Limiting liability in contracts is a widely accepted strategy to manage potential risks and protect against lawsuits or claims. By including a limitation of liability clause, companies can often transfer certain risks to the other party, making it a popular option for mitigating legal exposure.
While insurance may cover certain claims, not all risks are insurable, which makes a limitation of liability clause even more essential. These clauses are standard in many agreements, including service and asset purchase contracts.
The Importance of Limitation of Liability Clauses
A limitation of liability clause restricts the financial exposure a company may face if a claim arises. If enforceable, this clause sets a maximum—often called a “cap”—on the damages a company could owe. Liability caps typically apply either to all claims under the agreement or specific claims, and they may be limited to amounts such as:
- Fees paid under the contract
- A pre-set flat amount
- Coverage available under an insurance policy
Significant Reduction in Financial Exposure
Studies show that including a limitation of liability clause can reduce a company’s financial responsibility by up to 90%. This makes these clauses a powerful tool for companies looking to minimize risk.
Are Limitation of Liability Clauses Enforceable?
Despite concerns over enforceability, courts generally uphold these clauses. In most cases, service providers in contract disputes successfully claim that they are liable only for the amount charged for the services, particularly when the clause is carefully drafted and both parties had the opportunity to negotiate it.
However, limitations of liability may not be enforceable if they violate public policy, were not negotiated freely, or in cases of fraud or breach of fiduciary duty. For example, a court might not uphold the clause in a fraud case, allowing the claimant to challenge and potentially void the agreement (see Hooks v. Samson Lone Star, Ltd. P’ship, 457 S.W.3d 52, 57 (Tex. 2015)).
Six Tips to Strengthen Your Limitation of Liability Clause
A well-drafted limitation of liability clause can enhance enforceability. Here are key drafting tips:
- Use a Bold Section Heading: Label it clearly as “LIMITATION OF LIABILITY” or “DAMAGES.”
- Make the Clause Stand Out: Use bold, italic, or underline formatting.
- Isolate the Clause: Place it in a stand-alone paragraph.
- Use Larger Font: Ensure it is noticeable compared to other contract provisions.
- Keep It Clear and Concise: Avoid overly complex language.
- Consult a Lawyer: Professional drafting is crucial for enforceability.
Limitation of Liability and Insurance
If insurance provisions are not excluded from the liability cap, any recoverable amount under insurance would be subject to the liability cap. For instance, if a contract requires $6 million in liability coverage but the cap is $600,000, only $600,000 can be recovered unless insurance is specifically carved out of the limitation.
In Summary
If your limitation of liability clause is enforceable, it can restrict potential claims to a specific amount, offering significant financial protection. Having legal experts draft this clause can improve its enforceability and safeguard your company from extensive liability.
