Commercial Division Blog
Questions of Fact Preclude Dismissal of Gross Negligence Claim
On March 12, 2019, the First Department issued a decision in S.A. De Obras y Servicios, COPASA v. Bank of Nova Scotia, 2019 NY Slip Op. 01706, holding that questions of fact precluded the dismissal of a gross negligence claim, explaining:
The parties' March 2010 engagement letter provided that Scotia would be paid only if COPASA and Cointer successfully reached financial close; this payment — called a Success Fee — could not exceed $975,000. The engagement letter also included an exculpatory clause that limited defendants' liability for any direct loss or damage arising from or in connection with the services provided however the direct loss or damage is caused including negligence or willful misconduct by defendant" to 50% of the amount of the Success Fee actually received by defendant.
. . .
The record before us establishes that triable issues of material fact exist as to whether Scotia was grossly negligent in its development of the bid model for the Ruta 5 project. We affirm Supreme Court's denial of Scotia's motion to dismiss the sixth cause of action.
It is well-settled that contractual limitations on liability are generally enforceable. However, public policy forbids a party from attempting to avoid liability for damages caused by grossly negligent conduct. Thus, a gross negligence claim will be sustained where a party's conduct evinces a reckless disregard for the rights of others or smacks of intentional wrongdoing.
. . . Plaintiffs have raised an issue of fact as to whether Scotia's conduct in its development of the bid model was grossly negligent. Whether this indeed is a case of a simple mistake or reckless indifference is for a jury to determine" and summary judgment should have been denied.
Scotia recognized that modeling error and, specifically, the risk that a model does not conform to the tender documents, was one of the key risks of its business. Both COPASA's and Scotia's experts agreed that such risks are inherent in the financial advisory business and so an entity in Scotia's position must implement procedures to effectively guard against such risks.
Scotia maintained a Development and Audit Procedure for preparing and assessing financial models. That procedure required a secondary modeler to review the primary modeler's work to identify potential errors and provided that each financial model should be subject to at least three separate internal model audits before bid submission and one audit before financial close. Scotia referred to this internally as a model audit or a four-eye approach. Bodden, whose colleagues viewed him as a junior guy needing guidance, was assigned as the primary modeler. There is conflicting testimony about whether a secondary modeler was assigned: Bodden testified that Mégret filled that role, while Mégret stated that there was no doubt in his mind that he was not the secondary modeler. For his part Carneiro stated that he did not think that Mégret formally reviewed the financial model. Carneiro also acknowledged that the four-eye approach was not followed for the Ruta 5 transaction despite it being the current existing protocol.
As a result of deviation from the four-eye approach Scotia did not detect the modeling error prior to submission of the bid model, and COPASA and Cointer submitted a bid that was substantially lower than they had intended. Plaintiffs have sufficiently alleged that defendants' conduct evinced a reckless disregard for plaintiff's rights insofar as it failed to comply with, or actively disregarded, its own policies.
A second key risk identified by Scotia is departure or absence of an employee. Nevertheless, in the four weeks leading up to the bid submission, Scotia fired Kelly, the Managing Director of the Ruta 5 project; Carneiro was traveling on a different assignment, and then on vacation, and Carmen Lopez, who Carneiro expected would be taking over for him while he was away, was also fired. Thus, in the critical period prior to the bid submission, Scotia's senior team members on the Ruta 5 project were absent.
Finally, COPASA and Cointer's expert opined that Scotia's conduct represented an "extreme departure" from industry standards for the development of financial models. Specifically, plaintiffs' expert stated that industry standards and best practices — not to mention Scotia's own Development & Audit Procedures — required that the Ruta 5 model be subject to multiple internal audits by an experienced financial modeler who had a thorough understanding of the tender document requirements for this particular project. While Scotia's expert concluded to the contrary, and that Scotia had utilized numerous safeguards, this issue is one for a jury to resolve.
(Internal quotations and citations omitted).
Contract terms that limit a party's damages are common in commercial transactions. As this decision shows, there are important limits to the enforceability of such clauses. Contact Schlam Stone & Dolan partner John Lundin at email@example.com if you or a client face a situation where you are unsure whether a contractual damages limitation is enforceable.