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This Wisdom of the Crowd (ACC member discussion) was compiled from the questions and responses posted by the Litigation Network on their Forum. This discussion addresses whether lost profits are direct or indirect damages and, if direct, what are the appropriate methods of calculation in the United States and in the United Kingdom. 

 

*(Permission was received from ACC members quoted below prior to publishing their Forum Comments in this Wisdom of the Crowd Resource)

 

Question

 

We recently acquired an entity that was party to a requirements contract for certain goods and services. This contract ran through the end of 2017; however, because we already obtain those same goods and services from another vendor, we terminated it early. The vendor has taken the position that, because we terminated the requirements contract early, they're entitled to damages as a lost volume seller under the UCC - a damages calculation that includes damages for lost profit. In reviewing the contract, we noticed that it states that neither party will be liable to the other for any indirect or consequential damages suffered in connection with the contract. We're wondering what effect (if any) the limitation on indirect and consequential damages may have on the vendor's claim for lost profits. Has anyone dealt with this situation, or a similar situation?  
Wisdom of the Crowd:

Response #1: I cannot answer regarding US law but as a first guideline, I recommend that you consult the recent UK decision in Fujitsu Services Ltd v IBM United Kingdom Ltd [2014] EWHC 752 (TCC) that dealt with the same subject-matter, concluding that through the exclusion clause, no damages for lost profits could be required for breach of contract. The same reasoning would probably not apply under most European civil law jurisdictions because exclusion clauses are normally held to be inapplicable when the breach is caused by the willful intent or gross negligence of the other party: voluntary termination or non-pursuit of a requirements contract would most likely classify as a willful act. Otherwise, beware that an exclusion or limitation of "indirect and consequential losses" will not necessarily serve to exclude loss of profits where that loss is regarded as direct, to the extent that it arose naturally and immediately from the breach of the contract.1

Response #2: Generally, with the caveat that it depends on the jurisdiction and on the specific wording of the contract, the parties can contractually modify UCC/statutory rules and courts would not interfere.
So, except for some specific instances (like product liability, clauses against public policy and such) I would say that a well drafted provision limiting damages is perfectly valid.

 

Mind however that in some cases where the clause limited the rights of a party (specifically warranty cases but also limitation of damages) the UCC has been interpreted in some jurisdictions as requiring to write the clause all in capital letters and making the limitation conspicuous for the clause to be valid and not to be deemed "unconscious".
 

In sum I would say there certainly is an argument in favor of the clause validity.2

Response #3: Is it possible that those direct damages, which appear to be still allowable under this Limit of Liability clause, could be even greater than (purported) lost profits (for instance if the vendor could effectively demand performance of the entire contract including the payment of the full price of the goods that would have been sold)? (Or some other direct damage theory -- I'm sure you can come up with others, and the particular theory isn't my point here, but rather to note that direct damages are still available in all likelihood to this adverse party.)

 

If the DIRECT damages one might suffer are much worse than the demand for lost profits, might it not be better to view that demand as an attempt to settle reasonably?
 

Obviously, if there are other limit of liability things there that could help, such as a strict dollar limitation your acquired company negotiated on the same contract, that should enter into your thoughts as well.3

Response #4: The lost profits on goods that they would have sold to your acquired company would be considered direct or compensatory damages, because they restore the Vendor to the same position he would have been in but for the breach and were to be expected by both parties at the time of contract.

Indirect or consequential damages would be damages that weren't immediately foreseeable or obvious at the time of contract (i.e. these often include overhead expenses, delay damages, lost profits if a company was going to incorporate or resell the goods to another party; damages arising out of loss of use of the capital). Think Hadley v. Baxendale from law school. For example, if they lost a volume discount from one of their suppliers because of the breach (since they no longer needed to purchase as many goods) their costs would go up and their profit margins would go down. Those would be indirect damages.4

Response #5: In terms of experience, I think it's perfectly reasonable to disallow lost profits in light of the clause. I don't know what state you are in, but those clauses are usually fully enforceable because that's what the parties agreed to. You agreed that in the event of a breach (assuming there was a breach), you would only compensate actual damages, i.e., costs. And the same goes the other way, if they didn't deliver, they would only pay your actual losses and nothing for business interruption and things of that nature.

 

Further, depending on the mechanics of the acquisition itself, you might not have taken on that contract to begin with.
 

In practical terms, this is probably a matter of dollars and cents and what it would take to get this claim resolved.5

Response #6: I agree with Response #4. Direct damages for a vendor include lost profits. Vendor lost profits as a direct result of the breach. For the buyer, lost profits are an indirect damage. Buyer lost profits as an indirect consequence of Vendor, for example, not supplying goods, which is the direct damage. Thus, a generic limitation of liability clause like you describe, which does not cite lost profits, should not prevent vendor from getting the profits it would have gained had you fulfilled your obligations. If the limitation of liability cites lost profits specifically and is mutual, then I think that creates an ambiguity that could go either way. Although I think it would be unfair for such a provision to exclude lost profits for a vendor because profits are the only reason the vendor is entering into the contract, and if the buyer could exclude lost profits, then that undermines the core purpose of the contract that both parties committed to.6

Response #7: I agree that requirements contracts are a special animal. If you exclude profit, what is left to the contract in terms of compensation for the vendor? There is a good chance that the extra cost to buy elsewhere would be seen as your loss if vendor breached and lost profit from not having sold as vendor's loss if you breached.
 

The wrinkle is that you don't know how much profit vendor stands to lose as result of your termination until you reach the end date of the terminated contract (assuming that the contract was not invalidated by a non-assignment clause in the merger or by other terms such as a significant change in needs). So you may need to estimate, or revisit periodically.7

Response #8: To recap, New York recognizes that lost profits can sometimes be general, and other times consequential damages. In rejecting a bright line rule, NY's Court of Appeals has held that "damages must be evaluated with the context of the agreement," requiring "a careful look at the underlying agreement to determine whether lost profits were general damages." Biotronik v. Conor Medsystems Ireland, 2014 WL 1237154 (finding that Biotronik's lost profits were general based on the "nature of the agreement."); see also PNC Bank v Wolters Kluwer Financial Services, 73 F. Supp. 3d 358, 377 (S.D.N.Y. 2014) (finding that PNC Bank's lost profits were consequential, as the agreement was "more closely akin" to "a simple resale contract.").

Of course, this is a state-by-state issue.8

_____________________
1Erik Verbraeken, Senior Group Counsel, Johnson Controls (Jan. 13, 2016)
2Monica Boccia, General Counsel, Biesse America (Jan. 13, 2016)
3Michael Fleming, Associate General Counsel, Cray Inc. (Jan. 13, 2016)
4Lisa Wright, General Counsel, Norman S. Wright Mechanical Equipment Corp. (Jan. 13, 2016)
5Pavel Bespalko, Counsel, c/o Russian Standard (Jan. 14, 2016)
6James Schindler, Vice President, Assistant General Counsel (Jan. 14, 2016)
7Katerina Kogan, Attorney, ESI International (Jan. 14, 2016)
8Edward Paulis III, Vice President & assistant General Counsel, Zurich North American Group (Jan. 21, 2016)
Region: United Kingdom, United States
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