BUSINESS DIVORCES:  Drafting the Resolution Agreement — Setting the Subject Scope

Drafting the Resolution Agreement — Some Typical Provisions  posted last month discusses some of the terms typically found in a business divorce resolution agreement.

Here is a short discussion about the set of terms in a business divorce resolution agreement which defines its subject scope.

Which Terms in the Agreement Define its Subject Scope?

Several different provisions in the agreement read together may identify the matters the parties expect the agreement to cover and the matters the parties do not intend the agreement to address — that is, the subject scope of the contract.

Among those provisions are the recitals and the merger clause (also referred to as the integration clause, saying that this written document contains the entire agreement of the parties).  Other sections that can evidence the subject scope include the release and the post-closing covenants  (the parties’ future obligations).  Add, also, the Governing Documents.

If the agreement is well drafted, these different sections fit together tightly, without gaps between them and without conflicting with each other.  Because some of these provisions are “boilerplate,” however, it can be easy to slap them into the agreement instead of joining them together carefully.  When that occurs, the drafters are setting the stage for another battle between the parties.

A Good Idea: An Explicit Provision about Scope

The agreement should precisely define its objective in a designated section that sets forth the parties’ exact intentions in choosing to enter into the agreement.  That paragraph can prove crucial in interpreting other terms of the contract in the future.  It is essential for the parties to express what relationship, dispute, obligations, rights, and so on they want to end, settle, release and terminate.  Equally important is the parties’ clear expression of what existing matters they wish to remain in effect.

An Example of the Problem if the Subject Scope is Fuzzy

Here is an example, from real life, of the fuzzy subject scope problem.

The Governing Documents of the company in which the parties are members contain one provision restricting members from competing with the entity (Noncompetition Covenant) and another obligating the entity to indemnify members against third-party claims based upon actions they take on behalf of the company (Indemnity).  Both sections explicitly provide that they survive a member’s withdrawal from the company.

The company’s members quarrel.  They enter into a business divorce resolution agreement under which Smith withdraws from the company while Jones and Brown, the remaining members, continue the business.

The recitals and merger clause in the business divorce agreement do not reference the Noncompetition Covenant or the Indemnity.  Likewise, the release given by Smith does not carve out an exception for the Indemnity.

A few months later, a third party sues Smith for something he did while a member of the company.  He writes the company to invoke his indemnification rights under the company’s Governing Documents.

It is no surprise — except to Smith — that the company (Jones and Brown) decline his claim for indemnification.  After all, in the business divorce agreement, Smith released the company from all of its contractual obligations to him.

When Smith opens a new business that competes with his old company, he hears again from Jones and Brown.  Now they are invoking the provisions of the company’s Governing Documents the prohibit a withdrawing member from engaging in a business in competition with the company.  Because the company did not release Smith from the competition restrictions when he withdrew, Smith realizes — too late — that he has another problem.

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