Many acquisition agreements contain boilerplate excluding recovery for punitive, special and consequential damages. The clause may also include “lost profits” as an example of “consequential damages” or sometimes as a separate item that is excluded from recovery. The parties should pay attention to this boilerplate to avoid the unintended result that lost profits are not recoverable even if such lost profits are a direct result of the transaction contemplated by the acquisition agreement.

The boilerplate clause emanates from the English case of Hadley v. Baxendale, 9 Exch. 341 (1854), which established the general rule that recoverable losses for a breach of contract are limited to those directly arising from the breach or arising from special circumstances of which the breaching party had knowledge when the contract was made. A party damaged by a breach may, however, contractually waive these damages.

The exclusion of lost profits from recoverable damages is often provided for in the acquisition agreement as an example (or subset) of consequential damages. Consequential damages are one of the more common types of damages that are explicitly excluded from recovery in acquisition agreements. According to the 2013 Private Target M&A Deal Points Study published by the Mergers & Acquisitions Committee of the American Bar Association, more than half of the acquisition agreements surveyed contained a provision expressly excluding consequential damages as a recoverable damage. While the survey did not include lost profits as a separate type of damage or indicate whether the agreements that excluded consequential damages may have included lost profits as an example of consequential damages, care must be given to any waiver of lost profits.

For acquisition agreements governed by New York law, New York courts have respected the parties’ ability to limit potential liabilities in a contract and have enforced provisions that expressly exclude lost profits. For example, in Great Earth International Franchising Corp. v. Milks Development, 311 F.Supp.2d 419 (S.D.N.Y. 2004), the court found that a clause limiting liability for lost profits or for consequential damages precluded the buyer from all claims of lost profits, even though the lost profit damages at issue may have been considered “general damages” directly resulting from the transaction.

The boilerplate waiver may take several forms. Lost profits may be included as an example of consequential damages. For example, the provision might state “in no event shall any indemnifying party be liable to any indemnified party for any consequential damages, including loss of future revenue or income.” In this first formulation, lost profits are a subset of consequential damages. In the following second formulation, “in no event shall any indemnifying party be liable to any indemnified party for any consequential damages or loss of future revenue or income,” lost profits are a separate class of damages in addition to consequential damages and not merely just a subset of consequential damages.

Although there may only be minor language differences, widely different, and at times unintended, consequences may result from either formulation. For the first formulation where lost profits are a subset of consequential damages, courts would likely find that lost profits should be waived only if the lost profits are found to be consequential damages and not general damages. In the case of the second formulation where lost profits are a separate class of damages, courts would likely disallow recovery for lost profits in any situation. Where the provision is silent on lost profits, lost profits would presumably only be disallowed if found to be consequential damages and not general damages.

The first formulation may not effect the parties’ intent if they actually desire to exclude recovery for lost profits in any situation. While lost profits are generally considered consequential damages, this is not always the case. There are times when lost profits may be considered “general” or “direct” damages. While consequential damages have not been precisely defined with respect to acquisition agreements, courts have analyzed in other contexts when lost profits might be general damages and not consequential damages. For example, the court in Tractebel Energy Marketing, Inc. v. AEP Power Marketing, Inc., 487 F.3d 89 (2d Cir. 2007) (holding that the lost profits claimed were general damages and not consequential damages as the lower court had concluded) 1 described the distinction between lost profits as consequential damages and lost profits as general damages as follows:

Lost profits are consequential damages when, as a result of the breach, the non-breaching party suffers loss of profits on collateral business arrangements. In the typical case, the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transactions, is contingent on the performance of the primary contract. When the breaching party does not perform, the non-breaching party’s business is in some way hindered, and the profits from potential collateral exchanges are “lost.”…

By contrast, when the non-breaching party seeks only to recover money that the breaching party agreed to pay under the contract, the damages sought are general damages. The damages may still be characterized as lost profits since, had the contract been performed, the non-breaching party would have profited to the extent that his cost of performance was less than the total value of the breaching party’s promised payments. But, in this case, the lost profits are the direct and probable consequence of the breach. The profits are precisely what the non-breaching party bargained for, and only an award of damages equal to lost profits will put the non-breaching party in the same position he would have occupied had the contract been performed.

Whether lost profits are considered consequential damages or general damages is thus signifi- cant since, if using the first formulation of the waiver described above, such lost profits would likely be recoverable as general damages. This would be the case even though the parties may have intended to exclude recovery for all lost profits, no matter the situation.

Unintended consequences may also arise from the second formulation of the lost profits waiver provision described above. Where lost profits are waived as a separate class of damages, courts will likely disallow recovery for lost profits in any situation, even in cases where the lost profits are considered general damages directly relating to the transaction contemplated by the acquisition agreement. For example, a seller may represent and warrant in the acquisition agreement that a particularly lucrative contract of the target company is valid and enforceable. If the seller has breached this representation and the contract is in fact terminated or otherwise unenforceable, the buyer may be surprised to find that the lost profits stemming from the unenforceable contract (which contract may have formed the primary basis of the buyer for consummating the transaction) is not recoverable since all lost profits have been waived. This potential outcome may result even though the lost profits may be found to be general damages directly related to the acquisition agreement which the buyer had specifically bargained for. Due to the language of the provision, the buyer may be precluded from any claim for lost profits.

In a recent case that may expand the circumstances when lost profits are considered general damages, Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 2014 WL 1237514 (N.Y. March 27, 2014), the New York Court of Appeals, in a split decision, reversed the lower court and held that the lost profits at issue were general, and not consequential, damages and were thus not barred by the consequential damages waiver in the contract, despite the fact that the claimed lost profits related to the resale of the defendant’s product by the plaintiff to third parties. The court noted that prior decisions on whether lost profits were consequential or general damages focused on the distinction between “whether the lost profits flowed directly from the contract itself or were, instead, the result of a separate agreement with a nonparty.” However, the court stated that “[t]his distinction does not mean that lost resale profits can never be general damages simply because they involve a third party transaction. Such a bright line rule violates the case-specific approach we have used to distinguish general damages from consequential damages.” In analyzing the facts, the court noted that the contract used the plaintiff’s resale price as a benchmark for the price to be paid to the defendant and although not specifically identified in the agreement, the lost profits from resale can be seen to flow directly from the pricing formula. Thus, the court held that “any lost profits resulting from a breach would be the ‘natural and probable consequence’ of that breach.” In New York, courts will thus take a careful look at the underlying agreement and facts and circumstances surrounding the transaction in determining whether lost profits are general or consequential damages.

The parties to an acquisition agreement should carefully consider the implications of including any boilerplate “lost profits” waiver. If lost profits directly result from the transaction and represent the “benefit of the bargain,” New York courts may find such lost profits to be general damages and not consequential damages. If the provision only excludes lost profits as a subset of consequential damages, such lost profits may thus be recoverable as general damages. Conversely, if the lost profits waiver provision specifically excludes lost profits as a separate class of damages, then the provision may have the effect of precluding damages that are directly related to the transaction. In both cases, the outcome may be unintended. Upon careful consideration, the parties may even determine that a lost profits waiver is not needed as the seller’s concerns may be alternatively addressed through other means, such as through indemnity caps or deductibles.