The Futility of the Damage Limitation Provision

This Federal Court decision highlights the futility of attempting to limit damages.  The intentions of parties to a contract may not be met by typical damage limitation provisions.

Aculocity, LLC (“Aculocity”), a data management software developer, entered into a contract with Force Marketing Holdings, LLC (“Force”), a provider of marketing services to automobile dealers, to develop software for Force. Dissatisfied with the software, Force refused to make the payments due under the contract and the contract was terminated.

Aculocity brought suit against Force alleging: (i) breach of contract based on Force’s failure to make payment; (ii) breach of the contract’s confidentiality provision; (iii) breach of the contract’s non-solicitation provision; (iv) copyright infringement under the U.S. Copyright Act; (v) misappropriation of trade secrets under the Illinois Uniform Trade Secrets Act; and (vi) misappropriation of trade secrets under the U.S. Defend Trade Secrets Act.  Aculocity seeks “loss of revenue” based on Force’s failure to make the payments due under the contract; “loss of revenue” and punitive damages based on Force’s use of the software after the contract was terminated; lost profits under 17 U.S.C. § 504(b) of the Copyright Act; punitive and statutory damages under 17 U.S.C. § 412 of the Copyright Act; injunctive relief requiring Force to return Aculocity’s source code; and generally seeks “actual damages, lost profits, consequential damages, interest, costs, and reasonable attorney’s fees”.

The contract includes the following damage limitation provision:

In no event will either party be liable for consequential, incidental, indirect, punitive or special damages (including loss of profits, data, business or goodwill), regardless of whether such liability is based on breach of contract, tort, strict liability, breach of warranties, failure of essential purpose or otherwise, and even if advised of the likelihood of such damages.

Rather than engage in discovery, Force filed a motion for partial summary judgment asserting that, because of the damage limitation provision, as a matter of law, Aculocity’s damages are limited to the amount that was to be paid under the contract.

The district court disagreed.

At the outset, the court held that direct damages – also referred to as “general damages” – may include lost profits, stating that “whether lost profits are direct damages depends on their degree of foreseeability”.  (Citations omitted.)  For example, in Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61, 67 (Ill. 1987), lost profits were determined to be direct damages when the defendant improperly failed to include an advertisement for plaintiff in a newly published telephone directory.  The court held that in the event Aculocity seeks lost profits based on Force’s use of the software after the contract was terminated, such losses would be considered to be foreseeable when the contract was entered into and flow naturally from Force’s breach, and, as such, would constitute direct damages that are not precluded by the damage limitation provision.

Force also asserted that Aculocity cannot recover damages under the Copyright Act, Illinois Uniform Trade Secrets Act, or U.S. Defend Trade Secrets Act because the damage limitation provision bars recovery of consequential, incidental, indirect, punitive, or special damages “regardless of whether such liability is based on breach of contract, tort, strict liability, breach of warranties, failure of essential purpose or otherwise.”  Again, the district court disagreed, and held that “while the clause unambiguously limits tort claims for consequential, incidental, indirect, punitive or special damages based on the parties’ contractual duties, [it] does not bar damages based on violations of statutes containing duties independent of the contract”.  The court reasoned that “[a]lthough the clause states that it applies regardless of whether such liability is based on ‘tort . . . or otherwise,’ that does not suggest the parties intended to bar recovery for rights provided for by state and federal statutes.  Instead, it suggests that the parties intended to limit recovery from tortious (and other) violations of the [contract].”

Further, the district court reasoned that the contractual requirement for Aculocity to carry general liability insurance with limits up to $1 million per occurrence and a $2 million annual aggregate “indicates the parties contemplated that Aculocity could have liability several times greater than the amount paid [] under the contract”, and that “[i]f the parties intended to bar damages from any statutory violations, there would be little need for Aculocity to carry such insurance coverage.”

Except with respect to recovery of attorney’s fees and punitive damages under Aculocity’s breach of contract and copyright infringement claims, and statutory damages under 17 U.S.C. § 412 of the Copyright Act (which the court ruled were barred from recovery by the damage limitation provision), Force’s motion for partial summary judgment was denied.

To limit damages to the amount to be paid under a contract, the drafter must understand which damages will be considered to be foreseeable at the time that the contract is entered into and flow naturally from a breach, i.e., direct damages.  The drafter must also evaluate whether statutory damages can be barred from recovery.

At Rosenfarb LLC we produce well-supported, well-reasoned and well-communicated damage calculations that withstand the rigors of litigation. We are a firm of forensic accounting and valuation experts. We understand business – which is an amalgamation of events and transactions with often complex and nuanced underlying economic purposes. We have keen insights and always connect the dots. We understand the litigation process. We frame the issues simply and in alignment with the litigation strategy. We use logic to support our opinions, while creating compelling stories. We are sincere, professional and credible. We are accounting experts with legal acumen.

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