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Avoiding common pitfalls under limitation of liability

The content of this article is not intended to, and does not, constitute legal advice, and should not be used, referred to or relied upon as such.

Despite taking great care to ensure that your business fulfils its obligations fully and promptly, from time to time you may find yourself in a situation where a mistake has been made, a process has failed or deliberate action has been taken, which results in a claim of breach by a contractual counter-party.

In these cases, an appropriately drafted limitation of liability clause can provide your business with invaluable protection. In this article we identify a handful of common pitfalls to look out for when handling limitation of liability, and how they might be guarded-against.

A Conspicuous Absence

Whilst it may seem obvious, a simple but important step your business can take to protect itself is to check whether or a not a contract under consideration contains a limitation of liability clause in the first place. Whilst there are exceptions, limitation of liability clauses are common to a wide-range of commercial contracts; the wholesale absence of such a clause may provide an early warning sign of potential exposure.

It's Not Me; It’s You

Once you’ve established that a contract does contain a clause governing limitation of liability, it’s then important to look more closely at its content. Often, the party who has produced and issued the first draft of a contract, whether a supplier or a customer, will adopt a default position of limiting their own liability but not yours. A clause which is deliberately drafted to be one-sided in favour of your counter-party will not provide your business with any protection; by conducting this check we can begin to consider what amendments or changes we may seek to negotiate with the counter-party. In some cases, we may seek to amend the clause in order that the protection provided by it is mutually beneficial, as opposed to one-sided.

Percentage and Annual Escalators

Whilst determining what constitutes a reasonable liability cap can be affected by a wide-range of variables, it’s common for service providers to try to peg their maximum liability to a portion of the revenue they stand to earn under the contract in question. For example, service providers may try to cap their maximum liability at the value of the fees or charges which are payable across a particular twelve month period during the contract term.

Counter-parties who seek enhanced liability caps, may attempt to apply escalators which, if accepted, can quickly and significantly increase your business’ potential liability. For example, a counter-party may seek:

• A cap equivalent to 150% of twelve months’ fees; or

• An annual cap of 200% of twelve months’ fees.

In the first example, we can see that potential liability has increased by a further 50%, whilst in the second example, potential liability has been made subject to a double escalator. By making the cap ‘annual’ the counter-party has ensured that potential liability resets every twelve months during the contract term, whilst simultaneously doubling the value of potential liability in each case from 100% of twelve months’ fees to 200%.

Your business should stand ready to resist the imposition of liability caps which are made excessive by unreasonable use of these escalators.

Beware the Super-Cap

In the same vein, your business should be on the lookout for ‘super-caps’, so-called because they apply enhanced caps on liability which can extend up to an equivalent of 200% or more of twelve months’ fees, or alternatively, can express maximum liability in the form of a specific, and proportionally high, financial value. Super-caps typically apply to one or more specifically identified areas of potential liability, such as data protection or intellectual property, and can also present a double-edged sword to your business. In addition to allowing for significant liability in connection with the identified area, by making that area subject to its own separate and standalone cap, space for additional liability is also opened up under any accompanying general limitation of liability clause. In essence, a contract containing a super-cap relating to data protection and an accompanying general limitation of liability clause for anything else, is likely to allow for greater overall liability than a contract which contains one, appropriately limited, cap covering all matters.

Disguised Carve-Outs

Even after checking to ensure a contract covers limitation of liability, that the content of the clause is not unfairly one-sided and that any escalators or super-caps have been handled appropriately, it’s then important to check for carve-outs which may have been placed elsewhere within the agreement, in an attempt to hide or suppress their impact.

For example, you may work hard to negotiate an acceptable limitation of liability clause only to later discover an additional provisional stating something like:

“The limitations of liability set down in clause X, do not apply to losses or liabilities arising in connection with breach by Y of its confidentiality or data protection related obligations.”

If undetected or unaddressed, carve-outs of this nature can leave your business exposed to potentially unlimited liability in important areas, undermining any work which may have been done to agree the content of the main limitation clause.

To Conclude

An appropriately drafted limitation of liability clause can provide your business with vital protection in the event of a claim for breach, however there are a range of important matters to consider in order to ensure that protection is not undermined. If you require assistance with any of the matters discussed in this article, or would like to find out more, please get in touch via hello@ne2-data.com