It is common for businesses to try and limit their liability in contracts. This means inserting clauses in your contracts that reduce your legal responsibility if something goes wrong. These are known as limitation of liability or exclusion of liability clauses. For example, these clauses could reduce the amount of money you have to pay in compensation. This article will set out the basics of exclusion and limitation of liability clauses, and explain how you should think about incorporating them into your business contracts. It will also explain the responsibilities that you cannot contract out of.

What Does ‘Limiting Your Liability’ Mean?

A limitation of liability provision will limit whether someone can sue you for breaching your contract. If a court finds that it can be enforced, a limitation of liability clause can limit the amount of damages (i.e. compensation) you will be required to pay.

For example, imagine that your business sells software services and your online platform goes offline one afternoon due to a technical issue. One of your customers, who relies on the platform to conduct business, loses a large sum of money during this downtime. They decide to sue you to cover their loss. If your service agreement limits your liability for this type of scenario, you won’t be required to pay the full amount.

Liability clauses are a risk management exercise and are extremely important. In the small business context, the difference between a limited and a full payout could affect the existence of your business.

How Should I Approach Liability Clauses?

You will need to identify the aspects of your business that contain risk, and then attempt to protect yourself against them. Think to yourself, which part of this business arrangement could go wrong? What is the worst-case scenario?

Usually, it will be something foreseeable but outside of your control. For example, a risk might be that a third party supplier doesn’t meet a deadline that is necessary for the deal to move forward. Once you identify these types of scenarios, you can decide which party will be responsible for them if something goes wrong, and to what extent.

You can limit liability in various ways, such as:

  • putting an upper limit on the amount that you can be sued for;
  • setting a minimum threshold that must be met before you can be sued; or
  • setting a timeframe to limit when someone can make a claim.

Can I Exclude Liability Altogether?

Yes. If you want even stronger protection, you can draft provisions in your contract that exclude certain liability altogether. Exclusion clauses will specify outcomes that you won’t be held responsible or required to pay for.

Consider the software company example. In this scenario, your services agreement could exclude liability for any losses caused due to scheduled downtime. In this scenario, even if a customer lost money during scheduled downtime, they wouldn’t be able to sue you.

Limitations of Excluding or Limiting Liability

You can draft a contract which contains broad and far-reaching liability and exclusion clauses. However, this type of contract is not always practical or enforceable, meaning the court may determine that it is invalid.

Firstly, from a practical point of view, it can be difficult to negotiate a one-sided agreement. If you are negotiating with someone with equal bargaining power, they may push back against your liability provisions if they are too extreme.

Secondly, if there are uneven bargaining positions between the contracting parties, the courts may strike down limitation and exclusion clauses. 

When Will a Court Disregard Liability Clauses?

The courts have the power to enforce consumer guarantees and protect consumers against unfair contract terms. Therefore, regardless of what your contract says, a court may disregard a clause or even an entire agreement if appropriate.

Consumer Guarantees

The Australian Consumer Law provides a range of consumer guarantees to consumers who purchase goods or services that cost:

  • $40,000 or less; or
  • more than $40 000, but are products for domestic, household or personal use.

Some of the guarantees that the law provides are that:

  • goods and services are ‘fit for their purpose’ (i.e. appropriate for the use they are designed for);
  • services will be provided with ‘due care and skill’; and
  • goods will be of an ‘acceptable quality’.

You cannot get out of or exclude these guarantees when entering into a consumer contract.

Unfair Contract Terms

Courts can also determine that certain clauses in a contract are unfair and strike them out.

These rules are in place to protect consumers engaging in ‘standard form’ contracts, which are contracts that aren’t fairly negotiated. Rather, the contract is prepared and presented by a party in a much stronger bargaining position. For example, consider a gym membership agreement, which is presented on a ‘take it or leave it basis.’

To make up for the power imbalance in this type of situation, the law considers this kind of contract unfair if it:

  • results in an imbalance of the contracting parties’ rights or obligations;
  • is not reasonable to protect the ‘legitimate interests’ of the party that is benefitting from the clause. This means the court will examine if the party has a specific and valid stake in the clause. For example, if a contract stated that a party could end the contract without any consequences (such as paying compensation), a court will likely find that this isn’t necessary to protect the party’s core interests; and
  • would be detrimental to the other party to allow the term.

The courts have wide discretion when deciding whether or not a contract term is unfair. They assess the term in the context of the contract as a whole. As such, many different types of liability clauses could be considered unfair.

Contract Terms That Are Always Unfair

There are also several types of exclusions which are explicitly considered unfair contract terms, including exclusions that allow:

  • one party to choose when to comply with their obligation; and
  • employers to avoid ‘vicarious liability’ (i.e. employers being legally responsible for the actions of their employees).

Key Takeaways

It is possible to use liability and exclusion clauses to limit your legal responsibility in contracts, such as the amount of money someone can sue you for. However, it is important to understand that you cannot limit your responsibilities entirely, because a court can ignore liability or exclusion clauses that it considers unfair. The law will try to protect the weaker party in an unbalanced contract scenario. If you have questions about liability clauses or Australian Consumer Law, you can contact LegalVision’s competition lawyers on 1300 544 755 or fill out the form on this page.

Simon Hillier
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