Key Takeaways

  • Exemption clauses are contract terms limiting or excluding a party’s liability.
  • Courts interpret exemption clauses strictly and will scrutinize ambiguous wording.
  • Different types include limitation clauses, indemnity clauses, and exclusion clauses, each with specific applications.
  • To be enforceable, an exemption clause must be clearly incorporated, reasonable, and compliant with applicable laws.
  • Unenforceable clauses may be deemed invalid, leaving a party exposed to unexpected liabilities.

An exemption clause is a stipulation in a contractual agreement between two parties that limits the liability of one party in the case of breach of contract or contract default. There are a few different types of exemption clauses, but the three most common are:

  • Limitation clauses
  • Indemnity clauses
  • Exclusion clauses

Exemption clauses can be more in favor of one party than the other, so it's always important to be aware of these clauses, review them carefully, and negotiate if necessary.

Limitation Clause

Courts tend to be more accepting of limitation clauses, also called limited liability clauses. These can be less drastic than other exemption clause types, which is why courts seem to be more comfortable enforcing them. Limitation clauses don't completely exclude one party from any kind of liability, but they ease the blow a bit.

If a company includes a limitation clause in a contract, for example, it might state that if an individual is injured under contract, they will pay as much as $500 to cover damages. The clause will likely be worded negatively, so it would probably say that the company will not pay any more than $500 to cover damages.

Limitation clauses or limited liability clauses limit what an individual or company can be held responsible for, while still requiring a bit of liability so that the other party is afforded some damages.

Examples of Limitation Clauses in Practice

Limitation clauses are widely used across industries to cap potential liability while still offering some recourse. Examples include:

  • Software agreements: A software company may limit its liability for any malfunction to the cost of the software license.
  • Event contracts: An event organizer may limit liability to the value of the booking fee in the case of cancellation due to unforeseen circumstances.
  • Logistics contracts: A shipping company may limit liability to a set amount per kilogram for lost or damaged goods.

In these cases, the clause is designed to manage risk proportionally while preserving the contract’s core obligations.

Indemnity Clause

Of the three different types of exemption clauses, indemnity clauses are the most complicated. If two parties enter into a contract with an indemnity clause, one party is held liable for all losses that the other party might cause. This is called indemnification, one party protects or defends the other if they are sued.

Indemnity clauses work well in sales agreements. For instance, if one company sells a software design to another, they might include an indemnity clause in the contract in case an outside party tries to sue on grounds of intellectual property piracy. All costs of the lawsuit, including damages, would be completely covered by the company that originally created and sold the software design, even though the other company owned it.

Common Uses of Indemnity Clauses

Indemnity clauses are often tailored for specific contexts. Common uses include:

  • Construction contracts: A subcontractor indemnifies the general contractor against claims from third parties for on-site injuries.
  • Intellectual property licensing: A licensor indemnifies the licensee against infringement claims arising from the licensed content.
  • Professional services: A consultant indemnifies a client for losses caused by the consultant’s negligence or misconduct.

These clauses allocate financial responsibility and aim to protect the indemnified party from the actions or omissions of the indemnifier.

Exclusion Clause

Exclusion clauses are frequently found under the terms and conditions part of a contract. Pick up the owner's manual for just about any product and you'll find a terms and conditions section. Most companies include an exclusion clause that says something like, "(company name) is not liable for any damages if our products are used unlawfully or outside of their intended use."

Because companies cannot control exactly how their products will be use by consumers, exclusion clauses protect them from being sued for things they couldn't help. For example, a company that makes rat poison cannot be sued if a person ingests it and dies because the product is not meant to be ingested.

In such cases, exclusion clauses keep the company protected from liability for any and all damages in a certain type of breach of contract. Other times, exclusion clauses can simply limit how much a party is held liable for to help lower the amount of risk they take on in forming a contract.

One party may draft a contract with an exclusion clause that states that they may only be held liable for as much as $10,000 in a specific event. This way, if something goes wrong, one party can't take the other for everything they're worth, but the defaulting party is still held responsible for their actions.

Courts’ Interpretation of Exclusion Clauses

Courts often interpret exclusion clauses strictly, narrowly, and against the party seeking to rely on them. If the wording is ambiguous, courts may resolve doubt in favor of the party seeking protection from the clause’s effects.

Factors influencing interpretation include:

  • Whether the clause was clearly and expressly incorporated into the contract.
  • The clarity of language used to specify what liabilities are excluded.
  • The relative bargaining power between the parties.

In some jurisdictions, certain liabilities (e.g., death or personal injury from negligence) cannot be excluded regardless of the contract language.

Exemption Clause Enforcement

Exemption clauses can be fairly simple to draft into a contract, but they are sometimes difficult to enforce with the court.

In order to be enforceable, the drafting party must be sure that the exemption clause:

  • Is obvious and clearly stated in the contract
  • Doesn't exploit a weakness in the other party (like a massive company taking advantage of a smaller company's lack of resources)
  • Allows for opportunity to negotiate the clause and is not adhesive

Courts tend to be skeptical of exclusion clauses that totally exclude one party from any liability at all, especially if these total exclusion clauses aren't written properly. Taking a party to court over an exclusion clause is still very expensive and time consuming, even if the case goes in your favor, so be careful what you sign and read terms and conditions carefully.

Key Factors for Enforceability

For an exemption clause to be enforceable, several critical factors must be satisfied:

  1. Incorporation: The clause must be incorporated into the contract at the time of agreement, either by signature, reasonable notice, or course of dealing.
  2. Clear wording: Any ambiguity in the language may render the clause unenforceable.
  3. Reasonableness: Courts will assess whether the clause is fair, considering:
    • The bargaining power of the parties
    • The nature of the transaction
    • The availability of alternatives
  4. Compliance with statutory limits: Some laws prohibit exclusion of liability for certain harms, such as personal injury due to negligence.

Failure to meet these conditions could result in the clause being struck down in court.

Frequently Asked Questions

  1. What is the purpose of an exemption clause?
    An exemption clause limits or excludes a party’s liability for certain risks in a contract, managing exposure to lawsuits or damages.
  2. Are exemption clauses always enforceable?
    No. They must be clearly incorporated, reasonable, and comply with laws. Courts may strike them down if they’re unfair or ambiguous.
  3. Can an exemption clause exclude liability for negligence?
    In many jurisdictions, liability for personal injury or death from negligence cannot be excluded, even if stated in the contract.
  4. How do courts interpret exemption clauses?
    Courts interpret exemption clauses narrowly and against the drafting party, especially if the clause is unclear or unfair.
  5. What’s the difference between an exclusion clause and a limitation clause?
    An exclusion clause eliminates liability entirely for certain breaches, while a limitation clause caps liability to a set amount.

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