When a party in a binding contract suffers economic loss is that party limited to recovery from a claim for breach of contract or can economic or consequential damages be recovered? That was a question put before the United States District Court for the Eastern District of New York.

In the case, the plaintiff provided information technology services while the defendant provided systems for storing and protecting client data. The parties entered into two separate agreements under which the plaintiff was to consider the defendant’s software products and also borrow its hardware during an evaluation period. After the evaluation period the plaintiff was to either license the evaluated programs and purchase the hardware or return both to the defendant. The parties elected to go forward with the upgrade. Each of the agreements between the plaintiff and defendant contained a broad limitation of liability provision that effectively provided that the defendant would have no liability for consequential, exemplary, special, indirect, incidental or punitive damages or any other loss or expense (including loss profits) even if it had been advised of the possibility of such damage, loss or expense.

The plaintiff took issue with the defendant’s performance claiming that the process disabled many of its normal back-up and redundancy measures, leaving the plaintiff’s system in what it claimed was a “fragile” state. The plaintiff further alleged that the upgrade resulted in the corruption of nearly all email databases and file servers. The plaintiff alleged that the defendant’s reckless conduct in carrying out the upgrade made it impossible for plaintiff’s clients to access their data, alleging to have caused a “crisis in confidence” that led to the loss of clients and devastation of plaintiff’s business. The “calamitous” performance of the upgrade prevented the plaintiff from pursuing a lucrative partnership with a major regional telecommunications provider.

The plaintiff filed its lawsuit setting forth four causes of action for: 1) gross negligence; 2) negligent misrepresentation; 3) breach of contract (due to gross negligence); and 4) breach of the implied covenant of good faith and fair dealing. The defendant filed a motion to dismiss.

The court, indicated that under New York’s Economic Loss Doctrine, a party to a contract that suffered economic loss only (not personal injury) was, in most cases, limited to recovery pursuant to a claim for breach of contract and could not recover economic or consequential damages in tort. The court stated that applying the economic loss doctrine, New York courts have held that recovery of damages in tort was generally not available in an action alleging the poor performance of a contracted-for product.

The court also indicated that even in the absence of personal injury, New York courts recognized a claim in tort under circumstances where a party to a contract could properly allege that a breach of a duty owed to the plaintiff existed separate and apart from the contract. Factors to consider when determining whether a plaintiff could state a claim for breach of duty alongside a claim in tort were: First, courts were to consider the nature of the injury alleged. Where “the nature of the harm” alleged was “catastrophic,” the behavior involved may give rise to a duty of care that existed outside of the contract. Next, courts considered the way in which the injury occurred and the harm that followed. The court pointed out that the parties entered into two separate agreements, as previously mentioned.  The court held that any duty arising from this contractual obligation arose directly from the contracts at issue and did not form a separate and independent duty, the breach of which could support a claim in tort.

While a failure of the upgrade may have resulted in damage to certain data, any harm that occurred was due to installation and re-booting issues. Therefore the court granted the defendant’s motion to the extent that it ordered dismissal of all claims based on tort. The court construed the claim alleging gross negligence, as a claim asserting breach of contract and therefore, the court ordered the parties to continue with discovery with respect to the breach of contract claim, which was the only claim that remained.

To ask Les Gold a question, e-mail sdm@bnpmedia.com.

READERS ASK

Q: My company installed an alarm system pursuant to a contract at a retail store. Unbeknownst to us the subscriber sold the business and did not notify us. The new owner made no payments, but we did not remove the system. When the new owner had a break-in, the alarm system did not operate. Do we have any responsibility? 

ANSWER: This is more of a factual question. Did you have any correspondence with the new owner requesting that they sign a new contract or that they confirm the original contract? Did you notify the owner that the system was not going to be operative? Did you send statements to the new owner and did you receive any response from the new owner?

Notwithstanding any of the above questions, you should have notified the new owner that service was going to be discontinued for nonpayment. If the new owner, in fact, acquired the corporation and your contract was with the corporation, there could be responsibility on your part. On the other hand, if the new owner neglected or failed to pay for the service, they should have been notified that the service was going to be cancelled.

 I believe that the claim is defensible, but before I could fully answer, we really must know additional facts. If, of course, there is a contract which contains the important limitation of liability provisions, you should be protected. If the contract was not assumed by the buyer, the buyer can take the position that they are not bound by the limitation of liability provisions. That being the case, however, the buyer would be hard pressed to take the position that you have any contractual responsibility.