Drafting your contract to immunize you from liability even for gross negligence

An opinion by the New York Court of Appeals reminds drafters that, under the law of that state, a contract can be structured to absolve a service provider from liability even for its own negligence or gross negligence. The trick, according to the court, is to draft the contract so that:

1. the customer agrees to buy insurance to cover any damage or other loss that might result from the service provider’s negligence; and

2. the customer also waives the service provider’s liability, agrees to look solely to its insurer for recovery, and waives subrogation, so that the customer’s insurance company can’t come after the service provider for reimbursement of whatever the insurance company has to pay out for the damage.

This drafting approach worked for Diebold, Inc., an alarm-system company. Diebold provided backup alarm service for a bank. The bank was burglarized, allegedly because of Diebold’s gross negligence in ignoring problems with the alarm system. Diebold’s contract with the bank, though, included provisions like those enumerated above: The contract required the bank to buy insurance, and included a waiver of Diebold’s liability. As the court described the provision:

Diebold’s contract contained a clause entitled “Property Insurance and Waiver of Subrogation” where Abacus agreed to obtain insurance coverage to cover its losses in the event of a theft. The agreement between Diebold and Abacus provided that Abacus “shall look solely to its insurer for recovery of its loss and hereby waives any and all claims for such loss against Diebold” and that Abacus’ insurance policy would contain a clause providing that such waiver would not invalidate the coverage. [1]

The bank claimed that Diebold’s alleged gross negligence invalidated the limitation of liability. The court, however, held that while the exculpatory provision could not relieve Diebold for liability for gross negligence, the insurance provision and waiver of subrogation would be enforced: “A distinction must be drawn between contractual provisions which seek to exempt a party from liability and contractual provisions which in effect simply require one of the parties to the contract to provide insurance for all of the parties.” [2]

Incidentally, Diebold’s co-defendant did not have a mandatory insurance requirement in its contract, but merely left it up to the bank to decide whether to purchase insurance, nor did it include a waiver of liability and of subrogation. The court held that the co-defendant’s limitation of liability provisions could not withstand a claim (if proved) of gross negligence [3].

Comment: A contract drafter wanting to use the Diebold approach might also want to include a choice-of-law provision specifying New York law as the governing law for the contract. (Of course, other states’ law might be to the same effect.)

Comment: The court’s reasoning seems to imply that it didn’t matter which party buys the insurance — as long as the amount of the insurance wasn’t unreasonable, then it was OK to require the customer (or whoever) to look solely to the insurer for recovery of any loss that might occur.

Comment: In the real world of sales negotiations, a happy medium might be for the contract to provide:

• that the service provider’s liability is limited to X dollars, or to some formula such as X times the amount paid by the customer in the previous 12 months; and

• that the customer must purchase insurance (or self-insure) against losses in excess of the agreed limited amount, with the customer also waiving the service provider’s liability in excess of that amount.

Notes

[1] Abacus Federal Savings Bank v. ADT Security Services, Inc., No. 33 slip. op. at 4 (N.Y. Mar. 22, 2012) (affirming most grounds of dismissal of bank’s claim against alarm-system companies after burglary, but reversing as to breach-of-contract claim against one defendant) (citations, alteration marks, and internal quotation marks omitted), available at http://goo.gl/8YFL4.

[2] Id., slip op. at 6 (same parenthetical notes as above). The court went on to explain that “We have observed that gross negligence, when invoked to pierce an agreed-upon limitation of liability in a commercial contract must smack of intentional wrongdoing. It is conduct that evinces a reckless indifference to the rights of others.” Id., slip op. at 8 (same parenthetical notes as above).

[3] Id., slip op. at 4, 9 (same parenthetical notes as above).