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Limitation of Liability clause is important in Contracts

Soumya Bajpai

| Updated: May 11, 2020 | Category: Legal Service

limitation of liability clause

A limitation of liability clause, or liability clause, is defined as a disclaimer for an agreement that limits the conditions under which the disclaiming party may be held liable for loss or damages. It further defines the limits of damages which may be claimed in certain instances. The limitation of liability clause stipulates that one party will be obligated to pay to the other party under certain terms of an agreement for a particular happening of an event. This limited clause limits the amount as well as the types of damages a party can recover from the other party.

It defines the boundaries of damages for both the parties of a contract. The limitation of liability clause is the qualifier to the idea of a liability. Liability is an obligation by which compensation is provided when one fails to perform according to agreed or negotiated standards. However, everyone has to face an inherent risk while performing the contract. There are various types of loss and damages which are susceptible because of external factors.  Sometimes it is almost impossible to fulfill obligations in a 100% capacity, and therefore it is important to accept limits under contract law.

Why one needs a limitation of liability clause?

This limitation of liability clause is the efficient way to bridge the gap on certain mishappening of an event. The liability amount undertaken by one party (usually service provider). The following are important things:

  • The party, limited its liability, can extend its potential exposure under a particular agreement.
  • It can also predict the maximum exposure and contingent liabilities.
  • The party can take adequate insurance cover in order to take care of any potential liabilities.

This limitation of liability clause is prevalent more to service agreements and normally favors a service provider who wants to limit the exposure. The reason and rationale behind such a clause is to protect the service provider from taking risks, which may not be compensated with the small amount. The service provider profit margin on projects or assignments in many cases is supported by taking unlimited risk in may aspects. Even insurance covers also come with several riders and disqualifications, and the insurers insist on limitation of liability clauses in the agreements.

Usually, when the party who drafts an agreement has the upper hand in this particular regard, the party incorporates limitation of liability clause in its favor to limit their exposure from the risks. However, the enforceability of the limitation of liability clauses is not absolute, mainly in cases that involve gross and deliberate negligence on the part of the service provider itself. It also depends on merits of each case differently.

Limit and cap a monetary amount of potential damages

The limitation of liability clause reaffirms those circumstances wherein neither of the party can be held responsible for any losses. However, there are many obvious incidents when damages and losses are out of reasonable control. The common law principles say, parties of a contract are held responsible only for foreseeable damages. A limitation of liability clause may explicitly cap the number of potential damages which can be claimed and to which a company requires to be disclosed.

Is a limitation of liability clause enforceable under law?

The question of enforceability under the law has been up for debate for a long time as all states have different approaches regarding the enforceability of a limitation of liability clause. In other countries, the limitation of liability clauses is viewed as void because most of the agreements cannot be negotiated. For example, when customers use online platforms, they usually don’t have the opportunity to argue for a higher cap regarding the potential damages. However, there is enforcement of a limitation of liability clauses, especially in the commercial setting. In commercial transactions, limitation of liability clauses are seen as a necessary and valid transfer for risk.

Courts whereas generally refuses to enforce clauses on these grounds which are:

  • Unclear in expressing the intentions of the party to another
  • Ambiguous or unconscionable
  • Against a public policy or statue

How the limitation of liability clause minimizes risk?

Every commercial transaction carries a risk while doing a business and performing a contract. The party may commit a breach of the contract through misrepresentation, infringement of intellectual property rights, negligence, and breach of statutory duty, as possible offenses. Without the limitation of liability, parties seeking damages may not recover any amount of money with a potential limit. This can obviously damage the company’s financial interests. It also further has the consequence of attracting more lawsuits against the company in hopes of successful claiming of damages.

Limitation of liability clause examples in certain cases

The limitation of liability clause can explicitly exclude certain forms of losses and damages. For instance, a limitation of liability clause can limit the liability of a company versus the liability of other parties involved. The Company must not be individually liable to a Buyer for any damages regarding breach of fiduciary duty made by third-parties, unless the Company’s act involves failure by fraud, intentional misconduct, or a violation of law. The incidental, special, or consequential damages are typically written in the limitation of liability clauses and the types of damages for which parties cannot be held responsible.

Notwithstanding anything written contrary, the Buyer agrees to the extent that company will not be held liable for any losses or damages for indirect, incidental, special or consequential delivery of goods or services, irrespective of whether the Buyer has been advised or otherwise have anticipated the possibility of such loss or damage.

Lastly, the limitation of the liability clause can also clarify the maximum amount of damage that can be claimed by the other party during the performance of an event.

Business contracts

When the contract is made between two businesses, then the limitation of liability clauses are said to be prohibited under the Unfair Contract Terms Act (UCTA) during the following circumstances:

  • In case of death and personal injury caused due to negligence
  • The breach of contract and misrepresentation
  • The breach of terms implied by the law which are not expressly mentioned in the contract such as the quality and fitness, for the purpose of goods has to be guaranteed even if there is no express term in the agreement

However, in regards to breach of contract, misrepresentation, and breach of implied terms, it is always necessary to limit the party’s liability if the limitation clause is ‘reasonable.’ While considering whether a clause is reasonable or not, the courts will take the factors such as parties relative bargaining position or the information available to the parties when the original contract was made. For instance, a limitation clause that caps liability to the value of a contract is more likely to be reasonable than one that excludes liability altogether.

Consumer contracts

The Limitation of liability clauses, when done by business-to-consumer contracts, is less enforceable than in business contracts. Any contractual provision which imposes an imbalance between the parties to the detriment of the consumer is considered unfair and is prohibited. In order to enforce the liability clause, this will be subject to the reasonable test. The court must consider that the restriction of liability is unreasonable and does not bind upon the consumer.

Draft of limitation of liability clause

When a draft of a limitation clause is made, it is important to identify precisely the risk attached to a contract and the subsequent losses which may occur from those risks. The losses made to party accept to compensate other than in case of fraud, death or personal injury.

Conclusion

Limitation of liability clause serves the purpose of protecting the company from various potential lawsuits and from exorbitant damages. There are only certain types of damages that can be covered by insurance; it is important to limit the types of claims and to cap the amount that can be recovered in instances of damage and loss.

In order to be effective, the limitation of liability clause needs to be written as valid and enforceable. Clauses must be written in a clear and unambiguous manner, placed in a conspicuous location within a contractual agreement, and unmistakable in expressing intentions of either party. The law imposes restrictions for the application of limitation of liability clauses. In particular, the extent of liability will be limited, and it depends on whether the contract involves a consumer or not.

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Soumya Bajpai

Soumya has done LLB (Hons) and has a 2+years experience in writing. Her main interest is in reading judgments, new enactments and amendments taking around in law. She always strives to bring the best to work that she does.

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