Tag: consequential damages

Actuarial Firm Owes No Independent Legal Duty to Health Plan; Lost Profits Claim Lopped Off – 2nd Cir.

The Second Circuit appeals court recently examined the contours of New York’s economic loss rule in a dispute involving faulty actuarial services.

The plaintiff health care plan provider in MVP Health Plan, Inc. v. Optuminsight, Inc., 2019 WL 1504346 (2nd Cir. 2019) sued an actuary contractor for breach of contract and negligence when the actuary fell short of professional practice standards resulting in the health plan losing Medicare revenue.

The plaintiff appealed the district court’s bench trial verdict that limited plaintiff’s damages to the amounts it paid the actuary in 2013 (the year of the breach) and denied the plaintiff’s request for lost revenue.

The plaintiff also appealed the district court’s dismissal of its negligence count on the basis that it was duplicative of the breach of contract claim and the actuary owed the plaintiff no legal duty outside the scope of the contract.

Affirming, the Second Circuit first addressed the dismissal of plaintiff’s negligence claim. In New York, a breach of contract claim is not an independent tort (like negligence) unless the breaching party owes a legal duty to the non-breaching party independent of the contract. However, merely alleging a defendant’s breach of duty of care isn’t enough to bootstrap a garden variety contract claim into a tort.

Under New York law, an actuary is not deemed a “professional” for purposes of a malpractice cause of action and no case authorities saddle an actuary with a legal duty to its client extraneous to a contract. In addition, the court found the alleged breach did not involve “catastrophic consequences,” a “cataclysmic occurrence” or a “significant public interest” – all established bases for a finding of an extra-contractual duty.

Next, and while tacitly invoking Hadley v. Baxendale, [1854] EWHC Exch J70, the seminal 19th Century British court case involving consequential damages, the appeals court jettisoned the plaintiff’s lost revenues claim.

Breach of contract damages aim to put the plaintiff in the same financial position he would have occupied had the breaching party performed. “General” contract damages are those that are the “natural and probable consequence of” a breach of contract. Lost profits are unrecoverable consequential damages where the losses stem from collateral business arrangements.

To recover lost revenues as consequential damages, the plaintiff must establish (1) that damages were caused by the breach, (2) the extent of those damages with reasonable certainty, and (3) the damages were within the contemplation of the parties during contract formation.

To determine whether consequential damages were within the parties’ reasonable contemplation, the court looks to the nature, purpose and peculiar circumstances of the contract known by the parties and what liability the defendant may be supposed to have assumed consciously.

The court found that plaintiffs lost revenues were not damages naturally arising from defects in actuarial performance. Instead, it held those claimed damages were twice removed from the breach: they stemmed from plaintiff’s contracts with its member insureds. And since there was no evidence the parties contemplated the defendant would be responsible for the plaintiff’s lost revenues if the defendant breached the actuarial services agreement, the plaintiff’s lost profits damage claim was properly dismissed.

Afterwords:

MVP provides a useful primer on breach of contract damages, when lost profits are recoverable as general damages and the economic loss rule.
The case cements the proposition that where there is nothing inherent in the contract terms or the parties’ relationship that gives rise to a legal duty, the non-breaching party likely cannot augment its breach of contract action with additional tort claims.

Limitation of Damages Clause Doesn’t Bar Trade Secrets, Copyright Claims – IL ND

A Federal district court in Illinois recently addressed the scope of a limitation of damages provision in a dispute over automotive marketing software. The  developer plaintiff in Aculocity, LLC v. Force Marketing Holdings, LLC, 2019 WL 764040 (N.D. Ill. 2019), sued the marketing company defendant for breach of contract – based on the defendant’s failure to pay for plaintiff’s software – and joined statutory copyright and trade secrets claims – based on the allegation that the defendant disclosed plaintiff’s software source code to third parties.

The defendant moved for partial summary judgment that plaintiff’s claimed damages were foreclosed by the contract’s damage limitation provision. The court denied as premature since no discovery had been taken on plaintiff’s claimed damages.

The agreement limited plaintiff’s damages to the total amount the software developer plaintiff was to be paid under the contract and broadly excluded recovery of any “consequential, incidental, indirect, punitive or special damages (including loss of profits, data, business or goodwill).”  The contractual damage limitation broadly applied to all contract, tort, strict liability, breach of warranty and failure of essential purpose claims.

In Illinois, parties can limit remedies and damages for a contractual breach if the agreement provision is unambiguous and doesn’t violate public policy.

Illinois law recognizes a distinction between direct damages and consequential damages. The former, also known as “general damages” are damages that the law presumes flow from the type of wrong complained of.

Consequential damages, by contrast, are losses that do not flow directly and immediately from a defendant’s wrongful act but result indirectly from the act. Whether lost profits are considered direct damages depends on their (the lost profits) degree of foreseeability. In one oft-cited case, Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61, 67 (Ill.1987), the Illinois Supreme Court held that a plaintiff’s lost profits were direct damages where the publisher defendant failed to include plaintiff’s advertisement in a newly published directory.

The District Court in Aculocity found that whether the plaintiff’s lost profits claims were direct damages (and therefore outside the scope of the consequential damages disclaimer) couldn’t be answered at the case’s pleading stage.  And while the contract specifically listed lost profits as an example of barred consequential damages, this disclaimer did not apply to direct lost profits. As a result, the Court denied the defendant’s motion for partial summary judgment on this point. [*3]

The Court also held that the plaintiff’s statutory trade secrets and copyright claims survived summary judgment. The Court noted that the contract’s damage limitation clause spoke only to tort claims and contractual duties. It was silent on whether the limitation applied to statutory claims – claims the court recognized as independent of the contract. [*4] Since the clause didn’t specifically mention statutory causes of action, the Court refused to expand the limitation’s reach to plaintiff’s copyright and trade secrets Complaint counts.

Take-aways:

Aculocity and cases like it provide an interesting discussion of the scope of consequential damage limitations in the context of a lost profits damages claim. While lost profits are often quintessential consequential damages (and therefore defeated by a damage limitation provision), where a plaintiff’s lost profits are foreseeable and arise naturally from a breach of contract, the damages will be considered general, direct damages that can survive a limitation of damages provision.

Economic Loss Rule Requires Reversal of $2.7M Damage Verdict In Furniture Maker’s Lawsuit- 7th Circuit

In a case that invokes Hadley v. Baxendale** – the storied British Court of Exchequer case published just three years after Moby-Dick (“Call me ‘Wikipedia’ guy?”) and is a stalwart of all first year Contracts courses across the land – the Seventh Circuit reversed a multi-million dollar judgment for a furniture maker.

The plaintiff in JMB Manufacturing, Inc. v. Child Craft, LLC, sued the defendant furniture manufacturer for failing to pay for about $90,000 worth of wood products it ordered.  The furniture maker in turn countersued for breach of contract and negligent misrepresentation versus the wood supplier and its President alleging that the defective wood products caused the furniture maker to go out of business – resulting in millions of dollars in damages.

The trial court entered a $2.7M money judgment for the furniture maker on its counterclaims after a bench trial.

The Seventh Circuit reversed the judgment for the counter-plaintiff based on Indiana’s economic loss rule.  

Indiana follows the economic loss doctrine which posits that “there is no liability in tort for pure economic loss caused unintentionally.”  Pure economic loss means monetary loss that is not accompanied with any property damage (to other property) or personal injury.  The rule is based on the principal that contract law is better suited than tort law to handle economic loss lawsuits.  The economic loss rule prevents a commercial party from recovering losses under a tort theory where the party could have protected itself from those losses by negotiating a contractual warranty or indemnification term.

Recognized exceptions to the economic loss rule in Indiana include claims for negligent misrepresentation, where there is no privity of contract between a plaintiff and defendant and where there is a special or fiduciary relationship between a plaintiff and defendant. 

The court focused on the negligent misrepresentation exception – which is bottomed on the principle that a plaintiff should be protected where it reasonably relies on advice provided by a defendant who is in the business of supplying information. (p. 17).

The furniture maker counter-plaintiff’s negligent misrepresentation claim versus the corporate president defendant failed based on the agent of a disclosed principal rule.  Since all statements concerning the moisture content of the wood imputed to the counter-defendant’s president were made in his capacity as an agent of the corporate plaintiff/counter-defendant, the negligent misrepresentation claim failed.

The court also declined to find that there was a special relationship between the parties that took this case outside the scope of the economic loss rule.  Under Indiana law, a garden-variety contractual relationship cannot be bootstrapped into a special relationship just because one side to the agreement has more formal training than the other in the contract’s subject matter.

Lastly, the court declined to find that the corporate officer defendant was in the business of providing information.  Any information supplied to the counter-plaintiff was ancillary to the main purpose of the contract – the supply of wood products.

In the end, the court found that the counter-plaintiff negotiated for protection against defective wood products by inserting a contract term entitling it to $30/hour in labor costs for re-working deficient products.  The court found that the counter-plaintiff’s damages should have been capped at the amount representing man hours expended in reconfiguring the damaged wood times $30/hour – an amount that totaled $11,000. (pp. 9-17, 24).

Take-aways:

1/ This case provides a good statement of the economic loss rule as well as its philosophical underpinnings.  It’s clear that where two commercially sophisticated parties are involved, the court will require them to bargain for advantageous contract terms that protect them from defective goods or other contingencies;

2/ Where a corporate officer acts unintentionally (i.e. is negligent only), his actions will not bind his corporate employer under the agent of a disclosed principal rule;

3/ A basic contractual relationship between two merchants won’t qualify as a “special relationship” that will take the contract outside the limits of Indiana’s economic loss rule.

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** Hadley v. Baxendale is the seminal breach of contract case that involves consequential damages.  The case stands for the proposition that the non-breaching party’s recoverable damages must be foreseeable (ex: if X fails to deliver widgets to Y and Y loses a $1M account as a result, X normally wouldn’t be responsible for the $1M loss (unless Y made it clear to X that if X breached, Y would lose the account, e.g.) [https://en.wikipedia.org/wiki/Hadley_v_Baxendale]