Biotronik A.G. v. Conor Medsystems Ireland, Ltd.

OPINION OF THE COURT

Rivera, J.

In this breach of contract action, plaintiff sought lost profits from an exclusive distribution agreement as general damages. We hold that lost profits were the direct and probable result of a *802 breach of the parties’ agreement and thus constitute general damages.

L

In May 2004, plaintiff Biotronik A.G., a manufacturer and distributor of medical devices, and defendant Conor Medsystems Ireland, Ltd., the developer and manufacturer of CoStar, a drug-eluting coronary stent, entered an agreement designating plaintiff as the exclusive distributor of CoStar for a worldwide market territory excluding the United States and certain other countries.1 The geographic territory covered by the agreement included countries in which plaintiff had an existing direct sales business.2 The agreement allowed defendant to take advantage of plaintiffs distribution business and sales force in order to penetrate the market.

Under the agreement, plaintiff served as defendant’s “distributor . . . with respect to [CoStar] for sale to any purchasers for use (or for re-sale in the case of [plaintiff]’s sub-distributors)” in the designated territory. The agreement required plaintiff “[t]o use commercially reasonable efforts to promote, market, and distribute [the stents]” in the territory. Plaintiff agreed to supply defendant with “all reasonably required support to comply with any local regulatory law and requirement” and to assist defendant with the registration of its trademarks. Thus, defendant relied on plaintiffs expertise in handling a wide range of regulatory matters in order to make sales of CoStar possible.

Nonetheless, defendant maintained direct involvement in the marketing and sale of CoStar. For example, the agreement required that plaintiff use only defendant’s sales and technical literature, which had to display references to defendant and plaintiff in equal prominence. Plaintiffs translations of these materials were subject to defendant’s final approval. Defendant would supply training support and sales samples, including free initial training, and would provide additional sales training, for a fee, as requested by plaintiff. Thus, defendant retained considerable influence over the quality and nature of CoStar’s sales and marketing.

*803 The agreement was not a simple resale contract, where one party buys a product at a set price to sell at whatever the market may bear. Rather, the price plaintiff paid defendant reflected the actual sales, and sales price, of CoStar stents. The agreement required plaintiff to pay defendant a transfer price calculated as a percentage of plaintiffs net sales of CoStar: 61% for direct sales and 75% for indirect sales.3 Each quarter, the parties would calculate a minimum price based on net sales during the preceding quarter. Plaintiff remained obligated to pay defendant the full transfer price for its sales, even when the actual sales price exceeded the minimum price. Thus, the contract would only operate if plaintiff sold stents, and the payment defendant received bore a direct relationship to the market price plaintiff could obtain.

The agreement further required plaintiff to provide defendant with a forecast, updated monthly, which predicted plaintiffs intended purchases for the upcoming 12-month period. The purpose of the forecast was to facilitate plaintiffs “marketing plans” and permit defendant and its suppliers “to meet their lead times” for CoStar. The agreement required plaintiff to make a minimum monthly order, but defendant could limit the maximum order to 130% of the most recently forecasted quantity. Thus, the agreement guaranteed defendant a set number of sales each month, but defendant could cap the number of orders it filled even when plaintiff was ready, willing, and able to sell more stents.

The agreement allowed defendant to terminate immediately in the event of a change of control of plaintiff “that has, or in the reasonable opinion of [defendant] could have, a material adverse effect on the distribution” of CoStar.

The agreement included a damages limitation provision restricting the parties to general damages:

“NEITHER PARTY SHALL BE LIABLE TO THE OTHER FOR ANY INDIRECT, SPECIAL, CONSEQUENTIAL, INCIDENTAL OR PUNITIVE DAMAGE WITH RESPECT TO ANY CLAIM ARISING OUT OF THIS AGREEMENT (INCLUDING WITHOUT LIMITATION ITS PERFORMANCE OR BREACH OF THIS AGREEMENT) FOR ANY REASON.”

*804 The agreement was to be governed by New York law. Its term was through December 31, 2007, and it provided for an automatic one year renewal, absent a timely termination notice from either party.

When the parties entered the agreement, defendant had not received regulatory approval for CoStar from either the European authorities or the United States Food and Drug Administration (FDA). However, the agreement anticipated that CoStar would pass regulatory hurdles following ongoing tests in certain European countries. In February 2006, after defendant obtained European regulatory approval, plaintiff began distributing CoStar.

In February 2007, Johnson & Johnson acquired defendant. At the time of the acquisition, Johnson & Johnson marketed another drug-eluting stent, known as Cypher, which was directly competitive with CoStar. Also at this time, defendant was engaged in a drug trial to secure FDA approval to distribute CoStar in the United States. According to plaintiff, defendant used a substantially different product during this trial than it had in its European trials.

In May 2007, defendant announced that the FDA trials could not establish that CoStar was equivalent to Taxus, a widely marketed stent manufactured by Boston Scientific. Based on these results, defendant terminated its FDA application and notified plaintiff that it was recalling CoStar and removing it from the worldwide market. Defendant paid plaintiff 8,320,000 Euros and a 20% handling fee to satisfy its recall obligations under the agreement.

IL

In November 2007, plaintiff sued defendant for breach of contract and sought damages for lost profits related to its resale of the stents. Plaintiff argued that its claim for lost profits on the resale of CoStar constituted general damages, falling outside the scope of the agreement’s limitation on recovery.

Defendant moved for summary judgment on both liability and damages. Supreme Court denied summary judgment on the question of liability, concluding that disputed issues of fact remained as to whether defendant breached the agreement (Biotronik, A.G. v Conor Medsystems Ireland, Ltd., 33 Misc 3d 1219[A], 2011 NY Slip Op 51980[U] [2011]). However, Supreme Court also concluded that the lost profits sought by plaintiff *805 were consequential damages and subject to the agreement’s damages limitation provision, leaving plaintiff with claims for only nominal and other damages. By denying plaintiff lost profits as a remedy, Supreme Court effectively ended the lawsuit, and the court entered a judgment dismissing the complaint.

Plaintiff appealed to the Appellate Division, which affirmed the judgment, concluding that plaintiffs claim for lost profits was barred by the agreement’s limitation on consequential damages (Biotronik A.G. v Conor Medsystems Ireland, Ltd., 95 AD3d 724, 725 [1st Dept 2012]). The Appellate Division granted plaintiff leave to appeal to this Court and certified a question asking whether its order was “properly made” (2012 NY Slip Op 85229[U] [2012]).

We agree with plaintiff that damages must be evaluated within the context of the agreement, and that, under the parties’ exclusive distribution agreement, the lost profits constitute general, not consequential, damages.

III.

Based on the damages limitation provision of the agreement, plaintiff may only recover lost profits if they are general damages.4 The limitations provision does not specifically preclude recovery for lost profits, nor does it explicitly define lost profits as consequential damages. We thus turn to our precedent for guiding principles to assist in determining whether, under this agreement, plaintiff’s lost profits are general damages and therefore recoverable.

General damages “are the natural and probable consequence of the breach” of a contract (American List Corp. v U.S. News & World Report, 75 NY2d 38, 43 [1989]; Kenford Co. v County of Erie, 73 NY2d 312, 319 [1989]). They include “money that the breaching party agreed to pay under the contract” (Tractebel Energy Mktg., Inc. v AEP Power Mktg., Inc., 487 F3d 89, 109 [2d Cir 2007], citing American List Corp., 75 NY2d at 44). By contrast, consequential, or special, damages do not “directly flow from the breach” (American List Corp., 75 NY2d at 43).

“The distinction between general and special contract damages is well defined but its application to specific contracts and *806 controversies is usually more elusive” (id.). Lost profits may be either general or consequential damages, depending on whether the non-breaching party bargained for such profits and they are “the direct and immediate fruits of the contract” (see Tractebel, 487 F3d at 109 n 20, citing Masterton & Smith v Mayor of Brooklyn, 7 Hill 61, 68-69 [1845]). Otherwise, where the damages reflect a “loss of profits on collateral business arrangements,” they are only recoverable when “(1) it is demonstrated with certainty that the damages have been caused by the breach, (2) the extent of the loss is capable of proof with reasonable certainty, and (3) it is established that the damages were fairly within the contemplation of the parties” (Tractebel, 487 F3d at 109, citing Kenford Co. v County of Erie, 67 NY2d 257, 261 [1986]).

Lost profits from the breach of a distribution contract are subject to these principles, and we have recognized such profits as general damages where the nature of the agreement supported a conclusion that they flowed directly from the breach. In Orester v Dayton Rubber Mfg. Co. (228 NY 134 [1920]), a case involving a distribution agreement where the issue was the proper measure of damages, we treated lost profits as general damages for breach of an exclusive distribution agreement. In Orester, the manufacturer of a particular brand of tires sought to penetrate the market in Onondaga and neighboring counties through an exclusive distribution agreement with the plaintiff. Under the agreement, the manufacturer sold and supplied its tires to plaintiff at a reduced price, and plaintiff agreed to “aggressively push” the sale of the tires within an exclusive territory. After plaintiff sold 200 tires under the contract, defendant refused to provide more tires, and plaintiff sued for lost profits. We stated that the buyer’s damages were limited to “only those that would naturally arise from the breach itself, or those that might reasonably be supposed to have been contemplated by the parties when the contract was made.” (Orester, 228 NY at 137). We held that those damages included net profits from the sale of the tires (id. at 138-139). We observed that the contract “contemplated building up a business for the sale of the [seller’s tires] and creating a demand for that particular tire” (id. at 138). We concluded that the plaintiffs resale profits were not the result of “collateral engagements or consequential damages” (id.). Instead, the profits “if reasonably certain, may be said to measure the value of the contract to the plaintiff’ (id. at 138-139). Lost profits were, accordingly, the natural and probable consequence of defendant’s breach.

*807 In American List Corp. v U.S. News & World Report (75 NY2d 38 [1989]), we concluded that lost profits denied plaintiff were the natural and probable consequence of defendant’s breach (id. at 43-44). The case involved a contract that obligated the defendant to a 10-year rental of mailing lists compiled by the plaintiff. At the time of the agreement, defendant sought to expand its readership to the college student market. Plaintiff did not yet have mailing lists of college students, and defendant agreed to finance start-up costs through higher fees for the first five years. Attached to the agreement was a schedule of the plaintiff’s estimated annual losses and profits. Further, the agreement required an annual review of the estimated figures in order to “adjust[ ] the cost per name to be charged to defendant” (id. at 41). Plaintiff provided, and the buyer purchased, names sufficient to conduct three mailings during a 11/2-year period. A year after the parties signed the contract, defendant was purchased by a new owner, who canceled the contract.

We concluded that plaintiff could recover as general damages “moneys which defendant undertook to pay under the contract” (id. at 43). The schedule of plaintiff’s estimated losses and profits “reflected the cost of this joint venture to defendant” (id. [internal quotation marks omitted]). Accordingly, the lost profits were the natural and probable consequence of defendant’s breach (id. at 43-44).

Defendant relies on Compania Embotelladora Del Pacifico, S.A. v Pepsi Cola Co. (650 F Supp 2d 314 [SD NY 2009]) for its argument that plaintiff cannot recover lost profits as general damages. However, Compania, like Orester and American List, took a careful look at the underlying agreement to determine whether lost profits were general damages. In Compañía, the parties entered an exclusive bottler agreement under which the defendant authorized the plaintiff to bottle, sell and distribute Pepsi Cola to a designated area in Peru. Over the course of several years, the parties complied with the agreement until, eventually, the defendant failed to prevent a competitor from selling Pepsi in plaintiff’s exclusive distribution area. The District Court for the Southern District of New York concluded that plaintiff could not recover its lost profits. The court stated that lost profits are consequential damages “when, as a result of the breach, the non-breaching party suffers loss [of] profits on collateral business relationships” (id. at 322, quoting Tractebel, 487 F3d at 109). The plaintiff sought “lost profits from lost sales to third-parties that are not governed” by the agreement, *808 which the court concluded were consequential damages (id.). Had plaintiff sought lost profits “caused by the breach,” or under “an existing resale contract,” or under an “exclusive distributorship agreement,” the damages would have been general, not consequential (id.). Instead, plaintiff sought only lost profits that were the result of collateral business arrangements, which it could not collect as general damages.

The distinction at the heart of these cases is whether the lost profits flowed directly from the contract itself or were, instead, the result of a separate agreement with a nonparty (see e.g. Appliance Giant, Inc. v Columbia 90 Assoc., LLC, 8 AD3d 932 [3d Dept 2004] [Supreme Court erred when it included loss from subsidiary rental contracts as general damages in a breach of a lease agreement]; In re CCT Communications, Inc., 464 BR 97 [SD NY 2011] [classifying as consequential damages lost profits earned through third-party contracts for telecommunications services]; International Gateway Exch., LLC v Western Union Fin. Servs., Inc., 333 F Supp 2d 131 [SD NY 2004] [lost profits on a third-party distribution contract were consequential damages]). This distinction does not mean that lost resale profits can never be general damages simply because they involve a third-party transaction. Such a bright-line rule violates the case-specific approach we have used to distinguish general damages from consequential damages (American List Corp., 75 NY2d at 42-43; Kenford Co., 73 NY2d at 319; Orester, 228 NY 138-139).5 The present case illustrates the wisdom of our traditional approach.

Here, the agreement used plaintiff’s resale price as a benchmark for the transfer price. The contract clearly contemplated that plaintiff would resell defendant’s stents. That was the very essence of the contract. Any lost profits resulting from a breach would be the “natural and probable consequence” of that breach (Tractebel, 487 F3d at 108; American List Corp., 75 NY2d at 44).

Although the lost profits sought by plaintiff are not specifically identified in the agreement, it cannot be said that defend *809 ant did not agree to pay them under the contract, as these profits flow directly from the pricing formula. The purpose of the agreement was to resell. Indeed, defendant, like the defendant in Orester, sought to enter a market unavailable to it by capitalizing on plaintiffs distribution network. The fact is that both defendant and plaintiff depended on the product’s resale for their respective payments.

The dissent argues that plaintiffs lost profits were not a natural and probable consequence of the breach, in part, because the contract did not require any payments from defendant to plaintiff (see dissenting op at 816). This argument places form over substance and is not compatible with Tractebel and American List. Whether lost profits are the natural and probable result of a breach does not turn on which party actually takes out the checkbook at the end of the fiscal quarter. Instead, we look at the nature of the agreement.

Defendant argues, alternatively, that plaintiffs claim for lost profits must fail under UCC 2-715 (2) (a), which includes as consequential damages “any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise.” Defendant’s reliance on UCC 2-715 (2) (a) is misplaced. As the Official Comment makes clear, section 2-715 (2) rejects the “tacit agreement” test for recovery of consequential damages, and follows the common-law rule that the seller is liable for consequential damages of which the seller had “reason to know.” (UCC 2-715, Comment 2.) The Official Comment that “resale is one of the requirements of which the seller has reason to know” does not resolve the issue presented in this case (UCC 2-715, Comment 6).6

Here, the parties’ agreement was not simply one between a seller and a buyer who is in the business of reselling. The agree *810 ment was much closer to the “joint venture” identified in American List Corp. (75 NY2d at 43). The parties negotiated a pricing formula and target volume based on the resale of CoStar. The agreement reflects defendant’s anticipation and dependence on the resale, and, as such, the agreement reflects an arrangement significantly different from a situation where the buyer’s resale to a third party is independent of the underlying agreement.7

Accordingly, the order of the Appellate Division should be reversed with costs, the case remitted to the Appellate Division for further proceedings in accordance with this opinion, and the certified question not answered as unnecessary.

. The agreement specified the territory as “Worldwide, except for Japan, United States, India, Pakistan, Australia, New Zealand, Kenya, Sri Lanka, Tanzania, and Korea.”

. The agreement specified Austria, Belgium, Brazil, China, Czech Republic, France, Germany, Hungary, Israel, Italy, Lithuania, Netherlands, Poland, Russia, Spain, Denmark, Switzerland, and United Kingdom as countries where plaintiff would conduct direct sales.

. Indirect sales were sales made by affiliates.

. Contract provisions limiting remedies are enforceable unless they are unconscionable (Wilson Trading Corp. v David Ferguson, Ltd., 23 NY2d 398, 403 [1968]). In this case, plaintiff does not argue that the limitation is unconscionable.

. The dissent would rely on this bright-line rule and consign the “natural and probable consequence” test to the dustbin of legal history (dissenting op at 819-821). As the dissent must acknowledge, however, the law continues to recognize the “natural and probable consequence” to be the measure of general damages (see id. at 811-812). Such a test requires a court to look at the contract in its entirety to determine the probable consequences that will befall a non-breaching party, not simply to turn to a schedule of payments and conclude that the inquiry is at an end.

. Indeed, other jurisdictions have found that the UCC does not establish a categorical rule for classifying lost profits as consequential or general damages (see e.g. ViaStar Energy, LLC v Motorola, Inc., 2006 WL 3075864, 2006 US Dist LEXIS 78331 [SD Ind, Oct. 26, 2006, No. 1:05-ev-1095-DFH-WTL]; Callisto Corp. v Inter-State Studio & Pub. Co., 2006 WL 1240711, 2006 US Dist LEXIS 31004 [D Mass, May 4, 2006, No. 05-11953-GAO]; Biovail Pharms., Inc. v Eli Lilly & Co., 2003 WL 25901513, 2003 US Dist LEXIS 27916 [ED NC, Feb. 28, 2003, No. 5:01 CV-352-BO(3)]; Moore v Boating Indus. Assns., 754 F2d 698 [7th Cir 1985]; DP Serv., Inc. v AM Intl., 508 F Supp 162, 167 [ND Ill 1981]). These cases reflect the notion that “section 2-715 (2) is not an exhaustive specification of the necessary and sufficient conditions for application of the concept of consequential damages” (1 James J. White et al., Uniform Commercial Code § 11:7 at 987 [Practitioner’s 6th ed 2010]).

. The dissent disregards the relationship between the resale price and the transfer price, focusing instead on the fact that plaintiff would have to pay a minimum price each quarter in a hypothetical situation where it sold no product (see dissenting op at 814, 816). As the contract provided, however, the parties negotiated the minimum transfer price each quarter, presumably based on sales in the foregoing quarter, to serve as a benchmark price. Hypothetical disaster scenarios aside, the minimum transfer price, like other prices in the contract, responded to the market realities of the parties’ quasi-joint venture, including prices in the resale market. In other words, “[w]hatever profit [plaintiff] might make was contingent on the selling prices it negotiated with its customers” (id.), but so too was defendant’s profit.