Structuring a solid contract is all about minimizing risk and uncertainty at every step of the process.
In most cases, parties want to ensure that there is a shared understanding as to the provisions of the contract. When parties reach a clear and mutual understanding, this necessarily minimizes the risk of a lawsuit later on.
A well-drafted sale of goods contract will specifically address the expectations of each party with regard to the type and quality of the goods. A service contract will indicate the timeline for the provision of such services, as well as the cost expectations. Provisions relating to the choice of law and venue may be included to minimize the uncertainties of legal interpretation – for example, an employment contract might require the application of California law, which will render the interpretation of certain contract provisions quite differently than the laws of other states.
Though a lawsuit may seem unlikely when you first enter into a contract, conflict is sometimes unavoidable. As such, properly drafting a contract requires that the parties account for the real risk of litigation. One common way for minimizing this risk is the implementation of a limitation of liability clause.
What is a Limitation of Liability Clause?
A limitation of liability clause can be written in a multitude of ways, but generally speaking, it is a provision or set of provisions that work to limit or otherwise circumscribe the potential damages of a breach of contract.
Let’s sift through this legal terminology with a short example.
Imagine that you are a contractor, and you would like to enter into a contract to help renovate a client’s kitchen. The contract is well-defined and adequately describes the services to be rendered, the timeline, and the costs involved. As an extra precaution to protect yourself, however, you consider a limitation of liability clause, primarily because of the potential for damages in a breach of contract situation.
Suppose that you renovate the kitchen, but the client feels that the quality of the materials used is insufficient and therefore constitutes a breach of contract. If the client were to sue you for breach of contract, they might assert substantial damages based on an estimation of the costs of hiring you, plus the cost of re-renovating with a different contractor. Though you conducted the renovation for, say, $20,000, the various damages asserted by the client later on might add up to much more, perhaps $50,000 or higher.
With a clear, unambiguous, and uniquely tailored limitation of liability clause, you can prevent this risk of substantially higher damages than expected. A limitation of liability clause can be used to set a flat damage amount in the event of breach, or it can indicate some other agreed-upon value (perhaps the cost of the services in total – here, $20,000).
Limited liability clauses can be specifically tailored to suit the needs of the contracting parties: flat damage amounts (otherwise known as liquidated damages) can be imposed, damages in the event of delay or other issues of minor breach can be limited, and breaching parties can be forced to indemnify (to pay) the non-breaching party for the costs of litigation.
The Enforceability of Limitation of Liability Clauses
Whether a particular limitation of liability clause will be enforceable depends largely on state law governing the contract, the unique circumstances of the case, and the drafting of the limitation of liability clause itself. Though the intricacies of state enforcement of limitation of liability clauses are not within the scope of this article, you can better ensure that your clause is enforced by drafting your limitation of liability clause according to certain accepted standards.
Clear and unambiguous.
In states where limitation of liability clauses are acceptable, they are generally not enforceable unless the provisions are written clearly and unambiguously such that the contracting parties were truly aware how the clause would affect their right to recover damages.
The clause should clearly specify the circumstances under which it applies. Concise clauses tend to be more readable and more unambiguous, so do make an attempt to write cleanly and in a way that avoids excessive verbosity. The intent of the contracting parties should be expressed in an obvious manner.
Visual prominence.
The courts in some states have occasionally refused to enforce limitation of liability clauses in situations where the language of the clause was not visually prominent enough. It is recommended that you capitalize, bold, or otherwise “highlight” your limitation of liability section to ensure that even a casual scan of the contract would reveal its existence.
Maintain the balance of power between the parties.
As a matter of public policy, many states require that the balance of power between the contracting parties be relatively equal. If one party enjoys a significantly stronger position at the bargaining table, or is significantly more sophisticated, this may count against enforcement of the limitation of liability clause. As a rule, courts typically do not want to enforce provisions where one of the parties was not an equal or knowledgeable partner.
Discussion between the parties.
A limitation of liability clause is not likely to be enforced if a mutual understanding has not been reached. Though this should be resolved through clear and unambiguous drafting, it will certainly help if you discuss the details of the clause with the other contracting parties. Sufficient engagement not only helps to ensure that a mutual understanding has been reached, but may also minimize conflict by opening up communication between the parties.