Canada: New York Court Explains When Lost Profits Are Recoverable

The New York Court of Appeals, the state's highest court, recently held in a 4 to 3 decision that a plaintiff could recover lost profits for a breach of contract—even though the contract precluded recovery of consequential and special damages. The decision is noteworthy for contract drafters who are advised to expressly exclude lost profits in a limitation-of-liability provision when that is the parties' intention.

The decision in Biotronik, A.G. v. Conor Medsystems Ireland, Ltd. concerned an exclusive distribution agreement for the sale of a medical device. Prior to the end of the agreement's term, the defendant manufacturer took the device off the market and terminated the agreement. The manufacturer paid the plaintiff distributor € 8.32 million and a 20% handling fee to reimburse the distributor for its inventory and the costs associated with the termination.

The parties' agreement, governed by New York law, contained the following provision limiting the damages available in the event of a breach:

The distributor sued for lost profits of $85 million related to the discontinued resale of the devices under the agreement. It argued that lost profits were "general damages" not precluded by the agreement's damages limitation. The trial court disagreed and dismissed the lawsuit because it concluded that lost profits were consequential damages excluded by the parties' agreement—a unanimous Appellate Division affirmed.  

The Court of Appeals reversed, with the majority holding that "damages must be evaluated within the context of the agreement, and that, under the parties' exclusive distribution agreement, the lost profits constitute general, not consequential damages."

General damages are the natural and probable consequence of the breach of an agreement, including "money that the breaching party agreed to pay under the contract." Consequential or special damages, on the other hand, do not directly flow from the breach of contract.

In the context of resale and distribution agreements, a distinction is drawn between lost profits that would have flowed directly from the contract and those that would have resulted from a separate agreement with a nonparty, i.e., a collateral transaction. The distinction is not, however, a bright line and determining when lost profits are general rather than consequential damages requires a "case-specific approach." The Court acknowledged that the application of the rule to specific contracts and controversies can be "elusive." Indeed, nine judges (the trial judge, the appellate panel, and the Court of Appeals dissenters) concluded that the distributor's claimed lost profits in the Biotronik case were consequential damages, while only the four judges in the Court of Appeals majority determined otherwise.

The majority observed that "[t]he agreement was not a simple resale contract, where one party buys a product at a set price to sell at whatever the market may bear." Rather, the agreement included target volumes and a formula for determining the price the distributor paid the manufacturer for the devices based on actual sales and the resale prices. The Court likened the agreement to a "joint venture" and held that the manufacturer agreed to pay the distributor's profits because they flowed directly from the pricing formula. Noting that both parties depended on the device's resale for their respective payments, the majority concluded that "the agreement reflects an arrangement significantly different from a situation where the buyer's resale to a third party is independent of the underlying agreement."

The dissent criticized the majority for accepting the distributor's "creative" reading of the agreement's pricing formula and remarked, "[c]reativity on this scale is no boon in the commercial world, 'where reliance, definiteness, and predictability are such important goals of the law itself, designed so that parties may intelligently negotiate and order their rights and duties.'"

The take-away from the Biotronik case for the commercial world is that parties to New York-governed contracts intending to exclude lost profits in the event of a breach cannot assume that the exclusion of consequential or special damages will suffice. Contracting parties should expressly exclude "lost profits."

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