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Drafting contracts

(c) Best practice rules on drafting conditions – intro and overview

Best practice rules. Below are best practice principles and rules of good practice related to drafting conditions, conditional clauses and triggering events. Where a reference is made to a “condition”, the same applies to triggering events and, albeit to a slightly lesser extent, to conditional clauses. The best practice rules refer to conditions being ‘satisfied’ or not; no difference in meaning is intended where the word ‘fulfilled’ is used and the same principles apply to conditions that should not be fulfilled in order for the object of that condition to have its effect.

1) The object of the condition, conditional phrase or triggering event should be clearly defined.

The object of a condition is what is made conditional: the right or obligation that comes to life or ceases to exist when the condition is satisfied (or fails to be satisfied). Make sure that it is clear what exactly is conditional.

For example, in a share purchase agreement, conditions precedent can be formulated in several ways. Consider the following examples:

Purchaser’s obligations are subject to each of the following conditions being satisfied:
The Closing is subject to each of the following conditions being satisfied:

The obligations in this Agreement are subject to each of the following conditions being satisfied:

This Agreement is subject to:

Obviously, the first condition is very one-sided and Purchaser-friendly; the second condition is probably the most reasonable and adequate; and although the third condition is more specific than the last, the effect of both  is that various provisions will cease to be effective (e.g. notably on confidentiality, applicable law and dispute resolution).

The object of a condition can be anything which the parties agree, but would typically range from:

  • the agreement (as a whole): this is dangerous since (strictly speaking but probably not intended) the non-fulfilment of a condition also drags along the binding nature of a choice of law and the provisions on dispute resolution and confidentiality.
  • a closing or completion of the transaction: this is a common provision in financial and M&A transactions.
  • a right or obligation of a party: the conditionality of a right or obligation is often indicated by the words provided that or a mere unless or if. All rights and obligations can be subject to certain conditions being fulfilled. For example, a right to an indemnity will typically be subject to the condition that the party seeking the indemnity makes full disclosure of relevant facts and gives the indemnifying party full control and authority to conduct the defence.
  • the completion (or waiver) of the last closing step: if several steps must be taken either consecutively or concurrently, for example during the closing of a transaction, the parties often agree that all steps are conditional upon the last step being completed. Obviously, the effect of this will be that all steps take effect (and become unconditional) in the split second of fulfilment of the last step.
  • certain events taking place: for example, a revolv­ing credit agreement permits multiple borrowings, requiring a complete set of closing conditions in respect of the ini­tial draw-down or closing and an additional, separate (usually shorter) set of conditions that must be satisfied by the borrower at the time of each draw-down (i.e. with the lapse of time).

2) Bring conditions that relate to the same object together in one article or section of the agreement.

This best practice rule is consistent with the general drafting technique of grouping exceptions to a rule together (see paragraph 1.3(b) on ambiguity). The legibility of conditions improve if they are separated out of the object to which they relate. A similar technique is used when a definition is lifted out of a contractual provision or the text of another definition (i.e. by creating a new defined term and substituting this term in the overly complex provision or definition, respectively).

Alternatively the contractual provision may have the following pattern: there is a general obligation, which contains a few objects; each of those objects is phrased generally but requires to be refined by exceptions, qualifications, limitations or conditionality. Now, to prevent accurate drafting efforts resulting in an unclear provision, it is helpful to untangle all those objects and to connect the right conditions with the right objects.

An illustration of this is a licence provision: the licence clause itself lists the elements of exclusivity, geographical scope, sub-licensability, assignability, and its royalty-bearing character, whilst the exceptions, qualifications, limitations and conditions to each of those elements are usually elaborated in the subsequent sections.

Where to locate conditions? If conditions affect various articles of an agreement, list the conditions in a separate article; if conditions or triggering events affect various elements of a section, separate them out in the same section or in a separate section of the same article.

3) Divide conditions clearly, subject-by-subject and consider enumerating them.

Because the effect of a condition can be very important to the parties (since potentially the entire agreement is at stake), it is strongly recommended to formulate and present each condition in a clear and unequivocal manner. For example, a drafter should prevent two conditions becoming confused and interpreted as one consisting of two sub-conditions (each of which must be met).

Example (triggering events). An example is the following clause taken from an escrow agreement in which the escrow agent should be able to apply clear and strict criteria:

The Escrow Agent shall release the Technology and Know How to Customer immediately:

(a)     upon receipt of a joint written instruction to that effect from Supplier and Customer, stating the deposit code and date;
(b)     upon receipt of a notice that Supplier shall be dissolved or liquidated, is declared bankrupt or otherwise insolvent pursuant to the laws and regulations of a jurisdiction to which Supplier is subject;
(c)     in the event that Supplier is in material breach of its obligations arising from the Principal Agreement, upon receipt of a copy of Customer’s notice of default to Supplier, provided that if the Escrow Agent deems that such breach was capable of being remedied, a reasonable term for remedy permitted in such notice has also expired.

The Escrow Agent may deem:

(i)     a breach by Supplier to be “material” if Supplier failed to deliver the Product ordered by Customer (X) within the period specified in the purchase order or Statement of Work, or (Y) strictly in accordance with the agreed specifications, as stated in the notice of default.
(ii)     a period for remedy of any breach to be “reasonable” if it is no less than 30 days;

(d) in  the event that a court judgment has become final and conclusive or has become provisionally enforceable, resulting in the Escrow Agent being obliged to deliver the Material to Customer.

Ordering the conditions. As is the case for enumerations generally, the legibility of conditions improves if they are listed subject-by-subject. Apply a logic to the order of the conditions. An exception to this can be that the legibility of a listing of items, one of which is verbose and the other just a few words, may require that the short conditions are listed first and the lengthier ones thereafter.

Sentence structure. Often, conditional clauses are placed together at the beginning of a sentence. However, it is recommended to follow the general drafting principles of section 1.1(c)(i) (the left-right principle): make the reader comfortable by first driving your point home (and start with the main principle, followed by the conditions).

Enumerated conditions. If you do enumerate the conditions or triggering events, apply the enumeration principles of section 5.2(d).

4) Each condition and each conditional clause should be formulated such that it is capable of being either ‘satisfied’ (or ‘fulfilled’) or not.

This is the same best practice rule as applies to drafting warranties where each warranty should be capable of being either correct or incorrect. Conditions and triggering events are important components of a contract. Especially where a condition contains a subjective element, the trigger as to whether it is satisfied or not becomes fluid.

Text interpretation required. The more questionable the satisfaction of a condition is, the more likely it is that only one party determines whether or not it is satisfied. In that case, the condition may qualify as a potestative condition and be invalid or inoperative. Also, if the parameters for satisfying a condition are vague, the ‘reasonableness factor’ of invoking the condition becomes more important. After all, from a legal point of view, whether or not a condition is satisfied (or fulfilled) or not remains a matter of interpretation.

Conditions vs. obligations. Mixing up conditions and obligations is a source of ambiguity. This is particularly sensitive if you explore the dividing line between a condition, on the one hand, and an obligation depending on the performance of another obligation on the other hand. For example, compare:

If Purchaser becomes aware of a matter which is likely to give rise to a Warranty Claim, Seller shall not be liable in respect of such Warranty Claim unless Purchaser has given notice of the relevant facts to Seller promptly after becoming aware of the matter or such facts.
If Purchaser becomes aware of a matter which is likely to give rise to a Warranty Claim, Purchaser shall give notice of the relevant facts to Seller promptly after becoming aware of the matter or such facts.

In the first example, a right to an indemnification exists (with the condition that the claim which gives rise to the indemnification is notified promptly); whereas in the second example, which is not a condition, such right to an indemnification is not affected if no prompt notice has been given. The second example is in fact a lex imperfecta in that the breach of the obligation to notify (promptly) remains a priori without consequences.

The failure to satisfy a condition results in the non-existence of a right or obligation to which the condition pertains; the failure to perform an obligation upon which another obligation or a right depends results in a claim for restitution, a right to suspend performance or a claim for damages.

Grammatical recommendations. As a consequence of the rule that conditions should be capable of being correct or not, it is recommended that you use the present tense in all conditions. The present perfect is also acceptable if the condition represents a preliminary question that needs to be settled (as opposed to a matter that needs to be negotiated and agreed on). Therefore, it is recommended to avoid the use of shall (or will).

5) Never include a warranty, an obligation or other operative clause in a condition.

A condition is a hard and fast statement. By including an obligation, warranty or other operative provision in a condition, the condition (and its strong effect) may easily become ambiguous or even lose its character of conditionality. For example:

The Licence is subject to the condition that Licensee is at all times in full compliance with Licensor’s Trademark Guidelines and, if it is not, it shall remedy such non-compliance within ten business days after Licensor notifies Licensee of such non-compliance.

Do you agree that in this example the conditionality of the licence (and therefore the strength of the trademark) has disappeared or at least become negotiable? What do you think will happen if the licencee is able to remedy non-compliance at once but takes the full ten business day period? Or if during the ten business days an event of force majeure occurs (permitting the remedy only after a few more business days?). How alert will the licencee be in preventing any non-compliance?

At the very least, a drafter should distinguish the obligation from the condition by clear conditional wording (e.g. provided thatunlessif) or by inserting the condition in a separate sentence. If there are more than two conditions or if a condition is rather wordy, it is recommended to bring all obligations (and warranties or other operative clauses) that relate to the satisfaction of a condition into a separate section of the contract.

6) Distinguish exceptions from conditions.

‘Exceptions’ pertain to a ‘rule’ (or, equally, a right or an obligation) and might be governed by their proper rules (or not be governed by any particular principle). ‘Conditions’ trigger the application or the applicability of a rule, a right or an obligation. Two examples to illustrate the difference:

If Purchaser becomes aware of a third party claim which gives rise to a Warranty Claim, it shall give prompt notice of the relevant facts to Seller, except that any failure shall not affect the rights of Purchaser unless Seller can demonstrate that such failure prejudiced Seller’s ability to successfully defend the matter giving rise to the Warranty Claim.

Seller shall indemnify Purchaser against each third party claim which gives rise to a Warranty Claim, provided that Purchaser shall give prompt notice of the relevant facts to Seller…

In common law jurisdictions, the distinction between exceptions and conditions may be relevant in view of the remedies that may be invoked. Those remedies may restrict a party in the legal actions it is able to invoke. For example, in case of an exception to a licence grant (e.g. a licence under a patent or copyrighted work) the granted right does exist but using the right as exempted would result in a breach of contract; whereas in case of a condition to a granted right remaining unsatisfied, the granted right itself has not come into existence, which entitles the owner of the right to start an action for infringement. As a starting point the remedy for breach of contract is a claim for damages; in case of infringement of a right, the owner of the right may also claim that the infringing acts stop (which might be extremely disruptive) and claim the benefits or profits derived from the act of infringement (which might well exceed the plaintiff’s damages). This distinction does not necessarily work out the same way in all common law jurisdictions, but from a legal-traditional point of view the unavailability of a remedy might alert the drafter to choose for either an exception or a condition.

A provision is clearer and more comprehensible if it distinguishes between the rule and the exceptions to that rule, than if the rule is formulated such that the exceptions become conditions for the inapplicability of that rule. Conditions may give rise to further distinctions or to their own contractual regime, which may become a source of wordy clauses.

7) Do not phrase the key obligation of an agreement as a condition.

For example, it is nonsense to stipulate that the transfer and delivery of the Shares would be a condition to closing. This is because despite all exclusions or limitations of liability, if one party is unable to perform its key obligation, no law would protect such party against the other party deferring the performance of its obligation. Similarly, making the transaction subject to a condition that the key obligation is performed is like repeating the law of contracts.

The obligations of Seller in connection with the Closing are subject to the following conditions being satisfied:

(e)     all Share certificates and the shareholder registers of the Acquired Companies required to complete the Transaction shall be delivered to Seller.

Exception. The best practice rule must be distinguished from a conditionality that does make sense. This might be the case if the key obligation must be performed by more than one party (e.g. several sellers who should each hand over their own shares) or if the object of the transaction consists of various objects (e.g. the shares of several companies are to be transferred). In those cases, it is appropriate that a purchaser requires that no shares are deemed to be transferred (and no part of the purchase price is available to any seller) unless all shares are actually transferred. For example:

Purchaser shall not be required to purchase or acquire any of the Shares unless all of the Shares are sold and transferred.

8) Conditions referring to the absence of a fact or the non-occurrence of an event require a statement in writing that such fact is absent or that such event has not occurred.

Obviously, in most transactions, the purchaser of a business (or a bank providing a loan or credit facilities) will not be in a position to establish whether a condition that something did not happen before the closing of a transaction has been satisfied. At the same time, pursuing the closing could legally operate as an implicit waiver of the condition. The effect of a waiver is obviously to the detriment of the other party (e.g. the purchaser or bank) because the deal-breaking impact of a condition would disappear completely. For example:

The obligation of Purchaser to consummate the transactions to be performed by it in connection with the Closing is subject to satisfaction of the following conditions:
(a)     no legal proceeding shall be pending at any court or quasi-judicial or administrative agency of any jurisdiction which may possibly result in an unfavorable order or judgment that would (i) prevent consummation of any of the material transactions contemplated by this Agreement, (ii) cause any of the transactions contemplated by this Agreement to be rescinded following consummation, (iii) affect adversely the right of Purchaser to own any of the Shares or to control the Acquired Company, or (iv) affect adversely the right of Company to own its assets and to operate its business (and no such order or judgment shall be in effect); and
(b)     Seller shall have delivered written confirmation to Purchaser that any and all consulting agreements it may have with the Acquired Company are terminated and no fees pursuant to those agreements are due or payable.

Despite the implicit waiver of the condition as a consequence of closing, it would be appropriate to convert the condition into something with a strong legal effect: if the seller (or borrower) must hand over a written statement that ‘the something’ has not happened, the written statement would imply a warranty by the seller (or borrower) that such ‘something’ is absent. If that would be incorrect, the burden of proof that the seller (or borrower) was not aware of the incorrectness of its statement would shift to the seller. Also, being required to provide such a statement would prompt the seller (or borrower) to inquire actively whether its statement is indeed correct, in order to avoid the purchaser (or bank) alleging that it ought to have been aware of the ‘something’.

9) Do not include a best efforts provision in connection with a condition, unless it specifies a required (i.e. a particular or preferred) course of action in a meaningful manner.

In European continental legal systems, the general principle of good faith requires that the parties make best efforts in order to have each condition satisfied in due course. This means that, in connection with the conditions, upon entering into an agreement there is an implicit presumption that all internal approvals required for the consummation of the transaction are obtained as soon as possible after signing of the agreement; that merger filings are made (and all answers to any competition authority’s questions are given) in due course; and that any adverse events are dealt with in such manner that damages are minimised for the purchaser (i.e. between signing and closing, the seller would act in a trustee-like role vis-à-vis the purchaser).

In a European context, it would be redundant or even exaggerated to provide:

Subject to the terms and conditions in this Agreement, Purchaser and Principal Seller shall, and Principal Seller shall procure that the Company shall, use commercially reasonable efforts to take promptly, or cause to be taken promptly, all actions, and to do promptly, or cause to be done promptly, all things reasonably necessary, proper or advisable under applicable laws and regulations to satisfy the conditions to the other Parties’ obligations to consummate the Acquisition and to remove any injunctions or other impediments or delays, legal or otherwise, in order to consummate and make effective the transactions contemplated by this Agreement. Each Seller will use its commercially reasonable efforts to cause the other Seller to fulfil such other Seller’s obligations under this Agreement.

If the parties are able to provide how a certain course of action must be undertaken by a party, it makes sense to specify those actions. In such case, the best-efforts obligation is partly turned into a results-oriented or milestone-driven obligation. For example, a purchaser (who would normally coordinate the preparation of merger filings) could be obliged to propose antitrust remedies before the appropriateness of such remedies would even be addressed by the competition authorities.

10) Conditions are for the benefit of both parties, unless otherwise specified.

For example, in respect of a choice of court, one party may need to prevent its being effectively unable to take recourse on the other party as a consequence of complications in the enforcement of a (favourable) court decision:

Section 11.2 is for the benefit of the Pledgee only. For the avoidance of doubt, subject to the applicable law, the Pledgee may initiate concurrent proceedings in any number of jurisdictions.

Obviously, the benefit of a condition is often determined by the context in which the condition applies. A technique to identify the beneficiary of a condition is to use the active tense, to personalise (or to ‘de-nominalise’) the related obligation or right (see section 1.1(c)).

In large transactions with several conditions, a separate section can be included to identify which conditions are for the benefit of which party (or both parties). The identification would also specify that the relevant party is solely entitled to waive the condition. For example:

Benefit. The Conditions under 2.1(a), (e), (f) and (g) are for the benefit of Purchaser and may be waived by Purchaser. The Condition under 2.1(b) is for the benefit of Sellers and may be waived by each Seller. The Conditions under 2.1(c) and (d) are for the benefit of all Parties and may be waived by Purchaser and a Seller acting jointly.

Note how any practical complications of having more than one seller (each of whom would need to waive its right) are avoided by establishing the authority of each seller to bind all.

11) Include a deadline before which all conditions must be satisfied.

A deadline is a relatively strong incentive for a party to have the conditions satisfied as soon as reasonably practicable. Obviously, a deadline provides a certainty about the rights and obligations of both parties. Such deadline is usually called a ‘long stop date’ or ‘drop dead date’.

It is recommended to provide for a deadline, that is realistic in view of what must happen or can happen during the period when not all conditions are satisfied. For example, it does not make sense to agree on a long stop date which precedes the day on which a competition authority would be required to make a decision on the proposed merger transaction (where a positive decision or the lapse of a statutory period to make the decision implies the satisfaction of a condition). But obviously, if the long stop date does cover such period, the non-satisfaction of the condition would be caused by a failure to submit the merger filing in a timely fashion.

12) Specify the effects of non-fulfilment of a condition.

If one or more of the conditions will not be satisfied, the disappointed party may want to claim the pre-contractual liability of the other party. Also, several actions might have been taken in anticipation of the completion of the agreement or the satisfaction of the condition and such actions may have an irreversible aspect or may require efforts or costs to achieve reversal.

Typically, the non-fulfilment of a condition results in the right of either or both parties to terminate the agreement without any liability towards other parties involved in the transaction. For example:

If the Conditions are not satisfied or waived on or before the Long Stop Date, each Party may terminate this Agreement and the other Party shall not have any claim against the Party so terminating this Agreement as a result of such termination. Following termination, this Agreement shall cease to have effect, except for this Section and Articles [confidentiality, notices, costs, applicable law and dispute resolution], and except furthermore that such termination shall not affect any rights or liabilities of either Party in respect of any preceding breach of this Agreement.

Do not repeat the law. It is unnecessary to provide that the right to terminate cannot be invoked by a party who caused the non-fulfilment of a condition (whether this is the consequence of a party’s failure to make sufficient efforts to have a condition satisfied or to start making such efforts in a timely fashion). This is because the law will not permit such termination right to be exercised.

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