Sunset Provision: What It Is and How it Helps Investors

What Is a Sunset Provision?

A sunset provision, or sunset law, is a clause in a statute or regulation that expires automatically on a specified date. A sunset provision provides for an automatic repeal of the entire or sections of the law once that sunset date is reached.

Once the sunset date is reached, the language subject to the provision is rendered void. To extend the length of time that a provision subject to a sunset clause is effective, Congress must amend the statute, or the regulatory authority must amend the regulation, as applicable.

How a Sunset Provision Works

The purpose of a sunset provision is generally to enable lawmakers to enact a law when change or government action is required reasonably for a limited period, when the long-term ramifications of the law in question are difficult or impossible to foresee, or when circumstances warrant such a legal structure.

A good example of legislation warranting a sunset provision is the U.S.A. Patriot Act. Intended to address relatively short-term security concerns following the events of Sept. 11, 2001, the act, when it was initially drafted, included a sunset provision for Dec. 31, 2005.

Often, a law with a sunset provision can get votes because lawmakers who might otherwise oppose the permanent implementation of the law may be okay with a temporary implementation due to special circumstances.

Advantages and Disadvantages of a Sunset Provision

The main advantage of a sunset clause is that one or either party will no longer have obligations to the clause, without pursuing a formal end to that provision in the contract. It is easy to plan around a sunset provision as it is known in the initial contract stages and will not appear as a surprise later on.

The provision can also be used to head off any potentially combative legal situations that may occur down the line. Both parties are able to negotiate the sunset provision upfront before they become invested in the project. It is also possible to realize the clause occurred or was triggered too early in the project. In this case, it can easily be extended to a new date if both parties agree.

Depending on which side of the contract you are on, the provision can also compel action from one of the parties. This is commonly seen in licensing agreements where one party's access to the licensing expires and they are required to then purchase or rent the new version.

This line of thought extends to contractual parties using sunset clauses as insurance against changing market conditions, writing a sunset provision into an agreement for the sole purpose of providing themselves with an exit strategy. If the party who wrote the clause determines it would be in their best interest to delay for a period of time until the clause is triggered they may do so, leaving the other party without legal recourse.

This sort of contract strategy can be seen sometimes with producers of products such as houses, software, or others. They agree to sell or deliver the product at a specific price to the buyer but when nearing delivery, they discover they could sell to a different buyer at a much higher price. In this instance, they would simply drag their feet until the sunset clause was triggered, abandon the project, then complete it and sell it to the new buyer.

Real World Example

A common example of a sunset provision occurs when artists are being signed by a talent representation company. An agent wants to sign a new up-and-coming band that the agent thinks will be able to make the company some money. So they all sit down and work out a contract, and the agent signs the band.

Because the band had a previous understanding of contract law, they wrote in a sunset provision with the begrudged acceptance of the agent. In the clause, it states that the agent makes 20 percent of the band's profit for the first three years. In the fourth year, that drops to 10 percent, and in the fifth year, the agent is no longer entitled to any net profits from new releases or live shows.

Over time, the band does well and the agent makes their percentage. Over the years, however, the band notices the agent is taking more clients and is not servicing them as well as the agent used to. They become increasingly hesitant to resign the agent. This is exacerbated by a new talent agency showing an interest in their rising stardom and is offering better terms.

The band then lets the sunset clause trigger without releasing new material. The agent tries to negotiate to extend the contract, but the band doesn't feel it's in their best interest. They sign with the new talent management company, and only then release their new material, the profits of which go to the new management company.

The original agent isn't happy with this deal, but they also could have paid more attention to the band and not taken on more clients than they could reasonably service. In this example, the band used the sunset clause to avoid paying an agent that they no longer felt was looking out for them in the way they should have.

The Bottom Line

Sunset provisions can be used by one or both parties as a form of automatic protection. The clause is negotiated and written into a contract to allow either party an exit strategy when the clause is triggered. However, opportunistic parties can hide or add complex sunset clauses to contracts in order to provide themselves an opportunity to abandon a less-than-profitable undertaking. Sunset provisions can be seen all the way from Federal Law to simple contracts such as software sales.