Lost Profits: Direct or Indirect Damages?

In 2014, the New York Court of Appeals, in Biotronik A.G. v. Conor Medsystems Ireland, Ltd., held that the lost profits claimed by a party were “general damages”, and were recoverable. They were recoverable despite the limitation of liability provision in the contract, which stated that neither party would be liable for “any indirect, special, consequential, incidental or punitive damage with respect to any claim arising out of [the] agreement” for any reason, including a party’s performance or breach of the agreement.

Why is a case that was decided in 2014 worthy of writing about now? It’s been over three years since the Court’s decision, and we still commonly see limitation of liability language in commercial contracts that does not clearly address the issue of lost profits, and whether they are direct or indirect damages. That may be a strategic decision of the drafter, or it may be an oversight. While New York law does not govern all commercial contracts, other courts may rely on Biotronik in the future, or reach a similar holding independently. Regardless, it’s generally better to have a contract that clearly expresses the intent of the parties, rather than have a court determine it.

Direct Damages vs. Indirect Damages

Consider whether lost profits are reasonably foreseeable and quantifiable. Will breach of the contract almost surely cause a party to lose profits? Is there a reasonably certain way to prove the amount of lost profits? If so, lost profits may be considered direct damages. For example, if the parties have a non-compete agreement, the main purpose of that agreement is to ensure one party does not compete with the other party for business, thereby diverting customers, which results in lost profits. Lost profits can be reasonably quantified by sales to each diverted customer by the competing party. This is a situation where lost profits would likely be considered direct damages.

Defining Lost Profits

Consider whether the parties want lost profits to be recoverable. A provision can be included in the contract expressly stating that lost profits are direct damages, or that lost profits are indirect damages. Limitation of liability language can be included that states lost profits are not recoverable, regardless of how they are categorized. Alternatively, the limitation of liability language can expressly exclude lost profits from the limitation, making them recoverable.

Ultimately, whether lost profits should be recoverable, and how they are addressed in a contract will depend on the individual relationship or transaction in question. Given the potential for dispute, drafting clear language is key.

How to Negotiate Your IT/Tech NDA Faster (or, Living with a Suboptimal NDA)

Recently I found myself watching a past episode of HBO’s award-winning tech comedy series, Silicon Valley. If you’ve never watched it, it’s about a Silicon Valley tech start-up and its struggles, successes, and missteps. Although at times the show can be a bit gratuitous, part of its interest derives from the proximity – at least on some conceptual level – of many of its plot lines to reality.

Because I routinely help clients with non-disclosure agreements (NDAs) and related issues, I cringed watching the “Runaway Devaluation” episode from the second season. In this episode, the start-up (a data compression company called Pied Piper) is invited to an initial meeting with a potential funding source (Branscomb Ventures), which has already invested in a competing compression company, Endframe. Shortly after the meeting begins, the Pied Piper team begins sharing critical details of how its data compression technology is built and works. Later, realizing that Branscomb’s intention for the meeting was only to gather these details for the improvement of Endframe’s products, Pied Piper storms out of the meeting.

While it appears there was no NDA between Pied Piper and Branscomb Ventures covering the meeting’s discussions, in reality it is routine for parties to potential IT and technology transactions to put an NDA in place. Vendors, customers, and others in the IT/technology industry generally understand the need to protect their trade secrets and other valuable information when sharing them to evaluate potential relationships with vendors who provide software, hosting, outsourcing, professional technology services, and data breach investigation and remediation services. Among typical participating parties, the need to put in place an NDA is rarely disputed, and many NDA terms and conditions are quite common.

That said, NDA negotiations can nonetheless become time-consuming or contentious. Whether based on a party’s bad experience in a previous situation, defensive or offensive tendencies, or need to avoid deviations from company policies, otherwise common NDA terms can lead to uncommonly protracted negotiations. For a vendor looking to sell to a new customer, lengthy or difficult NDA negotiations can cause the potential customer to view the vendor as being difficult to deal with, or, worse, to drop the vendor from consideration entirely. For a customer wanting to urgently find a vendor to provide services to address a data breach, time to negotiate an NDA is not a luxury.

Even with NDAs, though, there are ways to speed up the negotiations – which, additionally or alternatively, can also provide mitigations to living with a less-than-desirable NDA. The following steps are a few that may allow an NDA party to get comfortable with otherwise problematic NDA terms in a specific case. (Importantly, these measures should not be implemented if contrary to a contractual obligation or law, nor should they replace sound judgment and risk management.)

For a disclosing party that:

(1) After discussions start, is concerned that the receiving party may not handle or treat its confidential information in way that is satisfactory (or that the NDA’s confidentiality terms are not optimal), the disclosing party can do as Pied Piper did and cease providing any more information. (Though, this may stifle productive business discussions, and the party should attempt to put a retroactive NDA in place.)

(2) Believes that the confidentiality terms are not ideal or has concerns about the receiving party’s handling or treatment of its confidential information, the disclosing party can proactively intentionally limit disclosure to only its least sensitive information. (This step, too, may hamper meaningful discussions between the parties.)

(3) Is concerned that the duration of the NDA may cover discussions too far in the future to be appropriately covered under the NDA, the disclosing party can terminate the NDA after the then-presently contemplated discussions.

(4) Has concerns about the information protections provided by the NDA or the receiving party, the disclosing party can conspicuously mark all information disclosed as “CONFIDENTIAL” – that is, even if the NDA doesn’t require it. And, after disclosing confidential information orally, the disclosing party can follow each such disclosure with a written notice expressly identifying the orally disclosed information as “CONFIDENTIAL.”)

For a receiving party that:

(1) Has concerns about its ability to fully adhere to the NDA’s limitations on use and disclosure of the disclosing party’s information, the receiving party can actively limit the number of its personnel who see or have access to the information.

(2) Is concerned about its risk of non-compliance with the NDA’s confidentiality terms, the receiving party can consciously limit the number of copies it makes of the disclosing party’s information (including copies in the form of email attachments). (This assumes copying is permitted.)

(3) Has concerns that it may struggle to meet the NDA’s limitations on disclosure and use of the disclosing party’s information, the receiving party can immediately destroy (or return) the information once it is no longer needed.

As for Pied Piper, it turns out that Endframe did indeed improve its products using Pied Piper’s technology. However, whether due to the lack of an NDA – or, more likely, the constraints of a ten-episode television season for Silicon Valley – Pied Piper was forced to take other, non-legal actions to advance its interests.