Managing disputes in Canada and the U.S.: Limitations of liability clauses

Andrew Bernstein (00:05): So, you just bought a manufacturing plant. And of course, you received representations and warranties that the building is in good condition and that the company is entitled to legally operate. And of course, the sellers brought down those representations and warranties at closing. You close the deal. You walk over to the plant, and you walk in the door.

Here's what you see: The walls are falling down. The floor is subsiding. The machinery is all piled into a corner. And there's a big hole in the middle of the floor. What can you do? I'm Andrew Bernstein of Torys’ litigation group here in Toronto, and I'm here with my partner, Erica Goldman, who practices litigation at Torys New York. And we're going to discuss the limitation of liability clauses.

Erica, I would say there's one thing I get asked about from our corporate colleagues more often than any other.

Erica Goldman (00:48): Is it why do litigators have an end of the year karaoke party that they aren't invited to?

Andrew Bernstein (00:54): Okay. There's a question that I get asked about by our corporate colleagues, the second most from any other.

Erica Goldman (01:01): Can we talk about the karaoke question, though?

Andrew Bernstein (01:03): Okay, yes. So, the answer to the karaoke question is: we're more fun and we're better singers. But let's turn to the subject at hand. You've walked into your manufacturing plant that you just bought, and things are not good.

Erica Goldman (01:15): It really doesn't sound good.

Andrew Bernstein (01:16): Right. And unfortunately, it gets worse because at that very minute, an environmental inspector walks in and says, “Are you the owner of this facility?” And you say, “Yes, I am the owner of this facility.” And the inspector says, “Well, I deemed it unsafe for work a week ago, so why are there still employees hanging out here?”

Erica Goldman (01:37): So, let me guess. You're going to shut the plant down.

Andrew Bernstein (01:39): You have to shut the plant down.

Erica Goldman (01:41): And make repairs.

Andrew Bernstein (01:42): You're going to make repairs. And the worst part is this. Let's say you use that plant to make cornmeal and the business you just bought also takes that cornmeal and makes it into cornbread and you can't find another source of cornmeal that quickly. So you have to shut your cornbread plant, too.

Erica Goldman (01:59): And so, you're losing revenue.

Andrew Bernstein (02:00): You're losing revenue. You bet.

Erica Goldman (02:01): And what else?

Andrew Bernstein (02:02): Well, you've got to fix the hole and you've got to rearrange the machinery and you've got to try and get an inspection. Since your cornmeal and cornbread customers are mad that you're not delivering. And then, in case things weren't going badly enough, your new bank calls and complains that you are offside your debt covenants because you are borrowing new money to pay for repairs.

But you say, Don't worry, I've got an indemnity clause against the seller that says that they will be liable for direct damages, although not indirect, consequential, special, incidental, punitive or exemplary damages.

Erica Goldman (02:33): And what does that say about lost profits?

Andrew Bernstein (02:35): Oh, of course. The clause says there can be no award of lost profits unless those lost profits are direct damages. So, let's talk about what all of that means. Erica, I'm going to ask you some questions about the damages that this company has suffered. And I want to understand whether you think the company would be entitled to them. So, the cost to repair the hole in the floor. Is that in or out?

Erica Goldman (02:56): That's in.

Andrew Bernstein (02:56): Okay. And what about the lost revenue because the cornmeal plant shut down. In or out?

Erica Goldman (03:02): Also in, because these would be considered direct damages given that the company operates a cornmeal plant.

Andrew Bernstein (03:08): And what about the lost sales of cornbread you were going to make from the cornmeal?

Erica Goldman (03:12): A little trickier. So, these would be consequential damages and generally recovery would turn on whether the lost cornbread sales were foreseeable by the seller. Put differently, did the parties contemplate cornbread sales? Did the seller have a reason to know before entering the agreement that the company intended to make and sell cornbread? Regardless, the limitation of liability clause here would probably bar recovery.

Andrew Bernstein (03:36): Because there are consequential damages.

Erica Goldman (03:38): Correct.

Andrew Bernstein (03:38): Okay. So, what about the lost profits in the corn meal plant?

Erica Goldman (03:44): So, in our scenario, they're in, but only if they constitute direct damages. Because of the loss of cornbread sales are consequential and therefore unrecoverable, so too are the lost profits under our limitation of liability clause here.

Andrew Bernstein (03:58): Now, this company, this owner is a responsible owner, and it says, “Well, I've got to mitigate my damages.” So it mitigates its damages by, among other things, getting a new inspection to get the no work order lifted. That, of course, costs $1,000. Is that in or out?

Erica Goldman (04:17): Out! The inspection cost, as you mentioned, is really just loss mitigation. And so, it's likely viewed as incidental damages which are unrecoverable here.

Andrew Bernstein (04:24): And I would just say that one of the things that people are constantly surprised by is that incidental damages are the cost of mitigation, and under a standard limitation of liability clause, they're not going to be recoverable. So, let's talk about the last thing. The bank has now called the loan because the company was offside its covenant. The company refinances better at a higher rate. Can it collect the difference back from its seller?

Erica Goldman (04:49): Probably not. The damage is pretty attenuated. It's neither direct nor foreseeable by the parties. Andrew, would any of these answers have been different under Canadian law?

Andrew Bernstein (04:59): So, I don't think so. I think that if we were given those scenarios and asked, we would give it the same ins and outs that you gave. I would say that under Canadian law, what exactly constitutes consequential damages is, or at least can be, the subject of some ambiguity. And so, it's hard to give advice that's too definitive about what's in and what's out.

But subject to that, I think my answers would have been really the same as yours. Erica, do you have any takeaways here for our clients?

Erica Goldman (05:29): I would say avoid boilerplate. It can lead you astray. So, limitation of liability clauses are not one size fits all. Tailor your clause according to the context, the specific circumstances of that agreement. Relatedly, think about the types of losses that you are excluding and whether there are industry-specific special circumstances to account for. Finally, failing to specify the excluded types of damages can create confusion and litigation.

The business you just bought has unforeseen problems. Can you hold the seller liable? Toronto partner Andrew Bernstein and New York partner Erica Goldman discuss limitations of liability and how distinctions between types of damages—and what you set out in your contract—will determine whether damages a buyer suffers are recoverable from a seller.

Watch more of our Managing Disputes in Canada and the U.S. series.

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This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

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