On December 15, 2014, the United States District Court for the Southern District of New York ruled in PNC Bank v. Wolters Kluwer Financial Services that defendant Wolters Kluwer Financial Services ("WKFS") was not liable for certain breach of contract damages relating to a malfunction in software WKFS had licensed to PNC Bank ("PNC"). In ruling on competing motions for partial summary judgment, the court found that such damages fell within the scope of a provision excluding liability for any consequential damages.
The case concerned an agreement under which WKFS licensed a computer system to PNC to manage the distribution of legally required disclosures to individuals who had applied for mortgages from PNC. Some time after PNC began using the system, it began receiving complaints from customers who received loan disclosure packages later than required by federal and state laws and regulations. PNC alleged that, due to a malfunction in WKFS's software, more than 10,000 loans had been similarly affected. PNC issued refunds of residential mortgage settlement costs to 2,038 customers and commissioned an investigative audit to determine how to respond to the disclosure deficiencies. The decision to take such remedial steps was unilaterally made by PNC.
The agreement at issue contained an indemnity pursuant to which WKFS would indemnify PNC for all costs arising from, among other things, a claim or demand brought against PNC by a third party for gross negligence or willful misconduct by WKFS. PNC claimed it was entitled to the indemnification, but the court dismissed any argument that the indemnification applied because no third party claim had been asserted.
The court then focused on PNC's damages claims which WKFS was attempting to limit with its summary judgment motion. Significantly, the agreement provided that:
"Neither party will be liable for any special, indirect, consequential or punitive damages, including but not limited to, lost profits arising out of or related to this agreement and the services and/or products supplied hereunder, even if the parties have knowledge of the possibility of such damages and whether or not such damages are for[e]seeable."
Recognizing that the foregoing waiver would exclude any claim of consequential damages, the parties argued over what amounts claimed by PNC constituted direct (i.e., general) damages versus consequential damages. PNC argued that the refund and audit expenses it incurred due to the malfunction were direct damages, as opposed to consequential damages, owed by WKFS under the terms of the agreement. According to PNC, its damages were a "natural and probable consequence" of WKFS's breach and thus recoverable as direct damages. PNC relied on the decision in Biotronik v. Conor Medsystems Ireland, in which the New York Court of Appeals held that the plaintiff's lost profits resulting from a breach were direct damages because they were "clearly contemplated" under the parties' agreement.
The court disagreed with PNC, finding that the WKFS license agreement was not like the agreement at issue inBiotronik and instead was "more closely akin to what the Court of Appeals called 'a simple resale contract, where one party buys a product at a set price to sell at whatever the market may bear.'" According to the court, PNC licensed software from WKFS to deliver documents to its customers, and PNC, on its own and without WKFS's input, charged its customers for this service, and further chose to refund customers certain fees and conduct an audit when a possible breach arose. No provision of the WKFS agreement required PNC to do so, and WKFS played no part in this decision. In contrast, in Biotronik, the lost profits claimed as direct damages were a specific element of the direct compensation between the parties under the agreement at issue in that case.
Under such circumstances, the court found that PNC's damages were not a "natural and probable consequence" of the alleged breach, but "instead a form of consequential damages, because [they were] one step removed from the naked performance promised by the defendant." The court further found that the distinction between direct and consequential damages did not turn on their foreseeability. Although PNC's damages were a potentially foreseeable result of the breach, foreseeability is only relevant where it is intended to limit the extent to which consequential damages may be available. In this case, the agreement expressly excluded consequential damages "even if the parties have knowledge of the possibility of such damages and whether or not such damages are for[e]seeable." The court then ruled that these alleged damages were excluded.
The court questioned why PNC had not sought to recover its direct damages, which would have been equal to the amounts directly paid by PNC to WKFS for the allegedly malfunctioning system. Recognizing that this was likely the only form of general damages recoverable, PNC had moved to amend its claims to include such general damages. The court, in its discretion, ultimately granted PNC's request and provided WKFS additional discovery.
This decision has important implications for the drafting of consequential damages provisions, whether in technology contracts or other supply, services or license type contracts. Under the principles of PNC Bank, in determining whether a party's damages are direct or consequential, a court may consider such factors as (1) whether the defendant was involved in any decisions by the plaintiff to incur the costs subsequent to the breach, (2) whether the agreement required the plaintiff to make such decisions, (3) whether the compensation components of the agreement provide clear guidance as to amounts that would be direct damages, and (4) whether the agreement provides any guidance on the scope of permissible consequential damages (e.g., foreseeable damages). Where a possible breach has occurred, the non-breaching party should consider these factors in determining the actions it may take and what damages it may reasonably expect to recover.
In negotiating new contracts, if there are foreseeable damages, such as those in the PNC Bank case, regardless of whether they might be deemed direct or consequential damages under applicable law, a licensee/recipient should openly discuss such categories of damages with the licensor/provider and make clear determinations in their agreements as to the financial arrangement upon occurrence of such events. The PNC Bank decision makes clear that a licensor/provider type party can significantly benefit from avoiding the foregoing discussion in negotiations and obtaining a general waiver of consequential damages.