Survival of Reps and Warranties: Drafting Lessons from the Delaware Court of Chancery

Survival of Reps and Warranties: Drafting Lessons from the Delaware Court of Chancery

Last week Chancellor Strine of the Delaware Court of Chancery issued an opinion in GRT, Inc. v. Marathon GTF Technology, Ltd., No. 5571-CS (Del. Ch. July 11, 2011), addressing whether a provision in a joint venture contract that particular representations would survive for one year and thereafter terminate along with any remedy for breach effectively operated to shorten the statute of limitations with respect to claims relating to those representations.  Courtesy of John Reed, a partner in DLA Piper's Delaware office, below is a brief summary of the case and a few key takeaways.

The provision at issue stated that certain "representations and warranties ... will survive for twelve (12) months after the Closing Date, and will thereafter terminate, together with any associated right of indemnification ... or the remedies provided ..."  The plaintiff-investor argued that the Survival Clause should not be read as shortening the time period in which a claim for breach must be brought, but instead only as shortening the period of time in which a breach may occur subject to the ordinarily applicable three-year statute of limitations.  The Chancellor rejected the argument and held that "the contract plainly shortened the three-year statute of limitations applicable to breach of contract claims to one year."

The Chancellor did not review parole evidence because he determined there was no other reasonable interpretation.  The opinion is detailed and acknowledges that there are scholarly writings suggesting the issue is not entirely clear (which begs the question of whether the Chancellor is correct that there is just one "reasonable" position), but he distinguishes those authorities.  In any event, there are some drafting lessons to be learned in order to ensure a client's intent and expectations will be satisfied and to avoid having to litigate the issue.

The Chancellor suggested there are at least four distinct possible ways to draft a contract addressing the life span of the contract's representations and warranties:

  • The first possibility is where the contract expressly provides that the representations and warranties terminate upon closing.  In that case, the court noted that "all the major commentaries agree that by expressly terminating representations and warranties at closing, the parties have made clear their intent that they can provide no basis for a post-closing suit seeking a remedy for an alleged misrepresentation."
  • The second possibility is where the contract is silent as to whether the representations and warranties survive or expire upon closing.  This scenario creates the most doubt, but the Chancellor observed that most authorities suggest a hard and fast rule that "[u]nless the parties agree to a survival clause extending the representations and warranties in the agreement past the closing date, the breaching party cannot be sued for damages post-closing for their later discovered breach."
  • The third situation is where the contract contains a discrete survival period during which the representations and warranties will continue to be binding on the party who made them.  That is the situation the court addressed in the case.  Despite his ruling, the Chancellor stated the following: "Admittedly, there is some commentary that does not view a contractual survival clause as unambiguously establishing a contractual limitations period. But the purpose of that commentary is to urge practitioners to adopt a new approach to drafting the provisions of merger and acquisition agreements involving representations and warranties, their lifespan, and the ability to sue for their breach."  Whether the court should have reviewed parole evidence to glean the parties intent will have to be determined by the Delaware Supreme Court, assuming the investor appeals.  For the future, the suggestion on how to avoid the issue should be followed.
  • The fourth situation is also important to understand in order to manage a client's expectations, and that is where the contract provides that the representations and warranties will survive indefinitely.  The Court pointed out that "[a]s a matter of strict or literal construction, one might imagine that a clause which provides that the representations and warranties shall survive indefinitely would mean that the representing and warranting party would face indefinite post-closing liability for its representations and warranties. But, in light of the public policy underlying statutes of limitations in general, and the widespread refusal of courts to permit parties to extend the limitations period beyond the legislatively determined statute of limitations and thereby violate the legislature's mandate, the general rule is that in such a situation, courts will treat the indefinite survival of representations and warranties as establishing that the ordinarily applicable statute of limitations governs the time period in which actions for breach can be brought."

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