Contracts provide a lot of information: How payments are made, when deliveries are expected, and where lawsuits regarding the contract will be filed. But one of the most important things a contract can do is allocate risk and costs associated with those risks. Two provisions that help with that are limitation of liability and indemnification clauses. Today, we’ll discuss limitation of liability provisions and, later we’ll cover indemnification clauses.
Limitation of liability provisions are well-named. They help limit the party’s liability. Often, this happens by stating a limit to the amount of exposure a party would face in the event a lawsuit is filed. For example, it might be flat amount (e.g., $1 million) or more closely related to the amounts related to the contract (e.g., no more than the amounts paid under the contract). Usually, it also limits the types of damages that can be claimed.
For example, if Burt’s Berets was supposed to deliver 1,000 berets to Fancy Francois’ French Emporium pursuant to a contract, and Burt’s Berets failed to do so. The contract might limit claims to only profits lost by Fancy Francois’ French Emporium due to loss of sales directly related to the breach of the contract. Those damages are expected for such a breach, and it makes sense for Burt’s Berets to be responsible for that risk and costs. These are usually called direct damages.
However, if Fancy Francois’ French Emporium was planning on selling all of its assets to Charlie’s Chapeaus and that sale now has to be delayed because the proceeds of the sale of the berets where going to reduce debt before the sale. That risk may not be foreseeable and may not be fair for Burt’s Beret to hold that risk. Therefore, often provisions disclaim that type of damage in a limitation of liability clause. These are usually called consequential damages. Sometimes it even makes sense to specifically call out specific consequential damages such as lost profits from business interruption as being disclaimed to avoid confusion if big numbers are likely.
Not every limitation of liability is OK, though. Courts have refused to enforce such provisions where the provision was ambiguous or unconscionable (e.g., limits it to $0); one party had unequal bargaining powers or a higher level of sophistication – especially if no negotiations were available; or public policy or a statute prohibits the enforcement of the provision.
Because these provisions can seriously limit liability, courts require that these provisions are “conspicuous,” which means these are usually in all capital letters and in bold LIKE THIS. That way it sticks out on the page.
So the bottom line is you can and should limit your liabilities via your contract but make sure it is clear what is and is not limited. It should be fair to both parties. And finally, if you ever see something in a contract in all capital letters and in bold, READ IT!