Drafting Contracts: How and Why Lawyers Do What They Do (2013) PDF

[Ed.: This page appears on the inside cover of the print book.] Use the following questions as a quick reference to help guide your decision as to which contract concept will memorialize a specific business term properly. 1. Representation and warranty: Has a party said something on which the oth...

[Ed.: This page appears on the inside cover of the print book.] Use the following questions as a quick reference to help guide your decision as to which contract concept will memorialize a specific business term properly. 1. Representation and warranty: Has a party said something on which the other party is relying? 2. Covenant: Has a party promised to do something in the future? A covenant creates a duty to perform, also known as an obligation. A right is the flip side of a covenant. 3. Discretionary authority: Does a party have a choice or has it been given permission (a kind of choice) to do something? 4. Declaration: Is the business term a definition? Does it establish a policy? (a) To test whether a business term is a declaration, ask whether a party would want a monetary remedy if it were not true. (b) If a party would want a monetary remedy, the business term is not a declaration. It must be either a representation and warranty or a covenant. 5. Conditions: Does the business term require that one thing must happen before another thing happens? Stated differently, must events occur in a chronological sequence? (a) Condition to an obligation (and the obligation). If an event occurs, X has an obligation. (i) Ongoing condition: The condition is not a condition to the performance of a subject matter performance obligation. (ii) Walk-away condition: The condition is a condition to the performance of a subject matter performance obligation. If a walk-away condition is not satisfied, the party for whose benefit the condition exists may (A) choose to waive the failure of the condition and perform the subject matter performance obligation; or (B) choose not to perform the subject matter performance obligation without being in breach and walk away from the contractual relationship. Although the failure of the condition creates a choice for the party that would have had the obligation, the contract provision to be identified is not discretionary authority. It is the condition to an obligation and the obligation. The choice arises as the common law consequence of the failure to satisfy the 2 condition to the subject matter performance obligation, not because of contractual agreement. (b) Condition to discretionary authority (and the discretionary authority): Must an event occur before a party may exercise discretionary authority? (c) Condition to a declaration (and the declaration): Must an event occur before a policy has substantive consequences? (d) If/then test: When creating an if/then statement, the then clause should state who has the obligation to perform or who has the discretionary authority. Correct If X happens, Y is obligated to perform... Do not use the following formulation: Wrong If X does not happen, then Y is not obligated to... This formulation states the common law consequences of the failure to satisfy a condition, not the condition to an obligation and its obligation. 3 Drafting Contracts 4 EDITORIAL ADVISORS Vicki Been Boxer Family Professor of Law New York University School of Law Erwin Chemerinsky Dean and Distinguished Professor of Law University of California, Irvine, School of Law Richard A. Epstein Laurence A. Tisch Professor of Law New York University School of Law Peter and Kirsten Bedford Senior Fellow The Hoover Institution Senior Lecturer in Law The University of Chicago Ronald J. Gilson Charles J. Meyers Professor of Law and Business Stanford University Marc and Eva Stern Professor of Law and Business Columbia Law School James E. Krier Earl Warren DeLano Professor of Law The University of Michigan Law School Richard K. Neumann, Jr. Professor of Law Maurice A. Deane School of Law at Hofstra University Robert H. Sitkoff John L. Gray Professor of Law Harvard Law School David Alan Sklansky Yosef Osheawich Professor of Law University of California at Berkeley School of Law Kent D. Syverud Dean and Ethan A. H. Shepley University Professor Washington University School of Law 5 6 DRAFTING CONTRACTS How and Why Lawyers Do What They Do Second Edition Tina L. Stark Visiting Professor Fordham University School of Law 7 © 2014 Stark Legal Education, Inc. Published by Wolters Kluwer Law & Business in New York. Wolters Kluwer Law & Business serves customers worldwide with CCH, Aspen Publishers, and Kluwer Law International products. (www.wolterskluwerlb.com) No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or utilized by any information storage or retrieval system, without written permission from the publisher. For information about permissions or to request permissions online, visit us at www.wolterskluwerlb.com, or a written request may be faxed to our permissions department at 212-771-0803. To contact Customer Service, e-mail [email protected], call 1-800-234-1660, fax 1-800- 901-9075, or mail correspondence to: Wolters Kluwer Law & Business Attn: Order Department PO Box 990 Frederick, MD 21705 Library of Congress Cataloging-in-Publication Data Stark, Tina L., 1953- author. Drafting contracts: how and why lawyers do what they do / Tina L. Stark, Visiting Professor, Fordham University School of Law. p. cm. Includes bibliographical references and index. eISBN 978-1-4548-2905-8 1. Contracts—United States. 2. Contracts—United States—Language. 3. Legal composition. I. Title. KF807.S73 2013 346.7302’2—dc23 2013039766 8 ABOUT WOLTERS KLUWER LAW & BUSINESS Wolters Kluwer Law & Business is a leading global provider of intelligent information and digital solutions for legal and business professionals in key specialty areas, and respected educational resources for professors and law students. Wolters Kluwer Law & Business con-nects legal and business professionals as well as those in the education market with timely, specialized authoritative content and information-enabled solutions to support success through productivity, accuracy and mobility. Serving customers worldwide, Wolters Kluwer Law & Business products include those under the Aspen Publishers, CCH, Kluwer Law International, Loislaw, ftwilliam.com and MediRegs family of products. 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MediRegs products provide integrated health care compliance content and software solu-tions for professionals in healthcare, higher education and life sciences, including profes-sionals in accounting, law and consulting. Wolters Kluwer Law & Business, a division of Wolters Kluwer, is headquartered in New York. Wolters Kluwer is a market-leading global information services company focused on professionals. 9 10 For Bobby and Mort Weisenfeld, my mother- and father-in-law, who have always treated me as if I were their daughter For their son Dave, my best friend and beloved husband and For their grandson Andy, my wondrous treasure 11 About the Author Tina L. Stark is a Visiting Professor at Fordham University School of Law, where she was an adjunct from 1993-2007. In 2012, the Burton Foundation honored her with its Award for Outstanding Contributions to Legal Writing Education for her work on contract drafting. In 2011, she was one of 26 professors chosen from a nationwide search to be included in the study What the Best Law Teachers Do.1 From 2007-2011, Professor Stark taught at Emory University School of Law, where she was a Professor in the Practice of Law and the first Executive Director of that school’s Cen-ter for Transactional Law and Practice. While there, she created a multi-year, integrated transactional skills curriculum designed to graduate students with both a doctrinal founda-tion and the skills to provide an employer value beginning on Day 1. During the 2011-2012 academic year, Professor Stark was a Professor of the Practice of Law at Boston University School of Law and the Founding Director of that school’s Transactional Program. Professor Stark is a former corporate partner at Chadbourne & Parke LLP. While there, she had a broad- based transactional practice that included acquisitions, dispositions, recap-italizations, and financings. In addition, she developed and implemented the firm’s corporate training program. Before entering law school, Professor Stark was a commercial banker at Irving Trust Company. When teaching, Professor Stark emphasizes the relationship between law and busi-ness, drawing on her experience as a corporate partner at Chadbourne and as a commercial banker at Irving Trust Company. In addition to teaching at law schools, Professor Stark has lectured on law and business issues for CLE organizations and at firms, corporations, and government agencies in the United States, Canada, England, Italy, China, and Poland. As a consultant, she assisted a London law school in creating and implementing its transactional skills curriculum. After receiving her A.B., with honors, from Brown University, Professor Stark earned her J.D. from New York University School of Law, where she was a contributing editor to the Journal of International Law & Politics. Following law school, she clerked for Judge Jacob D. Fuchsberg of the New York State Court of Appeals and was an associate with Bar-rett Smith Schapiro Simon & Armstrong. Professor Stark is the editor-in-chief and co-author of Negotiating and Drafting Con-tract Boilerplate, publisher, American Lawyer Media (2003). 1. Michael Hunter Schwartz, Gerald F. Hess, & Sophie M. Sparrow, What the Best Law Teachers Do (Harv. U. Press 2013). 12 Summary of Contents Preface to the Second Edition Preface to First Edition Acknowledgments to Second Edition Acknowledgments to First Edition Part 1 Translating the Business Deal into Contract Concepts Chapter 1 A Few Words About Contract Drafting and This Book Chapter 2 The Building Blocks of Contracts: The Seven Contract Concepts Chapter 3 Translating the Business Deal into Contract Concepts: Part 1 (Representations and Warranties & Covenants and Rights) Chapter 4 Translating the Business Deal into Contract Concepts: Part 2 (Conditions, Discretionary Authority, and Declarations) Part 2 Drafting a Contract’s Parts Chapter 5 A Contract’s Parts Chapter 6 Introductory Provisions: Preamble, Recitals, and Words of Agreement Chapter 7 Definitions and Defined Terms Chapter 8 Action Sections Chapter 9 Representations and Warranties Chapter 10 Covenants and Rights Chapter 11 Conditions to an Obligation Chapter 12 Discretionary Authority and Declarations Chapter 13 Will and Shall Chapter 14 Drafting the Contract Concepts — A Summary Chart Chapter 15 Endgame Provisions Chapter 16 General Provisions Chapter 17 Signatures 13 Part 3 Drafting Clearly and Unambiguously Chapter 18 Legalese Chapter 19 Clarity through Format Chapter 20 Clarity through Sentence Structure Chapter 21 Ambiguity Chapter 22 Numbers and Financial Provisions Chapter 23 A Potpourri of Other Drafting Considerations Chapter 24 Deconstructing Complex Provisions Part 4 Drafting from the Client’s Perspective Chapter 25 Adding Value to the Deal Part 5 Putting a Contract Together Chapter 26 Organizing a Contract and Its Provisions Chapter 27 The Drafting Process Chapter 28 How to Review and Comment on a Contract Chapter 29 Amendments, Consents, and Waivers Part 6 Drafting Ethically Chapter 30 Ethical Issues in Drafting Part 7 Additional Exercises Chapter 31 Additional Exercises Part 8 Exemplars and Guided Reading Exercises Chapter 32 Exemplars and Guided Reading Exercises Exhibit Escrow Agreements Index 14 15 Contents Preface to the Second Edition Preface to First Edition Acknowledgments to Second Edition Acknowledgments to First Edition Part 1 Translating the Business Deal into Contract Concepts Chapter 1 A Few Words About Contract Drafting and This Book 1.1 Introduction 1.2 What Does a Contract Do? 1.3 What Are a Contract’s Goals? 1.4 What Is the Context Within Which Contracts Are Drafted? 1.5 Does This Book Cover All Kinds of Contracts? 1.6 Why Should You Learn to Draft if You Plan to Litigate? 1.7 What Will This Book Teach You? 1.8 How Is This Book Organized? 1.9 Stylistic Matters 1.10 Some Final Words Chapter 2 The Building Blocks of Contracts: The Seven Contract Concepts 2.1 Introduction 2.2 Capsule Definitions 2.3 Translating the Business Deal into Contract Concepts Chapter 3 Translating the Business Deal into Contract Concepts: Part 1 (Representations and Warranties & Covenants and Rights) 3.1 Introduction 3.2 Representations and Warranties 16  3.2.1 Definitions 3.2.2 Remedies 3.2.3 Why a Party Should Receive Both Representations and Warranties 3.2.4 Risk Allocation 3.3 Covenants 3.3.1 Definitions and Uses of Covenants 3.3.2 Degrees of Obligation 3.3.3 Remedies 3.4 Rights Chapter 4 Translating the Business Deal into Contract Concepts: Part 2 (Conditions, Discretionary Authority, and Declarations) 4.1 Introduction 4.2 Conditions to Obligations 4.2.1 The Basics 4.2.2 Ongoing Conditions and Walk-away Conditions 4.2.3 Relationship between Conditions and Covenants in Acquisition Agreements and Financings 4.2.4 Risk Allocation 4.3 Discretionary Authority 4.4 Declarations 4.5 A Contract’s Building Blocks Appendix 1: Contract Concepts Appendix 2: Summary Chart Part 2 Drafting a Contract’s Parts Chapter 5 A Contract’s Parts 5.1 Introduction 5.2 Introductory 17  5.2.1 Provisions Preamble 5.2.2 Recitals 5.2.3 Words of Agreement 5.3 Defined Terms and Definitions 5.4 Action Sections 5.4.1 Subject Matter Performance Provisions 5.4.2 Payment Provisions 5.4.3 Term 5.5 Closing-related Provisions 5.6 Other Substantive Business Provisions 5.7 Endgame Provisions 5.8 General Provisions 5.9 Signature Lines 5.10 Schedules and Exhibits 5.10.1 Introduction 5.10.2 Schedules 5.10.3 Exhibits Exercises Chapter 6 Introductory Provisions: Preamble, Recitals, and Words of Agreement 6.1 Introduction 6.2 Preamble 6.2.1 Name of the Agreement 6.2.2 Date 6.2.3 Parties 6.2.3.1 Identifying the Parties 18  6.2.3.2 Defining the Parties 6.2.4 Defining the Agreement 6.3 Recitals 6.4 Words of Agreement 6.5 Cover Page and Table of Contents Exercises Chapter 7 Definitions and Defined Terms 7.1 Introduction 7.1.1 Definitions 7.1.2 Defined Terms 7.2 Strategic Concerns in Defining Terms 7.3 Definitions as Standard-setting Tools 7.4 Placement of Definitions 7.5 Guidelines for Drafting Definitions and Defined Terms 7.5.1 General Guidelines 7.5.2 Specific Guidelines: Defining Terms in the Definitions Section or Article 7.5.3 Specific Guidelines: Defining Terms in Context 7.6 Other Provisions in the Definitions Section Exercises Chapter 8 Action Sections 8.1 Introduction 8.2 Subject Matter Performance Provision 8.3 Payment Provisions 8.4 Term 8.5 Special Provisions in Acquisitions and Financings 19  8.5.1 Action Sections in Acquisitions 8.5.2 Closings and the Closing Date in Acquisitions and Financings 8.5.3 Closing Deliveries in Acquisitions and Financings Exercises Chapter 9 Representations and Warranties 9.1 Introduction to Chapters 9 through 14 9.2 General Comments on Drafting Representations and Warranties 9.3 Drafting the Substance of Representations 9.3.1 Representations with Respect to the Past, Present, and Future 9.3.2 Active vs. Passive Voice 9.4 Warranties 9.4.1 Warranties with Respect to the Future 9.4.2 Risk Allocation Exercises Chapter 10 Covenants and Rights 10.1 Drafting the Substance of Covenants 10.2 Drafting Guidelines 10.3 Covenant Articles in Acquisition Agreements Exercises Chapter 11 Conditions to an Obligation 11.1 Introduction 11.2 Drafting the Substance of a Condition to an Obligation 11.3 Signaling a Condition Outside of a Conditions Article in an Acquisition or a Financing Agreement 11.4 Conditions Inside a Conditions Article in an Acquisition or a Financing Agreement 11.4.1 Signaling a Condition Inside a Conditions Article in an Acquisition or a Financing Agreement 20  11.4.2 Contractual Consequences of a Failed Condition 11.4.3 Relationship between Covenants and Conditions in an Acquisition Agreement 11.4.4 In an Acquisition Agreement, Whose Condition Should It Be? Exercises Chapter 12 Discretionary Authority and Declarations 12.1 Discretionary Authority 12.1.1 Drafting the Substance of a Discretionary Authority Provision 12.1.2 Signaling Discretionary Authority 12.1.3 Conditions to Discretionary Authority 12.1.4 Discretionary Authority Posing as a Declaration 12.2 Declarations Exercise Chapter 13 Will and Shall 13.1 Introduction 13.2 When to Use Will 13.3 When to Use Shall and Testing Whether Shall Is Correct Chapter 14 Drafting the Contract Concepts—A Summary Chart Exercises Chapter 15 Endgame Provisions 15.1 Introduction 15.2 Some General Comments on the Terms Notice of Termination and Termination Notice 15.3 General Comments on Grounds for Termination 15.4 Neutral Terminations 15.4.1 What Constitutes Neutral Termination 15.4.2 Contractual Consequences of Receipt of Notice of Termination; Termination Date 21  15.4.3 Survival of Common Law Rights and Obligations and Specified Contractual Provisions 15.5 Friendly Terminations 15.5.1 What Constitutes a Friendly Termination 15.5.2 Termination Notice, Contractual Consequences of Receipt of Termination Notice, and Termination Date 15.5.3 Survival of Common Law Rights and Obligations and Specified Contractual Provisions 15.6 Unfriendly Terminations 15.6.1 What Constitutes an Unfriendly Termination and Details of a Termination Notice 15.6.1.1 What Constitutes an Unfriendly Termination 15.6.1.2 Some Details of a Termination Notice 15.6.2 Consequences of Termination Notice of an Unfriendly Termination 15.6.2.1 Grace Period and the Opportunity to Cure 15.6.2.2 Contractual Consequences of Receipt of Termination Notice — Monetary and Nonmonetary 15.6.2.2.1 Price Adjustments 15.6.2.2.2 Self-help 15.6.2.2.3 Default Interest 15.6.2.2.4 Injunctive Relief 15.6.2.2.5 Liquidated Damages 15.6.2.2.6 Indemnities 15.6.2.2.7 Cumulative v. Exclusive Remedies 15.6.2.2.8 Payment Provisions 15.6.2.2.9 Setoff Provisions 15.6.2.2.10 Immediate Termination on Receipt of Termination Notice 15.6.2.3 Survival of Common Law Rights and Obligations and Specific Contract Provisions 15.7 Dispute Resolution Provisions 22 15.8 Location of the Endgame Provisions 15.9 Drafting the Endgame Provisions 15.10 Endgame Chart Exercises Chapter 16 General Provisions 16.1 Introduction 16.2 Assignment and Delegation 16.2.1 The Basics of Assignments and Delegations 16.2.2 Anti-assignment Provisions 16.2.3 Anti-delegation Provisions 16.3 Successors and Assigns 16.4 Governing Law 16.5 Waiver of Right to a Jury Trial 16.6 Notice 16.7 Severability 16.8 Amendments 16.9 Merger 16.10 Counterparts Exercises Chapter 17 Signatures 17.1 Introduction 17.2 Execution and Delivery 17.2.1 Definitions 17.2.2 Delivery and Contract Formation 17.3 The Concluding Paragraph 23 17.4 Drafting the Signature Blocks 17.4.1 The Basics 17.4.2 Drafting the Signature Block of an Individual 17.4.3 Drafting the Signature Block of a Corporation 17.4.4 Drafting the Signature Blocks of a General Partnership, a Limited Partnership, and a Limited Liability Partnership 17.4.5 Drafting the Signature Block of a Limited Liability Company 17.4.6 Drafting Officers’ Certificates 17.5 Mode of Execution 17.5.1 E-signatures 17.5.2 Counterparts 17.5.3 Stand-alone Signature Pages 17.6 Antifraud Mechanisms 17.7 Initialing Other than as an Antifraud Mechanism 17.8 Acknowledgments Exercise Part 3 Drafting Clearly and Unambiguously Chapter 18 Legalese 18.1 Introduction 18.2 Formal and Archaic Words 18.3 Couplets and Triplets 18.4 Pretentious and Verbose Expressions Exercises Chapter 19 Clarity through Format 19.1 Introduction 19.2 Sections and Subsections 24 19.3 Tabulation 19.3.1 Explanation of Tabulation and When to Use It 19.3.2 How to Tabulate 19.3.3 Multilevel Tabulation 19.3.4 Double Tabulation 19.4 Numbering Systems 19.5 Headings 19.6 Table of Contents 19.7 Typography Exercises Appendix: Tabulation Guidelines Chapter 20 Clarity through Sentence Structure 20.1 Introduction 20.2 Short Sentences 20.3 Sentence Core 20.3.1 Keep the Core Together 20.3.2 Reduce the Number of Words Preceding the Core Words 20.4 Short Before Long 20.4.1 Put Short Phrases Before Long Phrases 20.4.2 Put the Short Equivalent as the Subject in a Declaration Exercises Chapter 21 Ambiguity 21.1 Introduction 21.2 Ambiguity and Vagueness 21.2.1 Definition of Ambiguity 25  21.2.2 Vagueness Distinguished from Ambiguity 21.3 Ambiguities Arising from And and Or 21.3.1 The Meaning of And and Or 21.3.2 And and Or in the Same Sentence 21.3.3 And/Or 21.4 Ambiguities Arising from Sentence Structure 21.4.1 Modifiers of Items in a Compound or Series 21.4.2 Multiple Adjectives 21.4.3 Sentence Ending with a Because Clause 21.4.4 Successive Prepositional Phrases 21.5 Say the Same Thing the Same Way 21.5.1 Establishing Standards 21.5.2 Craftsmanship 21.5.3 Issues in Acquisition and Credit Agreements: Representations and Warranties v. Covenants 21.5.4 Similar Provisions in More than One Agreement 21.5.5 Contract Provisions and Documents Based on Statutory Provisions 21.6 Dates, Time, and Age 21.6.1 Dates 21.6.1.1 The Problems 21.6.1.2 The Cures 21.6.2 Time 21.6.2.1 Measurement of Time Periods 21.6.2.2 Time of Day 21.6.3 Age 21.7 Using If/then Formulations to Draft Conditions 26 21.8 Plurals 21.9 Provisos Exercises Chapter 22 Numbers and Financial Provisions 22.1 Introduction 22.2 How to Draft Provisions Using Numbers 22.3 How to Draft Mathematical Formulas 22.3.1 Basic Mathematical Operations 22.3.2 The Order of Mathematical Operations 22.3.3 Drafting the Formula 22.4 How to Draft Provisions Involving Financial Statement Concepts 22.4.1 GAAP as an Evolving Standard 22.4.2 GAAP’s Authorization of Alternative Methods 22.4.3 Non-GAAP Alternatives 22.4.4 Provisions Using Balance Sheet Accounts 22.4.5 Provisions Using Revenue and Earnings Concepts Exercises Chapter 23 A Potpourri of Other Drafting Considerations 23.1 Gender-neutral Drafting 23.2 The Cascade Effect 23.3 Exceptions 23.3.1 How to Signal an Exception 23.3.2 Placement of the Exception 23.3.3 Except as Otherwise Provided 23.4 Notwithstanding Anything to the Contrary 27 23.5 Including 23.5.1 Including Is Restrictive 23.5.2 Including Is a Term of Enlargement 23.5.3 Including Signals That Illustrations Follow 23.5.4 What Should the Drafter Put in the Contract? 23.5.5 Avoiding Clunky and Redundant Drafting 23.5.6 Without Limiting the Generality... 23.6 Ejusdem Generis 23.7 Expressio Unius Est Exclusio Alterius 23.8 Contra Proferentem 23.9 Deem 23.10 Nominalizations 23.11 Parallel Drafting 23.12 Respectively 23.13 As the Case May Be 23.14 There Is and There Are 23.15 The Possessive Exercises Chapter 24 Deconstructing Complex Provisions 24.1 The Six-step Process 24.1.1 Explicate 24.1.2 Create Clarity through Format 24.1.3 Create Clarity through Sentence Structure 24.1.4 Clarify Ambiguities 24.1.5 Root Out Legalese 28  24.1.6 Check Substance Exercise Part 4 Drafting from the Client’s Perspective Chapter 25 Adding Value to the Deal 25.1 Introduction 25.2 Money 25.2.1 Amount to Be Paid or Received 25.2.2 Timing of Payments 25.2.3 Credit Risk 25.2.4 Issues Relating to Payment Formulas 25.2.5 Transaction Expenses 25.2.6 Accounting and Tax Issues 25.2.7 Who, What, When, Where, Why, How, and How Much? 25.2.8 Endgame 25.3 Risk 25.3.1 Types of Risk 25.3.2 Evaluating the Risk 25.3.3 Methods to Mitigate Risk 25.4 Control 25.5 Standards 25.6 Endgame Exercises Part 5 Putting a Contract Together Chapter 26 Organizing a Contract and Its Provisions 26.1 Introduction 29 26.2 A Contract’s Organizational Structure 26.2.1 Organization at the Macro Level 26.3 Organization of the Business Provisions and Individual Provisions 26.3.1 Subject Matter and Relative Importance 26.3.2 Contract Concepts 26.3.3 Chronology 26.3.4 Party 26.4 Organization of Acquisition Agreements Exercises Chapter 27 The Drafting Process 27.1 Introduction 27.2 Agreeing to the Business Terms 27.3 Determining Who Drafts the Contract 27.4 Learning about a Transaction 27.4.1 Learning about a Transaction from a Client 27.4.2 Learning about a Transaction from a Supervising Lawyer 27.5 Preparing to Draft a Contract 27.5.1 Researching the Law and Obtaining the Advice of Specialists 27.5.2 Researching the Parties and the Industry 27.6 Drafting with and without a Precedent 27.6.1 Choosing a Precedent 27.6.2 Using a Precedent 27.6.3 Drafting without a Precedent 27.7 The Logistics of Drafting a Contract 27.8 Drafting a Contract 30  27.8.1 Other Drafters 27.8.2 Translating the Business Deal into Contract Concepts 27.8.3 Drafting the First Draft 27.8.3.1 How to Begin 27.8.3.2 The Definitions 27.8.3.3 The Business Provisions 27.8.3.4 Finalizing the Contract 27.8.4 Redrafting the Contract 27.8.4.1 The Cover Memo Exercises Chapter 28 How to Review and Comment on a Contract 28.1 Introduction 28.2 Prepare 28.3 Contract Analysis: How to Read and Understand a Contract Provision 28.4 Get Your Bearings 28.5 Read the Key Business Provisions 28.6 Read the Entire Contract 28.7 Prepare Comments 28.7.1 Markups 28.7.2 A Memorandum 28.7.3 Oral Comments Exercise Appendix: Framework for Contract Analysis — Long Form Chapter 29 Amendments, Consents, and Waivers 29.1 Introduction 31 29.2 Amendments—General Information 29.3 Inside-the-contract Amendments 29.3.1 The Introductory Provisions and the Definitions 29.3.2 Deciding What to Amend 29.3.3 The Action Sections 29.3.4 Other Provisions 29.4 Restated Agreements 29.5 Outside-the-contract Amendments 29.6 Consents 29.6.1 Definitions 29.6.2 Drafting the Request for Consent and the Consent 29.7 Waivers 29.7.1 Definition 29.7.2 Drafting the Waiver 29.8 Choosing between a Consent and a Waiver Exercises Appendix 1: An Inside-the-Contract Amendment Appendix 2: An Outside-the-Contract Amendment in Letter Format Part 6 Drafting Ethically Chapter 30 Ethical Issues in Drafting 30.1 Introduction 30.2 The Drafter’s Role 30.3 The Drafter’s Responsibility 30.4 Interactions with Third Parties Exercises 32 Part 7 Additional Exercises Chapter 31 Additional Exercises Exercise 31-1: Revised Car Purchase Agreement Exercise 31-2: Aircraft Purchase Agreement Exercise 31-3: Revised Aircraft Purchase Agreement Exercise 31-4: Amendment to the Aircraft Purchase Agreement Exercise 31-5: Shoeless Joe Jackson Exercise Exercise 31-6: National Security Exercise Exercise 31-7: Closing Certificate Exercise Exercise 31-8: Endgame Exercise Exercise 31-9: Ellsworth Agreement Exercise 31-10: Trademark Licensing Agreement Part 8 Exemplars and Guided Reading Exercises Chapter 32 Exemplars and Guided Reading Exercises Document 1—House Purchase Agreement Document 2—Website Development Agreement (Version 1) Document 3—Assignment and Assumption Agreement Document 4—The Action Sections of an Asset Purchase Agreement Document 5—Bill of Sale Document 6—Endgame Provisions in Acquisition Agreements Document 7—Drafting Client Memoranda Document 8—Website Development Agreement (Version 2) Exhibit Escrow Agreements Index 33 34 Preface to the Second Edition The following discussion occurred in 2005 between the publisher’s editors and me —before I signed the contract for the First Edition: Person 1: It’s a great idea. Person 2: But there’s no market. Persons 1 and 2 and me: If we build it, they will come. And you came —in numbers I never thought possible. Enough of you came, you could almost say that Contract Drafting has become a mainstream course. Indeed, enough of you came, that the publisher said, “Write a second edition.“ So, here it is. Highlights of the Second Edition 1. The Second Edition retains the same organizational structure and pedagogy as the First Edition, but with two additions. First, students will spend more time learning how to work with precedents. For example, the textbook includes a well-drafted House Purchase Agreement that students can use as a precedent for the Car Pur-chase Agreement. Second, students will learn contract analysis —how to read a contract. The Teachers’ Manual includes the pedagogy and many of the textbook’s exercises do double-duty, so teaching this new skill will fit easily into most syllabi. 2. Most chapters have expanded discussions of their respective content, along with new exercises. 3. The Second Edition virtually completely overhauls Chapter 15 —Endgame. It now discusses in detail common contractual remedies and provides a multitude of exem-plars. The exemplars come from a host of contracts, so students can see the provi-sions at work. Among the contracts from which the provisions have been taken are a grocery supply agreement, a construction agreement, a theater lease, and a movie distribution agreement. 4. Chapter 16 —General Provisions now includes examples of well-drafted provisions, so that students have basic precedents going forward. 5. Scattered throughout the book and in Chapter 32 are multiple well-drafted exemplars for students. These exemplars are more than bare bones contracts. The Chapter 32 exemplars are populated with annotations that explain associated business and legal issues and ask questions designed to help students problem solve the agreement’s drafting. These annotations give students context for what they are reading and help avert a mindless markup. I call the pedagogy for using the annotations guided reading. 35  6. The textbook has revised the Aircraft Purchase Agreement exercise. By omitting some provisions and redrafting others, the APA more directly addresses the sig-nificant issues. The memos giving instructions are also more targeted. In addition, Chapter 32 includes exemplars of action sections and endgame sections in acquisi-tion agreements so that students gain practice working with precedents. This move reduces the textbook’s narrative discussions on acquisitions —a topic not all profes-sor want to teach. 7. The poorly drafted, much-maligned Asset Purchase Agreement appears no longer in the textbook’s appendices. But it’s on the website for anyone who grew attached to it. 8. The website will include significant new material: (a) Multiple exercises not included in the textbook (b) Standard comments that you can use when grading some of the more signifi-cant exercises. They are in a Word document, listed in order by section num-ber. All you need to do is copy and paste the comment into a Word Comment bubble—and then tailor as necessary. These standard comments work because students regularly make the same mistakes because provisions target a specific pedagogic issues. So, when a student errs in her drafting, the error probably resembles the same error of previous students. I update these comments regu-larly, so please check the website right before you use the comments. (c) Proposed grading suggestions. The grading document allocates to each draft-ing, business or legal issue a number of points reflective of the issue’s difficulty; for example, fewer points for the preamble and more points for the action sec-tions. The website provides detailed information on how to use the grading documents. Tina L. Stark November 2013 36 Preface to the First Edition Drafting Contracts brings a new approach to the teaching of contract drafting. It empha-sizes the nexus between the business deal and the contract, both in the material taught and in the exercises students work on. In addition, it teaches students to think critically about the law and the transaction they are memorializing. To draft a contract well, a drafter must know the rules of good writing —and more. Among other things, a drafter must understand the business deal; know how to use the contract concepts to reflect the parties’ deal accurately; and be able to draft and recognize nuances in language that change the deal. In addition, a good drafter knows how to add value to a deal by discerning and resolving business issues. Drafting Contracts reflects a real world approach to contract drafting, bringing together years of real world contract drafting experience and law school teaching. Although new to the market, the materials in Drafting Contracts have been used in law school classrooms for more than 13 years, including use of the manuscript at more than ten schools. Drafting Contracts teaches students through narration and drafting exercises. The exercises are numerous, permitting a professor to choose the ones most appropriate for his or her class. As designed, the exercises in later chapters incorporate material from earlier chapters, so that students practice what they have already learned while integrating new skills. Professors need not, however, teach the materials in Drafting Contracts in the order set out. The book is sufficiently flexible that professors can reorder the chapters to suit any curriculum. This book’s organization reflects its pedagogy. Part 1 teaches the material that is the course’s foundation. Its chapters introduce students to the building blocks of contracts: representations and warranties, covenants, rights, conditions, discretionary authority, and declarations. These chapters do more, however, than define the terms. They show how and why a drafter chooses a specific contract concept by teaching the analytic skill of translat-ing the business deal into contract concepts. In Part 2, Drafting Contracts sets out the framework of an agreement and works through it from the preamble to the signature lines, in each instance discussing the business, legal, and drafting issues that occur in each part of a contract. After these chapters, in Part 3, Drafting Contracts turns to the rules for good drafting and to techniques to enhance clarity and to avoid ambiguity. Although the chapters in this Part concentrate on more traditional drafting issues, they nonetheless remain sensitive to how the business deal affects drafting in subtle ways. 37 In Part 4, students learn how to look at a deal from the client’s business perspective and how to add value to a transaction by identifying business issues using the five-prong frame-work of money, risk, control, standards, and endgame. In Part 5, students learn the drafting process, from organizing the initial contract to amending the signed agreement. Students also learn how to analyze and comment on a contract that another lawyer has drafted. Drafting Contracts directly addresses ethical issues unique to contract drafting, both through textual material and exercises in Part 6. The book’s final part, Part 7, provides supplementary exercises. Drafting Contracts is designed for use in an upper-level drafting course but can be integrated into a variety of other courses, including a first-year writing or contracts course, a mergers and acquisitions course, a transactional simulation course, a transactional clinic, and an upper-level writing survey course. The Teachers Manual suggests appropriate chap-ters and exercises for each of these uses. The Teachers Manual is detailed. For exercises that require the redrafting of a provision, the TM includes the original provision, a mark-up showing the changes, the final version, and Notes explaining the answer. For exercises that require free drafting, the TM includes an example of a good answer along with Notes explaining the answer. In addition, the TM provides answers to commonly asked questions and tips on how to present material. The Drafting Contracts website will also be a resource available to professors and stu-dents. First, professors will have access to an electronic version of the TM, so anything in it can be copied and incorporated into class notes. Second, professors will be able to down-load PowerPoint slides and additional exercises. Third, the website will include Word and WordPerfect versions of each provision in a large, readable font. These provisions can be projected on a screen in the same way that a PowerPoint slide can be projected. Once pro- jected, the professor and students can work through the revision together. The website will also have additional exercises to give professors even more choices for assignments. Finally, to minimize the word processing that students do, the website will include electronic ver-sions of the longer exercises. Drafting Contracts teaches contract drafting in a new way. It teaches students how to think like deal lawyers and how to reflect that thinking in the contracts they draft. Tina L. Stark May 2007 38 Acknowledgments to the Second Edition I first thank my adopters and would-be adopters. You waited patiently for this second edi-tion. Unfortunately, life intervened, and earlier publication was not a realistic possibility. During this time, my publisher graciously delayed publication and supported me through a difficult time. The mantra was, “We will publish when you are ready.” I will always be most grateful to Carol McGeehan (Publisher, Aspen Publishers) and Dana Wilson (my editor) for the many kindnesses they showed during my extended illness. I also thank my adopters for taking the time to send me suggestions. As for my stu-dents, it was a joy to teach them, and the book is better because of their uncensored cri-tiques—which were always given with a smile. During the writing of this edition, I had superb help from my research assistants, both those from Emory and BU: Connor Alexander, Kasey Chow, Trey Flaherty, Roy Hakimian, Blake Kamaroff, Lisa Prestamo, Melissa Softness, and Sam Taylor. I particularly thank Anna Katz who worked with me at the pressured end of the writing process, juggling multiple projects with panache and good humor. I give most special thanks to Nancy Stein who read every word, commented on sub-stance and style, and worked tirelessly to make the book right. She also provided solace and dear friendship during difficult times. I am delighted to call her my friend. I also thank Terry Lloyd, my longtime friend and colleague. His financial acumen added depth and accuracy to Chapter 22 —Numbers and Financials Provisions. Any errors are mine. Only a publisher who values and pursues excellence can publish a quality textbook. For me, Aspen is that publisher. Dana Wilson skillfully guided me throughout the writing pro-cess, providing wise counsel, good humor, and compassion. I look forward to working with her on the third edition. Julie Nahil copy edited the book, paying extraordinary attention to substance, style, and formatting. Her questions were perceptive and her proposed changes often added elegance to the text. Sharon Ray, the compositor, did a wonderful job designing and formatting the book. The exemplars in Chapter 32 required formatting work rarely seen in textbooks. Sharon inserted, by hand, each annotation, revising repeatedly until each page was correct. No computer program could accomplish what I envisaged. Sharon did. Finally, I have three family members to thank. First, to my mother, Cookie Stark. In 2007, she told me that I had to take the Emory job because it was what I always wanted. That permission was a gift. She was 75 years old, when daughters are supposed to be hanging around. But she gave me her blessing to leave. It was a gift that only a special mother could give. Second, to my husband, Dave. Your love embraces me and makes possible everything I do. My words are inadequate. Finally, to my son, Andy. Your pursuit of life inspires me and brings me a mother’s joy. You are happy, and I could want nothing more. Besides, you’re a stitch. 39 The author gratefully acknowledges permission from the following sources to use excerpts from their works: ABA Model Rules of Professional Conduct, 2013 Edition. Copyright © 2013 by the American Bar Association. Reprinted with permission. Copies of ABA Model Rules of Professional Conduct, 2013 Edition are available from Service Center, American Bar Association, 321 North Clark Street, Chicago, IL 60654, 1- 800-285-2221. This informa-tion or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express writ-ten consent of the American Bar Association. Informal Opinion 86-1512 © 1986 by the American Bar Association. Reprinted with permission. Copies of ABA Formal Ethics Opinions are available from Service Center, American Bar Association, 321 North Clark Street, Chicago, IL 60654, 1-800-285-2221. All rights reserved. This information or any or portion thereof may not be copied or dis-seminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Shaw, Alan, excerpts from Fordham Law School course materials. Reprinted by permission. Stark, Tina L., Thinking Like a Deal Lawyer, 54 J. Leg. Educ. 223, 223-224 (June 2004). Excerpts appear in Drafting Contracts Sections 2.3 and 3.1. Reprinted by permission. Stark, Tina L. et al. eds, Negotiating and Drafting Contract Boilerplate, ALM Prop-erties, Inc. 2003. All material from Negotiating and Drafting Contract Boilerplate is used with permission of the publisher —ALM Publishing (www.lawcatalog.com); copy-right ALM Properties, Inc. 2003. All Rights Reserved. 40 Acknowledgments to the First Edition I began this book in 1993 when I first began teaching at Fordham Law School. Unfortunately, the text was only in my head. It took another ten years before I began to put the words on a page. This lengthy gestation has led to a long list of people to thank. I begin by thanking my students. They were the first to encourage me to write this book. Through the years, their comments and insights challenged me to rethink and clarify my ideas. While writing this book, I had the help of the following practitioners and professors: Helen Bender, Robin Boyle, Ruthie Buck, Sandra Cohen, Carl Felsenfeld, John Forry, Eric Goldman, Morton Grosz, Carol Hansell, Charles Hoppin, Vickie Kobak, Terry Lloyd, Lisa Penland, Nancy Persechino, and Sally Weaver. Their input and that of Aspen Publishers’s anonymous reviewers greatly improved this book’s quality. I thank my colleague Alan Shaw for his intellectual generosity and careful review of the manuscript. In addition, I am grateful to Peter Clapp, someone whom I have never met, but who gave me line-by-line comments on almost every chapter. Richard Green at Thelen Reid Brown Raysman & Steiner LLP was most helpful. He not only reviewed chapters, but also graciously arranged for his firm’s word processing wonders to turn my typed pages into a manuscript. While working on this book, I had the enthusiastic and dedicated support of my student research assistants: Hannah Amoah, Stephen Costa, Sarah Elkaim, and Noel Paladin-Tripp. I thank Fordham Law School for its generous support of this book. I also thank Rick Garbarini for his good work and friendship. Richard Neumann of Hofstra Law School played a pivotal role in this book’s publication by introducing me to Richard Mixter at Aspen Publishers. I thank them and Carol McGeehan at Aspen for having had the imagination to envisage a contract drafting textbook market, even when one barely existed. Others at Aspen also played important roles. Barbara Roth expertly shepherded me through the writing and design process, and Sarah Hains and Meri Keithley artfully designed the book’s pages to showcase the contract provision examples. In addition, Kaesmene Harrison Banks skillfully guided the book through production on a tight timeframe, and Lauren Arnest meticulously copy-edited the manuscript. Finally, I thank my husband Dave and son Andy. Their unwavering love, support, and encouragement make everything I do possible. They also make me laugh—at myself. The author gratefully acknowledges permission from the following sources to use excerpts from their works: American Bar Association, ABA Informal Opinion 86-1518. © 1986 by the American Bar Association. 41 Reprinted with permission. Copies of ABA Ethics Opinions are available from Service Center, American Bar Association, 321 North Clark Street, Chicago, IL 60610, 1-800-285-2221. American Bar Association, ABA Model Rules of Professional Conduct, 2006 Edition. © 2006 by the American Bar Association. Reprinted with permission. Copies of ABA Model Rules of Professional Conduct, 2006 Edition are available from Service Center, Ameri-can Bar Association, 321 North Clark Street, Chicago, IL 60610, 1-800-285-2221. Gulfstream Aerospace Corporation, Gulfstream G550 photo and technical data. © Gulf-stream Aerospace Corporation. Reprinted by permission. Shaw, Alan, excerpts from Fordham Law School course materials. Reprinted by permission. Stark, Tina L., Thinking Like a Deal Lawyer, 54 J. Leg. Educ. 223, 223-224 (June 2004). Excerpts appear in Drafting Contracts Sections 2.3 and 3.1. Reprinted by permission. Stark, Tina L. et al. eds, Negotiating and Drafting Contract Boilerplate, ALM Prop-erties, Inc. 2003. All material from Negotiating and Drafting Contract Boilerplate is used with permission of the publisher —ALM Publishing (www.lawcatalog.com); copy-right ALM Properties, Inc. 2003. All Rights Reserved. 42 Drafting Contracts 43 Translating the Business Deal into Contract Concepts 44 A Few Words About Contract Drafting and This Book 1.1 INTRODUCTION A well-drafted contract is elegant. Its language is clear and unambiguous, and its organization cohesive and thoughtful. But drafting a contract requires more than good writing and organizational skills. A drafter should have keen analytical skills; a superior ability to negotiate; a sophisticated understanding of business, the business deal, and the client’s business; a comprehensive knowledge of the law; and a discerning eye for details. It also helps to have formidable powers of concentration, physical stamina, mental acuity, tenacity, the ability to multitask, and a sense of humor. Finally, a drafter must enjoy working with colleagues to create a product—the contract. 1.2 WHAT DOES A CONTRACT DO? A contract establishes the terms of the parties’ relationship. It reflects their agreement as to the rules that will govern their transaction. The rules generally include the statements of facts that each party made that induced the other to enter the transaction; each party’s promises as to its future performance; each party’s rights; the events that must occur before each party is obligated to perform; each party’s discretionary authority; how the contract will end, including the events that constitute breach and the remedies for breach; and the general policies that govern the parties’ relationship. These rules are the parties’ private laws, which the courts will enforce, subject to public policy exceptions found in statutes and common law. Indeed, commentators speak of contracts as private law. They also refer to them as planning documents. Unlike litigation, which looks back in time, contracts look forward to the parties’ future relationship and reflect their joint plans. A contract also helps the parties to problem solve. Often parties will have the same goal but differ as to how to 45 resolve a specific business issue. A well-written contract can bridge this difference, giving each party enough of what it needs to agree to the contract. 1.3 WHAT ARE A CONTRACT’S GOALS? When drafting, you are trying to create a document that serves multiple purposes. Sometimes, you may not be able to accomplish all of them, but you should try. A well- written contract should do the following: Accurately memorialize the business deal. Be clear and unambiguous. Resolve problems pragmatically. Be sufficiently specific that the parties know their rights and obligations, but be flexible enough to cope with changed circumstances. Advance the client’s goals and reduce its risks. Give each side enough of what it needs so that each leaves the table feeling that it negotiated a good deal. Be drafted well enough that it never leaves the file drawer. Prevent litigation. 1.4 WHAT IS THE CONTEXT WITHIN WHICH CONTRACTS ARE DRAFTED? Most contracts are drafted in a different atmosphere from that in which litigators draft memoranda and briefs. Litigators are out to win. They want to defeat their adversaries in court; cooperation is not generally a big part of their playbook. But doing deals and drafting contracts differ from litigation. Neither party wants to give away the candy store, but each looks for a way to get the deal done. The argot of deal lawyers also differs from that of litigators. While litigators talk about their adversaries— those with whom they will battle through a war of words—deal lawyers and their clients talk about the other side or the principals. These phrases acknowledge that the parties are not aligned, but they are softer than adversaries and reflect a different relationship. The parties are competitive, but in the context of a cooperative venture.1 Each may be willing to walk away from the deal, but each has incentive to find a way to get the deal done. 1.5 DOES THIS BOOK COVER ALL KINDS OF CONTRACTS? This book focuses on the drafting of business contracts, not standard form consumer contracts. The scope of the phrase business contracts is intended to be broad and encompassing. It is intended to cover all negotiated 46 contracts, whatever the topic or dollar amount. Within its reach are contracts for the sale of a used car, the construction of an office tower, and a settlement agreement between litigating adversaries. It does not cover a standard form contract that a corporation puts to a consumer. The distinction matters because it affects a drafter’s contract drafting style and a contract’s substance. Today, most consumer contracts are drafted in plain English, a style of drafting in which simplicity and clarity prevail. This book will not teach you to draft in plain English. Instead, for business contracts, this book espouses a style of drafting that this author calls contemporary commercial drafting. It resembles plain English, but it is not the same. It draws on the principles of plain English and promotes clarity through, among other things, simpler language, shorter sentences, and formatting. It differs from plain English, however, in important ways. First, plain English drafters make their contracts more reader friendly by, for example, adopting an informal tone. Although the business world is more informal than it used to be (think business casual dress), it is hard to imagine a multimillion dollar contract between Apple and Intel in which Apple is referred to as we and Intel as you. But more important than tone is the approach to the contract’s substance. A plain English contract’s provisions are pared down to their bare essentials, while a business contract’s are hefty, retaining all provisions that might add value or protect against risk. Carl Felsenfeld, one of the first proponents of plain English, explained the difference between the two kinds of contracts as follows: The plain English movement requires a new drafting approach. Each provision [of a consumer contract] must be analyzed one at a time against the specific transaction and the type of protection required. Many of the traditional legal provisions may well be found essentially unnecessary. It is basic to this approach that one must regard drafting for a consumer transaction as quite different from drafting for a business transaction. … One does not yet, for example, see it taken seriously, in the teaching of contract law. Traditionally, [promissory] notes were not divided in this way and many of the carefully drafted provisions that cluttered up consumer documents, while important, perhaps even essential, to a business transaction really added very little to the typical consumer loan. … The point is that consumer drafting must be regarded as a separate process from business drafting. A legal principle derived from this, while perhaps extreme, does lead the way: “In a business transaction, if a risk can be perceived draft for it. In a consumer transaction, unless a risk seems likely, forget it.”2 1.6 WHY SHOULD YOU LEARN TO DRAFT IF YOU PLAN TO LITIGATE? If you plan to litigate, you should learn to draft for two reasons. First, you will regularly draft contracts as a litigator. Litigating parties settle more often than they go to trial. The settlement they reach is a business deal, just like any other, and it must be memorialized clearly and accurately. Failure to do so can lead to another dispute and further litigation. Second, knowing how to draft will make you a better litigator. Many of the cases that you litigate will grow out of contract disputes. To represent your client properly, you must be able to analyze a contract and its provisions. If you understand how and why a drafter wrote a provision in a specific 47 way, you will be able to craft more persuasive legal arguments. 1.7 WHAT WILL THIS BOOK TEACH YOU? This book will teach you how to write a contract and how to think about writing a contract. The first requires that you learn basic principles of contract drafting: For example, use recitals sparingly; limit the number of definitions; avoid ambiguity; do not use the false imperative; tabulate to promote clarity; and say the same thing the same way. Learning how to think about writing a contract will require you to learn how business people and their lawyers think about a transaction and the contract that memorializes it. Some of the questions that lawyers and their clients think about include the following: What are the client’s business goals? How can the contract frustrate or further those goals? What risks inhere in the transaction? What business issues does a provision raise and how can the drafting resolve them? Does a provision give the other side too much control? Do the representations and warranties allocate too much risk to the client? How can the drafter change a covenant’s standard of liability to reduce the client’s risk? Should a particular event result in a breach? What remedies are appropriate if a party breaches the contract? Asking and answering these and other questions are the fun part of contract drafting. They are what make you more than “a mere scrivener”—the ultimate insult to a contract drafter. 1.8 HOW IS THIS BOOK ORGANIZED? Part 1, composed of Chapters 1 through 4, provides the framework for the course. It introduces you to the building blocks of contracts: representations and warranties, covenants, rights, conditions, discretionary authority, and declarations. Part 1, however, does more than define these terms. It shows how and why a drafter chooses a specific contract concept. It does this by teaching you the analytic skill of translating the business deal into contract concepts. The translation skill is the analytic skill that deal lawyers use when drafting. It differs from that used in writing a persuasive document—whether a memorandum or a brief. Rather than applying the law to the facts, a deal lawyer translates the client’s business concerns (a deal lawyer’s facts) into contract concepts and then into contract provisions. By learning this skill in the beginning of the course, you will later be able to layer 48 knowledge of how to draft on top of a framework that has taught you what you are drafting. Part 2 begins with Chapter 5. That chapter provides an overview of Part 2 by introducing you to a contract’s parts. Preamble—name of agreement, date, and the parties. Recitals—why the parties are entering the contract. Words of agreement—statement that the parties agree to the provisions that follow. Definitions. Action sections—promise to perform the subject matter of the contract and monetary provisions. Other substantive business provisions. Endgame provisions—specific business provisions dealing with the contract’s end. General provisions—the “boilerplate” provisions. Signature lines. Schedules. Exhibits. This chapter also shows you how the contract concepts you learned in Chapters 3 and 4 are integrated into a contract’s parts. In the remainder of Part 2, Chapters 6 through 17, you will learn how to draft each of the listed parts. Some of this will entail learning detailed drafting rules, but much of it will require you to learn to think like a deal lawyer. Chapters 18 through 24, which compose Part 3, will teach you rules and techniques to enhance clarity and to avoid ambiguity. You will learn, among other things, about formatting, clarity through sentence structure, tabulation, and common causes of and cures for ambiguity. You will also learn how to draft formulas and provisions that use accounting concepts. Chapter 25, the only chapter in Part 4, will teach you how to look at a deal from the client’s business perspective and how to add value to a transaction by identifying business issues. In Part 5, Chapters 26 through 29, you will learn the drafting process, from organizing the initial contract to amending the signed agreement. You will also learn how to analyze and comment on a contract that another lawyer has drafted. Part 6, which consists of Chapter 30, addresses ethical issues unique to contract drafting. 49 Part 7, which consists of Chapter 31, contains additional exercises for you to work on. Part 8 contains the final chapter, Chapter 32. That chapter provides exemplars of well- drafted contracts and guided reading exercises. In addition, the exemplars will serve as precedents for some of the exercises you do for class. This book concludes with several exhibits. Each exhibit provides background on specific issues not appropriate for the body of the textbook. 1.9 STYLISTIC MATTERS As you read this book, you will see that some words and phrases are in bold and others in italics. Words or phrases in a bold font signal important terms, many of which are defined. Italics are used for three purposes: to signal contract language, to provide supplementary information, and to emphasize a word or phrase. You will also notice that the book uses two kinds of boxes to highlight contract language. Short provisions are inside shaded boxes. Successors and Assigns. This Agreement binds and benefits the parties and their respective permitted successors and assigns. When two or more provisions are within a shaded box, each is numbered to distinguish where one ends and the other begins. Longer provisions are inside an unshaded box—to show you how the provision would look on a contract page. This Noncompetition Agreement, dated March 16, 20XX, is between Attorney Staffing Acquisition Co., a Delaware corporation (the “Company”), and Maria Rodriguez (the “Executive”). Background 1. Attorney Staffing Inc., a Delaware corporation (the “Seller”), provides temporary lawyers to law firms in the greater Chicago area. 2. The Seller is selling substantially all of its assets to the Company in accordance with the Asset Acquisition Agreement, dated February 1, 20XX (the “Acquisition Agreement”). 3. The Executive is the sole stockholder of the Seller and its President. 4. The Executive has extensive knowledge of the Seller’s business, including its client base and pool of temporary lawyers. 5. It is a condition to the consummation of the Acquisition Agreement that the Executive enter into this Noncompetition Agreement. Accordingly, the parties agree as follows: 50  1.10 SOME FINAL WORDS This course is a lot of work. But it is a great deal of fun (or so my students have told me). You will be learning the quintessential deal-lawyering skills: You will be learning to think and draft like a lawyer. Have fun. 1. Settlement and divorce negotiations are two notorious exceptions. 2. Carl Felsenfeld, Language Simplification and Consumer Legal Forms, remarks made at program on simplified legal drafting, American Bar Association, New York City, Aug. 7, 1978, in F. Reed Dickerson, Materials on Legal Drafting 267 (2d ed., Little, Brown & Co. 1986). See also Carl Felsenfeld & Alan Siegel, Writing Contracts in Plain English 28-29 (West 1981). 51 The Building Blocks of Contracts: The Seven Contract Concepts 2.1 INTRODUCTION To draft a contract, you must use contract concepts. These concepts are the foundation of every contract, the building blocks that, when properly assembled, express the parties’ business deal. In this chapter, you will be introduced to those concepts. Once you understand why contract concepts are used in a specific way, you can learn how to assemble them to create a contract and how to express a contract provision clearly and unambiguously. Here are the seven contract concepts, which when integrated into a contract’s parts, result in a contract: Representations. Warranties. Covenants. Rights. Conditions. Discretionary authority. Declarations. You already know something about these concepts from your first-year contracts course. Now you will learn in more depth how deal lawyers use them. 2.2 CAPSULE DEFINITIONS These are quick definitions of the seven contract concepts. You will learn more about each of them in Chapters 3 and 4. A representation is a statement of a past or present fact, made as of a moment in time to induce a party to act. A warranty is a promise that if the statement in the representation is false, the maker of the statement 52 will indemnify the other party for any damages suffered because of the false statement. A covenant is a promise to do or not to do something. It creates a duty to perform. A right is the flipside of a covenant. A right entitles a party to the other party’s performance. A condition to an obligation is a state of facts that must exist before a party is obligated to perform. Discretionary authority gives a party a choice or permission to act. Sometimes the exercise of discretionary authority is subject to the satisfaction of a condition. A declaration is a fact as to which both parties agree, generally a definition or a policy for the management of the contract. Sometimes a declaration is subject to the satisfaction of a condition. 2.3 TRANSLATING THE BUSINESS DEAL INTO CONTRACT CONCEPTS Each contract concept serves a different business purpose and has different legal consequences. Accordingly, drafters choose from among these concepts when memorializing the business deal. The analytical skill of determining which contract concept best reflects the business deal is the translation skill; it requires the drafter to look at each specific agreement of the business deal and to translate it into contract concepts. Only then can a drafter memorialize the business deal in a contract provision. The analytical skill of translating the business deal into contract concepts fundamentally differs from the analytical skill that litigators use. Litigators take the law and apply it to the facts to create a persuasive argument. They then memorialize that argument in a brief or a memo or otherwise use it to sway another, be it the other party or the court. In this paradigm, litigators seek a certain legal result by working backward from the law to a static set of facts. For example, imagine that a driver is going 80 miles an hour and hits a pedestrian; the pedestrian dies, and his heirs bring a lawsuit against the driver. The legal issue is whether the driver was negligent. To determine this, a litigator looks at the components of the cause of action for negligence and then to see whether each of the components can be matched up with the facts. The law is applied to the facts. Depending on whom the litigator represents, the conclusion may vary. The analytical skill of deal lawyers stands this paradigm on its head. Deal lawyers start from the business deal. The terms of the business deal are the deal lawyer’s facts. The deal lawyer must then find the contract concepts that best reflect the business deal and use those concepts as the basis for drafting the contract provisions. Chapters 3 and 4 teach the translation skill by looking at each of the contract concepts and examining its role in an agreement. Although we will be using the purchase of a house as the factual basis of much of our discussion of contract concepts, these same concepts are the building blocks of all contracts. 53 54 Translating the Business Deal into Contract Concepts: Part 1 (Representations and Warranties & Covenants and Rights) 3.1 INTRODUCTION Before deal lawyers begin to draft, they learn the terms of the business deal. Those terms are the deal lawyer’s facts. The lawyer must then find the contract concepts that best reflect the business deal and use those concepts as the basis of drafting the contract provisions. This skill is known as translating the business deal into contract concepts, often referred to in its truncated form as the translation skill. It is the foundation of a deal lawyer’s professional expertise and ability to problem solve. Without it, negotiating and drafting are abstractions. By learning this skill first, you will be able to layer knowledge of how to draft on top of a framework that has taught you what you are drafting. This chapter and the next discuss the seven contract concepts in depth and demonstrate how to use them in a contract. This chapter deals with representations and warranties, then covenants and rights. Chapter 4 deals with conditions, discretionary authority, and declarations. As part of this discussion, you will learn not only the legal aspects of each contract concept, but also its business purpose. Chapter 4 ends with two appendices that summarize the material in Chapters 3 and 4. You can use them as a quick reference. 3.2 REPRESENTATIONS AND WARRANTIES 3.2.1 DEFINITIONS Imagine that Sally Seller has listed her house for sale and that Bob Buyer is interested in purchasing it. But before Bob agrees to buy the house, he wants to learn more about it. All that he knows now is that the house is a two-story Cape Cod painted brown. He asks Sally the following questions during a telephone call: When was the house built? How old is the roof? Do all the appliances work? Is the house wired for Internet and cable television and is the wiring functioning properly? Is there a swimming pool? Is there a swimming pool water heater? Does it use propane gas for fuel? 55  How much propane gas is in the tank? What color are the living room walls, and when were they last painted? How much property comes with the house? Sally responds to Bob by telling him the following: The house was built in 1953 along with other houses in the neighborhood. The roof is four years old. All the appliances are in excellent condition. The house is wired for Internet and cable television, and the wiring is functioning properly. Yes. A swimming pool is on the property. Yes. A swimming pool water heater is on the property, and it uses propane gas for fuel. The tank is exactly one-half full with propane gas. The living room’s walls are painted eggshell white and were painted one year ago. Sally mentions that she has been thinking of painting them a pale blue to coordinate with her furniture. The house is on a one-acre lot. After hearing Sally’s answers, Bob visits the house and immediately decides that it is perfect for him. He and Sally agree on a $200,000 purchase price. Bob then calls his lawyer and asks her to draw up the contract and to include within it the information that Sally has told him. He tells his lawyer that he relied on Sally’s answers when deciding to buy the house. How does the lawyer include the information in the contract? The answer is that she will use representations and warranties. A representation is a statement1 of a past or present fact2 as of a moment in time3 intended to induce reliance.4 56 Assume that Sally and Bob sign a contract today for the sale of the house and that in the contract Sally tells Bob the following: The roof is four years old. Sally’s statement is a representation. She made that statement (a statement) today (a moment in time). (Had she made the statement a year ago, the roof would have been three years old, and if she were to make the statement in a year, it would be five years old.) In addition, she made the statement to convince Bob to purchase the house (to induce reliance). The representation that the roof is four years old is a statement about a present fact. Sally also made representations with respect to facts concerning the past: The house was built in 1953 along with other houses in the neighborhood. Although a party can make representations with respect to present and past facts, it generally cannot do so with respect to future facts.5 Those are mere statements of opinion. Chapter 9 discusses this issue in more depth. For Bob to have a cause of action for fraudulent misrepresentation, also known as the tort of deceit, Sally must have known that her statement was false when she made it; Bob must have relied on Sally’s statement; and that reliance must have been justifiable.6 That is, Bob must not have known that Sally’s statement was false. So, for example, if Bob purchases the house after his contractor inspects the roof and tells Bob that the roof is much older than four years, Bob cannot justifiably rely on Sally’s representation that the roof is four years old. Accordingly, Bob would not have a cause of action in tort for fraudulent misrepresentation as to the roof’s age. He might, however, have a separate cause of action for breach of warranty based on Sally’s statement in the representation about the roof’s age.7 Do not equate a statement in a representation with a representation. A representation is more than a bald statement of fact. It must be a past or present fact intended to induce the reliance of the person receiving the statement. As you proceed through this chapter, focus on the salient role of reliance in establishing the tort cause of action for breach of warranty. A warranty differs from a representation. A warranty is a promise by the maker of a statement that the statement is true.8 In the context of a contract with both representations and warranties, the statements referenced in the definition of warranty are those the maker made in the representation. Thus a warranty requires the 57 statement’s maker to pay damages to the statement’s recipient if the statement was false and the recipient damaged. The warranty acts as an indemnity.9 Generally, it does not matter whether the recipient knew the statement was false and did not rely on it. The critical question is not whether the buyer believed in the truth of the warranted information, as [the seller] would have it, but “whether [the buyer] believed [it] was purchasing the [seller’s] promise [as to its truth].”10 The dispute as to reliance’s role in a cause of action for breach of warranty stems from the oddity of its birth as a creature of tort law. English lawyers created warranties centuries ago to tackle the common law’s inflexibility. At the time, no contract-related writ permitted a plaintiff to sue the other side if it had not performed its obligations under the contract. The ever-inventive common law lawyers solved the problem by transforming nonperformance of a contract into a tort—an action of deceit that required reliance. Over time, a suit for breach of warranty became an action of assumpsit, a contract action.11 Nonetheless, through the centuries the contours of the cause of action remained uncertain and controversial. Warranty’s birth as a tort haunted it. American scholars extensively debated and analyzed warranties concerning the sale of goods during much of the twentieth century.12 Codification of the law of warranty concerning the sale of goods in the Uniform Sales Act, and subsequently in the Uniform Commercial Code, did little to quell the debate about whether reliance was a required element of a cause of action for breach of warranty.13 Outside the context of the sale of goods, academic writing about warranties appears nonexistent, despite the use of warranties in all kinds of commercial agreements (e.g., leases, licenses, and acquisition, credit, settlement, and entertainment agreements).14 The evolution of warranties outside the U.C.C. context pivots on the 1990 case of CBS Inc. v. Ziff-Davis Publishing Company. In that case, New York’s highest court held unequivocally that a warranty was contractual, and that reliance was not an element in a cause of action for its breach.15 (The Second Circuit has qualified the CBS decision by holding that a party waives its cause of action for breach of warranty if the party knows of a warranty’s falsity and does not explicitly preserve its rights.16 Nonetheless, the breadth of the CBS decision leaves open whether New York’s Court of Appeals would concur with the Second Circuit.17) Since the seminal CBS decision, the majority of courts addressing the issue of reliance have agreed with the CBS court and held that reliance is not an element of a cause of action for breach of warranty.18 In addition, courts have roundly criticized the small number of decisions holding to the contrary.19 Thus the modern view is that warranty has shed its tort origins20 and is a promise like any other in a contract.21 This book goes forth on that basis. (Because state Law governs this issue, be sure you know the law in the state whose law governs the transaction.) Chapter 9 discusses the consequences of this now bright-line distinction between representations and warranties. With this context, let’s return to our house purchase hypothetical. As stated previously, Bob would not have a 58 cause of action for misrepresentation with respect to the roof’s age because his contractor had told him that it was older than Sally represented. Nonetheless, because Sally also warranted the roof’s age, Bob would be able to sue for a breach of warranty post-closing—so long as he told Sally when they were closing that he was reserving his right to make a claim.22 Deal lawyers almost always negotiate for both representations and warranties.23 For example, in the house purchase agreement between Sally and Bob, the representations and warranties article would be introduced with the following language: The Seller represents and warrants to the Buyer as follows: By virtue of this one line, every statement in the sections that followed would be both a representation and a warranty. In the purchase agreement between Sally and Bob, Sally’s representations and warranties would resemble the following: Seller’s Representations and Warranties. The Seller represents and warrants to the Buyer as follows: (a) The house was built in 1953, along with the other houses in the neighborhood. (b) The roof is four years old. (c) All the appliances are in excellent condition. (d) The house is wired for Internet and cable television, and the wiring is functioning properly. (e) A swimming pool is on the property. (f) A swimming pool water heater is on the property, and it uses propane gas for fuel. The propane gas tank is on the property. (g) The tank is exactly one-half full with propane gas. (h) The living room’s walls are painted eggshell white and were painted one year ago. (i) The house is on a one-acre lot. Finally, when determining whether a party made a misrepresentation and breached a warranty, a statement’s truthfulness is always determined by comparing the statement to reality as of the moment in time when the statement was made, not when the determination of truthfulness is made.24 Therefore, Sally’s representation and warranty are truthful so long as the living room walls were painted eggshell white when she stated that they were that color. It would be irrelevant with respect to claims for misrepresentation and breach of warranty that she painted the walls pale blue after she made the representation in the contract for sale but 59 before she sold the house to Bob. Of course, the painting of the walls would not be irrelevant to Bob. But to obtain a remedy, he would need to rely on a cause of action other than misrepresentation and breach of warranty. He would need a covenant and perhaps a condition.25 3.2.2 REMEDIES Representations and warranties are common law concepts. As such, they carry with them common law remedies. The differences in these remedies can directly affect which cause of action is the most favorable for a plaintiff to plead. A party can make three types of misrepresentations: innocent,26 negligent,27 and fraudulent.28 A litigation alleging any of these misrepresentations is a suit in tort. Typically, innocent and negligent misrepresentations must be material to support a remedy.29 The law with respect to fraudulent misrepresentations depends on the jurisdiction. In some jurisdictions, a misrepresentation need not be material for it to constitute a fraudulent misrepresentation,30 while in others it must.31 If a misrepresentation is innocent or negligent, the usual remedies are avoidance and restitutionary recovery.32 Avoidance permits the injured party to unwind the contract.33 Both lawyers and courts often refer to it as rescission. Restitutionary recovery requires each party to return to the other what it received, either in kind or, if necessary, in money.34 A misrepresentation may also be fraudulent—a misstatement made with knowledge of its falsity (scienter).35 In this case, an injured party has a choice of remedies. First, it may void the contract and seek restitution,36 just as with innocent and negligent misrepresentations. Alternatively, it may affirm the contract, retain its benefits, and sue for damages based on a claim of fraudulent misrepresentation,37 sometimes referred to as the tort of deceit. The injured party’s damages claim could also include punitive damages,38 which, of course, can be significantly larger than general damages. (Lawyers sometimes refer to affirming the contract as standing on the contract.) If an injured party decides to affirm the contract by suing for fraudulent misrepresentation, the measure of damages depends on which state’s law governs the contract. Most states use the benefit of the bargain measure of damages,39 with the minority using the out-of-pocket measure of damages.40 The benefit of the bargain measure of damages results in a higher damages award and is the measure of damages that a party generally receives on a contract breach. It is equal to the value that the property was represented to be minus the actual value. So, if the property was represented to be worth $10,000 but was actually only worth $3,000, the damages would be $7,000. 60 Out-of-pocket damages are equal to the amount the plaintiff paid for the property minus the actual value. Thus, if the plaintiff paid $5,000 for property that was only worth $3,000, it could recover only $2,000 in damages. The difference in recovery between the benefit of the bargain damages and out- of-pocket damages can be an important factor when a plaintiff decides whether to sue for fraudulent misrepresentation or breach of warranty. Specifically, if an injured party asserts a claim for breach of warranty, a contract claim, the remedy for that breach is full benefit of the bargain damages.41 Therefore, in a state that follows the out-ofpocket rule of damages for fraudulent misrepresentations, a plaintiff would probably be better off pursuing a breach of warranty claim, as its benefit of the bargain damages would be greater.42 A claim for fraud might become the preferable claim, however, if a plaintiff could successfully argue for punitive damages. The following chart summarizes the remedies associated with representations and warranties. In this discussion, false representations have been referred to as misrepresentations. Although some lawyers colloquially speak of breaches of representations, that terminology is incorrect. A breach is a violation of a promise. Because representations are not promises, they cannot be breached. Instead, a party makes misrepresentations. It is correct, however, to speak of breaches of warranties, as warranties are promises. 3.2.3 WHY A PARTY SHOULD RECEIVE BOTH REPRESENTATIONS AND WARRANTIES As the preceding sections have made clear, multiple benefits accrue to a party who receives both representations and warranties. To summarize, these benefits are the following: First, a party may void the contract and receive restitution only if that party receives representations. Second, a party may sue for punitive damages only by claiming a fraudulent misrepresentation. Third, if a party cannot prove justifiable reliance on a representation, that party can still sue for breach of warranty. 61  Fourth, if a state follows the out-of-pocket rule for damages for fraudulent misrepresentations, a party can still recover the greater benefit of the bargain damages by suing for breach of warranty. Fifth, a breach of warranty claim may be easier to prove than a fraudulent misrepresentation claim. As noted earlier, to prove fraudulent misrepresentation, a plaintiff must demonstrate scienter, that the defendant knowingly made a false representation.43 As proving a party’s state of mind can be difficult, a breach of warranty claim, which has no such requirement, may be the easier claim to win.44 3.2.4 RISK ALLOCATION Each representation and warranty establishes a standard of liability. If a statement is false—if the statement does not reflect reality—then the standard has not been met and the party making the statement is subject to liability. By establishing standards of liability, representations and warranties serve an important business purpose. They are a risk allocation mechanism. This means that the degree of risk that each party assumes with respect to a statement varies depending on how broadly or narrowly the statement is drafted. Recall that Sally told Bob that the propane gas tank was exactly one-half full. That is a precise statement. It is posited as an absolute, without any kind of wiggle room. It is a flat representation. It is a high-risk statement for Sally because if she is even a little wrong, Bob has a cause of action for misrepresentation and breach of warranty. He might not have a claim for a great deal of money, but he could certainly bring a nuisance suit and hope for a quick settlement/price reduction. Sally could have reduced her risk by making a less precise statement. She could have made a qualified representation. For example, she could have said, “[T]he tank is approximately half-filled.” Then if the propane gas tank had been less than one-half its capacity, Sally might still have been able to contend that her statement was true. Her risk of having made a false statement would have been reduced. Bob, however, would have assumed a greater risk with respect to Sally’s statement about the amount of fuel in the tank. Originally, Bob would have had a cause of action if the tank was even a little less than half full. Now, in order to prove a misrepresentation and breach of warranty, Bob must argue what approximately means. The risk allocation has shifted more of the risk to Bob.45 To see how risk allocation works in a more sophisticated context, imagine that you are general counsel of a $100 million company that is selling all of its shares in a wholly owned subsidiary (the Target). Your current task is to negotiate the no litigation representation and warranty that appears in the stock purchase agreement.46 You know the statement needs to be qualified. But how? Immediately following this paragraph are five versions of a no litigation representation and warranty. The first version is the language in the agreement. The subsequent versions represent the evolution of your thinking with respect to what kind of qualifications would be appropriate. Read all of the versions and see if you can explain how each version changes the risk allocation. 62 Version 1 No Litigation. No litigation is pending or threatened against the Target. Version 2 No Litigation. Except as stated in Schedule 3.14, no litigation is pending or threatened against the Target. Version 3 No Litigation. Except as stated in Schedule 3.14, no litigation is pending or, to the Seller’s knowledge, threatened against the Target. Version 4 No Litigation. Except as stated in Schedule 3.14, no litigation is pending or, to the knowledge of any of the Seller’s officers, threatened against the Target. Version 5 No Litigation. Except as stated in Schedule 3.14, no litigation is pending or, to the knowledge of any of the Seller’s three executive officers, threatened against the Target. For the purpose of this representation and warranty, “knowledge” means, cumulatively, (a) each executive officer’s actual knowledge; and (b) the knowledge that each executive officer would have had after a diligent investigation. Again, Version 1 is how the representation and warranty appears in the stock purchase agreement. It is a flat representation and warranty. You immediately recognize its most obvious flaw: It is false. Virtually every company has some litigation, and the Target is no exception. If the representation and warranty is not changed, the Seller is at great risk because it knows that the statement is false. A cause of action for misrepresentation could allege fraud. Therefore, the first qualification is that the representation and warranty must indicate pending litigations. The typical way to do this is to list them on a disclosure schedule and then to refer to the schedule in the representation and warranty. Version 2 does this. For a more detailed discussion of schedules, see § 5.10. The easy part is now over. On further review, you see that the representation and warranty actually makes two statements: one about pending litigation and the other about threatened litigation. At first, you do not see this as a concern as the disclosure schedule can qualify the representation and warranty not only with respect to pending litigation, but also with respect to known, threatened litigation. But what if the Seller does not know of an existing, threatened litigation against the Target? Perhaps someone is claiming that a product malfunctioned and intends to sue. It is an unknown, threatened litigation. After concluding that this is an unfair risk for the Seller to assume, you ask the Buyer’s counsel for a knowledge qualification with respect to 63 unknown, threatened litigation.47 He acquiesces, and the representation and warranty is redrafted as set forth in Version 3.48 While the form of the Version 3 representation and warranty decreases the Seller’s risk of liability, it increases the Buyer’s risk. Because the Seller is no longer making a representation and warranty about unknown, threatened litigation, the Buyer will have no cause of action if unknown, threatened litigation against the Target actually exists. Version 4 addresses the problem of what constitutes the Seller’s knowledge. In the hypothetical, the Seller is a corporation, a juridical entity formed when its certificate of incorporation was filed with the appropriate governmental authority. As it is not a living, breathing human being, what constitutes its knowledge is not immediately apparent. Is it the knowledge of the company’s managers, or the knowledge of everyone from the president to the employees on the shop floor? From your perspective as general counsel (to put words in your mouth), it undoubtedly is an unfair risk for the Seller to be liable for the knowledge of every company employee. Accordingly, you request that the representation and warranty be further qualified so that the Seller is responsible only for its officers’ knowledge.49 With this change, the Seller no longer takes a risk as to the knowledge of an employee on the shop floor. However, the Seller’s decrease in risk means that the Buyer’s risk has commensurately increased. If an employee on the shop floor, in fact, knows of a threatened litigation, the Buyer will have no cause of action against the Seller because its representation and warranty is true: No officer knew. Thus, should the threatened litigation turn into an actual litigation and result in an award of damages, the Buyer would be obligated to pay it. At this point, you are on a roll. You decide that even knowledge of any of the Seller’s officers is too great a risk. Therefore, you go to the well again and ask the Buyer’s counsel to change the qualification so that it reads knowledge of any of the Seller’s three executive officers. This is the language in the first sentence of Version 5. At this point, however, the Buyer’s counsel says: “Enough. If knowledge is limited to three executive officers, they could walk around with blinders on doing their best to acquire no knowledge of threatened litigation. This is too much risk for the Buyer to assume.” The Buyer’s counsel instead proposes to define knowledge as the aggregate actual knowledge of each of the executive officers and their imputed knowledge; that is, the knowledge each executive would have had if the executive had performed a diligent inquiry. This is the compromise language in the remainder of Version 5. The Seller has limited its risk to the knowledge of the three executive officers, while, concurrently, the Buyer has eliminated its risk of the executive officers’ intentional oblivion. Understanding the impact of risk allocation is essential to fulfilling your role as a counselor. Clients too often misunderstand the purpose of representations and warranties and think that the time spent negotiating them is mere wordsmithing.50 By explaining to a client that the wording of the representations and warranties can affect potential liability, you have explained that money is on the table, something that clients readily understand. 64  3.3 COVENANTS 3.3.1 DEFINITIONS AND USES OF COVENANTS We will first look at covenants in the context of the sale of Sally’s house to Bob and then in other contexts. Imagine that after Sally and Bob have agreed to a price, Bob tells Sally that he cannot immediately purchase the house as he first needs to obtain a mortgage. A delayed closing is acceptable to Sally, and they agree to close the sale on the last day of the next month. This delay creates a gap period between the signing of the purchase contract and the closing.51 (A closing is when parties exchange the agreed performances. Typically, closings occur only in acquisitions and financings. In an acquisition, it would be the day the seller transfers its property to the buyer, and the buyer pays the seller; in a financing, it would be the day the bank makes the loan to the borrower, and the borrower agrees to repay it.) As Bob and Sally finalize their agreement, Bob tells Sally that he is concerned about what will happen to the house during the gap period. Specifically, he does not want the living room walls painted, and he wants to make sure that the propane gas tank is at least one-third full with propane gas when he moves in on the closing date. Sally agrees. To incorporate Sally’s agreement into the purchase contract, the lawyers use covenants, called promises in the argot of Restatement (Second) of Contracts.52 A covenant is a promise to do or not to do something.53 It creates a duty to perform if a contract has been formed.54 The duty to perform is sometimes called an obligation.55 In the purchase agreement between Sally and Bob, the covenants will resemble the following: Seller’s Covenants. The Seller (a) shall not paint the walls between the signing and the Closing; and (b) shall cause the propane gas tank to be at least one-third full with propane gas on the Closing Date. Although the need for these covenants in the purchase agreement arose because of the gap period between signing and closing, covenants are used in multiple other contexts. One of the most important is in the subject matter performance provision. In this provision, each side covenants to the