Morgan Miller Blair

A recent decision of the Ninth Circuit U.S. Court of Appeals stands as a reminder to parties and counsel negotiating acquisitions that the acquisition agreement must explicitly state their intentions, if any, to limit the time period after closing in which one party may sue the other.  Western Filter Corporation v. Argan, Inc., decided in August 2008, held that a buyer’s claims against the seller could not be dismissed as untimely based on a purchase agreement provision limiting the survival of representations and warranties without an unambiguous statement of intent to shorten the applicable statute of limitations. 

The Case. The Western Filter case grew out of a familiar scenario:  buyer’s remorse due to alleged seller misrepresentations.  In 2003, Western Filter purchased all of Puroflow, Inc.’s stock from Puroflow’s parent, Argan, Inc. for $3.5 million.  In the stock purchase agreement, each party made representations and warranties to the other.  The agreement also contained a customary survival clause providing that each party’s representations and warranties survived the acquisition closing for one year, except for a specified list of representations and warranties (not implicated in the case) that survived indefinitely.  The agreement required Argan to indemnify Western Filter for its losses resulting from any breached representation and warranty by Argan, and a portion of the purchase price was escrowed to cover any post-closing claims by Western Filter.

After closing, Western Filter asserted that Argan had greatly overstated Puroflow’s inventory value.  Settlement negotiations were unsuccessful, and 18 months after closing, Western Filter sued Argan in Los Angeles County Superior Court for breach of contract, intentional misrepresentation and other causes of action.  After removing the case to federal district court, Argan sought summary judgment on the grounds that the suit was barred by the one-year survival clause.  The district court granted summary judgment and dismissed the case, concluding it was time-barred, based on the “plain meaning” of the survival clause.  However, the Ninth Circuit Court of Appeals reversed, finding the survival clause ambiguous and therefore not sufficient to shorten the limitations period under California law.  Because Western Filter had sued within the limitations periods set by statute (which ranged from two to four years for the claims brought by Western Filter), its claim was timely and could proceed.  In supporting its holding, the Ninth Circuit pointed to California case law that permits, but disfavors, contractual shortening of a statutory limitations period set by statute, and therefore requires such an agreement to be clear and explicit.  The Ninth Circuit apparently concluded that the parties might have intended the one-year survival clause to specify “when a breach of the representations and warranties may occur, but not when an action must be filed.”

Pointers.  Experienced M&A practitioners may find surprising some of the reasoning in the Western Filter opinion, and perhaps its conclusion.  Since this was a federal court seeking to apply California law in the absence of a clear prededent, a California court might even conclude differently.  However, the case offers many useful lessons for negotiating acquisition agreements and even business contracts generally:

• Survival clauses in M&A agreements governed by California law must be carefully drafted to ensure they have their intended effect.  If the parties intend to shorten their time to bring claims, in addition to stating that the representations and warranties survive the closing until a specified date (as did the Western Filter survival clause), the agreement should state that representations and warranties terminate on that date and that no claims based upon them can be brought after that date.  The agreement should state that the parties intend to contractually establish their own limitations period for bringing certain claims, and acknowledge that their agreed time period may be shorter than what the law otherwise provides. 
• If the parties desire post-closing survival of representations and warranties, the acquisition agreement must expressly state this, since the Western Filter court appeared to conclude that representations and warranties terminate at closing absent a statement that they will survive. 
• Finally, while Western Filter did not address the applicability of its holding outside the M&A context, it appears that its reasoning would apply to any contract, particularly those containing representations and warranties, such as venture capital investments and intellectual property licenses.  So negotiating parties in other contexts must be cautious in drafting limits on a party’s time to sue, to ensure that they get what they bargained for.