By Anne-Marie Eileraas
Companies based outside California may be reluctant to accept California as the governing law for their contracts. While some companies base their view on first-hand experiences, others cite media reports and surveys placing California in the bottom ranks of states’ legal and regulatory environments. For example, in late 2019, the U.S. Chamber Institute for Legal Reform published results of its latest survey of how participating U.S. business executives view the states’ legal environments, specifically regarding litigation and liability. California, along with Illinois and several southeastern states, fell in the bottom 10 states.
Whatever one’s view of such surveys, what’s clear is that polls tend to home in on a narrow range of issues: the perceived fairness of consumer/class action litigation and “hometown” jury verdicts. They don’t shed much light on the typical economic issues that arise in business-to-business contracts. Is California substantive law unfavorable for companies who contract under it?
Part 1 of this blog post will touch on California legal issues relevant to business contracts; more specifically, technology agreements for services, XaaS/cloud agreements, and software licenses. (This article does not address agreements with individuals, such as for personal or consulting services, which are subject to very different considerations under California law.) Part 2, coming soon, will discuss California venue for business litigation.
Choice-of-law clauses under California law
If a contract properly specifies California governing law and venue, most likely a court will enforce it. There is a strong policy favoring enforcement of contractual choice-of-law provisions in California. Many California-based companies, such as Oracle, Cisco, VMWare, and Palo Alto Networks, routinely use California choice of law provisions in their contracts.
In California, the court (not a jury) decides issues of contract interpretation and the application of contract defenses, such as force majeure. That may be of comfort to contracting parties, since pretrial jury waivers are unlawful in California. California courts strive to give effect to the mutual intent of the parties at the time of contracting. However, if the language of a contract is ambiguous in light of all the circumstances, a court will consider extrinsic evidence relevant to prove a particular meaning.
Legal issues that may favor customers
Not surprisingly given courts’ latitude to interpret contracts, California contracts law has pros and cons for companies purchasing software or services, and the following issues under California law, on balance, could be helpful and protective of their interests.
• Good faith and “best efforts” in California contracts
Under California law, an implied covenant of good faith and fair dealing protects the express promises in a contract and prevents one party from exercising its discretion to deny the other party the benefits of the contract. Unlike in some states, the implied covenant is not absolute; California permits parties to contract out of it with express provisions, such as a right to terminate in a party’s sole discretion.
The implied good-faith covenant can be helpful to customers in scenarios where, as a practical matter, some terms cannot be finalized until a future time, when the contract is in effect. While an “agreement to agree” is not enforceable, an agreement to negotiate in good faith can be enforced and can permit a party to recover damages.
Also helpful to a customer of technology services, California courts interpret “efforts” clauses to require more of a party than just acting good faith. A provider contracting to use its “best efforts” to perform a service must use the diligence that a reasonable person would exercise under the circumstances. It’s not enough for a vendor to say “I tried…”
• Availability of damages and failure of exclusive remedies
A well-drafted liquidated damages clause can reduce uncertainty of remedies if the other party does not perform. Liquidated damages clauses are presumed valid in California, with the burden of proof on the party seeking to invalidate a clause to show that it was unreasonable under the circumstances existing at the time of the contract.
California law protects an aggrieved party’s right to get a fair remedy when the other party breaches a contract, despite language in the contract excluding or limiting recovery. California Commercial Code §2719 provides, “Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this code.” The commentary to §2719 notes “it is of the very essence of a sales contract that at least minimum adequate remedies be available. If the parties intend to conclude a contract for sale within this Article they must accept the legal consequence that there must be at least a fair quantum of remedy for breach of the obligations or duties outlined in the contract.”
Note the commercial code applies to sales of goods, which can include software under a case-by-case analysis of whether the essence of the transaction is for goods or services. The commercial code provides for specified remedies, but courts have also relied on it to invalidate exclusions of consequential damages. For instance, in RRX Indus. v. Lab-Con, Inc., 772 F.2d 543 (9th Cir. 1985), the court interpreting California law invalidated a consequential-damages waiver in a software agreement after the vendor’s “repair” remedy failed of its essential purpose.
• Force majeure clauses
California courts do not enforce force majeure clauses literally. California cases have equated force majeure clauses to the common-law doctrine of impossibility, and courts will read certain common-law elements of a force majeure defense into contract terms. Most notably, a force majeure event must be beyond the reasonable control of the party seeking to be excused; and the incident must truly impose extreme and unreasonable difficulty, rather than merely render performance harder or more costly (including consideration of the party’s reasonable efforts to mitigate). Courts will consider the context and determine whether a party’s obligations should be delayed or completely terminated, in whole or in part.
Additionally, force majeure clauses must be drafted with particularity to overcome the presumption that only events unforeseeable at the time of contract will be excused. Mere “boilerplate” clauses will not excuse a party from performing if the event claimed as a force majeure was reasonably foreseeable.
Parties have significant freedom to draft express contractual indemnity clauses under California law. Courts will enforce a properly drafted indemnity covering a party’s negligence, including negligent misrepresentations and non-disclosure of material facts. However, outside of the insurance context, if a party “seeks to be indemnified for its own active negligence, or regardless of the indemnitor's fault, the contractual language on the point ‘must be particularly clear and explicit and will be construed strictly against the indemnitee.’” Prince v. Pacific Gas & Electric Co., 45 Cal. 4th 1151 (Cal. 2009). It is against public policy for an agreement to indemnify a party from knowingly unlawful future acts. Cal. Civ. Code §2774.
California has adopted statutory rules for interpreting indemnity provisions that apply unless expressly overridden by the parties. Those rules require, among other things, that the indemnifying party must defend indemnified claims upon the request of an indemnified party. Cal. Civ. Code §2778.
With attentive drafting, customers can protect their interests under California law by including indemnity provisions tailored to manage the risks of the technology they are buying.
• No one-sided provisions for recovery of attorneys’ fees
California generally follows the “American rule” for attorneys’ fees, meaning that each party to a dispute must pay its own legal fees. However, California’s civil code overrides unilateral attorneys’ fees provisions in a contract. If a contract has a term awarding attorneys’ fees to only the seller in the event of a dispute, that provision will be interpreted to award attorneys’ fees to whichever party prevails in a claim for breach of contract. Cal. Civ. Code §1717. This can protect customers contracting under one-sided vendor forms.
Scenarios where California law may not be as customer-friendly
Companies should investigate how California law applies to their specific industries or to particular kinds of contracts. For instance, because California law in general is more protective of individuals (especially employees), customers should understand the implications for any business contracts involving individual services under California law. Companies should be especially cautious when retaining independent contractors or attempting to include non-solicitation and non-compete clauses in their agreements.
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