Recently, it has struck me that many business folks who “negotiate tons of IP license agreements,” fail to understand the difference between covenants, representations and warranties that are “standard” in many such agreements. Well, that is not too surprising. What is very surprising, however, is that many of their lawyers also fail to appreciate the differences as well! Many think the terms are synonymous and thus use them interchangeably. They are not. So, for those of you tired of faking the funk, here is some (either fresh or refresher) “Contracts 101!”
A covenant is a promise by a party by which it pledges that something is either done, will be done or shall not be done.
Example 1: “Licensee shall pay Licensor a flat royalty based on 2.5% of Gross Revenues received from the sale of Licensed Products.”
Example 2: “Company A hereby covenants not to sue Company B under any patent listed in Exhibit A for infringement based upon any act by Company B of manufacture, use, sale, offer for sale or import that occurs after the Effective Date.”
A representation is a statement of fact that induces a party to enter into the contract. The statement, made before or at the time of making the contract, regards a past fact or existing circumstance related to the contract which influences such party to enter the contract.
Example 1: “Licensor represents to Licensee that it has the full and unencumbered right, power and authority to enter into this Agreement and to grant the license rights granted by Licensor to Licensee hereunder.”
Example 2: “Company A hereby represents that it owns full legal and equitable title to each patent listed in Exhibit A.”
A warranty is an undertaking or stipulation that a certain fact in relation to the subject of the contract is or shall be as it is stated or promised; and refers to an agreement to protect the recipient against loss if the fact is or becomes untrue.
Example 1: “Licensor warrants to Licensee that it has not received any written notice or claim, and is not otherwise aware that the Licensed Technology infringes or misappropriates the proprietary rights of any other Person.”
Example 2: “Company A warrants to Company B that the Technical Information provided hereunder will be the same as that used in the design, production, installation and maintenance of Licensed Products produced in its own factories.”
So why should you care!?
Well, generally speaking, when a breach of a covenant is “material” (i.e., a breach that destroys the value of the contract for the non-breaching party), it excuses the non-breaching party’s performance. This often is subjective and can be expensive to prove in later litigation. (Thus, the more specificity drafted into a contract – i.e., a listing of the specific and most-likely events that trigger a termination event – the better that contract protects the parties.)
Upon a false representation (or misrepresentation), however, the defrauded party may elect to void the entire contract, and recover any sums paid. When a breach of warranty occurs, the damages recoverable are the difference in the value as warranted (i.e., how they should have been) and the value as received. This is because “representations” should be statements made by a party after investigation and with a belief that such statements are true, and “warranties” should be statements a party makes while willing to accept financial responsibility if the statement turns out to be untrue, regardless of whether they actually (or should have) investigated.
In sum, upon a breach of a covenant or breach of warranty, the contract remains binding and damages only are recoverable for the breach; whereas upon a misrepresentation, the defrauded party may elect to void the entire contract. When you consider the differences in available remedies (and applicable statutes of limitations), it is important to understand whether a covenant, representation or warranty should be made during the drafting of each clause in the contract.
The commonly-held paradigm that “representations” cover past and existing statements, and “warranties” cover existing and future statements is as solid as a published patent application’s claims before a first Office action. That is probably why it has become commonplace for contract drafters to use the form: “Party A represents and warrants [insert statement(s) of fact].” But, what does that mean? One could argue that the defrauded/non-breaching party would then have a choice as to an action for (fraudulent, negligent and innocent) misrepresentation, or an action for breach of warranty if the statement turns out to be untrue. But not all commentators and courts may agree with that conclusion. Surprisingly, the leading contracts horn book I used in law school is silent on this issue!
The fact of the matter is that using “represents and warrants” may not affect the choice of action an aggrieved party may bring in some circumstances and jurisdictions. But, those of you who have read my previous post on using both words (and digits) to express numbers, know that I dislike archaic practices that no one bothers to question. By the same token, one commentator has observed that: “[T]hese usages often render the modern contract an utter chore to draft, read and interpret. They also encourage a general heedlessness as to meaning, thereby increasing the odds that a given piece of contract prose will contain a drafting flaw that results in a dispute or deprives a client of an anticipated benefit.” The solution? In the context of an IP license, one could always use the broader terms “representations” or “represents,” and avoid “warranties” or “warrants” because these latter terms may imply an obligation. Then, similar to my advice with respect to covenants, one may consider being more specific with respect to the aggrieved party’s remedy if a factual assertion proves untrue (e.g., termination, money damages, substitution, indemnification, etc.).
Happy contract drafting…but I warrant covenant that the foregoing is not the end of the issue!