When you think you have negotiated a great deal, it is time to look at the detail. Is your business on the line if things go wrong? Are you able to exclude, limit or cap liability in B2B contracts?
In this bite-size video and article, our commercial solicitors discuss how, in a business to business relationship, your company can reduce its exposure to risk by limiting liability in your commercial contracts.
How limiting liability can benefit your business
As a breed, entrepreneurs all seem to have boundless energy and are unfailingly positive. Those are great traits and it is what gets you from start-up to listed company, provided the enthusiasm is tapered with a dose of scepticism so your company is protected through limiting your liabilities, wherever possible.
The benefits of limiting liability include:
- You reduce your exposure to commercial contract litigation
- You end up not paying damages, or a reduced amount, because the contract excluded liability or capped your liability to a specified figure
- You know the extent of any liability so you can budget for the worst case scenario, rather than an unknown quantum of damages
- You don’t experience the same degree of reputational damage if things go wrong as there is less likelihood of publicity and a court dispute over the extent of your liability
Whilst those are some of the benefits of limiting liability when negotiating a commercial contract, or signing up to terms and conditions, there is one disadvantage as everything comes with a price. If you want to limit your liability, your customer may want the price of your goods or services to reflect your limited liability and their increased exposure. Likewise, if you want to drive the price of a product down, your manufacturer or supplier may want to adjust and reduce their liability. Failure to do so may make the venture commercially unviable as they will be exposed to too much risk for limited profit.
The importance of using liability clauses
The importance of using liability clauses can't be overstated because without a limitation clause your exposure and damages are unlimited as in UK law damages are not linked to the value of the contract. The consequential loss could be far higher than you could have ever contemplated when signing the contract. You can't assume that just because the value of a contract is relatively small for your business that any corresponding liability will be equally modest.
Take the example of an IT or SAAS commercial contract for an online booking platform. The customer, a hotelier, may have recently taken out the contract for a modest monthly subscription. If there is a data loss that results in lost bookings or displeased hotel guests, what is the extent of the liability of the SAAS provider? Open ended liability for a contract of limited value is not commercially viable. Liability either needs to be excluded, limited, capped or the price needs to reflect the generous liability cover. For a more in depth look at SAAS contracts have a look at our On-demand webinar: SaaS contract key terms and our article SaaS Contract Negotiation Essentials.
Types of limited liability clauses
There are a wide variety of liability clauses that can be negotiated and included in a commercial contract but essential first steps are to:
- Assess the risk by carrying out due diligence
- Look at options to minimise the risk
- Consider if insurance is available to cover all or some of the risk and how cost effective the insurance is
Determining these points then puts you in a good position to negotiate on limited liability provisions as you have a clearer idea of what you need to achieve to make the contract commercially viable for your business in light of the assessed risk.
When looking at ways and clauses to limit liability there are three main options:
- Exclusion of liability
- Limiting liability
- Capping liability
The best option will depend on the nature of the risk you are attempting to limit liability for and the overall contractual terms. For example, a highly competitive product price may tempt you to accept more liability than you otherwise would be willing to agree to.
Whilst it may be tempting to limit or exclude liability for everything, over enthusiastic contract drafting can work to your disadvantage. That’s because:
- There are some liabilities you can't legally exclude (such as fraud)
- Where the Unfair Contract Terms Act 1977 (UCTA) applies to standard business contracts, and includes a statutory reasonableness test to liability clauses, the contract term must be “a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.”
- Where there is a blanket exclusion of liability for contract breaches that may, in the opinion of a court, make the contract void or result in an invalid contract
When it comes to excluding liability, commercial solicitors say that sometimes less is more effective. It is a balancing exercise to be considered when negotiating and drafting contracts. It is a question of looking at the risk, assessing whether the risk is in the control of one contracting party, whether it is an insurable risk, and then negotiating on liability clauses that are acceptable and workable for both parties.
A point to remember is that you are liable unless you expressly exclude in a contract. Whilst you don’t want blanket refusal to accept any liability, you do need carefully constructed exclusion clauses, tailored to your business circumstances.
Capping liability is a popular means of controlling liability as the exposed party then has a degree of certainty over the extent of their potential liability. Consideration should be given to having different caps, depending on the nature of the liability. Negotiations often centre around the amount of the financial cap. Options include:
- The value of the contract
- A percentage of the contract value with the percentage on a sliding scale depending on the length of the contract
- The contract price – this could be the full contract price or the amount paid under the contract at the time the liability arises. If liability occurs in month one then the capped liability may be very modest in comparison to the amount of damage
- The limit of the supplier's insurance provision – if this type of cap is agreed there needs to be careful drafting of the agreed insurance provision and evidence of the insurance
Tips on limiting liability in commercial contracts
Our commercial solicitors tips on limiting liability in commercial contracts include:
- Ensure that your commercial contract is in writing or you are not contractually bound by email exchange, without sufficient attention to liability. For more information on contracting by email take a look at Are emails enforceable contracts? When emails become legally binding
- Define the obligations each party is under in the contract because clearly scoped out obligations limit liability
- If there are pre-conditions to a contract, or the other party needs to meet obligations before liability kicks in, then this should be clearly stated
- If possible, limit liabilities by limiting obligations from absolute to use of best or reasonable endeavours or by limiting liability by imposing deadlines to make claims. The deadlines and conditions will need to be reasonable, such as only using approved engineers to service a product before making a claim or a condition that products need to be serviced and failure to do so limits liability. For a further look at what endeavours means in commercial contracts have a read of our article Interpreting Endeavours Clauses.
- Consider inclusion of a force majeure clause to escape liability if there are circumstances beyond your control
- Ensure termination and variation clauses are drafted in a way that is consistent with liability and indemnity provisions and work in conjunction for you
- If there is liability try to specify remedies rather than leave it as open ended damages
- Make the limitations on liability clear and severable to reduce the risk of a court saying that the limitations are unreasonable
- Check the wording of indemnities and the liability provisions to ensure consistency
- If using subcontractors, ensure you negotiate that they will provide you with indemnities and agree to accept similar liabilities to those agreed by you in the head contract
Quick video overview
In this bite-size webinar, Angela Kerry discusses how, in a business to business relationship, your company can reduce its exposure to risk by limiting liability through your commercial contracts. She covers:
- How limiting liability can benefit your business
- The importance of using liability clauses
- The types of clauses you could use
- An example limitation clause from a SaaS agreement