A Potential Shield for PE Sponsors: Interpreting the Term “Affiliate” in Contracts

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In an important ruling, especially for private equity sponsors, the New York Court of Appeals recently held in Ellington v. EMI Music, Inc. (Ellington), that use of the term “affiliates” in a contract includes only those affiliates in existence at the time the contract was executed, absent explicit language demonstrating that the parties intended to bind future affiliates of the contracting party to the contractual obligations. Though it is still too early to tell how broadly the court’s holding will be applied, including the extent to which it will apply to fact patterns that are not identical to those in the case, this majority holding may provide a shield for private equity sponsors concerned about the risk that an agreement entered into by one of their portfolio companies may have adverse impact on separately managed “sibling” companies in the same portfolio. Some of those concerns may be allayed, if the agreements at issue under New York law do not explicitly demonstrate the parties’ intent to bind future affiliates of the contracting party.

The New York Court of Appeals Decision

The agreement at issue in Ellington was a 1961 United States copyright renewal agreement between Edward Kennedy “Duke” Ellington and Mills Music, Inc. (now EMI). The heir and grandson of Duke Ellington commenced a breach of contract action to recover royalties allegedly due under a royalty provision contained in the agreement. The preamble of the agreement defined the “Second Party” to the agreement as “American Academy of Music, Inc., Gotham Music Service, Inc., and their predecessors in interest, and any other affiliate of Mills Music, Inc.” The amount of royalties due to Ellington’s grandson turned on whether the profits of foreign subpublishers affiliated with EMI at the time the profits were earned, but not yet affiliated with the contracting party at the time the royalty agreement was executed, should be considered in the royalty calculation.

On appeal, the New York Court of Appeals affirmed the lower courts’ holdings and held, “[a]bsent explicit language demonstrating the parties’ intent to bind future affiliates of the contracting parties, the term ‘affiliate’ includes only those affiliates in existence at the time that the contract was executed.” In analyzing the parties’ intent under the agreement, the court stated that the use of present tense language, and not forward-looking language, was probative of an intent to limit application to then-current affiliates.

The New York Court of Appeals’ holding had the support of four of the seven justices. The concurring justices agreed with the outcome but rejected the majority’s interpretation of the term “affiliate,” highlighting that the holding “seems wrong” and “invites parties to create new affiliates, and to have them do what the old affiliates are prohibited by the contract from doing.”

Holding Ramifications

The holding may surprise practitioners because many agreements do not define “affiliates” with forward-looking language to expressly capture future affiliates and the potential for gamesmanship, given such a default interpretation seems dangerous. This case impacts all contracts that use the term “affiliate,” including provisions related to releases, license grants, non-competes, and assignment/change of control.

While the ultimate determination in any case will be made following a fact-specific inquiry, this holding should comfort private equity sponsors who are concerned, when acquiring portfolio companies, that they risk being bound by restrictions on “affiliates” under certain agreements that do not expressly state whether the term is meant to bind future affiliates.

*Associate Lauren Springer contributed to the drafting of this article.