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Terminating a contract has consequences. But what those consequences are depends upon what the contract actually says, or doesn’t say, about the effect of terminating that contract or a particular aspect of the parties’ relationship created pursuant to that contract. Several recent cases from different jurisdictions all indicate that the effect of terminating an agreement was not as carefully addressed in many agreements as it should have been. The problem, it seems, is that many contract drafters fail to distinguish between the termination of the contract itself and the ongoing relationship of the parties created by that contract, or they fail to preserve claims for certain pre-termination breaches or the enforcement of certain ongoing obligations intended to continue post-termination.
Thus, in a recent Delaware Court of Chancery decision, Yatra Online, Inc. v. EBIX, Inc., 2021 WL 3855514 (Del. Ch. Aug. 30, 2021), the court was faced with an effect of termination provision in a merger agreement that provided as follows:
Section 8.2. Effect of Termination. In the event of any termination of this Agreement as provided in Section 8.1, the obligations of the parties shall terminate and there shall be no liability on the part of any party with respect thereto, except for the confidentiality provisions of Section 6.4 (Access to Information) and the provisions of Section 3.26 (No Other Representations and Warranties; Disclaimers), Section 4.17 (No Expenses), this Section 8.2, Section 8.3 (Termination Fees) and Article IX (General Provisions), each of which shall survive the termination of this Agreement and remain in full force and effect; provided, however, that, subject to Section 8.3(a)(iii) [the provisions addressing payment of the termination fee], nothing contained herein shall relieve any party from liability for damages arising out of any fraud occurring prior to such termination, in which case the aggrieved party shall be entitled to all rights and remedies available at law or equity. The parties acknowledge and agree that nothing in this Section 8.2 shall be deemed to affect their right to specific performance under Section 9.9 prior to the valid termination of this Agreement. In addition, the parties agree that the terms of the Confidentiality Agreement shall survive any termination of this Agreement pursuant to Section 8.1 in accordance with its terms.
Note that, unlike most typical effect of termination provisions in merger agreements, which carve-out liability for a pre-termination “willful breach,” this provision only carved out “damages arising from any fraud occurring prior to such termination.” But when the outside date arrived, the target decided to terminate the merger agreement, as was its right, and then sued the buyer claiming that the buyer had breached certain covenants related to its obligation to file and have the SEC declare effective an S-4 in an effort to avoid the buyer’s obligations to close the merger agreement.
But, while the target had the unquestionable right to terminate the merger agreement, the effect of such termination was dictated by the terms of the effect of termination provision, which eliminated any liability of the parties respecting the obligations set forth in the contract, unless there was “fraud.” Even though the allegations of nonperformance of the various efforts covenants respecting the preparation and filing of the S-4 appeared egregious, they did not amount to fraud according to the court, and because there was no carve out for pre-termination breach of contract, the effect of the target’s decision to terminate was clear: no claim for pre-termination breach was available. Despite the target’s argument that this result was absurd because it would require the target to keep the agreement alive in order to sue for the breach, the court found that:
[T]here is nothing absurd about a contract that, in essence, requires parties to sue for breach without terminating the agreement. … Thus, the Merger Agreement provided a choice to a party faced with a breach by the counterparty: either (a) sue for damages (or specific performance) or (b) terminate the Merger Agreement and extinguish liability for all claims arising from the contract (except those specifically carved-out, including claims for fraud). The latter option would be preferable where, for example, the terminating party believed it had some liability exposure of its own and would prefer to terminate the Merger Agreement to eliminate that risk. This is a perfectly logical way for parties contractually to manage risk, and it is not for this Court to redline the parties’ bargained-for limitations of liability because one party now regrets the deal it struck.
Switching from effect of termination provisions in merger agreements to another familiar context, a recent United States Court of Appeals for the Ninth Circuit decision addressed the effect of a termination provision in an nondisclosure agreement (NDA). BladeRoom Group Limited v. Emerson Electric Co., 11 F.4th 1010 (9th Cir. Aug. 30, 2021) (applying English law), involved a typical nondisclosure agreement that prohibited the disclosure of confidential information obtained during the consideration of a potential acquisition transaction. The NDA was governed by English law. After the deal failed to materialize and negotiations were terminated, the potential purchaser was alleged by the potential target to have misappropriated and used confidential information obtained during the negotiation of the potential acquisition. The district court found in favor of the target and awarded substantial damages. One of the issues at trial was the impact of the following termination provision in the NDA:
The parties acknowledge and agree that their respective obligations under this agreement shall be continuing and, in particular, they shall survive the termination of any discussions or negotiations between you and the Company regarding the Transaction, provided that this agreement shall terminate on the date 2 years from the date hereof.
The potential acquirer argued that under the plain language of this termination provision, its confidentiality obligation ended 2 years after the date the NDA was signed (apparently there was some question as to whether the use and disclosure of the confidential information occurred before or after that 2 year period and the potential acquirer had sought to exclude any evidence regarding that use or disclosure after the 2 year period). The district court, however, held that despite the proviso terminating the agreement after 2 years, “the purpose of the contract [was] to protect information, not provide for its release after 2 years.” Thus, according to the district court, “the NDA’s confidentiality obligations survived beyond two years.” To hold otherwise, according to the district court, “would lead to an absurd result and would create some inconsistency with the rest of the [NDA].”
But the Ninth Circuit, applying well-recognized principles of English contract interpretation precedent, reversed the district court, holding that the termination provision’s “natural meaning unambiguously terminated the NDA and its confidentiality provision two years after it was signed.”
Finally, in Miller v. Honkamp Krueger Financial Services, Inc., 9 F.4th 1011 (8th Cir. Aug. 24, 2021), the United States Court of Appeals for the Eighth Circuit had occasion recently to consider the effect of a termination provision in an employment agreement that contained a covenant obligating the employee not to compete with the employing company for one year after termination of the “Employee’s employment.” Unfortunately for the company, the employment agreement also contained the following provision in Section 2: “the parties agree that either party may terminate the Agreement on written notice.” So, within a few days after the employee left its employment with the company (and thereby terminated her employment), the former employee sent the company a notice formally terminating the employment agreement itself. The former employee thereafter asserted that she was no longer bound by the non-compete. The Eighth Circuit agreed:
By its terms, the non-compete provision survived the termination of Miller’s “employment.” But there is nothing in the non-compete provision to suggest the parties intended it to survive the termination of the Employment Agreement. And the contract treats the term of employment and the term of the Employment Agreement as two distinct concepts.
Section 2’s distinction between the term of employment and the term of the Employment Agreement is critical because, as noted above, the non-compete provision only survives the termination of Miller’s employment. There is nothing in the non-compete provision to suggest that it survives the termination of the Employment Agreement. It follows that when Miller left her employment with HKFS on September 4, the non-compete provision remained in force, … [but] when Miller terminated the Employment Agreement in writing on September 7, the non-compete provision became inoperable.
So, there you have it. Enough said.
- At common law, a party is generally permitted to terminate an agreement if its counterparty commits a material breach of that agreement. And unless the agreement provides otherwise, that termination of the agreement by the non-breaching party does not typically eliminate the breaching party’s liability for its pre-termination material breach of the agreement. But when an agreement specifies that the effect of termination is to eliminate all liability for the obligations set forth in that agreement, the parties have “alter[ed] the common law rule” and, in the absence of specific carve-outs from that effect of termination, liability for pre-termination breaches have in fact been eliminated. See AB Stable VIII LLC v. Maps Hotels and Resorts One LLC, 2020 WL 7024929, at *103 (Del Ch. Nov. 30, 2020); In re Anthem-Cigna Merger Litigation, 2020 WL 5106556, at *134 (Del Ch. Aug. 30, 2020).↵
- Those principles generally track the approach taken by most U.S. courts. See Glenn West, A New Year’s Resolution for Deal Professionals: Make Sure Your Written Deal Documents Say (And Will Be Interpreted to Mean) What You Meant, Weil Insights, Weil’s Global Private Equity Watch, January 2, 2018, available here.↵
- See also Fulton v. Honkamp Krueger Fin. Servs., 2020 WL 7041766 (D. Minn. Dec. 1, 2020) (employee subject to the same form of employment agreement as was the employee in Miller and court reached the same result, holding that where employee terminated the employment agreement and then immediately afterwards terminated the employment itself, employee was not subject to non-compete when accepting new job offer following termination of employment because the agreement itself had already terminated).↵