Clause Elements

Each time I review a set of clauses for the Clause of the Day, I am stuck by their common features, even though the source material is drawn from a wide range of different agreement types, drafted by different firms, for different clients.

The clauses all share common characteristics. They frequently use the same terms of art or common phrases.

Deeper analysis shows that they are composed of common sub-elements. For example, the Non-Disclosure Obligation in confidentiality agreements contains four components: (a) confidentiality, (b) non-use; (c) non-disclosure; and (d) protection of information. The Conduct of the Business clause in acquisition agreements typically contains four elements requiring the seller to: (a) conduct business in the ordinary course consistent with past practice; (b) preserve its business organization (or assets); (c) keep its directors and employees; and (d) keep its customer and supplier relationships and preserve the goodwill of the business.

Clauses, just like the agreement as a whole, are a checklist of elements, detailing required and optional clause terms.

Of course, the existence of common features is really not surprising. The clauses are all seeking similar objectives. The language has evolved over time, much like common law, into a well used reference. But while, commonality exists, it has not been codified.

By contrast, in the field of architecture, design and build standards are codified. MasterSpec, by ARCOM, provides comprehensive documentation that “automates specification production tasks and simplifies creating custom office masters for specific regions, clients, and products.” (MasterSpec). My architecture friends tell me that standards are required because the lawyers would otherwise sue them.

Analysis of clause elements highlights the value of precedent and the related contentious issue of garbage-in; quality-out. Words are important. Precedent is important. What is included (or omitted) in the clause is just as important as how the language is expressed.

Organizing the Covenants Article in Legal Agreements

A covenant is an agreement to perform, or to refrain from performing, a specified action. It exercises a continuing interest over an asset, property interest, or performance obligation. For example, a covenant on real estate "running with the land" imposes restrictions upon the use of property regardless of the owner. Covenants may be applied to a property license (e.g. a software license,) or a license to use money (a loan), or a license to use real property (a lease) to limit the use of the asset. A covenant can also be applied to a performance obligation to restrict the actions of a party bound by the covenant, such as a non-compete provision.

The covenants article in legal agreements is, however, frequently unorganized. Related provisions may not be located near each other making it difficult to determine if the article contains all required clauses and does not contain duplicate or overlapping provisions.

Where a high-level organizing theme is found, it is sometimes an arbitrary classification that cannot neatly group all the terms. For example, where a pre-closing/post-closing classification is used, where should the confidentiality covenant appear? An analysis of legal agreements shows that the Covenants article is generally grouped into 5 different, high-level organizing themes:

• Single Covenants Section
• Covenants and Additional Agreements
• Covenants of the Seller and the Buyer
• Affirmative and Negative Covenants
• Pre-Closing and Post-Closing Covenants

An alternative classification considers the purpose or goals of the covenants. While some goals may overlap and serve multiple purposes, the principal objectives are:

• Perform actions to consummate the agreement
• Keep the parties informed
• Preserve and protect property
• Comply with laws, regulations and obligations
• Limit or control actions

Applying this scheme, ContractStandards proposes the following organizing theme that can be applied to all agreements.

1. Perform Actions (Consents, Approvals and Filings)

1.1. Best Efforts
1.2. Cooperation
1.3. Consents and Approvals
1.4. Stockholder Meeting (Approval)
1.5. Third Party Consents
1.6. Regulatory Filings
1.7. Governmental Approval
1.8. Securities-Related
1.9. Listing Approvals
1.10. Exclusive Rights
1.11. Fees and Expenses
1.12. Assistance

2. Information and Notification

2.1. Access to Information
2.2. General Information Obligation
2.3. Financial Statements
2.4. Information Regarding Collateral
2.5. Title Information
2.6. Casualty and Condemnation
2.7. Notice of Developments
2.8. Notice of Default
2.9. Notice of Litigation
2.10. ERISA Notices
2.11. Environmental Notices
2.12. Regulatory Notices
2.13. Officer’s Certificates
2.14. Inspection

3. Business and Operations

3.1. Corporate Existence
3.2. Charter Documents; Amendment of Material Documents
3.3. Nature of the Business; Lines of Business
3.4. Conduct of the Business (Ordinary Course)
3.5. Goodwill
3.6. Company Name; Company Headquarters
3.7. Maintain Books and Records
3.8. Accounting Changes
3.9. Fiscal Year; Fiscal Quarters
3.10. Limitations on Changes; Fundamental Changes
3.11. Ownership of Subsidiaries
3.12. Transactions with Affiliates

4. Equity; Ownership Interests

4.1. Capital Structure
4.2. Transfer of Equity Interests
4.3. Dividends; Distributions
4.4. Issuance of Securities
4.5. Stock Option Plans
4.6. Capital Expenditures
4.7. Restricted Payments

5. Assets

5.1. Acquisition of Property
5.2. Disposition of Property
5.3. Limitations on Leases
5.4. Limitations on Sale Leasebacks
5.5. Maintain Properties
5.6. Maintain Insurance
5.7. Intellectual Property

6. Liabilities

6.1. Pay Obligations
(a) Payment of Taxes
(b) Payment of Debt
6.2. Limitations on Indebtedness
(a) Leverage Ratio
(b) Fixed Charge Coverage Ratio
(c) Liquidity
6.3. Subordinated Debt
6.4. Limitations on Liens
6.5. Limitations on Loans, Advances and Investments
6.6. Limitations on Guaranty Obligations
6.7. Limitations on Contingent Obligations
6.8. Limitation on Negative Pledges
6.9. Limitations on Swap Agreements / Hedging
6.10. Restrictive Agreements / Burdensome Agreements
6.11. Protection of Lender’s Priority Status
6.12. Additional Collateral
6.13. Additional Guarantors
6.14. Pledged Assets
6.15. Appraisals

7. Personnel & Employment

7.1. Compensation
7.2. Employee Benefit Plans
7.3. Directors and Officer’s Insurance
7.4. Resignation of Directors
7.5. Severance Arrangements
7.6. Employee Matters; Hiring Employees
7.7. Employee Inventions Agreements
7.8. Employee Confidentiality Agreements

8. Compliance with Laws and Obligations

8.1. Comply with Laws and Regulations
(a) Environmental Compliance
(b) Bulk Sales Law
(c) Blue Sky Laws
8.2. Comply with Agreements and Obligations
8.3. Performance of Obligations

9. Use of the Transferred or Licensed Asset

9.1. Use of Proceeds
9.2. Restrictions on Use of Licensed Property

10. Restrictive Covenants

10.1. Confidentiality
10.2. Non-Competition
10.3. Non-Solicitation of Business
10.4. Non-Solicitation of Employees
10.5. Non-Disparagement
10.6. Enforcement
10.7. Acknowledgement
10.8. Publicity and Announcements

11. Further Assurances

11.1. Further Assurances
11.2. Disclosure Supplements