United States: M&A Indemnification Provisions: Are You Drafting Unenforceable Time Limits?

In an M&A transaction, the convention is for the seller to make representations and warranties to the buyer regarding the target business.  When the target business is a private company, the acquisition agreement typically provides the buyer with a post-closing right to indemnification if any of the seller’s representations and warranties prove to be untrue. The purchase agreement also typically provides that the buyer’s right to indemnification is the buyer’s exclusive remedy for breaches of the seller’s representations and warranties. 

Indemnification Time Limits in M&A Agreements 

How long after an acquisition closes may the buyer of a business bring a claim for indemnification against the seller?  After selling a business, the seller desires to cut off the seller’s post-closing liability for breaches of the representations and warranties in the acquisition agreement as quickly as possible.  The seller wants the comfort of knowing that the proceeds of the sale received by the seller at closing are no longer at risk. 

Consequently, it is common in M&A agreements to provide that the buyer’s right to bring a indemnification claim against the seller for breaches of most representations and warranties (excluding certain “fundamental” representations and warranties) terminates on a negotiated date.  According to the American Bar Association’s 2015 Private Target M&A Deal Point Study, 82% of acquisition agreements included in the study provided that the buyer’s right to bring indemnification claims based on non-fundamental representations and warranties terminated 18 months or less after closing. 

Shortening the Statute of Limitations (“SOL”) 

The statute of limitations in South Carolina for bringing “an action upon a contract” is three years.  S.C. Code §15-3-530(1).  A provision in an M&A agreement that purports to limit the buyer’s right to bring indemnification claims to a period of 18 months from the closing is essentially an attempt to shorten that statute of limitations. Is the 18-month time-bar enforceable? 

South Carolina law does not permit parties to a contract to shorten an otherwise applicable statute of limitations.  Specifically, S.C. Code §15-3-140 provides:

No clause, provision or agreement in any contract of whatsoever nature, verbal or written, whereby it is agreed that either party shall be barred from bringing suit upon any cause of action arising out of the contract if not brought within a period less than the time period prescribed by the statute of limitations, for similar causes of action, shall bar such action, but the action may be brought notwithstanding such clause, provision or agreement if brought within the time period prescribed by the statute of limitations in reference to like causes of action. 

In Scott v. Guardsmark Security, 874 F.Supp 117, 121 (D. South Carolina, 1995), the District Court applied §15-3-140 and found that a time limitation in an employment agreement was void because “South Carolina law prohibits contractual provisions that reduce a statute of limitations.”

Applying §15-3-140 to M&A indemnification provisions, it is likely that a provision in an M&A agreement that purports to limit the buyer’s right to bring indemnification claims against the seller to a time period that is shorter than the three-year statute of limitations is unenforceable. 

Consequence to M&A Parties: Shortening the SOL

How should M&A parties address South Carolina’s prohibition on contractually shortening the statute of limitations?  Short of legislative change, the answer is not readily apparent.  

Time bars of 18 months or less for buyer indemnification claims based on breaches of non-fundamental representations and warranties are market practice in M&A deals. South Carolina sellers have a strong interest in obtaining this deal term and ensuring that it is enforceable. 

One possibility is for South Carolina sellers to choose the law of another state to govern their M&A agreements.  It is well established under Delaware law, for example, that parties to a contract may agree to shorten the length of time in which claims may be brought so long as the length of time is reasonable.  See, e.g. Closser v.Penn Mut. Fire Ins. Co., 457 A.2d 1081 (Del. 1983).  

The parties must then engage in choice of law analysis, however, to evaluate whether the choice of another state’s law to govern the M&A agreement is likely to be respected.  In addition, there is authority finding that application of S.C. Code §15-3-140 cannot be circumvented by choosing the law of another state as the contract’s governing law.  

In Scott v. Guardsmark Security, 874 F.Supp 117 (D. South Carolina, 1995), the Court addressed an employment contract governed by Tennessee law that contained a provision requiring the employee to bring any legal action arising from the employee’s employment within six months of the date on which the cause of action arose.  The Court found that “South Carolina’s public policy must control regardless of whether Tennessee’s substantive law applies to this dispute.” Id. at 121. The Court then applied S.C. Code §15-3-140 and found that “the time limitation in the contract is void.”  Id. at 121. 

Sellers in South Carolina face risk that time bars on the buyer’s right to bring indemnification claims that are shorter than South Carolina’s three-year statute of limitation are unenforceable.  Drafters of M&A agreements can attempt to reduce this risk through choice of law and exclusive venue provisions that look to the laws and forums of other states.  It may be helpful in enforcing those provisions that larger M&A transactions often involve parties, assets, and operations outside of South Carolina.  In some situations however, legislative change may be required to fully eliminate the risk. 

Consequence to Commercial Parties: Shortening the SOL

Parties to contracts often attempt to shorten the length of time in which claims can be brought not only in M&A agreements, but also in many other types of agreements.  For example, it is not unusual in a supply agreement or distribution agreement to provide that warranty claims against the seller must be brought within a certain length of time – often 12 months – from receipt of the products.  Similarly, insurance policies often contain time limits for asserting claims. 

Those time limits are likely unenforceable under South Carolina law to the extent that they are deemed to attempt to shorten the otherwise applicable statute of limitations. Contract drafters should consider whether a choice of law and venue provision outside of South Carolina is advisable in any contract situation with respect to which the prohibition of § 5-3-140 might limit the enforceability of a negotiated time bar.  

If parties choose the law of a state other than South Carolina as the governing law for a contract, the parties should examine that state’s law with respect to the enforceability of contractual provisions that alter the otherwise applicable statute of limitations.  The enforceability of the choice of law and venue provisions must also be analyzed.

Indemnification Time Extensions in M&A Agreements 

In M&A agreements, common practice includes not only shortening the otherwise applicable statute of limitations, but also lengthening it.  Most M&A agreements provide that the buyer can bring indemnification claims for breaches of certain “fundamental” representations and warranties given by the seller for a longer negotiated period, such as 10 years, and sometimes indefinitely.  “Fundamental” representations typically include representations such as the seller’s authority to enter into the agreement, due incorporation, capitalization, and lack of conflicts.  The buyer also may negotiate for a right to bring claims based on other specified representations and warranties – such as with respect to taxes, environmental matters, and employee benefit matters – during a longer period after closing. 

Lengthening the Statute of Limitations     

A provision that purports to allow a buyer to bring claims for breaches of certain representations and warranties within 10 years from the closing is essentially an attempt to contractually lengthen the otherwise applicable statute of limitations.  Under South Carolina law, can the parties to a contract lengthen the statute of limitations? 

At least one case applying South Carolina law indicates that parties to a contract can lengthen the statute of limitations.  See Westbrook Co. v. Hanover Ins. Co., 2011 WL 2600983 at *3 (June 30, 2011) (“South Carolina law does not prohibit contractual lengthening of the limitations period”).  Also, an argument can be made that because the South Carolina Code contains an express statute prohibiting contract parties from shortening the statute of limitations, but does not contain an analogous statute prohibiting contract parties from lengthening the statute of limitations, it is permissible for contract parties to lengthen the otherwise applicable statute of limitation. There remains some uncertainty, however, under South Carolina law on this question. 

Consequence to M&A Parties: Lengthening the SOL 

M&A indemnification provisions that permit the buyer to bring indemnification claims based on breaches of fundamental representations and warranties over long time periods are market practice in M&A deals. Buyers have a strong interest in obtaining this protection and ensuring that it is enforceable. 

Under Delaware law, courts have held that contractual provisions that attempt to lengthen the otherwise applicable statute of limitations are against public policy.  See, e.g. Shaw v. Aetna Life Ins. Co., 395 A.2d 384 (Del. Super Ct. 1978).  There was a period of time when practitioners in Delaware – and other practitioners working with M&A agreements governed by Delaware law – addressed Delaware’s public policy prohibition on extending the statute of limitation by executing contracts under seal.  Under Delaware law, the statute of limitations for a contract executed under seal is 20 years.  

More recently, in 2014, the Delaware legislature passed a statute that provides that parties to written contracts involving at least $100,000 may provide that any action based on such a contract may be brought within a period specified in the contract up to 20 years from the accrual of the cause of action.  Consequently, there is no longer a need to execute contracts governed by Delaware law under seal to achieve enforceability of indemnification provisions that allow for periods of up to 20 years to bring claims. 

S.C. Code § 15-3-520(b) provides for a 20-year statute of limitation for “an action upon a sealed instrument . . . ”.  In Lyons v. Fidelity National Title Insurance Company, 415 S.C. 115, 129 (2016), the South Carolina Court of Appeals found that the 20-year statute of limitations prescribed in S.C. Code §15-3-520(b) applied to a title policy because “the presence of a seal on the face of the policy, next to the president’s signature, evidences an intent to create a sealed instrument.” 

To obtain certainty that an indemnification provision in an M&A agreement governed by South Carolina law that permits the buyer to bring claims for breaches of fundamental representations over longer period of time is enforceable, the agreement should be executed under seal.  Another alternative is to choose the governing law of another state, such as Delaware, where the law is settled that parties to a contract can agree to a longer statute of limitations. 

Consequence to Commercial Parties: Lengthening the SOL

Though perhaps not as prevalent as short time bars, parties sometimes desire to extend the length of time during which claims can be brought under contracts. For example, a licensee may want to obtain a right to receive indemnification from a licensor for intellectual property infringement claims over a long period.  Parties to non-disclosure agreements desire to preserve their rights to trade secrets by imposing non-time barred obligations on the parties to maintain the confidentiality of trade secret information.  

Contract drafters should consider using a sealed instrument or choosing governing law other than South Carolina with respect to any contract that contains a provision that may be deemed to extend the otherwise applicable statute of limitations. When choosing the law of another state as governing law, contract drafters should bear in mind that the enforceability of contract provisions that are deemed to alter the statute of limitation varies state by state. 

Takeaway

M&A agreements and other agreements may contain provisions that are deemed to attempt to alter the applicable statute of limitations.  Those provisions may be unenforceable in South Carolina. With respect to contracts governed by South Carolina law that attempt to alter the applicable statute of limitation, care should be taken to analyze the risk that those provisions may be unenforceable and to determine whether any steps can be taken to reduce that risk.

This article originally was published in the May 2017 edition of SC Lawyer magazine. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.