One of the most common negotiating tools is the use of contractual limitations on liability to establish the risk each party undertakes in an agreement. Each party always wants to limit its own risk, while at the same time requiring the other party to maintain full liability. Negotiating these types of limitations of liability provisions are an important part of any arrangement.
Typically, limitations on liability involve three features of recovery: the (1) type, (2) cause, and (3) amount of damages. Depending on the agreement, each of these features will more specifically address each party’s liability and the overall cost and risk associated with the arrangement.
For instance, the type of damages may be direct (the natural result of the breach), versus consequential (non-obvious, arising out of special circumstances). Additionally, the cause may be a breach of confidentiality or indemnification. These features are important in any arrangement, but we are going to focus on forms of contractual limitations on liability.
Liability “Caps”
A cap is an upper limit to the amount of recovery available for breaches. Caps are beneficial because they provide parties with certainty. For example, an agreement might limit the parties’ liability to $10,000. However, cap amounts can vary by the type or cause of damages. Caps can have varying levels, where parties negotiate higher secondary caps for specific types or causes of damages.
Typically, caps are tied to other fees and payments in an agreement. For instance, the extent of the liability for damages could be the amount that was paid for the goods or services under the agreement. A timeframe might also be applied to the amount paid under the agreement. For example, the parties may agree to cap liability at the amount paid under the agreement for the twelve (12) month period prior to the claim.
Liability “Exclusions”
Exclusions allow a party to avoid any liability for specific claims arising from an agreement. It is common to see exclusions applied to consequential damages, lost profits, revenue, or reputational harm. Parties generally want to avoid liability for unanticipated damages which exclusions allow them to do.
However, there are certain things that may not be excluded such as damages resulting from gross negligence, willful misconduct, or intentional wrongdoing. Some courts have deemed these exclusions too broad or unreasonable to be enforced.
“Carve-Outs”
Both caps and exclusions may be subject to carve-outs – situations where neither will apply. Carve-outs typically have either a much higher cap or unlimited liability. Examples of issues that are commonly carved-out are breaches of confidentiality, fraud, or certain data security breaches.
Whether using a cap, exclusion, or carve-out, understanding how these forms interplay and apply is a negotiation tool that allows parties to be both creative and prudent in their agreements.
**This Legal Bulletin is for informational purposes only and not intended as legal advice for specific situations.