[Don’t bother reading this post! It has been superseded by this post.]
I was pleased to see that today D.C. Toedt posted on his blog this item about defining gross negligence in a contract. It’s something that I’d idly thought about before consigning it to a far corner of my mind.
In his post, D.C. considers the caselaw regarding the effect of releasing a contract party in advance from liability for its gross negligence. He notes that different U.S. states define gross negligence differently, and that many foreign jurisdictions apparently don’t recognize the concept. That by itself is something that drafters should bear in mind.
He goes on to propose a contract definition of gross negligence, concluding as follows:
A U.S. court might well disregard such a contractual definition of gross negligence. It might instead apply whatever definition the court deemed to be required by applicable law.
But there would seem to be at least a chance that a court might hold that public policy did not bar the parties from agreeing to their own definition of gross negligence.
A contractual definition of gross negligence might therefore be helpful or even essential to determining whether a risk-shifting clause should be pierced.
So all in all, including a definition of gross negligence in a contract is probably worth the effort.
I’d like to pick up where D.C. leaves off. I apologize to D.C. for moving the discussion to my blog, but what I have to say wouldn’t really fit as a comment to his post.
I see a number of issues:
First, contracts refer to gross negligence in two different ways: they release Acme from liability for gross negligence, or they carve out gross negligence from provisions (a release, or indemnification provisions) that benefit Acme. The former can fall foul of a state’s rule that such releases are unenforceable as against public policy. By contrast, a carve-out excluding gross negligence from a provision benefiting Acme wouldn’t have any public-policy implications.
Second, defining gross negligence in a contract would have no effect on enforceability of an advance release from liability. A court would consider whether the conduct in question constitutes gross negligence under the law of the forum, and whether the contract sought to release the party in question from liability for that action. What label the contract puts on that conduct would be irrelevant.
Third, a definition of gross negligence might be acceptable for purposes of a carve-out excluding gross negligence from a provision benefiting Acme, but it’s hard to see how it would be of any use. Determinations of gross negligence are so fact-specific, and any definition would be so vague, that parsing subtle variations in a definition of gross negligence while drafting the contract seems pointless.
And fourth, given that determinations of gross-negligence are so fact-specific, who is going to decide whether a carve-out applies? Can the party that would otherwise have to pay Acme decide unilaterally? That seems like an invitation to litigation. Perhaps provisions that carve out gross negligence should provide that the carve-out would apply only after a court has made a determination of gross negligence. That would raise the same issues as the meaning of “prevailing party” (see this post). Carve-outs using a negligence standard raise the same issue.
[Updated September 5, 2012: How about referring to recklessness instead of gross negligence? It’s a less legalistic word.]
Ken, in my experience, many US lawyers insist on including a carve-out to an indemnity in the case of “gross negligence or wilful misconduct”. It is very difficult arguing this point from first principles, when it seems to be hard-wired into so many US contract negotiators as a bog-standard clause (a bit like your compatriots’ fondness for “indemnify and hold harmless”). Of course, you can and sometimes should negotiate it, but other times you save your powder for more immediate issues. I would, however, be extremely cautious about any clause that said “negligence” rather than “gross negligence” as this sometimes has the effect of fundamentally shifting the balance of the indemnity.
Usually, if I am asking for an indemnity, I don’t want weasel words that dilute it or give the other party more ways to litigate over it. On the hand, if I am willing to give an indemnity, do I really care about stating a carve out of this kind? There are so many other issues I might want to think about first, eg who has conduct of the claim. In extreme cases of wilful misconduct or something close to it, I think an English judge might well find some canon of construction that allows him to do justice and avoid the strict language of the indemnity. In many cases where “standard” indemnity clauses are included, I don’t think, looking at it from first principles, that including a carve out for gross negligence is a priority. In any case, I probably wouldn’t use that phrase as gross negligence is not a familiar concept in English commercial cases (although it sometimes appears in other contexts).
Given that the term is difficult to negotiate with Americans and indeed with people from any jurisdiction who slavishly use US templates, perhaps without understanding them, I would often be more comfortable with leaving the carve-out in if it is clearly limited to extreme cases. I was pleasantly suprised by DC’s analysis of the meaning under the laws of certain US states, and by his suggested definition, which seemed to place the term very close to the wilful misconduct end of the spectrum.
There is another point in relation to civil law countries. I haven’t yet worked out in my mind whether this is essentially the same point as in the US but presented differently. In countries such as Germany, France, Netherlands, etc, it seems that limitation of liability clauses are ineffective if they purport to limit or exclude liability for a party’s gross negligence or wilful misconduct. This is, of course, an English translation of the relevant terms. Therefore, limitation of liability clauses in those countries sometimes include an explicit carve-out for those terms. In this case there would seem to be little point in defining the terms differently to how they are understood under the applicable law, so a definition would seem inappropriate.
I like your idea of only allowing the carve-out after the court has decided, but in practice will this make any difference? Isn’t this a criticism of indemnities generally, that although they may look like they provide a shield to the indemnified party against the costs and traumas of litigation, in practice they are often litigated in parallel to the litigation that is the subject of the indemnity? I am not a litigator so I would be interested to hear litigators’ views on this point.
Thanks for the mention, Ken. I agree with your second point that a court might well ignore a contractual definition of gross negligence (and you kindly quoted from my blog page to that effect).
As to your first point, though, it’s not at all clear that a court would recognize a difference between an advance release from liability, on the one hand, and a so-called benefit such as an indemnity, as you suggest.
The underlying public policy, stated broadly, seems to be that (absent special circumstances such as the provision of insurance coverage) some courts will refuse to give effect to a clause by which a party purports to shift the risk of that party’s own wrongdoing.
For example:
* In the Dresser v. Page Petroleum case (which I found via one of your Adams Drafting blog entries), the Texas Supreme Court addressed whether an advance release from liability for one’s own negligence was required to be conspicuous, a requirement that prior precedent had applied to indemnity obligations covering one’s own negligence.
The supreme court said yes: “we can discern no reason to fail to afford the fair notice protections to a party entering into a release when the protections have been held to apply to indemnity agreements and both have the same effect. The policy considerations underlying the enforcement of indemnity clauses to warrant the application of the fair notice requirements to releases as well. This is especially true because of the difficulty often inherent in distinguishing between these two similar provisions. Therefore, we hold that the fair notice requirements of conspicuousness and the express negligence doctrine apply to both indemnity agreements and to releases in the circumstances before us ….” Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (citation and footnote omitted, emphasis added).
* In a two-paragraph opinion, approving a refusal to enforce an indemnity clause (where the indemnitee itself had apparently been negligent), a New York appeals court cited precedent concerning advance releases from liability. See Lachhonna v. Consol. Edison Co. of New York, Inc., 170 AD 2d 191 (N.Y. App. Div. 1991).
* Not quite on point as to indemnities, but still informative: In the Sommer case I cite (in which the New York Court of Appeals set out the definition of gross negligence on which my Common Draft definition is based), the court said: “It is the public policy of this State … that a party may not insulate itself from damages caused by grossly negligent conduct. This applies equally to contract clauses purporting to exonerate a party from liability and clauses limiting damages to a nominal sum.” (Emphasis added, citations omitted.)
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As to your third and fourth points: As a practical matter, litigation is virtually inevitable in the type of situations contemplated by a contractual definition of gross negligence. The point of including the definition isn’t to guide the parties’ business operations, it’s to (try to) guide the court in deciding a motion for summary judgment.
D.C.: What I say in my first point is that if a contract releases Acme from liability for, or indemnifies Acme against the consequences of, its own gross negligence, that raises an issue of public policy. But if a contract deprives Acme of a benefit in the case of its gross negligence, that doesn’t raise an issue of public policy, so courts wouldn’t care.
Even considering the matter after a good night’s sleep, I can’t see myself ever defining gross negligence. If it’s an issue of public policy, courts would apply their own standards. And even if it isn’t, a definition would be of little or no relevance in such a fact-specific inquiry. I suppose it’s analogous to the definition of insanity, in that differences in potential definitions might be relevant in marginal cases. But it’s all so theoretical that my eyes glaze over.
As regards who makes the determination, there might be some value to making it clear to the parties that nothing would get sorted out without litigation. But adding a bunch of prevailing-party type verbiage would probably clog things up while offering little benefit.
Ken
Ah — we’re in agreement then, when you say “if **a contract** deprives Acme of a benefit in the case of its gross negligence, that doesn’t raise an issue of public policy, so courts wouldn’t care.” (Emphasis added.) I hadn’t read your first point that way.
I also agree that in many situations, drafters won’t bother trying to agree to a definition of gross negligence, but instead will let the chips fall where they may.
For what it’s worth, 13 contracts filed on EDGAR in the past year contain a definition of “gross negligence.”
One benefit of defining “gross negligence” would be that many parties might not have the foggiest idea what it means. But I think that the problems with including a definition outweigh any informational benefit.
Ken:
The most common use of the phrase “gross negligence” is in a longer phrase like “gross negligence or willful misconduct.” This is commonly proposed in two contexts:
1. An indemnifying party will not have an obligation to indemnify where an otherwise-indemnified loss is caused by the indemnified party’s gross negligence or willful misconduct.
2. There will be an exclusion for claims of gross negligence or willful misconduct in an exclusion of types of damages, a cap on damages, a waiver of claims, or a contractual statute of limitations.
My problem with this phrase is that the cases that D.C. cites arose from a theory that applied well to risk shifting of tort claims through an indemnity or advance release. They do not work all that well then they apply to a claim of breach of contract.
Gross negligence can mean little more than finding a good plaintiff’s lawyer. In particular, in a contract setting, the parties allocate responsibilities. If one party relies on the other party doing something, so does nothing itself, that could be enough of an entire absence of care to survive a motion to dismiss or for summary judgment. Or if the service to be delivered simply does not include something, the failure to deliver it could be the entire absence of care. And if you are contractually required to do something, failing to take risks into account could be the entire absence of care.
Willful misconduct is likewise troublesome. Most activities in relation to a contract are intentional in some respect. What must be intended – the conduct, the harm, that it be misconduct? Is breach always misconduct? If an action that is both intentionally taken and breach would be willful misconduct, then the exception destroys the whole purpose of the limitation.
One of the main purposes of a limitation on liability is to allow the parties to calculate what the damage ought to be, get it paid, and move on with some certainty. These broad exceptions, when put into any context where one party is thinking of suing the other, just gives the lawyers a way to find a possible path to a pot of gold. And that creates incentives that drive lawsuits.
So I usually counter-propose an exception that is narrower in scope, such as for malicious or bad-faith breach, which usually covers what the other side cares about – that being subjectively bad behavior. If I want to include something that includes a sense of indifference to the harm, as opposed to intending the harm, I would include wanton breach (with reckless breach being the next step down on the scale).
Note that all of these exceptions, if applied to a damages cap, probably undermine the ability of a party to abandon the contract and send a check for the amount of the cap. If that is important, it should be specially negotiated, rather than left to the ambiguous application of these exceptions. Abandonment is often specifically negotiated (as a carve-out to limitations of liability) by a customer where the customer is dependent on a service provider’s continued performance.
Chris
Chris: I’ll need longer to digest all this, but one quick point: “Wanton” being higher up the scale than “reckless”? Stay tuned for a blog post.
By way of low-grade follow-up, I agree that this is a mess. At some point soon I’ll attempt a top-to-bottom analysis, but for now, here are a couple of points.
Gross negligence is a tort concept. Won’t that carry over into every use of “gross negligence” in a contract? In other words, for a gross-negligence carve-out to apply, you have to successfully bring a tort claim against the party in question.
And beyond the question of whether “misconduct” refers to the conduct or the harm, against what standard is misconduct to be measured? What’s in the contract? Some notion of good faith?