Gross Negligence Claims Cannot Overcome Sole Remedy Clause

On December 22, 2020, the Court of Appeals issued a decision in Matter of Part 60 Put-Back Litig., 2020 NY Slip Op. 07687, holding that gross negligence claims could not overcome the damages limitations in a sole remedy clause, explaining:

In New York, contractual exculpatory clauses intended to insulate a party from liability for its own negligence are enforceable, albeit disfavored and closely scrutinized, so long as the contract language is clear and unequivocal and the clause does not violate statutory law or a separate rule of public policy. Furthermore, contract terms providing for a sole remedy are sufficiently clear to establish that no other remedy was contemplated by the parties at the time the contract was formed, for purposes of that portion of the transaction especially when entered into at arm's length by sophisticated contracting parties. It is well settled that courts must honor contractual provisions that limit liability or damages because those provisions represent the parties' agreement on the allocation of the risk of economic loss in certain eventualities.

On the other hand, it is equally well settled that public policy forbids a party's attempt to escape liability, through a contractual clause, for damages occasioned by grossly negligent conduct. Gross negligence differs in kind, not only degree, from claims of ordinary negligence. Gross negligence, when invoked to pierce an agreed-upon limitation of liability in a commercial contract, must smack of intentional wrongdoing or evince a reckless indifference to the rights of others.

In light of two potentially competing lines of precedent, we must consider whether the sole remedy provision here may be rendered unenforceable by plaintiff's allegations that a breach of contract occurred as a result of gross negligence.

We have previously considered the application of the gross negligence public policy rule only in cases where the contract provision at issue was an exculpatory clause, purporting to wholly immunize a party from liability, or a nominal damages clause limiting damages to, at most, $250. We have not yet determined whether grossly negligent conduct may render unenforceable contractual provisions that do not wholly insulate a party from liability for its breach, but instead impose reasonable limitations on either liability or the remedies available to the non-breaching party. We conclude that, in a breach of contract case, grossly negligent conduct will render unenforceable only exculpatory or nominal damages clauses, and the public policy rule does not extend to limitations on the remedies available to the non-breaching party.

This conclusion is in keeping with the secondary sources laying the groundwork for the rule. The Restatement (Second) of Contracts provides that a term exempting a party from tort liability for harm caused intentionally or recklessly is unenforceable on grounds of public policy. That is consistent with the rule announced by the first Restatement in 1932. When articulating the rule in our decisions, we have relied on these Restatement provisions, as well as Williston on Contracts. That treatise similarly provided that an attempted exemption from liability for a future intentional tort or for a future willful act or one of gross negligence is void. The use of the word exempt in these secondary sources suggests total immunity from liability.

. . .

Limiting the scope of the gross negligence public policy exception to exculpatory and nominal damages clauses in breach of contract cases is also consistent with the public policy concerns animating the rule. When a party engages in conduct that smacks of intentional wrongdoing or evinces reckless disregard for the rights of others, public policy will not permit that actor to escape all liability for its misconduct. Furthermore, policy does not allow the party injured as a result of such wrongdoing to be left uncompensated for its losses. These public policy concerns do not apply with equal force where, as here, sophisticated commercial parties choose a remedy that will be available in the event of a breach of contract to the exclusion of others.

Moreover, we will enforce the bargain that contracting parties have freely made, absent some violation of law or transgression of a strong public policy. Freedom to contract itself is deeply rooted in public policy. Freedom of contract prevails in an arm's length transaction between sophisticated parties such as these, and in the absence of countervailing public policy concerns there is no reason to relieve them of the consequences of their bargain. When the clause limiting liability is negotiated at arm's length by sophisticated parties, provides for more than nominal damages, and does not wholly exculpate the breaching party, the rationales underlying the gross negligence public policy exception fail to overcome the public policy in favor of freedom of contract, where, as here, the only causes of action raised in the complaint sound in breach of contract.

We decline to extend the scope of this public policy rule in a breach of contract case to invalidate limitations on liability or remedies available to the non-breaching party. Rather, in a breach of contract case, grossly negligent conduct will render unenforceable only exculpatory or nominal damages clauses.

The sole remedy provision at issue here is neither an exculpatory clause nor a nominal damages clause. Exculpatory clauses immunize a party from liability for its own misconduct. The sole remedy provision does not immunize defendants from liability for a breach of the representations and warranties. Nor does it limit plaintiff's damages to a nominal sum. Instead, the sole remedy provision provided a mechanism by which defendants could correct the breach—cure or repurchase of a nonconforming loan—which was intended to make the Trust whole.

(Internal quotations and citations omitted).

Schlam Stone & Dolan represents investors in RMBS actions against underwriters and trustees and in related proceedings, such as trust instruction proceedings where an RMBS trustee seeks court guidance regarding the management of an RMBS trust. If you or a client are RMBS investors and have questions regarding potential claims against a trustee or how to influence the trustee's prosecution of a put back or repurchase action like the one at issue here, contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com.