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.