Routine bits of contract clutter have the potential to create real problems. Baron Oursler, senior counsel at the transportation company FleetPride and one of the participants at last week’s “Drafting Clearer Contracts” seminar in Houston, told me about an amazing example of that. I now pass it on to you, dear reader.
It involves a dispute between UBS Securities and the hedge fund Highland Capital that played out in the aftermath of the financial crisis. Baron was part of the team representing Highland Capital. The dispute ended up before a New York lower court, which in 2009 considered Highland Capital’s motion to dismiss the complaint. (For a PDF of the opinion, go here.)
The dispute involved a proposed collateralized-debt-obligation transaction to be sponsored by Highland Capital. It failed, so UBS Securities sued, alleging that two offshore funds affiliated with Highland Capital, referred to in the opinion as CDO Fund and SOHC, had agreed to provide collateral to UBS to mitigate and offset any losses it suffered in case of adverse economic conditions but had failed to do so. UBS Securities alleged losses exceeding $745 million.
The transaction was expressed in three contracts: an engagement letter between UBS Securities and Highland Capital and two warehouse agreements between UBS Securities and the three Highland Capital entities.
UBS Securities alleged that Highland Capital had a duty to indemnify UBS Securities for its losses. It based that claim on two provisions in the contracts. The first is in section 3(c) of the engagement letter:
UBS Securities and [Highland Capital] agree that the CDO Fund and SOHC will in aggregate bear 100% of the risk of the Warehouse Facility in accordance with their respective Allocation Percentages (as defined in the Warehouse Documents) and otherwise in accordance with the terms of the Warehouse Documents ….
And the second is the provision in the engagement letter in which Highland Capital agreed, in essence, to indemnify UBS for any losses arising from breach by Highland Capital or its affiliates of any of their obligations in the engagement letter.
Understandably, the defendants argued, among other things, that nothing in section 3(c) triggered the indemnification obligations, as section 3(c) didn’t contain a promise by Highland Capital:
Defendants argue that it would be unreasonable to infer that this provision imposes an affirmative obligation on Highland Capital that UBS Securities did not also undertake, since they agreed upon the very same language. According to defendants, section 3(c) is just an acknowledgment by the signatories that the Funds will bear certain risks.
But the court wasn’t convinced—it declined Highland Capital’s motion to dismiss. Here’s the relevant part of the court’s reasoning (citations omitted):
The first and chief reason is that section 3(b) of the engagement letter does not in fact contain the word “acknowledge”; it states that UBS Securities and Highland Capital “agree that the CDO Fund and SOHC will in aggregate bear 100% of the risk of the Warehouse Facility.” Since the agreement is between UBS Securities and Highland Capital, but the undertaking to bear this risk is—in the first instance, at least—by the Funds, there is some question as to what UBS and Highland Capital “agree[d]” to do, if anything, in this provision. Plaintiffs argue that the parties understood and intended by this provision that Highland Capital would ensure that the Funds would bear 100% of the risk of the warehouse facility, because of its close relationship with those entities. In support of their argument, plaintiffs have submitted some evidence that Highland Capital acted on behalf of the Funds at other times during the course of this transaction. I find that plaintiffs’ reading of section 3(c) is not unreasonable based on the documents before me.
The construction at issue in this dispute is here is agrees that. This is what MSCD has to say about agrees that:
It’s commonplace for drafters to preface a provision in the body of the contract with agrees that, as in the parties agree that Acme shall purchase the Shares from Doe. But agrees that is redundant and so should be omitted—we know from the lead-in that the parties are agreeing to everything in the body of the contract. The same applies to covenants that.
Redundant use of agrees that is just one example of what I call “throat clearing”—tacking an extraneous subject and that-clause on to the front of what would otherwise be a self-contained provision. For other examples, see this 2014 post and this 2015 post.
But when a disgruntled contract party has enough at stake, it might be inclined to fasten on to a bit routine of clutter in a contract and use it as a stick with which to beat the other side. That’s exactly what UBS Securities did in this instance. And for purposes of a motion to dismiss, the judge—presumably a stranger to close analysis of the building blocks of contract language—was willing to give UBS Securities the benefit of the doubt.
Absence of the word acknowledge in section 3(c) is of no significance. Throat-clearing language uses a bunch of different verbs, including acknowledge. Section 3(c) works just fine without the “agree that” preamble—I suggest that it’s language of policy. Although I recommend using acknowledge in contracts only in language of declaration that serves to accept the other side’s facts, it’s unobjectionable to refer in pleadings, as Highland Capital did, to the parties acknowledging something by means of language of policy.
Without a lot of discussion, the appeals court reversed. (For a PDF of the opinion, go here.) But winning in expensive litigation is a distant second to not being involved in litigation at all. This dispute should spur drafters and reviewers to eliminate categories-of-contract-language clutter from contracts. If the other side asks why you’ve deleted a given “agrees that” from their draft, point them to this dispute.