Examining Commonly Used Contract Provisions

Snell &Wilmer
Enforceable or Unenforceable?
Examining Commonly Used Contract Provisions
Tuesday, June 11, 2013

3:30 p.m. 4:00 p.m.
Registration
4:00 p.m. 5:30 p.m.
Program
5:30 p.m. 7:00 p.m.
Reception
1.5 hours of CLE credit provided
The Queen Mary
1126 Queens Highway
Long Beach, CA 90802
(877) 342-0738
In todays market of proliferating disputes and increasing

litigation costs, the stakes are high when it comes to
composing a well-drafted contract. Contracts are an everyday
part of doing business. On June 11, we invite you to leave
the negotiating table behind and join us aboard the historic
Queen Mary to demonstrate your knowledge of commonly
used contract provisions during an interactive CLE contest.
A panel including Snell & Wilmer attorneys Keith Gregory, Jim
Scheinkman and Josh Schneiderman, and Power-One, Inc.
Secretary and General Counsel Tina McKnight will lend insight
and challenge your contract expertise on topics such as:
Preparing contracts to avoid litigation
Understanding the enforceability of common provisions
Managing contracts in-house
Following the program, we invite you on deck for networking,
drinks and beautiful harbor views.
Keith Gregory
Snell & Wilmer
Jim Scheinkman
Snell & Wilmer
Josh Schneiderman
Snell & Wilmer
Tina McKnight
Power-One, Inc.
Keith Gregory | kgregory@swlaw.com

Partner, Snell & Wilmer
Keith Gregory practices in the areas of general business matters, corporate, franchise and partnership
disputes, and intellectual property and commercial litigation. He is an experienced litigator, with
considerable background in intellectual property issues, licensing agreements, trade secret matters and Uniform
Commercial Code issues, especially within the electronic components and semi-conductor industries. Keith serves on
the SAE International AS6081 Committee, established to develop standards proscribing counterfeit parts avoidance
requirements for independent distributors.
Tina McKnight | Tina.Mcknight@power-one.com

Secretary & General Counsel, Power-One, Inc.
Tina McKnight joined Power-One in December 2008 as Secretary and General Counsel. Before
joining Power-One, Tina served as Senior Vice President and General Counsel of BCBG Max Azria
Group, an international retailer. Prior to that she served as General Counsel and Secretary to Magnetek, Inc., a global
power supplies and renewable energy business. Tina has also held in-house legal positions with Natrol, Inc. and Great
Western Financial Corporation and was an attorney in the Los Angeles office of Brobeck, Phleger and Harrison after
graduating from law school. Tina earned her J.D. from the University of Southern California's Gould School of Law and
her B.A. from the University of California, Los Angeles.
Jim Scheinkman | jscheinkman@swlaw.com

Partner, Snell & Wilmer
Jim Scheinkman is a practice group leader of Snell & Wilmers Business and Finance Group. His
practice focuses on assisting mid-market companies and their owners in mergers and acquisitions,
financings, joint ventures, corporate governance and shareholder dispute resolution, securities offerings, technology
development and transfers, executive compensation and other corporate and commercial matters. Jim also serves as
general outside counsel for a variety of mid-market businesses.
Josh Schneiderman | jschneiderman@swlaw.com

Associate, Snell & Wilmer
Josh Schneiderman is a member of Snell & Wilmers Business & Finance group in the firms Los
Angeles office. He advises clients on a wide range of transactional matters, including mergers and
acquisitions, joint ventures, franchising and public and private offerings of debt and equity securities. Josh also advises
public and private companies on corporate governance matters, including Sarbanes-Oxley compliance.
June 11, 2013
Tuesday, June 11, 2013
Application of Attorneys Fees Clauses

Homer and Bart enter into an agreement that contains the
following clause:
The prevailing party in any dispute arising out of this
Agreement shall be entitled to recover its attorneys fees and
costs from the other party.
Homer sues Bart for breach of contract as well as on a tort
theory. Homer prevails on his tort claim and is awarded
$25,000 in damages, but the court finds in favor of Bart on the
breach of contract claim. Both parties seek attorneys fees.
Who is entitled to recover the attorneys

fees?
2013 Snell & Wilmer L.L.P.
A.
Homer because he is the prevailing party since he

received a net monetary recovery
B.
Bart because he prevailed on the breach of contract claim,

and under California law governing attorneys fees, the
party prevailing on a contract claim recovers even if the
other party prevailed on the non-contract claims
C.
Neither party is awarded attorneys fees because the two

claims cancel each other out
D.
Both Homer and Bart are entitled to attorneys fees as to

the particular claim upon which they prevailed, and the
court will engage in complex mathematical calculations to
determine how much each should receive

Correct Answer: A
Homer because he is the prevailing party since he received a net
monetary recovery
In determining which party recovers attorneys fees when a lawsuit
involves not only a breach of contract claim but other types of claims, the
court will look to the specific language of the attorneys fee clause.
If the language is general, e.g., arising out of or in connection

with, then a court will likely award attorneys fees to the party with a
net monetary recovery, which in this case was Homer.
If the language specifically states that attorneys fees will be awarded

to the party prevailing on the contract, then a court will likely award
attorneys fees to the party that prevails on the contract claim, even if
the other party prevails on other non-contract claims.
Enforceability of AS IS language
Ned Stark is in the market to buy a house and, after viewing a
property owned by Tywin Lannister, decides to purchase it.
Tywin knows that the house has been condemned by the
government but assures Ned that there are no government
actions against the property. Ned and Tywin sign a purchase
and sale contract that contains an as is clause. One week
after moving into the house, Ned discovers the condemnation
notice stuck to a fence post. Ned sues Tywin for various
claims, including breach of contract and fraud, and Tywin
cites the as is clause as a defense.
Is the as is clause enforceable or

unenforceable?
A.
Enforceable because as is clauses are unequivocally

legally binding
B.
Enforceable because Ned had an opportunity to inspect

the house beforehand and is therefore bound by the as is
clause
C.
Unenforceable because Tywin concealed from Ned the

existence of the condemnation action by intentionally
misrepresenting that the house had no government action
against it
D.
Unenforceable because as is clauses are prohibited

under California law
Correct Answer: C
Unenforceable because Tywin concealed from Ned the
existence of the condemnation action by intentionally
misrepresenting that the house had no government action
against it
California courts recognize the enforceability of

As Is clauses, but have recognized an
exception to this rule where a seller, through
fraud
or
misrepresentation,
intentionally
conceals a defect in the property.
Lingsch v. Savage, 213 Cal. App. 2d 729, 740742 (1963).

International Arbitration
Any dispute, controversy or claim arising out of or relating to
this contract, including the validity, invalidity, breach, or
termination thereof, shall be finally settled by binding arbitration
[administered by the AAA or ICC or some other arbitration
commission], and judgment upon the award rendered by the
arbitrators may be entered in any court having jurisdiction. The
arbitration shall be conducted in English in [name of city, state,
United States] in accordance with [the chosen arbitration rules,
e.g., the United States Arbitration Act or the ICC Rules of
Arbitration] and [the chosen governing law, e.g., the
substantive law of the state of California]. There shall be [one
to three] arbitrators, named in accordance with such rules.
This clause will be enforceable

in which jurisdictions?
10
A.
United States
B.
China
C.
Any country that has signed the

United Nations New York Treaty
D.
All Jurisdictions
11
Correct Answer: C
Any country that has signed the United Nations New York
Treaty
While both A and B are correct, because both the United

States and China are signatories to the United Nations
New York Treaty approximately another 130 countries
are signatories to this treaty as well. The main reason
that parties engaged in international transactions want to
include this type of provision in their terms and conditions
is so that if a dispute arises and they are forced to litigate
then they will have an award that is enforceable in the
other partys jurisdiction.
12
Waiver of Jury Trials

California Dreaming, Inc., a CA corporation, and
ILUVNY, Inc., a NY corporation, enter into a merger
agreement and agree to a neutral governing law of
Delaware even though neither company does
business in Delaware. The Agreement contains a
clause waiving the right to a trial by jury. California
Dreaming files suit against ILUVNY in CA state court
alleging breach of rep.
Is the waiver of jury trial enforceable?

13

A.
Enforceable because DE law re waiver of

jury trial will apply
B.
Enforceable because CA law re waiver of

C.
Unenforceable because DE law re waiver of

D.
Unenforceable because CA law re waiver of

14

Correct Answer: D
Unenforceable because CA law re waiver of jury trial will apply
Article I, Section 16 of the California Constitution: Trial by jury

is an inviolate right and shall be secured to all In a civil case
a jury may be waived by the consent of the parties expressed
as prescribed by statute.
Grafton Partners v. Superior Court: CA Supreme Court strictly

interpreted Article I, Section 16 and held that jury trial waivers
are only permissible when they are prescribed by statute.
Only statute that expressly permits waivers is Section 631(f) of

the Code of Civil Procedure, which notably does not authorize
waivers before parties have submitted a claim to court.
15
Best Efforts vs. Reasonable Efforts

Montague, Inc. and Capulet, Co. are
negotiating a contract whereby Capulet will
provide services to Montague. Montague
proposes contract language that states that
Capulet will use its best efforts, but Capulet
crosses out best efforts and replaces it with
reasonable efforts.
Which is better for Montague, best efforts or
reasonable efforts?
16

A.
Best efforts because it is a more stringent

requirement than reasonable efforts
B.
Reasonable efforts because a best efforts

clause is not enforceable in California
C.
It doesnt matter because California courts

have not differentiated between the two terms
D.
It doesnt matter because Montague, Inc. and

Capulet, Co. will end up feuding in court
anyway
17

Correct Answer: C
It doesnt matter because California courts have not differentiated
between the two terms
Currently, there is no case law in California specifically addressing

this issue of whether there is a distinction between best efforts and
reasonable efforts.
However, existing California case law suggests that best efforts and
reasonable efforts are essentially interchangeable. Although
California has declined to provide a clear definition of best efforts,
the courts have ruled that best efforts means that the promisor must
use the diligence of a reasonable person under comparable
circumstances.
California Pines Prop. Owners Assn. v. Pedotti, 206 Cal. App. 4th
384, 387, 795 (2012).
18
Venue Selection
An agreement between Penguins, Inc. and Kings, Co. contains
the following clause:
This Agreement shall be governed by and construed in
accordance with the laws of the State of California, and the
parties hereto agree to submit to personal jurisdiction by and
venue in the State of California, County of Alpine.
After a dispute arises, Penguins, Inc. objects to the venue
selection clause, stating that it violates the California statute
regarding venue selection.
Is the venue selection clause

enforceable or unenforceable?
19
Venue Selection
A.
Enforceable, regardless of whether the choice

of venue complies with the statutory venue
provisions.
B.
Enforceable, only if Alpine County is a

statutorily permissible county.
C.
Unenforceable, regardless of whether the

choice of law venue complies with the statutory
venue provisions.
D.
Unenforceable because no one even lives in

Alpine County.
20
Venue Selection
Correct Answer: B
Enforceable, only if Alpine County is a statutorily permissible county.
A venue selection clause is void only insofar as it disrupts statutory

venue provisions. Agreements fixing venue in some location other
than that allowed by statute are a violation of that policy. However,
if the venue selected is permitted by statute, then the court will
enforce such a provision. See Battaglia Enterprises, Inc. v.
Superior Court of San Diego County, 215 Cal. App. 4th 309.
A consent to personal jurisdiction is enforceable if freely negotiated

and not unreasonable and unjust. See Burger King Corp. v.
Rudzewicz, 471 U.S. 462 (1985)
Code of Civil Procedure Section 395 generally governs venue.
21
Mandatory Mediation
Before any legal action is filed between the parties,
except for an ex parte application that seeks either
injunctive relief or a pre-judgment remedy such as a
temporary protective order, the parties agree to
participate in a mediation before a neutral mediator
that will last a minimum of four hours unless the
matter is resolved in less than that amount of time.
The parties further agree to equally share in all of
the costs associated with the mediation.
How will the parties benefit from this

type of contractual clause?
22
Mandatory Mediation
A.
Limit their attorneys fees
B.
Keep the lines of communication open

with the other contracting party
C.
Allows the parties to think out of the

box in reaching a solution to their
problem
D.
All of the above

23
Mandatory Mediation
Correct Answer: D
All of the above
Once litigation is filed, most parties to a contract stop
talking with each other and leave most of their
communications to their lawyers. A mediation before the
litigation will bring the parties together and give them an
opportunity to try to figure out if they have any ability to
compromise so as to allow their business relationship to
continue. Also, if the parties choose a creative mediator
that mediator might be able to develop ideas that the
parties have not considered before the mediation.
24
Liquidated Damages
Money Bags Bank, Co. (MBB) sued Give Me Cash, Co.
(GMC) for breach of contract. MBB alleged GMC failed to
pay $100K under a contract for financial advisory
services. GMC disputed the claim, countering that MBB
had breached the contract. The parties entered into a
Settlement Agreement calling for GMC to make three
payments of $20K each. If GMC missed a payment, MBB
would immediately be entitled to $100K plus interest and
attorneys fees.
Is this provision enforceable or

unenforceable in CA?
25
Liquidated Damages
A.
Enforceable, because liquidated damages clauses

are enforceable in CA
B.
Enforceable, because the damages are reasonable

and proportional to MBBs damages
C.
Unenforceable, because liquidated damages clauses

are not enforceable in CA
D.
Unenforceable, because the damages are not

reasonable and proportional to MBBs damages
26
Liquidated Damages
Correct Answer: D
Unenforceable, because the damages are not reasonable and
proportional to MBBs damages
While liquidated damages clauses are enforceable in California,

the amount of liquidated damages has to be reasonable and
proportional relative to the amount of the actual damages.
Here, GMC disputed the underlying claim and whether or not it

owed the $100K. As a result, the parties entered into a
settlement agreement calling for the payment of an aggregate of
$60K.The liquidated damages provision applied to a breach of
the settlement agreement, not the financial services agreement.
$100K of liquidated damages is not proportional to the actual
damages suffered here, which is loss of the $60K payment under
the settlement agreement.
27
Fundamental Policy Exceptions to

Choice of Law Provisions
In California, a choice of law provision
will not be enforced if the chosen
states law to be applied is contrary to a
fundamental policy of California.
Which of the following may qualify as a
fundamental California policy?
28

A.
Protection of the right of employees to not have any

part of their wages taken back by their employer.
B.
Protection of the right of citizens to pursue any lawful

employment (policy against covenants not to
compete).
C.
Protection of Californias statute of limitations.
D.
Protection of every citizens right to Hang Loose
E.
A and B
F.
B and C
29

Correct Answer: E
Protection of the right of employees to not have any part of their wages
taken back by their employer AND Protection of the right of citizens to
pursue any lawful employment (policy against covenants not to
compete).
In determining the enforceability of a choice of law

provision, the court must determine whether (1) the
chosen state has a substantial relationship to the parties
or the transaction, or (2) whether there is any other
reasonable basis for the choice of law.
If either test is met, the court must determine whether

the chosen states law is contrary to a fundamental
policy of California.
30
Contractual Limitations on
Bringing Claims
An agreement between Draper Partners, Inc. and Olson
Company states that the representations and warranties
contained in the agreement survive the Closing for a
period of one year.
Olson Company discovers a that breach of the
representations and warranties by Draper Partners, Inc.
was made within the first year after the Closing, but does
not bring a claim for the breach until after the expiration
of the one year period.
Will the court allow Olson Companys claim?

31
Bringing Claims
A.
The claim is allowed because California courts are

fundamentally opposed to any contractual limitation
on the bringing of claims.
B.
The claim is barred because it was not brought within

the one year period.
C.
The claim would be barred if the agreement also

stated that no claim for indemnification may be
made more than one year after Closing.
D.
The claim is allowed because the court would not

read the boilerplate language anyway.
32
Bringing Claims
Correct Answer: C
The claim would be barred if the agreement also stated that no claim for
indemnification may be made more than one year after Closing.
Courts generally enforce a parties agreement to shorten a limitation period than

otherwise provided by statute, provided it is reasonable, and such agreements do
not violate public policy. See Zalkind v. Ceradyne, Inc., 194 Cal. App. 4th 1010
(2011).
The Ninth Circuit has held that, because California law does not favor contractual
stipulations to limit a statute of limitation, that such stipulation must be clear and
explicit. It held that a clause similar to the one in the example was ambiguous and
served only to specify when a breach of the representations and warranties may
occur, not when an action must be filed. Western Filter Corp. v. Argan, Inc., 540
F.3d 947 (2008).
Thus, if parties wish to limit the period of time within which legal action must be
commened, they should use specific language, such as that used in Answer C.
33
Joint Drafting
The agreement has been prepared and negotiations in
connection therewith have been carried on by the joint
efforts of the respective parties. This Agreement is not to
be construed strictly for or against any of the parties
since both parties have jointly drafted it.
An ambiguity exists in a contract entered into between
ABC Corp and XYZ LLC regarding when certain goods
are supposed to be delivered. XYZ claims that the
ambiguity should be construed against ABC, because
ABC prepared the contract and all XYZ did was sign it.
Will the ambiguity be construed against ABC?

34
Joint Drafting
A.
No, because the parties agreed in the contract

that it was jointly drafted
B.
No, because the court determined that no

ambiguity existed
C.
Yes, because XYZ did not participate in any

negotiations
D.
Yes, because Civil Code Section 1654 controls

35
Joint Drafting
Correct Answer: A
No, because the parties agreed in the contract that it
was jointly drafted
While Civil Code Section 1654 typically governs
when an ambiguity exists in a contract, that
ambiguity will not be construed against the drafting
party if the parties have agreed that the contract was
jointly drafted by them.
36
Time of the Essence

Florist Co. hires Grow Co. to deliver 1,000 roses to Florist
Co. by July 10. The contract contains a time is of the
essence clause. The agreement also provides that in the
event of a breach, the breaching party shall have 10 days to
cure following notice of the breach. In reliance on the July
10 delivery date, Florist Co. agrees to provide 1,000
centerpieces for Happy Couples wedding. On July 11,
Florist Co. notifies Grow Co. it has failed to deliver and
needs the roses delivered immediately for the wedding.
Grow Co. delivers the roses on July 14. Florist Co. sues
Grow Co. in CA for its costs to buy roses at retail for Happy
Couples wedding.
Who wins?
37
Time of the Essence

A.
Grow Co. wins because time is of the essence

clauses are not enforceable in CA
B.
Grow Co. wins because an express cure period

trumps a time is of the essence clause
C.
Florist Co. wins due to reliance only
D.
Florist Co. wins due to reliance combined with time

is of the essence clause
38
Time of the Essence

Correct Answer: B
Grow Co. wins because an express cure period
trumps a time is of the essence clause
Time is of the essence clauses are generally

enforceable under CA law unless they act as
a forfeiture
However, courts will not interpret a time of the

essence clause as limiting or depriving a party
of the benefit of any cure period specified in
the agreement.
39
Contract Management
Discussion
Tina McKnight
Secretary & General Counsel
Power-One, Inc.
Typical In-House Contract Management

Scenario
Widely varying contract function

among businesses
Contract management, to the extent it
exists, is disjointed
Reasons
41
Role of the General Counsels Office
Educate on the purpose of legal

involvement
Guide enterprise-wide contract
management processes that balance
risk and profit
Create efficiencies
42
Successfully Engaging the Legal

Department
Understand the business

Be part of the team
Manage risk dont try to eliminate it
Engage executive management and
identify the 10 Commandments for
your company and TRAIN
Understand who the decision maker is
Be efficient
Show the benefit of engaging legal
counsel early in the process
43
Best Practices for In-House Management

of Contracts
Have an enterprise wide contract

management system
Centralize the repository
Simplify the delegation of authority and
TRAIN
Clarify responsibilities and TRAIN
Have a process for contract submission
Focus the right Resource on Contracts
by Type
44
Best Practices for In-House Management

of Contracts
Use simplified forms and templates

where appropriate
Plain English
Alternative choices
Update
-
analyze frequently renegotiated clauses and

revise to reflect consistent outcomes
Make forms and templates available

TRAIN
Build financial review into the process

before or concurrent with legal review
Evaluate legacy contracts
45
ORANGE COUNTY BUSINESS JOURNAL

$1.50 VOL. 36 NO. 13
Page 1
www.ocbj.com
APRIL 1-7, 2013
SECURITIES Advertising Supplement
APRIL 1, 2013
P l a n B f o r R ul e 1 0 b5 -1 Pl a n s ?
by James J. Scheinkman and Lulu Chiu, Snell & Wilmer LLP
ompanies and their executives who utilize Rule 10b5-1 Plans to

reduce the risks from insider trading claims when trading in
company securities should evaluate plan use given recent
increased scrutiny by the media and securities regulators. Since the
adoption by the Securities and Exchange Commission (SEC) of
Rule 10b5-1 (the Rule) in 2000, executives and directors at public
companies have widely used plans to take advantage of the
affirmative defense to insider trading suits created by the Rule.
Plans can be particularly helpful as class action securities plaintiffs suing
companies and insiders, in order to establish a key element of their case, often
point to executive trading occurring in close proximity with the timing of
company disclosures at issue in the case.
The Wall Street Journal recently conducted an investigation examining such
plans and published a series of articles within the past several months calling
into question certain plan practices by some participants. The investigation
found that of roughly 20,000 executives or trades sampled, around 1,500 of
them recorded gains (or avoided losses) of 10 percent in the week following the
trade, compared to only 800 who posted a loss of 10 percent. Executives who
traded irregularly recorded average gains (or avoided losses) of over 20 percent
in the week following their trade, a result that executives who traded on a more
regular pattern were much less likely to achieve.
The FBI and SEC in turn opened investigations concerning seven executives
whose trades the Wall Street Journal highlighted as suspicious, while the U.S.
District Attorneys office for the Southern District of New York subpoenaed five of
those seven executives. The Wall Street Journal also reported that the SEC will
be conducting broad computerized surveys akin to the Journals investigation.
The Council of Institutional Investors has publicly requested new Rule
guidelines or revisions for 10b5-1 Plans, while various shareholders have
proposed to companies the adoption of what they consider to be best practices
concerning plan use.
Under the current Rule, plans must be in writing and specify, or set forth a
formula for determining, the number of securities to be traded, the trade price
and the trade date. Typically, this is implemented as a contract with a securities
broker. Alternatively, the plan can grant a broker sole discretion over how, when,
and whether to trade, but this is used less frequently. The plan can only be
adopted when the executive is not aware of material nonpublic information, and
the executive is acting in good faith and not as part of a plan or scheme to
evade the prohibitions of the Rule. The executive cannot deviate from the plan
and cannot engage in offsetting hedging transactions in connection with sales or
purchases made under the plan.
In general, plans work well for executives who have a long-term stock
strategy, such as diversification, or for planning for a known event, such as
college funding. They are not suitable for every executive, particularly those who
prefer to have flexibility and control over their trading or who want to make a
one-time trade.
Some of the current issues being discussed regarding plans, either as Rule
changes or as best practices implementation, include:
Establishing a sufficient waiting period prior to trading under a

plan. The Rule does not currently mandate a waiting period between plan
adoption and implementing trades. A sufficient waiting period is important to
About Snell & Wilmer
Snell & Wilmer is a full-service business law firm with more than 400
attorneys practicing in nine locations throughout the western United States and
in Mexico, including Orange County and Los Angeles, California; Phoenix and
Tucson, Arizona; Denver, Colorado; Las Vegas and Reno, Nevada; Salt Lake
Reprinted with the permission of the Orange County Business Journal
establish good faith.

Further limiting the executives ability to make amendments to or
cancel a plan. Although the current Rule bars an executive from amending a
plan while possessing material nonpublic information, the Rule does not
expressly prohibit the executive from cancelling a plan at any time, including
while he or she possesses material nonpublic information. Frequent
amendments or cancellations, however, place doubt on whether an executive
implemented a plan in good faith.
Limiting the adoption of multiple or overlapping plans. Although an
executives use of multiple plans may be justified under certain circumstances,
having more than one plan may raise questions as to motivation.
Company involvement and tracking of plans. The Rule does not require
executives to provide the plan to the company. However, having the plans
furnished to the company can further demonstrate good faith, and the
companys ready access to the plans is very useful when in the midst of
addressing the securities law implications of a significant company development
or crisis.
Public Disclosure of Plans. Company disclosure of plans in a Form 8-K or
other filings also may be helpful to support a good faith determination. It also
may be beneficial from an investor relations standpoint to avoid stock analyst
and investor alarm over insider sales when the inevitable subsequent Form 4
filings occur.
While identification and evaluation of best practices is very appropriate,
companies should be wary of one size fits all approaches. Rule 10b5-1 Plans
should be viewed in the context of, and as a part of, a companys overall insider
trading policies. Moreover, companies should keep in mind that executives may
be reticent to use plans if the requirements imposed for use are overly
burdensome and restrictive. Careful thought should be given to establish those
policies which best advance for a particular company and its executives the
goals and purposes of having these plans.
Jim Scheinkman
Jim Scheinkman is a partner in the Orange County

office of Snell & Wilmer and is a practice group leader
of the firms Business & Finance Group. Contact Jim
at jscheinkman@swlaw.com or 714.427.7037.
Lulu Chiu
Lulu Chiu is an associate in the firms Los Angeles

office whose broad transactional practice
encompasses real estate and business finance and
securities law. Reach Lulu at lchiu@swlaw.com or
213.929.2548.
City, Utah; and Los Cabos, Mexico. Representing corporations, small

businesses and individuals, Snell & Wilmers mission is to take a genuine
interest in our clients, understand their objectives and meet or exceed their
expectations. Visit www.swlaw.com for more information.
CORPORATE COMMUNICATOR
Editor
Jeff Beck
602.382.6316
jbeck@swlaw.com
SPRING 2012
Negotiating Investment Banking M&A
Engagement Letters:
Keeping the Investment Bank Incentivized
While Protecting Your Interests
By Marshall Horowitz and Joshua Schneiderman
Authors
Marshall Horowitz
213.929.2519
mhorowitz@swlaw.com
Joshua Schneiderman
213.929.2545
jschneiderman@swlaw.com
Angela Perez
602.382.6354
alperez@swlaw.com
Congratulations we hope. Your company has battled

through the past several years of troubled economic times
and has come out on the other side stronger for it. Cautious
investors
who
have
been
Jeff Becks Quarterly
hoarding their cash are slowly
Tidbit of Interest:
testing the investment waters,
and a flurry of investment
The Bureau of National
bankers are rummaging through
Affairs reported that a
Manhattan Institute Center
the remnants looking for the
for
Legal
Policy
study
diamond in the rough that
showed that just 2 percent
entices some of this sidelined
of shareholder proposals
money back into the markets.
offered for votes at annual
meetings of the largest 150
One of the wiser investment
U.S. public companies were
bankers now remembered a
from institutions without
distant meeting with you and has
a social, religious or labor
realized, rightfully so, that your
affiliation and about twothirds of all shareholder
companys recent EBITDA growth
proposals filed at those
and margin expansion make you
meetings were filed by
a very appealing candidate to a
one of four individuals (or
potential buyer. The investment
their family members or
foundations).
banker has approached your
company, laid out a compelling
case for why a sale at this time might

make sense for your company, and has
convinced you to plant a for sale sign in
your corporate offices and test the market.
The investment banker has served up his
firms standard engagement letter, and
asked that you sign it so you can partner
up and kick off the process.
At this point you are conflicted you
know this investment banker is supposed
to be on your side and working for
you and you certainly do not want to
start the relationship on the wrong foot.
At the same time, there are a number
of provisions in the engagement letter
that make you uneasy, and you wonder
whether they are customary or if there
is room for negotiation. Beyond some of
the obvious negotiable points (such as the
amount of the success fee), we highlight
below several aspects of the engagement
letter that should be evaluated with care
and that have room for negotiation.
Fees
Without going into all the issues related
to the investment bankers fee, there are
a few points that come up frequently in
discussions with investment bankers, such
as the possibility of a progressive fee
structure and the timing of payments to
the investment banker, which are worth
addressing here. The fee payable to the
investment banker in an engagement letter
is most likely calculated as a percentage of
the price for which the company is sold.
PAGE 2 | CC
While an investment banker should always

be working to get the company the greatest
value in the sale, it is not uncommon to
tweak the fee structure to give the bank
some extra encouragement. One way to
accomplish this is through a progressive
fee schedule (sometimes referred to as
a Reverse Lehman formula), where the
success fee percentage increases as the
sale price crosses certain thresholds. Under
certain circumstances, minimum and/or
maximum fees might be appropriate. While
some banks will insist on a minimum fee, it
is nevertheless important to negotiate the
amount of the minimum fee to ensure that
the bank remains properly incentivized to
get its client the best deal.
Also worth considering are provisions in the
engagement letter that relate to the timing
and manner of payment of the investment
bankers fees. It is possible that a potential
buyer makes an offer for a company that its
owners think is too low, and they counter
with a higher price. For example, the
buyer may have expressed some concern
about whether the companys projected
future revenue levels are realistic, but has
indicated a willingness to pay an additional
amount for the company following the sale
if the projections pan out commonly
referred to as an earnout. In this situation,
the company probably would not want its
investment banker to collect a fee at the
time of closing on the earnout component
it is reasonable that the banker should only
get paid if the company/owners get paid.
To account for this, the engagement letter

should specify that the investment banker
does not get paid its fee on the earnout
unless and until the earnout component
of the purchase price is actually earned and
paid. If the investment banker balks at
this position, as a compromise, the parties
might agree that the banker will receive
its fee at the closing of the transaction
based on a transaction value that factors
in receipt of only a portion of the earnout
amount. In addition, if the investment
banker is amenable to the idea, it may be
prudent to specify that the banker gets
paid in the same form of consideration as
the company/owners get paid, so that, for
instance, if the company/owners receive
equity in the buyer as consideration, the
company/owners do not have to come up
with cash to pay the banker.
In addition, while it is common for
an investment banker to receive an
upfront retainer and a success fee
upon consummation of a transaction,
occasionally an engagement letter will call
for milestone payments at other points in
time. For instance, the investment banker
may have included a provision in the
engagement letter that calls for payment
of a portion of its fee upon the signing of
a definitive transaction document, and
the balance of its fee upon consummation
of the transaction. If the banker has
proposed a structure that incorporates
milestone payments, and that is something
a company is willing to consider, it is best
PAGE 3 | CC
to ensure that the milestone payments

are only earned upon the achievement of
legally meaningful and objective events.
For instance, if the banker has asked for
a milestone payment upon the signing
of a letter of intent or term sheet, a
company will likely want to resist this
point, as letters of intent and term sheets
are often nonbinding. While a letter of
intent may be meaningful from a moral
perspective, it typically only requires the
parties to continue to negotiate in good
faith, which would leave the company
paying an investment banker fee with no
assurance that it actually has a binding
transaction. Most investment bankers
will agree to offset any amounts owed
for a success fee against the companys
retainer. Finally, the banker may propose
that its fee be calculated off a base that
includes value over and above the cash
purchase price, such as lease payments
(if there is an affiliated landlord) or the
value of compensation under employment
agreements entered into in connection
with closing. These types of items should
be viewed with skepticism and negotiated
with great care.
Carveouts from
Transactions
the
Definition
of
The engagement letter will typically

provide that the investment banker will
be entitled to its fee upon consummation
of a transaction. In a sale context, the
term transaction will usually be defined
to cover the sale of all or part of the capital
stock of a company, the merger of a

company with an acquirer, or a purchasers
acquisition of all or substantially all of a
companys assets. It is also not uncommon
for the term transaction to be defined
even broader, and to pick up capital
raising transactions such as issuances of
debt and equity securities. Depending on a
companys circumstances, however, there
may be a number of transactions that it
will want carved out from the definition of
transactions.
Suppose a company has been in very
preliminary talks for several months with
one of its suppliers about the possibility
of combining the two companies to take
advantage of synergies. If, after the
investment banker has been engaged,
these talks become more serious and a
decision is made to pursue a combination
with the supplier, arguably the investment
banker should not be entitled to a fee.
After all, this was a potential transaction
the company identified and nurtured
on its own prior to discussions with the
investment banker. It is not uncommon,
therefore, to list on a schedule to the
engagement letter a number of parties
with whom the company has already had
discussions about a sale transaction and
to specify that a sale to, or combination
with, any of those listed entities will not be
considered a transaction for which the
investment banker will be entitled to a fee.
Remembering of course that the goal is to
keep the investment banker working hard
PAGE 4 | CC
on the companys behalf, the company

might instead provide for a reduced fee to
the banker in connection with a sale to a
party listed on the schedule.
Alternatively, imagine a situation where
several years ago, as part of a capital
infusion from a minority investor, a
company granted that minority investor
an option to purchase a 51 percent stake
in the company at a set price in the
future. The company will likely want its
engagement letter to make clear that if
the minority investor exercises its option
during the term of the engagement with
the investment banker (or during the tail
period, discussed below), then the banker
will not be entitled to collect a fee for that
transaction.
Services
One
important
component
in
an
engagement letter is a description of
the services that the investment banker
will provide in connection with the
engagement. This list of services may
include reviewing a companys financials
and comparing them to industry data,
identifying and approaching potential
purchasers, coordinating potential buyers
due diligence efforts and assisting in
negotiations. If the investment banker has
not already offered to do so, and it is not
addressed in the engagement letter, it is
important to reach an agreement at this
stage on who will be responsible for drafting
the disclosure document that will be used
to market the company. If the engagement

letter is not clear as to who will bear
responsibility for preparation of marketing
materials, the investment banker might
request an additional fee if the company
enlists its assistance with such tasks down
the road. The services provision of the
engagement letter should also make clear
that the company has the final decision on
all important transaction matters, such as
final approval of marketing materials, who
the bank shops the company to, whether
to engage a bidder in further negotiations
and, most importantly, whether to accept
or reject a purchase offer.
The Bankers Expenses
The engagement letter likely calls for the
client to reimburse the investment bank
for all expenses it incurs in furtherance
of the engagement. While a company will
not have much luck asking the investment
bank to cover its own expenses, there
is often room to establish a cap on outof-pocket expenses that the investment
banker will not exceed without first
obtaining the clients consent. This cap
can be a monthly cap or an aggregate
cap. Alternatively, the parties might agree
that the investment banker will not incur
any individual out-of-pocket expenses in
excess of a certain amount without first
obtaining the companys consent, though
before agreeing to a provision such as
this, it is important to note that it affords
the investment banker some wiggle room
to divide what may seem like one expense
PAGE 5 | CC
that crosses the agreed-upon threshold

into multiple separate expenses none of
which reach the threshold.
Term, Termination and Tail
Most investment banks structure the term
of the engagement in such a way that
it will perpetually renew absent some
affirmative action by the company to
terminate the engagement. For instance,
the engagement letter might provide that
the engagement lasts for six months,
but that it automatically renews for
additional successive one-month periods
if neither party provides written notice of
its intent to terminate the engagement.
Provisions such as this are notorious for
catching up with unwitting companies
who forget to notify their investment
banker of their intent to terminate the
engagement and wind up on the hook for
a hefty commission when they enter into
an unrelated transaction some years down
the road. Further, as discussed in detail
below regarding tail periods, sending the
termination notice one month in advance
of signing up for the new transaction is
unlikely sufficient to steer clear of paying
the investment banker its windfall. Rather
than agree to the investment banks
standard formulation of the termination
clause, it may be preferable to propose that
the engagement automatically terminates
after a set number of months unless the
parties mutually agree in writing to extend
the term of the engagement.
In addition, and almost without fail, an

investment banker will insist that the
engagement letter include a tail period.
The tail period is a period of time after
the termination of the engagement
during which, upon the completion of a
transaction, the investment banker would
still be entitled to its fee. While it is fairly
common to negotiate the duration of the
tail period, there are other features of the
tail that can often be revised to a companys
benefit. Frequently, the investment banker
will propose that the phrase transaction
means the same thing for purposes of
the scope of its own engagement as
well as the tail period. Depending on
the amount of leverage a company has
with its investment banker, the company
may have luck narrowing the scope of
the types of transactions that would
be covered by the tail. For instance, the
investment banker might agree that it will
only receive a payment for consummation
of a transaction in the tail period if that
transaction is with a third party who was
solicited by the investment banker during
its engagement and received a copy of
the companys disclosure document.
Depending on the circumstances, it
might even be appropriate to limit the
investment bankers fee in the tail period
to cover transactions with parties who
were brought to the companys attention
by the investment banker and with whom
the company engaged in active and
substantive negotiations (which is a phrase
that should be defined in the engagement
PAGE 6 | CC
letter). To limit the potential for disputes

down the road, it is also not uncommon
for the engagement letter to provide that
upon termination, the investment banker
must provide the company with a list of
those parties who fit within the active and
substantive negotiations standard.
Indemnification
Probably the most confusing part of
any engagement letter for a company
is the indemnification provision, which
is notorious for being filled with run-on
sentences that can extend for up to half a
page. If the indemnification provision is not
contained in the body of the engagement
letter, it will be attached as an annex or
exhibit to the main letter. In general, there
is relatively little room for negotiation
of the indemnification provision. The
investment banker will generally insist
on being indemnified for any liability it
incurs in connection with or as a result of
the engagement other than any liability
resulting from its own willful misconduct or
gross negligence. This standard is common
across banks, and it would be highly unusual
for a bank to agree to accept liability for
any conduct on its part that does not rise
to this level. Investment banks are of the
view that it is someone elses company
they are marketing, and therefore the
company needs to be responsible for what
is said. While a company may have some
success tinkering with the terms of the
indemnification provision on the margins,
banks are typically very reluctant

deviate from their standard language.
to
Conclusion
While it is no doubt important for a
company to maintain a positive and
collaborative
relationship
with
its
investment banker, that does not mean
the company should simply accept the
initial draft of the engagement letter that
its investment banker serves up without
negotiating certain fundamental points. In
fact, discussing the points set forth above
prior to signing of the engagement letter
will help the parties avoid disputes during
the course of the engagement, which
should help foster a productive working
relationship. An investment banker can
add tremendous value to a sale process
by helping to demonstrate a companys
value, identifying and engaging potential
buyers and assisting with negotiations;
however, before engaging an investment
banker, it is important that a company
do so on reasonable terms that strike an
appropriate balance between incentivizing
the banker and protecting certain of
the companys legitimate interests. A
reputable banker will understand and
appreciate the companys needs for
many of the protections discussed in this
article, and will probably even respect the
company more as a client if the company
recognizes and can articulate its need for
these protections.
PAGE 7 | CC
Social Media Practices and

Policies for the Pharmaceutical
Industry
By Angela Perez and Brandon Batt (formerly an
associate with Snell & Wilmer)
The Food and Drug Administrations much

anticipated draft guidance related to the
use of social media by pharmaceutical
companies fell far short of what the industry
expected. More than two years after the
FDA held initial hearings on the topic, it
quietly released social-media guidelines
that addressed only one particular issue:
communications relative to off-label uses
of their products. But, there is more
guidance to come. The FDA indicated upon
release of this limited guidance that it
expects to release multiple draft guidances
relative to social media and other issues,
including fulfilling regulatory requirements
when there are space limitations (i.e.,
the 140-character limit of Twitter) and
correcting misinformation.
While the guidance itself is important and
marks the first time that social media
channels such as Twitter and YouTube have
been mentioned by name in FDA guidance,
its narrow focus provides little in the way
of direction to an industry yearning for
clarity relative to online marketing issues
generally. Despite its narrow focus, there
is a silver lining. The pharmaceutical
industry can take comfort in the fact that
the guidance does not appear to suggest
that the industry stop using social media

for marketing purposes.
The pharmaceutical industry has been
understandably disappointed by the pace
of progress relative to guidance on the
use of social media. Big Pharma spent
$1 billion in online promotions last year
and is expected to reach $1.5 billion in
spending by 2014; however, we believe
this represents a fraction of the spending
that might be expected if clearer guidelines
were established. Rather than wait for
definitive guidance from the FDA that
many predict will never come,[1] a host of
industry players are making attempts at
developing consensus on a way forward. In
February 2012, the Digital Health Coalition
introduced its Social Media Guiding
Principles and Best Practices for Companies
and Users, which represents a consensus
of the industrys top digital marketers on
issues relating to social media and online
communications. Though the document
was conceived as an exercise in industry
self regulation, the group hopes it will
inform FDA thinking on the topic.
Regardless of the ambiguous state of the
law, the use of social media continues to
grow as a major form of communication
between FDA-regulated companies and
their customers. Companies must interpret
the FDAs guidance and use it as a means
of understanding the FDAs thinking on
the subject of social media. Below is some
information on how participants in the
industry are using social media despite
PAGE 8 | CC
the lack of guidance, followed by some

suggestions for implementing an effective
social media strategy at a pharmaceutical
company.
Industry Practice
Big Pharmas use of social media is
expanding but companies still need to be
cautious. Big Pharma currently utilizes many
types of social media platforms to discuss
public policy, corporate responsibility
and to generally promote their brand
and products to the public. For example,
companies like Sanofi and Pfizer have
used websites and online videos to engage
in educational campaigns in connection
with the need for various products. It is
estimated, however, that the vast majority
of companies in the pharmaceutical
industry do not participate in social media.
For these companies, there may be a
larger burden associated with remaining
compliant with applicable regulations in
the fast-pace world of social media. New
tools are developed on a rapid basis, which
requires companies to improvise and to
consistently review and/or modify their
social media strategies. For example, when
Facebook Inc. began allowing customers
to post messages on companies pages,
companies such as Johnson & Johnson and
AstraZeneca deleted some of their pages
and temporarily removed others due to
the uncertainty created by the situation.
Social Media Practices and Policies:

Some Suggestions
1. Maintain a Written Social Media

Policy
Being part of a heavily regulated and

competitive industry can result in a
cultural environment that does not easily
lend itself to safely making the kind of
instant unfiltered communications often
seen in social media channels. To combat
the associated risks, companies today
must work closely with both their legal
and marketing teams to maintain an upto-date social media policy and to ensure
its compliance with its terms.
Basic Terms. The purpose of the social

media policy is to guide the company
and employees use of social media.
A well-drafted social media policy will
discuss the basic guidelines regarding
permissible and prohibited conduct,
best practices and the level of privacy
employees should expect when using
either company or personal equipment.
As FDA-regulated companies continue to

expand their use of social media, the need
for diligent monitoring of the companys
and employees communications is more
important than ever. Large numbers of
employees engaging the public (on their
own behalf or the companys) amplifies
the potential for violating applicable laws
or a companys internal policies. It has
been predicted that in 2013 and beyond,
all industries are likely to encounter a
new generation of privacy, employment,
defamation and other legal claims arising
out of these social media platforms.
Proper and consistent training will allow
employees to safely use social media while
still growing a customer base and business.
Below are some basic tips to help a
company maintain a healthy social media
existence in the pharmaceutical industry.
PAGE 9 | CC
A Social Media Policy Should Establish

Processes and Procedures. A social
media policy should include processes
and procedures to ensure that social
media communications are properly
vetted by the appropriate departments.
Having a clear workflow will allow the
company to properly create, monitor
and censor communications before
they are sent, including posting any
disclaimers or declaring the companys
sponsorship of a website or product.
This workflow also will help to prevent
communications that are distributed
through an incorrect medium. For
example, while promoting a drug
through a social media site, companies
should ensure that promotion is
restricted to the physicians who have
agreed to receive promotional content
and does not reach the public.
A Social Media Policy Should be

Transparent.
Employees.
Employees
should
be aware that all communications
on
company-owned
equipment
can be subject to review by the
company. The companys social
media policy (in conjunction with
other policies) should establish
realistic privacy expectations for
employees, referencing the fact
that each employees right to free
speech is not unlimited, and that
they are prohibited from disclosing
the
companys
confidential
or
proprietary information and they
are prohibited from disclosing offlabel information to the public at
large. If your company monitors
its websites and social media
accounts (Facebook, blogs, etc.) for
unapproved, harmful, deceptive or
illegal comments, have disciplinary
actions in place and be diligent to
enforce them.
Customers and Business Partners.
Every comment or response to the
companys communications may affect
its reputation or relationships with
other parties, not to mention violate
applicable regulations (think: doctors
posting recommendations on how to
use products to the public). Although
the current thought is that companies
are not responsible for the comments
of others, this issue can be further
PAGE 10 | CC
mitigated by making it known to the

public what types of communications
will not be tolerated.
Every Employee Should Sign an
Acknowledgement. Each employee
should sign an acknowledgment stating
he or she has read the companys social
media policy and agrees to abide by its
terms and conditions.
2. Train All Employees
Training is Crucial. Companies can
substantially mitigate their exposure by
training all employees about its current
policies and the dos and donts
related to social media. According to
a recent study, almost 15 percent of
employees have made a status update
or tweeted about their work; 31 percent
of employers surveyed reported having
taken
disciplinary
action
against
employees for the information they
communicated about the company.
Employees are Responsible for
Their Own Messages. Well trained
employees should understand who is
responsible for creating, editing and
reviewing communications before they
are published to one of the companys
social media accounts. Employees
should be on notice that any comments
related to the company or its products
must be accompanied by a statement
verifying they are an employee of the
company, along with an appropriate

disclaimer.[2]
to a companys objectives when used

responsibly.
3. Keep Organized
Given the regulatory controls placed
on companies in the pharmaceutical
industry, the threat of an audit by the
FDA or another governmental agency
is real. Companies should prepare
for this reality by using technology
that
automatically
archives
all
communications in a way that makes
them easily accessible in the event of
an audit.
4. Other Important Tips
Security measures always should
be taken to protect confidential
information.
If social media communications include
a disclaimer, remember that per FDA
guidance, the public should be able to
access all related information easily
with only one click.
We expect the FDA to provide additional
guidance in the future related to social
media. In the meantime, FDA-regulated
companies should be careful with their
approach and apply existing laws to
social media communications just as one
would to other forms of media governing
the industry. Above all, remember that
social media can be an incredible asset
PAGE 11 | CC
Notes:
_______________
Note that while the FDA has not provided
guidance related to social media, other
government agencies such as the U.S.
Federal Trade Commission, the National
Labor Relations Board and the Securities
and Exchange Commission have provided
guidance that may be applicable to a
companys social media communications.
[1]
For example, the views expressed herein

are mine alone and do not necessarily
reflect the views of [my company].
[2]
Business & Finance Attorneys

Denver
Roger Cohen
rcohen@swlaw.com
303.634.2120
Brian Furgason
bfurgason@swlaw.com
303.634.2096
Brian Gaffney
bgaffney@swlaw.com
303.634.2077
Kristin Sprinkle
kmsprinkle@swlaw.com
303.634.2112
David Thatcher
dthatcher@swlaw.com
303.634.2146
Las Vegas
Pat Curtis
pcurtis@swlaw.com
702.784.5226
Sam McMullen
smcmullen@swlaw.com
702.784.5221
Zach Redman
zredman@swlaw.com
702.784.5261
Los Angeles
Susan Grueneberg
sgrueneberg@swlaw.com
213.929.2543
Marshall Horowitz
mhorowitz@swlaw.com
213.929.2519
Joshua Schneiderman
jschneiderman@swlaw.com
213.929.2545
Gregg Sultan
gsultan@swlaw.com
213.929.2555
Orange County
Katy Annuschat
kannuschat@swlaw.com
714.427.7410
Anthony Ippolito
tippolito@swlaw.com
714.427.7409
George Ng
gng@swlaw.com
714.427.7444
William Pedranti
wpedranti@swlaw.com
714.427.7445
Jim Scheinkman
jscheinkman@swlaw.com
714.427.7037
Mark Ziebell
mziebell@swlaw.com
714.427.7402
Phoenix
Jeffrey Beck
jbeck@swlaw.com
602.382.6316
Anne Bishop
abishop@swlaw.com
602.382.6267
Brian Burke
bburke@swlaw.com
602.382.6379
Brian Burt
bburt@swlaw.com
602.382.6317
Jon Cohen
jcohen@swlaw.com
602.382.6247
Melissa Sallee
msallee@swlaw.com
602.382.6302
Franc Del Fosse

fdelfosse@swlaw.com
602.382.6588
Jeff Scudder
jscudder@swlaw.com
602.382.6556
Michael Detro
mdetro@swlaw.com
602.382.6697
Garth Stevens
gstevens@swlaw.com
602.382.6313
Michael Donahey
mdonahey@swlaw.com
602.382.6381
Bianca Stoll
bstoll@swlaw.com
602.382.6236
Matthew Feeney
mfeeney@swlaw.com
602.382.6239
Nicholas Varela
nvarela@swlaw.com
602.382.6237
Cheryl Ikegami
cikegami@swlaw.com
602.382.6395
Richard Katz
rkatz@swlaw.com
602.382.6142
Eric Kintner
ekintner@swlaw.com
602.382.6552
Daniel Mahoney
dmahoney@swlaw.com
602.382.6206
Joseph Miller
jmmiller@swlaw.com
602.382.6738
Angela Perez
alperez@swlaw.com
602.382.6354
Terry Roman
troman@swlaw.com
602.382.6293
Salt Lake City

Cortland Andrews
candrews@swlaw.com
801.257.1802
Ken Ashton
kashton@swlaw.com
801.257.1528
Chad Hoopes
choopes@swlaw.com
801.257.1938
Brad Merrill
bmerrill@swlaw.com
801.257.1541
John Weston
jweston@swlaw.com
801.257.1931
Tucson
Lowell Thomas
lthomas@swlaw.com
520.882.1221
2012 All rights reserved. The purpose of this newsletter is to provide our readers with information on current topics of general interest and nothing herein shall
be construed to create, offer, or memorialize the existence of an attorney-client relationship. The articles should not be considered legal advice or opinion, because
their content may not apply to the specific facts of a particular matter. Please contact a Snell & Wilmer attorney with any questions. The Corporate Communicator
is published as a source of information for our clients and friends. This information is general in nature and cannot be relied upon as legal advice. If you have
questions regarding the issues in this newsletter, you may contact a Business & Finance professional or your regular Snell & Wilmer contact.
PAGE 12 | CC
ORANGE COUNTY BUSINESS JOURNAL

$1.50 VOL. 35 NO. 39
Page 1
www.ocbj.com
SEPTEMBER 24-30, 2012
MERGERS & ACQUISITIONS Advertising Supplement
SEPTEMBER 24, 2012
Goo dw ill Hun tin g:

E nforcing Non-Competes in California M&A Transactio ns
by Jim Scheinkman and Christy Joseph, Partners, Snell & Wilmer LLP
n late August, a California appellate

decision provided a useful primer
on drafting non-competition
covenants in California merger and
acquisition transactions. In Fillpoint
LLC v. Maas, the California Court of
Appeals affirmed a judgment of the
Orange County Superior Court holding
unenforceable a non-compete in an
employment agreement entered into as
part of a business sale. The decision
provides useful guidance for buyers in
drafting non-competes to properly protect the goodwill of the acquired business in a
manner that will withstand court scrutiny.
noted that the provision barred solicitation

of even potential customers. It also cited
its prior decision in Strategix Ltd. v.
Infocrossing West Inc. which considered
non-solicitation provisions prohibiting the
solicitation of all employee and customers
of the buyer as being impermissibly
broader in scope than non-solicitation
provisions which barred solicitations of
customers and employees of the sold
business only.
Non-competes in California
California has a strong public policy protecting each persons right to pursue his or her
chosen lawful occupation. This public policy is codified in California Business and
Professions Code Section 16600 and provides that generally every contract by which
anyone is restrained from engaging in a lawful profession, trade, or business of any kind is
to that extent void.
The California Legislature has provided an exception to permit non-competes entered
into in connection with business sales. Business and Professions Code Section 16601
allows that any person who sells the goodwill of a business may agree with the buyer to
refrain from carrying on a similar business within a specified geographical area in which the
business has been carried on for so long as the buyer carries on a like business. This
exception is available in transactions structured as a sale of substantially all of the
operating assets of a company or its division or subsidiary, or the sale by a shareholder of
his or her stock in a company. As part of an enforceable non-compete, courts will also
enforce non-solicitation covenants barring the seller from soliciting the sold businesss
employees and customers.
In allowing this exception, California has recognized the important commercial purpose in
protecting the value of an acquired business, recognizing that, when a seller is paid for the
goodwill of a business, it is unfair for the seller to engage in competition which diminishes
the value of the sold business.
However, courts have emphasized that this exception is limited and have declared that,
in order to uphold a non-compete pursuant to Section 16601, the contract may not
circumvent Californias deeply rooted public policy favoring open competition and must
clearly fall within this limited exception.
The Issues Presented in Fillpoint

In 2005, Handleman Co. acquired Michael Maass stock in Crave Entertainment Group.
In the Stock Purchase Agreement, Maas agreed not to compete with the sold business for
a period of 36 months following the closing. As part of the acquisition, Maas entered into an
Employment Agreement containing a non-compete covenant for one year following the
termination of his employment with Crave. Maas resigned from Crave about three years
after its sale and after the expiration of the non-compete in the Stock Purchase Agreement;
however, approximately six months later, he began working for a competitor of Crave
during the period that the non-compete in the Employment Agreement remained operative.
Fillpoint, which had acquired Crave from Handleman, then sued Maas for breaching his
Employment Agreement and also sued his new employer and its principal for interference
with contract.
In its decision, the Court was willing to read the Purchase Agreement and the
Employment Agreement together as an integrated agreement as the agreements were
signed by the parties around the same time and referenced each other. This was helpful to
the buyer since a non-compete in an employment agreement, standing alone without
integration with a purchase agreement, would be unenforceable. This is also consistent
with other California court decisions which have generally held that the location of a noncompete in a document separate from the purchase agreement, such as an employment or
non-competition agreement, is not fatal, in and of itself, to its enforcement provided that the
covenant otherwise meets the statutory requirements.
However, the Court declared that the fact that the two Agreements should be read
together does not mean that the non-compete in the Employment Agreement is enforceable
automatically. In striking down the non-compete in the Employment Agreement, the Court
distinguished that covenant from the non-compete in the Purchase Agreement Maas had
complied with, which the Court considered appropriate to protect the goodwill of the
acquired business for a specified period and to serve the purposes of the statutory
exception. The Court viewed the non-compete in the Employment Agreement differently,
finding that that covenant was much broader and prevented Maas for one year after
employment termination from making sales contacts or making actual sales to anyone who
was a Crave customer or potential customer, working for or owning any interest in a
business which would compete with Crave, or employing or soliciting for employment any
of Craves employees or consultants.
The Court concluded that the non-compete in the Employment Agreement was directed
towards affecting Maas rights to be employed in the future in this case, for a year after
the end of the three-year non-compete period in the Purchase Agreement. In doing so, the
Court cited a concession in the buyers appellate brief that the two covenants were
intended to deal with different damages the employee might do wearing his separate hats
of majority shareholder and key employee. Accordingly, the Court held that the Purchase
Agreement covenant was properly focused on protecting the acquired goodwill for a limited
period of time, but the Employment Agreements covenant improperly targeted Maas
fundamental right to pursue his profession.
In addition, the Court also found that the non-solicitation provisions were too broad. It
Reprinted with the permission of the Orange County Business Journal
Key Considerations for Buyers

A review of this decision and other cases leads to a conclusion that had the noncompetition covenant in the purchase documentation been drafted differently, the buyer
may have achieved its aims by keeping the employee from competing during the one year
after his employment ended. For example, the Fillpoint decision distinguished an earlier
decision in Alliant Ins. Services v. Gaddy which upheld identical covenants in a purchase
agreement and an employment agreement which applied for the later of five years following
the purchase or two years after termination of the employees employment with the new
company.
When drafting non-competes, buyers and their counsel should consider the following:
Integrate, Integrate, Integrate. It is critically important that the various transactional
documents appropriately reference each other, particularly if non-compete covenants are
contained in documents outside of the Purchase Agreement. The covenants in different
deal documents should also be consistent with each other. One of the factors which may
have influenced the decision in Fillpoint was the fact that Maas had already satisfied his
non-compete in his purchase agreement. Accordingly, the buyer had to justify separate and
different non-compete provisions in the employment agreement. Had the provisions been
consistent with each other, it would not have faced this battle.
Make Your Case for Enforcement in the Deal Documents. The non-compete
provisions should be drafted with an eye towards subsequent legal challenge and should
make the case themselves as to their absolute necessity to protect the acquired businesss
goodwill. This can be done through a number of means including, recitals confirming that
the purpose of the non-compete is to protect the goodwill and the reasonableness of the
provisions in doing so, closing conditions and other provisions which make clear the buyer
would not have closed on the purchase without these essential protections, and allocating
part of the deal consideration to goodwill.
Dont be Greedy. Buyers should not overreach by barring sellers from activities beyond
the scope of the statutory exception. The courts will take umbrage at covenants which not
only bar solicitation of the customers and employees of the acquired business but which
cast a broader net to all of the buyers employees and customers. Practitioners sometimes
take illusive comfort that courts will blue pencil non-competes with overbroad or omitted
restrictions and make them enforceable by providing reasonable limitations. However,
California courts will not go so far as striking a new bargain for the purposes of saving an
illegal contract. As stated by the Court in Strategix, had the parties intended to reach such
limited and enforceable covenants, they could have negotiated for them. We will not do
so for the parties now.
Conclusion
The law governing non-competes in California mergers and acquisitions serves as
another example that careful thought and analysis is requisite to accomplish the parties
objectives and to implement their bargained agreements. Parties who proceed without
understanding what courts will permit and who overreach do so at their peril.
Jim Scheinkman
Jim Scheinkman is a partner and practice group leader of the

firms Business and Finance Group in Snell & Wilmers Orange
County office. His practice focuses on assisting mid-market
companies and their owners in mergers and acquisitions,
financings, joint ventures, corporate governance and shareholder
dispute resolution, securities offerings, technology development and
transfers, executive compensation and other corporate and
commercial matters. Jim also serves as general outside counsel for
a variety of mid-market businesses. Jim can be reached at
714.427.7037 or jscheinkman@swlaw.com.
Christy Joseph
Christy Joseph is a partner and practice group leader for the

labor and employment law group in Snell & Wilmers Orange
County office. Her employment-related litigation experience
includes representation of employers in federal and superior
courts, as well as before administrative agencies in matters
involving wrongful termination, discrimination claims, sexual
harassment, ADA and medical condition claims, wage and hour
claims including class actions, tortious interference, unfair
competition, breach of fiduciary duty and trade secrets. Christys
practice further includes counseling employers not involved in
litigation regarding contractual, statutory and legal rights, and employment obligation
matters. She can be reached at 714.427.7028 or cjoseph@swlaw.com.
w w w. s w l a w. c o m
Counterfeit electronic parts flood U.S. market

By Keith M. Gregory
Reprinted and/or posted with the permission of Daily Journal Corp. (2012).
Electronic components are essential to our daily lives. They are
incorporated into medical devices as well as cell phones, our
automobiles and MP3 players. Also, electronic components are
incorporated into sophisticated military and aerospace items.
Unfortunately, the number of counterfeit electronic parts
being produced and sold by unscrupulous manufacturers has
exploded in the last 10 years, flooding the military, aerospace
and commercial markets. This flood of counterfeit electronic
parts was abrupt and unanticipated. By the time government
and commercial contractors, distributors, and the federal
government began to recognize the scope of the problem,
millions of counterfeit parts had entered the supply chain.
counterfeiting industry, initiated an investigation and held a

hearing in November 2011. The SASC investigation confirmed
the Department of Commerces findings that counterfeit
electronic parts had flooded every aspect of the supply chain.
In mid-2007, the U.S. Department of the Navy began to

suspect that an increasing number of counterfeit electronic
parts were permeating the U.S. Department of Defense supply
chain, and it asked the Bureau of Industry and Securitys Office
of Technology Evaluation, under the Bureau of Commerce, to
conduct a base assessment of the counterfeit electronics in the
supply chain. In January 2010, the Department of Commerce
released its study in a report titled Defense Industrial Base
Assessment: Counterfeit Electronics. The findings of the
Department of Commerce were shocking. Between 2005 and
2008, the incidents of counterfeit electronic parts encountered
by original component manufacturers more than doubled. In
fact, the incidents of counterfeit electronic parts increased in
every industry tracked in the study, and the Department of
Defense encountered counterfeit electronic parts in every type
of discrete electronic component, microcircuit, bare circuit
board, and assembled circuit board.
In ideal situations, contractors can source electronic parts

directly from the original component manufacturers, thus
minimizing the risk of receiving counterfeit parts. But the
original manufacturers often stop producing the needed
electronic parts long before the lifecycle ends for the products in
which they are used. Reengineering or redesigning the electronic
parts is usually prohibitively expensive, and procurement agents
often find it necessary to purchase aftermarket manufactured
parts to replace worn parts in the still useful products. Because
sourcing these aftermarket parts from unknown sources is often
the only option, there is a risk that counterfeiters will introduce
counterfeit parts into the supply chain.
The Department of Commerce found that [t]he proliferation

of counterfeit parts is not limited to occasional, isolated
incidents, but is increasingly present at every level of the supply
chain. It further concluded that [n]o type of company or
organization has been untouched by counterfeit electronic
parts. Even the most reliable of parts sources have discovered
counterfeit parts within their inventories.
In 2011, the Senate Armed Services Committee followed
up on the Department of Commerces assessment of the
The problem of counterfeit electronic parts in the supply chain

stems not from American contractors and distributors, but from
the actions of the counterfeiters, many of whom are based in
China. These counterfeiters take fake and used parts (obtained
from electronic waste imported from the United States) and
disguise them to look like genuine new parts so that they can be
sold to contractors and distributors in the United States.
The federal government too has struggled to stay ahead of the

flood of difficult to detect counterfeit parts. A March 2010
report by the Government Accountability Office noted that the
Department of Defense was only in the early stages of gathering
information on the counterfeit parts problem and had not
adopted a uniform definition of counterfeit parts. And in its
2010 assessment, the Department of Commerce observed that
the Department of Defense had not yet established regulations
for authenticating parts or reporting incidents of counterfeiting.
Indeed, there is no Department of Defense-wide recognized
definition of counterfeit parts. There are no regulations
establishing authentication procedures. There are no reporting
requirements. And the department relies on antiquated
procurement and quality control practices that are not
specifically designed to address counterfeit electronic parts.
Both the Accountability Office and the Department of

Commerce recognize that the government needs to act to help
prevent counterfeiters from introducing counterfeit parts into
the supply chain.
The recent flood of counterfeit parts being manufactured and
the lack of guidelines have resulted in largely inconsistent
anti-counterfeiting procedures being employed by different
distributors. Even when distributors identify counterfeit
electronic parts, they are uncertain as to what actions they should
take or to whom to report the counterfeiting. Largely due to
this confusion, as the Department of Commerce documented
in 2010, only 9 percent of independent distributors reported
notifying federal authorities after learning that a counterfeit
part had shipped. Fortunately, some distributors have
independently taken leading roles in attempting to reduce the
risk of counterfeit products entering the supply chain. These
distributors use sophisticated testing and inspection procedures,
maintain approved supplier lists, have begun to avoid sourcing
materials from identified high risk areas, quarantine suspect
counterfeit parts, and work with organizations dedicated to
fighting counterfeiting.
The government has recently begun to address the growing
counterfeiting problem and looks to soon establish universal
protocols for contractors and distributors to follow. On Nov.
29, 2011, Sen. Carl Levin introduced an amendment to the
National Defense Authorization Act that begins to establish
guidelines for the detection and reporting of suspect counterfeit
electronic parts. The amendment passed and was signed
into law by President Barack Obama on Dec. 31, 2011. It
gives the Secretary of Defense six to eight months to define
counterfeit electronic parts and establish regulations aimed at

keeping counterfeit parts out of the Department of Defenses
supply chain. These regulations will finally give contractors
and distributors much needed guidance on what constitutes
a counterfeit part, procedures to minimize the risk of passing
counterfeit parts along in the supply chain, and what actions to
take if a company believes it was sold counterfeit parts.
In addition to initiating the development of universal
reporting and testing procedures, the amendment aims to
target bad actors who are responsible for counterfeit parts
entering the governments supply chain. It directs the Secretary
of Defense to develop remedial actions, including suspension
and debarment, against suppliers who repeatedly introduce
counterfeit parts into the supply chain. Levin emphasized that
the amendment was aimed at those suppliers who repeatedly
fail to avoid placing counterfeit parts into the supply chain,
rather than diligent suppliers who are themselves occasional
victims of counterfeiters who flood the market with their
parts. In this manner, the amendment attempts to strike a
balance between going after repeat offenders, who have shown
a deliberate lack of diligence in attempting to keep counterfeit
parts out of the supply chain, with the acknowledgment that
some counterfeit parts can slip through even the most rigorous
anti-counterfeiting measures.
These steps taken by federal government will have the effect of
creating a more level playing field where counterfeiters will no
longer be able to control the market and make it a safer place for
manufacturers, distributors and consumers.
Keith M. Gregory
213.929.2547
kgregory@swlaw.com
Keith Gregory practices in the areas of general business matters,

corporate, franchise and partnership disputes, and intellectual
property and commercial litigation. He is an experienced litigator,
with considerable background in intellectual property issues, licensing
agreements, trade secret matters and Uniform Commercial Code
issues, especially within the electronic components and semi-conductor
industries. Keith was recently appointed to the SAE International
AS6081 Committee, established to develop standards proscribing
counterfeit parts avoidance requirements for independent distributors.
DENVER | LAS VEGAS | LOS ANGELES | LOS CABOS | ORANGE COUNTY | PHOENIX | SALT LAKE CITY | TUCSON
Thank You!
2013 All rights reserved. Notice: As part of our effort to inform you of changes in the law,
Snell & Wilmer L.L.P. provides legal updates and presentations regarding general legal
issues. Please be aware that these presentations are provided as a courtesy and will not
establish or reestablish an attorney-client relationship or assumption of responsibility by Snell
& Wilmer to take any action with respect to your legal matters. The purpose of
the presentations is to provide seminar attendees general information about recent changes
in the law that may impact their business. The presentations should not be considered legal
advice or opinion because their individual contents may not apply to the specific facts of a
particular case.
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Snell &Wilmer

Tuesday, June 11, 2013

In todays market of proliferating disputes and increasing

Keith Gregory | kgregory@swlaw.com

Tina McKnight | Tina.Mcknight@power-one.com

Jim Scheinkman | jscheinkman@swlaw.com

Josh Schneiderman | jschneiderman@swlaw.com

June 11, 2013

Tuesday, June 11, 2013

Application of Attorneys Fees Clauses

Who is entitled to recover the attorneys

Application of Attorneys Fees Clauses

Homer because he is the prevailing party since he

Bart because he prevailed on the breach of contract claim,

Neither party is awarded attorneys fees because the two

Both Homer and Bart are entitled to attorneys fees as to

Application of Attorneys Fees Clauses

If the language is general, e.g., arising out of or in connection

If the language specifically states that attorneys fees will be awarded

2013 Snell & Wilmer L.L.P.

Is the as is clause enforceable or

Enforceable because as is clauses are unequivocally

Enforceable because Ned had an opportunity to inspect

Unenforceable because Tywin concealed from Ned the

Unenforceable because as is clauses are prohibited

2013 Snell & Wilmer L.L.P.

California courts recognize the enforceability of

Lingsch v. Savage, 213 Cal. App. 2d 729, 740742 (1963).

This clause will be enforceable

Any country that has signed the

While both A and B are correct, because both the United

2013 Snell & Wilmer L.L.P.

Waiver of Jury Trials

Is the waiver of jury trial enforceable?

Waiver of Jury Trials

Enforceable because DE law re waiver of

Enforceable because CA law re waiver of

Unenforceable because DE law re waiver of

Unenforceable because CA law re waiver of

Waiver of Jury Trials

Article I, Section 16 of the California Constitution: Trial by jury

Grafton Partners v. Superior Court: CA Supreme Court strictly

Only statute that expressly permits waivers is Section 631(f) of

Best Efforts vs. Reasonable Efforts

Best Efforts vs. Reasonable Efforts

Best efforts because it is a more stringent

Reasonable efforts because a best efforts

It doesnt matter because California courts

It doesnt matter because Montague, Inc. and

2013 Snell & Wilmer L.L.P.

Best Efforts vs. Reasonable Efforts

Currently, there is no case law in California specifically addressing

Is the venue selection clause

Enforceable, regardless of whether the choice

Enforceable, only if Alpine County is a

Unenforceable, regardless of whether the

Unenforceable because no one even lives in

A venue selection clause is void only insofar as it disrupts statutory

A consent to personal jurisdiction is enforceable if freely negotiated

Code of Civil Procedure Section 395 generally governs venue.

2013 Snell & Wilmer L.L.P.

How will the parties benefit from this

Limit their attorneys fees

Keep the lines of communication open