This article covers six key things to consider when negotiating the limitation provisions of your contract.
1. In practice, what are the risks for the parties?
A crucial first step is to think about the losses each party could potentially face if things go wrong. This step helps frame discussions and can significantly ease negotiations.
For the supply of goods and services, a good question to ask is what would happen if the relevant goods and services were not delivered as intended – could the recipient obtain alternatives quickly and easily elsewhere? At the other extreme, could the supplier’s actions jeopardize the recipient’s business?
Once this process is complete, it should be much clearer where you can be flexible and where you should insist on protection.
2. What is the correct level for any liability cap?
In almost any context, we would expect to see a clause setting a monetary cap on liability.
The clause often limits liability to the value of the contract – for example, if the contract is for £100,000 of timber, the liability cap is £100,000. This is often justified by the fact that a party’s potential liability should not exceed what it can get out of the contract.
Although common, this limitation can, and often should, be pushed back. The damages that one party can cause to the other often far exceed the value of the contract and it may be unfair for the innocent party to take the hit. This question often arises in the context of professional services in particular, where part of the point of involving professionals can be to ensure that a high-value project runs smoothly.
One approach that may work well is to tie the liability cap to the amount of insurance that the supplying party is contractually obligated to carry. Alternatively, the cap can be increased to a higher multiple of the contract value, or separate caps can be introduced for different types of losses.
3. What, if anything, should be excluded from this cap?
Some liabilities cannot be excluded by law and it is common for these liabilities to be expressly accepted as part of a limitation clause. The most commonly applicable are:
- liability caused by the fraud or dishonesty of the party;
- liability for injury or death caused by negligence or lack of reasonable care; and
- liabilities under statutory provisions implied in the sale of goods and the provision of service contracts.
It is also common to exclude specific risks from the cap. What is appropriate depends on the specific facts, but parties often accept unlimited liability for criminal activity, willful default (i.e. provisions where it seems unfair to allow one party to benefit from their wrongdoings ) or, more arguably, breaches of indemnities (see below).
4. Will the limitations actually be enforceable?
English law imposes many restrictions on limitation clauses, especially since such clauses can be abused by the stronger party in the negotiations.
Entire tomes have been written on the subject of enforceability, with what counts as enforceable depending on such questions as whether the recipient is a consumer and the type of contract involved. In short, however, to help ensure the clause is enforceable, the limitations should be reasonable, clear and visible.
It is also useful to subdivide limiting provisions into different clauses – this can limit the risk that one unreasonable provision will render them all unenforceable. Well-drafted contracts will also include what is called a “separation” clause to facilitate this.
5. How should I handle financial losses?
It is common to see provisions excluding “indirect and consequential losses”. This is quite often put in place on the basis that it will mean that financial losses (eg loss of profits, loss of anticipated savings, damage to goodwill) are excluded. This is a misconception; indirect and consequential losses are losses which are not the natural results of the breach in the ordinary course of events, but result from a particular circumstance of the case. Financial losses can be direct losses when they are the usual and foreseeable results of a breach.
If you want to exclude financial losses, it is better to specifically define the specific types of losses in the document.
6. What about allowances?
Indemnities are clauses obliging one party to indemnify another for a specific type of loss.
It is relatively common to award indemnities for certain third-party claims (for example, a claim brought by a third party that software provided under a contract infringes that third party’s intellectual property).
Unless there is a particularly good reason to award compensation for a specific peril, however, you should, where possible, refrain from awarding compensation. Indemnity invariably increases your liability beyond what would normally be the case. Nor is it common in an English law context to award significant damages.
It may be appropriate for allowances to be outside the normal cap of limitations, but generally only (among other points) if the allowances are specific and limited in scope.
Negotiating any limitation of liability requires a deliberate and thoughtful approach to providing protection against liability and loss under a contract.