The most important rules in business according to Warren Buffet are: "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1."
The same should also apply to commercial contracts. Most people will focus on the value and the potential profit, but often not the risks, obligations and potential liabilities associated with the contract.
Whether you are a seller, service provider or a purchaser of goods and services, it is important to assess the extent of your potential liabilities and to limit them where possible. This guide will help you to manage and mitigate such risks through limitation and exclusion of liability clauses.
The most direct ways for parties to limit their liabilities under a contract is by (i) excluding liability for certain types of loss through exclusion of liability clause or (ii) putting a financial cap on liability for such losses through a limitation of liability clause. Such limitation of liability, exemption or exclusion clauses either seek to limit or exclude a party’s liability, or the counterparty’s rights or remedies.
The following are some typical limitation of liability, exclusion or exemption clauses used to limit a party’s liabilities in a contract:
Limitation of liability and exclusion clauses are effective ways of balancing the risk between parties to a commercial contract. They are useful for the parties to state that what they are not taking responsibilities for and to exclude liabilities on certain matters through these clauses. However, limitation of liability and exclusion clauses need to be approached with care.
For an exclusion clause or a limitation of liability clause to be effective, it must satisfy the following requirements:
Limitation of liability, exclusion and exemption clauses should be drafted with due care. In particular, the liability in question should be clearly defined when drafting these clauses. In relation to an exclusion clause, the excluded liability should be clearly and specifically craved out with the remaining liability being recoverable under the contract. The terms used must clearly and unequivocally cover the obligation or liability that they seek to exclude or restrict.
For example, instead of a general wording to exclude “any loss however caused”, it would be helpful to use more specific terms such as excluding “any loss arising from wilful intent or negligence” to ensure that loss arising out of negligence is excluded. Clarity of terms would reduce the probability of expensive litigation down the road.
The limitation of liability and exclusion clauses will also need to be clearly incorporated into the contract for them to be effective. This should not be a problem where both parties agree to and sign the written contract. However, this would be an issue if the supplier or service provider provides the goods and services on the basis of its terms and conditions without requiring the customer to sign or acknowledge.
Your terms and conditions (including the limitation of liability and exclusion clauses) will only be deemed to be accepted by your counterparty if (i) it has been fairly brought to the other party’s attention; and (ii) the counterparty purchase the goods and services anyway being aware of such terms and conditions. The more unusual or onerous is the limitation of liability / exclusion clause, the more prominence it should be given.
If the purchaser has sent you its own form of “terms and conditions”, that would make things even more complicated. A “battle of the forms” will erupt and the last party who has been last sent the “terms and conditions” before the transaction is generally deemed to have accepted the terms of the other party. One will need to determine who the winning party is in order to decide which limitation of liability and exclusion clauses have been incorporated.
A limitation of liability clause or an exclusion clause may be unenforceable if they are unreasonable – for example, if the liability caps are set too low, or exclusions are too broad in scope. The more reasonable, narrow and realistic is the clause, the more likely it is to be upheld by a court.
In relation to a general commercial contract, liability for breach of contract cannot be excluded without reasonable grounds to do so. What constitutes reasonable will depend on the facts, including but not limited to: (i) the relative bargaining position of each party, (ii) whether there are alternative options available, and (iii) whether any incentives to agree were given to such terms.
The downside of drafting an all-encompassing limitation or exclusion of liability clause is that it may run the risk of being struck down by the court. If the entire limitation of liability clause is struck down, then the party may face unlimited potential liability, which is the exact opposite of the original intention of the party.
On any ambiguity of terms, the court may apply the “contra proferentem” rule, which means that the clause will be interpreted strictly and construe any ambiguity against the party seeking to rely on it. The court will also look to the other contractual terms agreed to ascertain the parties' original intentions and intervene only when strictly necessary.
In many common law jurisdictions, there are unfair contract and consumer protection legislation to balance public policy against the freedom of contract. In many cases, there is a power imbalance between the contracting parties and the stronger party should not be free to impose its terms on the weaker party in negotiations to absolve itself from any potential liabilities and obligations.
For example, the English Unfair Contract Terms Act imposes a reasonableness test on many limitation clauses, such as liabilities for negligence, misrepresentation and implied terms. Similar to the test above, the clause must be fair and reasonable in the circumstances which were, or ought reasonably to have been, known to, or in the contemplation of, the parties at the time of entry into the contract.
Furthermore, English law stipulates that one cannot exclude or limit liability for death or personal injury caused by negligence. Other liabilities caused by negligence can only be limited or excluded if the contract terms pass the "reasonableness test". In addition, there is generally no limitation on liability for fraud.
If you need any information on termination for breach of contract, please refer to:
The two main types of clauses are: (i) limitation of liability clause with financial caps on claims and liabilities; (ii) exclusion clause that seek to exclude or limit certain types of loss:
(a) The easiest way to limit your liability is to specify an aggregate financial liability ceiling in your limitation of liability clause, for example:
The aggregate amount of the liability of Party A for all Claims shall not exceed [Amount].
Instead of having a fixed monetary amount, the amount can also be expressed as x times the amount of the value of goods and services provided by Party A. Generally, “manifest and reckless default, fraud, fraudulent misrepresentation or reckless misconduct by the defaulting Party” will not be included in the liability cap.
(b) Another way is to impose a cap on individual claim, for example:
Party A shall not be liable for any individual Claim unless the liability of Party A in respect of such Claim exceeds [Amount] (in which event Party A shall be liable only for the excess over [Amount]).
This may appear to be more reasonable in court as an aggregate liability cap for all claims may be construed as too wide or all-encompassing.
(c) For higher value items, products or services, one may wish to set a minimum financial threshold for claim:
Party A shall not be liable for any Claim unless the aggregate amount of the liability of Party A for all Claims exceeds [Amount] [(in which event Party A shall be liable only for the excess over [Amount]).
This is similar to an excess in car insurance. This is to disincentivise small claims unless the aggregate liability is over a certain threshold.
The parties may wish to agree in advance on the amount of liquidated damages which could be recovered in respect of a specific breach, for example:
If, [BREACH OCCURS], then Party A shall be liable for liquidated damages for such delay at the rate specified below:
[(a) from what date;
(c) maximum liability.]
Liquidated damages are usually used to assess damages arising from the late performance of contractual obligations or failure to achieve performance or output criteria. This is usually drafted as a percentage of the value of the work per day after the completion date.
The stipulated sum should represent liquidated damages judged at the time the contract was made, it amounts to a genuine pre-estimate of the damage which the innocent party would suffer as a result of the breach.
However, it will be unenforceable if it is in the nature of a penalty designed to secure the performance of the contract, regardless of whether the actual loss is greater or smaller than the liquidated damage. In general, if the amount of liquidated damage is disproportionately high, it runs a higher risk of being deemed as an unenforceable penalty.
Another common restriction is to impose time limit on claims:
Party A shall not be liable for any Claim unless it receives from Party B written notice containing specific details of the Claim including Party B's estimate (on a without prejudice basis) of the amount of such Claim on or before [Date], in the case of a Claim for breach of any of the Warranties.
Again, the time limit should not be too short, otherwise it would run the risk as being regarded as unreasonable and thus become unenforceable.
(a) One can also choose to exclude certain categories of liability completely. The most common examples are indirect losses, such as loss of profit, loss of revenue, and loss of business. For example:
Party A shall not under any circumstances whatever be liable for:
(b) You may also wish to exclude losses or damages of distant categories, contingent liabilities or where the scope of potential losses or damages is too vague to be priced. Other items you may wish to carve out are claims arising from the acts or omissions of the claiming party, and claims as a result of a change in law.
(c) In addition, one may wish to exclude money paid out by insurer in relation to the claim from the liability claim, or if already claimed, be paid out to the defaulting party. This will prevent the claiming party from being doubly compensated.
Another way to limit liability is to lower the performance standard under the contract. For example, the obligation to use "reasonable skill and care" is often easier to achieve than to guarantee something will be "fit for purpose. Similarly, the obligation to perform on a "best effort" basis is a more limited commitment than to undertake to use "best endeavours". “Best endeavours” require you to do everything possible to achieve the outcome, regardless of whether it is against your own commercial interest. Whereas “best effort” only requires you to make your best effort to achieve the outcome, and does not require you to take extra steps might be contrary to your commercial interests.
Instead of trying to agree on the losses and liabilities to exclude, one can also identify the losses that are intended to be recoverable and include them as warranties. This is probably easier for the parties to agree on and everything else outside of the warranties shall be excluded. Warranties are particular common for larger priced items, services and businesses. In addition, items that have been disclosed can be excluded from warranties.
Party A shall not be liable for any Claim in respect of any fact, matter, event or circumstance to the extent that:
(a) (in the case of a claim for breach of Warranty) such fact, matter, event or circumstance has been disclosed in this Agreement, the Disclosure Letter or in any document disclosed to any director of or professional adviser to Party B; or
(b) allowance, provision or reserve has been made for such fact, matter, event or circumstance or to the extent that payment or discharge of the relevant matter has been taken into account therein.
To limit any potential liability from innocent or unintentional pre-contractual statement inadvertently becoming a pre-contractual representation, it is common for the parties would usually include an “Entire Agreement” clause and / or a “Non-reliance” clause in the contract. An Entire Agreement clause usually include terms to the effect of:
This Agreement sets out the entire agreement and understanding between the parties with respect to the subject matter of it.
A non-reliance clause is more common for financial contracts. The parties acknowledge that they have made their own independent decisions to enter into the contract and have not relied on representations made outside of the contract.
Force majeure is a common clause in a commercial contract to stipulate the consequences of an extraordinary or unforeseen event beyond the control of the parties, such as the event described as “Acts of God”. A simple example is as follow:
None of the parties shall be liable for any failure or delay in performing any of its obligations under or pursuant to this Agreement if such failure or delay is due to any cause whatsoever outside their reasonable control, and they shall be entitled to a reasonable extension of the time for performing such obligations as a result of such cause.
The force majeure clause helps to limit liability and allocate risks when unforeseen events adversely affect the ability of one or both parties to perform their contractual obligations on time or in full.
For a more comprehensive selection of force majeure clause, please go to:
Limitation of liability clause and exclusion clauses are of fundamental importance in managing and allocating risks in commercial contracts. They are often the subject of intense negotiations between the contracting parties to exclude certain types of losses or set a financial ceiling for the contracting parties’ total liability. One should consider the following factors when negotiating limitation of liability clauses:
You may well have limitation of liability and exclusion clauses with everything in your favour (i.e. minimal liability cap and exclusion of all liabilities), but if these clauses are unreasonably broad and onerous, they may be held unenforceable by the court. Not only would they not achieve their intended purpose, they may actually have the opposite effect of offering no protection against unlimited liability.
A well-drafted clause allows both parties to balance their risks with the potential benefits of the contract. For a more comprehensive list of limitation of liability and exclusion clauses, please go to:
Please note that this is just a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your lawyer.
DocPro Legal is a team of legal professionals with a passion for making quality documents and legal contract templates widely available to the public through cutting edge technology. Our lawyers are qualified in numerous common law jurisdictions including the United Kingdom, Australia, New Zealand, India, Singapore and Hong Kong. We have experience in major law firms and international banks with expertise in business, commercial, finance, banking, litigation, family, succession and company laws.
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