When drafting a contract or legal document, one aspect to keep in mind is the importance of apportionment of liability should something go awry with the contract or otherwise. Agreeing to a contractual limit of liability can effectively reduce one’s risk, especially in high-asset contractual situations.
Attorneys often accomplish this task by including a limitation of liability provision in their contracts. Limitation of liability provisions usually cap any damages to the contract amount or to a number which is reasonable under the contract. For example, a contract may limit the amount of liability by stating:
To the fullest extent permitted by law, the parties agree that Party A’s total liability to Party B or its agents for any claim Party B may bring against Party A for damages, however arising—including but not limited to Party A’s action, inaction, breach of contract, or negligence—shall not exceed $50,000, or the total fee for services rendered on the contract, whichever is greater.
However, some contracts may benefit from limiting the type of liability rather than the amount. For instance, perhaps the expected actual damages would be relatively low in a given situation, but the possibility of punitive or consequential damages is likely. In such case, it may behoove the party to limit liability by type of damages, agreeing to something similar to the following:
The parties agree that they shall not be liable one to the other for any consequential or indirect damages, including but not limited to lost profits, lost wages, or emotional damages, which may arise from any dispute, claim, cause of action, or any other liability.
There may be still further situations in which a limitation of liability clause is most effectual when based on a specific time period for bringing claims. Although almost every jurisdiction has enacted specific statutes of limitations for certain actions, one can also contractually limit the time period in which to bring an action. For example, one may use the following provision to limit the duration of liability:
No suit may be brought against Party A unless the suit is brought within two years after the execution date of this contract.
Additionally, some contracts (like insurance policies) may include limitation language that addresses the order in which obligations will arise between various parties, even those who are not parties to the contract. For example, many insurance policies state whether the coverage afforded under the policy is “primary” or “excess” coverage, but also provide terms identifying how payments will be apportioned:
If there is additional primary coverage under a separate policy, this company will only pay its equal proportion of the total amount of covered loss.
Once it is determined how liability needs to be limited in a contractual agreement, an attorney should take careful steps to ensure the limited liability provision is actually enforceable. Below are ten ways that your drafting of limitation of liability provisions may be ineffectual and unenforceable.
1. Your clause is not conspicuous.
If your limitation of liability clause is buried in the contract, written in small print, or difficult to find, it may not be enforceable. Even though the terms in most contracts are “read together as a whole,” limitation of liability terms should not be hidden in fine print or shrouded by overly technical language.
Contract drafters including a limitation of liability provision should ensure it is conspicuous by putting the provision in bold or all caps, underlining the provision, having the provision initialed, or all of the above. Where the limitation language is included in an amendment to the original contract, terms encompassing the amendment within the underlying contract should also be conspicuous. Whatever you can do to make the language as conspicuous as possible, the better. A court needs to see that the other party actually agreed to the limitation and was aware of the limitation’s presence in the contract – this can be a key defense when the limitation language is challenged by the other contracting party.
2. Your clause is not clear.
If your limitation of liability provision does not include clear language that unambiguously explains what is being limited, how, and when, then your clause may be unenforceable. The provision should specifically and concisely spell out the details of the limitation.
Think of the “4W+1H” rule from school – Who, What, When, Where, and How. Who and what does this language affect with respect to the contract? When is the limitation triggered or under what contingent circumstances? Is there a time limit applied or is it limited in geographic scope? Does it apply to a certain type or amount of liability? Is there a situation in which the liability may not apply (i.e. an exclusion to the limitation language)? Do your best to answer all these questions when drafting your provision.
3. Your clause contains too much “legalese.”
To make your provision clear, as described above, you should primarily use language that an ordinary person can understand. Using fancy legal language (often referred to as “legalese”) can cause confusion or a complete lack of understanding when dealing with non-legal parties. Although there are always those “magic terms” that attorneys like to include (and in many cases, need to include), do your best to make sure the legalese stays out of your limitation of liability provision. The easier the terms are for the other party to understand, the more likely those terms will be found to be enforceable.
4. Your clause is not negotiated with the other contracting party.
Courts are wary to enforce a limitation of liability provision in situations where the other party did not actively negotiate the terms to value the full consequences of those limitations. This is also true in “contracts of adhesion,” where there is unequal bargaining power in the negotiation process and the circumstances demonstrate that one of the parties did not feel like they could, or had power to, negotiate the limitation terms.
Therefore, it is important to ensure your clause is “negotiated.” This does not mean that the parties must write and rewrite the provision, but it does mean that the provision needs to be brought up and discussed with the other party to the contract. In some cases, it also makes sense to include broad language agreeing that each of the parties is responsible for reading all of the terms of the contract and discussing those terms with their own counsel, including any terms which may limit the liability of one or both parties. If the clause is never discussed between the parties, a court may decide it is a “contract of adhesion” (discussed below) and decline to enforce the provision. It is easy to avoid this outcome if you discuss the clause up front.
5. There is no proof of the negotiation process.
Conducting a fair negotiation of the provision is not enough if you cannot prove the negotiation existed, especially when the enforceability of the term is challenged. Without proof of the negotiation, you will not be able to fight against a party who says they “didn’t know about” or “didn’t agree” to the provision.
It is important to ensure evidence of the conversations, drafts, and negotiations are kept. Be sure to memorialize any conversations you have with the other party regarding the limitation of liability. Save and preserve your written discussions over e-mail, or if your discussion was oral, memorialize the conversation in a follow-up e-mail to the party. Better yet, if the clause does happen to change during negotiation, make sure you keep early drafts of the provision to show how it was negotiated, what changed, and what was discussed. In some instances, it also may be wise to include with the executed contract a separate signed acknowledgment by the other party that the negotiations took place.
6. You failed to check your local jurisdiction on enforceability of limitation terms and/or the existence of statutes that impact the efficacy of these provisions.
Every jurisdiction in the US will have its own rules and regulations regarding the enforceability of a limitation of liability clause. They will also have their own limitation statutes, which you will want to note. Some examples include:
10 LSA § 7-309: Duty of Care; contractual limitation of carrier’s liability
(b) Damages may be limited by a term in the bill of lading or in a transportation agreement that the carrier’s liability may not exceed a value stated in the bill or transportation agreement . . . However, such a limitation is not effective with respect to the carrier’s liability for misappropriation to its own use.
TCA § 12-3-701
(a)(1) The chief procurement officer may authorize the procurement of goods and services with a limitation of a contractor’s liability; provided, all respondents to a solicitation had an equal opportunity to request a limitation of liability.
44 ORS 527.785: Tort liability for injury or damage from large woody debris left on property
(1) A landowner is not liable in tort for any personal injury, death or property damage that arises out of the leaving of large woody debris on the property of the landowner under the provisions of ORS 527.610 to 527.770, under any rules adopted pursuant to ORS 527.610 to 527.770, or under any other law or rule requiring trees and large woody debris to be left upon property after logging or other activity on the land.
Attorneys need to check the jurisdictions which will govern their contracts to determine if there are rules on limitation in existence. Some statutes provide for specific limitations, while others will disallow any kind of limitation for certain types of damage or based upon the status of the contracting parties.
Ostensibly, your contract will include choice of law provisions and jurisdiction terms, in addition to the limitation provisions. Do your research prior to the drafting process and make sure your jurisdiction (1) allows the type of limitation contemplated for your contract, (2) does not limit the type of liability you provide for in the contract, and (3) provides mechanisms to enforce your limitation terms. Good research lays the foundation for enforcement and cannot be undervalued. Be sure to know how your type of limitation is enforced in your jurisdiction.
If your contractual limitation is restricted to a certain time period (limiting the time to bring a claim to two years, for example), you will also need to know what the statute of limitation is in your jurisdiction. Contracting to a lengthier limitation period than is allowed by statute for a certain claim is not going to limit your liability any more than if your provision never existed. Similarly, if your contractual time limitation is shorter than the existing statute of limitations, it is critical to know whether that shorter time period is enforceable, or statutorily void.
7. Your limitation is unreasonable or lacks proper consideration.
Many state courts will void a nominal limitation provision as unreasonable or unconscionable. To avoid this outcome, be sure that your limitation is actually reasonable under the contract. If the contract value is $2 million, but the liability is limited to $1,000, a court will likely determine this clause is unconscionable and unreasonable. The same is true if there is an imbalance between the amount of consideration paid for the limiting language and the extent of the limitation applied.
Look at industry standards and ensure your provision complies with the typical limitations of liability applied in similar cases. If there is no industry standard, analyze whether your limitation is reasonable compared to the anticipated loss or damages. Reasonability varies from state to state, so be aware of the cases in your state where the court found a limitation to be unreasonable.
8. Your clause is not broad enough to cover your potential liability.
Never forget that even if your contracts are the same, the situation never is. Every situation will require an analysis of the potential liabilities and risks which accompany individual contracts and agreements. Many times, using a standard limitation of liability provision in every contract will not be broad enough to cover the liability you are wishing to limit. For example, a contract focused on the sale of goods may wish to limit liability for possible expenses employed in shipping or selling the product.
However, if you only limit liability for those few issues, you are leaving your company exposed to a vast amount of liability which would not stem from such issues, including liability for third-parties, misuse of the product, lost revenues from undelivered goods, negligence, or for intentional torts. This limited list could also lead to further liability for consequential, punitive, or treble damages. Make sure that your language is broad enough to encapsulate all the areas of liability you are truly wishing to limit.
9. Your clause is too broad.
9. Your clause is too broad.
Despite the explanation above, it is possible to be too broad. Most courts will nullify or invalidate limitation of liability provisions which disclaim all liability and provide no room for any kind of conscionable liability. If your provision essentially excludes any possibility of judicial or monetary relief in some form, then your clause is too broad. This can even happen in contexts in which your provision is restricted to certain types of damages.
Take the following excerpt from Herrick v. Monsanto Co., 874 F.2d 594, 596 (8th Cir. 1989) as a prime example:
In Durham v. Ciba Geigy Corp., 315 N.W.2d 696 (S.D.1982), Durham, a farmer, applied herbicide to control foxtail. Although the herbicide was warranted to control foxtail, the weed flourished and damaged Durham's milo crop. When Durham claimed consequential damages, the manufacturer argued that the limitation of consequential damages clause precluded such recovery. The South Dakota court held that the limitation of remedy clause was unconscionable. It reasoned that plaintiffs should not be left without an adequate remedy because crop loss would be inevitable when the herbicide was ineffective and that such purchasers are not in a position to bargain about or to test the product. Id. at 700. The court found it unacceptable for manufacturers to restrict and abolish warranty and damages to the point that there is, in effect, no actionable warranty for the consumer. Id. at 701.
Although the herbicide company merely limited their consequential damages in their contract, the court determined that such limitation had the effect of disclaiming any actionable claim. Parties are free to contract for limitation of liability, but courts will not enforce a provision that offers a party no remedy. Be broad enough to disclaim the liabilities you are worried about but ensure there is some kind of relief for the other party if they have a viable claim for damages.
10. You are not adjusting your clause to the type of contract.
10. You are not adjusting your clause to the type of contract.
Imagine you are working as in-house counsel for a finance company. When it comes to limitation of liability provisions, you will likely focus on limitations related to market changes, breach of contract, etc., which you can use in almost every contract. However, when a multi-million dollar oil company hires you to serve as in-house counsel five years later, you cannot simply use the same limitation of liability provision in your contracts. Liabilities for oil companies are vastly different than liabilities for finance. You may have to worry about liability for environmental disasters and clean-up, nuisance, personal injury, etc. If you want your provisions to be effectual, you have to modify them according to the type of contract being negotiated. Do not copy and paste your previous provisions into different types of contracts.
Not only does your exposure to liability differ from state to state, but so do the rules and regulations for each particular field. Section 6 above gives several examples of specific limitation statutes which either allow or disallow certain limitations within certain fields. Be sure you know what the law is in both your state and your industry when drafting limitation of liability clauses.
Limitation of liability provisions are allowed in most U.S. jurisdictions. However, attorneys must be diligent in their preparations and be careful to draft the provisions so that these terms are in line with each jurisdiction’s rules, interpretations, and policies, as well as within each industry’s customs and norms. Just because one provision is useful and effectual, does not mean it will be effectual across the board. Effective attorneys must do their research first and draft their provisions according to the client’s needs rather than using a standard form for each contract.