Key considerations for suppliers when negotiating limitation of liability clauses

Limitation of liability clauses are crucial to businesses. They seek to mitigate risk and protect a business from what in theory could be an existential threat.

In simple terms, if a supplier breaches an obligation given in a contract then the customer can recover all losses suffered by the customer. Therefore, the customer would be entitled to compensation the purpose of which is to put the customer in the same position as if the contract had been performed properly.

So for example, if a supplier in breach of its contractual obligations allows a third party unauthorised access to a customer’s data, then the customer could claim all the losses that they suffer as a result. This could include compensation payments to end clients and fines levied by the data protection regulatory, without limit.

In this scenario, without any limitation of liability clause, the supplier could inadvertently be putting their whole business at risk.

The following key considerations should be evaluated when drafting a limitation of liability clause in business-to-business contracts:

Capping liability

There are generally three types of losses which cannot be limited by a contractual term. They are:

• Losses caused by the fraud and fraudulent misrepresentation of a party
• Liability to an individual for their death or injury caused by a lack of reasonable care
• Supplying goods without the right, or title, to do so.

The law views it as unconscionable on public policy grounds for a contract party to be able to exclude their liability for these things in a contract

Contract parties can, however, look to cap their liability arising from a contract in respect of most other breaches. Having a cap on liability limit in place – often expressed an a fixed amount – would mean that a supplier can plan for a “worst-case” scenario and ensure that adequate financial planning is in place. This ensures that the limit is something which the business would be able to absorb.

Beware of exclusions from the cap on liability

Should you have a cap on liability in place, the next step would be to ensure that there isn’t a list of exclusions to the cap, which would in effect make it redundant and put your business back in the position of having exposure to uncapped liability.

Larger customers will often try to negotiate a cap by excluding certain types of claims from it, such as those for breach of confidentiality or data protection law. These should be resisted where possible.

Insurance

Having insurance in place which will provide cover for a supplier in the event of a claim from a customer – typically “professional indemnity” and “product liability” insurance is very important in protecting a business from customer claims.

In addition, having a cap on liability reflecting the level of cover may seem like the sensible thing to do. However, it is important to consider when negotiating a cap on liability that your level of cover doesn’t mean an automatic right to a payout. There should always be a buffer between your level of cover and the cap you negotiate to protect your business in the event that your insurance policy does not pay out.

A well drafted and carefully prepared limitation of liability clause should be considered as the bedrock of any contractual relationship, it will determine exposure to risk whilst maintaining an adequate level of protection.