What To Do When Your Contractual Counterparty Gets Mired in a Public Scandal

A hypothetical: you are in-house counsel, and one morning you click on your daily news only to see one of your company’s key contractual counterparties is trending, and not in a good way. The contractual counterparty has endorsed actions, embraced opinions, or made decisions that have brought them into public disrepute. You are concerned that public opinion may turn to your company to disassociate from the counterparty in light of their heinous activities. When you reach your public relations team, they suggest severing ties with the counterparty. Ultimately, your executive team makes the decision – you need to figure out a way to terminate the contract with them. The problem? There is no breach. Your counterparty has been performing, and performing well. All obligations are otherwise being upheld. So, how do you get your company out of this tricky situation?

The primary solution is a morals clause. In this article, we discuss the application of the morals clause in the business-to-business context and key considerations for drafting and negotiating these clauses in your company’s contracts.

The Morals Clause in the Business-to- Business Context

Traditionally, morals clauses are incorporated in sponsorship contracts with performers to permit wary corporations to terminate if the performer becomes embroiled in scandal that may potentially rub off on the sponsor. Fortunately, given our heated, politicized climate, morals clauses can also be included in traditional business-to-business contracts if a counterparty, or its high-level executives or agents closely associated with it, engages in publicized misconduct that might negatively impact your company’s reputation just by doing business with it.

Morals clauses are extremely flexible and can be tailored to fit a variety of circumstances. One example is as follows:

“Customer shall have the right to terminate this Agreement immediately on written notice to Service Provider, if through action or inaction, Service Provider or its Affiliates, employees, or agents becomes the subject of public disrepute, contempt, scandal, or otherwise engages or has previously engaged in activity that is, or may become, injurious to the reputation of Customer or its Affiliates, employees, or agents.”

Considerations for Drafting and Negotiating Morals Clauses

Consider the following issues when drafting or negotiating morals clauses:

Consider the Prohibited Conduct. Life is complicated, and you never know what the future holds. You likely want broad language in a morals clause that gives you broad latitude to terminate a contract if for any reason your counterparty gets embroiled in scandal. However, if drafted too broadly, a morals clause may be too vague to be enforceable, so you must walk the line between a broad, vague term and one with greater specificity and clarity as to the definition of prohibited conduct. In addition, if your counterparty has the negotiating leverage to do so, they will likely push back and attempt to narrow the prohibited conduct. For example, some clauses permit termination in the event an executive is convicted of a crime involving moral turpitude. However, the public scandal and negative fallout will explode way before conviction – better to use language such as “alleged to have engaged in,” or “is arrested for a crime involving moral turpitude.”

Carefully Craft Your Remedy. There are a wide range of remedies that your company can include within a morals clause, such as termination of the overall contract, requiring termination of the employment of the bad actor, indemnification for prohibited conduct, or suspension of the contract for a defined period of time. When negotiating a morals clause, it is important to consider which remedy is appropriate for your particular circumstances. In any case, your company will want to guarantee it can quickly exit the arrangement if it wishes to do so by incorporating termination for convenience as a remedy and eliminating any cure period.

Protect the Appropriate Corporate Entities. Modern companies typically have a robust corporate structure, comprised of a number of subsidiaries and affiliates. In a reputational scandal, the bad actor may be a member of any number of these subsidiaries and affiliates. As such, when drafting a morals clause, it should cover all companies, subsidiaries, or affiliates in which the contracting counterparty owns an interest and potentially affiliated companies as well.

The Counterparty Will Likely Ask for Mutuality. When negotiating a morals clause, your counterparty will likely ask for mutuality, prohibiting your company’s employees, agents, and affiliates from engaging in the same prohibited conduct that you are asking of your counterparty or risking termination of the contract. To prepare for this, consider amending your company’s code of conduct and ethics policy to comply with any morals clauses in your contracts and ensure your employees and agents are aware of these policies.

You may never know what the next news cycle may hold, and it seems like public scandal is all around us. Including a morals clause may be critical to include in your contracts to handle or mitigate against unforeseeable reputational harm. However, for a morals clause to effectively protect your company, it must be drafted and negotiated properly, and consider the kinds of issues described above.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Kilpatrick Townsend & Stockton LLP

Kilpatrick Townsend & Stockton LLP on:

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