1. What Is a Contractual Limitations on Damages?
2. Agreements on Damages and Incorporation
3. Interpretation and Construction

A limitation of damages clause is a contractual agreement where parties either exclude or limit the availability of damages that statutory law otherwise entitles them to.

What Is a Contractual Limitations on Damages?

Setting limits on the damages one party can receive is very important, as it allows the parties to adequately assess and control their business risks when entering into an agreement.

Many commercial contracts have some type of damage limitation clause. Although these clauses are often used, they sometimes cause some legal difficulties, such as the following:

  • Determining the respective interests of debtors and creditors
  • How to fairly balance either party's freedom against mandatory legal provisions

Contractual limitations on damages are different from general “liability limitations” or “exemption clauses” which absolve a party from liability in that they exclusively relate to damages.

Agreements on Damages and Incorporation

The parties entering into a contract need to agree on the limitation of damages clause. Such an agreement cannot be formed unless there is a relationship between the debtor and the creditor. As long as all parties agree to the content in the clause, it's usually simple enough to include a limitation of damages in the contract.

It's possible for contract terms to be implied by each party's conduct. However, basing a limitation of damages just on conduct is rarely done, and setting terms is generally determined by examining previous dealings between the involved parties on the same terms. Just because the parties may have a personal relationship or established goodwill doesn't mean that a limitation of liability can be assumed.

You'll often find limitations on damages in a contract's general terms and conditions (GTCs). One party may have a standard set of terms and conditions that it includes in many contracts. However, they're only effectively included when the agreement itself refers to them.

In a civil law system, a GTC provision that's considered so outlandish that it couldn't have reasonably been expected won't be considered a valid part of the contract. In a common law system, however, a party must show that fraud or misrepresentation has occurred before escaping the consequences of signing a contract.

Likewise, when one party claims it didn't understand the GTCs of a contract he signed, he will have to prove to the court that the agreement is radically different from the one that the party meant to sign and that it wasn't a careless mistake.

Interpretation and Construction

Contractual limitations on damages are interpreted the same as other contractual provisions. The goal is to figure out the parties' intentions. There are various ways to arrive at the contractual intent.

You start by looking at the wording that the parties use. You should also look at how the various provisions are organized and the agreement's purpose. These factors may be more important than a strict interpretation of the language.

For instance, if an exemption clause is so general and broad in scope that if applied, it either would defeat the contract's purpose or create an absurdity. The court would then have to figure out the meaning to give effect to the contract.

In Anglo-Saxon tradition, there are rules to strictly interpret exclusion clauses, and these rules are frequently applied.

When a contract provides both a limitation of liability and a warranty, special consideration must be taken. In this case, one clause may prevail over the other. For instance, the court may find that the warranty is included in the main portion of the agreement, while the limitation of liability clause is an annex to the standard terms of the contract.

However, when a party gives a warranty, but doesn't assume liability for warranty breach at the same time, then the warranty should be treated as consistent with the liability limitation.

Because contracts are legally binding documents, it's vital to fully understand what you're agreeing to before you sign one. With all of the various provisions, fine print, and additions that a contract might have, it's important to take your time and read over everything carefully. Consult with an expert in contract law if you're unsure so that you're completely informed before you agree to any terms.

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