An exemption clause refers to a contractual provision that enables one party to reduce his or her obligations or liability if the contract is breached. The party receiving protection from such a clause is usually the one who drafted the contract. While an exemption clause can be found in many contracts, the court generally interprets it narrowly. The clause will only be valid if the court thinks it is reasonable. There are basically three different kinds of exemption clause: exclusion, limitation, and indemnity.

What Is an Exemption Clause?

When a contract is being drafted, one party may include a term to limit or exclude his or her liability under a specified circumstance, such as a breach of contract. Known as an exemption clause, this term serves the purpose of restricting liabilities that may result from the legal relation. For instance, a contract may contain an exemption clause stating that a party will only be liable for a maximum of $60. This type of clause is typically used to protect the party who prepared the agreement from being sued for damages or other losses by the other party.

Parties to a contract can include an exemption clause to distribute risk between them. The clause can be divided into an exclusion clause and a limitation clause. An exclusion clause is used to completely exclude liability for specified outcomes, while a limitation clause places a limit on the maximum amount of damages that one party has to pay if a certain part of the contract fails.

In general, the court adopts a narrow interpretation of exemption clauses. If it feels that an exemption clause in a contract is unreasonable, it can declare it void. Since a contract cannot be established unilaterally, an exemption clause must be reasonable in order to be legally acceptable.

Types of Exemption Clause

In today's business world, liability is a major concern for entrepreneurs who wish to enter into an agreement. They need to know what each contracting party is responsible for and how to determine their responsibilities. These concerns are often addressed in a contract's exemption clauses. Every kind of contract should have a “what if” clause. Also called an exemption clause, this clause should clearly explain the consequences for demonstrating unsafe behavior, breaching the contract, or other outcomes. The three main types of exemption clauses have different functions.

Exclusion Clause

Typically, an exclusion clause serves the purpose of entirely excluding a party from responsibility in the event of a contract breach. While it may not exclude the party from all responsibilities, it provides protection from any responsibility in relation to a specific event. While an exclusion clause provides complete exclusion of liability, it is not easy to enforce. Being suspicious of complete exclusion clauses, the court often overturns them if they are not properly written. An exclusion clause must be reasonable and clearly written in order to be enforceable.

Limitation Clause

A limitation clause is a more acceptable form of exemption clause, at least in the eyes of the court. It essentially serves the same purpose as an exclusion clause but to a lesser extent. A party with the protection of a limitation clause is not entirely excluded from liability in a specific event, but his or her liability is limited, which makes the situation more bearable.

Indemnity Clause

An indemnity clause is more complex than the other two types of exemption clause. In establishing such a clause, a party agrees to indemnify or absorb all the losses that he or she causes and hold the other party harmless. In other words, he or she will protect the other party in the event of a lawsuit instead of suing for damages.

Effects of an Exemption Clause

It is important for entrepreneurs to know what an exemption clause can and cannot do. In general, an exemption clause:

  • Excludes liability – The clause allows a contracting party to limit or exclude his or her liability if the contract is breached.
  • Restricts the freedom of contract – An exemption clause places restrictions on the rights of the contracting parties.
  • Prevents inequality of bargaining power – With an exemption clause, the weaker party can have the same bargaining power as the stronger party.
  • Only protects defendants – An exemption clause only benefits one party, which is usually the defendant.

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