CHAPTER 6
Limitation of Liability
Alimitation of liability (LOL) provision establishes a maximum dollar amount on contractor liability for breach of contract. The financial limit may apply to the aggregate of claims arising over the life of the contract or it may apply to specific causes of action. Causes of action is the situation or circumstance that entitles a party to obtain a legal remedy against another party. In the latter case, seller may be liable without limit for certain types of actions such as copyright and patent claims.
RISK
Absent an LOL clause, seller may be held legally responsible for causes of action that might have otherwise been mitigated or cancelled in their entirety; such causes of action may include indirect, punitive, incidental, consequential reparations and/or unlimited compensatory damages. These damages can be very costly to seller.
Defining these risks clarifies why seller should try to limit and possibly omit them in their entirety. Indirect or consequential damages are those that do not result directly from an act or cause but are more or less remotely connected with or growing out of it. For example, a company that has a contract to deliver jet engines may be heavily reliant on receipt of a turbine blade manufactured by seller. A problem during manufacturing delays delivery of the turbine blade by several months. As a direct result, buyer’s delivery date to their customer slips by an equal number of days. Each delay costs buyer a percentage of their profit. This financial loss is considered indirect or consequential damages that buyer may collect from the seller if seller did not take exception to it in the LOL.
Compensatory damages—also called actual damages—cover real injuries or economic loss such as attorney’s fees, medical bills, lost wages, or replacement of property. By agreeing to unlimited compensatory damages, a seller’s liability is open-ended. Depending on the degree of damages, seller may be held responsible for costs well in excess of the contract award. I worked for a firm years ago that tested missiles at a local prime contractor’s test site. We placed missiles on rails at the buyer’s test facility. The rails were designed to keep the missiles on path. The rails failed during one of our tests and a missile broke away, flying into a nearby mountainside. The entire hill caught on fire. The fire threatened nearby neighborhoods. Absent an LOL provision, the firm I worked for may have been held responsible or partially responsible for various costs associated with the damage rendered that would otherwise have been diverted to the buyer. Had any serious damage or death occurred, the cost could have been substantial.
Punitive damages—also referred to as exemplary damages—are money awarded a victim as punishment to the negligent party. Punitive damages can be excessive, since they are often used to deter others from committing a similar act. Such damages are in addition to compensatory damages. Punitive damages may exceed actual damages by a factor of three.
RESPONSE
Seller should always try to negotiate an LOL clause into a contract as a means to limit seller’s financial exposure associated with contract breach and/or negligence. Specific areas where financial exposure is minimized include warranty, indemnity, and liquidated damages. The first part of a properly worded LOL reads similar to the following example:
Seller’s liability is limited to the total compensation received by seller. To the fullest extent permitted by law, and notwithstanding any other provision of this Agreement, the total liability, in the aggregate, of seller and seller’s officers, directors, partners, employees, agents, and engineers (hereinafter referred collectively to as “consultants”), and any of them, to the owner and anyone claiming by, through, or under owner for any and all claims, losses, costs, or damages whatsoever arising out of, resulting from or in any way related to the project or agreement from any cause or causes, including but not limited to the negligence, professional errors or omissions, strict liability or breach of contract, or warranty express or implied of seller or seller’s officers, directors, partners, employees, agents, or seller’s consultants, or any of them, shall not exceed the total compensation received by seller under this agreement.
Notice that in this clause, the language specifically identifies the various legal causes of action that are included in the limitation. Inclusion of the various legal causes of action protects seller from instances when one clause is omitted from an LOL. For instance, when an LOL includes damages arising out of negligence but does not mention breach of contract, an owner might sue for breach of contract, thereby avoiding the limitation altogether.
In lieu of limiting damages to the total compensation received by seller, seller may opt to negotiate buyer’s compensation or a fixed dollar amount such as $50,000, whichever is greater. Contrary to what many may think, it is important as seller to make the limitation whichever is greater and not lesser. This is particularly true when performing a small profit job. If the contract profit is too small in comparison to the amount of the risk at stake, a court may refuse to enforce it.
Many buyers are willing to waive indirect and consequential damages against seller. Such damages may include indirect damages such as loss of rents due to the failure to complete a project on time, lost profits, and other economic losses. That is why it is important to include the following language in any indemnification clause:
Seller shall not be liable to buyer for any indirect or consequential damages whatsoever, whether such liability arises in breach of contract or warranty, tort including negligence, strict or statutory liability, or any other cause of action.
A complete LOL clause should read similar to the following example:
Seller’s liability is limited to the total compensation received by seller. To the fullest extent permitted by law, and notwithstanding any other provision of this Agreement, the total liability, in the aggregate, of seller and seller’s officers, directors, partners, employees, agents, and engineer’s consultants, and any of them, to the owner and anyone claiming by, through, or under owner for any and all claims, losses, costs, or damages whatsoever arising out of, resulting from or in any way related to the project or agreement from any cause or causes, including but not limited to the negligence, professional errors or omissions, strict liability or breach of contract, or warranty express or implied of seller or seller’s officers, directors, partners, employees, agents, or seller’s consultants, or any of them, shall not exceed the total compensation received by seller under this agreement. Seller shall not be liable to buyer for any indirect or consequential damages whatsoever, whether such liability arises in breach of contract or warranty, tort including negligence, strict or statutory liability, or any other cause of action.
A few common themes for seller’s consideration when drafting LOL clauses are identified below:
1) If the contract will also include an indemnity clause, keep it separate from the LOL clause. This will minimize the likelihood that a court will void the LOL clause based upon the state’s anti-indemnity statute, if any, or for public policy considerations. You might reference the LOL clause, however, in the separate indemnification clause.
2) Clearly identify the liability limit in the clause and provide a limit that is reasonably proportionate to the risks. The liability limit should not be a de minimus sum. In other words, it should not be too small in the eyes of the court. It could be linked to the liability insurance requirements of the contract, the total contract value, or some other reasonable amount. If seller bases it on insurance, do not refer to insurance proceeds, since this could expose your entire insurance program, which may be far in excess of the insurance required by the contract. Be careful to base it on the amount of insurance required by the contract only.
3) Do not bury the LOL clause in fine print or in another part of the contract. It should be prominently featured—at least equal to the other terms and conditions of the contract. Refer to the LOL clause in subsequent task agreements or work orders or be sure that they specifically incorporate by reference all terms and conditions (including the LOL) of the agreement.
4) Provide an opportunity, either in the clause or in another part of the contract, for the buyer to negotiate a higher limit of liability, either for a predetermined sum or otherwise.
5) Identify types of claims to which the clause applies, including negligence, breach of contract, and breach of warranty.
6) Include a separate clause in the contract stating that the LOL was mutually negotiated.
7) Include a clause stating that the services are being provided only for buyer and/or buyer’s customer in privity with buyer and that the services are not for the benefit of any third parties. Privity implies a legal relationship and mutuality of interest and obligations whereby legal claims may be supported by both parties.
In summation, seller will maximize the chances of the LOL clause being enforced if it is clearly drafted, prominently shown in the contract, and the cap is considered fair and reasonable for the effort in question. The clause is also more likely to be enforced if the two parties are of equal bargaining strength.
It is important to recognize that while some states recognize an LOL’s enforceability, others may not. For instance, the state of California is likely to uphold an LOL clause. Other states such as Alaska may not; Alaskan courts have not traditionally upheld such clauses. As a result, it is incumbent on seller to choose a governing law that will recognize the terms and conditions important to the seller. Keep in mind that you may negotiate a governing law that is separate from the state in which the work is conducted.