Introduction. Conversion

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1 Introduction OVERCOMING LIMITATION OF LIABILITY CLAUSES IN COMMERCIAL WAREHOUSE STORAGE CONTRACTS by Geoffrey W. Veith, Frederick E. Blakelock, and Paul D. Rowe Hecker Brown Sherry and Johnson, Philadelphia, PA Contained within the boilerplate language of most, if not all, commercial warehouse storage agreements is a clause limiting a warehouseman s liability for damage to the customer s goods. 1 The ability of a warehouseman to limit his liability has its basis in public policy: absent the limitation, storage costs would be excessively high since the warehouses would be required to carry perhaps hundreds of millions of dollars of liability insurance, depending on the nature of goods stored. Thus, warehouse limitations are meant to afford some measure of commercial protection to responsible warehousemen for liability arising from accidents and other unintentional losses. In most jurisdictions, the statutory basis for the warehousemen s ability to limit his liability is contained within that state s version of the Uniform Commercial Code. U.C.C provides: (1) A warehouseman is liable for damages for loss of or injury to the goods caused by his failure to exercise such care in regard to them as a reasonably careful man would exercise under like circumstances but unless otherwise agreed he is not liable for damages which could not have been avoided by the exercise of such care. (2) Damages may be limited by a term in the warehouse receipt or storage agreement limiting the amount of liability in case of loss or damage, and setting forth a specific liability per article or item, or value per unit of weight, beyond which the warehouseman shall not be liable; provided, however, that such liability may on written request of the bailor at the time of signing such storage agreement or within a reasonable time after receipt of the warehouse receipt be increased on part or all of the goods thereunder, in which event increased rates may be charged based on such increased valuation, but that no such increase shall be permitted contrary to a lawful limitation of liability contained in the warehouseman s tariff, if any. No such limitation is effective with respect to the warehouseman s liability for conversion to his own use. Thus, the Code specifically carves out an exception to limited liability in circumstances Issues do arise, however, as to what type of conduct constitutes conversion. Moreover, in situations where damage or loss cannot be attributed to theft by the warehousemen, the customer faces a more difficult obstacle. In order to overcome the limitation in such cases, counsel will need to consider other arguments, or else face the prospect of recovering only a fraction of his client s losses. Conversion The Uniform Commercial Code specifically states that a limitation of liability is unenforceable with respect to the warehouseman s liability for conversion of goods. See, e.g., Colgate Palmolive Co. v. S/S DART CANADA, 724 F.2d 313 (2d Cir. 1983) (applying New Jersey law, holding that no limitation of liability is effective in cases of conversion of goods by a warehouseman), cert. denied, 466 U.S. 963, 80 L.Ed.2d 562, 104 S.Ct (1984).

2 Under most states law, conversion occurs whenever a distinct act of dominion is wrongfully exerted over the personal property of another which is inconsistent with, or constitutes a denial of, the owner s rights in that property. The most obvious example of conversion is theft of the stored goods by the warehousemen. However, other acts of dominion, such as intentional damage, may constitute conversion. In cases of damaged, rather than missing goods, the warehouseman may contend that there has not been a conversion because conversions are limited to a failure to deliver the goods upon demand. See, ICC Industries, Inc. v. GATX Terminals Corp., 690 F. Supp (SDNY 1988). Other courts, however, have been willing to find conversion in circumstances where the bailee merely damages the goods. Lembaga Enterprises, Inc. v. Cace Trucking & Warehouse, Inc., 320 N.J.Super. 501, 507, 727 A.2d 1026 (1999). See also, Dan B. Dobbs, The Law of Torts 65(2) (2001) (major alteration or serious damage is often an extreme case of dispossession and counts as a conversion). Misdelivery to a third party may also constitute conversion as it involves an intentional dispossession. Lipman v. Petersen, 223 Kan. 483, 575 P.2d 19 (1978). Issues also may arise as to whether intent to convert need be shown on the part of the warehouseman. Some courts require proof of an intentional misappropriation to establish a prima facie case of conversion. International Nickel Co. v. Trammel Crow Distribution Corp., 803 F.2d 150 (5th Cir. 1986); Western Mining Corp. v. Standard Terminals, Inc., 577 F.Supp. 847 (W.D.Pa. 1984), aff d without opinion, 745 F.2d 49 (3d Cir. 1984). However, in other jurisdictions, conversion includes the unexplained disappearance of the goods. I.C.C. Metals, Inc. v. Municipal Warehouse Co., 50 N.Y.2d 657 (1980). In Lembaga, the New Jersey Appellate Division, interpreting New Jersey s version of U.C.C , noted that either intentional or negligent acts can give rise to conversion, and that the intent of the bailee does not play a part in an action for conversion. ( When goods are delivered to a bailee in good condition and then are lost or damaged, the law presumes a conversion. ) Id. Thus, in circumstances where goods are delivered to the warehouse in good order and condition, but are somehow damaged while in storage due to unknown causes, some states, such as New Jersey, will presume a conversion of the goods. Conversion may also include a warehouseman exercising unreasonable dominion and control over the goods. Blanken v. Harris, Upham & Co., 359 A.2d 281 (D.C. 1976). In other words, conversion arises from the bailee s commission of an unauthorized act of dominion over the property inconsistent with the bailor s rights in that property. Thus, if it can be proven that the warehouseman was aware that goods were being damaged while in his care, the warehouseman s failure to advise the customer of the damage as it was known to be occurring may amount to a conversion. For example, if a warehouseman knew that fruit was spoiling due to elevated temperatures in the warehouse, but instead of informing the customer, simply ordered that the rotting fruit be moved to a different freezer or that the leaking juice or other signs of spoilage be cleaned up, this conduct may establish a conversion. Gross Negligence or Willful and Wanton Conduct May Render the Limitation of Liability Provision Unenforceable Evidence of conduct more egregious than simple negligence may enable the customer to pierce the shield of the contractual limitation language. Willful and wanton misconduct is generally defined as the commission of a wrongful act with reckless indifference to the consequences where the actor

3 knew or should have known, that injury was likely to result. Willful and wanton misconduct or gross negligence has also been described as an extreme departure from the ordinary standard of care. Swisscraft Novelty Co., Inc. v. Alad Realty Corp., et al., 113 N.J. Super. 416, 426, 274 A.2d 59 (App. Div. 1971). Most states versions of U.C.C specifically exclude conversion from the limitation provision, but are silent as to what other types of conduct may vitiate the limitation. Other provisions in the U.C.C. provide some insight. U.C.C provides: Unless displaced by the particular provisions of this Act, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions. Pursuant to 1-103, where the Code does not address the issue of whether a warehouseman can invoke the limitation of liability provision in a warehouse receipt where the stored goods are damaged by the warehouseman s gross negligence or willful and wanton misconduct, the common law determines whether the limitation provisions in the warehouse receipts are legally enforceable. This analysis was used by the United States District Court for the District of Kansas in Butler Manufacturing Co., et al. v. Americold Corp., 835 F. Supp (D. Kan. 1993). In Butler, the warehouse receipt at issue in that case purported to limit liability for damages for which the warehouseman was legally liable. The court noted that Article 7 of the Uniform Commercial Code does not speak to such a limitation on damages directly, but that Kansas common law does. In looking to state law, the court cited Section of the Kansas Code, which provides that unless displaced by particular provisions of the U.C.C., the common law controls. The court determined that Kansas law prohibits the enforcement of limitation provisions where damages result from gross negligence or willful misconduct in performing a service for another for hire. The court then concluded that the limitation language in a warehouseman s receipt would not serve to limit damages under circumstances where the warehouse was grossly negligent or committed acts of willful misconduct. 835 F.Supp. 1274, It is the law in many jurisdictions that an attempted exemption from liability for future intentional tort or willful act or gross negligence is void. In a case involving losses resulting from the spoilage of meat in a meat freezer, the Louisiana Court of Appeals ruled that if plaintiff could prove a willful or deliberate disregard by defendant of its contractual duties, the contractual limit of liability is unenforceable. In Carriage Meat Co., Inc. v. Honeywell, Inc., 442 So.2d 796 (La. App. 4th Cir. 1983), the defendant agreed to install and monitor a temperature monitoring system in plaintiff s meat freezer. The contents of the freezer spoiled when the freezer ceased operating over a weekend. The defendant failed to alert plaintiff that an alarm in the freezer had been triggered, indicating a breakdown. The contract exculpated defendant from liability for any losses, even if due to defendant s negligent performance or failure to perform an obligation under the contract. The court determined that a willful failure to monitor the system or a deliberate disregard of a contractual duty would not be consistent with the type of service contemplated by the contract, and that liability would likely be imposed irrespective of the exculpatory clause. Carriage Meat Co., 442 So. 2d 796, 798.

4 Thus, a warehouseman s willful and wanton misconduct and/or gross negligence with respect to its contractual duties to the customer may preclude the application of the limitation of liability provision contained in warehouse receipts. The Warehouseman s Failure to Inform of Damage (or the Risk Thereof) to the Facilities or Goods May Constitute Fraud Although a reasonable contractual limitation of a warehouseman s liability is valid, such a limitation does not preclude liability for fraud or a violation of public policy. See, e.g., World Products, Inc. v. Central Freight Service, Inc., 222 F.Supp. 849, (D.N.J. 1963), aff d in part, vacated in part, 342 F.2d 290 (3d Cir. 1965). Fraud consists of the obtaining of an undue advantage by means of some act or omission that is unconscionable or a violation of good faith. 3 J. Pomeroy, A Treatise on Equity Jurisprudence 421 (5th ed.1941). A nondisclosure of a fact is the equivalent of a misrepresentation of that fact if disclosure would correct a mistake of the other party as to a basic assumption, and nondisclosure amounts to a lack of good faith and fair dealing. Restatement (Second) of Contracts, 161. In some cases, the warehouseman s nondisclosure of known, latent risks -- such as, for example, inadequate refrigeration capacity due to equipment failure -- may constitute a breach of the implied duty of good faith and fair dealing. Moreover, since disclosure of the problems at the warehouse would correct the customer s reasonable assumption that the warehouseman would be able to store the goods safely, the warehouseman s concealment or nondisclosure of these latent facility problems may constitute a material misrepresentation of implied fact that the warehouseman could properly and safely store the customer s goods. As a result, the limitation of liability provision contained in the warehouse receipt may be unenforceable if the produce should subsequently spoil due to inadequate refrigeration capacity. An action for fraud may be either legal or equitable, depending on the remedy sought. Jewish Center of Sussex County v. Whale, 86 N.J. 619, 624, 432 A.2d 521 (1981). Legal fraud consists of a material misrepresentation of a presently existing or past fact that is made with knowledge of its falsity and with the intention that the other party rely on that fact to its detriment. Id.; see also 3 J. Pomeroy, A Treatise on Equity Jurisprudence 421 (5th ed.1941). Equitable fraud is the appropriate theory where the plaintiff is seeking recission of the contract, or avoidance of an inequitable contract. A plaintiff seeking to prove that a misrepresentation constituted only equitable fraud does not need to establish the knowledge and intent elements. Jewish Center, 86 N.J. at 624. Since a rescission of a contract is an equitable remedy, only the elements of equitable fraud need to be proven by the plaintiff in his effort to avoid a damage limitation clause. The Warehouseman May Void the Limitation Provision by Moving the Goods or Otherwise Violating the Terms and Conditions of the Warehouse Receipt. The terms and conditions contained in the warehouse receipt may provide certain specific conditions under which the goods must be stored. In many cases, custom and/or course of dealing dictates that when goods are stored there is an understanding that the product will remain in its original location until called for by the customer. There is, theoretically, little chance that the product will be damaged sitting in one place, and the customer is aware of the location of his goods at all times. As a result, many warehouse receipts provide that the warehouseman must give notice to the

5 customer in the event his goods are to be moved within the warehouse after being place in a storage location: The warehouseman reserves the right to move, at his own expense of transfer, and upon notice sent by registered mail to the storer of record and to the last known holder of the negotiable warehouse receipt, any goods in storage from any warehouse in which they may be stored to any of his warehouses. When damage occurs to the storage facility or the goods themselves, however, the warehouseman may move the goods without notice to the customer. This may be done to salvage the goods, or in some cases, to hide the damage to the goods by redistributing the damaged product or by removing the goods from areas of the warehouse where it is clear damage has occurred. Failure to provide written notice of movement to the customer as required by the terms of the warehouse receipt may constitute a breach of the contract, thus precluding the warehouseman from seeking refuge in the contractual provisions purporting to limit its liability. Contract law principles dictate that such a breach of the notice provision must be shown to be material in order to operate to void the contractual limitation. But where damage has occurred without notice to the customer, the customer can assert that the breach of the notice provision was material because if the warehouseman had complied with his obligations, the customer may have either discovered the damage earlier or taken steps to salvage the goods. Compliance with the notice provision could have allowed the customer to mitigate its losses and the warehouseman s noncompliance arguably exacerbated the damages. Public Policy Considerations May Require that the Limitation of Liability Provision be Voided. A reasonable contractual limitation of a warehouseman s liability is valid under the UCC, but only in the absence of fraud or a violation of public policy. World Products, Inc. v. Central Freight Service, Inc., 222 F.Supp. 849, (D.N.J. 1963), aff d in part, vacated in part, 342 F.2d 290 (3d Cir. 1965). Moreover, the terms of an agreement between parties to a bailment need not be enforced if offensive to law. Silvestri v. South Orange Storage Corp., 14 N.J.Super. 205, 210, 81 A.2d 502, 504 (App. Div. 1951). As a matter of public policy, a reckless or deceitful warehouseman should not be permitted to evade responsibility for his misconduct by hiding behind the limitation of damages. Moreover, although U.C.C allows a warehouseman to limit his liability by setting forth a specific liability per article or item, or value per unit of weight, casually drafted limitation clauses may provide a remedy in terms other than those specified in the Code, such as 50 times the monthly storage charges, or other non-compliant terms. An argument can be made that since the law disfavors limitations of liability, warehouse receipt limitations that do not strictly conform to the statutory language are void. Conclusion Reasonable limitation of liability clauses in commercial warehouse storage contracts will be upheld in most cases. In order to obtain a more favorable recovery than is provided by the warehouse receipt, the customer will need to devise creative arguments and engage in a detailed investigation of the cause and circumstances of the loss.

6 In attempting to overcome an exculpatory clause, discovery of business records and other internal warehouse documents may be critical in making the required showing of recklessness. These documents may include, internal memoranda documenting problems or concerns with equipment, security and structural integrity of warehouse buildings. Such documents may reveal that the warehouseman knew that damage to the goods would likely result. In some cases, these smoking gun documents may evidence an attempt to deceive the customer about both the risk and the fact of severe damage to the stored goods. In every case, however, it is critical to creatively analyze the warehouse receipt and the circumstances of the loss if one is to have a realistic hope for a full recovery. Footnotes: 1 A warehouseman may not completely disclaim any liability for his own negligence. Clauses disclaiming all liability for negligence are generally invalid. See e.g., Fireman s Fund Am. Ins.Co. v.captain Fowler s Marina, Inc., 343 F.Supp. 347 (D.Mass. 1971); Kimberly-Clark Corp. v. Lake Erie Warehouse, 49 A.D.2d 492, 375 N.Y.S.2d 918 (1975). This article appeared in Volume I, Issue III of the NASP Subrogator. NASP