Ninth Circuit Limits Survival Clause in M&A Transaction Governed by California Law

In what the court described as "an issue of first impression," the Ninth Circuit Court of Appeals, applying California law, narrowly construed a provision in a stock purchase agreement that purported to limit the survivability of representation and warranty claims. The court held that the provision did not limit the time to bring claims for breaches of representations and warranties, but only determined the period during which "a breach of the representations and warranties may occur," effectively negating the provision. As a result of the ruling, limited survivability provisions in M&A transactions governed by California law may not be effective unless carefully and properly drafted.

Background of the Case. The decision, Western Filter Corporation v. Argan, Inc. (CD Cal. August 2008), involved a dispute between Western Filter Corporation and Argan, Inc. following Western Filter's acquisition of the stock of Puroflow, Inc., Argan's wholly-owned subsidiary. As is common in M&A transactions of this sort, the stock purchase agreement (the "SPA") contained a representation and warranty survivability provision. The limitation provision was brief and to the point. Specifically, the SPA stated that the parties' representations and warranties "shall survive the Closing for a period of one year," except for certain specified representations and warranties (which were not at issue in the case), which "survive indefinitely." The SPA also provided indemnification for breaches of representations and warranties.

After the transaction closed, Western Filter claimed that Argan "grossly misrepresented" the state of Puroflow's inventory. Western Filter filed suit in Los Angeles County Superior Court for intentional misrepresentation and breach of indemnity, among other claims, and Argan removed the action to federal court. Argan moved for summary judgment on the grounds that the survivability provision barred Western Filter from bringing claims after the end of the one-year period. The district court agreed and dismissed Western Filter's claims.

The Decision. On appeal, the Ninth Circuit rejected Argan's argument that the survivability provision barred claims brought after one year. The court determined that under Argan's interpretation, such a provision would constitute an agreement to shorten the statute of limitations for bringing a claim. The court reasoned that although California law permits those types of agreements, they are generally frowned upon. As a result, because the parties' intentions were not clearly stated in the SPA, the court held that the "one-year limitation serves only to specify when a breach . . . may occur," not "when an action must be filed." Therefore, the court denied Argan's motion, finding that Western Filter had brought its claim within the applicable statutory period.

Thoughts for the Future. It remains to be seen whether California state courts will adopt the Ninth Circuit's view of California law as expressed in Western Filter, as the decision appears vulnerable to attack on a number of grounds. Nevertheless, for now, parties to acquisition agreements governed by California law would be wise to give careful attention to how they draft survivability provisions. If the parties intend to limit the period for bringing a specified type of claim, careful drafting in light of Western Filter would suggest the following:

• The survivability provision should state (1) that the representations and warranties survive the closing until the termination date (as in Western Filter), (2) that the representations and warranties forever terminate at the end of the survivability period, and (3) that actions based on breaches of representations and warranties must be brought or noticed (as appropriate, to reflect the parties' agreement) before the end of the survivability period or forever be barred.  
• The acquisition agreement should clearly express the parties' intent to set forth a period of limitations for bringing certain claims and that such a time period may be shorter than otherwise provided by law.

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With careful drafting, parties to acquisition agreements governed by California law should be able to enforce their agreed upon survivability limits, notwithstanding the limits espoused in Western Filter.