Buyer Beware: Court Upholds Punitive Damages Waiver in Case Alleging Fraud for "New" Aircraft Sale

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In a recent decision,1 the Texas Supreme Court upheld a contractual waiver of punitive damages despite a finding of fraud by the seller in the sale of a supposedly new aircraft that instead contained used and repaired engines. Though typically not available for breach-of-contract claims, punitive damages (also called exemplary damages) may be awarded in addition to actual damages in cases involving fraud or other types of egregious behavior, both as a punishment and to serve as a deterrent. Waivers of punitive damages are often found in contracts involving the sale and financing of aircraft assets, notwithstanding some uncertainty as to the waivers’ utility and enforceability. In the case at hand, the Court upheld such a waiver and reversed the jury’s award of significant punitive damages.2

Background3

In 2010, the plaintiffs (two high-net-worth individuals and their controlled entities) purchased a new4 Challenger 300 aircraft from Bombardier through its subsidiary, Flexjet. The plaintiffs also engaged Bombardier, again through Flexjet, to provide management services for the aircraft. Rather than engaging a third party to inspect the aircraft and accept delivery, under the purchase and management agreements, the plaintiffs gave Bombardier exclusive power over inspection and technical acceptance.5 Both the aircraft purchase agreement and the management agreement included limitation of liability clauses whereby the plaintiffs expressly waived the right to seek punitive damages.6

Following delivery of the aircraft, the plaintiffs became dissatisfied with Flexjet’s management services and eventually cancelled the management arrangement. Upon a subsequent inspection of the aircraft, the plaintiffs discovered that rather than being new, the aircraft’s engines were delivered in 2008 and had been installed and removed multiple times on at least two other aircraft. Further, one of the engines had previously been repaired for an interstage turbine temperature (ITT) split as well as water contamination and oil-wetted cavities.

According to the Court, Bombardier knew of the engine’s history but never told the plaintiffs. The Court further noted that one of Flexjet’s pilots noticed the ITT split during the aircraft’s initial flight and raised the issue with certain other Flexjet employees, all of whom believed the plaintiffs should be made aware of the engine’s history, however, Bombardier operations executives ultimately directed them not to tell the plaintiffs. Further, expert testimony provided at trial stated that the engine’s flight hours before being used on the aircraft were not properly recorded, and that nothing in the engine logbook showed the extent of the ITT split or its cause even though that information should have been recorded.

The plaintiffs sued Bombardier asserting several claims, including breach of contract and fraud. The jury in the trial court found in favor of the plaintiffs on both the breach of contract and fraud claims and awarded the plaintiffs both actual and punitive damages on the fraud claim. Bombardier appealed the verdict, which the court of appeals affirmed. Bombardier then appealed to the Texas Supreme Court, arguing among other things that the limitation of liability provisions in the purchase and management agreements precluded any recovery for punitive damages.

The Court’s Decision

The Texas Supreme Court reversed the award of punitive damages to the plaintiffs and upheld the validity of the waiver of punitive damages clauses in such agreements, on the basis that both the purchase agreement and the aircraft management agreement: (i) were freely entered into by sophisticated parties represented by attorneys in an arm’s-length transaction, and (ii) included an express limitation of Bombardier’s liability for punitive damages. The Court explained “as the plaintiffs point out, we have held that ‘fraud vitiates whatever it touches.’ ... We have never held, however, that fraud vitiates a limitation-ofliability clause. We must respect and enforce terms of a contract that parties have freely and voluntarily entered.” The Court stated that parties to a contract may bargain to limit punitive damages, as was done by the plaintiffs and Bombardier in the purchase and management agreements. While acknowledging that Bombardier’s failure to provide the plaintiffs with the new engines they bargained for was “reprehensible,” the Court’s decision recognized the “strongly embedded public policy favoring freedom of contract.”

The Court also commented on the seeming contradiction that the plaintiffs sought both to enforce the agreements in part (by seeking an award of actual damages as opposed to rescission based on the fraudulent conduct) and to invalidate the agreements in part (by striking the limitation-of-liability clauses), noting “the plaintiffs ‘cannot both have [the] contract and defeat it too.’”7

In reaching its decision, the Court indicated that because the plaintiffs did not assert a breach-of-fiduciary-duty claim (relating to the fiduciary relationship created between the parties by a power of attorney granted to Bombardier to inspect and approve the aircraft), it elected not to decide the issue of whether a breach of fiduciary duty for fraudulent conduct would affect the validity of a contractual waiver of punitive damages.

Conclusion

Given the complexity of the case and the various issues involved with respect to both the fraud claim and the other claims asserted, a different result could be reached based on the causes of action asserted and the remedies pursued. The result of this case should not be seen as binding in jurisdictions other than Texas, and a different result could also be reached based on the venue for a case. Nonetheless, it seems the plaintiffs may have avoided this outcome had they taken some simple precautions, and in this regard we note the following practical tips:

First, in relation to contractual drafting, where an agreement contains a limitation--of-liability clause, consider including an exception stating that the clause will not apply in the event of fraud. Such exceptions are common, and it can be difficult for a counterparty to argue (especially to its customer) that it should be protected in the event of its own fraud or other similarly bad conduct.8 In addition, even for a new aircraft purchase, provide sufficient detail in the purchase agreement of the expected condition of the aircraft and its components at the time of technical acceptance, including an express statement that the aircraft (and all of its components, including the engines) will be new. While not stated as a factor in its decision, the Court’s note that the purchase agreement did not clearly indicate a “new” aircraft may have signaled a willingness to consider a defense based on contractual ambiguity.

Second, engage experienced advisors at the outset of any aircraft transaction to provide counsel on the various legal and technical considerations involved. Legal counsel experienced in aircraft purchases could have suggested certain contractual protections for the plaintiffs, such as the ones noted above. Similarly, an experienced technical advisor could have worked with legal counsel to craft appropriate contractual language for the required delivery condition as well as suggest a qualified inspector for the aircraft and reject technical acceptance until any nonconformity with the required condition was rectified. Aircraft are expensive and technically complex assets, and as such it behooves parties in aircraft transactions to work with experienced industry professionals who can identify potential problems at the appropriate time: before they come to fruition.

1 The case is Bombardier Aerospace Corporation v. SPEP Aircraft Holdings, LLC; PE 300 Leasing, LLC; Saracen Pure Energy Partners, LP; Crane Capital Group, Inc.; James R. Crane; Floridian Golf Resort, LLC; Champion Energy Marketing, LLC; and Crane Worldwide Logistics, LLC. The Court’s opinion can be found at: http://www.txcourts.gov/media/1443450/170578.pdf

2 The amount of punitive damages awarded was more than double the amount of actual damages. The ruling did not affect the actual damages award.

3 The factual and procedural backgrounds set forth herein are based exclusively on those outlined in the Texas Supreme Court’s decision.

4 The Court stated that the purchase agreement never clearly indicated that the aircraft would be new. Nonetheless, the Court noted that “[i]n the purchase negotiations, [the individuals] specified they were agreeing to purchase a new aircraft” and it seems to have been accepted without contention that the aircraft would be new at delivery.

5 According to the court, the plaintiffs did not hire a third party as they believed that, among other things, “a new airplane. . .wouldn’t. . .require an inspection.”

6 The purchase agreement provided that “Flexjet will not be liable to either customer for any indirect, special, consequential damages or punitive damages arising out of any lack or loss of use of any aircraft, equipment, spare parts, maintenance, repair or services rendered or delivered under this purchase agreement.” The management agreement provided that “[n]either party hereto may be held liable to the other party for any indirect, special or consequential damages and/or punitive damages for any reason, including delay or failure to furnish the aircraft or by the performance or non-performance of any management services covered by this Management Agreement.”

7 In this regard we note that “severability clauses” are also commonly included as part of the contractual “boilerplate” in aircraft purchase and finance transactions. Such clauses state that if any provision of the contract is found to be invalid, the invalidity will render only that provision ineffective without invalidating the remainder of the contract. It is unclear whether the purchase and management agreements contained such a clause, and the Court’s decision did not include any discussion on the effectiveness of such clauses.

8 One common formulation is that the clause will not apply in the event of “fraud, gross negligence or willful misconduct.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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