- Negotiating limitation of liability clauses requires a careful balance between protecting your interests and coming to a mutually beneficial agreement.
- The nature of the contemplated transaction will help inform you as to what types of liability are the more significant risk.
- Liability limits should be carefully negotiated to ensure they do not conflict or undermine the indemnification obligations of the parties.
As a corporate lawyer for Malbek, I often find myself knee-deep in negotiations over limitation of liability clauses. You might have heard these referred to as “LoL” clauses, but trust me, they are no laughing matter! In fact, they are one of the most heavily negotiated parts of any contract because they define how much risk each party is willing to shoulder.
They not just allocate risk, but also define the extent to which the parties to the contract are financially liable for damages or losses arising from things going awry. These clauses determine who is on the hook financially if something goes wrong.
Negotiating these clauses requires a careful balance between protecting your interests and coming to a mutually beneficial agreement. Here are some of the more critical elements to consider when you negotiate limitation of liability.
1. Types of Liabilities
You will want to clearly differentiate between direct and indirect liabilities to ensure a clear understanding of each party’s responsibilities. Direct liabilities typically arise from a breach of contract, negligence, or willful misconduct, while indirect liabilities include consequential, incidental, or special damages, such as loss of profit or business interruption. The nature of the contemplated transaction will help inform you as to what types of liability are the more significant risk and, accordingly, will need to be more carefully considered.
2. Capping Liability
Capping liability serves to not just allocate risk, but also to protect a business from too much financial exposure. Capping liability can take a multiple of forms. Two of the more common forms of caps are stipulating a fixed amount or stating a multiple of the fees paid under the agreement. Often the financial size of the transaction, the nature of the transaction, and/or the relative sizes of the two parties may inform how and what caps are put in place.
Parties often exclude certain types of claims from any liability caps. Common types of excluded claims include gross negligence, willful misconduct, data breaches, IP infringement, and indemnification obligations. Identify specific circumstances or types of claims that should be excluded from the limitation of liability clause. These are often excluded because of the significant nature of these types of claims and the relative risks of these claims to the business that may suffer if one of these events were to occur.
4. Mutual vs. Unilateral
Another key consideration is whether the limitation of liability clause should apply mutually to both parties or unilaterally to one party. Context here will play a significant role in making this determination. The company with more risk exposure may want the limitation of liability to be more unilateral while a company with relatively lower risk exposure may want the limit to be mutual. Often parties will make certain types of limits mutual and others unilateral.
5. Indemnification Relationship
Understanding the relationship between the limitation of liability clause and indemnification provisions can often be overlooked or not as carefully considered. This is a mistake. You want to ensure that the liability limits you have carefully negotiated do not conflict or undermine the indemnification obligations of the parties. The limitations of liability should be consistent with the indemnification obligations. If they are not, this could result in a contract that is unfair, ambiguous, or potentially riskier than contemplated for one or more of the parties.
Negotiating limitation of liability clauses requires a comprehensive understanding of each party’s risk exposure and a careful balance between risk allocation and maintaining a mutually beneficial agreement. By considering the various elements of these complex clauses, contract professionals can develop an equitable limitation of liability clause that helps to safeguard the interests of all parties involved.
One of the biggest tips I can share is to ensure you have an effective contract lifecycle management (CLM) solution by your side can make all the difference. Rely on a vendor that understands the complexities of these negotiations and the critical role that CLM plays in ensuring their success. If you are looking for a new CLM or to replace an existing one, be sure to check out our new eBook that identifies 8 building blocks to craft a compelling business case so you can streamline your negotiation process, mitigate risk, and forge mutually beneficial agreements.