When it Smacks, it Cracks – Your Limitation of Liability Clause, That Is

I am sure you have seen this or a similar contract clause before:  

"The Company's liability for damages,  including incidental or consequential damages, is limited to the total compensation paid to the Company by Customer

In New York, it is perfectly fine to include such a clause in a contract among business people, with the effect that the Company would not be liable for damages above the amount of money that has been paid by the Customer.  So the clause basically says…"you can have your money back, but above that, don't look to us".  But there is an important exception to this contractual freedom.  Even if your contract has the above clause, you will not be excused for willful or grossly negligent acts, because doing so, says New York, would violate its public policy.  

So the question often is, what conduct or omission would rise to the level of willfulness or gross negligence and thus make the above clause useless?   New York Courts have said: "when conduct smacks of intentional wrongdoing and evinces a reckless indifference to the rights of others…."   

For illustration purposes, take this dispute recently decided in New York's highest Court (Abacus Fed. Sav. Bank v. ADT Sec.Serv. Inc., 2012 NY Slip Op 02120):

A Bank hired two security companies to install and operate various security shields, alarm systems and other gadgets to protect its safe deposit boxes inside its branch.  Burglars got in anyway and cleaned out the safety boxes.  The alarm systems did not even go off and nobody noticed until employees returned to the branch on Monday morning.  The Bank claims that the security companies installed crappy security systems, did not inspect the systems, knew for months that the systems were not working properly and failed to inform the bank of the malfunctioning systems.  Of course, the Bank sued.

In defense, the security companies held up their contracts with the Bank, which contracts both had clauses that excused the security companies from liability for their own negligence and limited their liability to $250.  One of the contracts also contained a clause that provided that the Bank was required to obtain insurance to cover theft and that in the event of theft, the Bank's only remedy was under that insurance, never against the security company.

Was the alleged conduct "smack of intentional wrongdoing"?  If so, the court should have thrown out the limitation of liability contract clause.  

The lower court and the Appellate Division (first appeal)  held that the allegations in the amended complaint amount to nothing more than claims of ordinary negligence as opposed to gross negligence.

New York's highest court (second appeal), however, disagreed and said that the conduct constitutes gross negligence. 

I kind of agree.   A company in the business of providing security systems KNOWS that the system installed does not work flawlessly, fails to fix it and fails to notify the affected customer – a Bank- for months….really?  

But the case had another twist.  Remember, one of the security companies also had a clause that required the Bank to get insurance and solely look to that insurance for remedying the theft losses.  

The court upheld the effectiveness of that clause and quoted its rule from a similar decision (Great Am. Ins. Co. of N.Y. v Simplexgrinnell LP) - "a distinction must be drawn between contractual provisions which exempt a party from liability and contractual provisions which in effect simply require one of the parties to the contract to provide insurance for all of the parties.  Thus, that security company got away with its grossly negligent conduct.  

The lesson being: If you really want the above clause to stick and have that kind of bargaining power with your counterparty, you have to add another provision requiring the counterparty to get insurance.    

About Imke Ratschko

Imke Ratschko is a New York Attorney helping small businesses, business owners and entrepreneurs with all things "Small Business Law," such as litigation, contracts, business owner disputes, shareholder and operating agreements, sale or purchase of a business, investors, and starting a business. You can reach her at 212.253.1027.

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