System Shocks and Collaborative Contract Innovation

Impetus for innovation in the design of contracts often comes from "shocks" in courts, markets, or regulation. When such shocks occur, contract drafters seek to understand them and to respond by revising contractual language to meet the goals of the contracting parties. The Harvard Law School contracts wiki has been established to promote collaborative contract innovation. The blog below contains brief articles describing the system shocks — judicial decisions, changing markets, and new regulations — that may elicit changes in contract language. In most cases, the articles also contain links to sample contract language that responds to the reported developments. The articles in the blog are tagged with litigation, markets, and regulatory labels that, if selected, allow you to filter the postings according to the type of shock.

Market MACs in Credit Agreements After the Credit Crunch

Since the severe downturn in credit markets during the second half of 2007, some lenders have invoked material adverse change clauses to escape lending commitments (or similar agreements such as rate lock). These actions have been challenged by borrowers in court: e.g. Citigroup's commitment to Solutia to provide $1 billion in exit financing from Chapter 11; Citigroup's rate lock agreement with real estate developer Whitnall Glen; Prudential's rate lock agreement with borrower Langley (Langley v. Prudential Mortgage Capital Company (E.D.Ky. Civ. 07-cv-404-JMH). Such litigation is likely to prompt revision of market MACs in lending agreements.

In loan applications, in rate lock agreements or in commitments, lenders often wish to retain discretion to avoid the commitment or revise the interest rate upon the occurrence of significant shocks in capital markets, especially when they affect syndication or securitization prospects. In some cases where the lender has not issued a commitment, it relies on its general discretion not to go forward with the financing. However, that discretion might seem to contemplate only changes in credit risk associated with company- or industry-specific factors. So, it would seem advisable for the contract to include more specifically changes in capital markets.

Beneficial Ownership By-law Disclosure Proposal

According to a posting on the Harvard Law School Corporate Governance Blog by Philip A. Gelston of Cravath, Swain & Moore LLP, and an accompanying law firm memo, activist investors often accumulate large, and sometimes dominant, positions in target companies secretly by using total return swaps and other derivatives. Despite legal claims that these derivative holdings are not the same as beneficial ownership — claims being tested in litigation arising from the recent CSX proxy fight — in reality activists demand that targets, and their boards of directors, defer to the activists as though they were full owners of the stock represented by the derivatives. Some corporations have sought protection with a shareholder rights plan incorporating a broader concept of “beneficial ownership” that captures interests held though derivatives. Other corporations have adopted by-laws requiring extensive disclosure of derivative positions at the time an activist nominates directors or sponsors a shareholder proposal. The memo suggests considering an alternative approach of amending advance notice by-laws governing shareholder proposals to include new continuous disclosure obligations of beneficial ownership interests. In response to this development and the blog posting by Mr. Gelston, participants in this wiki are invited to post sample by-law language drafted in accordance with the following guidelines set forth in the memo.

Consequential Damage Waivers in Acquisition Agreements

The following posting by Glenn D. West and Sara G. Duran of Weil, Gotshal & Manges appears on the Harvard Law School Corporate Governance Blog. In response to the posting by Mr. West and Ms. Duran, this contracts wiki article includes "broad" and "narrow" versions of a consequential damages waiver, drafted in accordance with the guidelines set forth below in order to favor respectively the seller or the buyer in an acquisition agreement.

Arbitration Appeals after Hall Street

Contracting parties who decide to arbitrate disputes may wish to provide for appeal in cases of legal error. The Supreme Court in Hall Street (6-3) raised an obstacle to judicial review under the Federal Arbitration Act, by holding that judicial review may not be expanded by contract beyond the grounds listed in sections 10 and 11 of the Act. The Hall Street-Mattell contract provided: “[t]he United States District Court for the District of Oregon may enter judgment upon any award, either by confirming the award or by vacating, modifying or correcting the award. The Court shall vacate, modify or correct any award: (i) where the arbitrator’s findings of facts are not supported by substantial evidence, or (ii) where the arbitrator’s conclusions of law are erroneous.”

This contract language is reproduced in the Appeal to the Petition for Cert. 16a. The Supreme Court opinion may be found here.

Some future parties may opt against arbitration as a result. Other parties may provide for two levels of arbitration, with an appeal for errors of law or egregious errors of fact to another set of arbitrators.

Two other alternatives are addressed in this entry. The three dissenting justices (Stevens, Kennedy and Breyer, JJ), at least, seem to view the FAA objective as enforcing clear contractual agreements about arbitration.

Postsale Use Restrictions by Licensors after Quanta Computer

In Quanta Computer, Inc. v. LG Electronics (553 U.S. -- (2008), the Supreme Court applied the doctrine of patent exhaustion to restrict the ability of a patent licensor to restrict the use of a product embodying the patent, following a sale of the product by the licensee to a third party. The Court's opinion suggested that the licensor, however, could maintain some control by contractually limiting the authorization to sell granted to the licensee. According to the court, the license in the case, from LG Electronics to Intel, failed to include such provision, and therefore LG Electronics could not invoke its patent rights to restrict the use of the Intel product by the buyer, Quanta Computer.

"Clawbacks" of Executive Compensation

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According to a posting on the Harvard Law School Corporate Governance Blog by Amy L. Goodman of Gibson, Dunn & Crutcher LLP, and an accompanying law firm memo, provisions addressing the “clawback” of executive compensation have become increasingly common in the past few years. Clawback provisions vary by company, but they share a common goal of enabling companies to recover performance-based compensation to the extent they later determine that performance goals were not actually achieved, whether due to a restatement of financial results or for other reasons.

Beneficial Ownership after CSX

As reported in the Wall Street Journal, at least two companies — Louisiana-Pacific Corp. and Micrel Inc. — have changed their shareholder-rights plans in recent months to include equity derivatives when calculating levels of "beneficial ownership" that would trigger their respective poison pills. This contracts wiki article sets forth two alternative definitions of "beneficial ownership":

  • the definition of beneficial ownership in the Louisiana-Pacific plan; and
  • the comparable definition in the Micrel rights plan.
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