Companies often spend significant time and resources negotiating contracts before entering into business relationships, especially where the parties intend to have a longstanding, on-going relationship. The expectation is that the terms negotiated in the contract will apply if any questions arise in the relationship, and courts typically enforce these terms if one business brings a claim that the other breached the agreement.
However, a recent California Supreme Court decision, tested the limits of what parties can contract away, and decided that the parties cannot limit damages for liability for “willful injury to the person or property of another” (New England Country Foods v VanLaw Food Products).
New England Country Foods (NECF) is a Vermont-based company that began selling its barbecue sauce to the Trader Joe’s chain of food stores in 1999. NECF outsourced production to VanLaw Food Products, a Fullerton-based private label food manufacturer. The contract between the companies prohibited VanLaw from reverse-engineering the barbecue sauce.
The contract also contained provisions limiting the parties’ possible damages. A “Limitation on Liability” clause provided that “to the extent allowed by applicable law,” neither party would be liable to the other for loss of profits, business interruption and other routine business risks.
It also said neither party would be liable “for any punitive, special, incidental or consequential damages … regardless of whether the claim under which such damages are sought is based upon breach of warranty, breach of contract, negligence, tort, strict liability, statute, regulation or any other legal theory or law.”
NECF alleged that, as the expiration of its three-year contract with VanLaw approached and the companies were negotiating a renewal, “VanLaw hatched a backup plan in case negotiations broke down: it would clone NECF’s barbecue sauce and sell it directly to Trader Joe’s.”
The companies failed to negotiate a renewal of the contract. According to NECF, because of VanLaw’s promise to duplicate the barbecue sauce, Trader Joe’s ended its decades-long relationship with NECF. However, VanLaw was unable to replicate the sauce, and Trader Joe’s stopped selling it.
NECF sued VanLaw in federal court, claiming breach of contract, intentional interference with contractual relations, and other torts. It asked for $6 million in past and future lost profits, plus punitive damages.
VanLaw asked the court to dismiss the complaint, citing the provisions in its contract with NECF that limited damage claims.
The district court granted NECF’s motion, reasoning that the contract allowed only for direct damages and injunctive relief, whereas NECF sought lost profits, attorneys’ fees and costs, and punitive damages.
NECF filed an amended complaint, which argued that “the only possible harm ... from the wrongs committed by [VanLaw] are a loss of profits,” so applying the contract’s limitation-of-liability provisions “would completely exempt [VanLaw] from liability” resulting from the wrongs alleged by NECF.
The district court dismissed the amended complaint, this time with prejudice – meaning the case was permanently dismissed and NECF could not refile it.
NECF then appealed the district court’s ruling to the US Court of Appeals for the Ninth Circuit.
After hearing oral arguments, the federal appellate court asked the California Supreme Court to decide a key question in the case: “Is a contractual clause that substantially limits damages for an intentional wrong but does not entirely exempt a party from liability for all possible damages valid under California Civil Code Section 1668?”
That section of state law provides that “All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.”
In other words, a contract can’t protect someone from the consequences of gross negligence, willful misconduct, or breaking the law.
The justices acknowledged that “private parties have wide latitude to form contracts,” but that latitude is constrained by broader social policies. They added that “our tort system’s concern with vindicating social policy is at its zenith when it comes to willful wrongs.”
To illustrate that principle, they noted that insurance companies are not allowed to offer coverage for intentionally causing harm to another person; such a contract would amount to putting a price on knowingly and deliberately causing harm to another.
After reviewing state laws, public policy, and case law, the justices ruled that contract terms that include “limitations on damages for willful injury to the person or property of another are invalid.”
However, the justices noted that limiting damages for a breach of contract claim does not violate Civil Code Section 1668. Even if one party breaches an agreement for “nefarious or unethical reasons,” they said, that party is deemed to have done “nothing more socially opprobrious than to fall short in meeting a contractual commitment.” The Court’s decision was clear that Civil Code Section 1668 bars limitations of damages for claims of intentional wrongdoing, such as the torts of intentional interference with prospective economic relations and breach of fiduciary duty.
By Rachelle H. Cohen