Wednesday, October 12, 2011

When should you use Gross Negligence and Willful Misconduct in an Agreement

Gross negligence and willful misconduct are very high standards. Ordinary negligence is described as failing to do what a reasonable person would do. Gross negligence requires a conscious and voluntary disregard to a duty such as to make a product safe. Willful misconduct is a conscious or intentional disregard of the rights or safety of others.

Many times a supplier may only want to be liable to provide the buyer with an indemnity if their actions fall into one of those two high standards. The key in any negotiation is to consider the standards that you will be held to and make sure that your agreement with the supplier has the appropriate standards for any potential liability you may have. If you don’t you can wind up having to pay the full amount of a third party claim and not be able to collect anything from the supplier even though they caused the problem.

Let’s consider it first from a perspective of personal injury liability or property damage liability to third parties. If you agreed to and indemnity where the only time the Supplier would be responsible to indemnify you was if they were grossly negligent, let’s see what happens.

Gross negligence:

You buy a product from a supplier. You use that product in your product that you sell to a customer. The supplier’s product is defective and causes personal injury and property damage.
The third party sues your company because you are part of the sales chain. They may also sue the Supplier or you may seek to enjoin the Supplier in that lawsuit claim of negligence.

A claim of negligence does not require for the negligence to be gross negligence, it only needs to be ordinary negligence in failing to act as a reasonable party. In fact some courts have found strict liability for defective products. An item being “defective” is far different than “gross negligence”
If you agreed that the supplier would only need to indemnify you if there was gross negligence
his creates an imbalance. You could be liable to the third party simply because of a defective product, but the supplier would not be liable to you under the contract to indemnify you as the high standard had not been met. This does no insulate the supplier from the 3rd party claim it just impacts your rights with the supplier. This puts you in a poor position.

The injured party could sue you directly because you were in the sales chain. You could enjoin the supplier in the suit. Because of the higher standard the supplier doesn't have to defend or indemnify you or hold you harmless. You bear the cost of your defense. Further unless the court apportions a percentage or liability directly to the supplier, you would have with no recourse with the Supplier. You excused them from liability because their actions didn't meet the high standards.

Willful misconduct:

You receive confidential information from a third party. Under that confidentiality agreement you assume strict obligations for managing the information in a confidential manner. The exceptions to the confidentiality requirements do not include inadvertent disclosure. You have the right to disclose the information to the supplier provided that you have them enter into a confidentiality agreement that protects the owner’s rights in the information. In the negotiation with the Supplier on the confidentiality agreement they insert language that they will only be liable for willful misconduct. The supplier having received the confidential information makes a copy and goes to Starbucks to get a coffee. They leave Starbucks forgetting their briefcase that contains the confidential information. A reporter finds the briefcase and opens it to try to discover the owner to return it. They notice the confidential document and read it. The following day an article appears in their paper describing the confidential information. The owner of the confidential information reads about it in the paper and calls their law firm to sue you for the breach of the confidentiality agreement.

Since they entrusted you with the information as between you and the owner of the confidential information the standard that will be applied to you will be what you agreed to. You aren’t excused for an inadvertent disclosure, which it was. In your agreement with the Supplier you can only hold them responsible if their act was willful misconduct, which it isn’t. So you would be the
only party liable for the breach. You didn’t cause the disclosure to occur. You error was to agree to hold the Supplier to a lesser standard than you agreed to with the owner of the information.

The thing you need to remember is damage can occur even if the act itself did not represent gross negligence or willful misconduct. If you can be liable to a third party for acts that aren’t gross negligence or willful misconduct, if the supplier is the one that caused the damage you want them to be responsible. If you were to agree to only hold the supplier accountable for gross negligence or willful misconduct that leaves a large portion of your risk uncovered. You may have to pay the third party and not be able to recover anything from the supplier. A second thing to remember is Buyers can be liable for supplier actions. A buyer that resells a supplier’s product can be liable under product liability. Buyers can also be liable for supplier’s actions or inaction under the theory of agency.

Could you potentially use these higher standards in an agreement? If you are dealing with claims or breaches that will be strictly between the buyer and the supplier with no third party involvement, you could potentially agree to these higher standards as a way of sharing of the risk. That would be equivalent to saying that neither of us will be liable to the other for damages you sustain unless the act itself was gross negligence or willful misconduct. That makes it a form of no fault relationship where each party deals with their own damages unless the higher standards of gross negligence or willful misconduct are reached. Before agreeing to such a commitment I would want to make sure that there was a reasonable balance between the parties in their ability to cause damages or that the price I paid reflects my assumption of that risk. If you assume those risks your contract should have appropriate terms for you to manage and control that risk.

Want to learn more? The companion book "Negotiating Procurement Contracts - The Knowledge to Negotiate" is now available on A hotlink to
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