This guide explains the different parts that make up a limitation of liability block.
Limitation of liability blocks are essential blocks forming part of contracts that help parties manage their risks and protect their interests in case of disputes.
According to the latest data provided by World Commerce and Contracting, these clauses rank as the number one most negotiated term in contracts. Interestingly, they rank 10th when it comes to the most important terms in a contract and does not feature in the top 10 when it comes to the most frequent sources of disagreement, claims, and disputes.
Risk management: One of the primary reasons parties include limitation of liability clauses in their contracts is to manage and mitigate potential risks. By capping the amount of damages that can be claimed, parties can allocate their resources efficiently and effectively, knowing their maximum potential exposure.
Predictability: Limitation of liability clauses provide a level of predictability to the parties in case of disputes. By agreeing on a capped amount for damages, parties can focus on the resolution process and avoid lengthy and costly litigation battles.
The nature of the contract: Depending on the type of contract and the goods or services being provided, parties may have differing views on the appropriate level of liability limitation.
The bargaining power of the parties: Parties with more bargaining power may seek to impose more favorable limitation of liability clauses, while those with less bargaining power may push for higher caps on damages.
The risk profile of the parties: A party with a higher risk profile may be more inclined to negotiate for a lower cap on damages, as it may be more exposed to potential breaches and disputes.
Limitation of liability provisions generally addresses two distinct aspects.
First, certain damages or losses that the other party cannot claim. We refer to these damages or losses as unrecoverable damages or losses.
By waiving these losses or damages, the parties agree that they cannot claim these losses or damages from the other party. Therefore, liability for these types of losses or damages is limited.
When configuring the part that relates to unrecoverable losses, the following needs to be considered-
Parties-
Do the unrecoverable loss provisions apply to-
Unrecoverable losses or damages-
Parties mistakenly think that waiving consequential damages will include a waiver of claims relating to, for example, loss of business income.
However, consequential damages do not describe a particular kind of loss and do not always include a waiver of claims relating to the loss of business income.
A loss of business income can also be a direct loss (take, for example, a situation where the loss of business income was foreseeable when the Agreement was concluded, and such a loss would naturally arise from the breach of the Agreement), in such a case, loss of business income may be regarded as a direct loss and will not be limited by the waiver of consequential damages provisions.
If you want to make sure that all claims relating to losses that the parties intend to waive are being waived, a laundry list of claims relating to losses that will be waived can be included – for example:
Some of these losses may be direct losses, and some may be consequential losses.
A note of caution, be careful waiving claims for direct losses. Generally, you cannot waive all liability for a breach of contractual obligations (the aggrieved party must have some form of meaningful recourse in case of a breach of contract).
Examples of other claims relating to losses that you will likely not be able to waive are losses that relate to:
Then there are certain jurisdictions where you cannot waive claims relating to losses sustained for the supply of defective goods (there’s usually consumer protection legislation that regulates this).
The claims relating to losses that can and can’t be waived may differ from one jurisdiction to another. Therefore, an approach adopted in practice is to insert the phrase “to the maximum extent permitted under law” before the rest of the sentence that waives the claims relating to the specific losses.
Suppose you are acting for the party waiving claims related to the specific loss specified as unrecoverable losses; you may consider including certain exclusions from the waiver. These exclusions are often referred to as “carve-outs”.
Claims that are often “carved out” from the unrecoverable loss provisions include:
The second aspect generally addressed in limitation of liability provisions is maximum liability.
Parties-
Do the maximum liability provisions apply to-
The liability cap-
Maximum liability provisions are also sometimes referred to as the liability cap. These provisions limit the maximum amount that can be claimed from the defaulting Party.
The maximum liability provisions are often a hot topic of negotiation. For example, suppose you are a Provider whose liability is limited to a specific amount. In that case, you want this amount to be as low as possible to ensure that the business will hopefully stay afloat if things go south. On the other hand, if you are the Customer, you want to recover an amount that will sufficiently compensate you for your losses.
Different caps for different claims-
Finding a balanced approach to the maximum liability provisions often involves stipulating different liability caps for different types of breaches. For example, if there is a breach of the data protection provisions, the cap will be calculated one way, and if there is a breach of the confidentiality provisions, the cap will be calculated another way.
Cap structures-
Examples of different cap structures include:
Another important consideration is if the cap applies per incident or to claims over a period of time? Also, will legal fees, costs and interest also form part of the cap?
When you “carve-out” certain types of claims from the maximum liability provisions, it means that if this “carved-out” type of claim is instituted, then the claim will not be limited.
If you are acting for the Party in whose favor the maximum liability cap is agreed, you want to avoid situations where claims are are “carved out” from the maximum liability provisions.
Claims that are often “carved-out” from the maximum liability provisions, include:
Arguments For Including Limitation of Liability Provisions:
Risk Management: Limitation of liability provisions help both parties manage their risks by setting a cap on the damages that can be claimed in case of a breach or dispute. This helps create a balance between the potential gains from the contract and the potential liabilities.
Financial Predictability: By defining the extent of financial exposure, limitation of liability provisions provide financial predictability for both parties. This enables better planning, budgeting, and resource allocation.
Encourages Fairness: Limitation of liability provisions encourage a more equitable distribution of risk between the parties, ensuring that neither party is disproportionately burdened with potential liabilities.
Incentivizes Performance: By limiting the extent of liability, parties may be more incentivized to perform their contractual obligations efficiently and effectively, knowing that they are protected from excessive claims.
Promotes Innovation: Limitation of liability provisions can foster innovation, as tech companies are more likely to take risks and develop new products or services when they know their potential liability is capped.
Arguments Against Including Limitation of Liability Provisions:
Moral Hazard: Limiting liability can create a moral hazard, as parties may be less cautious and diligent in fulfilling their contractual obligations, knowing that their financial exposure is capped.
Reduced Compensation: In the event of a breach or dispute, the injured party may receive inadequate compensation for their actual losses if the liability is limited. This could lead to dissatisfaction and potentially harm the business relationship.
Perception of Unfairness: Limitation of liability provisions may be perceived as unfair, particularly if one party has significantly more bargaining power and imposes a disproportionate cap on liability that favors their interests.
Inadequate Incentive for Performance: If the limitation of liability is too low, it may not provide a sufficient incentive for a party to perform their contractual obligations diligently, as the potential cost of a breach may be lower than the cost of proper performance.
Legal Restrictions: In some jurisdictions, there may be legal restrictions on the enforceability of limitation of liability provisions, particularly in cases involving gross negligence, willful misconduct, or personal injury. This can make it challenging to draft and enforce such provisions effectively.
Summary of recommendations by World Commerce and Contracting–
Liability Tied to Agreement Obligations: A party should only be held responsible for not meeting the obligations mentioned in the agreement.
Burden of Proof and Liquidated Damages: The party seeking damages must prove the amount of damages, unless a pre-set amount is mentioned in the agreement. In that case, the pre-set amount will be used even if it doesn’t match the actual damages.
Limiting Risks and Establishing Liability Caps: Both parties should limit their risks and exposure to maintain their financial stability. Setting a cap on liability for direct damages, proportional to the contract’s value, helps protect both parties from severe financial consequences.
Responsibility to Mitigate Damages: The damaged party should try to minimize its damages as much as possible, either by following the law or by explicitly stating this in the agreement.
Apportioning Damages for Contributory Faults: If both parties contribute to the damages, they should share responsibility for their respective faults. Neither party should be held responsible for third-party actions that are beyond their control.
Exclusions and Exceptions for Liability: Excluding certain types of damages (like indirect or consequential damages) is standard in commercial agreements. However, exceptions may be made for specific situations, like breaches of confidentiality or certain indemnifications.
Prohibited Liability Limitations: In some cases, parties cannot limit their liability due to public policy. Examples include situations involving bodily injury, death, or damages caused by gross negligence or willful misconduct.
1.1
Unrecoverable
losses: Subject to
Section 1.2, a Party
its Affiliates, employees, shareholders, contractors, or customers will not be
liable to the other Party under any theory of liability (whether in contract,
delict (tort), or otherwise) and however caused under or relating to the
Agreement for indirect, consequential, special and punitive losses which
includes loss of profits, loss of business revenues, loss of anticipated
savings, loss of goodwill, or loss of data insofar as such losses are
consequential losses.
1.2
Exclusions
from unrecoverable loss provisions: Claims relating to:
(a)
breach
of confidentiality provisions under the Agreement,
(b)
claims
relating to any indemnity provided under the Agreement,
(c)
breach
of the data protection provisions under this Agreement,
(d)
any
act or omission that is grossly negligent,
(e)
any
act or omission that causes personal injury or death of a third party, or
(f)
any
act or omission that causes damage to property
are
excluded from Section 1.1.
1.3
Maximum
liability: Subject to
Section 1.4, the
maximum liability under or in connection with the Agreement of either Party,
under any theory of liability (whether in contract, delict (tort), or
otherwise) and however caused, cannot exceed a fixed amount of $[●] and
includes interest and costs and applies to all claims on an aggregate basis.
1.4
Exclusions
from maximum liability provisions: Claims relating to:
(a)
claims
relating to any indemnity provided under the Agreement,
(b)
breach
of confidentiality provisions under the Agreement,
(c)
breach
of the data protection provisions under this Agreement,
(d)
any
act or omission that is grossly negligent,
(e)
any
act or omission that causes personal injury or death of a third party,
(f)
any
act or omission that causes damage to property, or
(g)
to
wilful misconduct or fraud
are
excluded from Section 1.3.
1.5
Mitigation: In case of
any breach under the Agreement by a Party, the other Party must mitigate its
losses to the extent reasonable under the circumstances.
1.6
Survival: The
provisions under Article 1
will survive the termination of this Agreement.
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