In this first article of a three part series we will be focusing on caps on liability in commercial contracts and providing hints and tips for drafting and negotiating these clauses.
Almost every contract a business enters into will contain an exclusion or limitation of liability clause of one type or another.
In this series, we will focus on some of the key aspects of liability clauses and the challenges that these can present when drafting and negotiating a commercial contract. We will also offer a few simple tips to help you navigate the labyrinth of liability clauses and identify the most common areas of trouble.
Allocating risk and providing certainty
Exclusion and limitation of liability clauses are a sensible way of allocating risk between the parties, and they help to provide certainty as to the potential maximum exposure a business has under the arrangement. Along with ‘What am I getting?’ and ‘How much will it cost?’, ‘What risk am I accepting?’ is one of the fundamental questions asked by a decision-maker before signing on the dotted line.
As such exclusion and limitation of liability clauses are often the most contentious and heavily negotiated provisions and require careful drafting to ensure that they are enforceable.
So, how long IS a piece of string?
In this first article of the series we are focusing on caps on liability. Dealing with caps on liability is notorious for being one of the biggest challenges when negotiating and drafting liability clauses. It can be a tricky process, not least because there is no definitive baseline for the level of each cap. Each contract will be different; however there are a few key factors which you should always consider.
- Value of the contract: The amount of any cap will depend primarily on the value of the contract and the potential liability of the parties. It’s a simple question of risk and reward – is the value of the contract worth the level of risk accepted? For this reason, suppliers will often look to cap their liability at a percentage of the value of the contract.
- Separate caps: Are there some types of loss that a party is particularly concerned about or which could be much more costly to a business, such as damage to property or loss of confidential information? lf so, it may be appropriate to agree a separate cap on liability for these heads of loss.
- Insurance level: In considering what level of liability cap is reasonable, the level of insurance cover in place should be taken into account. Who is best placed to insure against the risk in question should also be considered. In an ideal world the cap on your liability should not exceed the scope of your insurance cover. This is often a contentious point and generally results in negotiations and compromise which are largely driven by the bargaining strength of the parties.
- Always a commercial decision: Ultimately, what level of liability cap is acceptable will always come down to a commercial decision of whether the benefits outweigh the risks. Where this bar is set will differ from business to business and contract to contract.
Overall, the drafting of liability clauses in commercial contracts is a cohesive process whereby the business and the lawyer need to work together to recognise the commercial goals and limits; whilst at the same time building a strong legal framework to protect the business. By recognising the potential pitfalls and points of contention highlighted above, you can be confident in your ability to draft and negotiate a strong position.
Whilst the cap on liability is often the clause that the business will be most interested in, don’t forget the implications of the other liability clauses and how you can use them to protect your business. In our next article of the series we will discuss the issues associated with exclusion clauses and the best way to ensure that your clause is effective and enforceable.
Authors: Sophie McKibbin & Catherine Harrison
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.