Private Equity

Some drafting lessons seem to require constant relearning. And that is no more the case than in drafting the ubiquitous “consequential damages” waiver. Although there are many reasons to avoid the use of the term “consequential damages” altogether, if you are going to use the term in a clause purporting to exclude a list of damages types, with the term “consequential damages” as an additional catch-all exclusion (as opposed to a limitation on the other listed exclusions), it is important to use it correctly. A case decided earlier this year by a Federal District Court, Endless River Technologies LLC v. Trans Union LLC, 2023 WL 24101 (N.D. Ohio Jan, 3, 2023), is a helpful example.

Endless River involved, among other issues, an appeal from a jury verdict awarding $18.3 million in lost profits allegedly arising from a breach of a development agreement. The defaulting party did not dispute that it had breached the agreement, but instead claimed that, by the terms of the development agreement, the lost profits awarded by the jury were contractually barred. The damages waiver in the development agreement provided:

IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR, AND BOTH [TRANS UNION] AND [ENDLESS RIVER] HEREBY WAIVE AS TO THE OTHER PARTY, ANY CONSEQUENTIAL, INCIDENTAL, INDIRECT, SPECIAL OR PUNITIVE DAMAGES INCURRED BY THE OTHER PARTY AND ARISING OUT OF THE PERFORMANCE OF THIS CONTRACT, INCLUDING BUT NOT LIMITED TO LOSS OF GOOD WILL AND LOST PROFITS OR REVENUE, WHETHER OR NOT SUCH LOSS OF DAMAGES IS BASED IN CONTRACT, WARRANTY, TORT, NEGLIGENCE, STRICT LIABILITY, INDEMNITY, OR OTHERWISE EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. THESE LIMITATIONS SHALL APPLY NOTWITHSTANDING ANY FAILURE OF ESSENTIAL PURPOSE OR ANY LIMITED REMEDY.

According to the court, and as apparently recognized by both parties, this provision did not waive all lost profits, but instead only waived lost profits that otherwise constituted consequential damages. The inclusion of “lost profits” following the “including but not limited to” listing of examples of the categories of damages excluded by excluding “any consequential, incidental, indirect, special or punitive damages” was apparently just that, an example of the types of losses that the exclusion of the broader excluded damages categories may include. In other words, lost profits was not an independently excluded category of damages. Thus, in order to determine whether the lost profits awarded to the non-defaulting party here were precluded by the excluded damages provision, the court had to first determine whether those lost profits were in fact “consequential damages.”¹ After all, not all lost profits are in fact consequential damages, and consequential damages are not limited to just lost profits.²

The court then proceeded to discuss the traditional distinction between direct or general damages, which were clearly not precluded by the excluded damages provision, and consequential or special damages, which clearly were precluded. That traditional distinction arises from the two limbs of Hadley v. Baxendale.³ According to the court, direct or general damages are those “arising naturally and usually from the breach” and which are “utterly foreseeable” because they always arise from any breach of any similar contract. In contrast, consequential damages do not invariable result from a breach of a similar agreement and arise because of the special circumstances of the non-breaching party. And because all damages must be foreseeable at the time of contracting to be recoverable, consequential or special damages require that the prospect of such non-normative damages be made known to the other party at the time of contracting. But the court then equates consequential damages with “indirect damages” by stating also that “[c]onsequential damages require proof of an additional ‘link in the causal chain’ in order to connect the damages to the contract.” Because “indirect damages” were in fact independently excluded by the damages waiver provision, that probably doesn’t matter. But it nevertheless illustrates the continued uncertain meaning of the term consequential damages.⁴

The court ultimately determined that the lost profits awarded by the jury here were in fact consequential damages because they had not “formed the very basis” of the development agreement terms that had been breached and would presumably therefore not invariably result from a breach. The lost profits here were instead based upon future transactions with third parties that were not in existence at the time the agreement was entered into. Had the damages waiver independently excluded “damages based upon lost profits of any kind,” the court could have presumably made very short work of this and not been required to delve into the confusing issue of what does and does not constitute consequential damages.⁵

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1 See Glenn D. West, Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements, 70 Bus. Law. 971, 974 n.15 (2015). The court doesn’t really explain why the other specifically excluded damages types were not relevant—i.e., “incidental, indirect, special or punitive damages.” But (a) lost profits are not “punitive damages,” (b) “special damages” are just a synonym for consequential damages, (c) although “indirect damages” are not a synonym for consequential damages, many courts treat them as if they were, and (d) “incidental damages” are typically limited to costs incurred in mitigating the damages that would otherwise occur. See Glenn D. West & Sara G. Duran, Reassessing the “Consequences” of Consequential Damage Waivers in Acquisition Agreements, 63 Bus. Law. 777, 789-90 (2008).

2 For a famous New York case determining that certain lost profits were direct damages rather than consequential damages see Biotronic AG v. Conor Medsystems Ireland Ltd., 11 N.E.3d 676 (N.Y. 2014), discussed in West, supra note 1, at 991-92.

3 See Glenn West, Do You Really Know What “Consequential Damages” Means?, Weil’s Global Private Equity Watch, May 18, 2020, available here.

4 The uncertain meaning of consequential damages is the reason this author has repeatedly called for the term to be stricken from the M&A deal lexicon. See Glenn West, Excluded Loss Provisions and the Danger of Contractually Slaying Mythical Dragons, Weil’s Global Private Equity Watch, December 13, 2021, available here. For supply, development and construction contracts there is much more of a reason to use the term than in the M&A context, but even then it should be used with caution.

5 See e.g., Hope International Hospice, Inc. v. Net Health Systems, Inc., 2023 WL 2433642 (D. Utah March 9, 2023)( “[Net Health] shall not be liable for any special, incidental, indirect, punitive, or consequential damages or for the loss of profit [or] revenue … arising out of the subject matter of this agreement.”).