Today, we learn about the difference between Warranties and conditions Precedent in a contract by examining the case of In re Carter's Claim. Decided by the Supreme Court of Pennsylvania in 1957, Carter's Claim touches on many concepts at the heart of important modern contracts, such as the concept of material adverse changes from merger agreements. A primacy has two ways to protect yourself in a contract, warranty protection and condition protection. Nonperformance of a warranty gives rise to breach of contract damages. Non occurrence of condition allows the primacy to suspend its own performance. Failure of a condition affords a defensive weapon, an excuse, but does not give an offensive weapon a claim for breach of contract. Phrase differently, a condition protection, allows the primacy to get out of his or her own promises. Whereas, a warranty protection, allows the primacy to actively sue for damages. Some have just described a condition proceeding as a shield, but not a sword. It gives rise to only a defensive protection, and the ability to withhold your own performance can at times provide stronger protections than the ability to sue for damages. defensive protections can work forfeitures when the other side has already relied. And defensive protections don't require the hassle of going to court and winning the judgment. The plaintiff, the buyer, and appellant, Lester L. Carden, entered into a 25 page written contract to purchase a Pennsylvania Corporation and five of its subsidiaries including the defendant at Pelly, Edwin J. Shuttle Company. About 187 thousand dollars of the purchased price was put in escrow to indemnify the plaintiff buyer against liabilities specified in the agreement. As we have studied before in centronics versus Jennicam, escrows involved an arrangement where part of the purchased price is held by a third party to compensate the buyer with effectively a reduced price if the seller's assets turn out to be worth less than expected. In the contract, listed under the heading of conditions precedent was a term "Paragraph nine" that said, "The financial condition of the defendant company, shall be no less favorable at the time of closing than on June 30, 1954," which was probably when the books closed at the end of the last financial year. As you know, the closing date refers to when the sale actually occurs with title up to the assets transferring to the new buyer. The plaintiff claimed that the financial condition was less favorable at closing and refused, and requested approximately 70 thousand dollars from the escrow. The parties submitted this to arbitration, the arbitrator awarded 3,182 dollars to the plaintiff. Plaintiffs appealed to the Court of Common Pleas was denied and the instant court affirmed. The main issue is whether the financial condition in this case was actually a warranty such that plaintiff is entitled to damages. The court held the agreement was carefully drafted and is clear that the provision in question is not a warranty, but a condition precedent. As such, plaintiff had the right to refuse to purchase because of the failure of this condition. But that option to refuse had to be made by the closing date, by accepting sellers performance and going ahead with the closing, plaintiff waived its right under the condition Precedent. The court explain the result in terms of the "Plain" meaning of the contract. In this case, the contract had the classic structure of distinguishing between two clearly demarcated sets of provisions. On the one hand, there were representations and warranties, and on the other hand, there were conditions. The structure is found in most corporate contracts. A result explained in terms of plain meaning is justified where the agreement has been drafted with particular clarity, and the other party has failed to introduce evidence that the words used are reasonably susceptible to another meaning. The buyer waived the expressed condition by electing to go forward with the purchased at the closing date. The agreement also contained a provision, "Paragraph 5 g" concerning value in the representation and warranties section, in which the seller represented that between June 30 and September 17,1954, there had not been "any change in companies or its subsidiaries, financial condition, assets, liability or businesses, other than changes in the ordinary course of business, none of which has been materially adverse. The buyer warranted that this representation was true. How was the scope of this warranty different than the scope of the condition concerning value? Well, the warranty or promise of value was limited to changes that were material adverse "other than in the ordinary course of business". So reductions in value from the ordinary course of business would not constitute a breach of the warranty, but would be a failure of the condition that the financial condition of the company shall be no less favorable. Reductions in value from the ordinary course of the business would accordingly give the buyer an option not to buy at the closing date, but not the right to sue for breach of warranty damages. After the closing date however, things change and the buyer if she chooses to close is left solely with the offensive remedy of suing for breach under the limited warranty. Why would the parties write a contract giving the buyer broader defensive protections than offensive protections? Well, the parties might have expanded the scope of the warranty to allow breach of contract actions for any reduction in value, or they might have decreased the scope of the condition for only reductions outside of the ordinary course of business. Either of these changes would have rendered the offensive and defensive protections congruent making them both conditions and warranty potections. The parties might have chosen however for asymmetric protections to constrain various types of buyer and seller opportunism. The parties might have realized that it was going to be hard to prove to a court whether the company experienced the reduction in value. The contract gave the buyer a broad right not to buy, but only allows the buyers to sue for damages if the seller does something outside of the ordinary course of business that hurts the firm value. So, if the seller starts liquidating the equipment, that's the outside the ordinary course of business and the buyer can bring suit for a reduction in value from that stripping of equipment. But the talked contract gives the seller strong incentives not to do anything outside the ordinary course of business, so as to limit the buyers offensive rights. Instead the contract in effect says, "if the company's overall financial condition has worsened, then don't buy it if you don't want to." But if you still want the company, don't try to sue for damages. This form of asymmetric protection strikes the balance between two types of opportunism. You don't want the seller to run the company into the ground, but you don't want to allow the buyer to hold up the sale at the last minute. Although this case is over 50 years old, the warranty-condition strategy is still employed to allocate risk between the date of contract and the date of the closing. In particular, buyers and sellers are worried about negative changes in the value of what's being exchanged between the contract date and before the closing. The warranty only covers changes in values that do not come from ordinary course of business. Condition covers changes from any cause. The contractual regulation of material adverse changes at the heart of In Re Carter's Claim has become one of the most hotly negotiated and litigated questions of merger law. Most friendly merger agreements contain material adverse change clauses. These are called MAC clauses or sometimes Material Adverse Effect, MAE clauses which make the buyers duty to buy conditional on there not being a material adverse change in the seller's financial condition. In recent years, merger agreements tend to include the traditional standard MAC or MAE terms but also explicitly negotiated curve outs that limit the buyer's ability to exit. The MAC and MAE provisions engender substantial litigation because it's hard for litigants to predict whether a particular negative event will be considered after the fact by a court as materially adverse. Sometimes contractual provisions are unclear whether they are creating promises or conditions. It's an interpretation issue where if in doubt the common law's preferences to interpret ambiguous provisions merely as promises, giving the promisee an affirmative offensive right to sue for damages but not the defense of right to withhold your own performance. This is because a failure of a provision of a condition can produce inequitable forfeitures, where one side refuses to perform after the other side has substantially relied. For example; Some contracts might include a provision saying buyer shall notify seller of the place of delivery two weeks in advance of the shipment date. Is this provision a buyer promise giving rise to a breach of contract action if the notice is late, or is it a condition relieving seller of the duty to ship if the buyer is a second late or is it both the promise and a condition? In one case a buyer who had contracted to buy rice failed by 12 hours to give seller two weeks notice. Because the price of rice was rising, the seller treated the provision as a condition and refused to perform. Courts will tend to treat ambiguous provisions as a promise and give the seller instead a breach of contract remedy and not as a condition unless the contractual provision is more clearly conditional in its language. This preference for interpretation in favor of promises however does not apply to contracts, "Of a type under which only the obligor generally undertakes duties." That's a quote from the Restatement Second Section 227. Insurance is regarded as a contract of this type, where the usual interpretation is that the insured has no enforceable duty to pay premiums. Rather, if the risk insured against occurs, the insurance companies duty to pay under the policy is merely conditioned upon the earlier payment of premiums. Unless special arrangements with third parties have been made however, the insured's failure to pay a premium is a failure of a condition rather than a breach of contract. Phrased differently, the insurance promise to pay the premium is treated as a condition precedent to the insurer's duty to provide coverage. Insurance is an odd kind of contract where the insurers right to a premium is solely protected by the defensive right of the insurer to withhold performance. With no insurer offensive right to sue for a buyer's breach. Stepping back we can see that promisee's right to a promisor's performance is protected in starkly different ways. An insurer's right to insurance premiums are protected solely by defensive rights. The buyer's right In Re Carter was protected before closing with larger defensive rights than offensive rights. But in Jacob & Young vs Kent we learn that the substantial performance rule protects the buyer's right to reading pripe with broader offensive rights than defensive rights. Because if you remember in that case the buyer could sue offensively for breach of promise but was not allowed to withhold her own performance. In summary, there are two ways for a promisee to be protected in a contract. Warranty protection gives rise to damages and condition protection gives rise to a defensive protection. The right to stop one's own performance. In determining whether an event is a warranty or a condition precedent, courts will usually rely on the plain meaning of the contract if the agreement is ambiguous. The interpretation favors promises instead of conditions in the interest of avoiding forfeiture.
