Termination & Limitation of Liability Clauses: Proceed with Caution

Construction and Procurement Law News, Q3 2018

Firm Alert

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Contractors and subcontractors expect to be paid, and, when contracts are terminated, the termination provisions play a critical role in determining payment. Just as important to contractors and subcontractors is limiting liability as much as possible. In a recent case, Atos IT Solutions and Services v Sapient Canada Inc., a Canadian court explored the relationship between termination clauses and limitation of liability clauses in the context of interpreting “lost profits.” Atos reminds us of the importance of being thoughtful in deciding which provision to utilize in terminating a contract, and the reality that limitation of liability clauses may be interpreted narrowly.

In Atos, the defendant, Sapient, was the general contractor for a $50-million-dollar IT replacement project. It subcontracted with Siemens to provide data conversion and application management support. The subcontract provided that Sapient could terminate the entire agreement “for cause,” and allowed it the right to terminate the data conversion services portion of the subcontract for convenience. As the project progressed, Sapient decided to terminate Siemens’ subcontract for cause. Three days later, Sapient executed a new $8-million-dollar agreement with the owner to provide the application management support services, which were originally within Siemens’ scope of work. Siemens sued for damages, including lost profits, alleging that the subcontract was wrongfully terminated.

After a five-week bench trial, the trial court found that there was no material breach of the subcontract justifying termination. As a fallback position, Sapient argued that it had a right to terminate at its convenience the portion of the contract associated with data conversion services. The trial court found that Sapient’s intent was to terminate the entire subcontract so that it could take over the application management services portion, which was not subject to the termination for convenience provision. As a result, the court determined that Sapient could not rely on the subcontract’s termination for convenience provision.

Having concluded that the subcontract was improperly terminated, the trial court focused on the issue of damages. Sapient argued that the subcontract’s limitation of liability clause meant Siemens could not make a claim for the lost profits arising from the breach of the application management support portion of the subcontract. In relevant part, the limitation of liability provision stated that neither party “will be liable to the other for indirect, special, consequential or punitive damages or for loss of profits ....” (emphasis added). The court found that “loss of profits” referred only to consequential or indirect profits, i.e., the opportunity cost associated with turning down other work due to work on the subcontract. As the court noted, a key principle of contract law is to place the plaintiff in the same position they would have been in had the contract been performed. Accordingly, the court concluded that the clause did not prevent Siemens’ recovery of lost profits from the application management support portion of the subcontract.

Although Atos involves an agreement for IT services, the lesson holds true for construction agreements. If, after careful consideration, it is decided to limit the agreement’s termination for convenience clause to specific obligations, the termination for convenience clause should be used only to terminate that specific obligation. If Sapient had done so here, it may have been able to eliminate Siemens’ award of lost profits. Finally, the court’s interpretation of the subcontract’s limitation of liability clauses serves as a helpful reminder that damage exclusion provisions may be narrowly construed.