Referring to “Lost Profits” in Liability-Limiting Provisions.

by Ken Adams (originally posted April 15, 2014 in Adams on Contract Drafting)

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.

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Ken Adams is president of Adams Contracts Consulting LLC, author of A Manual of Style for Contract Drafting, and an advisor to LegalSifter.