It is typical for business acquisition agreements (whether structured as sales of stock, sales of assets, or mergers or other reorganization transactions) to include representations and warranties by the seller. A survival clause usually is included, which states that the representations and warranties (which speak as of the closing) shall survive the closing for a negotiated period after the sale (usually one to two years, although certain “fundamental” warranties usually survive for a longer period). This survivability period allows time for the buyer to bring a claim for indemnification against the seller if it is found that those warranties are breached.

Does the negotiated survivability period serve to shorten the statute of limitations which would otherwise apply (in California, four years for breach of written contract)? That was the question faced in two separate appellate decisions under California law—one decided by the federal Ninth Circuit Court of Appeals, Western Filter Corp. v. Argan, Inc., 540 F. 3d 947 (9th Cir. 2008)—and the other decided by the California Court of Appeal, Zalkind v. Ceradyne, Inc., 194 Cal. App. 4th 1010 (2011).

The answer is “it depends”—depending on how the language of the acquisition agreement reads.

In Western Filter, Western Filter Corp. (“Western Filter”) acquired the stock of Puroflow, Inc. (“Puroflow”) from Argan, Inc. (“Argan”). The Stock Purchase Agreement stated that the representations and warranties made by Argan would survive the closing for a period of one year. Just before the year expired, Western Filter sent Argan a letter stating that it believed that Argan has overstated Puroflow’s inventory. However, Western Filter did not file a lawsuit until approximately eighteen months after closing.

Argan contended that the survivability clause had acted to limit to one year the four-year statute of limitations that would otherwise apply. Western Filter argued that the survivability clause had only set forth the time period within which a breach which occurred could be discovered. Finding that “California law does not favor contractual stipulations to limit a statute of limitation”, and that the limitation must be “clear and explicit” and “strictly construed against the party invoking the provision”, the Court sided with Western Filter, and held that the four-year statute of limitations applied. Thus, Western Filter was allowed to bring its indemnity claim even though the claim was commenced more than one year after the closing.

Three years later, a California state court confronted this issue in Zalkind. Stanley and Elizabeth Zalkind owned substantially all of Quest Technology LP (“Quest”). The Zalkinds and Quest entered into an Asset Purchase Agreement with Ceradyne, Inc. (“Ceradyne”) whereby Ceradyne acquired substantially all of Quest’s assets. The Asset Purchase Agreement provided, except for situations not otherwise applicable, that a claim for indemnification could not be made more than two years after the closing. The Zalkinds brought a lawsuit against Ceradyne more than two years after the closing, alleging that Ceradyne had failed to register with the SEC (for public resale) restricted stock the Zalkinds had received as consideration in the sale.

Ceradyne contended that the limitations provision of the contract should apply to shorten the statute of limitations which would otherwise apply; the Zalkinds and Quest argued that the language should be strictly construed against Ceradyne. The Court declined to follow Western Filter and found that an agreement to shorten the statute of limitations does not violate public policy, and therefore did not need to be strictly construed against the party seeking to enforce it. Therefore, the Court found, such a provision should be enforced if reasonable.

While at first blush Western Filter and Zalkind seem to have reached contradictory conclusions, the cases are capable of being harmonized due to differences in the way that the two acquisition agreements were written. The contract language in Western Filter merely stated how long the representations and warranties survived the closing, but did not specifically mention the time period within which a claim could be brought, However, the language of the contract in Zalkind specifically made reference to the time period by which a claim needed to be filed.

These cases illustrate how careful drafting, even with respect to “boilerplate” contractual provisions, is important in a business acquisition agreement in order to implement the parties’ intent and to avoid post-closing disputes about that intent. A seller should include a provision that specifically shortens the statute of limitations for bringing indemnification claims if that is the intention of the parties.