GPSolo September 2007
Business and Commercial Law
When the Boilerplate Gets Hot
Charlie had successfully negotiated more than 50 merger-and-acquisition transactions in his 20-year career, and without exception each one turned out just fine for his client. But the Long Horn Saloon deal would be different.
It was very important to set venue in Nevada, where the business is located.
Charlie’s firm had represented the two shareholders of the Long Horn Saloon—Ted and Paulina—when they sold their thriving Nevada tavern and dance hall chain to Big Apple Consolidators Inc., a mega-company from New York City. Under Charlie’s steady hand, Long Horn had grown from its one original tavern location into a small chain with multiple locations throughout Nevada. Revenues expanded to more than $10 million during the year of the sale.
Months later, Charlie organized a closing dinner, but a fax that was marked “URGENT” and delivered to his table brought the merriment to a sudden and unpleasant end. Big Apple’s Manhattan lawyer claimed that Ted and Paulina had defrauded his client and breached many of the representations and warranties in the purchase agreement. An enclosed draft complaint alleged that Ted and Paulina failed to disclose a significant contingent liability that, since the closing, came to fruition resulting in a settlement by Big Apple for $10 million. Two former patrons of Long Horn had filed negligence lawsuits under Nevada’s Dram Shop Act against Long Horn three months after Big Apple took ownership of the company. The former patrons had been drinking in Long Horn Saloon’s Carson City location two weeks before the acquisition closed. Apparently the two left the bar in separate cars and collided with each other in the snowy mountains leading to Lake Tahoe. Both drivers were severely injured in the crash. The police reported that each driver had a blood alcohol level well in excess of legal limits.
Big Apple claimed that Ted and Paulina knew about the crash and the prospects for a claim because the plaintiffs’ lawyers told Big Apple that they had called Ted two days after the accident to question him about the company’s insurance policy limits and threatened suit against the Long Horn owner. The draft complaint alleged that the purchase agreement made an unqualified representation that neither Ted nor Paulina was aware of any threatened litigation against Long Horn pending the sale, and that Ted and Paulina breached that representation and warranty.
Charlie quickly skimmed the last article of the agreement—the boilerplate—for information regarding choice of law, venue, arbitration, and jury trial. Not understanding what they meant in these circumstances, he asked his litigation colleague, Tom Throttler, for advice. Throttler skimmed the documents and then asked Charlie whether he had researched and considered how all of the provisions of the purchase agreement would affect his clients before the document was signed. Charlie was barely able to squeak out “no.” Charlie then explained, “I have used the boilerplate at the back of the purchase agreement for years and didn’t think twice about the actual effect of those provisions. I’ve never had a deal go bad.”
“Charlie, these provisions are very important when the ugly head of litigation is raised,” explained Throttler. “Article V, Paragraph A, says that any dispute over the transaction or the purchase agreement shall be litigated in the Circuit Court of Franklin County, New York. Let me tell you why venue matters. In a case like this, Big Apple’s lawyers will demand a trial by jury, and our clients will have no basis to object and get a judge to decide the case.
“Even worse,” Throttler continued, “Big Apple’s lawyers will be able to select a jury that is biased in its favor. As you know, Big Apple regularly invests in properties in this Adirondack Mountain vacation spot and is well liked. In addition, because Big Apple’s lawyers are in nearby Manhattan, it will have greater access to the resources necessary to try this case, while we would be operating thousands of miles from our home base. Finally, Ted and Paulina would have to hire local counsel in New York and incur additional expense. It was very important to set venue in Nevada, where the business is located. Few purchasers would object to that logical selection.
“I also notice that there is a short provision addressing arbitration,” commented Throttler. “Article V, Paragraph B, says that if the parties end up in a dispute over indemnification after the transaction closes, the buyer may opt for arbitration to resolve it. That provision gives the buyer the best of both worlds. Big Apple can choose to go to arbitration or can choose to litigate. Ted and Paulina have no choice in the matter. Big Apple, of course, has chosen to go straight to litigation, bypassing arbitration, which would have been a more cost-effective forum for Ted and Paulina.”
Charlie said, “I discussed the arbitration provision with Ted and Paulina, and I explained that it was a one-sided clause. Maybe I should have probed a little harder about threatened claims before passing on these arbitration provisions. I might have been able to deal with this Dram Shop case before we closed and avoided this mess!”
Throttler continued, “Article V, Paragraph C, says that the party who prevails in the event of a dispute is entitled to receive from the other party their attorney fees and costs. There are two very substantial reasons that sellers like Ted and Paulina are disadvantaged by such a provision. First, as the sellers, they are far less likely to successfully maintain a claim against the buyer for which they would be entitled to receive their attorney fees and costs. It is the buyer who is far more likely to succeed on claims against the seller because the seller has far greater access to information concerning the subject of the sale. Second, without any limitations, the specter of having to pay a Manhattan lawyer’s attorney fees places enormous additional pressure on Ted and Paulina to avoid the risks associated with a trial.
“The purchase agreement also says in Article V, Paragraph D, that the agreement shall be construed and interpreted according to the laws of the state of New York. Like venue, it is perfectly reasonable to expect the governing law to be that of Nevada, where the assets were located and Ted and Paulina live. Why on Earth, Charlie, did you agree to allow New York law to apply?”
“Truthfully, Tom,” responded Charlie, “I didn’t think it made any difference. Aren’t all states’ laws pretty much the same?”
“Let me explain the problem of failing to carefully consider the effect of governing law on your client in a case like this, Charlie,” Throttler scolded. “In addition to the buyer’s common law fraud suit, the buyer of a company’s stock will likely bring suit under the state’s applicable corporate and securities laws. These vary by state. In some states, the penalties are exclusively civil, and the buyer can seek rescission or damages. But in others, penalties can be criminal.”
Charlie was visibly shaken. Putting his hand on Charlie’s shoulder, Throttler concluded by saying, “Charlie, our clients are behind the eight ball by virtue of these boilerplate provisions.”
“I think we better closely examine the merits of Big Apple’s claims and advise our clients to be prepared to settle this matter rather than incur the substantial risks that we’ve been discussing.”
Charlie sighed, “Wow, I could never have dreamed that these provisions would have such an effect on our clients’ potential liability. I’ll call them in the morning. No one could sleep after getting this kind of bad news.”
For more Information About the Section of Business Law
This article is an abridged and edited version of one that originally appeared on page 43 of Business Law Today, November/December 2006 (16:2 ). For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.
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