

[1]       A ‘contracting State’ means a country that has ratified the Vienna Convention. Note that CISG Article 1 contains a more accurate rule indicating its applicability.

[2]       See CISG Article 29, and ITC Model Contract for the international commercial sale of goods (standard version) Article 18.2. However, note that ratifying States whose legislation requires sales contracts to be concluded in or evidenced by writing, may have set aside CISG Article 11, 29 or provisions in Part II, for a seller or buyer that has its place of business in that State (see Article 96).

 

Passing of ownership and risk in a sales contract

In an international sale of goods, the exact moment at which the risk of loss or damage to the goods passes from the seller to the buyer is of great importance. It determines whether the buyer must pay despite a complete or partial loss of the goods, or whether a seller should replace the goods if they have been damaged during transportation (CISG Article 66). As a rule, the risk passes when the ownership of the goods changes.

The parties may address the passing of risk (or the shift of ownership) in their contract expressly or by implication in the use of an Incoterm (see section 5.3). The ITC Model Contracts provide wording for the choice of an Incoterm, as well as for a transfer of property (i.e. ownership). Failing such a provision, the Vienna Convention sets forth a complete set of rules (see CISG Articles 66-70).

Passing of ownership depends on the applicable law

First of all, how the ownership of and risk related to the goods under contract pass from the seller to the buyer is a matter for the applicable property law. But property laws will also refer to specific acts or circumstances such as the handing over of the goods and may permit a ‘retention of title’ (i.e. postponement of transfer of ownership until the purchase price has been paid in full). Those acts or circumstances may still need to be specified.

The two situations contemplated by the Vienna Convention are when the sales contract involves carriage of the goods (CISG Article 67) and when the goods are sold while in transit (CISG Article 68). In all other cases, the risk passes to the buyer when it takes over the goods or from the time when the goods are placed at its disposal and it commits a breach of contract by failing to take delivery, whichever comes first (CISG Article 69).

In the frequent case when the contract relates to goods that are not then identified, they must be identified as covered by the contract before it can be considered that they have been placed at the disposal of the buyer and that the risk of their loss has passed to the buyer (CISG Article 69(3) and 69(2))

 

Fundamental breach and avoidance (termination)

Delivery of what sold goods, where?

Generally, a seller to a sales agreement is bound to deliver the goods, to hand over any documents relating to the goods, and to transfer the property in the goods, as required by the sales contract (CISG Article 30). In the absence of a contractual arrangement in the sales contract as to when, where or how the seller must perform these obligations, the Vienna Convention supplements the contract (CISG Article 31, 32 and 33).

If the seller under a sales agreement must hand over documents related to the goods – such as transportation documents, import clearances, certificates of origin or quality, or manuals – the sales contract should provide for when, where and in what form the documents must be delivered (CISG Article 34).

The goods. In order for the seller to deliver “the goods”, in cases involving specific goods, clearly the seller must deliver exactly those goods identified in the contract. If the seller handed over a sample or model, the goods must possess the qualities of the sample or model. In cases involving unidentified goods, the seller must deliver goods that generally conform to the description agreed to in the contract.

For example, if the contract demands delivery of corn, the seller has not “delivered” if it provides grain. However, the “goods” are considered as “delivered” even if they are non-conforming. For example, handing over to the carrier the requisite amount of no. 3 grade corn when no. 2 grade was called for, or handing over to the carrier five tons when ten tons were called for, would constitute delivery of “the goods”. Of course, even though “the goods” had been “delivered”, the buyer would be able to exercise any rights it might have because of the seller’s breach of contract.

‘Breach’ or ‘fundamental breach’ of a sales contract?

The third part of the Vienna Convention deals with the obligations of the parties to the contract. Obligations of the seller include delivering goods in conformity with the quantity and quality stipulated in the contract, together with related documents, and transferring the property of the goods. If a seller delivers goods that may be considered fit for the general purpose for which they are normally used, but that do not meet the specificities of the contract, the seller is in breach.

The same applies if the goods are delivered after the agreed delivery date, or if the seller fails to meet another obligation. Normally, such a breach of contract leads to a reduction of the purchase price, the buyer’s entitlement to compensation of damages or another remedy (including specific performance – CISG Article 28 and 46). Remedies may be cumulated to the extent they do not exclude each other by their very nature (CISG Article 45 and 61 par. 2).

In certain cases, a breach is fundamental:

Article 25 CISG
A breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.

Avoidance (termination) of a sales contract.

In case of fundamental breach, the aggrieved party may avoid (terminate) the sales contract (CISG Article 49 and 64). If a breach is not fundamental, the right to avoid the contract is dependent on whether the goods were delivered at all (if not, the terminating party must first fix a deadline allowing delivery). If the goods were delivered, the right to avoid the contract lapses after a reasonable period of time. Exactly when a reasonable period of time is considered to have lapsed, depends on whether the breach amounted to a delay in delivery or not: specific criteria apply as to the knowledge (or imputed knowledge) of the terminating party and (see CISG Article 49).

Case law on fundamental breach, avoidance or termination of a sales contract.

In many cases, the issue boils down to the question of whether a breach of contract is fundamental. To a large extent, this depends on whether or not any delivered goods were in conformity with the sales contract and fit for their purpose, and whether any non-conformity was discovered and notified in a timely manner (see section (d)).

Unilex, an initiative of Prof. M.J. Bonell (Rome, Italy), is a collection of hundreds of court decisions and arbitral awards based on the Vienna Convention.[1] The following cases are particularly illustrative for questions related to fundamental breach (CISG Article 35, whether or not leading to avoidance pursuant to Article 49):

Case: cadmium-contaminated mussels[2]
A Swiss seller and a German buyer concluded a contract for the sale of New Zealand mussels. The buyer refused to pay the purchase price after the mussels were declared ‘not completely safe’ because of the quantity of cadmium they contained: significantly greater than the advised cadmium levels published by the German Federal Health Department. The buyer notified the seller and requested it to take back the mussels. Six or eight weeks after the delivery, the buyer complained about defects of the packaging. The seller commenced an action claiming payment and interest. At first instance the Court decided in favour of the seller. The buyer’s subsequent appeals were unsuccessful.
The Court held that the buyer had to pay the purchase price. It was not entitled to declare the contract avoided under CISG Articles 25 and 49(1)(a) since the seller did not commit a fundamental breach. The Court confirmed the findings of the lower courts, according to which the mussels were conforming to the contract since they were fit for the purposes for which goods of the same description would ordinarily be used (CISG Article 35(2)(a)). The Court did find that the fact that the mussels contained a greater quantity of cadmium than the advised cadmium levels could well affect the merchantability of the goods, provided that the corresponding public law requirements were relevant.
However, like the lower courts, the Supreme Court excluded that the seller can generally be expected to observe special regulatory food quality requirements of the buyer’s state; it could only be expected to do so: (1) where the same requirements also exist in the seller’s country; (2) where the buyer draws the seller’s attention to their existence; (3) or, possibly, where the seller knows or should know of those requirements due to “special circumstances”, such as (i) when the seller has a branch in the buyer’s country, (ii) when the parties are in a longstanding business relationship, (iii) when the seller regularly exports to the buyer’s country, or (iv) when the seller advertises its own products in the buyer’s country.
The Court equally confirmed that the buyer was not entitled to avoid the contract because of non-conformity of the packaging (CISG Article 35(2)(c)). The decisive fact in this respect was that the buyer did not give notice of non-conformity of the packaging in due time (notice was given approximately two months after delivery).

Case: underperforming packaging machine[3]
A Swiss seller and a Spanish buyer concluded a contract for the sale of a packaging machine. The seller undertook to install the machine and prepare its operation at the buyer’s factory. A dispute arose between the parties regarding the required performance level of the machine. The buyer asserted that an output of 180 vials per minute had been agreed but the seller contended that this was neither possible nor agreed. On several occasions thereafter, the seller unsuccessfully attempted to increase the performance level. After two years, the buyer declared the contract terminated and claimed restitution of the purchase price plus damages. The seller counterclaimed for the outstanding purchase price along with damages. The seller lost the case in all three instances up to the Swiss Federal Supreme Court.
The Supreme Court stated that the actual performance of the machine delivered by the seller was well below the performance required under the contract. Therefore, the buyer was substantially deprived of what it had been entitled to expect under the contract according to CISG art. 25 and had the right to avoid the contract pursuant to CISG art. 49(1)(a).
As to the seller’s allegation that the buyer had forfeited its right to terminate the contract pursuant to the Vienna Convention, the Supreme Court emphasised a “reasonable” period of time as required by CISG art. 49(2)(b) must be determined in accordance with the circumstances of the case (inter alia, nature of the goods and lack of conformity, conduct of the seller subsequent to buyer’s notice of non-conformity), as well as the purpose of the provision.
In this case, the buyer had properly notified the lack of conformity pursuant to CISG art. 39(1), since it had done so immediately after the machine had been installed and the first test runs had been conducted. Furthermore, the relevant period of time for declaring the contract avoided had commenced only at a late stage, after the seller had eventually proposed an amicable settlement for a target performance level that would still be well below the performance required by the contract and the buyer became aware of the fundamental breach by the seller. Since the buyer declared the contract avoided approximately one month after the settlement proposal, it acted within a reasonable time.
Regarding the seller’s contention that the buyer had lost its right to declare termination of the contract due to its use of the machine (CISG art. 82(1)), the Swiss Supreme Court held that such provision applies only if the condition of the goods have been changing in such manner that it is unreasonable to expect the seller to redeem the goods. This was apparently not the case.

Case: defective pressure cookers[4]
A Portuguese seller and a French buyer concluded a contract for the sale of a stock of pressure cookers to be distributed in a French chain of supermarkets. After delivery, some of the cookers showed a defect that made their use dangerous.    The first instance Court held the contract terminated and condemned the seller to pay damages. Also, it ordered that all items were to be withdrawn from the market. The seller appealed, putting forward that termination should have been limited to those cookers which were defective (identification was possible by their serial number).
The Court rejected the seller’s claim. The number of the defective pressure cookers amounted almost to a third of the total number. Therefore, the seller’s breach of contract (according to CISG art. 35) was ‘fundamental’ under CISG art. 49, taking into account the nature of the goods and the need of security in their use.
Although the seller had stated that the defective items had a differing serial number permitting to limit the scope of a product recall, this did not result from the invoices, referencing to the same number. The seller did not provide for another way to identify the defective items. Partial termination was therefore not admissible.

Breach of a sales contract and analogy with Unidroit Principles.

The Unidroit Principles’ Article 7.3.1 uses the same concept of fundamental breach as CISG Article 25, but the Unidroit Principles calls it ‘fundamental non-performance’. Although the Unidroit Principles only apply in connection with the termination of a contract – and not also a claim for specific performance or other remedy – the criteria applied are the same, except that the Unidroit Principles are more specific about the circumstances that may be relevant to determine if a breach is ‘fundamental’:

SECTION 3: TERMINATION
Article 7.3.1 (Right to terminate the contract)
(1)  A party may terminate the contract where the failure of the other party to perform an obligation under the contract amounts to a fundamental non-performance.
(2)  In determining whether a failure to perform an obligation amounts to a funda­mental non-performance regard shall be had, in particular, to whether:
(a)  the non-performance substantially deprives the aggrieved party of what it was entitled to expect under the contract unless the other party did not foresee and could not reasonably have foreseen such result;
(b)  strict compliance with the obligation which has not been performed is of essence under the contract;
(c)  the non-performance is intentional or reckless;
(d)  the non-performance gives the aggrieved party reason to believe that it cannot rely on the other party’s future performance;
(e)  the non-performing party will suffer disproportionate loss as a result of the preparation or performance if the contract is terminated.

One illustrative arbitral award illustrates how the Unidroit Principles must be applied to determine whether a breach of contract is fundamental:

Case: exclusive supply of Mexican squash and cucumbers[5]
Defendant, a Mexican grower, and Claimant, a U.S. distributor, entered into a one year exclusive supply agreement according to which Defendant undertook to produce specific quantities of squash and cucumbers and to supply them to Claimant on an exclusive basis. Claimant had to distribute the goods on the Californian market against a commission. Due to a series of extraordinarily heavy rainstorms and flooding caused by the meteorological phenomenon known as El Niño, a complete harvest of crops was destroyed.
Claimant brought an action before the Centro de Arbitraje de México arguing that Defendant had breached the contract by not providing the agreed goods and by violating the exclusivity clause. The arbitral tribunal rejected the Defendant’s defence based on force majeure and hardship. It also established that the exclusivity clause was breached at least in one instance.
Concerning the request for termination, the Arbitral Tribunal pointed out that according to Unidroit Principles Article 7.3.1 par. (1), the non-performance by Defendant was fundamental since at least three of the criteria laid down in Article 7.3.1 (2) were met: first, Defendant’s failure to deliver the vegetables deprived Claimant of the goods it was entitled to expect under the contract; second, the Defendant’s violation of the exclusivity clause was intentional; and, third, these two circumstances were enough to give Claimant reason to believe that it could not rely on Defendant’s future performance.

[1]       See: http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13356&x=35

[2]       German Bundesgerichthof 8 March 1995 VIII ZR 159/94 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=108

[3]       Swiss tribunal federal, 18 May 2009, 4A_68/2009 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=1460

[4]       Paris Cour d’Appel, 4 June 2004, 2002/18702 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=984.

[5]       Arbitral Award (Centro de Arbitraje de México), 30 November 2006 (Unilex): http://www.unilex.info/case.cfm?id=1149.

Third-party claims

Third-party claims in general. A seller must deliver the agreed goods free from any third-party right or claim, unless the buyer agreed to accept the goods subject to that right or claim (CISG Article 41). This obligation is ‘implied’: it does not need to be required by the buyer or warranted by the seller to be enforceable. Examples of third-party claims: if materials or components of the delivered goods are still owned by a third party (e.g. if they were delivered under retention of title); if such materials, components, or the goods themselves were stolen from a third party; or if the ownership of such materials or components has not been transferred for any other reason (e.g. they were acquired in violation of mandatory laws).

Rights and claims. The seller has breached his obligation, not only if a third party’s claim is valid, but also and already if a third party merely makes a claim about the goods. This is because, once a third party has made a claim and until the claim is resolved, the buyer faces the possibility of litigation with and liability to the third party. Even if the seller asserts that the third-party claim is invalid – or if a good faith buyer can rightfully defend that, under the law applicable to the sales transaction, it will legally be deemed to acquire the goods free of third-party claims, (i.e. possession vaut titre) – the third party could still engage in time-consuming and expensive litigation against the buyer. Obviously, litigation will delay and disrupt the buyer’s use or resale of the goods.

It is the seller who carries the burden of demonstrating, to the satisfaction of the buyer, that a claim is frivolous. If the buyer is not satisfied that the third-party claim is indeed frivolous, the seller must take appropriate action to free the goods from the claim. From a buyer’s point of view, this could rarely be achieved within a reasonably short period of time. If that is not likely, the seller must either replace the goods, induce the third party to release the claim, or provide the buyer with an adequate indemnity (i.e. providing for defence in legal proceedings and against all losses arising out of the claim).

Third-party intellectual property rights. A different approach applies, however, to the delivery of goods that are not free from third-party rights or claims because they (allegedly) infringe intellectual property rights (CISG Article 42). The seller is not always aware of the existence of such IP rights, let alone that there has been an infringement. Therefore, the implied obligation at the time of contracting is qualified by two additional requirements. First, the seller is not liable if the buyer furnished the technical drawings, designs, formulae or other specifications from which the infringement results. Second, the seller must not have known or must not have been unaware of an alleged infringement under the law of the jurisdiction where the goods will be resold or otherwise used. This requirement is further limited: at the time of contracting, the seller must know or may not be unaware of the countries where the goods are intended to be resold or otherwise used. In other words, if a seller is aware of an infringement right or claim by a third party, and the buyer is not aware (and must not be aware) of the infringement right or claim, the seller may not sell the affected goods in the jurisdiction where the IP rights are alleged to be infringed.

International context and resale. In an international transaction, it is not obvious that the seller of goods should be liable to the same degree for all infringements of intellectual property rights. First, the infringement will often occur outside the seller’s country. The seller cannot be expected to have as complete knowledge of the status of IP rights that its goods might possibly infringe as it would know in respect of its own country. Second, it is the buyer who selects the countries to which the goods will be sent for use or resale. Therefore, as regards resale, the seller’s liability to the buyer for infringements is limited to the countries where the goods were envisaged to be resold (or used) by the parties at the time of contracting. If the parties had not anticipated use or resale in other countries, the seller’s liability is limited to infringements only in the jurisdiction where the buyer has its place of business.

Obligations of the buyer in international sales

Payment of the purchase price. The general obligations of the buyer under a sales agreement are to pay the purchase price of the goods and to accept delivery of them as required by the sales contract or the Vienna Convention. If the sales contract does not include sufficient details, the Vienna Convention provides supplementary rules, as follows:

1. Buyer fulfils all requirements. It is for the buyer to take such steps and comply with such formalities as may be required to effect payment of the purchase price (CISG Article 54).
2. No price agreed. If no purchase price has been established (and no clear and unequivocal parameters exist to establish the price), the purchase price is deemed impliedly to be the price generally charged at the time of the conclusion of the contract for such goods sold under comparable circumstances (CISG Article 55).
3. Net weight. If the purchase price is based on the weight of the goods, in case of doubt it is to be determined by the net weight (CISG Article 56).
4. Where to pay. The buyer must pay the purchase price at the seller’s place of business or, if the payment is to be made against delivery of the goods or documents, at the place of such delivery (CISG Article 57(1)).
5. When to pay. Failing a specified date of payment, the buyer must pay when the seller places the goods (or documents controlling their disposition) at the buyer’s disposal. The seller may make such payment a condition for handing over the goods or documents (CISG Article 58(1)).
6. Pay against delivery. If the sales contract involves transportation of the goods, the seller may dispatch the goods on terms whereby the goods (or documents controlling their disposition) will not be handed over to the buyer except against payment of the full purchase price (CISG Article 58(2)).
7. Pay after inspection. The buyer is not bound to pay the price until it has had an opportunity to examine the goods, unless the agreed procedures for delivery or payment are inconsistent with its having such an opportunity (CISG Article 58(3)).
8. No request required. The buyer must pay the full purchase price without the need for any request or compliance with any formality on the part of the seller (CISG Article 59).

Non-conformity notice. Regarding the conformity requirement, the Vienna Convention provides that the buyer should inspect the goods. The buyer must give notice of any non-conformity within a reasonable time after it has discovered it (or should have discovered it). Except if the parties agreed otherwise (e.g. a longer warranty period), the right of the buyer to give such a notice lapses, at the latest, two years from the date on which the goods were actually handed over to the buyer.

Buyer’s knowledge of non-conformity. The quality requirements of conformity to fitness for ordinary purpose and any particular purpose, to samples or models, or to packaging (CISG Article 35(2)) do not apply to the extent that the buyer, at the time of contracting, knew or could not have been unaware of a non-conformity in respect of one of those qualities. A buyer familiar with defects, failures or failing functionalities cannot claim that it had expected the goods to conform in those respects.

Buyer’s inspection and notice. If the buyer has had a reasonable and appropriate opportunity to inspect the goods prior to their shipment, it might lose its right to claim after arrival. The buyer’s duty to inspect the goods is particularly important for highly visible aspects such as packaging.[1] Obviously, if the buyer establishes a non-conformity, it must notify the seller as soon as practicable (CISG Article 39). Especially when the lapse of time might adversely influence the damages or resale price, courts are reluctant to award a buyer any damages in case of late claims. One illustrative example:

Case: damaging paper grinding materials[2]
A Swiss buyer purchased from a German seller grinding material in order to manufacture paper products. The products were resold to another Swiss company and processed into finished goods. After using the grinding material the buyer ascertained damage to its equipment and to the material itself. About twenty days later, the second Swiss company also complained that the tissues manufactured by using the buyer’s paper products were defective. An expert examination was then ordered. Upon receiving the expert report, the buyer notified the seller of the defects in the delivered material.
The Supreme Court reversed the decisions of the courts in first and second instance and held that the notice of lack of conformity had been timely given. The buyer could not have discovered the defect by an ordinary examination of the purchased goods either upon delivery, or at any time before damage ensued. In this case, the buyer could be allowed a period of one week from discovery of the damage to consider possible remedies. To this the two-week period of the expert examination is to be added, followed by the reasonable time for notice, which, according to the Court, usually amounts to one month. Therefore, seven weeks after discovery of the damage was considered to be still reasonable.
Finally, the Court determined that the buyer’s notice sufficiently precise about the nature of the non-conformity (CISG art. 39(1)): in case of machineries and technical equipment it is enough to describe the defects without the need to specify their root cause.

[1]       See for example: Camara Nacional de Apelaciones en lo Comercial de Buenos Aires, 31 May 2007 (Sr. Carlos Manuel del Corazón de Jesús Bravo Barros v. Salvador Martínez Gares): http://www.unilex.info/case.cfm?id=1197 or Oberlandesgericht Düsseldorf, 8 January 1993, 17 U 82/92: http://www.unilex.info/case.cfm?id=17.

[2]       German Bundesgerichthof, 3 November 1999, VIII ZR 287/98 (Unilex): http://www.unilex.info/case.cfm?id=447.

 

Remedies for breach of contract

Relevant CISG Articles. The remedies of the buyer for breach of contract by the seller are addressed in connection with CISG Chapter II obligations of the seller (CISG Articles 45-52), and the remedies of the seller for breach of contract by the buyer are addressed in connection with CISG Chapter III obligations of the buyer (CISG Articles 61-65). The same principles apply for both: if all required conditions are fulfilled, the aggrieved party may require performance of the other party’s obligations, claim damages, or avoid (terminate) the contract. In addition, the buyer may reduce the price if the delivered goods do not conform to the contract.

Specific performance. The foremost principle in case of breach of contract is that the buyer is permitted to require specific performance (unless it has resorted to a remedy that is inconsistent, such as termination of the contract – CISG Articles 28 and 46). Specific performance means that the seller must perform in kind: deliver the goods. Especially in the common law, this is inconsistent with the historic belief that a public court should refrain from interfering in private relationships. From this perspective, a court’s order to perform duly would also introduce complications related to the question of how such performance has to be effected. Since modern times, however – and particularly regarding sales contracts –common law courts have become less reluctant and have accepted the principle. In civil law countries, legislators have always considered such order of specific performance (instead of damages) to be the default remedy: in several jurisdictions, a court’s judgement might even operate as an instrument reflecting the contractual rights (e.g. as an instrument for effecting transfer of ownership).

Replacement. A buyer can require the delivery of substitute goods only if the goods delivered were not in conformity with the contract and the lack of conformity constituted a fundamental breach of contract (CISG Article 46(2)).

Force majeure. A party in breach of its obligations might excuse itself (and be exempted from liability) on the basis of an event of force majeure (CISG Article 79). To be excused successfully, the failure must be due to an impediment beyond its control (external) that the party could not reasonably have been expected to take into account (reasonably unforeseeable) at the time of the conclusion of the contract, and that it could not have avoided or overcome (no alternative for due performance).

Such event of force majeure exempts that party from the consequences of its failure to perform, including the payment of any damages. This exemption may also be invoked by a subcontractor. Furthermore, a successful claim of force majeure does not preclude either party from invoking any other remedy (e.g. a reduction of the purchase price if the goods contained defects) – see also section 4.4.

A key criterion to benefit from the force majeure exemption is that the party notifies the other party within a reasonable period of time. Otherwise, the other party is entitled to compensation of its damages to the extent that these could have been prevented but for the lapse of such additional time.

Suspension of performance and anticipatory breach. If, before the date on which performance is due, it becomes apparent that a party will not perform a substantial part of its obligations or will commit a fundamental breach, two scenarios are available to the (potentially) aggrieved party:

• it may suspend performance in cases involving a failure to perform a substantial part of the other party’s obligations, if such failure results from that party’s inability to perform or its lack of creditworthiness, or if such failure becomes apparent from that party’s conduct in preparing to perform (or the performance itself) (CISG Article 71); or
• it may avoid (terminate) the contract once it becomes clear that the other party will commit a fundamental breach of contract (CISG Article 72).

Preservation of the goods. The Vienna Convention imposes on both parties a duty to preserve any goods in their possession that belong to the other party (CISG Articles 85-88). This duty is particularly important in view of the international nature of the contract: the other party is from abroad and might not have representatives in the country where the goods are located. The party in possession of the goods may sell them, or may even be required to sell them, if circumstances so require. In such cases, the selling party is entitled to retain part of the sales price as a compensation for reasonable expenses incurred in preserving the goods and selling them. Obviously, it must account to the other party for the balance (CISG Article 88).

Intellectual property – introduction

‘Intellectual property’ refers to creations of the mind: inventions; literary and artistic works; know-how; technology; and symbols, names, images and designs used in commerce. Traditionally, intellectual property embraces two categories: copyright, which includes literary and artistic works in a broad sense of the word, whether regarded as art or used in commerce; and industrial property, all other creations including patents, trademarks, industrial designs and geographic indications of a source.

Terminology: IP, IPR and IP-rights. In practice, the term intellectual property is commonly referred to as “IP”, and intellectual property rights as “IPR” or “IP-rights”.

International nature. One of the most international fields of law is IP law. Not only do intangible goods move as fast across borders as e-mail, but also the law of intellectual property across the world has developed in the same direction. One reason for this is because IP-law was unified at a very early stage of its development through widely ratified multilateral treaties[1]. The infrastructure for international legislative and administrative assistance has been strengthened by the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). However, local regulations must always be studied because there might be limitations or additional regulations that may affect IP-rights.

WIPO. The WIPO (World Intellectual Property Organisation, in French: OMPI) is a United Nations’ agency dedicated to the use of intellectual property, which has been contributing significantly to the unification of IP law. WIPO’s mission is to promote innovation and creativity for the economic, social and cultural development of all countries through a balanced and effective international intellectual property system. WIPO administers numerous IP-treaties, provides IP-related educational materials and guidance, promulgates the importance and usefulness of intellectual property, and works continuously on the further development and unification of IP-laws[2].

Scope. In this section the most important intellectual property rights will be introduced:

1. Trademark law
2. Copyright law
3. Trade secrets (know-how and other confidential information)
4. Patent law
5. IP-licensing

Intellectual property rights that will not be addressed include: trade names, domain names, neighbouring rights, databases, plant breeder’s rights, semiconductor layouts (topography), designs and models, and portrait rights.

[1]       The main IP-conventions are the Paris Convention for the protection of industrial property (1883); the Berne Convention for the protection of literary and artistic works (1886); the Madrid Agreement concerning the international registration of marks (1891); the Nice Agreement concerning the international classification of goods and services for the purposes of the registration of marks (1957); and of more recent date: the Patent Cooperation Treaty (PCT, 1970); the Trademark Law Treaty (1994); the WIPO Copyright Treaty (1996); and the Patent Law Treaty (2000).

[2]       See http://www.wipo.int. This website contains most IP-related materials, including many publications explaining in detail how intellectual property is or can be protected.

Copyright in contracts

Technological and economic development of a country or business depends significantly on the creativity of individuals. If the result of creativity were not protected by law, the incentive to develop creative works would be limited. Copyright law protects an owner of ‘intellectual property’ against those who ‘copy’ the work. It also encourages the publication and dissemination of ‘creative’ works because it provides legal remedies enabling the copyright owner to derive benefits from the work.

Scope of copyright[1]. It is important to note that copyright protection also covers technological creations of the mind such as computer programmes, electronic databases, as well as the results of provided services. Furthermore, also non-artistic works such as technical guides, engineering drawings, maps, product manuals, and user guides are protected by copyright. In many jurisdictions, laws and regulations, as well as official decisions and judgments are considered to be in the public domain and cannot therefore be copyrighted.

‘Work’. Copyright protection relates to creations of the mind, also called works of authorship. This is a very wide concept and includes the following:

• literary works (e.g. books, text on a website, manuals);
• pictures, graphics and sculptures (including illustrations, plans and sketches);
• software source code;
• architectural works;
• sound and video recordings (e.g. music and films);
• any collection of the above (i.e. a selection as such may be a work).

‘Ideas’ excluded. The physical representation in which the copyrighted creation is expressed is protected. Copyright law does not protect the intangible creation: other than with patented inventions, copyright law protects only the form of expression of an idea, not the idea itself. The creativity in the choice and arrangement of words, sounds, colours or shapes is the object of protection under copyright law.

Originality. It is not necessary that the ideas expressed in the work are new or original. What is crucial is whether the form in which the idea is expressed (written or otherwise) is an original creation of the author. In order to be copyright protected, a work must be distinctly original and reflect the personal contribution of the author. It is unnecessary that the work meets a certain level of imaginativeness, or inventiveness. Also, the copyright exists regardless of whether the creation is beautiful, useful or of certain quality.

Copyright and service agreements. Whilst most service providers will not consider that their work for a particular customer justifies extra licence fees for using the work (in addition to the service fees for creating it), nevertheless if the services resulted in a ‘work of authorship’ and is ‘original’, a claim for licence fees would be justified.

The copyright: ‘use’. Copyright law distinguishes two types of protection. Moral rights allow the author to preserve the personal reference to the work. Economic rights allow the copyright owner to demand financial benefits (e.g. royalties) from others who use the work. The copyright owner can prohibit or authorise:

• use;
• reproduction;
• import, export or distribution (resale) of copies;
• in an increasing number of jurisdictions, rental (lease);
• public performance;
• broadcasting or other communication to the public;
• translation or adaptation.

Translations and adaptations. A copyright includes the right to translate a work into another language or to adapt it. Adaptation or modification of a work is generally understood as creating another work. An adaptation includes extending a work or combining it with other products. Furthermore, extending or combining two non-original works may result in an original (copyright protected) work. Using or copying a translation or adaptation requires the approval from the copyright owners of the original work and of the translation or adaptation.

Fair use (limitation of rights. There are limits to the restrictions a copyright owner may impose on others who use a work. Whilst copyright encourages creativity and economic development, a limited use of (parts of) copyrighted works facilitates honourable purposes such as criticism (especially parodies), comment, news reporting, education and research. Such use is not an infringement of the copyright. Similarly, most copyright laws permit individuals to make a single copy of the original work for private, personal and non-commercial purposes.

Duration of copyright. Copyright does not continue indefinitely. The term of a copyright begins when the work is created (under some national laws, when it is expressed in a tangible form). The copyright usually continues for at least 50 years after the death of the author (i.e. the EU, USA and several other countries adopted a 70-year period). Local regulations must be consulted; because local and international legislation is continuingly under modification or discussion.

[1]       In many languages, copyright is translated and known as author’s right. The term copyright refers to the regulations regarding copying a protected work made by the author or with his/her authorisation. The expression author’s rights emphasises the central position of the creator and his or her rights with respect to the created work).

Trademarks in contracts

Purpose and characteristics. A trademark is a symbol, logo, word or other indicator to identify a certain product or service and to distinguish it from other (similar) products and services. Trademarks serve to identify the commercial source of origin of a product or service, and distinguishes such source of origin from other suppliers. Many people attribute much broader purposes to trademarks, such as a means of communication with consumers or customers (e.g. by creating a ‘limited edition’ of their products by combining it with an icon of style or quality) or as a means for people to communicate with each other (e.g. by wearing certain clothing or icons of class). Also courts generally acknowledge that trademarks contribute to brand positioning and encourage businesses to invest in high quality of products by awarding high infringement damages, taking into account the inherent goodwill.

From a legal point of view, trademarks include word marks and service marks; their protection and enforcement follows the same rules. In a trademark licence, the licensed word mark is usually identified in uppercase: PRECONTRACTUAL, MDLCNTRCTS, Trader Options Investing Platform, etc. A slogan can also qualify as a trademark. Non-traditional marks such as colours, sounds, fragrances and tastes are increasingly accepted as trademarks.

One trademark may reflect both a product and a service at the same time, and a trademark may be both a word mark and (its design as) a logo. Similarly, a trademark will often coincide with a trade name.

Requirements for trademark protection. In order for a symbol, logo, word or other indicator to be protected under trademark law, it must be ‘distinctive’. Usually, several degrees of distinctiveness are identified, ranging from inherently distinctive (readily distinguishable as a mark) to a generic or descriptive indicator (without legal protection):

• Inherently distinctive marks are readily protectable because they are:
  • arbitrary marks: usually a common word used in an unrelated context (e.g. “Apple” for computers). Arbitrary marks consist of words or images which have a particular (dictionary) meaning, but which are used in connection with products or services unrelated to that dictionary meaning. For example, Salty would be an arbitrary mark if it is used in connection with telephones such as Salty Phones, as the term salt has no particular connection with telephones.
  • fanciful marks comprise a word that is entirely made up or invented to be used as a trademark. For example, “Kodak” had no meaning before it was adopted and used as a trademark for photographic and other goods.
  • suggestive marks invoke the consumer’s perceptive imagination. Suggestive marks tend to indicate the nature, quality or characteristics of the product or service, but do not describe this characteristic and therefore require imagination from the consumer to identify the specific characteristic. An example is Blu-ray, a technology used for high-capacity data storage.
• Acquired distinctiveness (not merely descriptive): if the mark’s descriptive element and the related product or service is less remote, the mark is only protected if the mark has acquired distinctiveness in the relevant market. As per the above example: if Salty is used for saltine crackers or anchovies, it is not protected as a trademark unless it can be shown that a distinctive character has been established through extensive use in the marketplace.
• Not a generic word: if a mark indicates a category of products (rather than a particular supplier or a specific product in that category) it is not distinctive and therefore not protected as a trademark. For example, the mark “salt” in connection with sodium chloride is not capable of distinguishing the products or services of a business from the products or services of other businesses.Some examples of such genericised (eroded) trademarks are: aspirin, yo-yo, zipper, thermos, heroin, escalator and kerosene.

In many jurisdictions, a trademark must be registered with the (national) trademark office in order to receive the desired protection or to intervene when others infringe the trademark. In a trademark licence agreement, it is important that it is made clear who is responsible for registration (and maintaining a registration).

Classification. Upon registration, the application should specify the class under which the trademark falls according to the Nice Agreement[1]. This classification serves to differentiate trademarks according to the types of goods or services. A trademark can fall in more than one class. The ‘Nice classification’, which has been adopted by 148 countries, consists of 45 classes (34 classes of products and 11 classes of services).

Geographical indications. Consistent with the TRIPS convention[2], the European Union restricts the use of geographical indications for certain ‘protected designations of origin’. In principle, a geographical indication cannot qualify as a trademark because it does not identify a specific company as the producer of goods. Nonetheless, the EU recognised the distinctive nature which a consumer may attribute to a product coming from a specific geographical area and therefore decided to grant protection. This is somewhat controversial because a geographical indication may have already been registered as a trademark elsewhere. Well-known examples of geographical protection in the EU are wines (e.g. Bordeaux, Champagne and port) and cheeses (e.g. Gouda, Roquefort, Parmesan and Feta).

Duration. Other than patents and copyrights, a trademark does not expire or end after a specific term. Although the registration of the trademark may expire, the trademark itself would not be affected. Nonetheless, in order for a trademark to remain valid and enforceable, it must continue to be used in the relevant market (and not become genericised).

Use and exhaustion. A trademark must be used in order to maintain the protection. Many jurisdictions require that a trademark owner (or its licensees under a trademark licence agreement) must genuinely use a trademark within five years after registration, unless there are valid reasons for non-use.

Although many trademark laws provide that the use of the trademark by a licensee accrues to the benefit of the licensor/owner of the trademark, it might be helpful to provide that such use does not accrue to the licensee. If it did, that would enable the licensee to terminate the trademark licence and start using the trademark itself without any obligations vis-à-vis the licensor, or even with a right to prohibit the licensor to use the trademark in the licensee’s territory.

After a product with a trademark has been ‘put into circulation’ on the market, the intellectual property rights in the trademark are ‘exhausted’. This means that the trademark owner cannot take action against the way the subsequent vendor (e.g. of second hand products or outlet stores of past-year products) presents the trademark.

Dilution and blurring effects. One of the most treacherous effects of poor trademark management is dilution or blurring of the trademark: when a trademark loses its distinctiveness. There may be several causes for dilution, a few can be prevented contractually and most require alert and adequate action. A trademark may lose its distinctiveness because:

• it is used or presented inconsistently;
• colours of the trademark are not always exactly the same (or contrast differently depending on surrounding colours), shapes of the trademark are similar across the product portfolio but not exactly the same, fonts used in connection with the trademark differ (e.g. Times New Roman vs. Garamond, or Arial vs. Helvetica or Verdana);
• the emotion or personality attributable to the trademark varies in a confusing manner (e.g. used in intimate contexts as well as aggressive statements, or both in a picture of a natural landscape and in a city nightlife setting, or to convey a sense of exclusiveness and a sphere of basic cheapness at the same time).

If a licence does not contain quality controls regarding the presentation of the trademark or the way it is presented in advertising and promotional materials, such licence is referred to as a ‘naked licence’. Lack of such quality control by the licensor entails a serious risk of dilution (i.e. loss of the trademark).

[1]           Agreement concerning the international classification of goods and services for the purposes of the registration of marks (Nice, France, 15 June 1957), as revised and amended.

[2]           The Agreement on Trade-Related Aspects of Intellectual Property Rights (“TRIPS”, Annex 1c to the Agreement Establishing the World Trade Organisation). Article 22 provides for a protection of geographical indications about the origin of goods in a way (and based on criteria) similar to trademarks.

Franchising – a few notes

Licensing a ‘concept’ (or ‘system’). Franchise arrangements are very similar to trademark licence agreements. Franchising concerns the licensing by a franchisor of a ‘concept’ or ‘system’ to one or more franchisees. The concept usually consists of a trade name, trademark, use of an internet domain name, and trade secrets in connection with a product and service, accompanied by detailed instructions or a manual regarding the production, marketing, sales and business model of the product and service. Some examples of franchising are hotel chains and fast food restaurants (e.g. Hilton, Meridien, NH Hotels, McDonalds, 7-Eleven, Subway, Burger King, Wendy’s, Kentucky Fried Chicken). Any combination of products or services and set of instructions to ascertain uniformity and recognisability is capable of being franchised.

A franchise often consists of several layers: the main franchisor licences the franchise concept to a limited number of franchisees, with typically one or two franchisees per geographical area. The franchisees, in turn, will have the right to grant sub-licences to sub-franchisees (in parts of the franchise territory). This is a common way to delegate the exploitation of the franchise concept to local entrepreneurs and to limit the management time required to instruct and supervise the sub-franchisees.

Compliance with the concept or franchise system. More than with trademark licences, a franchise agreement requires strict compliance with the licensed concept and the often-detailed instructions in the operations manual. For example, upon entering such franchise restaurant, the personnel will approach each time exactly the same way, often with exactly the same sentence (“Is there anything else I can do for you?”) or with ‘prohibited’ phrases (such as never say “No problem” after the customer said “Thank you”). Such uniform approach reinforces the consumer’s positive perception and recognition of the trademark.

Developing the franchise concept or system. A franchised concept usually develops continuously. Compliance with the concept therefore includes a contractual obligation to adopt all the changes in the franchised concept as they are adopted by the franchisor and communicated to the franchisees. Usually only the timing of adopting changes and the contribution by the franchisor in the costs of such changes are (to a limited extent) open to negotiation.

Collaborative element. In order to streamline the feedback of customers and to optimise the franchised concept, many franchise arrangements contain a committee of franchisees (or geographically oriented sub-committees of franchisees). Such committees enable large numbers of franchisees to communicate with the franchisor and to jointly improve the franchised concept.

Know-how and trade secrets

In many countries, ‘trade secrets’ (e.g. know-how) have a special legal status.

‘Trade secrets’. Trade secrets relate to confidential information that is not generally known or reasonably ascertainable, and by which a company can obtain an economic advantage over competitors or customers. This economic advantage must derive particularly from the fact that the trade secret is not publicly known, and not merely from the value of the information itself. Other than the term trade secret suggests, the legal concept is fairly broad. It includes formulas, practices, processes, designs, instruments, patterns, and compilations of information.

Protection: non-disclosure agreements. In order for a trade secret to enjoy legal protection, the owner must make reasonable efforts to maintain its secrecy. Such efforts include adoption of common technological security measures, non-compete arrangements in employment contracts, and non-disclosure agreements (NDA’s) with (potential) business partners and suppliers.

NDA scope. Two key elements of a standard NDA are: (a) a prohibition to disclose any part of the received confidential information to third parties, and (b) restrictions on the scope of use of the confidential information (i.e. use only for the specified authorised ‘Purpose’ of the NDA and sharing only amongst employees and affiliated companies on a need-to-know basis). Usually a penalty (liquidated damages) clause in case of a breach of confidentiality is not included. However, in some industries such clauses can be found. See also sections 1.3(a) and 4.7.

Trade secrets vs. patents. To obtain patent protection, a significant amount of information about the process or product must be submitted with the patent application and this information will become publicly accessible. After expiration of the patent, anybody can use the method or product. The temporary monopoly on the underlying invention is considered to be a trade-off for disclosing the information to the public. Obviously, this is not the case with trade secrets.

Licensing trade secrets. In the context of a know-how licence (also called ‘technology licence’) the licensor can impose or agree on obligations other than those strictly necessary to protect the secrecy, such as the following:

• the licensee can be prohibited to re-engineer or decompile the trade secrets (e.g if the trade secrets involve software);
• the licensee can be prohibited to analyse its composition (e.g. if the trade secret is a chemical substance, the disclosing party may seek tests of the substance’s properties, but wishes to prevent that the precise composition is discovered through analysis);
• the payment of a royalty for using the technology, even after the underlying patent has expired;
• sharing of know-how and experience in using or applying the know-how, or access to the licensee’s network or customer base;
• exclusive ownership by the licensor of derivative works (and modifications or improvements to the initial technology) that result from communications between the licensor and licensee;
• a right to audit (verification) in order to ascertain compliance with the licence terms;
• an obligation to notify the licensor in case of any identified infringements by others;
• an agreement that disclosure by the licensor blocks the licensee from using the disclosed confidential information for other purposes than those explicitly agreed.

Trade secrets and technology licences. In the framework of patent and know-how licence agreements, the licensed patent expires after 20 years and the licensed know-how continues. Note that any royalties payable after the licensed patent expires should probably be adjusted to only cover compensation for the know-how provided by the licensor. Nevertheless, one may wonder whether continuation of the licence agreement for the sole purpose of using the know-how related to the (expired) patented invention is even desirable at all after the patent expired (when probably all competitors developed the know-how).

Patents and patent licences

Patentability. A patent can be granted for:

• any invention;
• which is susceptible to industrial application (it must be of practical use);
• which is new; and
• which involves an inventive step.

An invention is ‘new’ (i.e. novelty criterion) if it does not form part of the state of the art. The state of the art (or state of technology) comprises everything in the public domain, whether made available by publication, oral description, use or in any other way before the date of filing of the patent application. An invention involves an ‘inventive step’ if, in view of the state of the art, the invention is not obvious to a person skilled in the art.

Patented inventions vs. copyrighted works. Inventions are considered new ideas or solutions to technical problems. Unlike protection of inventions, copyright law protects only the form of expression of ideas, not the ideas themselves. The creativity protected by copyright law is in the choice and arrangement of words, musical notes, colours and shapes.

From this basic difference between inventions and works of authorship, it follows that also the legal protection differs. Because a patent gives a monopoly right to exploit the invention, such protection is shorter in duration (usually 20 years). The essentials of the invention must be disclosed publicly in an official register. Because the protection of a work of authorship only prevents unauthorised use of the expressions of an idea, the term of protection is much longer, without any risk of damage to the public interest. Also, because copyright law entitles the author of a work to prohibit other persons from copying or otherwise using the work (a) the work is protected as soon as it is created, and (b) a public register of copyright protected works is unnecessary.

Scope of the patent. The scope of the patent is determined on the basis of the ‘claims’ in the patent registration. The patent claims are accompanied by descriptions (e.g. specifications, explanations, illustrations, calculations, examples, drawings) supporting the interpretation of the patent claims. The scope of patent protection is usually a strict, literal interpretation of the wording of the claims. The purpose of the descriptions is to resolve any ambiguity in the claims. The claim does not serve as a guideline for the descriptions.

Scope of patent protection. The scope of patent law protection is a matter of the national patent law of a State in which the patent is granted. Generally, the patent owner’s exclusive rights consist of the following:

• in case of a product patent, the right to prevent third parties (non-licensees) from making, using, offering for sale, selling, distributing or importing the product;
• in case of a process patent the right to prevent third parties (non-licensees) from:
  • applying or using the process; and
  • making, using, offering for sale, selling, distributing or importing products which are created directly by that process.

If a patent has been granted in a particular jurisdiction, others who wish to exploit the invention in that jurisdiction must obtain the authorisation (e.g. a licence) from the patent owner (or from a licensee of the patent owner who has the right to grant sub-licences). Unauthorised and non-licensed use or application constitutes a crime.

Encouraging inventions. Many large technological companies have an internal association of inventors. Many companies have adopted a policy to reward employees who make an invention. Such a policy facilitates the revelation of inventive ideas within the company and prevents that inventive ideas remain unprotected. In large organisations, this is often the result of a lack of awareness about the existence of inventions or the inventors’ failing to acknowledge the importance of their creations. Also, it incentivises an employee to report a potentially patentable invention and thereby earn a nice bonus. Such policy could also be extended to external suppliers (whose inventions are even less visible).

Identifying a patent. Every patent is registered with a unique number (European patents are preceded by the letters EP). In a patent licence or deed of patent transfer, it is common to include the title which the patent has been given, as well as the date as of which the patent was requested or granted. There are numerous websites with search engines including national patent registers worldwide. Although not strictly necessary, a (licensed or transferred) patent is usually identified by the following catch-all phrase:

Patent means the patent [application] registered under no. [_____] (and entitled [___________]) with priority date [_____], including [national patents issued on such application and] any continuations, continuations-in-part, divisions or additions thereof, reis­sues, renewals, revalidations, re-examinations, substitutions, extensions and any immediate foreign equivalents of them.

Infringement.  Contrary to trademark infringements, any action is typically taken after an infringing party has used the patented invention for some time. In a high-tech market where companies file hundreds or thousands of patent applications per year, also patent infringements are numerous, often not easy to prove and relatively costly to identify and challenge.

Inventions and patent criteria

Novelty and prior art. Sometimes, two companies make the same invention around the same time. The inventor who files the patent application first will be granted the patent[1]. Accordingly, in the investigation of the ‘novelty’ of the invention, the date of filing is determinative. In order to be considered new, nobody may have published about the invention (taken in its entirety, with all elements of the invention together in the publication) or otherwise made it available to the public. When assessing “prior art” a global approach is taken: if an inventor elsewhere in the world was first, that preceding invention determines state of the art.

A common (but expensive) mistake is if the inventor proclaims the invention in newspapers or on internet before filing for patent protection. Disclosures made to third persons or external organisations only safeguard patent protection if each person or organisation signs a (if only retroactively effective) non-disclosure agreement.

Priority year (grace period). In view of the prior art criterion, if someone files an application in a country which is party to the Paris Convention for the protection of industrial property, the applicant has six or twelve months after the first application to file for a patent in another State party as well. Publications about the invention or a sale or transfer of the patentable invention during those six or twelve months will be disregarded when determining whether an invention is new and involves an inventive step. This ‘grace period’ (or ‘priority year’) implies a right of priority over technological developments that take place in that period. Many patent offices publish the application 18 months after the priority date or filing date (the actual patent grant may take much more time).

Duration of patent examination. An inventor normally selects a few jurisdictions to file a patent application. Usually, these are large jurisdictions in which the impact of the patent will be considerable (e.g. the US, the UK, Germany, France, China, Japan) or jurisdictions in which the judicial patent system operates efficiently and professionally (e.g. the Netherlands, Chinese Taipei). After filing a patent, a national or supranational agency[2] examines whether the invention is new, involves an inventive step and is of industrial utility. If the examiner has any doubts, the institute will issue an ‘office action’ after which the applicant may further substantiate, withdraw, abandon, modify or pursue the patent claims. In many cases, the office action leads to narrowing down the scope of the claimed invention. Also, third persons (such as competitors) may oppose the patentability. Usually such doubts are decided in the applicant’s favour because a final and less-abstract judgment on the validity or scope of a patent is possible in court (whilst the alternative, rejection of the patent, precludes all protection).

The application and examination procedure takes several years. Depending on the jurisdiction and the technical discipline involved (e.g. chemistry, biotech, pharma, electronics), a final decision may take three to five years, or much longer. Once the registration is complete, the patent protection has retroactive effect from the date of filing.

Duration. A registered patent typically lasts 20 years after the date of filing the application. The owner of the patent may prohibit others to use the patented invention in any product or to use the patented process. Extension of the duration of the patent is not possible. However, in relation to pharmaceutical patents, where clinical trials impose a further limitation of the effective duration of a patent, some countries permit a limited extension or a certain period or exclusive commercialisation of the patent.

Prior use defence. If an invention was patented by one company but already invented and used by another, most jurisdictions permit the defence of ‘prior use’ against a claim of infringement by the patent owner. Prior use is exempted from patent infringement claims if the alleged infringer can clearly and convincingly prove that it used the patented invention in a commercial setting. Obviously, the date of such prior use must precede both the patent filing and the publication[3]. Understandably, such a ‘grandfather right’ does not apply if the former invention had been derived from the subsequent inventor. In order to prevent circumvention (or parallel trade), a prior user’s right is limited in scope and transferability.

Co-inventorship. A risk associated with patents is that a third party involved in the research or development work leading to the patent, may claim co-inventorship. For example, a customer or manufacturer of a research-focused supplier-inventor who was invited (a) to testing the invention, and (b) to assist in improving certain practical aspects of the invention. The customer or manufacturer might claim that it made a substantial contribution to the invention, which could result in co-ownership. Often, the customer or manufacturer is granted another benefit for its assistance, such as exclusive distribution or manufacturing rights during a certain period of time.

[1]       Including the US since the Leahy-Smith America Invents Act 2011 (AIA) of 16 March 2013. As of that date, the first-to-invent system was replaced by the first-to-file system, which has been adopted everywhere in the world.

[2]       In the EU, whilst the technical examination (of novelty and inventiveness) is conducted by a pan-European institute, a ‘European patent’ does not exist yet. After determination as to whether an invention is patentable, the applicant must choose in which EU member states it wishes to obtain patent registration (and in order to achieve this, certified translations of the selected member states must be prepared). European patents are therefore national patents.

[3]       In the US AIA (2013), the scope of excusable prior use defence is more extensive. The patented invention has to have been used at least within one year prior to the earliest effective date.

Utility patents

Some countries, such as Germany, France, Spain, Italy, Japan, China and Australia,[1] have introduced a system with a lighter degree of protection for ‘inventions’, which is known as the utility model[2].

Utility model vs. patents. A utility model also provides a monopoly right for an invention: the owner of a utility model can prevent an infringer from exploiting the invention in the territory for which the utility model was granted. Normally, the same remedies for infringement available under a patent are available for infringement of a utility model.

Differences between utility models and patents. A utility model is different in that the requirements are typically less burdensome. For a patent to be granted, the invention must be both ‘novel’ and ‘inventive’. For a utility model, the ‘prior art’ in assessing novelty is often more limited (‘absolute’ novelty is not always required), and an ‘inventive step’ has a considerably lower threshold and is sometimes not even required. Most jurisdictions will only grant utility models for products, and not for methods or processes. The first utility model laws actually limited protection to mechanical innovations. Furthermore, the term of protection of utility models is shorter, and a utility model is much cheaper to obtain.

Importance of utility models. In view of the shorter term of protection, utility models can be useful for products with a relatively short product lifecycle. Since the novelty and inventive step criteria are less stringent, utility models can be useful in connection with incremental research and development, where only small changes to existing inventions are made and therefore might not meet the requirement of an inventive step for a patent. Since utility models are granted much more expeditiously than a patent, they are effective in acting against an infringer in a timely manner. Furthermore, the lower costs for obtaining utility models make them particularly attractive for SME’s.

If an inventor has published about its invention, and thus a patent cannot be granted anymore, some jurisdictions such as Germany, allow a grace period. This grace period permits the inventor to obtain a utility model despite it being part of the state of the art.

Duration. Whereas a patent provides protection of up to 20 years, a utility model provides protection for a shorter term. The exact term depends on the jurisdiction, but is usually between 7 and 10 years.

Application procedure. Utility model applications can be filed at the patent offices of countries that acknowledge or grant utility models. Similar to a patent application, an application for a utility model should include a description, explanations, drawings and claims. Utility model applications are usually not examined before being granted and are therefore granted much sooner (the average time approximating six months).

Conversion into a utility model. Many countries allow the conversion of a patent application into a utility model application. Some countries provide a time limit for such conversion. If a patent application is refused, some countries allow the patent application to be converted into a utility model within a certain period after the refusal.

In some countries, such as Germany, it is possible to obtain both a patent and a utility model for the same invention.

[1]       Utility models (or similar IP-rights with a different name) are available in Albania, Angola, Argentina, ARIPO, Armenia, Aruba, Australia, Austria, Azerbaijan, Belarus, Belize, Brazil, Bolivia, Bulgaria, Chile, China (including Hong Kong and Macau), Colombia, Costa Rica, Czech Republic, Denmark, Ecuador, Estonia, Ethiopia, Finland, France, Georgia, Germany, Greece, Guatemala, Honduras, Hungary, Indonesia, Ireland, Italy, Japan, Kazakhstan, Kuwait, Kyrgyzstan, Laos, Malaysia, Mexico, OAPI, Peru, Philippines, Poland, Portugal, Republic of Korea, Republic of Moldova, Russian Federation, Slovakia, Spain, Taiwan, Tajikistan, Trinidad & Tobago, Turkey, Ukraine, Uruguay and Uzbekistan.

[2]       Utility models are also referred to as innovation patent, utility innovation or petty patent.

Licensing intellectual property

The owner of an IP right may grant licences to third parties to use those IP rights in one way or another. In such licences, a licensee sometimes has the right to grant sublicences. In this section, licensing of IP rights such as a trademark, copyrighted work, patent or software application will be discussed.

Core licence clause

The essence of a licence is usually reflected in one key licence provision and, if necessary, elaborated in subsequent clauses. In the licence clause, probably more than in any other type of agreement, the key elements of the agreement are identified.

Subject to the terms of this Agreement, Licensor hereby grants Licensee, and Licensee hereby accepts a perpetual, non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to use the Licensed Trademark in the Territory in connection with Licensed Products only.

The core licence clause (whether included in a Trademark licence agreement, Patent licence agreement, Software licence agreement or other IP-licence) would contain the following elements:

• Licence grant. The wording reflects the grant of licensed rights (“hereby grants”, “hereby accepts”). The word hereby is essential since it prevents that an additional written licence grant must be signed (as is typically required in connection with intangible rights);
• The licensed object. For example a trademark, patent, copyrighted work, know-how, software;
• The scope could include:
• type of use (e.g. manufacture, import, export, market, sell, distribute, use);
• territory restrictions (this could be a specified region, country, or worldwide);
• exclusivity (sole or non-exclusive);
• market segment restrictions (e.g. fitness-shops, shopping malls, supermarkets, webshop);
• the right to grant sub-licences; and
• duration (perpetual or irrevocable, or a specified time limit).
• Licence fees (i.e. royalty bearing, royalty-free or fully paid-up).

Differentiation in licensed uses. If the licence differentiates for the various uses, the above core licence clause becomes a matrix of several licences, each of which apply to a different scope and each subject to varying conditions. For instance, the above example could differentiate between the types of permitted uses as to degree of exclusivity, geographical reach, right to sub-license and royalty:

Licence. Subject to the terms of this Agreement, Licensor hereby grants to Licensee and Licensee hereby accepts:
(a)  a non-exclusive, royalty-free licence, without the right to grant sub-licences, to demonstrate the Licensed Trademark in connection with Licensed Products only; and
(b)  an exclusive, royalty-bearing licence, with the right to grant sub-licences, to make and have made the Licensed Trademark in connection with Licensed Products only.
(c)  a non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to market, have marketed, offer for sale, have offered for sale, sell, have sold, or otherwise distribute or have distributed, the Licensed Trademark in the Territory in connection with Licensed Products only.

Note that the verb “to use” is omitted in all subparagraphs. Instead, each subparagraph includes a specific type of ‘use’. Item (c) demonstrates that the possible differentiation in licensed uses might be very specific.

Licence elements

Geographical and market-related scope. A licence involving the sale of a patented product or a product or service under a trademark licence agreement is often limited to a certain geographical area (i.e. a region, a country or part of a country), and sometimes also to a specific market segment (e.g. supermarkets, petrol stations, bars or restaurants), or a type of promotion or customer channel (e.g. general consumers, tv-broadcasting, printed magazines, or luxury brand shops). See also sections 2.4, lead-in, (a) and (b).

As regards patents, the licence should not cover geographical areas in which no patent was granted. Furthermore, a licence must be considered to be a technology licence. However, the licensee may argue that the licensor failed to deliver what was agreed: a patented invention.

Exclusivity. A licence is either ‘exclusive’ or ‘non-exclusive’. “Exclusive” means that nobody is entitled to use the licensed IP in the agreed territory, market segment and customer channel, not even the licensor. If the licence is a sole licence, the licensor may not grant a licence to another in the same territory, market segment or customer channel. Nevertheless, the licensor itself remains entitled to distribute in that area. In other words, the licensee will be the only (sole) licensee for that area, operating alongside the licensor. See also sections 2.4, lead-in, (a) and (b).

Important incompatibilities. Both an exclusive and a non-exclusive arrangement may severely restrict the freedom of the licensor in its freedom to undertake sales activities or to appoint other potential licensees who may be more successful:

• The appointment of an exclusive licence for a certain market segment in a certain territory prohibits the subsequent appointment of a (even non-exclusive) licence in the same territory for a broader market.
• The appointment of a non-exclusive licence for a certain territory prohibits the subsequent appointment of an exclusive licence in that same territory (even though the former is not de facto active in the market segment or customer channel covered by the latter). In such case, the second licence must contain a carve-out permitting the first licensee to continue its activities.
• If a licensee is appointed with an exclusivity arrangement for a term of five years and the licensee does not generate any sales, the territory and market segment for which the licensee is appointed will effectively be ‘blocked’ for alternative sales efforts during those five years.

Temporal scope. Most licences are either perpetual or have a specific term. If the licence clause includes the word “perpetual”, there is no further need to provide for a termination mechanism. A term licence would be limited by the time period of the agreement. It is uncommon to address this in the licence clause and is usually stipulated in an article on ‘term and termination’. The agreed term should enable the licensee to recover its investments made in relation to the licensed IP (and make profit).

Occasionally, a licence is granted for the duration of a project. For example, if a party agrees to provide certain services with which it makes use of proprietary technology of the customer or a supplier of the customer, the service provider would need a licence to carry out the agreed services. Similarly, if parties enter into a joint development agreement, one or both parties might need a licence to complete their part of the agreed development work. Such licence might be implied by the scope of the agreement, but an express project-licence emphasises the proprietary nature of the IP involved and might bring to light which limitations ought to apply to such project-licence.

Right to sub-license. In some cases, a right to grant sub-licences is desirable. For example, if the licensee is granted a licence in respect of a territory whilst it cannot (or will not) exploit the full capabilities of the licensed IP alone. In such case, whilst the licensee might be in a better position to obtain the maximum potential of the market, it would be appropriate to grant sub-licensing rights. In sub-licensing, the licensor usually requires the licensee to assume a larger responsibility in case of IP infringements by third parties in that territory.

More common situations in which sub-licences are necessary, relate to the use of the IP by (a) companies affiliated to the licensee, and (b) subcontractors of the licensee. An example of a clause permitting such sub-licences:

Permitted sub-licences. Subject to the limitations applicable to Licensee, Licensee is entitled to grant sub-licences to:
(a)  its Affiliates, which are not also an Affiliate of a third party, with the limited right to [use] the Trademark, provided that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such sub-licensed Affiliate ceasing to be an “Affiliate” of Licensee;
(b)  its suppliers and subcontractors, with the limited right to use the Trademark for Licensee’s exclusive benefit, provided that the sub-licence shall be no more extensive than is strictly required for providing such subcontractor’s services to Licensee, and provided furthermore that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such subcontractor ceasing to be a subcontractor of Licensee for the sub-licensed type of services. Each sub-licence as referred to in this paragraph (b) shall be subject to the prior written approval of Licensor, which approval shall not unreasonably be withheld or delayed.

Competition law restrictions. In patent and know-how licence agreements, the parties should be free to compete with their own developed products, improvements or new applications of the technology to the extent that these are independent from the licensee’s initial know-how. It is permitted to oblige the licensee to grant a non-exclusive licence to the licensor for improvements and new applications of the licensed technology. For important prohibitions, see section 5.6(b).

Irrelevant licence elements. In the core licence clause, it is generally not necessary to stipulate matters which are otherwise implied by (contract or IP) law. Such words, as they are occasionally used, include:

• Non-transferability or non-assignability of the licence: the general contract law principles for transferability of the licence agreement apply. This means that, in order to be legally effective, such a transfer requires the consent of all the parties to the licence agreement. This means that the licensor has the right to refuse and thereby prevent any transfer.
• Irrevocability of the licence: general contract law provides that contracting parties are bound by the terms of their agreement. Revocation of the licence is only possible on grounds provided by the applicable law which justify a term licensor for improvements inaction of the licence (e.g. rescission in case of material breach or termination by a receiver in bankruptcy) or grounds expressly stipulated in the licence agreement (e.g. in cases of material breach, bankruptcy or change of ownership over the licensee).
• Personal nature: this is the same as the non-transferability of the licence and a statement that the licence is personal is therefore redundant. Every contract is personal to the parties involved.

Royalties

Licences are fully paid-up, royalty-free or royalty-bearing. A royalty-free licence is common in joint development projects and for service providers in the context of their provided services. Also, the right to give demonstrations or to hand out free (complimentary or testing) samples of a product is often free of charge.

Fully paid-up. If the licence is fully paid-up, it means that the licensee acquires the rights to use, as stipulated in the licence agreement, after a one-off (lump sum) payment. This licence fee structure is usually applied if the parties want to materialise the licence in one settlement, or more commonly, if the payment in periodical instalments is impracticable (e.g. in case of a broadly defined patent, if the licensee is active in a different industry and not amongst the usual customers of the licensor) or if the collection of licence fees is undesirably burdensome (e.g. in case of consumers or large numbers of users).

Royalty-bearing. Royalty-bearing licences take countless forms. A royalty implies the payment of a (recurring) licence fee, the amount of which is often dependent on the volume of “net sales” (turnover) of the product in which the IP is used or applied. It is important to define what the royalty amount covers. A common reference figure is a percentage of the net sales of the products on which the trademark is used or for which the manufacture of the licenced patent or know-how is used:

Net Sales definition. In patent or technology licences:

Net Sales means the aggregate amount of sales prices of the Products received by the Licensee and its affiliated companies, excluding:
(a)  taxes and duties paid by the Licensee for the sale of any Products;
(b)  insurance, packaging and transportation expenses of Products;
(c)  deliveries of Products to Licensee’s affiliated companies to the extent that such deliveries are also included in such affiliated companies’ aggregated sales prices; and
(d)  normal discounts, returns and rebates to Licensee’s customers.

In trademark licences, the above item (c) should be replaced by:

(c)  deliveries of Products to Licensee’s affiliated companies for internal use by such affiliated companies only;

In both definitions, certain product-unrelated pricing elements, relating to delivery, logistics and insurance, are taken out of the net sales definition. The two definitions are different:

• In patent and technology licences it is important to capture (in case of a process-related patent) all processes where the licensee applies the patented invention or (in case of a product-resulting patent) all products sold by the licensee and its affiliates (even if there is no sub-licensing right). Any captive product sales (i.e. internally to affiliated companies) should be included at the Net Sales amounts received by that affiliated company from its customers (deducting the captive transfer price) but should be calculated at an arm’s length price.
• In trademark licences, internal sales are irrelevant and only the sales realised by the licensee and its affiliated companies vis-à-vis their customers is relevant. The brand does not operate as a particular unique selling point.

A percentage of net sales results in zero (nil) royalties if the licensee makes no sales efforts at all. Therefore, in many turnover-related licences, the licensor requires a minimum sales effort from the licensee by agreeing on a minimum royalty commitment: regardless of whether the licensee achieves the agreed minimum level of net sales, it must still pay for it (‘take or pay’).

NRE. In some industries, it is common to pay a part of the licence fees in an upfront lump sum amount. Such non-recoverable or non-recurring engineering fee is also known as “NRE”. This is useful if the licensor has to undertake development work in order to fit its product with the licensed IP into a given environment. The results of the development can be licensed to other parties as well. The possibility to relicense the IP justifies that the licensor assumes the costs of the investment, whilst the upfront payment is a way of financing the development work.

Royalty reporting. If any part of the licence fees is directly linked to (sales) amounts realised by the licensee, it is inevitable that the licensee reports on its sales. Accordingly, the licensor will require that the licensee maintains accurate bookkeeping and its records must enable the calculation of royalties by reference to the sales. In other words, the licensee must be able to account for the precise number of products in which the licensed IP was used (and the sales prices received for each product).

It is common to require quarterly reporting, although monthly reporting (in case of questionable debtors or high volumes of sales) and annual reporting (in case of low sales volumes or long lead times) also are agreed on. Royalty reports should be submitted within a few days after the end of the reporting period. Payment of the royalty should be made shortly thereafter (sometimes after the issuance of an invoice).

Royalty audits. If royalties are dependent on a variable, such as fluctuating sales amounts, it is appropriate to provide for an audit right: a right of the licensor (or its independent auditing firm) to verify the accuracy of the licensee’s royalty reports. In many industries, a royalty audit is considered to be a step-up to terminating the licence. Nonetheless, an audit clause usually addresses the maximum frequency of permitted audits (if previous audits revealed no irregularities), that an audit must be announced in advance, that it must take place during working hours, as well as a ‘penalty’ mechanism for settling misreported royalties. An example of a royalty audit clause is included in Model international trademark licence agreement (Section 6.6).

 

Covenants in contracts vs obligations

What is a covenant? Broadly speaking, ‘cov­enants’ are the contractual devices ensuring that a party receives the benefits that it negotiated for in the business deal. In other words, covenants support the achievement of the purpose implied by the key provisions characterising the transaction.

In this section, a brief comparison will be made between covenants as opposed to conditions, various examples of typical covenants in different types of contracts will be discussed (one subparagraph will address M&A-related convenants and another subparagraph will address covenants in financial agreements). This section will finally address how a contract drafter can smoothen the effects of a covenant.

Covenants vs. conditions

Unlike conditions (and warranties) – which are statements of fact as at a specific point in time – covenants are ongoing promises by one party to take or not to take certain actions. But covenants and conditions are more related than it may seem at first sight. Compare the following examples:

1. Seller shall sell and deliver the Products to Purchaser, subject to the condition that Purchaser has paid the Purchase Price.
2. Seller hereby sells and delivers the Products to Purchaser, subject to the condition that Purchaser shall pay the Purchase Price within five days after the Signing Date.
3. Seller hereby sells and shall deliver the Products to Purchaser within five days after the Signing Date, subject to the condition that Purchaser has paid the Purchase Price.
4. Seller hereby sells the Products to Purchaser and Purchaser hereby purchases the Products against payment of the Purchase Price. Seller shall deliver the Products within five days after the date of this Agreement.

Example 1 does not contain an ‘act of purchase’ by the Purchaser and does not contain an unequivocal link between the Purchase Price being a “purchase price” and the sales. Example 2 has the same defects; the strict wording would not grant the Seller an action for performance against the Purchaser (i.e. the Purchaser could argue that despite Seller’s act of sale, the Purchaser’s act of purchase remains open until the Purchaser so decides). Example 3 is the same as example 2, except that the required order of performance of payment and delivery are changed. Example 4 is a proper sales provision without any explicit conditions (i.e. one may well argue that the sale is subject to the implied condition that the Purchase Price be paid).

Based on the wording used or missing in the examples (i.e. a reference to a “Purchase Price” and a failure to reflect that the products are “hereby purchased”, respectively) examples 1 to 3 may well need improvement. Whether they are more obligatory than a precise lawyer would prefer is a matter of (reasonable) interpretation. If they were written by a non-lawyer for a simple transaction between two individuals, it is quite possible that a court would determine that the main intentions of the parties as expressed in the examples are all the same: one party sells and the other party buys, against payment of a purchase price. If an amount has been paid and the Products have been delivered, a court will probably not invalidate the sale. Nonetheless, it emphasises the importance of drafting straightforward obligatory provisions in the active tense.

The relationship between conditions and covenants can also be explained in a different way. First, although a condition is not, as such, a ‘promise to act’ in a certain way, the stipulation of a condition often implies that the parties use reasonable endeavours that the condition will be satisfied in such manner that the object of that condition takes its anticipated effect. Accordingly, a condition may a contrario imply an obligation (i.e. a covenant) imposed on the party who is able to influence the satisfaction (positively or negatively) of that condition. Similarly, a covenant is not a key obligation and therefore many courts will refuse to permit a complete suspension or postponement of performance by the beneficiary of an obligation if the obligor fails to perform according to the covenant.

Second, if contractual obligations are drafted in the passive tense (i.e. without an actor or obligor being appointed) the distinction between covenants and conditions becomes fluid. This becomes clear when reading the American Restatement of Contracts:

“If in an agreement words that state that an act is to be performed purport to be the words of the person who is to do the act, the words are interpreted, unless a contrary intention has been manifested, as a promise by that person to perform the act. If the words purport to be those of a party who is not to do the act they are interpreted, unless the contrary intention has been manifested, as limiting the promise of that party by making performance of the act a condition.”

Although the distinction might not be of great relevance from a contract-drafting or even a practical perspective, it is important to be aware how conditions and obligations interact with each other.

Covenants in various contracts

Covenants in IP-related agreements. In a patent transfer agreement, the transferring party will transfer its invention. However, the transferee would like to maximise its use of the patented invention and also be made familiar with all technology know how connected to the patented invention.

Also, a transferor may want to avoid any infringement claims for the use of any remote elements in the patent that do not relate to the transferee’s business but was covered by the patented invention (as the patent was applied for in view of the transferor’s business): the transferor may seek a non-assertion or licence-back in connection with the transferred patent. Similarly, a licensor of trademarks or other intellectual property rights often requires from its licensees that they notify the licensor promptly of any infringements identified in the market of such licensee. Such stipulations are covenants.

Covenants in Lease or loan agreements. In a manufacturing equipment lease, the main objective of the lessor is to ensure that the lessee pays the rent timely and that it returns the equipment at the end of the lease. However, a lessor may want the lessee to operate and store the equipment in accordance with lessor’s instructions, to maintain the leased assets, to keep it insured and to allow periodical inspections by the lessor. The lessor, in addition to its concern regarding the value of the equipment, will want to prevent that the lessee will be unable to pay the rent timely. Likewise, the lessor might require that the lessee provides an ongoing security for the lease

The lessor, in addition to its concern regarding the value of the equipment, will want to prevent that the lessee will be unable to pay the rent timely. Likewise, the lessor might require that the lessee provides an ongoing security for the lease instalments. If the lease has a potentially significant impact on the lessee’s business, the lessor may even require periodical information about the lessee’s financial capability to continue paying the rent.

Each of the above examples of deal-related or unrelated purposes is accomplished by covenants that prescribe what the transferor or lessee must do, and cannot do, in respect of the transferred patent or leased equipment.

Covenants in M&A transactions

In M&A transactions, covenants will protect the purchaser’s interests prior to completion (i.e. covenants force a seller and the acquired companies to conduct the business in the ordinary course and to obtain the purchaser’s approval for important or extraordinary matters), as well as its commercial deal after completion in an active sense (i.e. the seller is required to take care of transaction-related interests or to continue to disentangle the acquired business) and in a passive sense (i.e. the seller should refrain from using its knowledge or business relationships to compete with the business it sold).

Disentanglement covenants. In addition, various matters related to the historic positioning of the acquired companies as part of seller’s group need to be addressed. The disentanglement is usually not completed on the closing date. For that reason, the following matters are commonly provided:

• Financial disentanglement: all securities, suretyships and collateral granted by the acquired companies for the benefit of the seller’s group and vice versa should be terminated (and replaced). This includes financial arrangements of any kind: cash pooling arrangements with the bank, security rights under credit facilities, currency exchange swaps or foreign currency hedge arrangements, surityship undertakings and parent guarantees by the selling shareholder, credit arrangements with suppliers that service both the sold companies and the remaining subsidiaries of the seller etc.
• Employee’s rights: although the position of employees does not change as a direct consequence of a change of control, many selling companies would like to ascertain that the employees will indeed keep their employment. Also, employee codetermination laws and regulations (or the mere existence of a works council) have had the effect that a seller and purchaser often agree on a certain (or an unchanged) level of employment after closing of the transaction. A covenant could therefore address matters such as:
  • the number of FTE during the next few years;
  • the continuous availability of certain specific facilities of the seller (e.g. an employee mobility centre);
  • the replacement of an employee share or option participation scheme by a reasonable alternative;
  • certain minimum requirements for the benefit of senior staff (who are not covered by a collective labour agreement);
• Pensions: whilst the pension rights of employees are also well-protected under European legislation, it is sometimes recommended that a purchaser takes over certain pension arrangements of the seller or arranges for a pension scheme that is substantially similar to that of the seller (e.g. defined benefit scheme, defined contribution scheme, capital contribution policy).
• Intellectual property rights: if IP does not constitute a significant part of the M&A transaction, some more basic aspects are dealt with in the covenants:
  • the cessation of the use of seller’s trademarks and trade names in the acquired companies business (i.e. usually such use is allowed until three months after closing) including the removal of nameplates and logos, and, less typical but for a sense of mutuality, of the acquired companies’ trademarks, trade names and logos by the seller;
  • the transfer of certain domain names and trade mark registrations (i.e. such transfer could be formalised on closing but the actual transfer registration process takes some time and is so different from country to country with so little interest by either party to have it done on closing that filling out the forms is typically a post-closing affair if it happens at all);
  • an undertaking not to permit the lapse of any IP-registration.
• Insurances: a seller will sometimes want to ascertain that certain business risks of the sold companies continue to be covered by insurance.
• Authorisations: in multi-party agreements, covenants may consist of authorisations or a (conditional) power of attorney to undertake certain actions on behalf of one or more parties.
• Taxation: Although often addressed in a separate schedule or tax agreement, tax matters obviously require a sort of ‘covenant’ in the context of an M&A transaction. Matters that may need to be addressed include the seller’s and acquired companies’ respective liability for any taxes, a termination of regional tax unities, the entitlement and reimbursement of tax benefits, communications with tax authorities and the conduct of any tax-related disputes.
• Intra-company agreements: in order to ascertain that the purchaser does not acquire a loss-making business because the seller has arranged highly unfavourable terms and conditions for itself, the ordinary course supplies by the acquired companies to the seller’s other subsidiaries are often terminated. Please note that these agreements contribute to the value of the acquired companies and are not, as such, of a transitional nature.
• Transitional services: the sold companies are often highly dependent on the availability of various services and facilities provided by their former holding company. To a lesser extent, this may also apply to services or facilities (if only in certain countries) hosted by the sold companies for the benefit of their former affiliated companies. For that purpose, a share or asset purchase agreement will typically contain a transitional services agreement that provides for an uninterrupted continuation of various services. The typical aspects to be addressed are the legal entities that are formally entitled to (responsible for) the service, the duration of each such service (i.e. not all services can be terminated easily), the service fee, payment and invoicing arrangements, particularities related to the service and the contact persons after closing. For ICT matters, which might include the availability of enterprise software systems, more elaborate arrangements are often necessary.

Pre-closing covenants. During the period between the signing and the closing of the transaction, the business of the acquired companies would typically be continued in the ordinary course of business. Anticipated investments (e.g.the renewal or maintenance of equipment and production installations) may or may not continue as planned. The purchasers will likely want to prepare, to reconfirm or to further elaborate their business plan for the acquired companies. Also, suppliers and customers contact their counterparts in the sold business asking for a clarification of the transaction (and certainty about their ongoing position). Some contracts contain change-of-control provisions, which may even trigger renegotiation of the pricing or other terms and conditions. As with everything in life, issues arise in the ordinary course of business. Because each such issue might affect the value of the acquired companies or the possibility of integrating the acquired business into the business of the purchaser, pre-closing covenants would be agreed, probably with some involvement of the purchaser. Such pre-closing covenants might address, for example:

• Access to facilities and information rights. Whereas competition laws prohibit the implementation of various (irreversible) measures, a purchaser would like to have some access rights to the acquired companies’ manufacturing facilities or offices and to certain (non-strategic) information. The seller will want to make sure that the purchaser does not interfere with the business activities and that the purchaser will comply with all security and safety measures.
• Undertaking to conduct the business in the ordinary course. It is appropriate for a seller to procure that the acquired companies undertake their business as usual.
• Approval rights. Various matters will be subject to the purchaser’s prior approval. They may include:
  • entering into agreements (distinguishing between ordinary course contracts, non-ordinary course contracts, unusual contracts or commitments under atypical terms and conditions, and contracts with a conflict of interest);
  • matters related to the acquired companies’ assets (i.e. no disposals or grants of pledges other than in the ordinary course of business and no unanticipated deviation from capital-expenditure-related investment plans);
  • matters related to the corporate structure, taxation and finance (including financial reporting), preventing a transfer of any entities, any amendments to corporate constitutional documents, tax-revaluations etc.;
  • employment-related matters, such as a change of the terms of employment (including of any collective labour agreements), the removal of (key) employees other than for urgent cause, or the employment of additional personnel;
  • IP-related matters (if not addressed otherwise);
  • an undertaking not to enter into, amend or terminate any joint ventures, partnerships, licences or important lease agreements.
  • settlement of claims and disputes and the conduct of any pending litigation.
• A duty to inform. Obviously, between signing and closing, the purchaser wants to be informed about all matters that might affect the value of the acquired companies, any of the warranties becoming incorrect and generally any business decisions by the acquired companies. It will also want to receive periodical management reports and quarterly or annual financial statements.

Credit-facility-related covenants

In credit facilities and loan agreements, as in M&A transaction agreements, covenants can similarly be divided into three categories:

• Covenants requiring action (i.e. promises to take a specified action);
• Negative covenants (i.e. promises not to take specified actions); and
• Financial covenants (i.e. promises to maintain certain levels of financial performance or not to take specific actions unless certain levels of fi­nancial condition or performance exist at the time).

Negative cove­nants are also referred to as restrictive covenants, because they restrict or prohibit certain actions (i.e. not permitting the creation of pledges over any assets of the borrower, or the undertaking not to grant any higher-ranking security rights over its assets compared to those of the lender).

Financial covenants. In their financing practice, banks have been developing great insight into the need to monitor their customers’ businesses. Those needs are satisfied by adequate financial covenants. Financial covenants restrict a borrower’s freedom to engage in activ­ities that may worsen its financial condition. These activities include the following:

• Incurrence of debt. More debt means more interest and princi­pal payments, implying a greater impact on the company’s cash flow.
• Creation of encumbrances (‘negative pledge’). The more assets are pledged or otherwise collateralised, the fewer assets are available to be used to satisfy the borrower’s unsecured claims and general obligations in the event of insolvency.
• Line of business. Especially in leveraged finance, finance agreements will require that the borrower does not change the essential scope or nature of its business activities.
• Sale of assets. Loss of income-generating assets could adversely affect the lessee’s cash flow. Sometimes also the assignment of receivables (factoring arrangement) is restricted or prohibited.
• Dividend distributions (‘leakage prevention’). Each euro distributed as dividend to share­holders reduces cash available for payment of rent. Also, intra-company transactions with affiliates that do not participate in the financial arrangement may endanger the leakage of valuable assets or cash out of the reach of the lenders.
• Investments. From a lender’s standpoint, cash spent on investments would be better spent on repaying amounts due to the lender.

Financial ratios in credit agreements. Financial covenants that require the covenanting party to periodically meet certain financial ratios are also used to ad­dress credit concerns. These ratios are set at levels de­signed as an ‘early warning signal’ in the event that the borrower is facing financial difficulties. Financial ratios are aimed at balancing the business decisions of a company’s management, in that the ratio established by a covenant requires that the company will at all times be capable of paying its debts, as should be determined on the basis of the company’s cashflow to debt ratio, a profitability (EBIT or PBIT) to interest indebtedness ratio, a current ratio (i.e. current assets to current liabilities) or a solvency ratio (e.g. borrowed money set off against equity). Such financial covenants will often also require that the borrower is of a certain ‘minimum net worth’.

Carve-outs and baskets: exceptions to covenants

The scope of a covenant can be limited or qualified in a few respects. The most important one is to create exceptions or to be specific regarding its scope. Two basic types of exceptions can be distinguished and will be addressed in this paragraph: carve-outs and baskets.

Carve-outs. A carve-out is formulated as an exception and functions as a removal, or carve-out, of part of the restriction imposed by the covenant. For example:

Borrower shall not sell any of its assets, except for any equipment that has reached its end-of-life status or a status of technical obsolescence.

Baskets. A basket, on the other hand, is an allowance that establishes the right to deviate from the covenant’s restrictions by some specified amount. The purpose of a basket is to give the restricted party a limited ability to deviate from a covenant’s restrictions. The above exception could be converted into a basket, as follows:

Borrower shall not sell any of its assets, except for any equipment that has reached its end-of-life status or a status of technical obsolescence up to an aggregate amount not exceeding EUR 15,000,000.

Similar baskets are found in the pre-closing covenants in share purchase agreements, where the purchaser requires the seller to obtain prior approval for certain types of transactions. The example shows that further distinguishing between the nature of the underlying transaction is helpful in finding a middle ground:

Except to the extent provided in a budget of Acquired Companies that has been fairly disclosed to or approved by Purchaser, Seller shall not permit Acquired Companies to do any of the following pending the Closing without the prior written approval of Purchaser (which approval shall not be unreasonably withheld or delayed):

(a) enter into an agreement or a series of related agreements which are in the ordinary course of business for an aggregate amount in excess of EUR 250,000;

(b) enter into an agreement or a series of related agreements which are not in the ordinary course of business for an aggregate amount in excess of EUR 50,000;

(c) enter into any abnormal or unusual agreements or commitments, including any which (i) are unlikely to become profitable, (ii) are of an unusually long-term nature or which cannot be terminated within 24 months, (iii) contain a payment term or potential liability exposure deviating significantly from Acquired Companies’ contracting policy as at the Signing Date, or (iv) would otherwise likely have a financial impact after the (initial) term of the contract;

(d) enter into any agreement in which a member of Seller’s Group has an interest.

Remedies for breach of a covenant. In most agreements that are subject to a European continental law, it is unnecessary to include a remedy in a covenant. Unlike in civil law jurisdictions, the default remedy under common law for breach of contract is that the harmed party is entitled to damages but not a priori to specific performance, which is an equitable remedy granted at the discretion of the court. In the European continental legal systems, the opposite applies (see paragraph 2.2(a)): by default, a party can ask for specific performance (and if that is not practicable or adequate, damages can be claimed). Because an entitlement to damages often does not protect the harmed party’s interests adequately, an agreement that is drafted in view of the law of a common law jurisdiction usually provides for specific remedies in the event of a breach of a covenant.

Representations and warranties – sense and all nonsense

Warranties, also referred to as representations (but see below), are statements of fact. At least, as a matter of best practice, representations and warranties should be statements that are either true or not true. Warranties are made by one party (e.g. a seller, service provider, borrower or licensor) to the other party, typically as at a particular moment in time. The purpose of a warranty is (a) by way of promise about the future post-signing, to confirm or stand in for the warranted facts and events, as those may be important to the other party’s expectations, and (b) to encourage (but in common law, this is called a representation) its business decision to enter into the transaction (on the agreed terms of the contract).

If warranties are incorrect, this would result in rights or remedies under the contract. For a distinction between representations vs. warranties (as is made in common law) this is essential. Below, we will address various aspects of warranties and best practices.

Introduction to warranties

Like recitals, warranties are statements of fact. Someone can ‘breach’ a contractual obligation or covenant, but not a statement of fact. A properly drafted warranty is either true (or correct) or not. There should be no room for something in-between. Of course, a warranty can be partially incorrect, but this implies that also the warranty in its entirety is incorrect. In the English language, it is also appropriate to stipulate that a warranty is ‘accurate’ (or ‘inaccurate’).

Smoking out the facts. The process of asking and negotiating warranties should trigger the disclosure of facts and events that might not otherwise become known. In this respect, warranties spur the seller on to discharge its ‘duty to inform’, whilst at the same time the purchaser effectively conducts its ‘duty to investigate’. Asking and negotiating the warranties is therefore a natural outflow of the due diligence investigation. (Ideally, a purchaser’s due diligence questionnaire will match the set of model warranties, which a purchaser would require if it had full bargaining power. At the same time, since such a set is likely ‘complete’, a seller would organise its data room consistent with such model warranties.)

For example, a purchaser will ask the seller of a company to make the following warranty:

Except as disclosed in Schedule 11, there have not at any time been any Spills or Contaminations on or from the Production Site.

When the seller receives this warranty as part of the first draft set of warranties, it has several options:

1. refuse to make the warranty (either in general terms “take a closer and critical look at what you are asking” or more specifically “we are unwilling to make this warranty”). In this last case, the suggestion arises that the seller hides environmen­tal contaminations, and the purchaser will want the warranty even more;
2. qualify and limit the warranty to the seller’s knowledge, so that the warranty is only incorrect if the seller fails to disclose relevant facts actually known to it. (Often, reference is made to the seller’s best knowledge: the qualification is non-sense because someone either ‘knows’ or ‘does not know’.) In many cases, the responsible former and current managers are named to further limit the scope of seller’s knowledge, imposing a necessity to scrutinise them about the warranties qualified as such.
3. make the warranty, as well as a disclosure of all facts or events of which it is aware.

Allocation of risk. A warranty removes legal issues related to attributability (and partly also of causation) of damages if the warranted facts or events appear to be incorrect. The result is that a warranty operates as a risk allocation mechanism. The party making a warranty assumes the risk that if the warranty is incorrect, the other party will have a claim against it or another appropriate remedy under the agreement. Depending on the interpretation of the warranty, a failure in the contractual object may fall within the scope of the warranty (and therefore the customer can make a claim) or it may not (and accordingly, the risk remains for the customer). It may well be that neither party knows whether a warranty is correct, even after comprehensive investigations and testing. Having the seller, service provider, borrower or licensor make the warranty is a simple allocation of risk.

Representations or warranties, in common law and elsewhere

Warranties, not representations and warranties. The word warranties is very often coupled with representations, in that the parties do not merely warrant, they would represent and warrant. Many people argue that ‘representation’ and ‘warranty’ signify the same legal concept, and that the use of the one or the other is interchangeable. While this is true for all non-common law systems (where warranties do not have a distinct meaning), within common law – most evidently under English law – the two terms relate to fundamentally different concepts.

Representations under common law. Under English common law, a representation is a statement of fact made by one party to induce the other party to enter into the contract. Being a statement of fact means that it can relate (and must be drafted to relate) to past or present facts or circumstances only. As in many other legal systems, a misrepresentation (a ‘breach’ of a representation), by consequence, affects (the appropriateness, validity or cause of) the transaction.

A misrepresentation operates the way the legal concept of ‘mistake’ (erreur, Irrtum, dwaling) works in non-common law jurisdictions. Accordingly, the default remedy is (and as codified for English law in the Misrepresentation Act 1967 indeed is) that the induced or misled other party may rescind the contract if the misrepresentation so justifies. An immediate consequence would then also be that, rather than a (contractually qualified or limited) claim under ‘contract’, such other party would claim in ‘tort‘ or ‘unjustified enrichment’.

Although one may reflect the representations in the contract, by a representation’s very nature (as an inducement to enter into the contract) such written reflection is not necessary: whether the remedy (rescission of the contract) is justified will be determined regardless of whether the representation was in writing. Having the representation in writing is of course good evidence.

Warranties under common law. The term warranty has a slightly different meaning: it reflects the promise about (the effects of) the contemplated transaction made by one party to the other, so about what such other party might expect from performance under the contract. If a warranty appears to be incorrect, the remedy under common law is: damages (and not rescission). If the incorrectness is fundamental, the contract can be terminated. However, the default remedy under common law is the payment of damages resulting from the warranty being incorrect.

Unlike a representation, the contract is not undone as though it never existed. A warranty should be drafted such that one can say that it is ‘correct’ or ‘incorrect’. Accordingly, like representations, semantically, a warranty takes the ‘structure’ of a statement of (past, current or future) facts. Whilst representations refer to the particular facts as they are (or would be) at the time of contracting, a warranty must be presumed to address a promised future fact, benefit or circumstance measured as of the moment such a warranty is made.

On similar grounds, warranties imply a contractual risk allocation mechanism, which is – in view of the remedy (rescission) – not the case with a representation. Having pointed out these notions of warranties vs. representations, it must be admitted that many common law lawyers are unaware of the distinction.

Reps and warranties in the rest of the world. On the European continent, one would expect that representation is the preferred wording. At least from a semantic point of view, the well-known concept of a ‘juridical act’ (being something like ‘a statement or declaration, which has legal effect as such’) seems to match better with that terminology (whereas a warranty has no specific legal meaning). Regardless of this somewhat arbitrary argument, European contract laws are conceptually built on notions such as the parties’ (mental, psychological) consent, their free (subjective) mutual will, or the meaning that a reasonable person would (objectively) attribute to what the parties expressed as their agreement.

Because of such notions, the English-language distinction is not so obvious that using one word or the other is of any decisive relevance. What is relevant is that one party makes a statement of fact and that the party relying on that statement may or may not invoke a contractual or statutory right when that statement happens to be incorrect.

Guarantee? Some European originating contracts may use the term guarantee (i.e. the verb) or guaranty (i.e. the act as such). This can be explained from the translated concept (e.g. ‘garantie’ (French), ‘Garantie’ (German), ‘garantie’ (Dutch)). Still, in the common law, the concept guarantee is much more closely related to a suretyship, the undertaking by one person to stand in for the due and timely performance by another person. In Black’s Law Dictionary’s explanation:

guarantee, vb. (18c) 1. To assume a suretyship obligations; to agree to answer for a debt or default. 2. To promise that a contract or legal act will be duly carried out.

Best practices of warranties

Best practice – written as a statement of fact. A representation and a warranty must be drafted as a statement of fact. A properly drafted warranty is either true (or correct) or not. There should be no room for something in-between. Of course, a warranty can be partially incorrect, but this implies that the warranty in its entirety is also incorrect. In the English language, it is also appropriate to stipulate that a warranty is ‘accurate’ (or ‘inaccurate’).

Best practice – never include obligations. Like recitals and definitions, a warranty should never contain obligations, remedies or other operative provisions. If the drafter wants to provide for an obligation or a remedy in the case a warranty is incorrect, or for any consequences depending on the degree of ‘incorrectness’ of a warranty, this should be addressed in a separate provision: a separate article, section or at least its own sentence.

Hindsight effect of obligations. If a party wants to ascertain that the other party has been acting as if the obligations had been agreed earlier in time, this should be achieved by a warranty, not by an obligation. It is simply impossible for a party to undertake that it would not have acted or would not have omitted to act in a certain manner in respect of a period preceding the date of execution of the agreement. This is because no-one can reverse time or step into a time machine in order to perform an obligation.  A party should only warrant that it did act (or did omit to act) in a certain manner up to the present date.

For example, a confidentiality agreement that should have retroactive effect must be phrased in the following way:

6.1       Preceding Disclosures. The Receiving Party hereby confirms that Confidential Information already disclosed in relation to the Purpose and any discussions already held between them, from 15 March 2020 and thereafter, shall be subject to this Agreement.
6.2       Warranty. The Receiving Party warrants that during the period between the date in Section 6.1 and the date of this Agreement, it has not disclosed, done or omitted anything that would have constituted a breach of this Agreement, if this Agreement had been in entered into immediately preceding such period of time.

Warranties in all-caps: ‘conspicuousness’ ? Many contract drafters believe that a disclaimer or limitation of liability must be printed entirely in capital letters. The requirement to capitalize can be found in the United States Uniform Commercial Code (UCC) and only applies to a few nominal types of contracts – the sale of goods, the licence of software, a lease or a warehousing contract. In such contracts, a seller of a product can disclaim implied warranties and limit its exposure to liability conspicuously. The UCC defines the conspicuous requirement as something written (printed) such that a reasonable person ought to have noticed it.[1]

Language would be considered conspicuous if it is in a larger font or other contrasting type or colour (for sales contracts, a broader definition applies). The UCC does not require all-capitals. Whether or not the text is considered conspicuous is for the court to decide. Finally, since the requirement of conspicuousness is based on the UCC, it applies only if the contract is governed by the laws of a U.S. state. Almost no other country adopted such a conspicuous requirement.

Warranties in ordinary course business contracts

Fitness for purpose and merchantability. In day-to-day business contracts, warranties related to fitness for a particular purpose and ascertaining the merchantability of the products are very common. Also the opposite, that such warranties are specifically disclaimed, is common practice.

What do they mean? Most legal systems require that a sold product must generally be fit for the ordinary purpose for which such products are to be used (and the meaning of which depends on the particular context). If not, the seller would be selling defective products and would rely on a disclaimer allowing it to be in material breach without any remedy or penalty. People call that deceit.

Should the parties agree on a warranty that the products are delivered “AS IS” (and that any other warranties are disclaimed), a purchaser should inform itself more careful as to whether the sold goods meet its expectations. However, even such limited ‘warranty’ does not permit the seller to deliver crap or even something of which it actually knows that it does not meet the purchaser’s expectations at all (unless the purchaser actually assumed the risk that the seller’s performance could potentially lead to no result at all). Non-performance is something else than performing with no guarantee of success.

Sometimes, a seller disclaims that a product is “fit for a particular purpose”. Such disclaimer attempts to avoid that a seller is held to deliver according to l is therefore ineffective if it allows the seller to deliver defective products. The trick is in the specificity of the purpose and in the extent to which the product should meet the purchaser’s personal intentions (i.e. those particular purposes on top of what may generally be expected).

In connection with a warranty of fitness for a particular purpose, the U.S. Uniform Commercial Code requires that (a) at the time of entering into the contract, the seller must have reason to know the purchaser’s particular purpose (i.e. the purchaser must have told or informed the seller in a somewhat deliberate way for what purpose it would use the goods), (b) the seller must have reason to know that the purchaser is relying on the seller’s skill or judgement to deliver suitable products, and (c) the purchaser must – in fact – rely upon the seller’s skill or judgement.

Disclaiming the merchantability of a product refers to the freedom of the purchaser to sell the product to third parties (and such third parties’ freedom to use it without infringing another person’s rights). Normally, this is not problematic at all. When the product is subject to a limited licence or if the use of the product independently or in combination with another product infringes the (intellectual property) rights of a third party, however, the product is not merchantable. The same applies if the product is subject to encumbrances or if it cannot be delivered because of any litigation, seizure or embargo.

Generally, merchantability is something that a seller should warrant. However, the complication in relation to intellectual property is that a seller is not always capable of knowing which IP-rights its competitors own (or in which jurisdiction they apply). Furthermore, it disregards another aspect of merchantability: the seller does not necessarily know how its product will be processed and probably the product is subject to additional regulatory requirements under any local law (e.g. export or import restrictions, registration requirements or specific permits or authori­sations). In the U.S. Uniform Commercial Code[2], ‘merchant­ability’ is equivalent to fitness for ordinary purpose.

Warranty of specifications. A warranty requiring that a product meets the ‘specifications’ may trigger the purchaser to clarify for which purpose it will use that product. Because this can be very subjective (and probably also subject to changes) it is risky for a seller to make warranties that the product is fit for the particular purpose for which the purchaser will use it.

Capitals. Many contract drafters believe that in international commerce, a disclaimer or limitation of liability must be printed in capital letters. For example:

THE PRODUCT IS PROVIDED TO PURCHASER “AS IS” WITHOUT ANY WARRANTIES OF ANY KIND. SELLER EXPRESSLY DISCLAIMS ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NON-INFRINGEMENT OF INTELLECTUAL PROPERTY RIGHTS. SELLER SHALL HAVE NO LIABILITY TO PURCHASER OR ITS AFFILIATES OR ANY THIRD PARTY FOR ANY DAMAGES, INCLUDING DAMAGES RESULTING OR ALLEGED TO RESULT FROM ANY DEFECT, ERROR OR OMISSION IN THE PRODUCT, ANY USED THIRD PARTY PRODUCTS OR AS A RESULT OF ANY INFRINGEMENT OF INTELLECTUAL PROPERTY OF ANY THIRD PARTY. IN NO EVENT SHALL SELLER BE LIABLE FOR ANY INCIDENTAL, INDIRECT, SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS) SUFFERED BY PURCHASER OR ITS AFFILIATES OR ANY OTHER THIRD PARTY ARISING OUT OF OR RELATED TO THIS AGREEMENT EVEN IF SELLER HAS ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.

Background: ‘conspicuousness’. The requirement to capitalise only applies to a few nominal types of contracts. They can be found in the Uniform Commercial Code (UCC) related to the sale of goods, the licence of software, a lease or warehousing contract: a seller of a product can disclaim implied warranties and limit its exposure to liability conspicuously. The UCC defines[3] the conspicuous requirement as something that is written (i.e. printed) in such a way that a reasonable person against whom it is to operate ought to have noticed it. Language in the body of a contract would be conspicuous if it is in a larger font or other contrasting type or colour (for sales contracts, a broader definition applies). The UCC does not require all-capitals. Whether or not text is conspicuous is for decision by the court. Finally, since the requirement of conspicuousness has its origins in the UCC, it applies only if the contract is governed by the law of certain U.S. states, where such a requirement is also adopted. This is the case only in a limited number of states.

Disclosures against warranties – strategy and best practices

Triggering disclosure and clarification. In major transactions, warranties serve to smoke out the facts. The process of asking and negotiating warranties should trigger the disclosure of facts and events that might not otherwise become known. In this respect, warranties spur the seller on to discharge its ‘duty to inform’, whilst at the same time the purchaser effectively conducts its ‘duty to investigate’. Asking and negotiating the warranties is therefore a natural outflow of the due diligence investigation. (Ideally, a purchaser’s due diligence questionnaire will match the set of model warranties which a purchaser would require if it had full bargaining power. At the same time, since such a set is likely to be ‘complete’, a seller would organise its data room consistent with such model warranties.)

Example and strategy. For example in the context of a sale of a chemical business, the buyer most probably wants to know whether there are any environmental contaminations for which the target company may be held liable at some point in time. The potential purchaser will ask the seller of a company to warrant the following:

Except as disclosed in Schedule 10, there have not at any time been any Spills or Contaminations on or from the Production Site.

To continue the example, the seller may have carried out environmental investigations providing a minimum of comfort that there are no environmental complications. However, there may have been hazardous spills that were not accurately reported in the records and not discovered in the soil investigation.

When the seller receives this warranty as part of the first draft set of warranties, it has several options:

1. refuse to make the warranty (either in general terms stating “take a closer and more critical look at what you are asking” or in more specific terms stating “we are unwilling to make this warranty”). In our example, refusal may imply that the seller is hiding environmental contaminations, and the purchaser will want the warranty even more;
2. qualify the warranty by the words to the seller’s knowledge, so that the warranty is only incorrect if the seller fails to disclose relevant facts actually known to it. (Often, reference is made to the seller’s best knowledge: the qualification best is nonsense because someone either ‘knows’ or ‘does not know’.) In many cases, the responsible former and current managers are named to further limit the scope of seller’s knowledge, imposing a necessity to scrutinise them about the warranties qualified as such;
3. limit the scope of the proposed warranty. A mark-up of the above example could state that the seller has always had adequate waste spill reporting policies in place in accordance with the best industry practices at such moment in time, and that it has conducted adequate soil investigations;
4. make the warranty, as well as a disclosure of all facts or events of which it is aware.

The best approach to negotiating warranties depends on several circumstances:

• the negotiating power and leverage of the disclosing party,
• the sensitivity of the negotiations generally (e.g. the level of mutual trust or confidence of the parties),
• the time of internal discovery of ‘defects’ in warranties (i.e. disclosure letters tend to be prepared and handed over after the warranties have been negotiated, at least to some extent),
• the disclosing party’s liability exposure in view of thresholds and baskets,
• the disclosing party’s general approach to being complete and comprehensive (or not),
• the willingness to address (highly) sensitive subjects (e.g. potential antitrust issues).

Disclosures may also be made by excluding, or carving out, the incorrect facts or events otherwise covered under the warranty. This is appropriate if the exception is rather extensive as opposed to the scope of the warranty against which it is disclosed.

The disclosing party should realise in advance that proposing a dis­closure may in turn trigger a buyer to require specific indemnities separate from the warranties (and excluded from the warranty-related limitations of liability). Such a specific indemnity may take many forms: from a specific indemnity limited in scope, time and amount to remedial action taken by the seller (or under its supervision and at its costs).

Disclosures – best practice rules. Like warranties, disclosures are statements of facts or events. Therefore, disclosures must not contain obligations, promises or undertakings of any kind. Like warranties, disclosures may refer to annexes attached to the disclosure schedule, which annexes may list, describe or otherwise report the disclosed facts or events.

It is good practice to organise meetings with the senior employees who should potentially have any knowledge of possible warranty breaches. In other words, when a disclosure letter is to be drafted, the disclosing party’s lawyers should meet with each such employee (or small group of employees). They should explain the impact of a warranty breach (i.e. being somewhat different from ordinary course warranties), the thresholds above which a warranty breach is likely to become an issue, and explain word-by-word what is meant by a warranty. Each employee should be encouraged to give as much information as possible. After that, he or she may well be requested to sign off on the reflection in the disclosure letter, or to document any disclosure. Subsequently, it should be the negotiation project team that decides whether or not making the disclosure is appropriate.

General vs. specific disclosures. The party that prepares the disclosure letter will try to avoid the disclosure of information that is publicly available (e.g. in public registers, such as for companies, for ownership rights of real estate, or for patents or trademarks). Obviously, the work related to making such disclosures can be enormous (with a risk of missing certain specifics), whilst the information itself may not be very useful (other than having an aggregated list of items that will be transferred).

Similarly, the disclosing party will prefer to refer to existing and readily available documents, such as the transaction’s information memorandum and (the Powerpoint handouts of) management presentations, as well as any disclosed financial statements and management reports. For this reason, a first draft disclosure letter will likely attempt to include all information that is generally available to the public or otherwise available to the other party. The part of the disclosure letter that addresses these disclosures is referred to as general disclosures (as opposed to specific disclosures that are prepared in view of a certain warranty).

In an M&A-transaction a seller will try to elaborate on the opportunities that were given to the purchaser and its advisers to undertake an (extensive) due diligence investigation. Accordingly, the seller will attempt to have the complete dataroom considered to be a disclosure against all warranties.

Numbering of disclosures. It is recommended that the numbering of individual disclosures match the numbers of the warranties. Accordingly, the disclosed item gets a number that corresponds to the warranty in connection with which it is primarily included.

Disclosure against what? Because a warranty will typically have a great level of overlap with matters addressed in other warranties, the related disclosures will inevitably need to be either repeated or a statement be included that the disclosures are deemed to be made against each of the warranties (and that grouping them is for convenience only). This also implies that the party seeking the disclosure may fail to recognise its impact, whilst at the same time, the opposite approach would lead to unnecessarily extensive and repetitive disclosure letters.

Warranties in large transactions (M&A or financing)

Below, we will address a few other particularities of warranties and limitation of liability as they are used in the context of major transactions (e.g. M&A or financing transactions).

Sandbagging and warranties. Negotiating for contractual provisions that create burdens to actually receiving compensation is referred to as ‘sand-bagging’. Sand bags are used to protect against invasions and may indeed imply the impossibilities associated with battles taking place in the trenches. Sand-bagging behaviour obviously insinuates that a seller is creating contractual burdens and is overly complicating a purchaser’s ability to recover damages. As Dutchmen, however, we should emphasise that sand-bagging is also a modest alternative to a dike and yet is a proper means to prevent a flood.

Making incorrect warranties. In line with the principle of allocating risk, some people consider that it is appropriate for a seller of a company to make warranties about information which it already knows to be incorrect, without making (or even attempting to make) disclosures against such warranties. Such behaviour may be questionable in the event that such incorrect warranty substantially impacts the purchaser’s ability to recover damages under any other warranties, because of the agreed limitations on liability claims (i.e. the ‘cap’).

It is inappropriate if a seller does not answer questions during a due diligence exercise, anticipating a subsequent first draft of warranties in which the subject matter will most likely be addressed (and also anticipating that it will be able to stay away from making such warranties during the negotiations). Conversely, a seller may expect that if a data room is not as such a disclosure against warranties and it contains important information that clearly and materially contradicts a warranty, such information should be addressed during the negotiations rather than that the purchaser raises it as a warranty claim immediately after the closing of the transaction.

Categories of M&A-warranties. Warranties commonly made in the context of an M&A transaction can be classified in three basic categories:

• Warranties about the transaction as such. The first category includes warranties related to the transaction. The purpose of these warranties (also known as enforceability warranties) is to ascertain that the party making them has the contractual capacity and authority to enter into the agreement, and that the contract is enforceable and does not violate a law or regulation. These are standard warranties. Under EU member state laws they are often also largely (if not entirely) redundant since modern legal systems will most likely protect the other party against such warranties being incorrect (in any respect). Therefore, enforceability warranties rather serve information purposes. They are rarely negotiated, except that a purchaser may try to extend their scope to subject matters in the second category.
• Subject matter warranties. A second category of warranties relates to the subject matter of the transaction. These warranties are made to en­sure that a party is acquiring what it agreed to and may reasonably expect, and are tailored to the specific context of the transaction. Some examples:

*   an ordinary sales agreement may include warranties that the products are unused, of good workmanship and free of any material defects;
*   a software licence would include warranties that the software will be free of worms and viruses and will not perform any operation other than specified in the Specifications;
*   a business and asset purchase agreement will include warranties that the sold property is free from encumbrances;
*   a patent licence contains warranties by the licensor that the patent is properly registered and does not infringe other (pre-existent) patented technologies;
*   a share purchase agreement includes warranties that the target company has withheld all taxes required to be withheld and paid all taxes in a timely manner.

• Warranties about the parties. Many contracts require the parties to make warranties about themselves. These are desirable if a party must be (and remain) able to perform its contractual obligations. Examples relate to the financial condition of the party, and in particular its creditworthiness.

To ‘bring down’ warranties. Warranties are made as of a particular moment in time. That moment can be the signing date of the contract, the closing date of the transaction or any other date provided for in the contract. Without further specification, a warranty will be deemed to be made on the date that the relevant product is delivered. Warranties that are deemed to be repeated on a later date are referred to as being brought down.

Bringing down warranties is usually required at times when a significant event occurs under an agreement. For example, a share purchase agreement may provide for completion of the transfer only after the required approvals are obtained; the pur­chaser will require the seller to bring down its warranties at the closing. This bring-down implies an extra incentive for the seller to make sure that the quality of the transferred business remains as it was at the signing date by leaving any deterioration for the account of the seller.

Warranty bring-downs are also found in other types of agreement. In master sale agreements with ongoing deliveries of products pursuant to purchase orders, the purchaser needs the warranties to be made as of each delivery date. Similarly, a borrow­er is required to bring down its warranties to the lender each time it draws under a loan or credit agreement.

If a warranty in a credit agreement provides that all of borrower’s subsidiaries are listed in a schedule, the bring-down of that warranty may become impossible (and rightfully so): when new subsidiaries are created or acquired, the creditworthiness of the borrower will probably change. In such cases, additional drawings cannot be made without violating the warranty, unless a specific waiver is obtained or an appropriate amendment made to the schedule. Obviously, such waiver or amendment will trigger the lender to scrutinise the creditworthiness of the borrower after creating or acquiring the subsidiaries.

Survival of warranties. Other than the bringing down of warranties at some future moment in time, there is also the concept of warranties ‘surviving the closing of a transaction’. Survival of the warranties in fact refers to the right of the purchaser to claim under those warranties.

Normally, the seller will limit this right by stipulating that all claims related to a warranty being incorrect must be made (or made known) within a certain period of time. In such case, it is appropriate to distinguish between the various types of warranties. Accordingly, short periods would apply to running business and tangible assets, whilst warranties related to real estate and environmental contamination would probably be subjected to longer periods. Warranties related to taxation are often subject to the statutory period during which tax authorities may continue to impose taxes related to the period before closing of the transaction.

[1]  UCC, Article 1, General provisions, Section 1-210 (10).
[2]  UCC § 2-314(2).
[3]  UCC, Article 1, General provisions, § 1-210(10).

Limitations of liability in contracts

Limitations of liability (and exclusions of liability) are almost invariably found in contracts. In addition to limitations on the warranty period to claim under the warranties, a supplier will normally limit its risks and exposure to liability in various other respects:

• the damages eligible for compensation: excluding indirect (consequential) damages, only damages individually exceeding a de minimis threshold and furthermore damages that are not remedied by the purchaser;
• matters affecting the purchaser’s compensation (i.e. scope of damages): aspects of own fault, mixed causation, claim-related benefits, recourse rights on third parties (e.g. suppliers);
• causation: limiting eligible damages to those being the immediate and adequate consequence of a warranty being incorrect;
• aspects managing the claim process: a purchaser’s ‘own risk, also known as a basket, which has to filled before a first claim can be made;
• (notification and) handling of third party claims that may give rise to a warranty claim;
• procedures for making warranty claims must be followed (e.g. not mere notifications of claims interrupting the contractual period of limitation but requiring that a claim is initiated).

Providing for a ‘cap’. Many contracts contain a monetary limitation of liability (a ‘cap‘). For M&A-agreements, such a cap is typically defined as a percentage of the (preliminary or adjusted) purchase price or simply a fixed amount (agreed by the same token). Normally, a cap should not apply to matters relating to ownership or entitlement to sell because it affects the entire sales transaction (and more).

For commercial contracts, such reference is not always readily determinable or the parties may have reasons to vary. Commonly used caps or limitations of liability are:

(a) a simple amount (perhaps relating to the amount ordinarily received under a purchase order);
(b) the amount of the purchase order (under which the defective products were delivered);
(c) the amount actually paid under the agreement during a period of time preceding the claim;
(d) a percentage of the amount under (c);
(e) the higher of (i) a simple amount, or (ii) a reference such as under (b), (c) or (d). The background of this is to provide substance during the initial period of time or in case of irregular deliveries; or
(f) the lower of the two references mentioned under (e). The background is of course to provide the widest possible approach to the conditions.

Any cap established in accordance with one of the above referenced amounts, will nevertheless be subject to further discussions. Solutions to overcome such discussions is to further distinguish for the risks involved (and not apply the standard one-size-fits-all clause). An example of such distinction was proposed by D.C. Toedt III:

A damages cap distinguishing the types of risk involved could be, for example:

(a) three times X for any damages that arise during the first 3 months after the later of the Signing Date or Milestone 1 having been delivered and accepted;
(b) two times X during the 9 months thereafter; and
(c) one time X thereafter until the later of 24 months after the Signing Date or 12 months after Milestone Y having been delivered and accepted.

In this example, the factor X could be:

(i) a fixed amount;
(ii) defined as the amount actually paid by customer to service provider during the 24 months preceding any claim; or
(iii) defined in any other convenient way.

In many commercial contracts in which intellectual property rights are at stake, the limitation of liability clause contains a carve-out or exception for breach of the confidentiality provision and for IP infringement claims. A very common (and between equal parties, often accepted) reference is:

…the amounts actually received by Seller under this Agreement during the twelve months period preceding the event or circumstances giving rise to a claim.

Note that in case of a claim, the customer will typically cease payment of its invoices (and in many industries, a seller will nevertheless continue its supplies, at least for a certain period of time), which makes twelve months preceding the claim relevant. Arguments to come to a higher amount (beyond one purchase order or the scope of the contract) are often established by reference to the amount that the parties order annually: in a good commercial relationship, a purchaser expects that for determining a cap on liability other supplies between the parties are also taken into account (i.e. no limitation merely to amounts paid under the agreement, let alone under a purchase order).

Carve-out cyber-security breach. A further carve-out is often made for cyber-liability: damages resulting from failing IT-security, poor software (being hacked or otherwise resulting in a data breach), poor security practices by the seller, etc. While a properly organised supplier should have this in order, the liability exposure (risk impact) is both significantly higher and the insurability under a cybersecurity insurance well-possible and common.

Indemnity clauses (for infringements)

Many contracts include an indemnity clause. Indemnity clauses entitle one party (the indemnified party) to be indemnified by its supplier (the indemnifying party) against damages resulting from a claim made by a third party and caused by the product or service delivered by that supplier.

Two indemnification clauses are commonly provided. First, the indemnity can relate to infringement of third party intellectual property rights resulting from the use of rights or technology licenced from the supplier. Secondly, an indemnity can relate to claims by customers of the indemnified party resulting from the use of contaminated raw materials or incorporation of defective half-products in the end-products supplied by the indemnified party; the indemnity is in fact the extension of a warranty that comes to life later in the supply chain.

Procedural law aspects. The scope and nature of such indemnification varies considerably from jurisdiction to jurisdiction. In some countries, the indemnity can be invoked in court proceedings by such third party claimant, following which, the party providing the indemnity would step into the position of the party with the benefit of the indemnity. In other countries, civil procedural law does not provide for such right (or obligation) of substitution but requires the indemnified party to continue the court proceedings notwithstanding its right to take recourse against the indemnifying party.

Indemnity clauses – addressed aspects. The indemnification provision should address the key elements:

• the subjects of the indemnity: who is entitled to be indemnified (this may include affiliates and subsidiaries of the indemnified party, as well as customers of the party that is contractually entitled to the indemnity);
• the object of the indemnity: which claims and which damages can be reimbursed or compensated and which claims are exempted;
• the conditions for indemnification: freedom to negotiate and settle, maximum amount of the indemnity;
• procedural aspects: prompt notice of the claim, responsibility to act or respond, required prior approvals or consent by the indemnified party;
• remedies: apart from a monetary settlement of the claim, other remedies are often possible (or should be provided for within a certain time frame);
• a counter-indemnity: claims that are exempted from the indemnity should be borne by the indemnified party (i.e. in case the claim is also made against the indemnifying party).

The wording indemnify and hold harmless is a doublet that originates from the Viking era in England. A purchaser-friendly indemnity for infringement of intellectual property rights could for example be as follows:

8.1 Supplier shall defend and indemnify Customer against all losses, damages and expenses incurred by Customer which arise out of or in connection with a claim or proceeding alleging that the manufacture, sale, importation, use or disposition by Customer or any of its customers of a Product or any part thereof, or of equipment incorporating such Product, directly or indirectly infringes Intellectual Property Rights, trade marks or trade secrets of a third party (a “Claim“).

8.2 In the event of a Claim, Customer shall:
(a)  notify Supplier of the Claim;
(b)  grant Supplier the authority to either settle or defend such Claim with counsel of its choice, provided that any settlement does not impose liability on Customer; and
(c)  cooperate and provide reasonable assistance in the defense of the Claim, at Supplier’s expense.

8.3 In connection with a Claim, Supplier may, at its expense, procure for Customer and its customers the right to continue all acts in relation to the Product, or if a procurement of such right is not a reasonable or viable option, (a) replace existing Products or parts thereof and (b) replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (c)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.

8.4 If a Product is held to infringe and its manufacture, sale, importation, use or disposition is enjoined, Supplier shall, at its discretion and expense, either procure for Customer and its customers (i) the right to continue all acts in relation to the Product, or (ii) replace the Product or part thereof and replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (ii)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.

A supplier (or licensor) geared indemnification will likely exclude various aspects. Although this may well be self-evident, being explicit in case of an overlap or division of responsibilities between the contracting parties is recommended. For example, the above section 8.2 can be continued as follows:

Supplier has no obligation or liability to Customer in connection with any Claim:
(a) to the extent that such Claim is attributable to specifications, designs or instructions provided by Customer; or
(b) to the extent that the Claim is based on any prototypes, risk production units, or disabled parts of the Product, the use of which has not been expressly permitted; or
(c) for any unauthorised use or disposition of the Product beyond the Specifications; or
(d) to the extent that the Claim arises from (i) a modification of the Product and the infringement would have been avoided without such modification, or (ii) the combination of the Product with any other product, service or technology, or (iii) the use of the Product or any part thereof in the practice of a process if Customer does not incorporate the Product into a device of which the end-user is a consumer; or
(e) to the extent a Claim arises from Customer’s continued manufacture, use, sale, offer for sale or other disposition or promotion after Supplier’s notice to Customer that Customer must cease such activity, provided such notice shall only be given if the Product is, or is likely to become, the subject of such a claim of infringement; or
(f) for any costs or expenses incurred by Customer without Supplier’s prior written consent.

Hardship clauses – Changed circumstances or imprévision

The legal context of hardship clauses addressing changed circumstances.
An area of the law that divides the legal traditions is visible in the concept of force majeure. During the late 19th century, the French Cour de cassation (‘supreme court’) established the overriding principle that contractual provisions are recognised as a strong force of law. Unless the parties provided for exceptions in the case of hardship or force majeure, the principle ‘contract is contract’ (pacta sunt servanda) prevails. This principle of “you have to deliver what you promised” is also essential in common law.

Nevertheless, some circumstances that go beyond the reasonable expectations of the parties may call the binding nature of a contract into question. The occurrences of life are infinite and, accordingly, upon the occurrence of unforeseen circumstances, a contract or a rule of law might provide an unjust result. It makes a hardship or force majeure provision of great importance[1].

Examples of hardship cases (where changed circumstances were acknowledged).
A change of circumstances triggering a renegotiation or change of an agreement should be highly exceptional. Cases in which such renegotiation or change would be appropriate could be:

• inflation of over 100 percent per day or per week (e.g. as happened in Zimbabwe (2008), Germany (1923), Greece (1944), Yugoslavia (1994)) whilst the contract was entered into during relatively stable economic circumstances (of low inflation);
• a collapse of the real estate market (price drops by over 95 percent in a few days), whilst the affected contractual obligations were non-speculative nature, unrelated to real estate market developments;
• a pricing formula linked to an electricity price index, which price index increases significantly (e.g. effectively turning the index from a ratio of less than 1 (one) into a factor in excess of 1 (one); in other words, changing a mathematical divider into a multiplier);
• a purchase price expressed in a currency that has become subject to extreme fluctuations whilst the contract was entered into during a period of relatively stable exchange rates;
• delivery requirements for countries that have become inaccessible due to political reasons or because of international trade embargo;
• minimum purchase requirements or exclusivity arrangements in long-term agreements, where the product (or a key component of it) has been abandoned due to technological developments.

The examples that might justify an amendment of the contract are highly exceptional. Courts are very reluctant to step into such revision. Obviously, whilst a hardship clause as such can be desirable, providing for changes of circumstances also lowers the threshold for a party to call upon it.

ITC Model contracts on hardship in contracts

The ITC Model Contracts provide for a contractual device applicable in exceptional cases of a change of circumstances. Those exceptional cases would typically include changes of circumstances or cases of hardship that (a) the parties did not already (implicitly) incorporate in the contract by way of risk allocation, (b) should not remain for the risk and account of the affected party (e.g. because the occurred change of circumstance is part of its business), or (c) could not be influenced by the affected party. For example the international long-term supply contract:

9. Change of circumstances (hardship)
   9.1          Where the performance of this contract becomes more onerous for one of the Parties, that party is nevertheless bound to perform its obligations subject to the following provisions on change of circumstances (hardship).
   9.2          If, however, after the time of conclusion of this contract, events occur which have not been contemplated by the Parties and which fundamentally alter the equilibrium of the present contract, thereby placing an excessive burden on one of the Parties in the performance of its contractual obligations (hardship), that party shall be entitled to request revision of this contract provided that:
   9.2.1 the events could not reasonably have been taken into account by the affected party at the time of conclusion of this contract;
   9.2.2 the events are beyond the control of the affected party; and
   9.2.3 the risk of the events is not one that, according to this contract, the Party affected should be required to bear.
   9.3          Each party shall in good faith consider any proposed revision seriously put forward by the other party in the interests of the relationship between the Parties.

Interference by a third person. The idea behind the clause is that the parties should be free to consult each other in the event of a major change in circumstances − particularly one creating hardship for a particular party. However, a company should only include the option at the end of Article 9.4 (right to refer to the courts/arbitral tribunal to make a revision or to terminate the contract) if (a) the company considers that it is not likely to be used against that party’s interests by a party in a stronger tactical position or (b) the right to refer to a court/tribunal is already an existing right under the applicable governing law in the event of hardship.

9.4          If the Parties fail to reach agreement on the requested revision within [specify time limit if appropriate], a party may resort to the dispute resolution procedure provided in Article 18. The [court/arbitral tribunal] shall have the power to make any revision to this contract that it finds just and equitable in the circumstances, or to terminate this contract at a date and on Terms to be fixed.

DCFR on hardship in contracts

The Draft Common Frame of Reference (DCFR) provides for a mechanism that is inspired by the approach of the Dutch Civil Code (art. 6:258) and the Italian Civil Code (art. 1467 (eccessiva onerosità)):

III. – 1:110: Variation or termination by court on a change of circumstances
(1)  An obligation must be performed even if performance has become more onerous, whether because the cost of performance has increased or because the value of what is to be received in return has diminished.
(2)  If, however, performance of a contractual obligation or of an obligation arising from a unilateral juridical act becomes so onerous because of an exceptional change of circumstances that it would be manifestly unjust to hold the debtor to the obligation a court may:
(a) vary the obligation in order to make it reasonable and equitable in the new circumstances; or
(b) terminate the obligation at a date and on terms to be determined by the court.
(3)  Paragraph (2) applies only if:
(a) the change of circumstances occurred after the time when the obligation was incurred;
(b) the debtor did not at that time take into account, and could not reasonably be expected to have taken into account, the possibility or scale of that change of circumstances;
(c)  the debtor did not assume, and cannot reasonably be regarded as having assumed, the risk of that change of circumstances; and
(d) the debtor has attempted, reasonably and in good faith, to achieve by negotiation a reasonable and equitable adjustment of the terms regulating the obligation.

Unidroit Principles on hardship in contracts

The Unidroit Principles address the issues related to hardship and probably provide for a more sophisticated framework, consistent with the ITC Model Contracts’ solution, permitting the parties to find a solution:

SECTION 2: HARDSHIP
Article 6.2.1 (Contract to be observed)
Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.

Article 6.2.2 (Definition of hardship)
There is hardship where the occurrence of events fundamentally alters the equilib­rium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and
(a)  the events occur or become known to the disadvantaged party after the conclu­sion of the contract;
(b)  the events could not reasonably have been taken into account by the disadvan­taged party at the time of the conclusion of the contract;
(c)   the events are beyond the control of the disadvantaged party; and
(d)  the risk of the events was not assumed by the disadvantaged party.

Article 6.2.3 (Effects of hardship)
(1)  In case of hardship the disadvantaged party is entitled to request renegotia­tions. The request shall be made without undue delay and shall indicate the grounds on which it is based.
(2)  The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
(3)  Upon failure to reach agreement within a reasonable time either party may resort to the court.
(4)  If the court finds hardship it may, if reasonable,
(a)  terminate the contract at a date and on terms to be fixed, or
(b)  adapt the contract with a view to restoring its equilibrium.

Because courts would be very reluctant to step into the position of a contracting party, the solution of a case of hardship would apply only in highly exceptional, special circumstances. Especially in common law and in French law, this principle is taken rather strictly. In the Germanic legal tradition, such force majeure or hardship provision is not a must-have. This is because the court will take an objective (more reasonable) approach as regards the question of whether a party is excused from performance given the occurrence of exceptional circumstances.

[1]  A comprehensive study of the scope and effect of unforeseen circumstances (and hardship, mistake and force majeure) in the European Union countries is: Ewoud Hondius & Hans Christoph Grigoleit (Eds.), Unexpected circumstances in European contract law, The common core of European private law, Cambridge University Press 2011, 692 p. (In the book, Willem Wiggers reported on the laws of The Netherlands.)

Force majeure clauses

Many suppliers are exposed to the risk that an event of force majeure prevents timely delivery or performance of their obligations. Force majeure clauses organise what happens if such circumstances (a ‘force majeure event’) occur.

Force majeure and business operations. Whether or not to include a force majeure clause, its wording and the definition of what entails an event of force majeure largely depends on the position of the contract drafting party. Force majeure clauses either favour the side where a force majeure event will typically occur (e.g. manufacturer, service provider, seller) or the side of the customer. It is typically the first group that wishes to provide for a force majeure clause.

A manufacturer would expand the scope of force majeure and increase its flexibility to remedy a force majeure event, including its consequences. The manufacturer, service provider or seller will tie in subjective elements, such as a strike by its own employees, interruptions in its supply-chain (including delays in delivery of raw materials), transportation difficulties, industrial disputes and other developments influencing any part of the supply chain, as well as circumstances that may be avoidable, such as the breakdown of equipment or any machinery. On the other hand, the customer will go for highly exceptional examples, which are objective, ‘completely’ unforeseeable and generally out of the control or manageability of the other party.

The above considerations imply that including a force majeure clause would be more appropriate in contracts governed by French law and furthermore depends on the position of the contract drafting party. A manufacturer, service provider or seller will likely include a provision as follows:

Notification of Force Majeure. A Party prevented from fulfilling its obligations duly and timely because of an event of Force Majeure shall inform the other Party without undue delay and make reasonable efforts to terminate the Force Majeure as soon as practicable. The Parties shall consult with each other in order to minimise all damages, costs and possible other negative effects.

For the purpose of this Section, Force Majeure means any and all circumstances beyond the reasonable control of the Party concerned, including acts of God, earthquake, flood, storm, lightning, fire, explosion, war, terrorism, riot, civil distur­bance, sabotage, strike, lockout, slowdown, labour disturbances, accident, epidemic, difficulties in obtaining required raw materials or labour, lack of or failing transportation, breakdown of plant or essential machinery, emergency repair or maintenance work, breakdown of public utilities, changes of law, statutes, regulations or any other legislative measures, acts of governments, supranational organisations or other administrative or public agencies, orders or decrees of any court, acts of third parties, delay in delivery or defects in goods or materials supplied by suppliers or subcontractors or an inability to obtain or retain necessary authorisations, permits, easements or rights of ways.

Effects. The Party prevented from fulfilling its obligations shall not be required to remove any cause of Force Majeure or to replace or provide any alternative to the affected source of supply or the affected facility if that would require additional expenses or a departure from its normal practices, or to make up for any quantities not supplied. If an event of Force Majeure has occurred, the Party prevented from fulfilling its obligations is entitled to allocate, in a manner it considers reasonable, the available quantities of Products amongst its customers and its own requirement.

Obviously, the customer will seek a different type of wording:

Notification of Force Majeure. A Party prevented from fulfilling its obligations duly and timely because of an event of Force Majeure shall promptly inform the other Party specifying the cause of Force Majeure and how it may affect its performance, including a good faith best estimate of the likely scope and duration of interference with its obligations, and shall make best efforts to terminate or avoid the Force Majeure circumstances as soon as practicable. The Parties shall consult with each other in order to minimise all damages, costs and possible other negative effects.

For the purpose of this Section, Force Majeure means unforeseeable and unavoidable circumstances entirely beyond the control of the Party concerned, such as acts of God and wars.Effects. The Party other than the Party prevented by a Force Majeure event shall be released from performing any of its obligations for the duration of the Force Majeure event. Furthermore, if an event of Force Majeure continues for more than 60 days, such latter Party shall be entitled to terminate this Agreement or any purchase order or part of a purchase order, with immediate effect and without liability to the Party prevented by the Force Majeure. Upon remediation of the Force Majeure event, the Party prevented by the Force Majeure shall promptly resume performance on all purchase orders of the other Party (which have not been terminated).

Note that you can download our model Force majeure clause customer-friendly from our model contracts platform. Our model Force majeure clause supplier-friendly is also shared on the platform.

Force majeure clauses. The middle ground is somewhere in between. An event of force majeure should be reasonably unforeseeable, out of the debtor’s control and reasonably unavoidable. Once an event of force majeure has occurred, whether contractually excusable or not, it is often possible to solve its consequences or at least to establish an appropriate way forward.

In such circumstances, it may well be important for the customer to receive all relevant information promptly and probably also to be involved in choosing the remedies. In view of the consequences and entitlement to stay involved, even a buyer or contractor may prefer to widen the scope of the force majeure situations and get an informed, preferred customer position.

Legal context of force majeure. An area of the law that divides the European legal traditions is visible in the concept of force majeure. In short, the background of this division goes back to the legalistic era of the late 19th century. At the time, the French Cour de cassation (French ‘supreme court’) established the overriding principle that contractual provisions are recognised as a strong force of law. Unless the parties provided for exceptions in the case of hardship or force majeure, the principle ‘contract is contract’ or ‘a contract serves as the law between the contracting parties’ (pacta sunt servanda) prevails.

In the Germanic legal tradition, such provision is not a must-have. As explained in connection with contract interpretation and legal cultures this is because the court will take an objective (more reasonable) approach as regards the question of whether a party is excused from performance given the occurrence of exceptional circumstances. Still, also in Germanic traditions, ‘contract is contract’.

Confidentiality clauses

Confidentiality clauses are commonly inserted in any kind of contract. They are quasi-miscellaneous provisions.

Still, a contract drafter should establish whether a confidentiality clause is indeed desirable. In contracts for the sale of bulk products, a confidentiality provision may well be excessive. In product development arrangements (sometimes as part of a sales contract), the developer may prefer to remain free to operate making use of information about the products or product applications of its customer. A confidentiality clause in a patent licence may obstruct registration of the licence in national patent registers (making the licence potentially invalid if the patent is sold and transferred to another party or if the patent owner goes bankrupt).

Define the scope of information. The scope of a confidentiality clause requires some care. It is essential to capture the right information. Some parties prefer to be rigorous and require that information is only considered Confidential Information if it is marked as such (and furthermore, in case of oral information, the confidential information must be put in writing and communicated within 30 days of the oral presentation to be covered by the confidentiality provision). A court should be suspicious of whether such a strict approach was indeed intended by the parties. Many companies are less formal; for them:

Confidential Information means any information of a non-public, confidential or proprietary nature; whether of a commercial, financial or technical nature; customer, supplier, product or production-related; and otherwise all information exchanged between the parties in the context of [the Purpose][this Agreement][the Project] shall be deemed to be ‘confidential’.

Of course, the definition can be extended by adding appropriate examples of confidential information, which may include samples, information relating to raw materials, formulae, recipes, specifications, software source code, patent applications, process designs, process models, catalysts and processed materials. Such additions should be product, sector or industry specific.

Note that the definition of Confidential Information is generic. It does not state that the information is owned by one party. This means that the body text should clarify which party may or must do what, and what rights apply upon disclosure.

Marking obligations. The ‘relaxed’ approach to defining confidential information is often complemented by an undertaking to mark information as confidential, for example:

Each Party shall use its best efforts to mark the Confidential Information which is disclosed in writing as being confidential. Failure to do so, however, shall leave the other Party’s obligations set forth in this Agreement unaffected.

The second sentence in this example is sometimes replaced by the more burdensome statement that orally disclosed information is only deemed to be confidential if it has been identified as such or summarised in a written document (with typically the requirement that it be sent to the Receiving Party within 30 days after the disclosure).

Scope of use (the “Purpose”). The scope of use of confidential information needs to be properly restricted. The two main provisions of a confidentiality agreement or clause address the disclosing party’s right to select or deny a disclosure to the receiving party, and the receiving party’s obligation to use disclosed information for a limited purpose only and furthermore to keep it confidential, as follows:

No obligation to disclose. Each Party may furnish Confidential Information to the other Party as it deems necessary or helpful for the Purpose. [to be used in mutual NDA’s]

No obligation to disclose. Each Party may furnish Confidential Information to the other Party as it deems necessary or helpful for [the completion of the Project] [the performance of the Services] [that Party’s performance]. [to be used in contracts]

Restrictions on use. A Receiving Party shall not use Confidential Information of the Disclosing Party for purposes other than in direct relation with the Purpose. The Receiving Party shall treat the Disclosing Party’s Confidential Information with at least the same degree of care as it would use in respect of its own confidential information of like importance, but in any event a reasonable level of care.

If a higher level of care would be more appropriate, it may be necessary to provide specific guidelines for protecting know-how. A disclosing party should in any case be entitled to rely on a higher level of care professed by the receiving party.  Please note the non-capitalisation of confidential information in the penultimate line, above.

Expanded scope to affiliated companies and employees. Because confidentiality obligations are normally assumed by two or a limited number of formal entities, it is important to expand the scope of confidentiality to people related to those entities. Furthermore, the receiving party should limit such expressed expansion only to the extent necessary (albeit that in practice ‘everybody’ will be aware that the parties are exchanging confidential information).

Related Parties. The Receiving Party shall disclose Confidential Information to its group companies (including subsidiaries and affiliates), directors, officers, employees or other representatives only on a need-to-know basis. Prior to the disclosure of the Disclosing Party’s Confidential Information to such persons, the Receiving Party shall inform each such person of the confidential nature of the Confidential Information and shall expressly require that the person agrees to treat the Confidential Information as is provided in this Agreement. Notwithstanding due observance of these requirements, the Receiving Party shall be liable for any breach of the provisions of this Agreement by such person.

Note that subsidiaries and affiliates are not covered, unless they qualify as a group company (normally meaning entities that are fully consolidated in the financial accounts and hence under full control of the receiving party). Employees are, in most jurisdictions, subject to statutory duties of confidentiality, but even when they are subject to such obligations by virtue of their employment conditions; it would be unusual not to expressly refer to their obligations.

Directors and officers are mentioned separately from employees because in most jurisdictions they are not an ‘employee’ of the company they serve. It is appropriate to stipulate that employees will receive confidential information on a need-to-know basis only, which makes it easier for the disclosing party to question unnecessary internal disclosures (and require a higher level of care).

Finally, because all these individuals are not themselves contracting parties and probably not even capable of bearing the consequences of a breach, it is important to attribute any such breach to the receiving party (even if the receiving party has implemented proper measures to prevent disclosure).

Exceptions to confidentiality. A properly drafted confidentiality clause also addresses the exceptions, even though they may be presupposed or raised as a defence against a claim for breach.

Special exception: intellectual property rights. If disclosures are made in connection with research or development projects or service agreements, and intended to be protected under intellectual property rights, it is important to regulate the input or suggestions for improvement. Intellectual property laws protect the creator or inventor for his or her own ideas, if, whilst presenting inventions to an adviser or interested customer, that customer gives feedback on the ideas, the latter may claim co-ownership or co-inventor rights. Such effect, co-ownership or co-inventorship merely resulting from feedback is often undesirable (but it is the legal consequence of a failing contractual arrangement to the contrary).

If the receiving party (i.e. the adviser or potential customer) refuses to waive ownership rights on any feedback given, and the disclosing party nevertheless desires to make the disclosure, it may be important to agree on a protocol allocating time and opportunity to make a disclosure in full or to give feedback, respectively. Examples can be found in most software licences or online Q&A’s, where modifications and suggestions for improvement or additional functionalities are gratefully appropriated by the licensor.

Subcontracting clauses in contracts

Many no-subcontracting clauses in contracts for provision of service or supply of goods prohibit subcontracting, either in the miscellaneous chapter or under the article on contract scope:

No subcontracting. No obligations under this Agreement or a Statement of Work, which may cause Customer, any of its subcontractors or customers (including end-users) to infringe upon third party’s Intellectual Property Rights shall be sub­contracted, unless it is approved by Customer, which approval shall not be unreasonably withheld or delayed. Service Provider shall procure that:
(a)  Article n [on quality, compliance and audit rights] shall extend to each sub­contractor and their subcontractors; and
(b)  each subcontractor shall comply in all respects with the provisions of this Agreement (as if it is Service Provider itself).
Supplier shall remain the primary debtor and be responsible for the due and timely performance by any subcontractor.

The practical merits of no-subcontracting clauses in contracts are not as severe as it may appear. The background of this is certainly not limited to a desire to understand or manage a service provider’s costs accumulating in the supply chain. Responsible business parties wish to be fully aware of the identity of all their suppliers in the supply chain. A customer often wants to make sure that know-how required for, or developed in connection with, the services obtained from a service provider does not become diluted over an extensive chain of subcontractors. Also, responsible business parties cautiously monitor the supply chain for generally unacceptable matters, such as child labour, remarkably bad working conditions or environmentally hazardous production methods.

Although some variations amongst national laws are likely to exist, communis opinio may tend to allow subcontracting, as the Common Frame of Reference shows:

1. C. – 2:104: Subcontractors, tools and materials
   (1)  The service provider may subcontract the performance of the service in whole or in part without the client’s consent, unless personal performance is required by the contract.
   (2)  Any subcontractor so engaged by the service provider must be of adequate compe­tence.
   (3)  The service provider must ensure that any tools and materials used for the performance of the service are in conformity with the contract and the applicable statutory rules, and fit to achieve the particular purpose for which they are to be used.
   (4)  Insofar as subcontractors are nominated by the client or tools and materials are provided by the client, the responsibility of the service provider is governed by IV.C. – 2:107 (Directions of the client) and IV.C. – 2:108 (Contractual obligation of the service provider to warn).

In many cases, the no-subcontracting clause merely triggers an information requirement to the customer, who does not intend to reject a request to have certain of the supplier’s obligations performed by a third party. Note however, that the prohibition does imply a ‘veto right’ and if the customer established a (dual) supplier policy, the agreed performance is likely assumed to be personal. In that case, the subcontracting clause will be enforced (or result in the ongoing evaluation of the subcontractors).

Notices clauses

Notices clauses serve various purposes, for example, they state where the addressee wishes to receive the execution copies of the contract, and identify the corporate departments for various types of notices in connection with the contract performance (e.g. account manager, quality complaints, product delivery, claims, IP-infringement). Normally, contact persons know how to find their day-to-day contacts (and otherwise, there is always a website with phone numbers); they will probably consult their internal predecessor rather than the contract itself for contact details of the other party in a certain case.

On to the use of indentation, inserting the addresses is often a messy affair. Also, putting the parties underneath each other makes the clause span over various pages (with arbitrary page breaks) and an inefficient flow of information. The best way is to use a table (without showing the table borders in the printed version):

In respect of Trader Options Investing Platform, to: P.O. Box 12345 1070 AB  Lutjebroek The Netherlands

In respect of Willem Wiggers, to: Vondelstraat 11H-4a 1054 GC  Amsterdam The Netherlands

Time of satisfaction. From a legal point of view, the time of fulfilment of the notice requirement is relevant. Where the timing of a notice is of the essence, it does make sense to stipulate that a notice shall be deemed to be delivered upon the notice being delivered to a courier service of international repute, provided that the notice was also faxed or sent as a scan attached to an e-mail. What matters is whether the applicable law follows the ‘receipt theory’ or the ‘dispatch theory’ to determine if a message was on time. The Common Frame of Reference adopts the receipt theory:

1. – 1:106: Notice

(1)  This Article applies in relation to the giving of notice for any purpose under these rules. “Notice” includes the communication of a promise, offer, acceptance or other juridical act.
(2)  The notice may be given by any means appropriate to the circumstances.
(3)  The notice becomes effective when it reaches the addressee, unless it provides for a delayed effect.
(4)  The notice reaches the addressee:
(a)  when it is delivered to the addressee;
(b)  when it is delivered to the addressee’s place of business, or, where there is no such place of business or the notice does not relate to a business matter, to the addressee’s habitual residence;
(c)   in the case of a notice transmitted by electronic means, when it can be accessed by the addressee; or
(d)  when it is otherwise made available to the addressee at such a place and in such a way that the addressee could reasonably be expected to obtain access to it without undue delay.
(5)  The notice has no effect if a revocation of it reaches the addressee before or at the same time as the notice.
(6)  Any reference in these rules to a notice given by or to a person includes a notice given by or to a representative of that person who has authority to give or receive it.
(7)  In relations between a business and a consumer the parties may not, to the detriment of the consumer, exclude the rule in paragraph (4)(c) or derogate from or vary its effects.

You may need to give some practical consideration to what you require in the notices clause. When a notice is urgent, a phone call is much more efficient than initiating communication by sending printed letters, which is often required to be sent by registered mail or overnight courier. Please note that in many jurisdictions, the registration of registered mail ends after crossing the national border. This makes a requirement to use registered mail useless. In other cases, the national and traditional post appears to be slower than going there by bicycle. Further, an overnight courier implies 24 hours delivery service but is still five to ten times more expensive than the regular 48 hours delivery service. Whilst an attorney-at-law may be concerned that, in case of claims, the other party sticks to the strict wording of the notices clause; can you imagine a court disregarding the fact that complaints were subsequently reported by phone (answered by the right person) and by e-mail (between the account managers) in addition to a formal notice being served (signed and attached as pdf to an email) because the contract required overnight courier services if the notice was not handed over in person?

Many addressees and many disciplines involved. In a framework of several interrelated contracts, it may be worthwhile creating a notices schedule to the agreement, in which the names of the contact persons of the disciplines involved are collected.

More persons on one side. In M&A transactions it is often desirable to stipulate that all purchasers or all sellers act in concert, or that notice by one of them shall be deemed to constitute a notification on behalf of all the others. This places the responsibility for communications with one party and prevents the other party being burdened by a variety of different positions and statements none of which is conclusive. This can be achieved by:

A notice by Seller to any or all Purchasers shall be deemed given upon the receipt by any one of the Purchasers. A notice given by any Purchaser to Seller shall be deemed to be the joint notice of all Purchasers. In case of several notices given by several Purchasers, Seller may deem the first notice received by it to constitute the joint notice of all Purchasers.

Waiver clauses

Most European member state laws provide that the failure of a party to claim or enforce its rights does not automatically qualify as a waiver of such rights. Also, if a party does ‘waive’ its rights in a certain situation, member state laws will not easily presume a blanket waiver.

Waivers. A failure of a Party to enforce strictly a provision of this Agreement shall in no event be considered a waiver of any part of such provision. No waiver by a Party of any breach or default by the other Party shall operate as a waiver of any succeeding breach or other default or breach by such other Party. No waiver shall have any effect unless it is specific, irrevocable and in writing.

The above clause specifies what may or may not be the consequence of a party’s behaviour or (informal) remarks.