Limitation of Liability: Everything You Need to Know
A limitation of liability clause, sometimes called a liability clause, refers to a legal provision included in a contract, which limits the level of exposure the company will face in the event of a claim or lawsuit filed against them.4 min read
2. Why is it Necessary to Limit Liability?
3. How Extensive Can Limited Liability Clauses be?
4. Are Limitation of Liability Clauses Enforceable?
5. How Can Your Business Limit Potential Liability?
What Is a Limitation of Liability Clause?
A limitation of liability clause, sometimes called a liability clause, refers to a legal provision included in a contract, which limits the level of exposure the company will face in the event of a claim or lawsuit filed against them.
In the event it's enforced, the liability clause will essentially ‘cap' how much the company is required to pay in damages, should they be held responsible for failing to perform an item stipulated in the contract.
Why is it Necessary to Limit Liability?
Common law protects parties from liability incurred due to unforeseen damages. however, there are often foreseeable damages that are known when the contract is entered into. Parties are liable for the full extent of any foreseeable damages, under common law. At their most basic level, limitations on liability serve as a simple reiteration of the basic common law principle protecting parties from unforeseeable damages.
While insurance can cover the majority of individuals and companies, there are certain claims that can't be insured. In such cases, limiting your liability is a form of protecting yourself financially in the absence of an insurance policy
How Extensive Can Limited Liability Clauses be?
The more robust a limitation of liability clause is, the more protection it offers. Some extend so far as to limit the extent of liability for foreseeable losses, as well as unforeseeable ones. This ensures the amount paid, in the event that foreseeable damages do occur, does not exceed a certain level. They may be foreseeable losses that arise as a result of particular types of claims, such as disclosing confidential information, or infringement.
Alternatively, the limitation may set an upper limit, or 'cap', on the total amount any party is liable to pay for any type of claim. Limitations can also be applied to any claims that may arise during the contract period or apply only to specific actions and claims.
There are four forms of liability that are typically limited by such a clause:
- The amount of fees and compensation paid under the terms of the contract
- A set sum of money
- The amount of insurance available to cover the contract
- A combination of the above
Are Limitation of Liability Clauses Enforceable?
Despite limitation of liability clauses reducing a firm's exposure by 90 percent, there has been controversy over whether they are enforceable. While there has been recent support from the courts for limitation of liability clauses, the debate over them has stemmed from the problematic nature of their enforcement. Some states extoll the belief that they cannot be enforced due to their adhesive nature and the inability of parties to enter into free negotiations to establish their terms in the contract. As such, the argument goes, these clauses are void as a matter of public policy.
When used in a commercial context, there are many states who view such clauses as entirely enforceable exactly as written and view them as a simple shifting of risk.
While there is still some controversy over which view is more accurate, the law does permit the negotiation of liability clauses by the parties involved, and as such they are enforceable. However, under certain circumstances, the courts can and have refused to enforce provisions. These situations include:
- Any ambiguity or unconscionable elements in the clause
- The event that parties did not fully or clearly express their intentions
- Instances in which one part possessed bargaining powers that were unequal to other parties, or possessed a greater extent of sophistication than other parties
How Can Your Business Limit Potential Liability?
Due to the controversial nature of enforcing a liability clause, it is only a valuable addition to your contract if it is enforceable. While there are cases of liability clauses being upheld even when poorly drafted, it's not a likely outcome. As a result, drafting an effective and enforceable limitation of liability clause is absolutely essential for your business. Here are a few tips to help you ensure you are well covered by your clause:
- Be conspicuous - use formatting to highlight it in bold font, or underline it. You can also separate the clause from the rest of your contract under a heading in a different section, or on another page. Doing this ensures no party can claim they were unaware of its presence.
- Use clear language - be concise and unambiguous.
- Negotiate your clause - discuss the liability clause with all parties signing the agreement, and negotiate any points on which they disagree.
- Keep your revisions and drafts - this will act as proof of negotiations.
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