As contracts professionals, our most important job is to reduce uncertainty and real-world risk associated with each transaction we touch. Pricing and other key terms may be decided by the sales or operations teams before we’re even consulted. But it’s generally up to legal and contracts professionals to protect against the potential downsides of any given deal.
Whereas indemnification clauses and intellectual property provisions are key to managing third-party risks, limitation of liability clauses can be a primary line of defense when it comes to first-party damages. Damages for breach of contract can also be mitigated or avoided using well-drafted conditions, detailed payment provisions, force majeure clauses, contractual statutes of limitation, and exclusive remedies provisions.
With limitation of liability clauses, we’re generally looking either to exclude certain types of damages, or to avoid damages that are disproportionate to the deal itself. Here are a few tips to keep in mind when drafting.
Don’t List Out Meaningless Exclusions.
It’s tempting to think of the battle lines on limitation of liability clauses as a binary question of “for” or “against.” If you are the seller in a sale of goods, you’ll push to exclude a laundry list of damages categories. If you are the buyer, you’ll probably want to keep your options open in the event of a seller breach.
But what are you actually accomplishing by including—or successfully fending off—that list of categorical exclusions?
Let’s look at an example. A quick search of the Law Insider contracts database pulled up this categorical exclusion language within the first half dozen search results:
…IN NO EVENT SHALL [XX] BE LIABLE FOR ANY SPECIAL, INCIDENTAL, INDIRECT, OR CONSEQUENTIAL DAMAGES WHATSOEVER (INCLUDING, WITHOUT LIMITATION, DAMAGES FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS INFORMATION, OR ANY OTHER PECUNIARY LOSS)…
What’s wrong with this language? For starters, “special,” “indirect,” and “consequential” are legal synonyms when it comes to damages. Under most circumstances, this would be viewed as harmless surplusage. But it’s worth noting that a litigator looking for a foothold could claim they were intended to have unique meaning in this context: “Why list them out if they were intended to be redundant? Just as ‘incidental’ has a different meaning than ‘consequential,’ ‘indirect’ was included here to mean…”
However, the larger problem with this list is that, while “consequential,” “special,” and “indirect” all refer to the same legal concept, that concept is itself uncertain.
As one judge put it recently, “Despite the vast number of cases purporting to define ‘consequential damages’ by repeating the same time-honored but general definitions and distinctions between consequential and direct damages, the meaning remains elusive.” DaimlerChrysler Motors Co. v. Manuel, 362 S.W.3d 160 (Tex. App. 2012).
Or, put another way, “Damages that might be considered ‘consequential’ in one contract may be direct damages in another.” Id.
In the world of commercial contracts, uncertainty benefits no one. Ok, maybe it benefits commercial litigators by giving them lots of contractual ambiguity to fight over. But everyone else—i.e., all parties to the deal—is better off knowing what to expect, even if it isn’t their preferred outcome.
Adding a laundry list of exclusions that has no generally understood meaning to your contract just adds oxygen to the fire of any subsequent litigation. Don’t do it. But if broadly excluding “consequential damages” will have unpredictable results, what should you do instead?
Be Specific.
Contracts allow the parties to decide between themselves what rules will govern their course of dealings, rather than leaving things open to assumption and judicial interpretation.
So do that.
Be as specific as possible, rather than relying on broad categories of exclusions that remain open to interpretation. In the example given above, the laundry list of exceptions is followed by this parenthetical:
(INCLUDING, WITHOUT LIMITATION, DAMAGES FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS INFORMATION, OR ANY OTHER PECUNIARY LOSS)
Sometimes lost profits are considered indirect—otherwise known as consequential—damages. In other instances, courts have treated lost profits as direct damages. See, e.g., Biotronik A.G. v. Conor Medsystems Ir., Ltd., 22 N.Y.3d 799 (2014). So the above parenthetical is helpful in that it specifies that the parties did not intend for lost profits to be recoverable. Less helpful is the fact that “lost profits” is listed as a subset of consequential damages, which leaves open the argument that it only excludes lost profits that can be defined as consequential, rather than direct damages.
But “…any other pecuniary loss”? Really?
This sounds an awful lot like excluding both “direct” and “indirect” damages—i.e., ALL damages. And if there are no damages available in the event of breach, do you even have contract? In this blog post, Ken Adams cites to a Texas Court of Appeals decision noting that reading a contract so as to preclude recovery of any damages would require finding the entire contract “illusory, void, and unenforceable.” This in an appellate opinion overruling a trial court decision, which brings us back to our “don’t include language that just feeds the flames of litigation” caveat.
Consider Language of Inclusion.
Instead of attempting to imagine every possible category, cause, or type of damages in your laundry list of exclusions, consider whether you might focus on stating exactly what damages are available and then making those remedies exclusive.
For instance, you might agree that the purchasing party is entitled to damages equal to the difference between the cost of obtaining substitute goods or services (aka “cover”) and the purchase price for those same goods or services under the contract. If I were negotiating on behalf of the buyer, I would want more—compensation for the delay and additional work involved in obtaining cover—or perhaps different remedies, but negotiating specific, exclusive remedies will leave both parties very clear on “what’s next?” in the event of breach.
Categorical limits aside, a simple monetary limit, or cap, on damages can set important boundaries for both parties. Generally speaking, your cap should be high enough to serve as a deterrent to breach, while remaining low enough to be both enforceable and economically viable.
Many contracts will cap damages either at a specific dollar amount or by reference to a multiple of the money changing hands under the contract itself. If you are setting your cap as a multiple or fraction of fees paid, it’s important to consider whether that percentage should apply to total fees paid under the contract or fees paid over a specific time period. For example:
…IN NO EVENT SHALL ANY PARTY’S AGGREGATE LIABILITY FOR DIRECT OR INDIRECT DAMAGES RELATED TO THIS AGREEMENT, REGARDLESS OF CAUSE OF ACTION, EXCEED TWO TIMES THE AMOUNT PAID…DURING THE THREE MONTHS PRECEDING THE EVENT GIVING RISE TO THE FIRST SUCH CLAIM…
Particularly for master contracts that cover a significant number of individual transactions, a cap that references a multiple of total fees paid could become meaningless or unnecessarily punitive over time. In addition to time limitations, you should also consider whether it’s appropriate to establish a cap on damages for the entire contract, specific transactions, or specific contract terms.
Consider the Contract as a Whole.
Remember that there are multiple ways to manage or mitigate damages for breach. As noted above, these include well-drafted conditions, detailed payment provisions, force majeure clauses, and contractual statutes of limitation. In the absence of agreement between the parties, you might even rely on common law or the Uniform Commercial Code.
If you choose to include a limitation of liability clause, don’t allow it to add ambiguity or contradiction to your contract. In addition to the specific issues articulated above, be sure to consider the relationship between your limitation of liability clause and the rest of the contract. Does it contradict, limit, or void important indemnification provisions? How does it relate to other remedies provisions?
There are many viable strategies when it comes to limiting liability under contract, but it’s essential to think through both the language of each individual clause and its relationship to the contract as a whole in order to avoid introducing ambiguity or contradiction into the final contract.
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Check out the earlier articles in this Beyond Just Boilerplate series, on indemnification clauses, mandatory arbitration clauses, and why we call it boilerplate. And stay tuned for our next installment.
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