Referring to “Lost Profits” in Liability-Limiting Provisions

MSCD 13.105 deals with provisions that exclude certain types of damages. Here’s an example:

Neither party will be responsible or held liable for any consequential, special, or incidental losses or damages.

Such provisions are often found in sections with the heading “Limitation of Liability.” Seeing as I’m not a fan of the word limitation (see this post), I’m experimenting with calling such provisions “liability-limiting provisions.” [Thanks to A. Wright Burke for setting me straight on terminology; see the comments.]

In MSCD, I say that excluding certain types of damages can be unhelpful for the following reasons:

First, many of those seeking that certain types of damages be excluded assume incorrectly that otherwise the nonbreaching party would be entitled to recover remote damages.

Second, the terms of art used in language excluding consequential damages are ill-understood and so are conducive to dispute.

Third, it can be arbitrary to exclude certain types of damages recoverable under the contract but not others.

And fourth, some provisions pile on the exclusions in a way that makes no sense.

(For more details, consult MSCD; for an earlier version, consult this post and this post.)

My aim with this post isn’t to rehash the entire subject. Instead, I want to focus on one phrase, lost profits. Here’s what MSCD recommends:

Instead, be specific as to what you’re excluding. Don’t use legal terms of art; instead, refer to “lost profits” or whatever other types of damages are of concern. But whatever types of damages you include, think through the implications.

But that recommendation doesn’t take into account that even a phrase as specific as lost profits can create confusion.

As evidence for that, I offer the recent New York Court of Appeals opinion in Biotronik A.G. v. Conor Medsystems Ireland, Ltd. (here), which I learned about from this post on ContractsProf Blog. In that opinion, which was backed by four judges, the court held that the lost profits sought by a distributor constituted general damages (also known as direct damages) that were recoverable under the liability-limiting provision of the contract at issue; they didn’t constitute consequential damages. Three judges disagreed and backed a dissenting opinion.

So what does this tell me? That even lost profits, which would seem less slippery than a term of art such as consequential damages, is still tricky. Here are the implications for the contract drafter:

  • If your liability-limiting provision refers to consequential damages and doesn’t mention lost profits, whether a court would conclude that lost profits constitute consequential damages would depend on the context, and different judges might reach different conclusions.
  • If your liability-limiting provision refers to consequential damages, “including lost profits,” in a dispute a court could presumably decide that the lost profits at issue are general damages and so don’t constitute lost profits that fall within the scope of the liability-limiting provision.
  • If your liability-limiting provision refers to lost profits without mentioning consequential damages, that seems arbitrary, in that the provision doesn’t take into account that lost profits have different implications in different deals.

So disputes over lost profits always have the potential to create confusion, however you address, or don’t address, the issue in the contract.

So I’m left feeling even more convinced that the simplest option is to forget about the traditional liability-limiting provision. You don’t need it to preclude liability for unforeseeable losses, as contract law doesn’t provide a remedy for unforeseeable losses. And if you want to limit damages, it would be simpler to state an absolute cap. If you nevertheless want to limit certain types of damages, don’t just trot out the usual broad terms. Instead, be very specific, in a way that reflects the actual transaction.

Posted in Selected Provisions | 7 Comments

  • Chris Lemens

    Ken:

    Another way would be to positively state an exclusive measure of what we usually think of as direct damages (even thought it is wrong). One would be the difference in market values between what was delivered and what was required. Another would be the cost of fixing what was delivered to comply with what was required or acquiring what was supposed to be delivered to conform with what was required. If you state one of those as the only remedy (other than indemnity for third party claims, or as the exclusive remedy for the core obligations, or whatever), that might fix the issue, depending on the deal.

    I don’t buy the argument that what I am trying to do is eliminate remote damages. I realize that is what some people think, but that’s not what I am trying to do by eliminating consequential damages.

    Chris

    • AWrightBurkeMPhil

      So what *are* you trying to do by eliminating consequential damages if not eliminate remote damages?

  • AWrightBurkeMPhil

    I think “liability-limiting provision” sounds better than “limiting-liability provision,” as “dog-eating barbarian” sounds better than “eating-dog barbarian.”

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

      I think that “dog-eating barbarian” sounds better than “liability-limiting provision.”

      You’re right. But my starting point was what the section itself might be called. I’m still undecided.

      • AWrightBurkeMPhil

        The section title should be “Liability Limited.” So what if it sounds like a railroad?

  • Paco Trouble

    Heretic!

    90% of attorneys’ job is to fuss over the Dog-Eating Barbarian provision. You trying to put people out of work, job-stealer!

    P.S. big fan of ditching these types of provisions; won’t happen until my boss and everyone in his generation retires and even then, it’s 6 to 1 and pick ‘em we lose this unhelpful rule.

  • SChalmers

    Ken

    For what it’s worth, the English have struggled with pretty much the same issues as your case addresses – here’s a link to an article by Linklaters – the title says it all!

    “UK – Indirect & Consequential Losses Including…..Not Very Much”

    http://www.linklaters.com/Publications/Publication1403Newsletter/PublicationIssue20080417/Pages/PublicationIssueItem3200.aspx

    In my industry (oil and gas/energy construction), parties almost always seek to limit recovery of much direct (pure economic) damage as well. For that reason, and because of cases like these, most parties agree to list the heads of loss categories independent of their characterization as direct or indirect/consequential.

    Scott