The United States Court of Appeals for the Ninth Circuit was asked in WESTERN FILTER CORPORATION v. ARGAN, INC., RAINER BOSSELMANN, ARTHUR F. TRUDEL and H AYWARD MILLER III, (No. 07-55535) filed August 25, 2008 to decide an issue of first impression under California law, whether a provision within a Stock Purchase Agreement ("SPA") permitting the representations and warranties of the parties to survive closing, also served as a contractual statute of limitation that reduced a longer period otherwise provided by California law.

The case involved Puroflow, Inc. ("Puroflow") which designs, manufactures, and sells industrial aerospace and automotive filtration products. Puroflow is a wholly owned subsidiary of Argan. Western Filter competed with Puroflow in the filter business. It decided to buy its competitor. On October 30, 2003, Western Filter executed the SPA with Argan, acquiring all of Puroflow's stock for $3.5 million.  Both parties made several representations and warranties. The portion of the contract at issue is found in Section 8.1 ("Survival Clause") which provided that "[t]he representations and warranties of [Western Filter] and [Argan] in this Agreement shall survive the Closing for a period of one year, except the representations and warranties contained in Section 3.1(a), (b), (c), and (f) and 3.2(a) and (b) shall survive indefinitely."

        After acquiring Puroflow, Western Filter discovered that Puroflow's inventory was allegedly worth significantly less than what Argan represented. On September 17, 2004, Western Filter sent written notice to Argan, claiming that "the management of Puroflow and Argan grossly misrepresented the financial condition of Puroflow." Western Filter claimed damages of $2,002,580 and asserted that it "ha[d] a claim against Argan not only for breach of representations and warranties, but also for fraud in the inducement." Six months later, Western Filter filed suit in the Los Angeles County Superior Court against Argan and its officers for breach of contract, intentional misrepresentation, concealment and nondisclosure, negligent misrepresentation, false promise, negligence, and declaratory relief. Argan removed the matter to federal court.²

        On March 15, 2007, the district court granted Argan's motion for summary judgment, concluding that Western Filter's claims were barred by the one-year limitation set forth in the Survival Clause. It concluded that "[t]he plain meaning of section 8.1's provisions clearly indicate that, if [Argan] breached certain representations and warranties, then for a one-year period after the closing Western Filter could file a claim against defendants for such breach", be it a suit for indemnification or a suit in law in the case of intentional misrepresentations."

        In support of its decision, the district court noted that the indemnification provision expressly provides that an indemnity claim is "subject to the limitation imposed by section 8.1." The district court also noted that other courts have interpreted materially indistinguishable language as creating a contractual statute of limitation period, that discovery has developed no evidence suggesting that the parties had a contrary understanding of the plain meaning of the Survival Clause, and that the demand letter to Argan was not sufficient to toll the statute of limitation.

        The district court "accept[ed] and adopt[ed] as its own" Judge M. James Lorenz's decision Herring v. Teradyne, Inc., 256 F. Supp. 2d 1118 (S.D. Cal. 2002). In Herring, as in this case, the sole issue was whether a survival clause constituted a one-year contractual statute of limitation or set forth the period of time during which a breach could occur. 256 F. Supp. 2d at 1125. Judge Lorenz concluded that the following survival clause was sufficient under California law to limit the applicable commercial statute of limitation: "[t]he covenants, agreements, representations and warranties of the parties hereto contained in this Agreement or in any certificate or other writing delivered pursuant hereto or in connection herewith shall survive the Closing until the first anniversary of the Closing Date."⁴ Id.; see Cal. Civ. Proc. Code § 337 (the statute of limitation for an action brought for breach of a written contract is four years); id. § 338(d) (the statute of limitation for an action for relief on grounds of fraud is three years).

        In an unpublished memorandum disposition, a three-judge panel of the Court of Appeals reversed the decision in Herring. Herring v. Teradyne, Inc., 242 Fed. Appx. 469 (9th Cir. July 13, 2007). They stated:

        The Ninth Circuit Court of Appeals also disagreed with the district court's conclusion that the survival clauses contained in the merger agreements clearly and unambiguously reduced the statute of limitations from four years to one year. Parties may contractually reduce the statute of limitations, but any reduction is construed with strictness against the party seeking to enforce it. See Lewis v. Hopper, 140 Cal. App. 2d 365, 367 (Cal. Ct. App. 1956). In Western Filter, they found no clear and unequivocal language in the survival clauses that permitted the conclusion that the parties had unambiguously expressed a desire to reduce the statute of limitations.

In California, the statute of limitation for a contract claim is four years, three years for a fraud or intentional misrepresentation claim, and two years for a negligent misrepresentation claim. See Cal. Civ. Proc. Code §§ 337, 338(d); Hydro-Mill Co., Inc. v. Hayward, Tilton & Rolapp Ins. Assocs., Inc., 115 Cal. App. 4th 1145, 1155 (Cal. Ct. App. 2004). It is a well-settled proposition of law in California that the parties to a contract may stipulate therein for a period of limitation, shorter than that fixed by the statute of limitations, and that such stipulation violates no principle of public policy, provided the period fixed be not so unreasonable as to show imposition or undue advantage in some way. Moreno v. Sanchez, 106 Cal. App. 4th 1415, 1430 (Cal. Ct. App. 2003). While allowed under California law, contractual stipulations are not favored. Lewis v. Hopper, 140 Cal. App. 2d 365, 367 (Cal. Ct. App. 1956) (stating that contractual stipulations are not favored "because they are in derogation of the statutory limitation". Therefore, "they should be construed with strictness against the party invoking them." Id.

         In Western Filter, the parties agreed that without the Survival Clause the representations and warranties would have terminated at the time of closing. Representations and warranties are statements of fact. The truthfulness of representations and warranties as of both the date of the representation and, when appropriate, the date of the closing is generally a condition to the closing. If, prior to closing, either the seller or buyer discovers that a representation or warranty made by the other party is not true, they have grounds for backing out of the deal.

        The closing date itself triggers the contractual limitation on liability. Unless the parties agree to a survival clause— extending the representations and warranties past the closing date—the breaching party cannot be sued for damages postclosing for their later discovered breach. With that premise in mind, Argan argued that the one-year limitation in the Survival Clause was intended to serve as a contractual time limit on any action brought based on a breach of the contract's representations and warranties. Under Argan's theory, Western Filter could not bring a claim without the Survival Clause, and, even with the Survival Clause, Western Filter only had one year after closing to bring such a claim.

        Since California law does not favor contractual stipulations to limit a statute of limitation, such stipulation must be clear and explicit, and is to be strictly construed against the party invoking the provision. Lewis, 140 Cal. App. 2d at 367. California courts have also suggested that language limiting the life of a warranty is not sufficiently clear and explicit to also limit the statute of limitation. In Hambrecht & Quist Venture Partners v. American Medical International, Inc., 38 Cal. App. 4th 1532 (Cal. Ct. App. 1995), the California Court of Appeal held that "a standard choice-of-law provision (which states that a contract shall be governed by the 'laws' of a particular jurisdiction) incorporates the statutes of limitations of the chosen state." Id. at 1536. In doing so, the court rejected the plaintiffs' argument that "the absence of a 'time to sue' clause or an explicit reference to Delaware's statutes of limitations means that the parties intended the forum's (California's) statutes of limitations to apply." Id. at 1544 n.10. It did not matter that in dealing with other "timing" issues the parties had expressly stated that the representations and warranties survived five years beyond closing because, as the court held, "[b]y using the term 'laws' in the choice-of-law provision, the parties incorporated Delaware's statutes of limitations without need for any additional contract language." Id. Moreover, the court stated that "a provision specifying the life of a warranty has no bearing on the time period for filing suit after the warranty has been breached." Id. The overwhelming essence of the California appellate court decisions is that parties must be more explicit than the language at issue in this case.

               The contract drafter is therefore put on notice that he/she should be more meticulous in explaining what he or she means in invoking the concept of survival, and what remedies and limitations are contemplated.  It is probably not sufficient after this case to say merely that representations and warranties "survive" for a period.   The agreement should go on to say that the intention of the parties (if such be the case) is that a complaint based upon breach of the representations and warranties must be filed, if at all, prior to expiration of the representations and warranties, and that the parties specifically intend that the statutory statutes of limitations of applicable law be superseded and replaced by the parties' agreement. 

Peter A. Kleinbrodt