International Business Advisory – Consequential Developments Under International Sales Law
The United States is one of 80 countries that have adopted the United Nations Convention on Contracts for the International Sale of Goods (CISG). The CISG governs the formation and interpretation of sales contracts between companies with places of business in separate CISG countries. Although there are many similarities in the legal rules established under the CISG and our homegrown Uniform Commercial Code, there are also some important differences and occasionally some surprises.
Certainly the Canadian company known as ETI Converting Equipment was shocked to learn that the limitation of liability clause in its sales contract with Topp Paper Company of Florida would not succeed in barring claims for consequential damages (such as lost profits) that Topp sought against ETI in a Florida federal district court.
ETI manufactures two lines of sophisticated equipment used in producing labeling products. Evidence was admitted showing that, over an extended period of time, Topp had reported to ETI ‘numerous problems’ with ETI’s machinery that ETI never successfully resolved to Topp’s satisfaction. Topp sued to recover the difference between the contract price it paid for the equipment and the value of the equipment in its defective condition, ‘together with all other and further relief as provided in the [CISG].’ As the case proceeded, the parties squabbled over whether Topp could submit evidence of lost profits that it could have earned from sales of products it would have made had ETI’s equipment functioned properly.
Whether Topp realized it or not when it sued to recover whatever relief the CISG afforded, the CISG allows recovery of consequential damages from breach of contract, including lost profits, suffered as a result of the other party’s breach. Such damages are limited by what should have been foreseen at the time the contract was made. In response to this claim, ETI cited the following disclaimer language from the parties’ contract:
Buyer’s exclusive remedy against Seller for any claimed defect or nonconformity in the equipment is limited to repair or replacement as set forth in this warranty. Seller neither assumes, nor authorizes anyone on its behalf to assume for it, any other obligation or liability. In no event shall the Seller be liable for indirect, consequential, special or incidental damages of any nature whatsoever, including lost profits or loss of use [of] the equipment.
Open and shut case to deny lost profits? Probably so under the Uniform Commercial Code. However, the CISG allows a party to ‘avoid the contract’ if it can prove that the other party’s performance has sunk to the level of a ‘fundamental breach’ of the contract. If the contract is avoided, then the only contract clauses that survive are those governing the settlement of disputes or provisions ‘governing the rights and obligations of the parties consequent upon the avoidance of the contract.’ Otherwise, avoidance of the contract releases both parties from their obligations under the contract, subject to any damages which may be due.
The Florida court held that ETI’s contractual disclaimer of consequential damages was not the kind of clause that survived avoidance of the contract. Since ETI’s performance under the contract was so poor as to entitle Topp to avoid the contract, ETI lost the benefit of the limitation of damages clause in that contract:
The lesson for exporters to other CISG countries is to spell out the rights and obligations of the parties following a fundamental breach by either party. Another approach might be to insert a clause waiving or severely limiting the parties’ right to avoid a contract. Under Article 6 of the CISG, the parties may ‘derogate’ from or vary the effect of any of the provisions of the CISG. Therefore, it may behoove an exporter to specifically exclude Article 74 of the CISG, which is the textual basis for claiming consequential damages, including loss of profit.
Yet another alternative would be to exclude the application of the CISG to the parties’ transaction in the first place. Be careful how you attempt to do this. Since Article VI of the United States Constitution makes CISG the supreme law of the land, a boilerplate clause stating the contract will be ‘governed by the laws of the Commonwealth of Virginia’ will simply lead the court, in a circular fashion, right back to the application of the CISG to such contract. – Chuck McPhillips
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2020.