Limited Liability Clause Definition
Limited liability clause definition is used to limit the total amount of financial damages received if contract obligations are not fulfilled.3 min read
Updated November 23, 2020:
Limited liability clause definition is used to limit the total amount of financial damages received if contract obligations are not fulfilled. Enforced under the general rules of freedom of contract in most states, the limited liability clause, or exculpatory clause, is designed to cap the liability of one of the parties on the contract. Contracts between companies often include clauses to limit liability.
Limited Liability Clauses
A limited liability clause can protect one party suing another party of the contract or from outside entities. The clause can also be used to protect a company who doesn't fulfill the obligations laid out in the contract by limiting how much the other party can recoup. When drafting a limited liability clause, it should be noted that:
- The liability clause can be as short as two sentences.
- The provision is written in all capital letters to meet the requirement of being clear and visible to the reader. This is a requirement of most states when creating a contract. The provision also answers the question that if something were to go wrong, how much is owed.
- The clause must include the overall scope and expectations of the indemnity or limited liability clause.
- A full and detailed description that covers all possible liabilities.
- If the clause violates public policy, the provisions will not be enforced. A violation of public policy example is if an existing statute conflicts with the contract clauses.
An example of a limited liability clause would be if a homeowner hires a roofing company. In the contract, a limited liability clause states that the roofing company's liability of $5,000. If the roof is installed then collapses and destroys the homeowner's personal property, the homeowner would only be able to receive $5,000 in compensation.
Indemnity clauses are written to require an agreement between one or both parties to provide defense and possible financial payments that stem from claims, lawsuits, or judgments. The clause states the ability of one of the parties to the contract to take legal action against another party to the contract, including third parties, for monetary or tangible damages. However, an indemnity clause does not offer full protection of third parties who did not sign a contract.
The clauses, when written by larger companies who have leverage, lean to the favor of the larger company. Smaller companies need to determine if the risk of the clause is outweighed by the financial gain of the contract. The clause language may include the obligation to pay any legal costs or attorney fees.
Depending on the state, the indemnity clause legality will vary. Alaska does not uphold indemnity clauses in regards to construction contracts as seen in City of Dillingham v. CH2M Hill Northwest, Inc., 873 P.2d 1271 (Alaska 1994) because of an existing Alaska anti-indemnity statute. In contrast, California will allow contractors the ability to negotiate liability as it did in Markborough v. Superior Court.
Adding Limited Liability and Indemnity Clauses
Limited liability and indemnity clauses are added as provisions to a contract to protect both parties. Companies that offer services to others can add language to the contract that will set a limit to the total liability they would be responsible for if there is a breach. In general, limited liability clauses protect the vendor that is paid under the contract agreement. Indemnity clauses can benefit either party by assessing the risk associated with any future claims that may occur.
Small businesses looking to contract with larger businesses should review their insurance coverages and limits before deciding to accept indemnity provisions. The cost of high insurance limits and comprehensive insurance may be the catalyst for smaller companies to accept the risk. They may also have to consider the consequences of asking for a limited liability clause that is to their advantage. In this case, they have to expect the other company may see it as a lack of competency so this should be addressed.
When creating a contract with limited liability clauses or indemnity clauses, hiring a lawyer will help confirm the language used is legal and meets state law requirements. A lawyer will also help determine if these clauses are legal in your state. Templates exist that can be used, but may invalidate the contract due to minor language changes.
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