Limitation of Liability

In previous posts in this series, we talked about the “boilerplate” provisions that you see in many contracts.  As we discussed, while these provisions may seem to be run-of-the-mill, they do have meaning and can affect the parties’ relationship.

Today I want to highlight another common provision, called limitation of liability. You may see this in contracts for consulting services, software licenses, and other deals, often in capital letters and printed in bold.  There is a reason for this.  Among other things, a contract sets out the obligations and rights of the parties.  Neither party wants its potential liability to be unlimited, and a limitation of liability provision does just that: it manages uncertainty and risk by limiting one or both party’s liability under the contract.  These provisions limit the types of claims that can be brought by a party, the types of damages a party may recover, and the amount of damages.

A simple limitation of liability provision may look something like this:

“NEITHER PARTY SHALL BE LIABLE FOR ANY INCIDENTAL, CONSEQUENTIAL, OR PUNITIVE, DAMAGES, INCLUDING BUT NOT LIMITED TO ANY DAMAGES FOR LOST PROFITS. IN NO EVENT SHALL THE TOTAL LIABILITY OF A PARTY EXCEED THE AMOUNTS PAID BY CLIENT, IF ANY, FOR THE SERVICES DURING THE TERM OF THIS AGREEMENT.”

This provision limits the type and amount of damages that a party may recover.  First, let’s look at the types of damages:

Incidental: the costs a party may incur in trying to avoid a loss under the contract due to the actions of the other party.

Consequential: the damages that result directly from something the other party did or did not do (for example, my newly re-designed website crashes and I lose a lot of online business).

Punitive: damages that are over and above the actual losses that a party suffered because of the other party, designed to punish that other party.

You may see other types of damages listed in limitation of liability provisions, including incidental, special, exemplary, and lost profits.  These may overlap the other categories defined above, depending on the law of the state governing the contract. Sometimes the lawyer who drafted the limitation of liability will list every type of damages he or she can think of, regardless of whether it is relevant to the subject of the contract, just to be “safe.”

A limitation of liability provision may also put a dollar cap on a party’s potential liability.  In the above example, the cap is the amount of fees the client paid under the contract.  If a client paid, say, $25,000 for a software license, and the software does not function properly and results in a much greater loss of revenue for the client, the licensor may want to limit its exposure to what it was paid by the client, $25,000.  For this reason, you should always read these provisions carefully, and consider what the consequences to your business could be if the service or product is defective, faulty, etc.

Limitation of liability clauses can get very complicated.  Depending on the subject matter—patents, software—or the potential risks, such as personal injury or property damages, the types of claims, damages, and limitations may vary.  For this reason, it is always important to read limitation of liability provisions with the following in mind:  what is the other party providing, what are the potential risks to your business if something goes wrong, and is the provision unfairly limiting the other party’s liability to you if that does happen.

Don’t be afraid to ask questions and push back if there is something you don’t understand or like in the other party’s contract, and don’t accept the answer that “this is our standard contract language” if you feel you need it changed.  Most terms are negotiable if you make a good argument as to why.