Limitation of Liability – Managing Risk and Exposure

In this article, we are considering negotiated contracts rather than those which one party imposes on another by way of clickwrap or similar methodologies.

A limitation of liability clause is a fundamental provision when negotiating a contract. An effective limitation of liability clause ‘limits’ how much a party pays to the other party by way of damages in respect of a breach of contract or other specified circumstances.

Although certain liabilities cannot be limited no matter the contractual wording, such as those that relate to death or personal injury resulting from a party’s negligence, a limitation of liability clause allows parties to a contract to agree in advance the maximum amount of financial exposure they are each willing to accept if contractual problems arise. Ultimately, a well drafted limitation of liability clause helps a business manage the potential risks arising from commercial relationships.

This key provision should be considered at the earliest opportunity because without due consideration financial exposure could be:

1. astronomical, outweighing any value the original contract held and/or outstripping any insurance coverage that may be in place; or
2. insufficient to cover losses with no incentive for a party to adhere to its obligations under the contract.

Furthermore, when potential investors or acquirers are conducting due diligence, they will check the existing contractual exposure of the target. They may shy away from businesses that are exposed to unusually high or unfathomable levels of risk. Managing your risk and exposure with effective limitation of liability clauses is therefore crucial if you are looking for investment or if one day you hope to sell your business.

Although outside the remit of this article, as part of their risk management, service and product providers need to take out professional indemnity and/or other appropriate forms of insurance to cover their exposure.

For legal assistance with your commercial contracts, if you are seeking investment, or if you want to discuss liability provisions in more detail, please contact John Harrington.