Willful Misconduct: Just How Bad Does It Have to Be?1/17/2017 | By: Randy J. Heller, Esq. | GDB 2017 Winter Newsletter
Limiting one’s liability in a contract in the event of a breach can be a prudent idea if both parties agree to such a clause. Such contractual provisions commonly contain an exception which provides that damages will not be limited if the other party engaged in “willful misconduct.” However, a recent Second Circuit Court of Appeals decision illustrated that negotiating a “willful misconduct” exception to counteract a limitation of liability provision can be a useless exercise.
Specifically, the Court held that the party alleging willful misconduct had to prove that the other party acted maliciously with intent to inflict harm and not merely for financial self-interest. This certainly set a high bar to overcome the contractual limitation of liability clause.
A “limitation of liability” provision in a contract puts a cap on a party’s damages in the event of its breach. New York courts have upheld such provisions as a legitimate means for sophisticated contracting parties to allocate risk in the event of a breach. Except in certain industries where statutes provide that a party may not avoid liability for its own negligence (e.g., lessors; caterers; building contractors) they are upheld. Therefore, it is important to consider appropriate exceptions when negotiating these clauses.
It is common for limitation of liability clauses to exclude “willful misconduct.” But what does that actually mean? Does the word “willful” mean anything more than an intentional act?
A federal appeals court recently had occasion to address that issue in a case styled, Process America, Inc. v. Cynergy Holdings, LLC, (2d Cir. October 5, 2016). This case involved dueling breach of contract claims between two parties involved in processing credit card transactions for merchants. Process America was an independent sales organization that signed up and serviced merchants for Cynergy, a bankcard processor. Process America sued Cynergy for residual payments it claimed were owed to it; Cynergy counterclaimed for Process America’s wrongful withholding of payments to the merchants and for stealing customers in violation of a non-solicitation agreement.
The District Court held that each party had committed a breach of the agreement. However, Cynergy had the benefit of a limitation of liability provision. The only exception to this limitation of liability was for willful misconduct, gross negligence or recklessness. Process America had argued that Cynergy should not be able to cap its liability by relying upon the limitation of liability clause because it had committed willful misconduct in deliberately withholding payment.
The Court of Appeals affirmed. In doing so, it addressed (and rejected) Process America’s argument. The Court cited New York law holding that the willful misconduct exclusion was to be narrowly construed. It did not apply to “merely intentional nonperformance of the Agreement motivated by financial self-interest.” Rather, it applied where the “defendant willfully intends to inflict harm on a plaintiff at least in part through the means of breaching the contract between the parties.” Stated another way, if the repudiation of a contract is “motivated exclusively by … economic self-interest,” there is likely to be insufficient proof of any intent to inflict harm.
The Court of Appeals conceded that once Cynergy reached its liability cap, it would have no motivation to resume payments, because it would be protected from liability for any further damages in excess of that amount. Nonetheless, the Court concluded that despite the possible economic self-interest reflected in Cynergy’s failure of payment, it did not rise to the level of “willful misconduct.”
This illustrates the difficulty in proving willful misconduct. One must prove that the other party terminated the contract despite believing it was not justified in doing so. This sets the bar very high.
So, while a party to a contract may negotiate exceptions to a “limitation of liability” clause, “willful misconduct” language may provide little help.