Excluding Direct and Indirect Damages

Earlier this month I unleashed the following tweet:

So I noted with interest the opinion of the Texas Court of Appeals in Innovate Technology Solutions, L.P. v. Youngsoft, Inc., 05-12-00658-CV, 2013 WL 6074126 (Tex. App. Nov. 19, 2013) (PDF copy here).

The contract at issue contained the following limitation of liability:

Not withstanding anything contained elsewhere in this Agreement and under any circumstance, for any reason whatsoever, YS shall not be liable for any incidental, ancillary, direct, indirect, special or consequential damages, including but not limited to lost profits, whether in tort or contract, and based on any theory of liability.

Given the presence of both “direct” and “indirect,” it’s not surprising that Youngsoft argued that because of that limitation of liability, “Innovate is not entitled to recover any damages from Youngsoft under any circumstances, notwithstanding anything to the contrary in the … Agreement.”

The trial court held in favor of Youngsoft, but the Court of Appeals reversed, holding that giving the limitation of liability the meaning sought by Youngsoft would make the entire contract “illusory, void, and unenforceable.”

This case serves as a reminder that attempting to exclude both direct and indirect damages makes no sense. (See MSCD 13.117.) It’s hard to imagine that anyone who includes both “direct” and “indirect” is really attempting to exclude all damages. Instead, it’s more likely that they’re just throwing in whatever happens to come to mind, whether they understand it or not. After all, many drafters don’t understand what “consequential damages” means (see this post and this post), so they’re not likely to worry to much about “direct” and “indirect.”

Posted in Selected Usages | 9 Comments

  • Chris Lemens

    Ken:

    I suspect that you are right about how “direct” came to be included in the agreement. Extrinsic evidence might have even shown that.

    And I agree with the court that reading the provision literally means that there is no remedy in damages, rendering the agreement illusory. I read the case to see if there could reasonably have been some other thing that rendered it non-illusory, such as a license or a realistic chance of an injunction. The case tells us nothing about those, but I think they are important. I think you could include a complete damages exclusion in a situation where the agreement reliably did something else. For example, a quitclaim could reasonably have a complete damages exclusion. So could a license of intellectual property. So could a confidentiality agreement where an injunction was the only realistic remedy anyway because any damages would be speculative.

    What bothers me about the court opinion was its conclusion that the literal reading of the damages exclusion was not sufficiently reasonable to even make the contract ambiguous. The trial court apparently applied the literal language and granted summary judgment, ignoring that there was another reasonable interpretation of the agreement because the damages provision conflicted with the remainder. But the appellate court doesn’t seem to have done better, effectively giving summary judgment on the issue, ignoring the literal language of the provision. I would have held the contract to be ambiguous as to whether all damages were excluded, allowed extrinsic evidence, and — if nothing else resolved it — punted it to the jury with an instruction about interpretation against the drafter.

    I realize that this is not a blog about court cases — it’s a blog about contract drafting. To force my point above into that mode, it is an illustration of how courts — not one, but two — can consistently get to insupportable results when bad drafting is in play.

    Chris

    • http://rickcolosimo.com Rick Colosimo

      I see your point about digging deeper, and I agree with that. At the same time though, the language is so simple that I don’t think you can say “ambiguous.” Poorly drafted, not what might have been intended — sure. But not ambiguous. Mistake? Could be. But not ambiguous.

      I don’t think courts are required, or intended, to rewrite contracts to save drafters from themselves. I think that’s where the mischief begins and drafters lose control over the contracts.

      Your points on when parties might legitimately exclude all monetary damages, and how they might clearly signal that intent, are EXCELLENT.

      • Chris Lemens

        Rick:

        Let me restate why I think the contract as a whole is ambiguous, to see if you still disagree.

        To find that a contract is ambiguous, a court must find that its language has two reasonable but inconsistent interpretations. I propose the following two:
        1. The literal language of the limitation of liability provision excludes every category of damages. Therefore, the party in question is not liable for damages.
        2. Other provisions in the agreement express or imply an expectation that damages could be recovered. The indemnity provision expresses it, and the warranty section implies it. Therefore, the party in question must be able to recover at least some money.
        It is remotely possible (since we don’t actually have the contract), that there is some way of squaring these. For example, perhaps there is some contractual definition of the term “damages” that would allow recovery of express remedies that are money. If that’s not the case, then these interpretations are inconsistent. If they are both reasonable, then the contract is ambiguous.

        What do you think? Are they both reasonable?

        The trial court believed that interpretation #2 was not reasonable in light of the express language of the limitation of liability section. The appellate court believed that interpretation #1 was not reasonable in light of all the other provisions of the agreement. I would have said that the contract as a whole was ambiguous, which would have allowed the court to consider extrinsic evidence and, if the extrinsic evidence was no help, rely on interpretation against the drafter.

        On your point about signaling, if I was intending to draft a complete exclusion of all damages, I would write it that way: “The Company will not be liable for any damages for breach of this agreement, regardless of the type of or reason for damages alleged or sustained. The other party acknowledges that (a) its remedy will be limited to an injunction [or whatever]; (b) that this exclusion is reasonable based on the unusual nature of this agreement; and (c) the Company would not enter into this agreement without this exclusion.” I think you would need explanatory acknowledgements because an exclusion of all damages is so unusual. Also, this might not be enforceable against a consumer or other statutorily favored group in some states. You might also need carve-outs to make it enforceable in some states, again depending on the context and the breadth of the exclusion (e.g., exclusion for damages for breach vs. damages related to the agreement). You would probably want to make it quite conspicuous.

        Chris

        • http://www.adamsdrafting.com/ Ken Adams

          Just to add a narrow point: Ambiguity arises when readers derive alternative inconsistent meanings from a given provision. That’s different from inconsistency. Inconsistent provisions aren’t ambiguous, they’re inconsistent.

          • AWrightBurkeMPhil

            If one provision is open to two reasonable but inconsistent interpretations, the inconsistency creates an ambiguity that is internal to the provision.

            If two distinct provisions are each individually clear but inconsistent with each other, the inconsistency creates an ambiguity that is external to each provision.

            Should a different name be given to the same type of uncertainty depending on whether it’s intra-provisional or inter-provisional?

          • http://www.adamsdrafting.com/ Ken Adams

            You’re correct that I shouldn’t be so quick to suggest that there are rigid distinctions between the different kinds of uncertainty. For example, I’ve been known to lie awake at night pondering how certain kinds of vagueness could be considered to exhibit ambiguity. I’ll ponder all this in due course.

        • http://rickcolosimo.com Rick Colosimo

          Thanks, Chris. I think that the “notwithstanding” language is seemingly intended to trump all the rest. It’s a nuclear word, which is probably why Ken tells us not to use it!
          What probably really happened here, as Ken surmises, is that someone just goofed and the language wasn’t intended to be there. I could see this path: 1- find the inconsistency; 2 – find it’s so unreasonable or unusual that a mistake is plausible; 3 – seek extrinsic evidence to resolve the matter; and 4 – predict that a finding would be made that direct damages were never intended to be excluded. If only it were that easy in real life: what a mess.

          Your solution is excellent.

          • Chris Lemens

            Rick:

            You make an additional point very well. It might be that the extrinsic evidence that I’d like a court to get to would show that the addition of “direct” was a mistake in drafting. And, if courts signaled that they would get to extrinsic evidence, I suspect that the drafter might be rather less inclined to argue positions where its own records might show that the addition was a mistake. (I don’t know whether that happened here, obviously.)

            Chris

  • Mark Anderson

    My take on the appeal court’s judgment is that the hurdle for summary judgment is very high and YS didn’t reach it, because there were other ways of construing the agreement, not least because of:
    (1) apparent inconsistency between the exclusion of liability and the indemnity; and
    (2) interpreting the exclusion in the YS way would mean no remedies, which would be a surprising outcome unless the parties clearly intended it.

    Therefore the matter should go to full trial.

    That seems like a sensible outcome to me.

    Looking at the drafting, I agree that it is very odd to include direct in that list, and agree with Ken’s view of it. Putting it half-way through the list makes it look more like a mistake. I wouldn’t like to predict how an English court would resolve the drafting issue, but I think the English appeal court might well have reached the same decision as the Texas appeal court on the summary judgment point.