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Seventh Circuit Update: A (Narrow) Opening for Recovering Lost Profits in Information Technology Dis Seventh Circuit Update: A (Narrow) Opening for Recovering Lost Profits in Information Technology Dis

Seventh Circuit Update: A (Narrow) Opening for Recovering Lost Profits in Information Technology Disputes

Recovery of lost profits in Information Technology (IT) disputes is often out of reach for litigants. These damages are elusive due to the interplay of contract and tort law that apply to IT arrangements.

The contracts pose challenges because they typically bar recovery of consequential damages, and courts often deem “lost profits” as consequential. Damages limitation clauses are ubiquitous in IT contracts. While meant to indicate the parties’ negotiated risk allocation, the provisions often fail to meet that purpose. When parties seek damages for lost profits, damages limitation clauses can dramatically limit a business’s exposure to liability. Often, the availability for recovery of lost profits will turn on whether they constitute direct or indirect damages. In most cases, lost profits are considered indirect damages, which parties can exclude in a damages limitation clause.[1] With recovery of damages barred by the contract, the only avenue to recover lost profits is through tort liability.

Finding no recourse under contract, litigants might turn to tort law. Recovery under tort law is similarly beyond the litigants’ grasp, though, because lost profits are considered purely economic, so barred by the economic loss — or, in Illinois, the Moorman, doctrine. The challenge of recovering lost profits has seemed insurmountable for decades in traditional IT disputes, but has been put under a spotlight given the increasing exposure from data security incidents.

A pair of recent decisions handed down by the Northern District of Illinois — Aculocity and DreamPak – while not resolving these problems, offer insight for litigants seeking (or trying to avoid) recovery of lost profits in an IT dispute. 

Aculocity

The Northern District of Illinois, earlier this year, confronted the question of whether lost profits, resulting from the alleged breach of a software development contract, constituted indirect or direct damages in Aculocity, LLC, v. Force Marketing Holdings, LLC.[2] Aculocity, a data management software developer and consultant, and Force Marketing, a provider of marketing services to automobile dealers, entered into a contract whereby Aculocity would perform certain professional software development services for Force Marketing. Aculocity believed it had completed the work, but Force Marketing was unsatisfied and refused to pay. Aculocity then brought suit for breach of contract — among other claims — and sought damages for lost profits.

The contract had a limitations clause that precluded damages for consequential damages and specifically referred to “lost profits.” Force Marketing filed for partial summary judgment arguing the agreement between the parties barred Aculocity from recovering “for consequential, incidental, indirect, punitive, or special damages (including loss of profits…).”[3] The court began its analysis by distinguishing between direct and indirect damages. Direct damages, according to the Northern District, “are ‘damages that the law presumes follow the type of wrong complained of.”[4] Indirect damages, on the other hand, are “losses or injuries that do not flow directly and immediately from a party’s wrongful act but rather result indirectly from the act.”[5] The parties did not dispute that Aculocity was entitled to direct damages. The issue was whether lost profits are recoverable as direct damages, rather than indirect damages. The answer to that inquiry depends on the degree of foreseeability for that type of damage.[6]

The court teed up the question but sadly did not answer it. Rather than make a determination as to whether the damages in this case were direct or indirect, the court punted the question — noting that additional discovery was necessary.[7] Aculocity, however, does stand for the proposition that lost profits are not necessarily consequential damages and are not automatically barred when sought under a contract with a damages limitations provision. Indeed, the opinion outlines a framework of analysis for future decisions addressing claims for recovery of lost profits, despite the presence of a damages limitation clause.

DreamPak

This year, the Northern District of Illinois also tangled with the question of whether lost profits are always barred by the Moorman doctrine. The court’s answer was no. In DreamPak, LLC v. Infodata Corp.,[8] the court considered a claim for lost profits arising out of a software sales and consulting contract. DreamPak, a manufacturer of dietary supplements, engaged Infodata to implement a new software package. The parties executed an agreement, which required Infodata to provide status reports throughout the project. According to DreamPak, when it asked for updates, Infodata was consistently unresponsive. Like other IT disputes, the parties had disagreements about multiple aspects of the contract’s performance. The parties’ disagreements regarding the scope of the project culminated in DreamPak terminating the agreement and bringing claims for breach of contract and negligent misrepresentation. DreamPak sought damages for lost profits and lost productivity. Infodata argued DreamPak could not bring a negligent misrepresentation claim for purely economic damages under the economic loss or Moorman doctrine, which bars recovery in tort for purely economic damages. DreamPak countered by arguing its claim fell within an exception to the Moorman doctrine allowing recovery for purely economic damages “where the plaintiff’s damages are proximately caused by a negligent misrepresentation by a defendant in the business of supplying information for the guidance of others in their business transactions.”[9]

Courts place businesses into three categories when evaluating this exception to the Moorman doctrine: (1) businesses that supply non-informational goods or services, where any information supplied is incidental to the sale of the product; (2) businesses that supply information as well as non-informational goods or services; and (3) businesses that provide a product consisting solely of information. Illinois applies Moorman to services as well as the sale of goods because both business contexts provide “the ability to comprehensively define a relationship” by contract.[10]

The court held that software is considered a non-informational product, so DreamPak could not recover economic damages stemming from the sale of the software. Still, DreamPak argued Infodata’s consulting service provided information and was not a tangible good, which would place Infodata in the second category of businesses described above: a business that supplies information and non-informational offerings. However, the court determined the software was the heart of the contract and any consulting services provided by Infodata amounted to nothing more than installation of the software, making any information provided “ancillary to the software provided.” [11] The court further stated even if it were to have found that Infodata fell within the second category of businesses, in this case all of the harm resulted from Infodata’s misrepresentations regarding the software, not any information Infodata would have provided about business practices.

The Moorman doctrine provides two other exceptions that allow recovery of purely economic damages under a tort theory of liability: (1) for personal injuries or property damage resulting from sudden, calamitous occurrences and (2) fraud. Importantly, the Seventh Circuit has determined data breaches do not constitute a sudden and calamitous event, but rather are a foreseeable risk of doing business.[12]

Accordingly, while not addressing a damages limitation clause, DreamPak sets the stage for considering the circumstances under which a party may be able to recover purely economic damages under a theory of tort liability where contract liability offers no relief.

Conclusion

Although Seventh Circuit courts have yet to articulate a clear rule on recovery beyond a damages limitations in the context of an IT contract, Aculocity and DreamPak provide an analytical framework that outlines situations where a party could recover lost profits, despite a contractual provision that, on its face, appears to exclude such recovery. First, if lost profits were deemed direct damages rather than indirect damages a court could allow recovery. This determination, at least in the Seventh Circuit, will depend on the foreseeability of the harm. Second, if the party seeking damages for lost profits does not have a contractual remedy, a court could still award damages for lost profits under a tort theory of liability if one of the three Moorman exceptions applies.

If you have additional questions, please contact Reena Bajowala.

Summer associate Kole Binegar contributed to this article.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
 
[1] Tate & Lyle Ams. LLC v. Glatt Air Techniques, Inc., 2016 WL 7422289 (C.D. Ill. May 20, 2016) (“Courts normally view lost profits and lost business opportunities as consequential damages”); see also Cole Energy Development Co. v. Ingersoll-Rand Co., 913 F.2d 1194, 1202 (7th Cir. 1990) ("[C]onsequential damages would include the lost opportunity cost [the plaintiff] incurred because the profits were delayed."); Afram Export Corp. v. Metallurgiki Halyps. S.A., 772 F.2d 1358 , 1370 (7th Cir. 1985) ("[A] forgone profit from exploiting a valuable opportunity that the breach of contract denied to the victim of the breach fits more comfortably under the heading of consequential damages than of incidental damages.”)
[2] No. 17-CV-2868, 2019 WL 764040 (N.D. Ill. Feb. 21, 2019).
[3] Id. at 2.
[4] Id.  (citing Westlake Fin. Grp. Inc. v. CDH-Delnor Health Sys., 25 N.E.3d 1166, 1174 (Ill. App. Ct. 2015).
[5] Id.
[6] See Westlake, 25 N.E.3d at 1174-75; Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61, 67 (Ill. 1987) (lost profits were direct damages when the defendant failed to properly include plaintiff’s advertisement in a newly published telephone directory).
[7] It is worth pointing out that other jurisdictions would disagree with this foreseeability analysis. “[F]oreseeability is the limit to all contract damages, not the distinction between direct and consequential damages.” Jay Jala, LLC v. DDG Construction, Inc., No. 15-3948, slip op. at 3-5 (E.D. Pa. Nov. 1, 2016).
[8] No. 1:18 C 3396, 2019 WL 3410221 (N.D. Ill. Jan. 8, 2019).
[9] In re Chi. Flood Litig., 176 Ill. 2d 179, 199 (1997).
[10] Community Bank of Trenton v. Schnuck Markets, Inc. 887 F.3d 803 (7th Cir. 2018) (citing Fireman’s Fund Ins. Co. v. SEC Donohue, Inc., 679 N.E.2d 1197, 1200 (1997), quoting Congregation of the Passion, Holy Cross Province v. Touche Ross & Co., 636 N.E.2d 503, 514 (1994)).
[11] See MW Mfrs., Inc. v. Friedman Corp., No. 97 C 8319, 1988 WL 417501 (N.D. Ill. July 21, 1998).
[12] See Cmty. Bank of Trenton v. Schnucks Mkts. Inc., 887 F.3d 803 (7th Cir. 2018).
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