Responses to Registrants Questions Not Provided During January 21, 2010 WebCast on Indemnification Provisions

Question:

You mentioned that indemnification for the indemnitee's negligence will not be upheld (or only if explicit). Thus, is it unnecessary to carve that out in a provision, ie, saying we will indemnify you for product defects or our negligence, ""provided, however, that this indemnification obligation will not apply to the extent the damage, etc. is caused by the negligence of indemnitee."" 

Response:

Please read my materials on public policy exceptions. As you will note various jurisdictions approach this issue in different ways. You should be able to check the law in the jurisdiction involved from the cites I provide. Please do advise me if you need further clarification after reviewing my materials -  Unless you want to avoid focusing the other side's attention to the issue and are satisfied with the law in the particular jurisdiction you would probably want to be as articulate as you believe is consistent with your negotiating position. In fact you will probably want to include a good deal more in the exception then merely negligence -  What about "acts or omissions" or "acts or omissions in breach of [name party]'s obligations under this agreement" or similar language ? 



Additional Materials for January 21, 2010 Webcast and Re-Casting on May 24, 2010

Sandbagging


    Various accounts of the origin of the term “Sandbagging” indicate that the term was originally used in the context of nineteenth century street life to refer to the use of a bag (or sock) filled with sand as weapons and more particularly in conjunction with ambushing an opponent or convenient victim. The concept of ambushing includes lying in wait, misrepresenting the actual potential of the perpetrator, or misrepresentation or non disclosure of relevant facts. It is in the latter context that the term “sandbagging” is carried over to the twenty-first century to games such as golf, poker, chess, billiards, go, and contract negotiation. A business practice that is on occasion referred to as “sandbagging” is for an executive to overestimate budget needs in order to produce a result at a below budget cost.
      In the context of contract negotiation and documentation the term “sandbagging” refers to an intentional non-disclosure by one party to the other for the purpose of establishing the basis of a claim based on breach of a representation or warranty of a contract or to facilitate a termination or threat of termination prior to closing on the basis of a failure of a condition precedent or breach of a warranty. For instance, the term would apply to the act of a purchaser in entering into a purchase contract with knowledge of the inaccuracy of a representation and warranty of the seller and not advising the seller of such knowledge. The purchaser is seeking to thus establish the basis for either a damage claim for breach of the warranty, a safety position in the case that the purchaser decides not to go through with the transaction or perhaps the basis for a last minute renegotiation of terms after the seller has substantially changed its position in reliance upon its perception that the purchaser is legally obligated to proceed with the transaction.
          Transactional agreements that contemplate a delayed closing (as distinguished from agreements signed by the parties simultaneously with the closing) usually provide that all or specified warranties “shall be true and correct in all material respects both upon execution of the agreement and at closing.” Such an agreement should but often does not provided for a procedure in the event that either after the execution of the agreement a party discovers facts inconsistent with the representation or due to circumstances occurring after the execution of the agreement the representation although true at the time of execution of the agreement is or may not be “true and correct” at the time of closing.
            For a number of reasons an attempt by a buyer to sandbag a seller may be both inadvisable and often quite dangerous for the buyer. Even without regard of whether a buyer was successful in achieving an advantage in a particular transaction by way of a sandbagging strategy, one may be fairly certain that knowledge of such circumstances will in all likelihood constitute a strong deterrent to anyone contemplating entering into a transaction with the known sandbagger. Thus even a prospective sandbagger with a low sense of ethical business practices and who views business as a “dog eat dog” environment should consider the possible impact that an attempt at sandbagging may have on his or her business reputation or that of his or her employer before embarking on such a strategy especially in light of the possibility that the strategy has a high possibility of not being successful.
            There is a fairly high probability that at attempt at sandbagging will not be successful and the possibility exists that an attempt at sandbagging may result in the loss of an advantageous business opportunity and possibly even expose the attempted sandbagger to contractual or tort damage claims. An examination of the effectiveness or intricacies of the various approaches that may be made by a prospective victim to counter an attempted sandbagging is beyond the scope of these materials. Such approaches include asserting claims for economic duress, breach of the implied covenant of good faith and fair dealing, breach of a state fair business practices act that is applicable to business transactions. Local law may also require (absent an effective contract provision to the contrary) proof of reliance to establish a claim or defense based on breach by a seller of a warranty.

              There are a limited number of cases on whether in order to assert successfully a claim for breach of a warranty or it is necessary for the claimant to establish reliance on the warranty. It appears that under current American non-insurance contract law the mere characterizing of a representation of fact as a “warranty” will not eliminate a reliance requirement if such requirement would otherwise exist. Courts applying the law of California, Kansas, and Tennessee in cases involving enforcement of contractual warranties have in effect applied the tort approach and required reliance while courts applying the law of Indiana. And Maryland have held that reliance need not be alleged or proved.

              In the Ziff-Davis case the Court of Appeals of New York held that the express warranties in an agreement for the sale of twelve magazines for $365,500,000 were bargained for terms of the contract and that therefore were enforceable although the purchaser had expressed doubt as to their truthfulness after the signing of the agreement but before the closing. The Court of Appeals framed the “ central question” of the case to be whether the failure to plead reliance is fatal to the purchaser’s claim for breach of express warranties. The opinion then indicated that in a court’s analysis of a claim for breach of an express warranty the critical question is not whether the buyer believed in the truth of the warranted information, but whether the buyer believed it was purchasing the seller's promise as to its truth of the warranted information and that to establish the claim no more is required in the way of reliance than reliance on the express warranty as being a part of the bargain between the parties. The opinion observes that this approach reflects the prevailing perception of an action for breach of express warranty as one that is no grounded in contract law and not tort law. Under this approach “Once the express warranty is shown to have been relied on as part of the contract, the right to be indemnified in damages for its breach does not depend on proof that the buyer thereafter believed that the assurances of fact made in the warranty would be fulfilled. The right to indemnification depends only on establishing that the warranty was breached.”


              The following facts as described by the majority opinion of the Court of Appeals reflect a somewhat standard scenario in these situations
              “In a January 31, 1985 letter, CBS wrote Ziff-Davis that,’[b]ased on the information and analysis provided [to it, CBS was] of the view that there [were] material misrepresentations in the financial statements provided [to CBS] by Touche Ross & Co., Goldman, Sachs & Co. and Ziff-Davis’. In response to this letter, Ziff-Davis advised CBS by letter dated February 4, 1985 that it ‘believe[d] that all conditions to the closing * * * were fulfilled”, that “there [was] no merit to the position taken by CBS in its [Jan. 31, 1985] letter’ and that the financial statements were properly prepared and fairly presented Ziff-Davis's financial condition. It also warned CBS that, since all conditions to closing were satisfied, closing was required to be held that day, February 4, 1985, and that, if it ‘should fail to consummate the transactions as provided * * * Ziff-Davis intend[ed] to pursue all of its rights and remedies as provided by law.’ (Emphasis added.)
              “CBS responded to Ziff-Davis's February 4, 1985 letter with its own February 4 letter, which Ziff-Davis accepted and agreed to. In its February 4 letter, CBS acknowledged that “a clear dispute” existed between the parties. It stated that it had decided to proceed with the deal because it had ‘spent considerable time, effort and money in complying with [its] obligations * * * and recogniz [ed] that [Ziff-Davis had] considerably more information available’. Accordingly, the parties agreed “to close [that day] on a mutual understanding that the decision to close, and the closing, [would] not constitute a waiver of any rights or defenses either of us may have” (emphasis added) under the purchase agreement. The deal was consummated on February 4.
              “CBS then brought this action claiming in its third cause of action that Ziff-Davis had breached the warranties made as to the magazines' profitability. Based on that breach, CBS alleged that “the price bid and the price paid by CBS were in excess of that which would have been bid and paid by CBS had Ziff-Davis not breached its representation and warranties.’

                Anti-Sandbagging provisions essentially provide that a party’s knowledge at a relevant point in time of the falsity of a warranty in a contract precludes such party’s effectively asserting a claim on the basis of such alleged breach of the warranty or effectively asserting such breach of the warranty as a defense to a claim by the other party.
                In an Indiana case, although the provision was not well drafted, the court depended on such provision in holding that a purchaser could not rely on a warranty in a business sale agreement since the purchaser had knowledge of the falsity of the warranty at the time of signing of the agreement.
                  These provisions are on occasion sometimes, rather awkwardly, referred to as “Anti-Anti-Sandbagging Provisions,” although they usually go well beyond merely invalidating an anti-sandbagging provision. These provisions are intended to permit enforcement of a warranty claim without reference to whether or not the claimant relied on such warranty. They treat the warranties in a contract not as inducement provisions but rather as the basis for indemnification obligations that do not depend on reliance. If so drafted such a provision might also be the basis for a party with knowledge of the inaccuracy of a warranty or representation to abort a transaction prior to closing on the basis of such inaccuracy not withstanding knowledge of such inaccuracy at the time of signing of the agreement.
                  In Telephia v. Cuppy the agreement for the sale of technology provided that “[n]o information or knowledge obtained in any investigation pursuant to [a specified section of the contract] shall affect or be deemed to modify any representation or warranty contained in this Agreement....” while another provision of the same agreement provided that “No investigation made by or on behalf of the Company [Telephia] with respect to [specified issues] shall be deemed to affect the Company Affiliates' ... reliance on the representations, warranties, covenants, and agreements made by [the seller].” The Court concluded that “this contractual language is clear, and that defendants may be held accountable to the warranties in the SPA regardless of plaintiff's reliance on those warranties. The Court then observed that “Although defendants argue that it would be ‘condoning a fraud’ to allow Telephia to enforce warranties that it knew to be false, the Court finds it no stranger a result than to interpret the SPA in a manner that results in Telephia having insisted on toothless provisions.”
                    Absent a detailed contract provision setting forth a relevant practical conflict resolution procedure for a situation in which the buyer believes that there is a breach of warranty that is material to the transaction and the seller disagrees, a buyer faced with knowledge of a apparent breach of a warranty by the seller that appears to the buyer to be material to the transaction is often faced with a dilemma in that there may be two or more courses of action none of which are particularly satisfactory to the buyer.
                    If the buyer decides not to close it may be ultimately determined by a fact finder that the facts underlying the warranty were not in fact materially false or that the breach of the warranty was not material to the transaction. If the buyer closes such action might constitute a waver of the seller’s breach. If the buyer deems the value of the transaction to exceed the adverse impact of the seller’s apparent breach of the warranty the buyer may have to swallow hard, attempt to close under a reservation of right and proceed to close as on balance this is a better approach then refusing to close even if in reality there is no issue as to the breach and its materiality.
                    A buyer may avoid being thrust on the horns of this dilemma by including in a purchase agreement a provision permitting the buyer to close on the transaction with a reservation of right to asset a claim for damages for any loss arising from the alleged breach by the seller of a warranty or failure of specified conditions to closing having occurred. Such a provision must be tailored to each transaction with particular concern for the definitions of terms such as “material” and “loss”