One New York law firm estimates that a limitation of liability clause reduces financial responsibility between contracting parties by up to 90 percent. Here’s what your in-house counsel should know about these provisions and how to draft effective ones.
Jessica Nguyen, Chief Legal Officer at Lexion, and Vi Duong, VP of Legal at Adswerve, recently hosted a workshop on this topic that broke zoom (because of the number of attendees). Learn how to effectively redline and negotiate indemnification and limitation of liability clauses for tech transactions by watching the recording here.
What is a Limitation of Liability clause?
A limitation of liability (LOL) clause limits the dollar amount and types of damages owed between contracting parties. They apply no matter the sustained harm or actual damage amount. These provisions apply to primary breach of contract and performance failure situations.
A LOL also caps the dollar amount of damages a party is entitled to under certain circumstances. These liability caps may limit damages to one of the following:
• Compensation and expenses paid under the contract
• A flat fee
• Insurance companies
Here is an example of a limitation of liability clause:
Limitations of Liability. TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW: i) [COMPANY] SHALL NOT BE LIABLE WHATSOEVER FOR INDIRECT, CONSEQUENTIAL, EXEMPLARY, OR INCIDENTAL DAMAGES, EVEN IF IT HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, AND ii) [COMPANY]’s TOTAL LIABILITY TO CUSTOMER UNDER ALL CIRCUMSTANCES SHALL BE LIMITED TO THE PURCHASE PRICE PAID BY CUSTOMER FOR THE [COMPANY] PRODUCT. FURTHER, [COMPANY] SHALL NOT HAVE ANY LIABILITY ARISING OUT OF OR RELATED TO CUSTOMER’S VIOLATION OF THE TERMS AND CONDITIONS OF THIS AGREEMENT, OR CUSTOMER’S FAILURE TO INSTALL ANY SOFTWARE UPDATE PROVIDED BY [COMPANY] IN A PROMPT MANNER. ADDITIONALLY, [COMPANY] IS NOT LIABLE IN TORT, CONTRACT, OR OTHERWISE FOR ANY PERSONAL INJURY, PROPERTY DAMAGE, DEATH, OR OTHER HARM ARISING OUT OF OR RELATED TO USE OF THE [COMPANY] PRODUCT TO MAKE A 911 OR SIMILAR EMERGENCY CALL.
How is limitation of liability different from an indemnification clause?
LOL clauses apply to the contracting parties. Generally, these clauses state that if a contracting party faces a claim from another business or customer, they will protect the other contracting party from also being pursued for damages.
Indemnification clauses relate to compensation for costs and expenses from third parties or direct claims.
Are limitations of liability enforceable?
In most cases, limitation of liability clauses are enforceable. Generally, courts uphold them when they are in contracts between two businesses that act as equals in the negotiation and bargaining phases of contract formation. But courts often won’t uphold a LOL clause if the contract is between a business and a consumer, as that suggests unequal bargaining power.
There are situations where LOL clauses are unenforceable, including:
• Breach of confidentiality agreements
• Gross negligence, willful misconduct, or fraud
• Breach of fiduciary duty
• Failure to pay
• Indemnification requirements
• Data security breaches and their expenses
• Liability that can’t be limited under your state’s laws
One ill-advised idea is to limit damages to a meager amount. For example, if you cap damages at $100, there is a good chance a court won’t consider that enforceable. Also, if a LOL provision becomes the subject of a lawsuit, expect the court to construe it against the benefiting party.
Drafting tips for limitation of liability clauses
The best practices for drafting LOL clauses focus on clarity and visibility. Tips for drafting successful limitation of liability include:
- Separate heading: Title the LOL section in all caps, underlined, bold with something like “LIMITATION OF LIABILITY” or “DAMAGES.”
- Make it noticeable: The clause should be in all caps, italicized, bolded, or underlined to stand apart from the rest of the contract. It should stand out from the other content.
- Stand-alone paragraph: Do not try and hide LOL with other material. Give it a separate paragraph to help it stand out more.
- Consider using larger font: If the rest of your contract is 12-point, consider making your LOL section 13 or 14-point.
- Make it short and sweet: Keeping your LOL at two lines may be too short, but definitely don’t exceed a paragraph. You may also want sales or other non-legal departments to read it to ensure it is in lay language and understandable.
Negotiating limitation of liability
When you are negotiating limitation of liability sections with the other party, ensure you understand:
- Each party’s actual risk: You may want secure data protection with that new cloud service, and they likely want reassurance that you’ll pay on time. Keep these risks in mind when crafting a LOL section.
- Service disruptions and risks: What will happen to your company if that new cloud service crashes? Will it leak data? Frustrate customers? Will you owe anyone money? You want a LOL that reflects these impacts and doesn’t leave your company at a disadvantage.
- Possible impacts of a data breach: Data breaches are frequently devastating and disruptive. They may impact your brand and even leave you vulnerable to statutory sanctions. You should cap these damages if the other party faces greater impacts from a data breach than your company.
- Payment for the service: Your payment helps you assess risk. Generally, the higher the payment, the greater the risk. You want to consider that before capping damages or completely writing the other party off from liability (or letting them insist on that term.)
- Leverage: If you are a small company negotiating with a behemoth like Amazon, they will likely use their market leverage to pressure you into accepting questionable LOL terms. Be aware of this and prepare to call it out if necessary.
- Industry standards: Your industry’s standards may suggest where you should limit liability and the indemnification needed for the possible risks.
Another good idea is to collaborate with your sales department. They should know which clauses you will redline immediately and others that require more negotiation. Communicate your expectations for contracts and set up an efficient review process.
Finally, never sign a contract if it assigns more liability to your company than it can handle. Check your insurance limits and terms to ensure it covers the risks. Communicate clearly during negotiation about limits. Negotiation can be challenging, so consider these tips for redlining contracts during negotiations.
Learn about LOL from expert in-house counsel
To learn more about redlining and negotiating limitation of liability and indemnification clauses—directly from CLOs who are doing it—check out our recent webinar. Lexion offers contract lifecycle management (CLM) software to help you create solid contracts that will benefit your company—if you’re ready, schedule a demo.