Businesses these days function in an environment that calls for them to collaborate and work together on various projects from time to time. Companies as big as Coca Cola and Heinz collaborated a few years back to manufacture environment-friendly sustainable plant bottles. Their collab turned out to be successful, but the same story does not hold true for all the liaisons that take place.

Some agreements come with their own set of hiccups which can turn into a million-dollar legal suit in no time if not attended to properly. You can’t control unprecedented events but can be prepared to tackle it. This can be done by incorporating the “Limitation of Liability (LOL)” clause in your contracts.

The limitation of liability clause limits the amount of claim that needs to be paid for the damages or loss suffered because of either breach of contract, misrepresentation, negligence, infringements, etc. The list is non-exhaustive. Thus, the inclusion of the liability clause is a necessity in all contracts. It helps to reduce either party’s exposure to risk.

Incorporation of Liability Clause – Clarity is King!

As per the IACCM report, limitation of liability is one of the most negotiated clauses across business contracts. It is critical that you understand the clause in order to identify the associated risks and the subsequent losses that may arise from such risks. Since parties have obligations to perform, it is listed in all the commercial contracts.

The easiest way to discern the liability clause is to break it down by asking questions that are relevant to your contractual agreement. These questions also support in structuring the clause and negotiating your agreement.

  • What could possibly go wrong with the transaction?
  • Can you afford to meet the claim in case of any damage?
  • Can the damage exceed the deal value?
  • How likely is a contract breach to happen?
  • Are there any economic risks attached to this contract and/or to that particular industry?

It is important to ensure that the clause is worded clearly and unambiguously to avert multiple interpretations. There are certain conditions that need to be conveyed in a simplified manner under this clause1

  1. Accept losses without limit: The clause should define the losses that each party accepts without limit. This may include fraud, death, personal injury, etc.
  2. Accept losses with a cap: Here, the parties to the contract accept losses with a cap and also specifies the number of damages they are liable for. It lists down the losses that will be capped and what the cap will be. This cap amount will depend on various factors like the value of the deal, parties’ level of insurance, the potential amount of damage a breach may cause, etc.
  3. Losses not covered: Certain losses will not be covered under the liability clause such as profit or loss in revenue ( indirect or consequential loss)

These clauses are prevalent in almost every commercial contract and are mostly in favor of the service provider to limit the exposure of risk. Usually, the party drafting the agreement has an upper-hand in this regard.

An example of a well-drafted limitation of liability clause would be of Zendesk. As per the conditions mentioned above, zendesk has clearly defined the losses that it accepts and the ones that it doesn’t. The cap for claims is clearly outlined in the clause for the other party. The most important aspect of their clause structuring is the use of simple, clear language and minimal use of technical jargon.

Liability clause -deal desk

Be Reasonable to make your Liability Clause Enforceable

Despite being crucial to commercial contracts, liability clauses are not always enforceable and might require the court to intervene. Including the liability clause in the contract makes it adhesive (Adhesive contracts allow one party to have substantially more power than the other during the contract creation process) and leaves little room for negotiation. In general, the law permits to negotiate the clauses. However, they refuse to enforce such clauses where they find that2

  • The provision was ambiguous or unconscionable
  • The intention of the parties’ was not clearly expressed
  • One party has an unequal level of power or a higher level of sophistication
  • There was a public policy or statute prohibiting the enforcement of such provision

The law imposes certain restrictions on the application of limitation of liability clauses. As per the Unfair Contract Terms Act (UCTA), the enforceability of liability clause is prohibited with B2B contracts under specific circumstances such as death or personal injury caused by negligence, breach of contract or misrepresentation, etc.

What makes the clause reasonable?
For the clause to be enforceable, it has to be “reasonable under all circumstances”. This can be justified taking into account factors like – the bargaining power of the parties at the time of contract creation or negotiation phase, the type of insurance both parties have in place of claim, whether the contract provided other remedies for a breach or negligence. This is subjective, depending on case to case.

Insure to Ensure – Limitation Of Liability

Not having insurance keeps businesses on the edge of their seats. Even though the liability clause limits the claim amount, companies are constantly on the lookout for insurance policies to be prepared for any lawsuit that might knock on their door. Obtaining a Commercial General Liability (CGL) insurance helps with the coverage if your business is sued. It also pays legal fees associated in fighting the charges or even the money that you need for settlement because you want to steer clear of court cases.

If your business is into manufacturing products, Product liability insurance is a must for you! This is similar to general liability but is specifically designed for manufacturers who sell products and helps in the coverage of claims from manufacturing to design defects. In simple terms, businesses are constantly exposed to risk and need to protect themselves because – “Prevention is better than cure”.

Limitation of liability is not a ‘boilerplate term’ in a contract but a critical clause. In the absence of such a clause, there is no financial limit to the claim that can be made by the other party. This can have adverse consequences resulting in wiping out or reducing shareholder value. Parties wishing to limit or reduce their exposure to risks should definitely include liability clause in their agreements.

Keeping all the technicalities aside, the most important thing to be mindful of is keeping the language simple if you are drafting the clause. And if reviewing, do it with the intention to negotiate and make the clause less adhesive and more balanced. Lastly, don’t forget to consult with your lawyer before you seal the deal!

Limitation of liability clause can be a challenging yet critical clause to deal with. Have you ever drafted or negotiated this clause in a contract? How did you go about managing it? Share your thoughts in the comments or tweet to us about it!

Reference:
1. Limitation of Liability
2. Enforceability of Liability Clause