Private Equity

One of the most fundamental principles of the common law of contract is that parties are “masters of their own bargains,” and they can order their contractual affairs pretty much as they see fit.  And this includes the decision not to contract at all.  But because contracting involves actions and words by the parties that the law deems evidence of an intent to contract, a previous post to Weil Private Equity Insights blog has suggested the means and manner to avoid accidentally contracting when that is in fact not your actual intention.^[1]  Once parties do decide to enter into a written contract, however, can they agree in that written contract that no subsequent words or conduct, except a written agreement, will constitute a modification or waiver of the original written contract?

Despite the fact that most commercial agreements contain “no oral modification” clauses that specifically state that the agreement may not be amended or modified except through a written agreement (a “NOM”), the answer to that question depends on the specific law governing the contract.  Indeed, many U.S. courts have found these clauses unenforceable on the theory that if a contract can be made orally, a written contract can be modified or amended orally (even in the face of a NOM).^[2]  And this seems to be the English view as well.  As noted in the recent English Court of Appeals decision, Globe Motors, Inc. v. TRW Lucas Varity Electric Steering Ltd.:

Absent statutory or common law restrictions, the general principle of the English law of contract is that … [t]he parties have freedom to agree whatever terms they choose to undertake, and can do so in a document, by word of mouth, or by conduct.  The consequence in this context is that in principle the fact that the parties’ contract contains a [NOM] does not prevent them from later making a new contract varying the contract by an oral agreement or by conduct.^[3]

In New York, on the other hand, there is a specific statute that states:

A written agreement or other written instrument which contains a provision to the effect that it cannot be changed orally, cannot be changed by an executory agreement unless such executory agreement is in writing and signed by the party against whom enforcement of the change is sought or by his agent.^[4]

But even in New York and similar jurisdictions, a NOM can be subject to waiver based on the right set of facts and conduct of the parties.^[5]  So, if a NOM can be waived even if it’s enforceable, can parties agree that no provision of their written agreement (including the NOM) can be waived except pursuant to a written instrument signed by the party against whom the waiver is alleged?

A recent Texas Supreme Court case, Shields Limited Partnership v. Bradberry, ^[6] suggests that the answer is a qualified yes.

Like NOMs, “no oral waiver” clauses (a “NOW”) predicate change – waivers of contractual rights – upon written consent.  Also like NOMs, they identify actions that cannot give rise to amendment or forfeiture under a contract.  But the Texas Supreme Court recently distinguished these clauses in one important respect: the court held that NOWs (unlike NOMs) can only be waived through acts that are “inconsistent with the right to enforce” such provisions.  That is, parties can set forth the acts that will not constitute waiver, and where such acts are committed, no waiver will be found.  As a result, NOWs may do what their NOM counterparts cannot: bind parties by their explicit terms, at least insofar as those explicit terms identify specific conduct that will not be deemed a waiver.  According to the Texas Supreme Court:

We agree a nonwaiver provision absolutely barring waiver in the most general terms might be wholly ineffective.  But we cannot agree that a nonwaiver provision is wholly ineffective in preventing waiver through conduct the parties explicitly agree will never give rise to waiver.   Such a contract-enforcement principle would be ‘illogical, since the very conduct which the clause is designed to permit [without effecting a waiver would be] turned around to constitute waiver of the clause permitting [a party to engage in] the conduct [without effecting a waiver].’^[7]

This decision was prompted by a dispute between a commercial property owner and one of its tenants, the San Francisco Rose restaurant in Dallas, Texas.  The dispute turned on the parties’ respective rights under a lease agreement — specifically, which party had a superior right of immediate possession at the time of litigation.  Though the tenant claimed to have exercised its option to extend the lease, the owner maintained that the tenant could only exercise this option, consistent with the terms of the lease, if the tenant had fulfilled all of its contractual obligations.  The owner further argued that such obligations had not been fulfilled, as the tenant repeatedly failed to pay rent in a timely manner.  But the tenant disagreed.  It argued that, by repeatedly accepting the tenant’s late payments, the owner waived its right to enforce the condition to the lease extension requiring that the tenant be in full compliance with all of its obligations.

In the absence of the NOW, the conduct of the owner (in consistently accepting late payments without notice that it was reserving its right) appears to be just the type of conduct that would ordinarily give rise to a potential waiver (by conduct) of the right to insist upon the otherwise strict condition.  The issue could thus be resolved only by resort to the lease’s NOW.  This provision specifically stated that:

All waivers must be in writing and signed by the waiving party. Landlord’s failure to enforce any provisions of this Lease or its acceptance of late installments of Rent shall not be a waiver and shall not estop Landlord from enforcing that provision or any other provision of this Lease in the future.^[8]

The question presented to the Texas Supreme Court, then, was whether, notwithstanding the contrary language in the NOW, the owner waived its rights by accepting the tenant’s late payments.  The court distinguished this case (which involved the question of “waiver”) from the related but different question of whether a written agreement containing a NOM can nonetheless be orally modified.  Like many other jurisdictions, prior Texas cases had in fact held that a NOM would not necessarily prevent an oral modification of a written agreement through conduct or words that effectively evidenced the parties mutual agreement to ignore the effect of the NOM.^[9]  But because “waiver requires an intentional relinquishment of a  known right or intentional conduct inconsistent with claiming that right,”^[10] and because accepting late payments was specifically identified in the NOW as conduct that would not constitute waiver of the NOW or the right to insist later upon compliance with the condition to extension requiring timely payments, the court held that there had been no waiver by the acceptance of late rental payments.

It is important to note that the NOW at issue in Shields was not the garden-variety broad NOW. A garden-variety broad NOW reads like the NOW at issue in a recent New York Appellate Division case, Kamco Supply Corp. v. On The Right Track, LLC:

No waiver of any provision of this Agreement or any rights or obligations of either party hereunder shall be effective, except pursuant to a written instrument signed by the party or parties waiving compliance.  This waiver shall be effective only in the specific instance and the specific purpose stated.^[11]

In the Kamco Supply case, persistent acceptance of less than full performance of an annual minimum purchase requirement in certain supply distribution agreements was deemed to constitute a waiver by the nonbreaching party of its right to insist upon strict performance notwithstanding the broad NOW.  According to this New York court:

[T]he [breaching] parties’ persistent and repeated failure to meet minimum purchase requirements, coupled with [the nonbreaching parties’] continued acceptance of such conduct without any reservation or protest until a few weeks prior to the expiration of the agreements (by which time it was, of course, too late to insist upon strict compliance with the terms of the agreements), equitably estops [the nonbreaching parties] from invoking the benefit of the no-oral-waiver provision.^[12]

The lesson, then, is to be as specific as possible in your NOW as to what conduct will not be deemed a waiver and to heed the Texas Supreme Court’s warning against clauses “barring waiver in the most general terms”^[13] — because blanket protection may ultimately prove to be no protection at all.

As with most drafting issues, appreciating the common-law roots of the legal principles at play will aid the drafter in determining the appropriate scope of any clause.  As noted by the court in the Kamco Supply case, “the roots of waiver lie firmly in equity, and ‘are designed to prevent the waiving party from lulling the other party into a belief that strict compliance with a contractual duty will not be required and then suing for noncompliance or demanding compliance for the purpose of avoiding the transaction.’”^[14]  Ultimately, therefore, the decision in Shields can be understood as enforcing a specific NOW that clearly delineated conduct that would not constitute waiver.  Thus, as masters of their own bargain, the breaching party could hardly have been lulled into believing that specific conduct (acceptance of late rental payments), which it agreed would not constitute a waiver, had actually resulted in a waiver by the nonbreaching party—the specificity of the conduct not constituting a waiver trumping any equitable estoppel that may have otherwise arisen by that conduct had the NOW been of the broad garden-variety.

Thanks to Weil summer associate John Christian for his contributions to this blog.