Recovering Lost Profits by Avoiding Limitation of Liability Provisions

By Daniel Mestasz

Lost profits are often the largest component of damages in breach of contract cases. Limitation of liability provisions, however, typically preclude those damages and other consequential damages. These provisions are in many types of contracts, particularly service contracts, supply contracts, and contracts governed by the Uniform Commercial Code. If a client has been damaged by a breach, avoiding that provision can be critical.

Like a rock thrown into a pond, a single breach can ripple through a company’s operations and damage its other relationships. For example, where a supplier sold defective paint to a dealer, the court did not limit the damages to replacement paint. Rather, the dealer was entitled to the profits it would have made on the contracts cancelled by its contractor customers, as well as its lost goodwill. Isenberg v. Lemon, 84 Ariz. 340, 349–50, 327 P.2d 1016, 1022–23 (1958). Similarly, where a city breached a towing contract, the towing company was entitled to lost profits on the sale of parts from the abandoned cars it would have recovered, lost profits from towing services, and damages for lost goodwill. All Points Towing, Inc. v. City of Glendale, 153 Ariz. 115, 735 P.2d 145 (App. 1987). See also Short v. Riley,150 Ariz. 583, 585, 724 P.2d 1252, 1254 (App. 1986) (where defendant wrongfully withheld liquor license in connection with restaurant purchase, plaintiff was entitled to any lost profits while operating the restaurant without the license).

Thus, where a breach causes lost profits or other consequential damages, it is important to see if the contract has a limitation of liability provision. If it is there, Arizona law presents some options to avoid it.

First, a party who has breached a contract in bad faith may not rely on a limitation of liability clause in that contract. Airfreight Express Ltd. v. Evergreen Air Center, Inc., 215 Ariz. 103, 158 P.3d 232 (App. 2007).

In Airfreight Express, the defendant contracted to provide maintenance repairs on an airplane so that the plaintiff could perform under an air cargo contract with Air France. Following a settlement agreement that required the defendant to make repairs, the plaintiff sued for breach of contract, alleging that the defendant made faulty repairs for the purpose of letting its sister company appropriate the Air France cargo business from the plaintiff. The court reversed the trial court’s summary judgment ruling that a limited liability clause precluded the plaintiff from recovering lost profits that it would have earned under the air cargo contract.

The court held that a bad faith breach precludes reliance on a limited liability clause, as held by courts from other jurisdictions and consistent with Corbin, the Restatement, and Arizona law. Id., at 110–11, citing 15 Grace McLane Giesel, Corbin on Contracts § 85.18 at 471 (2003) (a limited liability provision “is not effective . . . if the party acts fraudulently or in bad faith”), Restatement (Second) of Contracts, § 195 (1981) (prohibiting contracts exempting parties from intentional or reckless tort liability), and A.R.S. § 47–2719(C) (“Consequential damages may be limited or excluded unless the limitations of exclusions is unconscionable.”). The court further explained that as “a matter of public policy, a party should not benefit from a bargain it performed in bad faith.” Id., at 111.

Second, under the U.C.C., and “[p]ursuant to A.R.S. § 47–2719(B), a limitations of damages clause in invalid ‘[w]here circumstances cause an exclusive or limited remedy to fail of its essential purpose.’” Nomo Agroindustiral Sa De CV v. Enza Zaden North America, Inc., 492 F.Supp.2d 1175, 1181 (D. Ariz. 2007), quoting A.R.S. § 47–2719(B). In Nomo, a tomato grower sued its seed dealer for lost profits after its plants died from a virus. The court held that under Section 2719(B) and (C), the dealer could not rely on a limitation of damages clause to limit damages to the purchase price of seeds because it failed of its essential purpose (2719(B)) and was unconscionable (2719(C)). The court reasoned that parties to a sales contract cannot disavow minimum adequate remedies, which would include lost profits for defective seeds that resulted in a lost growing season:

The comments to [Section 2719] state: ‘[I]t is of the very essence of a sales contact that at least minimum adequate remedies be available. If the parties intend to conclude a contract for sale within this Article they must accept the legal consequence that there be at least a fair quantum of remedy for a breach of the obligations or duties outlined in the contract.’ [citing comment 1] . . . A farmer’s lost growing season and the accompanying loss of expected profits due to defective seeds clearly is not compensated by simply replacing or refunding the price of the defective seeds.”

Id.

A limitation of liability provision may not be the end of the world for companies devastated by another’s breach. Defeating that provision may be the first step to recovering lost profits and other consequential damages.

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