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It is important to protect your business, mitigate any risk and insulate the business from liability and damages. Almost, if not all, of the contracts your business enters into will include a liability clause. This clause apportions risk between the parties. Ensuring any contracts your business enters into includes a well-considered and negotiated liability clause is a good tool to manage risk when contractually engaging with other parties. This article outlines some factors to consider when reviewing and negotiating liability clauses in contracts that your business may receive from a potential service provider.

Why is a Liability Clause Important?

A liability clause can exclude liability altogether or limit liability by: 

  • capping the amount payable in damages related to a breach;
  • restricting the types of loss recoverable or the remedies available; or 
  • imposing a short time limit for claims. 

Depending on the drafting of a liability clause, it can prevent or limit your business from recovering damages due to a potential service provider’s breach of a contract.

Therefore, it is crucial to appropriately review a liability clause in contracts your business may receive from potential service providers.

Assessing the risk in engaging a potential service provider and negotiating the liability clause to mitigate any risk is an important risk management exercise. A liability clause can limit and reduce your business risk daily. Further, it can also impact your business’ prospective financing and acquisition opportunities. 

Stakeholders, prospective investors and prospective buyers may seek to review your business’ risk by referring to the contracts you have in place with service providers. 

By considering liability clauses and the collective risk your business bears, you ensure that your business is ready for due diligence and any opportunities investors and acquirers may offer. 

Exclusions and Limitations in a Liability Clause

When reviewing a liability clause, you should consider how a potential service provider may exclude or limit their liability. Consider in relation to the clause if there:

  • is a financial cap on the liability. If so, is it limited to a stated (such as a specific dollar figure) or calculable value (the fees your business has paid to the potential service provider for a certain period of time);
  • are exclusions of certain categories or types of loss and damages. For example, if consequential loss is excluded from the potential service providers liability;
  • are any available exclusive remedies for certain types of breaches; and
  • are any potential carve-outs and exceptions to any of the above limits.

How to Approach a Liability Clause

You should review the clause in detail. Determine whether the potential service provider seeks to exclude or restrict their liability to your business. If so, how they are doing so? When reviewing a liability clause, you should assess the clause itself and consider the points below. 

Damages in the Worst-Case Scenario

Consider the worst-case scenario and what damages you may incur in such a scenario. Is there a financial cap on the potential service provider’s liability? If so, ensure that the financial cap is enough to cover your loss and any damages you may suffer in the worst-case scenario. 

Appropriate Remedies

Think about all of the situations where something may go wrong. Following this, consider what remedies may be appropriate. Also, consider whether monetary compensation will always be the best or most practical solution. 

For example, if your potential service provider breaches any confidentiality clause, monetary compensation is not necessarily an adequate remedy. Rather, equitable relief, including an injunction, is more practical when there has been a breach of a confidentiality clause.

Exposure to Third Party Liability Claims

Suppose your potential service provider engages third parties to provide their services to you. In that case, you should consider whether you may be exposed to any liability claims by these third parties. If you may be exposed to such third party liability claims, you should ensure that the liability clause covers the exposure. 

That way, you have recourse to recover any third party liability claims from your potential services provider. 

For example, suppose your potential service provider is a software developer. In that case, you should ensure that the contract outlines that the software developer will accept responsibility for any loss or damage you may face if a third party makes an intellectual property claim concerning any software developed by the software developer, against you. 

Your Obligations

Do you have any obligations under the contract? If so, you may want to have your own liability clause limiting your liabilities. Additionally, you could ensure that the clause is more friendly and balanced between you and your potential service provider.  

What Position to Take When Negotiating a Liability Clause

Ultimately, the position you take when reviewing and negotiating a clause will depend on the contract’s facts and the arrangement between your business and the potential service provider. This includes, for example, the importance and the value of the agreement. 

Context plays an important part when negotiating a liability clause. It is best to take the time to understand the context of the contract and consider the risks to your business if something were to go wrong. 

Key Takeaways 

Reviewing a liability clause in a contract with a potential service provider is an important risk management exercise. You should not only focus on the clause itself and think about the risk your business may take on if something were to go wrong but also consider the context and your arrangement with a potential service provider. It is important to take your time when reviewing and negotiating a liability clause so that you can ensure it appropriately allocates risk in the best interests of your business. If you would like any assistance with your business’ liability clause, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.  

Frequently Asked Questions

What is a liability clause?

It is a clause in a contract that can exclude altogether or limit liability. This could include capping the amount payable in damages related to a breach, restricting the types of loss recoverable or the remedies available or imposing a short time limit for claims. 

Why is a liability clause important?

The drafting of a liability clause can prevent or limit your business from recovering damages due to a potential breach of a contract. Therefore, negotiating the clause can mitigate risk. 

What may be exclusions or limitations in a clause?

A service provider may have an exclusion clause or limited liability clause that you need to consider. These could include a financial cap on the liability, exclusion of certain types of loss or damages or exclusive remedies for types of breaches. 

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