Automotive MarketTrends | September 2019, Issue 3
Welcome to the latest edition of Foley’s Automotive MarketTrends newsletter, which continues to highlight key trends in the industry. In this issue, we focus on tips for drafting commercial agreements, and, more specifically, on those concerning warranties and indemnification, limitations of liability and damages, and strategies for protecting proprietary information.
Terms involving obligations for warranty and indemnification, as well as derived remedies, have become more significant than ever in the automotive industry in light of the record number of recalls and warranty campaigns initiated in recent years. Moreover, the warranty cost recovery programs initiated throughout the industry place heightened importance on negotiating and drafting contract terms that accurately reflect the roles of the parties and allocate risk according to those roles and the parties’ intentions.
Drafting Tips Concerning Warranties and Indemnification
Warranties are at the heart of a contract between a buyer and a seller. Simply stated, the No.1 tip for drafting a proper express warranty provision for automotive components or assemblies is to set forth what the supplier is promising the buyer that its parts will do. The express warranty provision should list performance requirements and technical specifications that the parts must meet. Express warranties should provide an objective measurement for performance under the contract. For example, requiring that a part meet specific technical specifications or cycle testing requirements is more precise and measurable than vague phrases requiring that a part be “free from defect” or “merchantable.” If the supplier is selling the buyer standard, off-the-shelf components and has no idea what the buyer’s end use for the parts will be, then the seller should not sign a broad warranty that includes an express design warranty or a warranty of fitness for a particular purpose. Instead, the supplier will want to disclaim all implied warranties and all other express warranties not specifically memorialized in the parties’ written contract.
Indemnification usually relates to third-party claims. Areas commonly covered in indemnification provisions include: (i) negligence and willful misconduct; (ii) IP infringement; (iii) breach (causing damage or claims to a third party); (iv) failure to comply with laws; or (v) personal injury or property damage. Upon notice of the third-party claim, indemnification provisions require one party to defend and hold harmless the other party against third-party claims arising from any of these scenarios.
Well-drafted indemnification provisions should indicate: (a) what constitutes reasonable notice; (b) which party is responsible for selecting legal counsel; (c) which party retains the authority to settle any claim; (d) broad categories of costs that are covered (including paying attorneys’ fees, judgments and/or any settlement amounts); and (e) a requirement that the party tendering the defense (i.e., seeking indemnification) will cooperate in the defense of the claim by providing documents, witnesses, etc.
Limitations of Liability and Damages
Case law, including the 1976 Seventh Circuit decision in Berwind Corp. v. Litton Indus., Inc., 532 F.2d 1, has greatly influenced how sellers draft liability limitations (like consequential damage disclaimers and overall damage caps) in contracts for the sale of goods, by virtue of the rationale the courts have used to not enforce a liability limitation. Drafting techniques derived from case law include the following:
Separate liability limitations from warranties. Practitioners and sellers should put the liability limitations in a separate stand-alone article of the agreement, so that a court does not determine that the presence of a consequential damage disclaimer in a warranty section means that the parties intended that the buyer would not be entitled to consequential damages only in a warranty claim.
Make liability limitations conspicuous. This requirement is generally interpreted to mean that the liability limitation provision should be in BOLD TYPEFACE AND CAPITAL LETTERS. Article 2 of the Uniform Commercial Code provides that “consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable...” UCC § 2-719(3). Courts rarely hold a consequential damage disclaimer to be unconscionable as between two commercial parties. Nonetheless, in Carter v. Exxon Co. USA, 177 F.3d 197, 207-209 (3rd Cir. 1999), the court concluded that the application of the consequential damage disclaimer in an agreement between two commercial parties was unconscionable, holding:
“[T]he disclaimer is not adequately conspicuous. The paragraph is not titled, and the critical language limiting Exxon's liability is not capitalized or highlighted. Thus, there is no indication that this far-reaching disclaimer might be of greater importance than other provisions of the paragraph or the agreement.”
The court found the lack of a title or highlighting to be particularly disturbing because the disclaimer was buried in a paragraph that purported to confer benefits on the plaintiff.
Explicitly mention that liability limitations apply to “torts” and/or “negligence.” Adding specific reference to torts makes clear that the liability limitations were intended to apply to tort claims as well as contract claims.
Strategies for Protecting Proprietary Information
In the highly competitive automobile industry, a company’s proprietary information and processes are some of its most valuable assets. While formally recognized intellectual property such as patents is a critical element of a company’s portfolio, proprietary information extends beyond formal intellectual property to include items such as manufacturing processes, data and test results, “know-how” within particular kinds of manufacturing, and important commercial information, such as pricing and business plans. Protecting these important assets can mean the difference between success and failure.
Where possible, companies should consider protecting critical processes and designs through a patent. Where proprietary information is not patentable or obtaining patent protection is otherwise impractical, protection of a company’s proprietary information often hinges on maintaining confidentiality of the information. In particular, companies should ensure that an appropriate confidentiality/nondisclosure agreement is in place before disclosing proprietary information to any third party (including customers, suppliers, and independent contractors). Disclosure of information without having confidentiality protections in place can result in the company losing any legal protections to which the information otherwise may have been entitled.
Within the company, access to proprietary information should be limited to those who need to use the information in order to perform their duties. Such individuals must be made aware of their duty to keep such information confidential. Where an individual is privy to particularly sensitive confidential information, to the extent permitted by law in a particular jurisdiction, companies should consider requiring non-compete agreements to limit the risk that the individual may leave and take his or her knowledge of such proprietary information to a competitor.
Finally, companies must take care that they do not inadvertently give away the company crown jewels as part of the contracting process. Many contracts, including many buyer terms and conditions, include provisions granting the buyer ownership or licenses to intellectual property and other information connected to the relationship. In many cases, this is appropriate. However, companies must take care to review such provisions and make sure that they do not go too far, particularly with respect to any rights that may be granted with respect to background intellectual property that each party brings to the relationship. By following these strategies and other best practices, companies can protect their proprietary information.