Commercial Contracts – Six questions to ask yourself when limiting liability
At Boodle Hatfield we deal with a whole range of commercial contracts. Regardless of whether it’s a contract for the sale of furniture or the supply of software, however, the most crucial clauses are often those where the parties attempt to limit their liability.
This article covers off six key things to consider when negotiating the limitation provisions in your contract.
1. In practice what are the risks to the parties?
A crucial first step is thinking about the losses that each party could feasibly be faced with if things go wrong. This step helps frame the discussions and can take a lot of the heat out of 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 supplied as expected – could the recipient get alternatives quickly and easily elsewhere? At the other extreme, could the supplier’s actions put the recipient’s business at risk?
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 right level for any cap on liability?
In nearly all contexts we would expect to see a clause putting a monetary cap on liability.
The clause often limits the liability to the contract value – e.g. if the contract is for £100,000 worth of timber, then the cap on liability is £100,000. This is often justified on the basis that a party’s potential liability should be no more than what they can get out of the contract.
While common, this limitation can, and often should, be pushed back on. The damage a party can cause the other is often greatly in excess of the contract value and it can be unfair for the innocent party to take the hit. This issue often comes up in the context of professional services in particular, where part of the point of getting the professionals involved can be to ensure a high value project goes well.
One approach that can work well is linking the cap on liability to the amount of the insurance the supplying party is contractually obliged to take out. Alternatively, the cap can be increased to a higher multiple of the contract value, or separate caps introduced for different types of loss.
3. What, if anything, should be excluded from this cap?
There are some liabilities that cannot be excluded by law, and it is common for these liabilities to be expressly accepted within a limitation clause. The most commonly applicable ones are:
- liability caused by the party’s own fraud or dishonesty;
- liability for injury or death caused by negligence or lack of reasonable care; and
- liabilities under the statutory terms implied into sale of goods and supply of services contracts.
It is also common to exclude specific risks from the cap. What is appropriate depends on the specific facts, but parties often accept uncapped liability for criminal activities, deliberate default (i.e. provisions where it seems unfair to allow a party to benefit from their wrongdoing) or, more debatably, breaches of indemnities (see below).
4. Will the limitations actually be enforceable?
English law puts quite a few restrictions on limitation clauses, particularly as such clauses can be abused by the stronger party in negotiations.
Whole tomes have been written on the subject of enforceability, with what counts as enforceable depending on matters such as whether the recipient is a consumer and the type of contract involved. In short, however, to help ensure the clause is enforceable, the limits should be reasonable, clear and visible.
It is also helpful to sub-divide the limitation provisions into different clauses – this can limit the risk of one unreasonable provision making all of them unenforceable. Well drafted contracts will also include what is called a ‘severance’ clause to aid this.
5. How should I deal with financial losses?
It is common to see provisions excluding “indirect and consequential losses”. This is quite often put in on the basis that this will mean that financial losses (e.g. loss of profits, loss of anticipated saving, damage to goodwill) are excluded. This is a misconception; indirect and consequential losses are losses that are not the natural results of the breach in the usual course of things but arise from a special circumstance of the case. Financial losses can be direct losses where they are the usual, predictable results of a breach.
If you want to exclude financial losses it is better to specifically set the specific types of losses in the document.
6. What about indemnities?
Indemnities are clauses requiring one party to compensate another for a specific type of loss.
It is relatively common to give indemnities for certain third party claims (e.g. a claim brought by a third party that the software provided under a contract infringes that third party’s IP).
Unless there is particularly good reason for giving an indemnity for a specific risk, however, you should otherwise resist giving an indemnity as far as possible. An indemnity invariably increases your liability beyond what would ordinarily be the case. It is also not standard in an English law context for extensive indemnities to be given.
It may be appropriate for any indemnities to be outside the normal cap on limitations, but generally only (amongst other points) if the indemnities are specific and limited in scope.
The negotiation of any limitations of liability requires a deliberate and thoughtful approach in ensuring protection from both liability and loss under a contract.
Boodle Hatfield and the Drive team have advised entrepreneurs and other parties in a range of commercial settings, and have a wealth of experience in ensuring secure arrangements for our clients. Please get in touch if you would like to learn more.
Charlie Hewlett is an Associate in the Corporate team at Boodle Hatfield and a member of the firm’s specialist Entrepreneurs Group and Ruby Dyce is a Trainee currently working with the Corporate department team.