If a guy in a shop gives me too much change, I'll give it back to him. But if someone makes a mistake in a commercial contract, that's bad luck. And mistakes do happen more often than you would think, given the prices lawyers charge for their services.
The classic lawyer's error, which is used to scare young lawyers into being careful, concerns a commercial lease.
Somewhere in London there is an extremely valuable commercial building, leased for virtually nothing thanks to a fundamental but simple lawyer's error.
The original one-year lease was drafted in 1927 and stated that the tenant had the option to renew for an additional one year on the same terms. What the lawyer for the landlord forgot to add was that "same terms" meant all the same terms except the option to extend.
Since the new lease also had the option to extend for one year, on the same terms, the tenant exercised the option, and one year later exercised it again, and again, and again for more than 80 years.
So now the tenant is paying 1927 market rent, around £350 (HK$5,300) a year, and the building is effectively worthless. I think the lawyer who drafted that lease went on to become a hairdresser.
The error that my team has just picked up in the agreements we are negotiating is not quite so bad, but it's pretty embarrassing nonetheless.
My client is buying an Asian industrial company from a big American conglomerate, and we are negotiating what is called a Share Purchase Agreement (SPA).
In all SPAs there is a concept of limitation of liability. When you buy a company you expect the seller to be liable for any problems that they didn't disclose. So if you find out that the company you just bought has assets on its balance sheet that don't really exist, you expect to be able to claim some sort of damages from the seller.
The flip side is that the seller doesn't want to have liability for these sorts of things for an unlimited time and for an unlimited amount.
There is of course an argument that there should be no limit and that if I lose money because you breached a contract then I should get compensated no matter what. But as sensible as this sounds, it's just not the way things work.
There is always a limit on the seller's liability and it's generally somewhere between 50 and 100 per cent of the purchase price and lasts for a few years. This means that if I pay US$100 million for a company, and two years later discover that there is a US$120 million problem, I can get back only US$100 million from the guys who sold it to me. And if I don't discover the problem for three years, then I get nothing.
In legal terms, the seller will accept liability for certain problems subject to the agreed limitations on liability. "Subject to" is a popular phrase in legal documents.
We have finished negotiating the limits on the seller's liability in our SPA, but we were just informed by the engineers of an operational problem at one of the seller's plants.
There are several approaches that we can take to this. Everything can be put on hold while we work out how much the repairs are going to cost, and then we deduct that amount from the purchase price. The deal can be suspended while the seller fixes the problem. Or the deal can be abandoned.
The last option is for the seller to simply accept liability for the problem, allow the deal to close and then compensate the buyer at some later point when everyone has worked out how bad the problem is. This is the option that we chose.
Trouble is, when their lawyers drafted their client's liability for this new problem into the contracts, they forgot to write "subject to" the limitations on liability. So they have unlimited liability forever for an unknown problem.
This is not a position any lawyer would ever allow their client to be in. If the cost of repairing the plant is for some reason more than the whole company is worth, they're on the hook for it. Nasty.
Not a single person on the team suggests that we should tell the seller that they have made a mistake. The SPA is signed, the deal closes and the contracts get filed away somewhere. Perhaps one day someone will need to look at the contracts again and will find the error.
And you know who'd get blamed? The lawyers. That's why no one tells the other team that they made a mistake. Even the nicest people in the world have no sympathy for lawyers.
Mighty error in two small words of 'legalese'
Sunday, June 8, 2008