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January 01, 2015

Advance Sheet: Do Lawyers Think about What They’re Doing?

Litigators should start questioning the inclusion of standard provisions that actually make little sense.

Robert E. Shapiro

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A distinguished corporate lawyer who later went on to fame and fortune as a successful businesswoman once remarked that litigators should never be trusted to draft settlement agreements. She had a point. Litigators are trained to provide a persuasive point of view in an adversarial context, pressing the client’s perspective on a particular factual or legal issue to the court or fact finder. Transactional lawyers, by contrast, work in a more cooperative context, especially once the basic terms of an agreement are set, thinking only at the margin about situations that might arise in the future and how to provide for them. There is artistry in both, of course. But the litigator primarily tries to parry an alternative point of view, while the transactional lawyer is trying to provide for a later problem that both sides have an interest (usually) in resolving in advance. In both respects, the latter, not the former, is the goal of a settlement agreement.

So it stands to reason that settlement agreements should be the province of transactional lawyers. But it almost never happens that way. Seldom do the litigators even think of consulting a transactional colleague, let alone relinquishing to that colleague the drafting of a settlement agreement. Most litigators are, in fact, rather insulted at the idea that they don’t know what they are doing. They mostly do, of course, especially where it really counts. For example, they are well versed in the various forms releases may take, from the narrow transactional release to the broad and mutual variety that wipes out everything known and unknown, matured or not. Even if transactional lawyers can be useful consultants, a double-check to make sure there are no eventualities left unconsidered, litigators understandably prefer to draft the documents themselves.

There is reason to believe, however, that many litigators do not really know what they are doing. The proof is that the standard settlement agreement often has provisions that really make no sense. Take the so-called “severability” provision. You know the type: a provision saying something to the effect that if a court later determines that one clause of the settlement is not enforceable, it will be carved out and the settlement will remain in effect. This may be standard, but it is completely nonsensical. The provision literally means that if a court later finds that the release the plaintiff has given the defendant is unenforceable, the agreement as a whole still stands. Huh?

The truth is that no one would really want such an outcome for any provision in the agreement, at least not in the ordinary circumstance. If so, there would be no reason to include the provision in the first instance. So why do these severability provisions exist? It misses the point to say that a later court would never really find a substantive provision unenforceable. What then is the point of severability?

Nor is it sufficient to say that the severability clause applies only to nonmaterial provisions. Not only does it not say so, but it would then be unnecessary altogether. If a nonmaterial provision is voided, legally that should not void the agreement anyway. And if the problem is that it is difficult to distinguish material and nonmaterial provisions, then the provision is worse than useless. It just builds a prospective controversy into the document. In short, the provision is nugatory at best and pernicious at worst. It is never desirable. But, sure enough, there it always is, defended by the even worse notion that it has always been there previously.

What is happening here? Simple: Litigators aren’t thinking. That the provision has always been included up to now is reason enough to them to have it included hereafter. No one stops to consider whether it really makes sense, as it becomes further and further entrenched in the world of “what’s done.”

Inanities and Pointless Provisions

There are similar inanities in other phases of litigation as well. What litigator does not automatically include the affirmative defense in his answer that “the complaint fails to state a claim upon which relief may be granted”? This is not an affirmative defense at all. What about other inapplicable defenses based on waiver, estoppel or laches, or the statute of limitations? Do the lawyers really know what they are doing when they include them? Beware. There is now a growing body of law stating that such defenses, when unsupported by logic or facts, are susceptible to a motion to strike. Cartier Int’l AG v. Motion in Time, Inc., 2013 U.S. Dist. LEXIS 50035 (S.D.N.Y. 2013). Maybe there are no real consequences if a motion to strike is filed or even granted, but it sure is a bad way to begin with a judge and more than a little embarrassing to explain to a client. The motto: Think before you do what’s always done, or run the risk of appearing not to know what you are doing.

Unthinking lawyering is hardly the sole province of litigators. Anyone who has ever litigated the warranties and representations in a purchase and sale document may have ample reasons for complaint about his or her transactional colleagues. Certain features of these provisions are commonplace. There are the representations and warranties themselves and usually some kind of provision saying they “survive” the closing. It is also customary to add some kind of provision specifying that each party indemnifies the other from any kind of loss, including a breach of the representations and warranties. The goal is clear: make certain that each party can rely on what the other party has represented as part of the negotiations, making fraud allegations unnecessary. These provisions have now become routine, done because always done. The question is whether they make sense and serve their purpose.

There are a host of questions about these provisions many lawyers never think about. Take the survival clause, for example. What’s it for? If the agreement is one that involves real estate, and the deed is transferred as part of a later closing, there is law in some jurisdictions saying that the prior agreement is “merged” into the final transaction, so you need to ensure the reps and warranties survive the closing. Outside real estate, though, it’s not at all clear that the provision is necessary to ensure that the reps and warranties “survive” the closing. Why wouldn’t they anyway? No harm done perhaps. Belt and suspenders. It would be far better, however, if survival is really key, to restate the relevant provisions in any later closing agreement or at least incorporate them by reference.

But there are other problems. There is this interesting question, for example: How long do the reps and warranties survive? Ask a transactional lawyer this question and you may get a blank stare. The answer is not at all obvious.

Two recent decisions in Delaware came to the conclusion that the survival clause ordinarily extends the representations and warranties for the duration of the statute of limitations. GRT, Inc. v. Marathon GTF Tech., LTD, 2011 Del. Ch. LEXIS 99 (Del Ch. July 11, 2011; ENI Holdings, LLC v. KBR Grp. Holdings, LLC, No. 8075-VCG (Del. Ch. Nov. 27, 2013). This makes sense. The reps and warranties are part of an agreement. The agreement is governed by the statute. The mere fact that the reps and warranties are said to survive the closing does not mean they survive forever or any longer than the governing state’s limitations statute allows. But when negotiating the agreement, does anyone stop to consider how long that is? It could be three years, four years, six years, or 10 years, depending on the state. Many transactional lawyers seem never to have thought this through.

But there is more. The number of years permitted by the statute starting from when? The making of the reps and warranties? The closing? The breach? When the breach is discovered? When? The answer, at least as far as one of the Delaware courts concluded, is the date of “accrual” of the cause of action. OK, but when is that? Accrual rules can give later litigators fits. Does the claim accrue when the rep and warranty is breached? When the breach became known? (One of the Delaware courts refused to apply the discovery rule.) When it causes harm? What kind of harm? Is anyone paying attention to these issues?

Is there any way around the statute? This may depend on whether you wish to lengthen or shorten it. Cases of the former are probably rare. Statutes of limitations are usually ample enough to allow for breach, discovery, and suit. But, again, the key question is whether lawyers with their preexisting forms are really thinking about what could happen. If they are in that rare case where a rep or warranty really needs to last well into the future, they may be comfortable relying on the survival clause, but the limitations statute and the rules of accrual may frustrate those hopes. They really ought to take a close look at the latter before proceeding.

Shortening the time can be a parlous undertaking of its own. In GRT, Inc., an operator and investor entered into a joint venture under which the operator would build a highly experimental facility, using the investor’s intellectual property, to convert natural gas into gasoline. The parties specified that the operator’s representations would survive for a period of one year after the closing, when the contractually provided remedies for breach would terminate too. Upon a breach, the operator was obligated to remedy any failure by modifying the plant’s design.

The representations were breached within months of the closing, but the investor waited almost two more years after closing to sue. He probably assumed that the breach occurred within the survival period and that he had the statute of limitations period to file his claim. The court found the suit to have been filed too late. It ruled that the survival provision applied to both the representation and the lawsuit, extending the former and limiting the latter to one year. The one-year limitation further applied to both the suit for breach of the rep and warranty and the suit for failing to remedy the breach. This was a drafting problem, surely, and any uncertainty left by the drafters could have been remedied by the investor’s lawyers either by filing a placeholder lawsuit or by putting a tolling agreement in place to ensure its claims were preserved. The larger point is that survival provisions are commonplace but careful thinking about them is not. The standard approach sometimes covers a booby trap of significant importance.

Indemnification and Arbitration

But this is not the end of the mischief these standard provisions can cause. Take the indemnity provision. What does it add? It is often thought that this provision lends force to any relief against a counterparty for breach of a rep or warranty. It mostly doesn’t. Any such breach gives rise to a remedy even without the indemnity provision. And while the indemnity provision adds a right to recover any costs from the breach, including attorney fees, most purchase and sale agreements routinely provide for the recovery of fees for a breach anyway.

A more immediate use of the indemnification provision is the protection it gives the transacting parties from third-party claims. Let’s say one party is buying a business from another. After the sale, a third party appears claiming the seller failed to honor some earlier contract. Because the buyer is now being sued for the seller’s previous misdeed, the indemnity provision gives the buyer an action against the seller for the amount of the third party’s claim.

Fair enough. But doesn’t the common law of indemnification and contribution provide a remedy here? To what extent does the written indemnification provide further relief? Perhaps it adds certainty, but there is a familiar problem lurking here too. How long does the protection last? The answer is it depends. In the absence of survival or limitations language in the agreement, the indemnity lasts as long as the applicable statutes of limitation, the period of time after the claim “occurs” or the claim “accrues.” But we are back in the soup again. When is that? Some states say notice, and others say when the loss occurs—which may be when the claim is made (by letter? by lawsuit?) or when money is paid.

Even this can be misleading. Suppose it is concluded that the cause of action accrues only from the time the buyer suffers a loss and extends from that date for as long as the statute of limitations provides. A contract is signed in year one. A third-party claim is raised in year five, but the seller refuses to take responsibility for the claim. The statute of limitations on contract breaches is four years. Is there a cause of action left? For how long? Four years from the seller’s refusal to accept the claim? Or is there a cause of action forever or for at least as long (for that particular breach) as it takes for the buyer to incur and pay on an actual loss?

Some states say a loss means an actual payout of money. But when does that payout take place? If a third-party claim is involved, the usual conclusion is that it occurs when the buyer has to hand over money to a third party. But aren’t there payout losses arising beforehand from the third-party claim? How about the buyer’s lawyers defending against the claim? They have to be paid. Isn’t that a loss arising from the third-party claim? If one waits until the third party is itself paid, might this not be long after the fees have been paid? Has the statute been blown?

Then there is the great-granddaddy of all drafting time bombs, the arbitration clause. There doesn’t seem to be any abatement in transactional lawyers’ willy-nilly inclusion of arbitration provisions in purchase and sale agreements in particular. Does this make sense? The big problem with arbitration is that it tends to favor one party over another without necessarily improving the fate of either. Arbitration these days no longer seems to eliminate discovery. And trading in the time-tested fairness of a jury trial and the right to appeal for a ruling by a panel of lawyers with their own ideas of fairness is not necessarily a step up. But very few transactional lawyers take careful stock of this.

In these cases, as in the others, the problem lies in not thinking. The primary quality of a good lawyer is that he or she thinks, even about—especially about—the routine. Never take what is always done as the answer to what should be done in any particular case. The consequences can be hazardous to all involved.

Robert E. Shapiro

The author, an associate editor of Litigation, is with Barack Ferrazzano Kirschbaum & Nagelberg LLP, Chicago.