RISK MANAGEMENT: WHAT IS THE EXPOSURE? UNDERSTANDING DAMAGES. by Marc S. Blubaugh Benesch, Friedlander, Coplan, & Aronoff LLP

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1 RISK MANAGEMENT: WHAT IS THE EXPOSURE? UNDERSTANDING DAMAGES by Marc S. Blubaugh Benesch, Friedlander, Coplan, & Aronoff LLP

2 AGENDA What Types of Damages Might Be Recoverable? What Can Be Done To Protect Against Those Risks? What Remedies Exist Against Insurer?

3 TYPES OF DAMAGES The type of damages turn on the type of claim being asserted: Breach of Contract (Expectation) Tort (Foreseeable / Punitive) Statutory (Defined)

4 Breach of Contract Contract damages are ordinarily based upon the injured party s expectation interest The damages are intended to give a party the benefit of its bargain by awarding a sum of money that will, to the extent possible, put that party in as good a position as the party would have been in had the contract been performed. Expectation interest damages can be either direct damages or indirect damages.

5 Direct Damages Direct damages are those that flow naturally and necessarily from the breach. Example: Out-of-pocket expenses, amounts necessary to cover for the breach, etc. (repairs, substitute goods, expedited delivery)

6 Indirect Damages Indirect or Consequential damages are those which result naturally, but not necessarily, from the breach Example: Lost Profits, Lost Customers, Contractual Penalties Imposed by Third Parties Hadley v. Baxendale (156 Eng. Rep. 145) (1854) (only recoverable if foreseeable / within reasonable contemplation of parties) BUT -- no bright line exists between what constitutes a direct damage and what constitutes an indirect damage (i.e., not all lost profits, lost revenue, etc. are necessarily indirect damages).

7 LOST PROFITS -- EXAMPLE A manufacturer issues an RFP to identify a new 3PL to provide warehousing and transportation brokerage services The manufacturer selects the 3PL and the parties sign a contract containing a waiver of consequential damages including lost profits. 3PL prepares to begin providing services Manufacturer issues notice stating that it has reconsidered decision to outsource and will start providing the services in-house through no fault of the 3PL who won the bid

8 Conventional Direct Damages Undertook significant recruitment efforts including, but not limited to, advertising for employment candidates, participating in job fairs, reviewing resumes, conducting first and second interviews of multiple candidates in order to fill the various hourly and salaried positions necessary to support the Agreement; Designed an operational layout for the facility and necessary equipment; Negotiated at length with suppliers for equipment and other necessary supplies; Designed all administrative support functions necessary for implementation of the Agreement, including appropriate forms, standards, and information collection methods; Spent considerable resources internally (and with outside counsel) reviewing and negotiating the Agreement Set-up and tested a new information technology system; Prepared for internal and external weekly start-up status meetings; Extensive, internal planning to support implementation of the Agreement; Extensive, external planning to support implementation of the Agreement; and Secured various, required financial arrangements necessary to implement the Agreement.

9 LOST PROFITS DIRECT OR INDIRECT? 3PL spent roughly $160,000 out-of-pocket BUT lost profits would arguably be $2,000,000 Manufacturer claims that lost profits are not recoverable due to the waiver of consequential damages 3PL argues these lost profits are in fact direct damages (i.e., the damages arose within the scope of the transaction between the two parties to the contract and did not stem from losses incurred by the non-breaching party in its dealings with third parties). Relied on a variety of authorities:

10 Spinal Concepts, Inc. v. Curasan, AG, 2006 WL (N.D. Tex. 2006) A manufacturer of a surgical product entered into a five-year agreement with a distributor for the distributor to market, sell, and distribute the medical product for use in spinal surgeries throughout the United States. However, the distributor then breached the distributorship agreement by failing to purchase the surgical product in question. The parties proceeded to arbitration, where the arbitrator awarded $2,000, in lost profits to the manufacturer. On appeal, the breaching party argued, among other things, that the manufacturer was not entitled to recover these lost profits because the distributorship agreement contained a waiver of consequential damages, which read:... in no event shall either party hereto be liable to the other party for costs of procurement of substitute goods, lost profits, or any other special, consequential, incidental, or indirect damages.

11 However, the court soundly rejected that analysis: On its face, the limitation of liability provision unambiguously prohibits recovery of any special, consequential, incidental, or indirect damages, including procurement of substitute goods or lost profits. In other words, it states that to the extent that lost profits are considered direct damages and not special, consequential, incidental, or indirect damages, they are excepted from this provision. To interpret the Agreement otherwise would defy logic. Both Parties entered into this Agreement with the intention of making a profit it is unreasonable to believe that they would agree to forego lost profits directly arising from the other party s breach of the Agreement, as [the breaching party] suggests. CASE SETTLED

12 PRACTICAL POINTS Carefully evaluate types of contractual damages theoretically available when claims arise (consider all types of direct and indirect damages) Good contracts can chill tenuous claims Draft clear waivers of Consequential Damages (including illustrations of the types of damages encompassed within):

13 EXAMPLE OF WAIVER UNDER NO CIRCUMSTANCES SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY OR ANY THIRD PARTY FOR ANY INCIDENTAL, CONSEQUENTIAL, SPECIAL, OR INDIRECT DAMAGES OF ANY KIND (INCLUDING, WITHOUT LIMITATION, LOST REVENUE, LOST PROFITS, OR OTHER LOST INCOME OR COMMERCIAL LOSS) RELATING TO OR ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT OR THE SERVICES, WHETHER BASED IN OR ARISING UNDER CONTRACT, WARRANTY, INDEMNITY, TORT (INCLUDING NEGLIGENCE AND STRICT LIABILITY), STATUTE OR OTHERWISE.

14 TORT CLAIMS Tort claims are often used to circumvent contractual limitations Consider whether Economic Loss Doctrine applies to eliminate a tort claim when based on same facts as a contract claim

15 ECONOMIC LOSS DOCTRINE Where a contract spells out the parties respective rights, the contract and not common-law negligence governs any dispute When the only injury is the economic loss to the subject of a contract itself, the action sounds in contract alone Exception exists when duty is owed independent of any contract

16 EXAMPLE Applies: Breach of a Distributor Agreement (because most states do not impose duties independent of contract upon distributors of general commodities) Does Not Apply: Breach of a Motor Carrier Agreement (because duties exist independent of contract)

17 What Are Damages in a Tort Claim? Compensatory damages are limited to those injuries or losses which are the natural, proximate, and probable (i.e., foreseeable) consequences of the wrong allegedly committed Punitive Damages generally arise from malice and are intended to punish to some extent

18 How Do These Differ From Contract Damages? Punitives not available for contract Waiver of Consequential Damages is not always effective to limit claims arising in tort Distinction is not between direct and indirect damages but between reasonable/probable damages and remote/speculative damages

19 EXAMPLES Other s Truck collides with your truck Possible range of tort damages: Repair to truck Towing of Truck Storage of Truck Actual damages to freight on board Lost Profit associated with Truck Lost Profit associated with Driver Increased premiums for insurance Increase in workers compensation premiums Deductibles

20 Michigan Millers Mut. Ins. Co. v. Christian (2003), 153 Ohio App.3d 299 Traffic accident between two commercial motor vehicles (sprayer and dumptruck) Sprayer s insurer subrogated and sued owner of dumptruck in tort for a variety of damages, including lost profits Trial Court awarded lost profits Defendant appealed on basis that lost profits do not reflect the measure of damages for a motor vehicle collision

21 COURT S HOLDING "[a] plaintiff may recover profits lost as a result of a defendant's tortious conduct if such damages may naturally be expected to follow from the wrongful act and if the damages are reasonably ascertainable. Accordingly, lost profits resulting from an motor vehicle accident caused by another's negligence are certainly cognizable damages. [l]ost profits may be established with reasonable certainty either directly or through an expert witness. Proof with mathematical precision is not required, nor need the proof be clear and irrefutable, but profit loss cannot be left to mere conjecture and must be capable of measurement based upon known reliable factors without undue speculation.

22 PRACTICAL POINTS Try to waive certain tort remedies (such as punitive damages) in any applicable contract Try to secure indemnification from other parties for claims arising out of services they provide Purchase your own insurance to address third-party tort claims Become an Additional Insured on another s policy where appropriate

23 STATUTORY CLAIMS Statutory claims are often used to circumvent contractual limitations EXAMPLES: Carmack Amendment, COGSA, Deceptive Trade Practices Measure of Damages: Varied and Defined by Statute (compensatory, double damages, treble damages, undefined punitive, disgorgement, attorneys fees, etc.)

24 EXAMPLE Carmack Amendment Most courts agree that the Carmack Amendment preserved the common law rule that special damages could be recoverable if foreseeable. But that does not usually answer the question. Paper Magic Group, Inc. v. J.B. Hunt Transport, Inc., 318 F.3d 458 (3 rd Cir. 2003) (holding that diminution in value of delayed Christmas cards was a general rather than special damage).

25 PRACTICAL POINTS Understand how certain statutory remedies can be waived (i.e., 49 U.S.C (b)(1) waiver) and draft contracts accordingly Become Additional Insured where appropriate Don t unduly rely upon Certificates of Insurance (keep in mind exclusions, etc.) Purchase insurance products that may protect against statutory claims

26 EXAMPLE -- Broker Insurance Products How to Protect Against Claims Shipper s Interest / All Risk: Encourage your customer to purchase this (or you purchase it on behalf of your customer) Shipper is the insured Narrower exclusions (i.e., no exclusion for Act of God but may have exclusion for nuclear damage) First Party / Dollar coverage (no need to wait for other insurance to pay first)

27 EXAMPLE -- Broker Insurance Products How to Protect Against Claims Contingent Cargo: Broker is insured Many different types (some follow form, some only apply when insurer insolvent, some only apply if trucker s policy was forged or voided, some only pay expenses of handling or storing damaged cargo, etc.) Ideally, broker wants a policy that covers any loss if trucking company and its insurer fails to pay a claim

28 EXAMPLE -- Broker Insurance Products How to Protect Against Claims Contingent Auto: Schramm (negligent selection) Jones (negligent selection) Sperl (vicarious liability / control) Heyl (negligent selection) Hoffman (joint venture)

29 EXAMPLE -- Broker Insurance Products How to Protect Against Claims Errors & Omissions Protects against failure to perform professional services Examples: Failing to follow shipper s instructions, internal delay, negligent selection (maybe), incorrect document preparation, failure to insure, etc. Some policies are purely indemnity (reimburse but won t front attorneys fees, costs, claims expenses, etc.)

30 OTHER INSURANCE PRODUCTS TO CONSIDER Crime Policies Pollution Policies Fiduciary Liability Policies Warehouse Legal Liability Policies Commercial General Liability Policies Directors and Officers Liability Policies Employment Practices Liability Policies Umbrella / Excess Policies THINK ABOUT ENDORSEMENTS

31 What Remedies Exist Against A Third-Party Insurer? Strategies Regarding a Third Party s Insurer (i.e., Motor Truck Cargo) Obtain an assignment of claim from actual claimant if necessary Obtain a judgment against a motor carrier Cajole and reason letters, calls, etc. Commence a Third-Party Direct Action against Insurer (some states permit)

32 What Remedies Exist For Insured Against An Insurer? Commence Timely Claims Process Provide timely notices internally and externally Use proper means to notify (provide details in writing) Be cautious incurring expense without written consent Avoid settling or compromising without insurer s consent Cooperate with insurer (provide statements, background facts, etc.) Don t forget the basics: Pay premium!

33 What Remedies Exist For Insured Against An Insurer? Phone Call / Letter Writing Campaign Insurance Broker Leverage Business Leverage Outside Counsel Leverage Complaints to State Department of Insurance (Usually Ineffectual) Ultimately, you may need to sue Declaratory Judgment (coverage) Breach of Contract (denials, delay) Bad Faith (denials, delay, wrongful settlement resulting in increased premiums?)

34 THANK YOU Marc S. Blubaugh Benesch, Friedlander, Coplan & Aronoff LLP 41 S. High Street, Suite 2600 Columbus, Ohio Telephone: (614) Facsimile: (614)