Reader @mpietruczak told me about this newsletter by Duane Morris. It’s about the decision of the U.S. District Court for the Northern District of California in Powertech Tech. v. Tessera, Inc. (PDF copy here). The court interpreted the phrase “non-breaching party” in a way that’s inconsistent with how I’ve used it.
The issue was whether under the contract at issue one party could terminate for breach by the other party even though the first party was itself in breach.
Here’s the termination provision:
Termination for Breach. Either party may terminate this Agreement due to the other party’s breach of this Agreement, such as failure to perform its duties, obligations, or responsibilities herein (including, without limitation, failure to pay royalties and provide reports as set forth herein). The parties agree that such breach will cause substantial damages to the party not in breach. Therefore, the parties agree to work together to mitigate the effect of any such breach; however, the non-breaching party may terminate this Agreement if such breach is not cured or sufficiently mitigated (to the non-breaching party’s satisfaction) within sixty (60) days of notice thereof.
Here’s what the court said in holding that the party seeking to terminate had no right to do so:
The termination clause refers to a “breaching party” and a “non-breaching party” in every sentence after the first: “The parties agree that such breach will cause substantial damages to the party not in breach . . . the non-breaching party may terminate this Agreement if such breach is not cured . . . to the non-breaching party’s satisfaction [].” Id. Without reading the first sentence out of context, the clause requires the party seeking to terminate for the other party’s purported breach to be substantially in compliance with its own obligations first.
But I recall having used “breaching party” and “non-breaching party” to convey a different meaning. The way I’ve used them, they’re equivalent to “Party A” and “Party B,” or “the transferring party” and “the non-transferring party.” In other words, I’ve used “non-breaching party” simply to distinguish that party from the other party; it doesn’t refer to that party’s status under the contract. I suspect that other drafters use “non-breaching party” in the same way.
So I suggest that whether the party in question could terminate should have been decided based simply on contract law. Nothing in the contract itself precluded termination.
I’m not yet prepared to say whether I’m inclined to recommend that you adjust your drafting to avoid having another court follow in the footsteps of the Powertech court in interpreting “non-breaching party.” But one option would be to use instead “the party claiming breach.”
[Updated April 7, 2014: As Chris points out in his comment, “the other party” would be even simpler. But I have at the back of my mind the notion that there’s a context where that wouldn’t work. I’ll revisit this at some point.]
I like “the party claiming (or not claiming) breach” because it avoids the conundrum of having first to decide whether the “party in breach” was actually in breach, which of course is the thing to be determined in the suit.
Although does it not present a problem for the very same reason, in that, depending on the drafting, it could allow a party to terminate having claimed a breach incorrectly (and perhaps even in bad faith)? You might actually want the question of whether the termination was valid to be subject to the outcome of the suit.
“Depending on the drafting” covers a multitude of sins, no? The contractual provision remains the same: termination for breach, not for being claimed to be in breach. “The party claiming breach” just puts things back into perspective from the pre-lawsuit standpoint. If the party claimed to be in breach was not actually in breach, then it wins the suit. Contracts are fragile things–one can seize any moment to terminate it; if one is wrong about the validity of the basis, the other side gets damages, but never gets to “reinstate” the contract.
I find it terrifying when a court – to my mind – interprets the word “the” to mean “a”. (Indeed, the extract from his judgment even says the agreement refers to “a” non-breaching party, which it doesn’t.) Why bother getting your words right if a court is going to ignore them anyway?
And where did the judge pull the word “substantially” from? If you think the contract says that a party must be non-breaching in order to terminate, how do you magically turn that into “substantially” non-breaching?
Ken:
How about “the other party”?
Chris
Uh, that seems to work. Now why didn’t I think of that?
It seems to me that the court read the contract right. First, using the term “non-breaching” sets a standard. Second, this sentence implies they meant the standard: “The parties agree that such breach will cause substantial damages to the party not in breach.” So the parties seem to be actually thinking about a situation where one is in bread but the other is not.
I think that using the terms as defined terms in the clause may have also helped the court to reach a different decision. Agree or disagree?
Agree, but the “rule” that a drafter should create only as many defined terms as needed suggests that one should exhaust other methods first.
One factor that might have influenced the court’s thinking: The contract was a patent license agreement, and it looked to me as though the party seeking to terminate the contract had been surreptitiously trying to “sleaze out of” its royalty obligation to the patent owner (although it appeared that the patent owner might not have had entirely-clean hands either).
1/ Would a simple solution be to start the provision, “Either party, even a party itself in breach, may terminate this agreement”?
2/ The termination provision raises other drafting issues. The first sentence uses both “such as” and “including” to exemplify “breach.” It might be better to omit all examples and stick with “Either party, even a party itself in breach, may terminate this agreement for any breach by the other party.” But if the drafter wants to give all the examples, it would be better to avoid the problems with “such as,” “including,” and their variants, and say, “Either party, even a party itself in breach, may terminate this agreement for the other party’s noncompliance with one or more of its duties, nonpayment of one or more required royalties, or nonprovision of one or more required reports, or for any other similar or dissimilar breach of this agreement by the other party.” Pound sand, iusdem generis!
3/ The second sentence has inappropriate language of agreement, but if you excise it, you’re left with “Such breach will cause substantial damages to the party not in breach.” To what category of contract language does that sentence belong? Policy? Is it meant to relieve the “breachee” of some burden of proof? Is it meant to bind nonparties such as courts? If so, does it succeed?
4/ The last sentence (“the parties agree to work together”) also has inappropriate language of agreement. Presumably the fix is to use “shall” in a disciplined way (“the parties shall work together”).
5/ The cure period as stated (“within 60 days of notice”) is technically 120 days long, but clearly means “within 60 days *after* notice thereof.” Also, if would more prudent to change “thereof” to “of the breach,” lest it be held to refer back to an intervening noun.
Regarding your point 3/, it should be language of declaration, with the parties acknowledging substantial damages. I suspect that it should refer to the possibility of damages, rather than certainty.
Danny: Welcome to the blog! I’m pleased that you find my stuff useful.
“Terminating party” and “non-terminating party” might not be subject to the potential confusion the court noted, but of course those terms suggest a different context.
And as per Chris’s comment, why not just “the other party”?
Ken
When the contract is expired by efflux of time, can a party terminate the contract after several months?