California Supreme Court holds that limitations of liability provisions are unenforceable for willful conduct under Civil Code section 1668

In response to a request from the Ninth Circuit Court of Appeals to interpret the scope of California Civil Code section 1668 and its rule that parties may not contract away liability for “willful injury to the person or property of another,” the California Supreme Court unanimously held on April 24 in New England Country Foods, LLC v. VanLaw Food Products, Inc. that a contractual claim limiting damages for willful injury to the person or property of another is invalid under section 1668, even where the contract does not entirely exempt a party from liability from all possible damages.

Key Takeaways

Limitation of liability clauses will not be enforceable under California Civil Code section 1668 when they operate to effectively exempt a wrongdoer from damages arising from willful injury. Notably, the California Supreme Court’s holding does not impact the continued viability of the economic loss rule, which provides that contracting parties may not recover in tort for purely economic damages arising from the breach of the contract unless the plaintiff can demonstrate harm caused by conduct independent of the contractual breach.

California Civil Code §1668

Enacted in 1872, California Civil Code §1668 states:

“All contracts which have for their object, directly or indirectly, to exempt any one from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.”

Summary of Case and Holding

New England Country Foods (“NECF”) began selling its brand of barbeque sauce to Trader Joe’s in 1999. While NECF initially made the sauce in-house, it later decided to outsource manufacturing to VanLaw Food Products (“VanLaw”). In 2015, the parties entered into a contract under which VanLaw agreed to manufacture NECF’s BBQ sauce. The contract also included a provision prohibiting VanLaw from reverse-engineering the BBQ sauce.

The contract also contained provisions limiting the parties’ possible damages. The limitation of liability provision provided that “in no event will either party be liable for any loss of profits, loss of business, interruption of business, or for any indirect, special, incidental or consequential damages of any kind, even if such party has been advised of the possibility of such damages.” An indemnification provision further provided that “in no event shall either party be liable for any punitive, special, incidental or consequential damages of any kind (including but not limited to loss of profits, business revenues, business interruption and the like), arising from or relating to the relationship between [VanLaw] and NECF, regardless of whether the claim under which such damages are sought is based upon breach of warranty, breach of contract, negligence, tort, strict liability, statute, regulation or any other legal theory or law, even if either party has been advised by the other of the possibility of such damages.”

NECF alleged that when the parties were unable to renew the contract at the time of its expiration, VanLaw decided it would “clone” the sauce and then sell it directly to Trader Joe’s. NECF asserts that because of VanLaw’s plan to clone the sauce, Trader Joe’s ended its decades-long relationship with NECF.

NECF sued VanLaw in federal court, claiming breach of contract, intentional interference with contractual relations, intentional interference with prospective economic relations, negligent interference with prospective economic relations, and breach of fiduciary duty. NECF sought $6 million in past and future lost profits and punitive damages.

The district court granted VanLaw’s motion to dismiss the complaint based on the contractual provisions that limited damages. The court reasoned that the contract allowed only for direct damages and injunctive relief, whereas NECF sought lost profits, attorneys’ fees and costs, and punitive damages. The court rejected NECF’s argument that parties cannot limit damages for future intentional conduct under section 1668, reasoning that it merely acts to prevent contracts that completely exempt parties from liability, not simply limit damages. With leave of court, NECF amended its complaint, this time alleging that the only possible harm from the alleged wrongs committed by VanLaw was a loss of profits and thus the limitation-of-liability provisions, if applied, would completely exempt VanLaw from liability, thus implicating section 1668.

The district court was unpersuaded, and citing the rule that parties may bargain to limit liability for a breach of contract, the court noted that it would “not erase bargained-for contract provisions simply because one party now wishes they were different.” Regarding section 1668, the court noted that the limitation provisions in the contract did not bar all monetary damages but merely limited them to specific types of damages that NECF did not suffer.

NECF appealed to the Ninth Circuit. After oral argument, the Ninth Circuit asked the California Supreme Court to decide the following question: “Is a contractual clause that substantially limits damages for an intentional wrong but does not entirely exempt a party from liability for all possible damages valid under California Civil Code Section 1668?” In response to that question, the court held that a contractual claim limiting damages for willful injury to the person or property of another is invalid under section 1668, even where the contractual terms do not entirely exempt a party from liability from all possible damages.

Rationale for Decision

The court based its conclusion that limitations on damages provisions in the contract at issue were invalid under section 1668 on three factors: (1) the language and purpose of the statute, (2) the policy discouraging willful tortious conduct, and (3) the general agreement in case law that limits on liability and full releases are treated similarly.

The court examined the language and purpose of section 1688 and concluded that the California legislature did not intend to allow parties to privately negotiate how much they are willing to pay where there is the infliction of willful injury. In reviewing the text of the statute, the court declined to read the word “exempt” to mean that section 1668 bars only full releases of liability. First, the phrase “exempt … from responsibility” does not necessarily mean exempt from all possible responsibility, and second, the language surrounding the word “exempt” suggests that section 1668 should be read broadly, as it applies to contracts that have for their object, directly or indirectly, to exempt anyone from responsibility for willful tortious conduct.

The court also analyzed and relied on the public policy discouraging willful tortious conduct in concluding that section 1668 applied. This application of the statute “effectuates its purpose of safeguarding our tort system.”  Although the court acknowledged that private parties have “wide latitude” to form contracts, that latitude is bounded by such broader social policies (“[O]ur tort system’s concern with vindicating social policy is at its zenith when it comes to willful wrongs.”)

Finally, the court based its holding on its conclusion that applicable law treats contractual limits on liability and full releases similarly. The court cited several cases that held that limitation of liability provisions are valid in similar circumstances as exemptions from liability, and then analogized that treatment to cases in which section 1668 had been applied to invalidate provisions that had merely limited a party’s liability, notwithstanding the fact that these cases did not address section 1668 ’s “willful injury” language.  The court also cited several cases from California and from other jurisdictions that have held that releases of liability for “willful or wanton” conduct are against public policy, without distinguishing between limitations on liability and full releases.

Comments About the Economic Loss Rule

The holding leaves untouched the economic loss doctrine which provides that contracting parties may not recover in tort unless the plaintiff can demonstrate harm above and beyond a broken contractual promise: [“Section 1668 does not preclude parties from limiting their liability for pure breaches of contract absent a violation of an independent duty that falls within the ambit of section 1668. Where the claims asserted are “nothing more than a breach of … contractual obligations,” section 1668 does not apply.”]

The court further acknowledged that many of VanLaw’s arguments for upholding the limitation provisions were rooted in its position that NECF had asserted nothing more than a contractual breach of the reverse-engineering provision “couched” as a tort. But whether NECF had adequately alleged torts independent of a breach of contract was not before the court, and the court expressly stated that it was not addressing the issue of whether or not NECF had adequately pleaded facts to support its tort claims that had a basis independent of those facts on which its contractual claims were based. Presumably, if the facts on which the tort claims were based are inextricably tied to those on which the contractual claims are based, then VanLaw would still be able to assert a defense based on the economic loss doctrine.

Interestingly, just days before the NECF opinion was published, the Colorado Supreme Court addressed the issue of whether or not there is an exception to the economic loss rule for willful and wanton conduct under Colorado law. In Mid-Century Ins. Co., v HIVE Constr., Inc., the court drew an important distinction between intentional conduct (which is an exception to the rule) and willful and wanton conduct and concluded that the exception does not apply in cases involving merely willful and wanton conduct. We analyzed the Colorado Supreme Court’s opinion on the economic loss rule here. To date, California has not recognized such exceptions to the economic loss rule in cases involving either alleged fraud or willful and wanton conduct.

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