On March 27, 2014, the New York Court of Appeals held that a provision excluding both parties' liability for consequential damages would not preclude recovery of lost profits that the court found were the direct and probable result of a breach of the parties' exclusive distribution agreement.
Biotronik A.G. ("Biotronik") and Conor Medsystems Ireland Ltd. ("Conor") entered into an exclusive distribution agreement in 2004, pursuant to which Biotronik agreed to be the exclusive distributor of CoStar, Conor's drug-eluting coronary stent, to end users and resellers in a specified territory. The agreement required Biotronik to pay to Conor (for each calendar quarter during the term of the agreement) the higher of an agreed upon “minimum transfer price" per unit of CoStar shipped to Biotronik, or a fixed percentage of Biotronik's average net sales of CoStar. Biotronik retained as profits from its CoStar sales any amounts earned above the agreed upon price, but if Biotronik sold zero CoStar units in a particular calendar quarter, Biotronik would still be required to pay the minimum transfer price to Conor. The agreement included a provision excluding both parties' liability for “any indirect, special, consequential, incidental or punitive damage with respect to any claim arising out of [the] agreement" for any reason, including a party's performance or breach of the agreement.
In May 2007, Conor notified Biotronik that it was recalling CoStar and taking it off the market because FDA trials failed to establish that CoStar was equivalent to another widely-manufactured stent. Conor gave timely notice that it intended not to renew the contract beyond the initial term and reimbursed Biotronik for its costs and expenses associated with the CoStar recall in accordance with the contract's terms. Biotronik sued Conor for breach of contract and sought as general damages (not barred by the limitation of liability provision) the lost profits that Biotronik claimed it would have made reselling CoStar. The trial court held that the lost profits sought by Biotronik were unrecoverable consequential damages barred by the contract's limitation of liability provision, and the Appellate Division affirmed.
The New York Court of Appeals, the highest court within the State of New York, reversed in a 4-3 decision, holding that the lost profits sought by Biotronik were the "direct and probable result of the breach of the parties' agreement and thus constitute general damages." Because the contract did not specifically preclude recovery of lost profits or characterize lost profits as consequential damages, the court evaluated lost profits based on general contract principles. The court noted that damages must be assessed in the context of the agreement because lost profits may be direct or consequential damages, "depending on whether the non-breaching party bargained for such profits and they are the 'direct and immediate fruits of the contract.'" The court reviewed previous decisions and found that "[t]he distinction at the heart of these cases is whether the lost profits flowed directly from the contract itself" or would have been earned pursuant to a separate agreement with a third party. The court found that, because the contract used Biotronik's resale price of the CoStar product as a benchmark for computing Biotronik's payments to Conor, the "very essence" of the agreement was that Biotronik would resell Conors stents, distinguishing this matter from a situation where the buyer's resale to third parties is independent of the contract. The court found that both parties' profits flowed directly from the pricing formula and were dependent on the resale of CoStar, such that any lost profits resulting from a breach would be the natural and probable consequence of that breach.
The dissent noted that the agreement addressed complicated matters including discontinuance of manufacturing and product recalls, as well as limitations of liability, and criticized the majority for allowing Biotronik to circumvent the natural meaning of the agreed upon liability limitations. The dissent disagreed that the contract dictated resale prices for CoStar or required Biotronik to resell CoStar units in order for Conor to be paid, noting that Biotronik was obligated to make minimum quarterly payments even if no units were sold during that quarter. The dissent distinguished the pricing mechanisms in this matter from past cases where lost profits were held to be general damages based on contracts that specifically required the breaching party to pay the non-breaching party specified sums comprising the non-breaching party's future profits. The dissent found, instead, that the damages in this case "flow from collateral transactions – Biotronik's contracts with its resale customers – rather than from any provision of the [a]greement requiring the breaching party to make a payment to the non-breaching party." The dissent also found that past precedent dictated that "profits a non-breaching party loses on third-party transactions are consequential rather than general damages even though ‘the ability of the non-breaching party to . . . generate profits on [these] collateral transactions, is contingent on the performance of the primary contract.'"
This case highlights the importance of specifically identifying lost profits in contractual limitation of liability provisions and not just relying on a general reference excluding consequential damages. The need to specifically exclude lost profits is further highlighted in supply and distribution arrangements, particularly where financial models and compensation provisions expressly reference downstream transactions. According to the majority in Biotronik, these types of provisions essentially bring third party transactions within the scope of an agreement and allow for an argument that lost profits were a foreseeable form of general damages. Companies with contracts governed by New York law should review their existing contracts and ensure that all future contracts specifically exclude lost profits in any clause purporting to limit a party's liability for lost profits type consequential damages. This is an easy drafting tip that could help avoid costly litigation in the future.