Glen Banks
Glen Banks ()

In its March 27 opinion in Biotronik v. Conor Medsystems Ireland,1 a sharply divided Court of Appeals ruled that a “no consequential damages” clause in a distribution agreement would not bar a distributor from recovering breach of contract damages for the profit it allegedly would have made reselling the product which was the subject of the distribution agreement. The court reversed a unanimous ruling below that the “no consequential damages” clause limited the distributor’s recovery to nominal damages. In its 2012 opinion in Abacus Federal Savings Bank v. ADT Security Services,2 the Court of Appeals noted that as a general rule “parties are free to enter into contracts…that limit liability to a nominal sum.” In Biotronik, the court was asked to decide whether the courts below properly applied a “no consequential damages” clause to rule that plaintiff could recover only nominal damages for breach of a distribution agreement.

Biotronik A.G., a distributor of medical products, brought suit against Conor Medsystems, Ireland, Ltd., a manufacturer of medical products, alleging that Conor breached a distribution agreement for a drug-eluting stent used in the treatment of coronary artery disease. Biotronik sought as damages the profits it allegedly would have made reselling the stent, or a substitute product provided by Conor, over the remaining term of the distribution agreement. Biotronik sought damages of $100 million.

The issue before the court was whether the claimed lost profits were “consequential damages” that could not be recovered given the “no consequential damages” clause in the parties’ agreement. If the lost profits were considered consequential damages, Biotronik could recover only nominal damages. The court ruled Biotronik’s claimed lost profits were general, as opposed to consequential, damages because the lost profits were the direct and probable consequence of the breach of the parties’ distribution agreement.

Background

Conor had developed a drug-eluting stent, known by the trade name of CoStar, for treatment of coronary artery disease. In May, 2004, Conor and Biotronik entered into the contract whereby Biotronik became the exclusive distributor of CoStar for most of the world, save the United States and nine other countries. Pursuant to the contract, Biotronik would pay to Conor a specified percentage of the gross profit Biotronik made from sale of CoStar. The remainder of the profit would be retained by Biotronik. The benefit that Biotronik would get under the contract would be its share of the profits derived from its sales of CoStar to third parties.

The contract provided that if during the term of the contract Conor stopped making CoStar, Conor would offer Biotronik a substitute product to distribute. A limitation on liability clause in the contract stated: “NEITHER PARTY IS LIABLE TO THE OTHER FOR ANY INDIRECT, SPECIAL, CONSEQUENTIAL, INCIDENTAL OR PUNITIVE DAMAGES WITH RESPECT TO ANY CLAIM ARISING OUT OF THE AGREEMENT (INCLUDING WITHOUT LIMITATION ITS PERFORMANCE OR BREACH OF THIS AGREEMENT) FOR ANY REASON.”

In 2007, Conor informed Biotronik that it would no longer produce CoStar and it was recalling the product from the market. Conor did not offer Biotronik any substitute product. Biotronik found that CoStar was a unique product and it could not find a similar product in the market to substitute for CoStar.

Biotronik sued Conor for breach of contract. It sought as damages the profits it would have made selling CoStar or a substitute product during the remaining term of the contract. Conor moved for summary judgment on Biotronik’s breach of contract claim. Conor argued that the lost profits Biotronik sought were consequential damages and the contract precluded recovery of such damages.

Biotronik argued that its claimed lost profits were not consequential damages because they were the anticipated direct and immediate fruit of the contract since, under the terms of the contract, a fixed percentage of the gross profit from Biotronik’s resale of CoStar would go to Conor with the rest being the benefit Biotronik received under the contract. Biotronik also contended summary judgment should be denied because the question of whether the claimed damages were direct or consequential damages presented a factual issue that could not be determined on summary judgment and had to be determined at trial by the jury.

The trial court (Bernard J. Fried, J.) ruled that the lost profits Biotronik sought to recover were consequential damages that were barred by the limitation on liability clause in the contract.3 In light of the ruling, Biotronik could recover only nominal damages for Conor’s alleged breach. Biotronik consented to entry of judgment dismissing its claim with the understanding that it could appeal the ruling that its claimed damages were precluded consequential damages.

The Appellate Division, First Department, unanimously affirmed the trial court’s ruling.4 It believed the claimed damages were consequential damages precluded by the limitation on liability clause in the contract. It said that a plaintiff seeking to recover the profit it would have made selling defendant’s goods to third parties is seeking consequential damages. That court said lost profits constitute general damages only where the non-breaching party seeks to recover money owed directly to it by the breaching party under the breached contract. The court believed the “clear and conspicuous” limitation on liability in a “negotiated commercial agreement between sophisticated parties” was not unconscionable. The court cited Section 2-719 of the Uniform Commercial Code, which provides “consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable.” The court gave Biotronik leave to appeal.

Proceedings, Court of Appeals

Prior decisions of the Court of Appeals indicated that there was nothing wrong with sophisticated commercial parties allocating risks in their contract even though the result would limit a recovery for breach of contract to nominal damages. In addition to noting that the parties were free to limit damages to a nominal sum, the court also had noted “[a] limitation on liability provision in a contract represents the parties’ Agreement on the allocation of the risk of economic loss in the event the contemplated transaction is not fully executed.”5

The issue before the Court of Appeals was whether Biotronik’s claimed lost profit damages should be considered general damages that could be recovered by Biotronik or consequential damages that were precluded by the contract. The court had previously noted that general damages “are the natural and probable consequence of the breach.”6 The court also had noted that although the distinction between general and consequential damages appeared well-defined, its application to specific contracts and controversies is usually more elusive.7

The court’s decision in American List Corp. v. U.S. News & World Report, Inc.8 had indicated that lost profits were consequential damages when the profit would have been earned pursuant to a contract other than the one that had been breached. The issue before the court in the Biotronik case was whether lost profits should be considered general damages when such damages were claimed to be a direct and probable result of the breach even though such profits would have been earned pursuant to a contract other than the breached agreement.

The oral argument before the Court of Appeals addressed whether American List should be applied to a distribution contract where the only benefit to the distributor would come from the distributor’s share of the profits on the sale of the distributed product to third parties. If such lost profits were excluded consequential damages, Biotronik essentially could recover only nominal damages for Conor’s alleged breach of the contract.

The oral argument opened with the court asking Biotronik’s counsel why Biotronik should be allowed to recover lost profits since the contract excluded an award of consequential damages. Counsel replied that recovery should be allowed because the claimed lost profits were the most natural, probable and direct result of the breach.

When the court noted that damages arising from collateral arrangements were normally considered consequential damages, counsel replied that a distributorship contract contemplated resale of the product being distributed and such resale was the purpose of the contract. Counsel argued that distribution contracts should be carved out of the general approach to determine whether damages were consequential because, in a distribution agreement, the profit garnered on resale of the product was the intended benefit of the contract. Counsel for Biotronik argued the line between general and consequential damages should not be drawn by focusing on whether the lost profit would come from the breached agreement or from other contracts. Rather, the focus should be upon whether the damage was a direct and probable result of the breach or dependent upon other circumstances.

Conor’s counsel argued that the normal measure of damage would be “cover” damages based upon the cost of obtaining something comparable to the product to which the distribution agreement applied. The fact that a comparable product might not be available was a foreseeable risk at the time of contracting. The implication of the argument was that the court should not circumvent the limitation on liability clause to protect a sophisticated party from a foreseeable risk that the party could have addressed at the bargaining table.

Conor’s counsel indicated that the court should not deviate from the American List rule when Biotronik could have, but did not, address in the contract what would happen if the contract were breached and Biotronik could not obtain a substitute product from Conor. Conor’s counsel argued that the court should not modify the contract’s consequential damage exclusion to relieve Biotronik of the consequences of a clear agreement that it freely chose to enter.

In rebuttal, Biotronik’s counsel stressed that the case law does not draw a bright line between consequential and general damages and that Biotronik did not agree with the view that New York law required profits that would have been earned from transactions with third parties to be viewed as consequential damages.

The Decision

In a 4-3 decision, the Court of Appeals reversed the decision below and ruled in an opinion by Judge Jenny Rivera, joined by Chief Judge Jonathan Lippman and Judges Victoria Graffeo and Robert Smith, that the claimed “lost profits were the direct and probable result of the breach of the parties’ agreement and thus constitute general damages.” The majority believed the issue of whether claimed damages were general or consequential must be evaluated in the context of the agreement. The majority noted that the contract did not exclude lost profits or define consequential damages. The court ruled lost profits could be general damages when the plaintiff bargained for such profits or the profits were the direct and immediate fruits of the contract. The court concluded lost profits can be general damages for breach of a distribution agreement.

Judge Susan Phillips Read authored a dissent in which Judges Eugene Pigott and Sheila Abdus-Salaam concurred. The dissent contended that the majority decision circumvented the natural meaning of the limitation of liability provision and the majority’s “creative reading” of the contract “is no boon in the commercial world, where reliance, definiteness and predictability are such important goals of the law itself, designed so where the parties may intelligently negotiate and order their rights and duties.”9

I will address the opinion further in my next column in May.

Glen Banks is a partner at Norton Rose Fulbright (Fulbright & Jaworski) and is the author of “New York Contract Law,” a Thomson Reuters publication.

Endnotes:

1. 2014 WL 1237154 (N.Y. March 27, 2014).

2. 18 N.Y.3d 675, 682, 944 N.Y.S.2d 443 (2012).

3. 33 Misc.3d 1219(A), 939 N.Y.S.2d 739 (Sup. Ct. N.Y. Co. 2011).

4. 95 A.D.3d 724, 945 N.Y.S.2d 258 (1st Dept. 2012).

5. Metropolitan Life Ins. Co. v. Noble Lowndes Intern., 84 N.Y.2d 430, 436, 618 N.Y.S.2d 882 (1994).

6. Kenford Co. v. County of Erie, 73 N.Y.2d 312, 540 N.Y.S.2d 1 (1989).

7. American List v. U.S. News and World Report, 75 N.Y.2d 38, 42, 550 N.Y.S.2d 590 (1989).

8. 75 N.Y.2d 38, 550 N.Y.S.2d 590 (1989).

9. Quoting Matter of Southwest Banking Corp., 93 N.Y.2d 178, 184 (1999).