Limitation of Liability Clauses – You Definitely Want One, But Why?

Many sophisticated business contracts contain limitation of liability clauses. By contractually limiting your liability, you can better plan for your level of exposure in the event something goes wrong. Limitation of liability provisions can be helpful risk management tools if drafted correctly.

First, limitation of liability clauses often limit the amount of liability to which you can be exposed in connection with the contract at hand. This can be done by specifying an actual dollar amount as a liability maximum, but such a limitation may also expressed as a fraction of the amount exchanged in the contract. For example, parties to a licensing agreement may provide that the liability of either party will not exceed the amount of royalties earned during the most recent year during the contract term.

Additionally, limitation of liability clauses frequently limit the type of liability to which a party can be exposed. This is commonly done by prohibiting either party from incurring special, consequential, incidental, punitive, or indirect damages. Limitation of liability clauses may also exclude damages for lost profits or interruption of business. Essentially, the goal is to limit a party’s ability to collect with respect to any damages or other losses that are not directly caused by the party at fault. For example, imagine that a plumber tasked with installing new sinks in a restaurant bathroom accidentally causes a pipe to burst and floods a significant portion of the restaurant. The restaurant must close for 2 days while the flooding is mitigated. If the plumber has excluded the restaurant’s ability to collect lost profits or other indirect damages, the plumber may be responsible for fixing the broken pipe and cleaning up the water, but she will not be liable for any profits lost by the restaurant resulting from the 2-day closure.

In negotiating limitation of liability clauses, note that sophisticated parties often ask for “carve-outs”, a.k.a. certain bad acts to which the limitations will not apply. The most common carve-outs are gross negligence, fraud, and willful misconduct. However, a party may also ask for more specific carve-outs if they are particularly concerned about certain risks, like intellectual property infringement, breaches of confidentiality obligations, or security incidents.

Finally, note that certain liability limitations may be prohibited by law, so you should consult with your attorney to determine whether there are any restrictions on limitations of liability in your jurisdiction that might be applicable.