We can agree that everyone wants to manage risks by limiting their liability in potential lawsuits or other claims. A limitation of liability is an excellent way to shift the risk to the other party in the contract and is generally an excellent solution to limit the potential legal liability of the parties.
Not all claims are insurable or protected by insurance. That is why limitation on liability clauses are so important. These clauses are common in various agreements from professional service agreements to asset purchase agreements.
Why is the Limitation of Liability Clause So Important?
A limitation of liability clause is a clause in a contract that restricts a company’s financial exposure in the event of a lawsuit or another claim. A limitation of liability clause, if found to be enforceable, can “cap” the number of potential damages incurred.
The liability cap may be applied to all claims that arise during the term of the agreement, or it might be restricted to specific claims. Liability caps are frequently limited to one of the following amounts: (i) compensation and expenses paid under the contract; (ii) a predetermined flat fee; (iii) insurance coverage.
Limitation of Liability Clauses Can Reduce Financial Responsibility Up to 90%.
We’ve established that a limitation of liability clause is a powerful way to reduce a company’s exposure when a dispute arises under a contract. In fact, according to one study, companies that included limitation on liability clauses in their contracts saw their potential financial exposure reduced by as much as 90%.
But How Enforceable Are Limitation of Liability Clauses?
Some question the enforceability of the provision especially if there is a wide gap between what a plaintiff would collect compared to the liability cap. The short of it is that limitations of liability are generally upheld and enforceable by the courts.
The defendant in a service contract dispute, which, needless to say, is typically the service provider, can usually successfully claim that they are not liable for more than what was charged for the services rendered under the agreement, or even under just a particular statement of work.
Whenever courts have held that limitation of liability clauses are not enforceable it is typically because it’s clear that both parties did not have an opportunity to freely negotiate the clause, the clause would be against public policy or something of the like. But if the clause is drafted correctly and both parties had legal counsel, the courts will uphold the limitation of liability clause.
It’s worth mentioning that if there is a breach of fiduciary duty or fraud claim, the limitation on liability clause is likely not going to be upheld. Meaning, if the fiduciary tries to enforce the limitation of liability clause in a contract with the claimant, the claimant has a good argument to void the agreement whether it is due to breach of fiduciary duty, a material omission or fraud. Hooks v. Samson Lone Star, Ltd. P’ship, 457 S.W.3d 52, 57 (Tex. 2015).
6 Ways to Make Your Limitation of Liability Clause More Enforceable
Limitation of liability clauses are powerful tools to limit your company’s risk, but they are only valuable if they can be enforced by a court. Proper drafting of the clause is key to its enforceability. Below are some contract drafting guidelines on how to increase the chances that a limitation of liability clause will be enforced.
1. Give it a Section Heading in Capital, Underline and/or Bold: such as “LIMITATION OF LIABILITY” or “DAMAGES”
2. Make the Clause Very Noticeable: Caps, Italicize, Bold, Underline to Stand Apart
3. Have the Clause be a Stand-alone Paragraph
4. Use larger font size than that the font used for provisions in the contract
5. Keep it as Short and Clear as Possible
6. Have a Lawyer Draft the Provision
Limitations of Liability vs. Insurance
Unless specific items, like insurance, are carved out of the limitation of liability provision, the limitation of liability provision would limit what could be recovered under those provisions to the liability cap. For example, if the contract required the service provider to carry $5,000,000 for comprehensive and general liability and $5,000,000 for auto liability but, but the contract had a limitation on liability cap of $500,000 that didn’t carve the insurance provision out of the limitation of liability, the most that can be collected for the dispute is $500,000 as opposed to $5,000,000.
Carve-outs from the limitation of liability can be done either in the limitation of liability section or in the specific section you want to exclude from the limitation such as insurance.
Potential claim holders against your company for breach of contract or any other claim can only get a pre-determined, limited amount of money if your clause is enforceable. This is much more likely if you have attorneys draft an enforceable limitation of liability clause in your contract.
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Disclaimer: The information in this article is for general information purposes only. Nothing in this article should be taken as legal advice for any individual case or situation. This information is not intended to create and viewing it does not constitute an attorney-client relationship.