Why Affiliates Should Not be Grouped in as “Parties” to a Contract

Most commercial contracts include defined terms to improve readability and reduce ambiguity. In some cases, however, those definitions do not receive the same scrutiny as other clauses and their application throughout the rest of the agreement can be overlooked. For example, when a party to a contract is defined “together with its affiliates,” the language may seem innocuous, but this linking of entities significantly impacts the nature of the contract and can result in a host of unanticipated risks and liabilities not only for the contracting entities but for those unnamed entities who may be inadvertently bound to a contract to which they are not even aware they are a party.

This issue is most often seen in SaaS and other licensed service agreements where affiliates are grouped with the main contracting party as “the parties” under the misguided rationale that allowing the master service agreement to apply to products or services used across an organizational structure saves the parties from having to re-negotiate the master agreement each time a new group of users is added. Unfortunately, this attempt at efficiency can turn out to be anything but efficient down the road. A quick review of some basic legal principles reveals the problems with this approach:

(1) The obligations of one entity do not become the obligations of a related entity, such as a parent or subsidiary, simply by virtue of their relationship to one another. Even where there is common control, the business activities and contractual obligations of each entity are separate and distinct.

(2) An entity’s affiliates, even in a parent-subsidiary relationship, are not the guarantors of contracting entity’s performance. Rather, a parent company is explicitly held not to be responsible for the debts or obligations of its subsidiaries unless it contractually agrees to be held responsible.

(3) A related party cannot be bound to a contract that it does not sign unless the main signing party has the authority to so bind it. Although this authority can be actual or apparent, it is a factual question requiring evidence to prove, not a pre-determined legal conclusion.

(4) Affiliated entities do not share assets or liabilities or follow the same practices and policies (unless there is a specific agreement to do so), or may not even be subject to the same legal framework if located in another country.

It follows then that before permitting a client to sign a contract binding the parties “and their affiliates,” you must understand the risks of using such an expansive definition. The following questions, although not exhaustive by any means, offer a general sense of the potential headaches that might result from lumping a party “and its affiliates” together:

1. Does the person signing the contract on behalf of the main party also have the authority to sign on behalf of each affiliate? If they do not, but sign anyway, who is liable for the misrepresentation, the (main) contracting party or the individual who signed? How can the affiliate be held liable for any breaches?
   
   
2. What does “affiliates” actually mean? Does it include all present and future affiliates of the signing party or just those in existence at the time of signing? If there is a corporate restructuring or sell-off of an affiliate after the contract is signed, does that action trigger any rights or obligations under the contract?
   
   
3. Assuming “the parties” (i.e., the party and its affiliates) are all responsible for performing under the agreement, how will that liability be shared? Are they jointly and severally liable for such performance? 
   
   
4. How would basic provisions like approvals, non-solicitation commitments or notice provisions be interpreted if “the parties” were obligated? For example, would notice be invalid if it is not made to all parties, even though the affiliates have not been specifically identified?
   
   
5. If the signing entity is giving knowledge-based warranties, do they include by reference the knowledge of all of its affiliates?
   
   
6. If either party breaches the agreement, can the non-breaching party proceed against all parties even if unnamed, undisclosed or located in a foreign jurisdiction? Would those foreign entities even be subject to the jurisdiction and law specified in the contract?
   
   
7. If either party breaches, is it liable to each of the affiliates separately and can each affiliate proceed against the breaching party independently?
   
   
8. Would any liability caps or disclaimers in the agreement bind the non-signing affiliates?
   
   
9. Would the indemnification provisions apply to all of the affiliates, even those not disclosed in the agreement? How would it impact the applicability of D & O and other insurance policies that might be held by all or some of the affiliates?
   
   
10. If the main contracting parties have signed a data processing agreement or made commitments as to use of data to each other, do those provisions bind all of the affiliates and their respective sub processors globally, even if subject to additional or other data privacy requirements or laws than the main contracting parties?

Fortunately, these risks can be eliminated by simply avoiding the practice of grouping a party with its affiliates under a contract. Alternatively, you can limit or at least define the scope of affiliates’ obligations through specific language in the contract; for example, by having the main contracting party guarantee performance on behalf of its affiliates or requiring joint and several liability for all parties for breaches. Finally, and perhaps quite obvious to every practicing attorney, simply require each intended party to the contract to be named and made a signatory to the contract.

If you need help with a commercial contract or have questions about an existing one, please contact Deborah Stehr at [email protected] or 917-855-6302.

Deborah Stehr is a member of our New York-area team and brings over 25 years of transactional and technology experience with a particular focus on the consumer goods industry, including digital services and e-commerce. Deborah has considerable experience in structuring both domestic and international arrangements for the manufacture, supply, distribution and sale of goods, as well as in protecting and monetizing brands and intellectual property throughout the product life cycle.