United States: Importance Of Carefully Drafted Provisions Limiting Damages

Contractual provisions limiting the types of damages that are available in the event of a breach, i.e. "limitation-of-liability provisions," are common in various types of commercial contracts. Such provisions may be useful in shielding a breaching party from significant liability, but their prevalence may cause some lawyers to view them as "mere boilerplate." Global Crossing Telecomms., Inc. v. CCT Commc'ns, 46 B. R. 97 (Bankr. S.D.N.Y. 2011), however, underscores that these provisions are not automatically enforced and are subject to certain exceptions. In light of this ruling, attorneys may want to consider several issues when drafting these provisions.

Global Crossing involved a dispute between Global Crossing Telecommunications, Inc. (Global Crossing) and CCT Communications, Inc. (CCT), two common carriers of telecommunication services. Id. at 102. The dispute arose out of a closely negotiated contract under which Global Crossing agreed to provide services to CCT; CCT, in turn, resold the services to retail customers. Id. Under the terms of the contract, Global Crossing charged CCT a flat monthly fee for calls to some destinations and a per-minute charge for calls to other destinations. Under this arrangement, Global Crossing had to "eat," or absorb, certain costs of international calls on the monthly fee plan that terminated in certain international areas. Id. This program became too costly and Global Crossing purported to terminate the agreement. CCT counterclaimed, seeking damages for breach of contract among other claims. Id. at 103.

The court began by analyzing whether contractual clauses limiting liability are enforceable. The contract contained the following damages provision:

Id. at 102 (emphasis added).

The court held that the damages limitation provision was enforceable under New York law and reflected an allocation of risks between sophisticated parties in an arm's-length transaction. Id. at 115. Parties may agree to limit their respective damages remedies under New York law (and under many other states' laws), except in the case of gross negligence or willful misconduct. Id. The court found that Global Crossing's conduct did not constitute willful misconduct because it was driven by "economically motivated financial self-interest," and CCT failed to identify any evidence of malice, egregious behavior, or gross negligence. Id. at 116.

Next, the court examined whether the damages limitation provision was ambiguous. It began this analysis with an overview of the law regarding contract damages. Id. at 116. The law divides damages for breach of contract into "general" and "consequential." Id. General damages flow naturally and directly from the breach. Id. Consequential damages, also called "indirect' damages, are intended to compensate a plaintiff for losses in addition to the value of the promised performance, i.e., the value of the benefits the performance will produce or the losses its failure may cause. Id. Lost profits may reflect either general or consequential damages. Id. at 117. General damages may be characterized as lost profits when the nonbreaching party would have profited to the extent that its cost of performance was less than the total value of the breaching party's promised payments. Id. Lost profits are characterized as consequential damages when, as a result of the breach, the nonbreaching party suffers loss of profits on collateral business arrangements. Id.

In light of these rules, the court held that the first clause of the limitation provision was "straightforward" and barred consequential damages, but held that the second clause excluding claims for "lost revenues, lost savings, lost business opportunity, or lost profits of any kind" was ambiguous. Id. at 119. The second clause presented an "interpretative problem" because it could be read to bar "lost profits" or "lost revenues" that fall within the category of general damages. Id. Thus, the court declined to conclude as a matter of law that the provision barred any such general or direct damages, but left open the possibility that extrinsic evidence may explain its meaning. Id. at 120.

Global Crossing underscores several important considerations regarding contractual provisions limiting damages:

• There are several exceptions to the enforceability of damage limitations, including gross negligence, willful misconduct, and other public policy exceptions, but such exceptions may be difficult to establish.
• Some statutes and contexts may create special relationships between the parties that preclude the enforceability of the limitations provisions.
• Although courts will often imply the exception for gross negligence or willful misconduct, it is best to explicitly state in contracts that consequential damages will only be available where there is gross negligence or willful misconduct.
• Given the frequent blurring of the distinction between general and consequential damages in practice, it is advisable to define the terms "consequential damages" and "general damages" by listing the specific types of damages included under each category. Because "lost profits" and "lost revenues" can both be interpreted to be categories of general damages, one should list these types of damages as types of consequential damages by using the phrase "including," and the term "lost savings" should generally be avoided or precisely defined.
• Drafting attorneys should consider excluding all consequential damages and also may want to consider a cap on damages.
• The damages limitation provision should appear in its own section and be conspicuously placed.
• Attorneys should consider language that the damages limitation provision reflects the express intent of the parties and reflects a deliberate and bargained for allocation of risk.
• It is generally advisable to include a choice of law provision mandating the applicability of New York law (or the law of another jurisdiction that is clear and favorable on this issue).

Damages limitation provisions may be very helpful, and drafting attorneys may want to consider these issues to increase the likelihood that they will be effective and minimize the risk of ambiguity in such provisions.

Copyright 2012. Morgan, Lewis & Bockius LLP. All Rights Reserved.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.