Contract negotiations involving limitations on liability and disclaimers of damages for breach of contract and tort claims can have significant ramifications for the contracting parties if the business relationship falls apart and litigation results. Under New York law, how the parties negotiate the allocation of risk of loss is enormously important.
This lesson was brought home in a noteworthy New York Court of Appeals decision in Abacus Federal Savings Bank v. ADT Security Services, Inc. et al., 18 N.Y.3d 675, 944 N.Y.S.2d 443 (N.Y. 2012). In that case, Abacus Federal Savings Bank (“Abacus”) brought an action against two firms that provide security services, ADT Security Services (“ADT”) and Diebold, Inc. (“Diebold”) to recover damages under tort and contract theories for losses incurred during a burglary at the bank.
Prior to the burglary, ADT contracted with Abacus to install and maintain a 24 hour industry-certified central security station to protect the branch premises and the vault. The ADT system was replete with motion and smoke detectors, and an alarm system. Abacus contracted with Diebold to provide a backup alarm system that included central system monitoring and “signal monitoring” which would activate an alarm if ADT’s alarm system failed to operate. The gravamen of plaintiff’s complaint was that neither security system worked appropriately during a burglary.
To cut to the chase, the Court of Appeals upheld the dismissal of all of plaintiff’s claims against Diebold, but permitted plaintiff’s breach of contract claim against ADT to proceed. Why was one defendant successful and the other not?
A good analysis of the case is contained in an article titled, “Think Twice About that Liability Disclaimer Carveout,” authored by Adam Chernichaw and Caitlin Johnston of White & Case, which appeared in Law360 on December 19, 2013.
Chernichaw and Johnston observe that the contracts between Abacus and ADT, and between Abacus and Diebold, both limited each security company’s liability to $250. However, the Abacus-Diebold contract expressly required Abacus to ensure against losses in the event of theft and to “look solely to its insurer for recovery of its loss… [and waive] any and all claims for such loss against Diebold.” The contract further required Abacus to obtain a policy that expressly allowed such a waiver. In contrast, the Abacus-ADT contract stated only that “insurance, if any, covering [loss] was Abacus’ responsibility.”
Chernichaw and Johnston note that, citing a public policy exception, the court allowed Abacus to proceed in its case for damages based on allegations of ADT’s gross negligence despite the contract’s limitation of liability. With respect to Abacus’ claims against Diebold, however, the Court of Appeals upheld the granting of Diebold’s motion to dismiss.
The key distinction made by the court was that one contract provision sought to exculpate the defendant from liability but that the other “simply require[d] one of the parties… to provide insurance for all of the parties.” The latter provision withstands even allegations of gross negligence. Thus, the Abacus-Diebold contract was clearly more effective in shielding Diebold for liability for its own gross negligence.
What is the takeaway for lawyers negotiating contractual limitations of liability? New York courts will generally allow a party to insulate itself from liability resulting from its own negligence by way of an exculpatory clause. Similarly, a party may protect itself by limited liability to a nominal sum. However, the same is not true for exculpatory clauses that seek to prevent the imposition of damages for “grossly negligent conduct.” Additionally, liquidated damages provisions are not enforceable against allegations of gross negligence.
In contrast to an exculpatory clause, indemnification provisions are unenforceable on public policy grounds only “to the extent that they purport to indemnify a party for damages flowing from the intentional causation of injury.”
Lawyers drafting their clients' complaints in these cases should be mindful that the court will closely examine whether the facts alleged in the pleading support an assertion of gross negligence as opposed to garden variety negligence. It is not sufficient to merely allege gross neglience and hope to escape the effect of an exculpatory clause in the client's contract with the defendant. In Abacus, the court found sufficient evidence of gross negligence in the bank's allegation that defendants had been aware for months prior to the burglary that the securitiy system had been malfunctioning and had neither investigated the reason for the malfunction nor placed the bank of notice of a problem.