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Drafting tip: Play the what-if game to check whether an exclusive-remedy formula might backfire on your client

In drafting and negotiating a formula for a contract — for example, a formula for computing damages — it’s important to consider how the computation might work under different factual scenarios. That’s because some courts take a laissez-faire attitude when contract provisions are agreed to by sophisticated parties represented by counsel. If such a formula ends up backfiring on one of the parties, that party might not get a sympathetic hearing.

For example, in a recent Seventh Circuit case:

  • A bank sold a package of distressed loans to an investment firm. The parties’ agreement included a representation about the status of the various assets that collateralized the loans in the package.
  • That representation, however, turned out to be incorrect as to some of those assets, meaning that the bank had breached the agreement.
  • A limitation-of-liability clause in the parties’ agreement capped the investment firm’s damages at an amount to be determined by computing the result of a specified formula.
  • On the facts of the case, that amount turned out to be a negative number, resulting in a zero damage award.

The investment firm claimed that the limitation-of-liability clause was unenforceable or waived, or that it failed of its essential purpose.

The district court disagreed, and granted summary judgment for the bank; the Seventh Circuit affirmed, saying:

Except in the most extraordinary circumstances, we hold sophisticated parties to the terms of their bargain. The terms of the parties’ bargain in this case results in zero recovery for [the investment firm]. The judgment of the district court is affirmed.

Southern Financial Group, LLC v. McFarland State Bank, No. 13-3378, part III (7th Cir. Aug. 15, 2014).

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