Building a limitation of liability clause

How to build a limitation of liability clause

Most disputed terms WCC ranking: 

16

Most important terms WCC ranking: 

6

Most negotiated terms WCC ranking: 

1

What is the purpose of a limitation of liability clause?

There are certain risks that a party will not be willing and able to take. For example, a claim for unlimited consequential losses can mean the end of the business.

Building blocks of a exclusion/limitation of liability clause

building blocks of a limitation of liability clause

Unrecoverable losses

Unrecoverable losses

Unrecoverable losses refer to losses which the Party cannot be held labile for if there is a breach of contract.

These unrecoverable losses are also sometimes referred the waiver of consequential damages (a concept that is often confused).

The waiver of claims relating to these types of losses is usually mutual. However, depending on bargaining power, it may happen that only one of the Parties waives claims relating to the unrecoverable losses.

Type of losses

Parties mistakenly think that waiving consequential damages will include a waiver of claims relating to, for example, loss of business income. However, consequential damages do not describe a particular kind of loss and do not always include a waiver of claims relating to the loss of business income. For example, a loss of business income can also be a direct loss where this loss was foreseeable when the Agreement was concluded, and such a loss would naturally arise from the breach of the Agreement. 

If you want to make sure that all claims relating to losses that the parties intend to waive are being waived, a laundry list of claims relating to losses that will be waived can be included – for example:

loss of profits, loss of business revenues, loss of anticipated savings, loss of goodwill, loss of data etc.

Some of these losses may be direct losses, and some may be consequential losses.

Be careful waiving claims for direct losses. Generally, you cannot waive all liability for breach of contractual obligations (the aggrieved Party must have some form of meaningful recourse in the event of a breach of contract).

Examples of other claims relating to losses that you will likely not be able to waive are losses that relate to:

  • your own fraud/dishonesty; and
  • negligence for death or personal injury.

 

Then there are certain jurisdictions where you cannot waive claims relating to losses sustained for the supply of defective goods (there’s usually consumer protection legislation that regulates this).

The claims relating to losses that can and can’t be waived may differ from one jurisdiction to another. Therefore, an approach adopted in practice is to insert the phrase “to the maximum extent permitted under law” before the rest of the sentence that waives the claims relating to the specific losses.

Carve outs

When you “carve-out” certain types of claims from the unrecoverable loss provisions, it means that if this “carved-out” type of claim is instituted, then the type of loss that was waived can still be persued. 

If you are acting for the Party that is waiving claims that relate to the specific loss that is specified as unrecoverable losses, you want to avoid situations where claims are are “carved out” from the unrecoverable loss provisions. If not possible, your second option will be to try and negotiate that these types of claims must be subject to the maximum liability cap.

Claims that are often “carved-out” from the unrecoverable loss provisions, include:

  • breach of confidentiality provisions under the Agreement
  • claims relating to any indemnity provided under the Agreement
  • breach of the data protection provisions under this Agreement
  • any act or omission that is grossly negligent
  • any act or omission that causes personal injury or death of a third party
  • any act or omission that causes damage to property
  • to wilful misconduct or fraud

Maximum liability

Maximum liability

Maximum liability provisions are also sometimes referred to as the liability cap. These provisions limit the maximum amount that can be claimed from the defaulting Party.

The maximum liability provisions are often a hot topic of negotiation. For example, suppose you are a Provider whose liability is limited to a specific amount. In that case, you want this amount to be as low as possible to ensure that the business will hopefully stay afloat if things go south. On the other hand, if you are the Customer, you want to recover an amount that will sufficiently compensate you for your losses.

Finding a balanced approach to the maximum liability provisions often involves stipulating different liability caps for different types of breaches. For example, if there is a breach of the data protection provisions, the cap will be calculated one way, and if there is a breach of the confidentiality provisions, the cap will be calculated another way. 

Type of claims

It often happens that Parties agree on a general maximum liability amount. However, when the transaction is “mission critical” with risks on both sides, the negotiations start focusing on different liability caps for different types of claims.

For Customer operating in a highly regulated environment, a breach of the data protection provisions may be catastrophic. Therefore, a higher cap for this type of breach may be appropriate.  

Liability cap

There are various ways that the liability cap can be structured.

Examples of different cap structures include:

  • Limited to a specific amount
  • Limited to all amounts paid under the Agreement
  • Limited to a % of the total contract value
  • Limited to the amounts paid under the Agreement for the last x months

 

Another important consideration is if the cap applies per incident or to claims over a period of time? Also, will legal fees, costs and interest also form part of the cap?

Carve-outs

When you “carve-out” certain types of claims from the maximum liability provisions, it means that if this “carved-out” type of claim is instituted, then the claim will not be limited. 

If you are acting for the Party in whose favour the maximum liability cap is agreed waiving claims, you want to avoid situations where claims are are “carved out” from the maximum liability provisions.

Claims that are often “carved-out” from the maximum liability provisions, include:

  • breach of confidentiality provisions under the Agreement
  • claims relating to any indemnity provided under the Agreement
  • breach of the data protection provisions under this Agreement
  • any act or omission that is grossly negligent
  • any act or omission that causes personal injury or death of a third party
  • any act or omission that causes damage to property
  • to wilful misconduct or fraud

Example clauses

Customer friendly

1.           TERMINATION

1.1         Material breach:  If a Party is in material breach of this Agreement and such breach is:

(a)         capable of being rectified, and the defaulting Party fails to rectify the breach within 7 days after the aggrieved Party provides a written notice requiring the defaulting Party to rectify the breach, then the aggrieved Party can terminate this Agreement with immediate effect and claim damages from the defaulting Party; or

(b)         not capable of being rectified, then the aggrieved Party can terminate this Agreement with immediate effect and claim damages from the defaulting Party.

Unless otherwise provided in the Agreement, the relief stipulated above will not limit the aggrieved Party’s rights. The aggrieved Party will have all available rights in terms of applicable law.

1.2         Termination for convenience:  A Party can terminate this Agreement for any reason and no reason before the end of the term of the Agreement by providing 30 days (the “Termination Notice Period”) written notice to the other Party. The Party terminating the Agreement under 1.3 must pay the other Party all amounts due up to the last day of the Termination Notice Period, with an amount equal to 10% of the value of the Agreement’s remainder.

1.3         Process after terminationUnless otherwise provided in the Agreement, when this Agreement terminates for any reason:

(a)         all due fees become payable;

(b)         all licenses granted under this Agreement will terminate;

(c)         all materials provided by either Party to the other under this Agreement will be returned within 30 days after the Agreement’s termination; and

(d)         all data within a Party's possession or control, including without limitation in the possession or control of its subcontractors, must be erased so that it cannot be recoverred.

1.4         Reasonable assistance:  The Provider will assist the Customer as requested to allow the services provided under this Agreement to continue and facilitate the orderly migration of these services (the Termination Assistance) for 60 days after the Agreement’s termination. During the Termination Assistance Period, the Provider must continue to comply with all requirements under this Agreement unless otherwise expressly agreed in the Exit Plan contemplated in 1.6.

1.5         Exit plan:  If and to the extent requested by the Customer, whether prior to or upon termination of this Agreement or during any Termination Assistance period, the Provider must assist the Customer in developing an Exit Plan (the “Exit Plan”) which must specify:

(a)         the tasks to be performed by the Parties in connection with the Termination Assistance;

(b)         the schedule for the performance of tasks under the Exit Plan;

(c)         specific license or ownership rights of the Parties with respect to software or other intellectual property;

(d)         a description and documentation of the services, service levels, fees, and access requirements that will be required to transition the service provided under the Agreement;

(e)         the right to pass confidential product or service information on to other providers; and

(f)           the specific wind-down terms applicable to each stage of the Termination Assistance, including how volume changes will affect the services provisioning.

1.6         Third-party agreements:  If there are third-party agreements that will need to be assigned to the Customer as part of Termination Assistance, and these third-party agreements are used by the Provider to support multiple customers, or these agreements contain provisions against assignment, then the Provider must provide reasonable assistance to the Customer in engaging those third-parties directly.

1.7         Terms of termination assistance:  With regards to the Termination Assistance:

(a)         it must be provided on terms similar to what the Provider offers for the same type of services to other customers of similar size, based on the volume and nature of the services as they are reduced over the life of the Exit Plan;

(b)         if the termination is due to a material breach of the Customer, including non-payment, then the Provider may require that the breach be remedied or the amounts due be paid before providing any Termination Assistance; and

(c)         if the Customer requests the Provider to provide the services under the Agreement directly to a replacement provider, then the Customer must ensure the replacement provider maintains the confidentiality of all information received and cannot use it to gain a competitive advantage over the Provider.

1.8         Survival:  The provisions under Article 1 will survive termination of the Agreement.

 

Provider friendly

1.           TERMINATION

1.1         Material breach:  If a Party is in material breach of this Agreement and such breach is:

(a)         capable of being rectified, and the defaulting Party fails to rectify the breach within 30 days after the aggrieved Party provides a written notice requiring the defaulting Party to rectify the breach, then the aggrieved Party can terminate this Agreement with immediate effect and claim damages from the defaulting Party; or

(b)         not capable of being rectified, then the aggrieved Party can terminate this Agreement with immediate effect and claim damages from the defaulting Party.

Unless otherwise provided in the Agreement, the relief stipulated above will not limit the aggrieved Party’s rights. The aggrieved Party will have all available rights in terms of applicable law.

1.2         Material adverse regulatory change:  The Provider may terminate this Agreement in whole, but not in part, in the event of a change in the regulatory environment applicable to the Provider that the change has a materially adverse effect on the Provider’s ability to fulfil their obligations under this Agreement. The termination right under 1.2 can be exercised by giving at least 2 months' prior written notice to the Customer.

1.3         Additional termination rights:  This Agreement may be terminated by:

(a)         a Party immediately, without advanced notice, if the other Party is deemed unable or admits their inability to pay their debts as they become due;

(b)         a Party immediately, without advanced notice, if the other Party suspends making payments on any of their debts;

(c)         a Party immediately, without advanced notice, if the other Party commences negotiations with their creditors to reschedule their indebtedness because of actual or anticipated financial difficulties; or

(d)         a Party immediately, without advanced notice, if the other Party is found guilty corrupt activities under applicable laws.

1.4         Survival:  The provisions under Article 1 will survive termination of the Agreement.

Can the governing law impact on limitation of liability clauses?

Certain liability cannot be limited under contract. For example, limiting liability relating to fraud or wilful misconduct will not be enforceable.

Public policy and legislation that protect consumer rights may also determine that certain liabilities cannot be limited.

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The Author

Martin Kotze is a commercial lawyer with over 10 years of experience. He specialises in transactional work within the Tech, Financial Services and Property industries. 

He is also one of the co-founders at DocNinja and regularly advises listed companies to small and medium enterprises on how to contract better with their customers. 

Martin Kotze

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