When are Limitation of Liability Clauses Appropriate?
You have reached a deal with another party and their lawyer has prepared the contract. When the contract arrives you are happy that the agreed upon deal terms are properly reflected in the agreement.
However, as you quickly glance through the “boilerplate” towards the end of the contract you notice the following clauses:
6. You may not recover from us, in contract or tort (including negligence), under statute or otherwise, any consequential, incidental, indirect, punitive or special damages in connection with claims arising out of this Agreement or otherwise relating to the Services, including any amount for loss of profit, data or goodwill, whether or not the likelihood of such loss or damage was contemplated.
7. Our total aggregate liability to you for any loss or damage arising out of or relating to this Agreement or the Services shall be limited to the total fees paid to us for the Services. This limitation applies regardless of whether our liability arises under contract, tort (including negligence), statute or otherwise. This limitation will not limit liability for loss or damage caused by our fraud or willful misconduct or to the extent prohibited by applicable law or professional regulations.
Many people don’t understand what these clauses mean, assume they are standard “boilerplate” and accept them without question.
But whether or not they are reasonable for your contract depends on the services being provided or other obligations being contracted for, the potential risks to the parties involved, the negotiating leverage of each party, and the availability of other alternatives in the marketplace.
For example, you may be contemplating the sale of your business and require a potential suitor to enter into a “Non-Disclosure Agreement” to protect against the unauthorized disclosure, or use, of confidential information vital to the success of your business before disclosing that information to the potential suitor. In that case, it is likely not appropriate to limit the liability of the recipient for the damages to your business that may be caused by the recipient’s improper disclosure, or use, of that confidential information.
Alternatively, if a service provider is providing high volume services at discount prices and low margins, the risk being assumed by the service provider may not be appropriately compensated by the fees charged without this clause. Said another way, if this clause is not included in the contract the service provider may need to increase its rates to justify the risk being assumed. The bottom line is that each contract should be reviewed in light of its own particular circumstances to determine if a limitation of liability clause is acceptable and, if so, on what terms.
That being said, when assessing the risks associated with limitation of liability clauses, it is also helpful to know the meaning of the various legal terms used.
Below is a very cursory explanation of some of the more commonly used terms in limitation of liability clauses.
Compensatory Damages (aka Actual Damages)
This is money awarded to an injured party to compensate for the actual quantifiable losses sustained by the injured party. Generally speaking, the purpose of awarding damages is to restore an injured party to the position the injured party would have otherwise been in had the harm not occurred (i.e. to compensate the injured party for its actual losses). There are two types of compensatory damages:
- General Damages: In a breach of contract claim, “general damages” compensate the injured party for the quantifiable amounts the injured party expected to receive, and would have received, from the contract but for the breach by the breaching party. To calculate these damages, one usually has to look no further than the contract itself.
- Special Damages or Consequential Damages: In a breach of contract claim, “special damages” or “consequential damages” may also be awarded to cover losses besides the contractual losses such as: loss of profits, business opportunities, or contacts; loss of product or business property; damage or harm to business reputation; etc. However, for a claim for special damages to be successful:
- the losses must be reasonable foreseeable at the time the contract is entered into;
- the losses must be reasonably calculable at the time the contract is entered into; and
- the losses must flow from the breach of contract (i.e. there must be a causal connection between the losses and the breach).
It is important to note that the foregoing terms are applied differently in tort claims. In tort claims, “special damages” refer to actual damages that can be calculated accurately such as lost wages whereas “general damages” refer to other losses that can be difficult to determine such as pain and suffering. Contracting parties should take these differences into consideration when drafting limitation of liability clauses in contracts.
Incidental damages are the direct costs or damages incurred as a result of the other party’s breach of contract (i.e. costs incurred to return merchandise). This is different than the consequential damages discussed above which are more indirect, being incurred not as a result of the breach itself, but being incurred due to the breach (i.e. loss of profits).
To provide certainty regarding the amount of damages that a breaching party may be required to pay to a non-breaching party, contracting parties often agree upon these amounts upon first entering into the contract. These are referred to as “liquidated damages”. Despite this agreement, the agreed upon liquidated damages should not greater than a fair estimate of what the actual damages might be if there is a breach as a contract term setting unreasonably large or disproportionate liquidated damages may be void if the court determines it constitutes a penalty or punishment for default.
Punitive Damages (aka Exemplary Damages)
Punitive damages may also be awarded by a court in circumstances where the plaintiff proves that the defendant’s conduct was “malicious, oppressive and high-handed [such] that it offends the court’s sense of decency”.
Invitation for Discussion:
If you would like to discuss the topics raised herein, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Nerland Lindsey LLP.
Note that the foregoing, and the attached document, are for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.