Creative Uses of Ambiguity in Contracts - m.acc.com · Creative Uses of Ambiguity in Contracts Alex...

Creative Uses of Ambiguity in Contracts

Alex Simpson, VP & General Counsel – Reis Inc.Stafford Matthews, Partner, DentonsYan Besner, Partner, Dentons

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Ambiguities in Contracts

[Testimony of William Jefferson Clinton, Grand Jury, OIC 8/17/98, p. 59]

5

A Few Starting Principles

ambiguous [adjective]: open to more than one interpretation; not having one obvious meaning.

Origin: early 16th century. From Latin ambiguus 'doubtful' (from ambigere 'waver, go around', from ambi- 'both ways' + agere 'to drive') + -ous.Oxford Dictionaries Online (2012)

6


Two Categories of Ambiguities:

Textual or Internal Ambiguity: failures in the language of the contract itself.

Transactional or External Ambiguity: The contract is clear and enforceable as written but a party has failed to anticipate and require essential transactional terms, placing the party and the benefits of the transaction at risk. The result is an incomplete contract.

In that case the party – not the contract – is in a state of ambiguity.

7


"I see England, I see France…"

Focus in this presentation on common law principles and case law. Most states in the United States and in Canada, including the province of Ontario, are common law jurisdictions.

California is one exception and has both common law and an extensive Civil Code setting forth substantive principles governing the interpretation and enforcement of contracts.*

*Cal. Civ. Code §§1429 et seq., 3509 et seq. Ontario also has substantive statutes governing certain classes of contracts including consumer agreements. See, e.g., s. 11 of the Consumer Protection Act , 2002, S.O. 2002, c 30, Sch A.

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On the other hand, Quebec is a civil law legal system which governs relations between persons. The civil law system is primarily embodied in the Civil Code of Québec, R.S.Q., c. C-1991 (the “Civil Code”).

The Civil Code contains specific provisions regarding the interpretation of contracts.* However the Civil Code provisions are generally waivable by the parties unless such waiver would violate public policy or is prohibited by the terms of a specific provision.**

* Civil Code of Quebec, articles 1425 to 1432.** Civil Code of Quebec, Article 9.

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First Law of Ambiguities - The Conservation of Ambiguity Principle:

Your capacity in any transaction to limit ambiguities in a contract by drafting additional or more complicated provisions will be finite. Some degree of ambiguity is inevitable in every contract.

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The Conservation of Ambiguity Principle:

Loosely based on the Heisenberg Uncertainty Principle that everyone learned about in high school science class.

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Second Law of Ambiguities:

Unambiguous contract language is generally enforced as written. Ambiguities will be resolved to the extent possible by reference to other language in the contract; by extrinsic evidence; and by construing the ambiguity against the drafter.

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Second Law of Ambiguities - Rules

Baseline Rule: Unambiguous contract language is generally enforced by

the courts as written by the parties. Every word has meaning and will be interpreted from the

writing alone to ascertain the intention of the parties, if possible.*

13

*E.g., Cal. Civ. Code §§1638, 1639; Buenz v. Frontline Transp. Co., 227 Ill. 2d 302, 308, 882 N.E.2d 525 (2008); H.W. Liebig & Co. Ltd. v. Leading Investments Ltd., [1986] 1 S.C.R. 70.


In cases of ambiguities in text:(1) Determine if the relevant clause is in fact ambiguous.

If the language is reasonably susceptible to only one meaning, the clause is not ambiguous and will be enforced as written.

A contract is not ambiguous simply because the parties disagree on its meaning.*

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*E.g., Dore v. Arnold Worldwide, Inc., 39 Cal. 4th 384, 393 (2006); Markham General Insurance Co. (Liquidator of) v. Bennett, 2006 CarswellOnt 3058 at para 19.


If the relevant clause is in fact ambiguous, the more probable and reasonable construction of two possible alternatives should be used if possible.*

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*See in particular Standard Meat Co. v. Taco Kid of Springfield, Inc., 554 S.W.2d 592, 596 (Mo. Ct. App. 1977) (More probable and reasonable construction of two possible alternatives should be used instead of one which produces a "redundant, illusory, absurd, and therefore unreasonable" result); Guarantee Co. Of North America v. Gordon Capital Corp., 1999 CarswellOnt 3171 (“If a given construction of the contract would lead to an absurd result, the assumption is that this result could not have been intended by rational commercial actors in making their bargain, absent some explanation to the contrary”).


(2) Extrinsic Evidence in Aid of Interpretation If still ambiguous, extrinsic evidence is used by the

court to determine meaning of the terms. Forms of extrinsic evidence include other writings, conduct of the parties and usage of trade.*

* Cal. Code Civ. Proc. §§1856(b), (c), (g), 1860; Casa Herrera, Inc. v. Beydoun, 32 Cal.4th 336, 343, 346 (2004); Head v. Inter Tan Canada Ltd., 1991 5 O.R. (3d) 192; Eli Lilly & Co, [1998] 2 S.C.R. 129; Leitch Gold Mines Ltd. v. Texas Gulf Sulphur Co. 1968 CarswellOnt 318.

16


(2) Extrinsic Evidence in Aid of Interpretation However the parol evidence rule generally prohibits

use of extrinsic evidence to alter, vary or contradict contract terms.*

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*See Cal. Civ. Code §1625; Sterling v. Taylor, 40 Cal. 4th 757, 767 (2007); (TransCanada Pipelines Ltd. v. Northern & Central Gas Corp., 1983 CarswellOnt 1430.


(3) Construed Against the Drafter If still ambiguous, the doctrine of contra proferentem

is applicable. Under this doctrine the ambiguouscontract or clause is generally construed against the drafting party.*

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*Taylor v. J. B. Hill Co., 31 Cal. 2d 373, 374 (1948); Pacific Gas & Electric Co. v. Superior Court, 15 Cal. App. 4th 576, 596 (1993) ("tie breaker"); Manulife Bank of Canada v. Conlin, 1996 CarswellOnt 3941; Reliance Petroleum Ltd. v. Stevenson, 1956 CarswellOnt 83 (“last resort”).


But: If contract terms are actively negotiated, some courts hold that neither party should be considered the drafter and the contra proferentem rule does not apply.

The contra proferentem rule also is waivable by the parties in most cases.

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* Indenco, Inc. v. Evans, 201 Cal. App. 2d 369 (1962); Hillis Oil and Sales Ltd. v. Wynn’s Canada Ltd., 1986 CarswellNS 147.


Example: Anti-contra proferentem clause:"The parties and their respective legal counsel have actively negotiated and drafted the provisions of this Agreement. Notwithstanding any rule to the contrary, no provision of this Agreement shall be interpreted or construed against any party because such party or its legal counsel was the drafter thereof."

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Not the end of the issue: A potential unintended consequence of the contra

proferentem waiver can be a court decision that the clause, or the entire contract if the clause is an essential or material term, is invalid or unenforceable because the ambiguity cannot be resolved through use of the doctrine.*

21

*See BioGenex Labs. v. Sentara Healthcare, 2010 U.S. Dist. LEXIS 22397, 21-22 (N.D. Cal. Mar. 11, 2010)(no meeting of the minds); White Point Co. v. Herrington, 268 Cal. App. 2d 458, 465, 468-469 (1968); Pagliaroli v. Industrial Alliance Insurance and Financial Services Inc., 2012 ONSC 6862. Compare, e.g., Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 953-954 (2008).

Second Law of Ambiguities - Text

NB: In the case of a contra proferentem waiver, consider a more detailed severability clause requiring the parties to renegotiate provisions held invalid or unenforceable, if that is otherwise consistent with the objectives of the Company.

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For example:"If any provision of this Agreement shall be held by the final judgment of a court of competent jurisdiction or the final award of an arbitrator to be invalid, void or otherwise unenforceable, such provision shall be enforced to the maximum extent possible to effect the intent of the parties, or, to the extent incapable of such enforcement, shall be deemed to be deleted from this Agreement, and the remainder of this Agreement shall remain in full force and effect. In such event the parties agree [to negotiate in good faith] to amend and replace such invalid or void or unenforceable provision with a valid and lawful and enforceable provision which most closely approximates the intent and economic effect of such invalid or void or unenforceable provision."

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Textual or Internal Ambiguities

24

[1] "And" and "Or" Conundrum

[1] Examples: "license to use, distribute and exploit" "license to use, distribute or exploit" "license to use, distribute and/or exploit" “license to X, Y and Z to use A, B and C”

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The terms "and", "or" and "and/or" are considered by the courts to be inherently ambiguous.

Standard Definitions:

And: Conjunctive, to connect words to be taken jointly.

Or: Disjunctive, to indicate an alternative between two or more choices.

And/or: Either or both of two or more alternatives.

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"Or" disjunctive: Meyer v. CUNA Mut. Ins. Soc'y, 648 F.3d 154, 165-166 (3d Cir. 2011); White v. County of Sacramento, 31 Cal. 3d 676 (1982); Piet v. United States, 176 F. Supp. 576, modified, 283 F.2d 693 (S.D. Cal. 1959); Tectonic Infrastructure Inc. v. Middlesex Centre (Township), 2004 CanLII 45493.

"Or" conjunctive: De Sylva v. Ballentine, 351 U.S. 570, 573 (U.S. 1956) ("the word ‘or’ is often used as a careless substitute for the word ‘and’"); Hawkins v. Hawkins, 511 S.W.2d 811, 812 (Mo. 1974) (“courts frequently interpret the word ‘or’ so as to carry out the plain purpose of the contract when the strict grammatical meaning of the word would defeat the purpose or lead to an absurd result”); Sayers & Associates Ltd. v. United Centre Inc., 1993 CarswellOnt 837.

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"And" disjunctive and equivalent to “or”: Tricor Am., Inc. v. Ill. Union Ins. Co., 351 Fed. Appx. 225, 227 (9th Cir. 2009)("and" read as "or" to effectuate intent of the parties); Ortho-McNeil Pharm., Inc. v. Mylan Labs., Inc., 2005 U.S. Dist. LEXIS 34380, 21-22 (D.N.J. July 18, 2005)("and" can be used to express alternatives); Universal Sales Corp. v. California Press Mfg. Co., 20 Cal. 2d 751, 775-776 (1942)(“there is almost an unanimity of holding to the effect that the terms 'and' and 'or' may be construed as interchangeable when necessary to effect the apparent meaning of the parties”); Maple View Building Corp. v. Tran, 2003 CarswellOnt 5994; Clergue v. Vivian & Co., 1909 41 S.C.R. 607 at 617.

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"And/or": Frequently criticized."The phrase ‘and/or’ is semantically and logically contradictory. A thing or situation cannot be simultaneously conjunctive and disjunctive….It is an indolent way to express a series of items that might exist in the conjunctive, but might also exist in the disjunctive…. [Furthermore] a bad-faith reader of a document can pick whichever one suits him - the ‘and’ or the ‘or.’ " [Carley Foundry, Inc. v. CBIZ BVKT, LLC, 2010 Minn. App. Unpub. LEXIS 284, 9-10 (Minn. Ct. App. Apr. 6, 2010). See, e.g., Higgins v. Orion, 1985 CanLII 2011].

29


Possible Alternatives: "Either X or Y" [disjunctive] "Both X and Y [conjunctive] "Either X or Y or both" "Any one or more of X and Y" "Each and all of X and Y“

Some drafters instead add a rule of interpretation to the contract such as: "The term ‘or’ shall have the inclusive meaning identified with the phrase ‘and/or’." But see First Rule of Ambiguity above.

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[2] "Arising under" – "Arising out of" – "Relating to"

The meaning and scope of the terms: "arising under""arising out of""arising from""relating to""in connection with" pose material risks for contracting parties and are the subject of endless debate and litigation.

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[2] Examples:

"Any controversy or dispute [under] [arising under] this Agreement shall be settled by binding arbitration."

"This Agreement shall be governed by and construed in accordance with the laws of the State of California, without reference to conflicts of law principles."

"Notwithstanding any contrary provision hereof, the total and cumulative liabilities of the Company for all matters [arising under] [arising out of] this Agreement at any time shall not exceed One Million Dollars ($1,000,000)."

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Arising under: Generally limited to matters of the interpretation and performance of the terms of the contract itself but not other claims between the parties. However this narrow interpretation has not been adopted uniformly by the courts.*

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*Compare Mediterranean Enters. v. Ssangyong Corp., 708 F.2d 1458, 1463 (9th Cir. 1983) and Cole v. Pearson Educ., Inc., 2011 U.S. Dist. LEXIS 110603, 14-15 (S.D.N.Y. Sept. 28, 2011) with Goldberg v. Focus Affiliates, Inc., 152 F. Supp. 2d 978, 982 (N.D. Ill. 2001); Heyman v. Darwins, [1942] A.C. 356, [1942] 1 All E.R. 337 (H.L.).


Arising out of or arising from: Includes matters that require the interpretation of the contract in order to resolve dispute, even if the claim may be based on statutory or other independent grounds.*

*Omron Healthcare v. Maclaren Exports, 28 F.3d 600, 603 (7th Cir. Ill. 1994); Lumascape USA, Inc. v. Vertex Lighting, Inc., 2006 U.S. Dist. LEXIS 25093 (N.D. Cal. Mar. 29, 2006). Compare Phillips v. Audio Active, Ltd., 494 F.3d 378, 391 (2d Cir. 2007)(more restrictive view in 2nd Circuit: claim must "originate" from contract); Heyman v. Darwins, [1942] A.C. 356, [1942] 1 All E.R. 337 (H.L.); Mantini v. Smith Lyons LLP, 2003 CanLII 20875.

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Relating to: Broader than "arising out of" or "arising from" - having some relationship to the contract without necessarily any causal connection.*

*Coregis Ins. Co. v. American Health Found., 241 F.3d 123, 128-129 (2d Cir. 2001); Dominguez v. Andrew Corp., 2007 U.S. Dist. LEXIS 91062, 15-16 (N.D. Cal. Dec. 4, 2007) (emotional distress claims "related to" stock purchase agreement).

35


In connection with: Similar to or even broader in scope than "relating to".*

*Simula, Inc. v. Autoliv, Inc., 175 F.3d 716, 721 (9th Cir. 1999)(every dispute having a significant relationship to the contract and all disputes originating in the contract); J.J. Ryan & Sons, Inc. v. Rhone Poulenc Textile, S.A., 863 F.2d 315, 321 (4th Cir. 1988)(unfair trade practices, libel and defamation); Mantini v. Smith Lyons LLP, 2003 CanLII 20875; Nowegijick v. The Queen, [1983] 1 S.C.R. 29, at 39 (“in respect of”).

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[2] Example

"Any controversy or dispute [under] [arising under] this Agreement shall be settled by binding arbitration."

Limited Scope: Ambiguous as to scope of binding arbitration.

Consider: " Any controversy or dispute arising out of or relating to or in connection with this Agreement shall be settled by binding arbitration."

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[2] Example

"This Agreement shall be governed by and construed in accordance with the laws of the State of California, without reference to conflicts of law principles."

Limited Scope: Ambiguous. Choice of law arguably limited to interpretation and performance of the contract terms only. Can be narrower than the jurisdictional or arbitration clauses.

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[2] Example

Consider instead: "This Agreement and any and all matters arising under or arising from or relating to this Agreement [or the subject matter hereof] [or the relationship of the parties]…."

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[2] Example

"Notwithstanding any contrary provision hereof, the total and cumulative liabilities of the Company for all matters [arising under] [arising out of] this Agreement at any time shall not exceed $1,000,000."

Scope: If “arising out of”: ambiguous at least as to non-contract claims (such as third party infringement claims or business torts). If "arising under”: limitation on liabilities is narrowed to straight contract claims.

Consider: " the total and cumulative liabilities of the Company for any and all matters arising out of or relating to this Agreement or any transaction hereunder [, including but not limited to ________,] shall not exceed…."

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[3] Ambiguous Modifiers

Examples:

"Black coat and hat"

"drilling or reworking operations" [Anderson v. Hess Corporation, 649 F.3d 891 (8th Cir. 2011) (interpreted to mean "drilling operations or reworking operations")].

"[termination for] any material breach of or default or failure to perform under the Agreement, including but not limited to any breach or default under Section ____."

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[3] Ambiguous Modifiers

Examples:

"Ozzy Osbourne's name, likeness, image, identity, persona, trademarks and right of publicity, and all intellectual property connected with the concert tour known as ‘Ozzfest’".

[Threshold.tv v. Monowise, Ltd., 2004 Cal. App. Unpub. LEXIS 9522 (Cal. App. Oct. 20, 2004) (emphasis added)].

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[4] Ambiguous Non-Modifiers

The failure to provide any modifiers equally problematic. Examples in the context of indemnification clauses:

“any act or omission of Distributor or any of its employees or agents in whole or in part"

“any intentional acts of Licensee in connection with the production and distribution of the Products”

“any use of the Licensed Rights in the Territory by Licensee”

“any liability arising out of or connected with the performance of work under this Agreement"

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[5] Failure to Conform or Rank

[5] Failure to conform or rank interrelated provisions a frequent ambiguity problem. Common disconnections:(1) Choice of law provision with arbitration or venue clauses.(2) “Determined by a court” severability provision with arbitration provisions.(3) Force majeure clause with monetary or indemnity and duty to defend obligations.(4) The correct internal ranking of indemnification clauses with clauses excluding or limiting liabilities.(5) Integration clause with other current contracts, or failure to carry over rights or obligations from superseded contract.

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Example - Severability Clause: "If any provision of this Agreement shall be held by the final judgment of a court of competent jurisdiction to be invalid, void or otherwise unenforceable…"

Limited Scope: Does not include possible decisions by an arbitrator. In the event of arbitration the right to severability is ambiguous.

Consider: "If any provision of this Agreement shall be held by the final judgment of a court of competent jurisdiction or the final award of an arbitrator to be invalid, void or otherwise unenforceable…"

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Example - Integration Clause: "This Agreement supersedes all prior and contemporaneous agreements, representations, warranties and negotiations between the parties regarding the subject matter hereof; provided however that (1) any and all confidential information under the prior ______ Agreement between the parties shall be deemed part of the ‘Confidential Information’ under this Agreement for all purposes, and (2) each and all of the [Product Warranties][obligations to indemnify and defend] under the prior______ Agreement shall remain in full force and effect and shall not be superseded or terminated."

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Third Law of Ambiguities:

The position of a party concerning transactional ambiguities in a contract depends on whether the party expects to be the probable plaintiff or the probable defendant in any lawsuit if the transaction fails.

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Third Law of Ambiguities

Probable Plaintiff: Baseline objective of the probable plaintiff is to maximize obligations of the other party to perform and to reduce textual and transactional ambiguities: Absolute and unconditional performance without

qualifiers Maximize required performance metrics Maximize procedural advantages in the event of a

dispute, including rights to terminate

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Contract terms for probable plaintiff: Detailed performance specifications Detailed product and service warranties Strict deadlines Outright transfer of ownership of IP and other rights Indemnification for breach or IP claims Termination for convenience Choice of law and choice of forum of favorable

jurisdiction Financial or contractual penalties for breach

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Probable Defendant: Baseline objective of probable defendant is the converse - to limit obligations and potential liabilities and [on balance] increase transactional ambiguities by: Minimizing the number or type of performance metrics Imposing preconditions and qualifiers to performance Making deadlines and milestones less strict and

subject to exceptions Maximizing discretion of the party to set or change

terms, or prevent the other party from doing so.

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Contract terms for probable defendant: Limit or disclaim reps and warranties No or limited indemnities, including indemnities for

intellectual property "Knowledge" and "materiality" qualifiers Performance based only on "best efforts" or

"commercially reasonable" standards Limitation of liabilities Contractual statutes of limitations Multiple rights to cure

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Fourth Law of Ambiguities:

The parties may intentionally agree to transactional ambiguities in a contract to "meet in the middle", or to compensate for an absence of reliable projections or data, or as contractual shifting of risk.

One party also may unilaterally use or recognize and leave in transactional ambiguities in a draft contract for strategic or tactical advantages.

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Classes of Transactional Ambiguities

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Transactional Ambiguities: Classes of Ambiguities

Transactional ambiguities include the following categories:(1) Land mines: intentional missing terms(2) Illusory or potentially illusory obligations(3) Trap doors and back doors(4) Overbroad or imprecise scope(5) Unintended "surprise" parties

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Transactional Ambiguities: [1] Land Mines

[1] Land Mines: Missing survival clause for relevant provisions

following termination, or listing of section numbers in a survival clause that misnumbers or omits key sections.

Missing disclaimers of implied warranties Disclaimers of implied warranties of merchantability

and fitness, but no disclaimer for implied warranties of noninfringement or title.

Failure to provide that representations or warranties survive the closing. [See Western Filter Corp. v. Argan, Inc.,540 F.3d 947, 952 (9th Cir. 2008)].

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[1] Land Mines: Statute of limitations on warranties [including

noninfringement warranties] running from the date of occurrence without regard to notice or knowledge of breach.[E.g., UCC § 2725(2). See generally El Pollo Loco, Inc. v. Hashim, 316 F. 3d 1032 (9th Cir. 2003)].

Missing limitations for consequential or special damages

Failure to state disclaimers or limitations of liability in caps or prominent typeface when required by law

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[1] Land Mines: No language in indemnification provision as to

whether direct party claims as well as third party claims are covered. Can be construed narrowly against indemnitee.*

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*See Crawford v. Weather Shield Mfg., Inc., 44 Cal. 4th 541, 552 (2008). Compare Zalkind v. Ceradyne, Inc., 194 Cal. App. 4th 1010, 1025 (2011)(definition of “indemnity” in California Civil Code contemplates both direct and third party claims); E.E. Caledonia Ltd. V Orbit Valve plc, [1994] Times L. R. 311 (C.A.).


[1] Land Mines: Broad force majeure clauses without any cut-off date

or exclusion for failure to pay money or to indemnify and defend [pro-defendant]; "outside of the control" of the party without any reasonableness limitation [pro-plaintiff].

Missing material terms under guise of a plain English or "short form" agreement. For example, an intellectual property transfer agreement with (1) no backup exclusive license if transfer otherwise limited by law; (2) no provision for after-acquired rights; (3) no provision for moral rights of attribution, integrity, disclosure and withdrawal.

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[1] Land Mines:“To the fullest extent permitted by law” versus “to the fullest extent not prohibited by law”: If “permitted by law” proviso is used, may require

proof by party of affirmative authorization by statute or case law before contract provision is enforceable.*

*See Jolian Investments Ltd. v. Unique Broadband Systems Inc., 2011 ONSC 3241; Joyce v. Joyce, 1984 CarswellOnt 265.

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[1] Land Mines: "Not prohibited" can shift burden to other party to

prove existence of a prohibition by statute or case law in order to avoid enforcement of contract provision.*

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*See generally Newman v. Checkrite California, Inc., 912 F. Supp. 1354, 1367-1368 (E.D. Cal. 1995); Som v. Daniels Law Offices, P.C., 573 F. Supp. 2d 349, 358 (D. Mass. 2008).; Citifinancial Canada Inc. v. Moniz, 2006 CanLII 31905 (ON SC); Commercial Life Assurance Co. v. Drever, [1948] S.C.R. 306.

Transactional Ambiguities: [2] Illusory Obligations

[2] Illusory or Potentially Illusory Obligations:[1] "Best efforts" clauses in lieu of a strict obligation to

perform. In general such clauses are enforceable.* However in a number of jurisdictions, "best efforts"

clauses are held illusory and unenforceable unless subject to measurable performance guidelines.**

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*Enforceable in Ontario: Place Concorde East Ltd. Partnership v. Shelter Corp. of Canada Ltd. 2003 CarswellOnt 5392 at para 180

**Don’t mess with Texas or Illinois: Ehringer. v. McData Servs. Corp., 646 F.3d 321, 327 (5th Cir. 2011) (best efforts to "further the promotion, marketing, licensing, and sale of Products" unenforceable under Texas law); Gentieu v. Tony Stone Images/Chicago, Inc., 255 F. Supp. 2d 838 (N.D. Ill. 2003) (Illinois)].


[1] "Best efforts" – New York New York law on “best efforts” clauses is still evolving

and some courts have held that a “naked” best efforts clause not enforceable under New York law in absence of clear guidelines against which to measure such efforts.*

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*Hard Rock Cafe Int'l, (USA), Inc. v. Hard Rock Hotel Holdings, LLC, 2011 U.S. Dist. LEXIS 76897 (S.D.N.Y. July 11, 2011); Strauss Paper Co. v. RSA Exec. Search, Inc., 688 N.Y.S.2d 641, 642-643 (N.Y. App. Div. 2d Dep't 1999). Compare Sedona Corp. v. Ladenburg Thalmann & Co., 2011 U.S. Dist. LEXIS 105320, 5-7 (S.D.N.Y. Sept. 15, 2011); US Airways Group v. British Airways Plc, 989 F. Supp. 482, 491 (S.D.N.Y. 1997); Van Valkenburgh, Nooger & Neville, Inc. v. Hayden Publishing Co., 30 N.Y.2d 34, 46 (1972).


[1] "Best efforts" California takes a more aggressive position in favor of

enforcing "best efforts" clauses.*

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*Cable & Computer Tech., Inc. v. Lockheed Sanders, Inc., 214 F.3d 1030, 1035 (9th Cir. 2000); Benson v. Rhino Indus., 2008 Cal. App. Unpub. LEXIS 3358 (Cal. App. 1st Dist. Apr. 23, 2008).


[1] "Best efforts" Various interpretations including "active exploitation

in good faith", or acting "with good faith in light of one's own capabilities".*

“[A]ny best efforts clause…can be satisfied by any of a wide range of possible levels and types of performance that comport with the exercise of 'good faith' by the obligor“. [United States v. Board of Education, 799 F.2d 281, 292 (7th Cir. 1986)].

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*Bloor v. Falstaff Brewing Corp., 601 F.2d 609, 612 (2d Cir. 1979); Western Geophysical Co. v. Bolt Assocs., 584 F.2d 1164, 1170 (2d Cir. 1978). See Bruce v. Region of Waterloo Swim Club, 1990 CarswellOnt 779 (leaving “no stone unturned”)].


[1] "Best efforts" Clause may not prohibit a party from selling

competing products, if licensed product is inferior or not competitive, or prevent a party from acting in its own interests unless materially harmful to the other party.*

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*E.g., Tas Distrib. Co. v. Cummins, Inc., 2011 U.S. Dist. LEXIS 124928 (C.D. Ill. Oct. 28, 2011); Western Geophysical Co. v. Bolt Assocs., 584 F.2d 1164, 1170 (2d Cir. 1978); Van Valkenburgh, Nooger & Neville, Inc. v. Hayden Publishing Co., 281 N.E.2d 142, 145 (N.Y. 1972).


[2] "Commercially reasonable efforts" No definitive standard under most state laws: entirely

dependent on particular facts and circumstances.*

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*E.g., Sempra Energy Resources v. California Dep't of Water Resources, 2005 Cal. App. Unpub. LEXIS 5349, 28-29 (June 21, 2005); Crocker Nat. Bank v. Emerald, 221 Cal. App. 3d 852, 861 (Cal. App. 3d Dist. 1990); 364511 Ontario Ltd. V Darena Holdings Ltd., [1998] O.J. No. 603, vard [1999] O.J. No. 1784 (implies sound judgment with an objective of financial gain).


[3] Postponed negotiation of essential terms: an "agreement to agree" not enforceable.*

[4] Open terms of performance under standards or conditions within the control of the performing party.**

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*Ablett v. Clauson, 43 Cal. 2d 280, 284-285 (Cal. 1954) (no contract if an essential term reserved for future agreement); Louis Lesser Enterprises, Ltd. v. Roeder, 209 Cal. App. 2d 401, 408 (1962); Canada Square Corp. v. Versafood Services Ltd., 1981 CarswellOnt 124 at para 26.

** See Prudential Ins. Co. v. Sempetrean, 525 N.E.2d 1016, 1020 (1988); Prystay v Prystay, 2004 CanLII 7057 (ON SC).


[5] Unlimited rights to cure for breaches of contract, including multiple breaches of the same type: "[Termination for breach], provided that the breaching party shall have the right to cure such breach within 30 days following written notice of such breach."Better: Add "provided however that such right to cure shall not be applicable to a series of the same or similar or related breaches".

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Transactional Ambiguities: [3] Discretion

[3] Discretion of Other Party: Example: "Company shall have the right, in its sole

discretion, to approve or reject any proposal submitted by Other Party."

Example: "Company reserves the right to discontinue development or distribution of the Products in its sole discretion at any time."

Example: An exclusive license of intellectual property for a percentage royalty but no stated obligation to market or generate revenues.

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[3] Discretion of Other Party: A covenant of good faith and fair dealing implied in

every contract under the laws of most states. Essence of implied covenant is that neither party will do anything to destroy other party's right to receive the benefit of the contract. [E.g., Cates Construction, Inc. v. Talbot Partners, 21 Cal. 4th 28, 43 (1999)].

However implied terms cannot be used to contradict or vary the express terms of the contract.

[E.g., Carma Developers (Cal.), Inc. v. Marathon Development California, Inc., 2 Cal. 4th 342, 374 (1992)].

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[3] Discretion of Other Party: Ontario law is unclear if a duty of good faith arises in all

circumstances. “Although Canadian law has not yet recognized a stand-

alone ‘duty of good faith in the performance of a contract that is independent from the terms of the contract, as the United States has done, the jurisprudence establishes that there is an implied contractual duty of good faith not to act in a way that defeats or eviscerates the very purpose and objective of the agreement”. [Nareerux Import Co. v. Canadian Imperial Bank of Commerce, 2009 ONCA 764 at para 69].

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[3] Discretion of Other Party: Sole discretion to accept or reject [or similar

types of discretion]: The right to exercise discretionary power affecting the rights of the other party is subject to implied covenant of good faith and fair dealing even if "sole" discretion.*

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*Locke v. Warner Bros., 57 Cal. App. 4th 354, 367 (1997); Gabana Gulf Distrib., Ltd. v. Gap Int'l Sales, Inc., 2008 U.S. Dist. LEXIS 1658, 23-24 (N.D. Cal. Jan. 9, 2008). See Mattei v. Hopper, 51 Cal. 2d 119, 123-124 (1958) (subjective satisfaction right must be exercised honestly and in good faith); Greenberg v Meffert, 1985 CarswellOnt 727 (can be objective or subjective); Partec Lavalin Inc. v. Meyer, [2001] A.J. No. 764.


[3] Discretion of Other Party: Contrast with sole discretion: Express right to

act or not act or to terminate:Express right to engage or not engage in acts or conduct is enforceable and generally not subject to the implied covenant of good faith and fair dealing, if the contract otherwise supported by adequate consideration.*

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*See generally Carma Developers (Cal.), Inc. v. Marathon Dev. California, Inc., 2 Cal. 4th 342, 374 (1992); Beraha v. Baxter Health Care Corp., 956 F.2d 1436, 1442 (7th Cir. 1992); Wolf v. Walt Disney Pictures & Television, 162 Cal. App. 4th 1107 (2008).


[3] Discretion of Other Party: Contrast with Missing Promise to Perform:

Covenants to use "good faith" or "best efforts" to generate profits for a licensor or other party are routinely implied when exclusive rights are granted with no corresponding promise to perform.*

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*Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798, 805 (1995) (market or refrain from marketing product); Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. 88, 91 (N.Y. 1917) (promise lacking, but contract "instinct with obligation"); Dawson v. Helicopter Exploration Co., 1955 CarswellBC 181 (S.C.C.)(followed in Canada).

Transactional Ambiguities: [4] Trap Doors

[4] Trap Doors and Back Doors: Anti-Assignment Clause as an Example

"Assignment. Neither party shall assign, transfer, delegate, sublicense or otherwise dispose of, whether voluntarily or involuntarily, by merger or operation of law or otherwise (collectively "Transfer"), this Agreement or any of its rights or obligations under this Agreement, without the prior written consent of the other party, which consent [shall not be unreasonably withheld] [may be withheld in its sole discretion]. As used herein, the term “Transfer" shall include without limitation any [material] change in the ownership or control of a party, including but not limited to the issuance or sale or other transfer of a majority of the voting stock or other ownership interests of such party in one or more transactions. Any purported Transfer by a party, except as expressly permitted herein, (i) shall be null and void and (ii) shall be deemed a material breach of this Agreement and grounds for immediate termination for cause."

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[4] Anti-Assignment Clause[1] "Null and void."

Contract provisions limiting or prohibiting assignments only limit a party's right to assign the contract, but not its power to do so, unless the contrary intent of the parties is set forth in the contract by use of "null and void" or similar language.

[Restatement 2d, Contracts §322(2)(a), (b); Cal. Civ. Code §§1457, 1458]

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[4] Anti-Assignment Clause Without "null and void" or similar language expressly

declaring the invalidity of the assignment, the assignment of the rights of a party generally will be effective to the assignee notwithstanding a general prohibition. The other party then would have a claim for damages for breach of contract.*

In Canada it does not appear that “null and void” language is required.**

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* Foad Consulting Group v. Musil Govan Azzalino, 270 F.3d 821, 831 (9th Cir. 2001) (development rights transferred notwithstanding anti-assignment clause); Pro Cardiaco Pronto Socorro Cardiologica S.A. v. Trussell, 863 F. Supp. 135, 137 (S.D.N.Y. 1994); Cal. Civ. Code §1458.

** Centurion Capital Corp. v. Wal-Mart Canada Inc., 1999 CarswellOnt 3896].


[4] Anti-Assignment Clause Exceptions for certain classes of transactions,

including purported assignments of nonexclusive patent licenses and nonexclusive copyright licenses. These are considered personal to the licensee and not assignable without consent.*

Certain categories of contracts are not assignable under Canadian law. [Re 433616 Ontario Inc., 1992 CarswellOnt 1077)].

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*Everex Sys. v. Cadtrak Corp. (In re CFLC, Inc.), 89 F.3d 673, 675 (9th Cir. 1996); Harris v. Emus Records Corp., 734 F.2d 1329, 1333 (9th Cir. 1984); SMC Promotions, Inc. v. SMC Promotions, 355 F. Supp. 2d 1127, 1133 (C.D. Cal. 2005).


[4] Anti-Assignment Clause[2] Back Door Assignment by Sale of Stock The sale of the stock of a corporation does not

constitute an assignment or transfer of the property or assets of the corporation, including any contract to which the corporation is a party.*

*E.g., Baxter Healthcare Corp. v. O.R. Concepts, Inc., 69 F.3d 785, 788 (7th Cir. 1995); Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489, 494 (1st Cir.), cert. denied, 521 U.S. 1120, 117 S. Ct. 2511, 138 L. Ed. 2d 1014 (1997) ("Absent compelling grounds for disregarding its corporate form" separate legal identity and ownership of contracts "survive without interruption notwithstanding repeated and even drastic changes in its ownership").

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[4] Anti-Assignment Clause[2] Back Door Assignment by Sale of Stock To avoid an indirect but effective transfer of the

contract by sale of the stock of the other party to a competitor or others, it is necessary to define "assign" in the clause to include a change of control or ownership of the party.[See United States Cellular Inv. Co. of Los Angeles, Inc. v. Airtouch Cellular, 2000 U.S. Dist. LEXIS 4731, 20-21 (C.D. Cal. Mar. 27, 2000)].

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Transactional Ambiguities: [5] Scope

[5] Overbroad or Imprecise Scope It is necessary to determine as a substantive

transactional matter whether key provisions of the contract are overbroad or imprecise from the position of the Company. For example:

Choice of Law: Consider whether the Company should bifurcate its choice of law provisions in order to maximize the potential benefits of applicable law, and avoid recognized risks from certain legal jurisdictions.

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Example:"This Agreement and all matters arising out of or relating to or in connection with this Agreement shall be governed by and construed in accordance with the laws of China; provided however that (i) all matters concerning the ownership, scope, validity, enforceability or infringement of the Intellectual Property of Company shall be exclusively governed and construed in accordance with the laws of the State of California and the federal laws of the United States of America; and provided further that Section ____ hereof (Arbitration) shall be exclusively governed by and construed in accordance with the [US Federal Arbitration Act]; in each case without reference to conflicts of law principles."

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[5] Overbroad or Imprecise Scope: Arbitration versus Litigation: Consider whether the

Company wants its key intellectual property issues, or any other subject matter essential to the business Company, decided by a neutral arbitrator with no rights of appeal.

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Example – Arbitration Clause: "Except for controversies or claims primarily arising out of or relating to the ownership, scope, validity, enforcement or infringement of any Intellectual Property Rights (collectively "Rights Claims"), all controversies or claims arising out of or relating to the Agreement shall be finally settled under the Rules of Arbitration of the International Chamber of Commerce in accordance with such Rules."

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[5] Overbroad or Imprecise Scope: Defective substantive scope: Apple Computer v.

Microsoft, 35 F.3d 1435 (9th Cir. 1994) (license to Microsoft of Apple Macintosh graphical interface for "derivative works" in Windows 1.0, permitting use of Macintosh GUI in subsequent Windows versions).

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Transactional Ambiguities: Moment of Zen

Apple Computer v. Microsoft, 35 F.3d 1435 (9th Cir. 1994):

“The 1985 Agreement licensed [to Microsoft] the right to use the visual displays generated by Apple's Lisa and Macintosh graphic user interface programs which appeared as derivative works in Windows 1.0. As a result, to the extent that later versions of Windows…use the visual displays in Windows 1.0 (which came from Apple), that use is authorized…. [T]he Agreement [further] has an integration clause which precludes contradicting its terms by collateral understandings.”

“Apple's further contention that the district court's interpretation of the Agreement must be wrong because it would be unreasonable to suppose that Apple knowingly gave away its most valuable technological asset ignores the fact that Apple itself received valuable consideration under the Agreement: the right to use and license any new displays created by Microsoft within five years, together with Microsoft's promises to delay release of an IBM-compatible version of Excel and to release an improved version of Microsoft Word for the Macintosh.”

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Transactional Ambiguities: [6] Surprise Parties

[6] Unintended "surprise" parties: Affiliates or controlled intermediaries of a party can be

used to manipulate the economics of the transaction or the legal rights and obligations of the other party.

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[6] Rudimentary Example A:Indemnification from Third Party Claims

"Company shall fully indemnify, hold harmless and defend ABC from any and all [damages, losses and liabilities] based on or resulting from any third party claim that …."

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[6] "Third Parties" Persons or entities who are not named parties or signatories are generally considered to be "third parties" with respect to a contract.

[See Westinghouse Electric Corp. v. Superior Court of Alameda County, 17 Cal. 3d 259, 274 (1976)(separate legal status of a subsidiary disregarded only in cases of fraud or injustice); Cal. Civ. Code § § 1550, 1558].

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[6] "Third Parties" Consider limiting the ability of an assignee or affiliate or other intermediary under the control of a party to act as a nominal “third party” or straw person.

For example:

“For purposes hereof, ‘third party’ shall mean a person or entity wholly unrelated to the indemnified party or any Affiliate thereof, and shall not include any Affiliate or assignee of the indemnified party or any other person or entity under the control of or acting in concert with the indemnified party, whether directly or indirectly.”

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[6] Rudimentary Example B: Revenue or Royalty Manipulation

"Licensee shall pay to Licensor a royalty equal to Seven Percent (7%) of Net Sales of the Products for each calendar quarter. "Net Sales" shall be defined as the aggregate adjusted gross [sales price] [royalties] received by Licensee during the relevant calendar quarter from the sale or other disposition of the Products."

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Involvement of affiliates or controlled intermediaries of the party can result in revenue or royalty manipulation. For example: Below-market sales of products by the licensee party for

royalty purposes to affiliates or controlled intermediaries, which then resell the products at a higher market price without additional royalties.

Sublicensing to foreign or other affiliates or controlled intermediaries in exchange for percentage royalty paid to licensee party on sales made at source, so that upstream royalties paid to licensing party represent only a percentage of a percentage - for example, an effective royalty of 5 percent of 5 percent, or only 0.25 percent.

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Possible solutions to “surprise parties” issue: All sales by the licensee party or its affiliates or

controlled intermediaries are aggregated and included in Net Sales for royalty purposes; or all sales or distributions to affiliates and controlled intermediaries are deemed sold at the then standard price for unrelated third parties at the relevant level of distribution.

All sales are deemed made "at source" and all royalties are computed as if made at source by the licensee party.

Assertion of implied covenant of good faith and fair dealing for gross manipulations of the contract. »

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In Closing

Best of luck!

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STAFFORD MATTHEWSPartnerDentons US LLP1530 Page Mill Road, Suite 200Palo Alto, California 94304T +1 650 798 0380 M +1 415 815 9850 [email protected] in California and England and Wales (SRA. No. 466691)

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© 2014 DentonsDentons is an international legal practice providing client services worldwide through its member firms and affiliates. This publication is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content. Please see dentons.com for Legal Notices.

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