The advent of cloud-based computing and remote data storage has increased business efficiency and the ability to collaborate with colleagues. However, the reliance on third parties to host crucial and sensitive data can have ruinous consequences for the company if their IT host loses this data. This is especially so as many service contracts for hosting data include clauses limiting the IT company’s liability for data loss.
In Mentis Sciences, Inc. v. Pittsburgh Networks, LLC (September 22, 2020), the New Hampshire Supreme Court upheld the validity of a limitation of liability clause in a data hosting contract and barred the data owner from recovering damages for the cost of recreating lost data and lost business profits. The plaintiff in this case, an engineering firm, lost valuable business data it had been acquiring since 1996 when its IT service provider had one of its physical drives fail. This data loss was permanent because the IT service provider defendant also failed to properly back up the data.
The NH Supreme Court ultimately held the plaintiff’s damages were consequential in nature (meaning they occurred because the other party failed to meet a contractual obligation) and unrecoverable because of the limitation of liability provision in the IT service agreement. The clause at issue in the case clearly stated the IT servicer defendant would not be liable for “indirect, special, incidental, punitive or consequential damages, including but not limited to loss of data, business interruption, or loss of profits.”
This ruling limited damages to the fair market value of the defendant’s services, which is essentially the contract price – a fraction of the actual damages to the plaintiff due to the data loss.
As a result of the Mentis Sciences decision, businesses contracting with IT companies to host valuable data should beware. Before contracting with an IT service provider, businesses should take steps to seek additional protection against data loss and consider:
- Obtaining legal advice before entering into IT service contracts. This would allow a business to analyze the assignment of risks in an IT service contract and whether it is acceptable to a client.
- Negotiating a more limited version of the limitation of liability clause. This could provide for specific responsibilities of the IT service provider, which would trigger liability if violated.
- Including a liquidated damages provision. A liquidated damages clause allows for a set amount of damages to be paid if the contract is breached. This clause may be beneficial to both parties as it could provide higher damages to the customer above the “direct” damages amount, and it could provide solace to the IT servicer as their damages arising from the contract are capped at a set number.
- Purchasing private insurance to cover third-party data loss.
On the other hand, IT service providers hosting customer data have a clear incentive to include similar limitation of liability language in their service agreements. The Mentis Sciences decision provides a definite framework for IT service providers to limit liability so that:
- The customer ultimately is responsible for the files and data transferred to the host servers, and the customer must maintain their own backup of files and data stored on the host servers. The customer essentially is just paying for space and bandwidth on the host’s servers, and if service is down, only the cost of the service is refundable. Otherwise, the IT servicer’s hosting of the data leaves it exposed to open-ended business damages.
- The IT provider potentially still is liable for direct damages arising out of the contract (based on the value of the performance itself). Limiting all potential liability in an IT services contract otherwise may violate public policy (See Orthopaedic Ctr. of S. Fla., P.A. v. Stryker Corp., No. 08-60742-CIV, 2008 WL 11331981 (S.D. Fla. Sept. 16, 2008)).
The economic loss rule will prevent the customer from pursuing tort recovery for purely economic or commercial losses associated with the contract relationship.