Exceptions to the Enforceability of Limitation of Liability Clauses

Snell & Wilmer

Snell & WilmerA common feature of some contracts, including construction and design contracts, is a limitation of liability clause that limits or "caps" the amount of potential damages a party faces in the event of a breach. Although Arizona courts will generally enforce limitation of liability clauses, there are at least four potential ways to attack their enforceability under Arizona law.

1. Bad Faith.

In Airfreight Express, Ltd. v. Evergreen Air Center, Inc., the Arizona Court of Appeals adopted the "sensible rule" that "[a]s a matter of public policy, a party should not benefit from a bargain it performed in bad faith." Examples of bad faith include "evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms and interference with or failure to cooperate in the other party's performance."

Airfreight provides a good example of the type of showing required for establishing bad faith. There, the plaintiff, AFX, had a contract with a company to repair AFX’s aircraft so that it could perform an air cargo service contract with a thirdparty, Air France. In support of its bad faith allegation, AFX had evidence showing that: (1) the repair company intentionally delayed repairing AFX’s aircraft and (2) the repair company encouraged Air France to contract with the repair company’s sister company to provide air cargo service instead of using AFX’s delayed and unrepaired aircraft. On appeal, the Arizona Court of Appeals found that AFX presented sufficient facts to preclude summary judgment on whether the defendant repair company performed the contract in bad faith.

2. Fraud and Other Intentional Torts.

Another avenue to attack a limitation of liability clause is if a party seeking to invoke the limitation clause acted fraudulently or engaged in other intentional torts. The Airfreight court quoted Corbin on Contracts for the proposition that a contractual limitation of liability is "not effective, however, if that party acts fraudulently" and it noted that the Restatement (Second) of Contracts prohibits contracts from exempting parties from "intentional . . . tort liability." Fraud is one type of intentional tort, but this general statement about "intentional tort liability" may encompass other intentional torts, such as a breach of a fiduciary duty and the intentional interference with contract or business expectancy.

3. Recklessness.

A party’s reckless tort behavior may also render a limitation of liability clause unenforceable. The Airfreight court noted that § 195 of the Restatement (Second) of Contracts prohibited contracts exempting parties from "reckless tort liability." And "[i]n the absence of contrary Arizona authority, [Arizona courts] follow the Restatement of the Law." As defined by the Arizona Supreme court, a party acts recklessly even if the party did not realize the high degree of risk involved, but a reasonable person would have. S. Pac. Transp. Co. v. Lueck (adopting and quoting the definition of recklessness in the Restatement (Second) of Torts § 500, cmt. 5).

4. An Activity that Affects the Public Interest.

Finally, an Arizona court may not enforce a limitation of liability clause if the activity at issue concerns a public interest. Section 195(2)(b) of the Restatement (Second) of Contracts provides that a contracting term exempting a party for negligence is unenforceable if "the term exempts one charged with a duty of public service from liability to one to whom that duty is owed for compensation for breach of that duty." This "public interest" exception appears to be broader than the prior three exceptions. That is, whereas an Arizona court will not enforce a limitation of liability provision if the party seeking to limit harm caused intentionally, recklessly or in bad faith, this exception entails a court not enforcing a limitation of liability clause to exempt even negligent harm if the activity at issue concerns a "public service."

In determining whether the type of service is a "public" service, courts generally consider whether the activity is one suitable for public regulation. A Minnesota court has stated that: "Types of services thought to be subject to public regulation have included common carriers, public utilities, hospitals and doctors, innkeepers, public warehousemen and services involving extra-hazardous activities." In Schlobohm v. Spa Petite, Inc. An Arizona court has discussed this public interest exception in at least one published decision, but the court found that the activity at issue – car racing – did not affect the public interest because car racing is a non-essential, recreational activity for amusement. See Valley Nat. Bank v. Nat'l Ass'n for Stock Car Auto Racing, Inc.

In sum, a limitation of liability clause is not ironclad and an Arizona court may not enforce such a clause upon a showing of the exempting party’s bad faith, intentional tort activity, recklessness or engagement in an activity affecting the public interest.

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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