edward x. clinton, jr. presentation on managing liability through contract provisions

5/28/2018 Edward X. Clinton, Jr. Presentation on Managing Liability Through Contract Provisions

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Edward X. Clinton, Jr.

The Clinton Law Firm


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Ed, I want to go into this new business, but Iam worried that something could go wrong, orthat I will get sued.


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! If you do anything in America enough timesor sell anything, you are almost certain to getsued. We may be able to limit the exposures

and protect you and your company fromsome types of claims.


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! Limit your clients liability in contracts.! Understand the tools that lawyers use or

should use to limit and/or manage suchliability.

! Four main areas of this discussion:! Limitations of Liability! Waiver of consequential damages! Liquidated damages and penalty clauses! Indemnities


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! Often the various types of clauses are usedtogether in the same contract.

! Example: Often times a limitation of liabilityclause will also have a waiver ofconsequential damages clauses and aliquidated damages provision.

! As we shall discuss later on, this is a goodthing.


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! Rule:! In keeping with the principle of freedom of

contract, contractual limitations are generally heldvalid in this State,unless it would be against thesettled public policy of the State to do so, or thereis something in the social relationship of the partiesto the contract militating against upholding theagreementIn the absence of a legislative directiveto the contrary, exculpatory provisions must be

deemed valid and enforceable.

! River North Ins. v. James O. Jones, 655 N.E.2d 987, Ill.App. 3d 175 (1s Dist. 1997).


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! What does this mean?! Our great state prohibits certain parties from

limiting their liability for negligence, such as:

! Inkeeper! Landlord

! These prohibitions are located in the Illinoisstatutes.


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! The North River Insurance case:! A dispute between insurance companies and

Holmes Protection of Illinois. Holmes was an alarmcompany. It built and designed a fire alarm

system, which was installed in a building.! Two years later, the building burned down.

! The insurance companies sued Holmes, who reliedon its limitation of liability clause in its contract.

! The clause is lengthy but the first sentence or twoare really important:


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! Purchaser acknowledges that Holmes is notan insurer; that insurance shall be obtainedby Purchaser, if any is desired; that the sum

payable hereunder to Holmes by Purchaserare based upon the value of services offeredand the scope of liability undertaken, andsuch sums are not related to the value of theproperty belonging to the Purchaser


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! So, Holmes is telling the owner of the building,We are not in the insurance business, we are inthe alarm business.

!The clause is particularly well-drafted because itlimits liability, prohibits consequential damagesand provides a liquidated damages clause andmost importantly the clause explains to theCourt why its a terrible idea to impose liabilityon the alarm company.

! The Court then understands why liability is beinglimited and, accordingly, enforces the provision.


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! Hopefully, anyone reading the contract canunderstand why the alarm company insertedthat provision- because it is not an insurance

company and it is not paid nearly enough topay that loss.

! Caveat: Remember, the contract clauselimiting liability will not apply to a third party.

!Thus, if the client causes an injury to a thirdparty, the clause is of no value at all.


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! Consequential and special damages aredamages that are the consequence of specialor unusual circumstances which are in the

reasonable contemplation of the parties whenmaking the contract.

! See Hanumadass v. Coffield, Ungaretti & Harris, 311Ill. App. 3d 94, 724 N.E.2d 14, 18 (1st Dist. 1999).


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!Consequential damages arescary.


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! They keep contract lawyers awake at nightbecause the damage award can be enormous.

! The most scary form of consequentialdamages is lost profits.


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! Lost profits can be recovered when:(a) The plaintiff can prove the damages to a

reasonable degree of certainty;

(b) The plaintiff can prove that the breach directlycaused the damages;

(c) The plaintiff can prove that the lost profits werewithin the reasonable contemplation of theparties.


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! Obviously, many contracts include a waiver ofconsequential damages.

! All software contracts include such a waiverbecause software can malfunction or crashand damage can be caused when that occurs.


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! An example from the Itunes license agreement:IN NO CASE SHALL APPLE, ITS DIRECTORS, OFFICERS, EMPLOYEES,AFFILIATES, AGENTS, CONTRACTORS, PRINCIPALS, OR LICENSORS BELIABLE FOR ANYDIRECT INDIRECT INCIDENTAL PUNITIVE SPECIALOR CONSEQUENTIAL DAMAGESARISING FROM YOUR USE OF ANY OFTHE SERVICES OR FOR ANY OTHER CLAIM RELATED IN ANY WAY TO

YOUR USE OF THE SERVICES, INCLUDING, BUT NOT LIMITED TO, ANYERRORS OR OMISSIONS IN ANY CONTENT, OR ANY LOSS ORDAMAGE OF ANY KIND INCURRED AS A RESULT OF THE USE OF ANYCONTENT (OR PRODUCT) POSTED, TRANSMITTED, OR OTHERWISEMADE AVAILABLE VIA THE SERVICES, EVEN IF ADVISED OF THEIRPOSSIBILITY. BECAUSE SOME STATES OR JURISDICTIONS DO NOTALLOW THE EXCLUSION OR THE LIMITATION OF LIABILITY FORCONSEQUENTIAL OR INCIDENTAL DAMAGES, IN SUCH STATES OR

JURISDICTIONS, APPLES LIABILITY SHALL BE LIMITED TO THEEXTENT PERMITTED BY LAW.


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Similar waivers of consequential damages areincluded in almost every software or servicescontract. Software companies know that almost

anything can go wrong with software programs andthe liability could be disastrous.


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! The most important requirement is that thepurchaser of the goods had the ability to reviewthe waiver of consequential damages beforepurchasing the goods. See Converting Systems,Inc. v. Hot-Line Freight System, Inc., 344 Ill. App.3d 1037, 801 N.E.2d 155 (1st Dist. 2003); Mageev. Walbro, 525 N.E.2d 975 (1988)(in bailmentcase, the limitation of liability was ineffective

where the customer had no knowledge of theterm before agreeing to store her fur coat withthe defendant.)


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! Razor v. Hyundai Motor America, 854 N.E.2d607 (2006). Plaintiff purchased a Hyundai andsued alleging that the car was defective andsought modest damages: (a) $5,000 in

diminution of value; and (b) $3,500 inconsequential damages. Hyundai refused tosettle this small case and managed to harmthe business community in doing so.

!The Illinois Supreme Court held that theconsequential damages waiver wasunconscionable.


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! The decisive fact for the Court, however, wasthe lack of evidence that the warranty, whichcontained the disclaimer of consequential

damages, had been made available to theplaintiff on or before the time she signed thecontract. 854 N.E.2d at 623.

! Hyundais argument that the limitation wasprinted in capital letters and was written inplain English did not sway the Court.


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! Thus, make sure your clients understand thatany waiver of consequential damages isprovided to the customer before the item is

purchased or the goods are delivered.


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! Brief Detour to the law of Software Contracts!! Here we are going to discuss an old case, ProCD v.

Zeidenberg, 86 F.3d 1447 (7thCir. 1996) where the

Seventh Circuit held that a license agreement onshrink-wrap was valid binding and enforceable. Thecustomer had the opportunity to read the license anddecline to buy the product.

!! Move forward a few years Now no one uses shrink-

wrap. Instead, you have to click on the license beforeyou use the software. If you dont click you do not getto use the product.


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! Sometimes your client will ask or express theconcern that a contract could be terminatedsooner than the client anticipates and that theclient will thereby incur a substantial loss.

! Example: A client agrees to open a new locationor make modifications to real estate, only to findout that the other party terminates the contractshortly after the relationship begins.

! One approach the lawyer may take is to add aliquidated damages provision to the contract thatwill, in theory, make the client whole, or limit theclients loss, if things do not go as planned.


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! This is a difficult area of the law, an area that hasproduced numerous contradictory decisions overtime.

! In 1917, the Illinois Supreme Court said: Thiscourt has said more than once that no branch ofthe law is involved in more obscurity bycontradictory decisions than whether a sumspecified in an agreement to secure performancewill be treated as a liquidated damages or a

penalty and that each case must depend on itsown peculiar and attendant circumstancesGiesecke v. Cullerton, 280 Ill. 510, 513 (1917).


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! Risk No. 1: Liquidated damages clauses aresubject to scrutiny in Illinois.


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! Illinois courts will attempt to determine if theliquidated damages clause is a penalty or aliquidated damages clause.! If the clause is deemed a penalty, it is void and

unenforceable.! If the clause is one for liquidated damages, it isenforceable.

! Remember: The determination of whether acontractual provision for damages is a validliquidated damages provision or a penalty clause isa question of law. Grossinger Motorcorp, Inc. v.

American National Bank & Trust Co., 240 Ill. App.3d 737, 749, 607 N.E.2d133 (1992).


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! The test:! A liquidated damages clause is valid and enforceable

when all three factors are present:

(1) The parties intended to agree in advance to thesettlement of damages that might arise from thebreach;

(2) The amount of liquidated damages was reasonable atthe time of contracting, bearing some relation to thedamages which might be sustained; and

(3)

Actual damages would be uncertain in amount anddifficult to prove.

See Grossinger, 240 Ill. App. 3d at 749; See also theRestatement of Contracts (Second) Section 356(1).


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! Caveat: The damages must be a specifiedamount for a specific breach, not a penalty topunish for nonperformance or as a means tosecure performance. See Grossinger, 240 Ill.

App. 3d at 750.

! Risk No. 2: If you are too greedy, your clause willnot be enforceable.


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! An example of a poorly drafted clause inan employment contract:Early Termination. The parties hereto agree that, in theevent that [defendant] terminates this Agreement prior to

the completion of the Subsequent Term, [plaintiff] shall beentitled to receive from [defendant] an amount whichcompensates [plaintiff] for the cost of training. Upon theexecution of this Agreement, [defendant] shall executeand deliver to [plaintiff] a promissory notein theprincipal amount of Fifty Thousand Dollars ($50,000).The Note shall provide that the principal amountwill bereduced by $2,083.33 per month for each of the twenty-four (24) months of theTerm of this Agreement.


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! Holding:! The clause was a penalty because it bore no relation

to the actual training costs. Indeed, the award wasinversely related to the amount of training costs.

! If the employee quit the first day (when minimaltraining costs had been incurred), he would beliable for $50,000.

! However, if the employee quit on the last day, hewould owe $2,083.33, after two years of training.


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! Risk No. 3: Illinois law does not permit theuse of an optional liquidated damages clause.

! Example: If buyer breaches the contract,buyer agrees to forfeit the earnest money, or,at the option of the seller, pay sellers actualdamages.

! To paraphrase a Florida court, you cannothave your cake and eat it too.


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! Illinois courts reject such liquidated damages clauses that giveone party the option to accept the liquidated damages amount ortake its remedy.

! As on court notes, this scheme distorts the very essence ofliquidated damages, which in effect is to provide the parties with

a pre-ordained settlement of the damage sum when actualdamages would otherwise be difficult to determine. CatholicCharities v. Thorpe, 318 Ill. App. 3d 304, 741 N.E.2d 651 (Ill.App. 1st Dist. 2000).

! In most cases, courts do not get involved in the nittygritty of contract provisions. They are reluctant to

rewrite contracts.

! In this area, however, courts frequently rewritecontracts by eliminating the liquidated damages

clause.


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! Warnock v. Patterson, (1stDist. 2007). TheFirst district recognized a cause of actionagainst a lawyer who included a liquidated

damages clause and an actual damagesclause in a real estate contract. The plaintifflost the ability to take the earnest moneybecause of the lawyers error.

!


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! Many commentators have criticized theliquidated damages/penalty cases on thegrounds that:

! (a) The cases demonstrate extraordinary judicialmanagement of the bargains of private parties,even where each side had a lawyer;

! (b) Even small dollar value liquidated damagesprovisions are often scrutinized;

! (c) For those who are litigators, consider a frontalattack on these cases argue that the cases areinconsistent with basic principles of freedom ofcontract.


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! Penalty clauses are bad because they hinderefficient breach. Here I quote Blacks LawDictionary: efficient breach theory is "the viewthat a party should be allowed to breach a

contract and pay damages, if doing so would bemore economically efficient than performingunder the contract." Breaching a contract is notwrong or bad and it should not be punished. So

its not wrong to breach and liquidated damagesclauses that have onerous penalties should besubject to judicial review.


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! No one should ever rely on a liquidateddamages provision and believe that the clientis protected Courts too often decide that

their ideas of what is right and wrong arebinding even though the parties agreedotherwise.

! One area where liquidated damages clauseshave had some success is in the defense ofclaims.


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! Instead of using the liquidated damages clauseas a remedy, use it as a fallback defense.

! Our example is a client in the environmentalconsulting business.

!Limitation of Liability: Buyer agrees that Clientshall not be liable for consequential damages,pain and suffering damages or lost profits.

! Buyer agrees to limit Clients liability to Buyerand anyone allegedly relying on Clients servicesto a sum not to exceed Clients fees for the

services performed on the project, provided thatsuch claims are not attributable to Clients grossnegligence of willful and wanton conduct.


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! The addition of a liquidated damagesprovision (Buyer agrees to limit Clientsliability a sum not to exceed Clients fees)

gives the Client a second defense to alawsuit.

! The lawyer drafting this clause has added amoat inside the wall of the castle.


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! Illinois enforces contract of indemnificationand the courts construe them to give effectto the intention of the parties.

! With respect to construction contracts, theLegislature has barred the parties to thosecontracts from any provision indemnifying aparty for its own negligence. 740 ILCS 35/1

! However, in all other contexts, you canenter into a contract that indemnifies youfor your own negligence.


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! Illinois courts prohibit agreements toindemnify an individual for willful misconductbecause such an agreement is against public

policy. Wright v. City of Danville, 174 Ill.2d391 (1996).


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! One area that I have been involved in manytimes as a litigator is litigation arising out ofthe sale of a business.

!When the business is sold, the Buyer willrequest that the agreement contain certainrepresentations and warranties.

! Those representations and warranties are thefuel for future litigation brought by the Buyeragainst your client, the Seller.


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! The books and accounting records of ACMEcompany have been prepared in accordance withgenerally accepted accounting principles, orGAAP.

!! ACME is compliance with all laws and

regulations of the State of Illinois.!! Another provision of the Agreement will state

that:!! Seller agrees to indemnify Buyer if any of the

representations shall prove to be false.


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! The question arises can the Buyer sue forindemnification even where the Buyer knew ofa problem or a liability before the Closing?

That is known as a sandbagging issue.

! I have personally worked on several litigationmatters where the claim for breach ofwarranty was known to Buyer before it closedon the purchase.


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! Anti-Sandbagging Clause

! Buyer acknowledges that it has had theopportunity to conduct due diligence andinvestigation with respect to the Company,and in no event shall Seller have any liabilityto Buyer with respect to a breach ofrepresentation or warranty under thisAgreement to the extent that Buyer knew ofsuch a breach as of the Closing Date.


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! Pro-Sandbagging Clause! The rights of Buyer to indemnification or any

other remedy under this Agreement shall not beimpacted or limited by any knowledge that Buyermay have acquired, or could have acquired,before the Closing Date.Seller herebyacknowledges that, regardless of anyinvestigation made (or not made) by or on behalfof Seller, and regardless of the results of any

such investigation, Buyer has entered into thistransaction in express reliance upon therepresentations and warranties of the Seller madein this Agreement.


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! We add the anti-sandbagging clause becauseoften the Seller of a business may not preparetheir books and records in a way that meetswith modern practice.

! Often business owners forget that someoneelse will look at the dispute in a differentlight.


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! I found several sources very helpful:! Kenneth Clarkson, Roger LeRoy Miller and

Timothy Muris, Liquidated Damages v. Penalties:Sense or Nonsense, 1978 Wis. L. Rev. 351 (1978)

! Aristides N. Hatzis, Having the cake and Eathingit too: efficient penalty clauses in Common andCivil contract law, International Review of Lawand Economics 22 (2003) 381-406

! Edward Hoffman, Liquidated Damages in IllinoisContracts, 45 Chicago-Kent Law Review Issue 2,Article 5


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! IICLE Contract Law 2013, including! Chapter 13 - Rights, Legal Remedies and

Calculating Damages for Breach of Contract, byShermin Kruse, Jessica Perez Simmons, and

Brandon Prosansky,! Chapter 4 Void Contracts or Clauses under

Illinois Statutes, Gregory J. Rastatter,! Chapter 5 Problems in Contract Formation,

Darren C. Baker! Anti-Sandbagging Clauses - Daniel Avery of

Goulston and Storrs, and Daniel H. Weintraub,Audax Group. Bloomberg law reports.


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! Thank you!! Contact information:

Edward X. Clinton, Jr.

The Clinton Law Firm

111 W. Washington Street, Suite 1437

Chicago, Illinois 60602

(312) 357-1515

[email protected]

edward x. clinton, jr. presentation on managing liability through contract provisions

Documents

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