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Negotiating contractual limitations of liability: Do it risk by risk, not one-size-fits-all

A common complaint: Too much time spent negotiating liability limitations

Limitation-of-liability provisions usually rank at or near the top of the IACCM’s annual surveys of the most-frequently-negotiated contract terms.

Ironically, the same surveys indicate that contract professionals fervently wish they could spend their time negotiating collaborative provisions (to try to keep trouble from happening) instead of liability provisions (in case trouble does come to pass).

I’ve been curious why this is such a recurring problem — why it’s been talked about for several years but doesn’t seem to have been solved, at least not that I’ve heard.

The root of the complaint:  Boilerplate.

I think I know why many companies have to spend too much time nego­tia­ting limitations of liability: A lot of the limitation provisions I’ve read over the years have been long, boilerplate state­ments; they might be fine for a simple, low-stakes contract, but their lack of speci­fi­ci­ty can give a reviewer pause, and complicate the discussion, when more is at risk:

  • Consequential-damages exclusions seldom spell out just what specific categories of damages can and cannot be recovered — it seems as though each party crosses its fingers and hope the courts will interpret the phrase ‘consequential damages’ in its favor. That, of course, makes negotiators nervous, because they don’t know wheth­er the particular type of damage they’re concerned about will qualify;
  • Damages caps usually take the form of a single, one-size-fits-all number that applies to every conceivable form of liability. It’s true that negotiators do sometimes debate whether particular types of damage (e.g., damages covered by an indemnity obligation) should be carved out entirely from the damages cap. But that’s a false di­chot­o­my; it assumes, for no reason, that a given type of damages will be either subject to the ‘default’ cap, or not subject to any cap at all.

Instead of resenting the time it takes to negotiate limitations of liability, perhaps we should try doing things a little differently — not necessarily in every negotiation, but definitely in those in which the liability limitations are likely to be closely scrutinized.

Systematically list risks of specific concern, then address liability limits for each

Contract drafters can speed up discussions of liability limitations, I’ve found, by breaking up general boilerplate language into more-concrete statements of risks that are of particular concern, which the parties can focus on more readily.

One technique that works well is to provide a table, such as in the example below, that (i) lists specific risks, and (ii) states, for each specified risk, what if any liability limits are agreed.

Using that table, the parties can systematically work through the list of risks and, for each risk, negotiate the limitations they’re willing to accept.

The example below is adapted from a couple of different large-scale software license agreements I’ve helped negotiate in recent years; the specific entries have been generalized (because it’s a hypothetical example).

[BEGIN EXAMPLE]

Special cases (“carve-outs”):  The following special cases are subject to the above excluded-damages and damages-cap-amount limitations above [Not included here — DCT] only as stated:

TYPE OF DAMAGES
RESULTING FROM BREACH
CONSEQUENTIAL DAMAGES, ETC.,
ARE: [1]
AGGREGATE AMOUNT
IS LIMITED TO:
All damages not listed below Excluded Damages cap amount
Personal injury Not excluded No limitation
Tangible damage to property [2] Excluded Damages cap amount or Provider’s applicable insurance coverage, whichever is less
Erasure, corruption, etc., of stored information that could have been avoided or mitigated by reasonable back-ups Excluded Only that amount that could not have been avoided or mitigated, up to a maximum of the damages cap amount
Other erasure, corruption, etc., of stored information Excluded Damages cap amount [or X dollars]
Lost profits from any of the above Excluded Damages cap amount [or X dollars]
Lost revenue from any of the above Excluded Damages cap amount [or X dollars]
Indemnity obligations Excluded No limitation [or X dollars, or X percent of the transaction]
Infringement of another party’s IP rights [3] [4] As determined by applicable copyright law, patent law, etc.
Willful, tortious destruction of property [5] No No limitation

NOTES:

[1] Consequential damages, etc., refers to any and all damages within the definition of excluded damages set forth above [not included in this example – DCT].

[2] Tangible damage to property does not include erasure, corruption, etc., of information stored in tangible media where the media are not otherwise damaged.

[3] For purposes of this clause, the term “intellectual-property rights” includes, for example, rights in confidential information.

[4] Damages for infringement are deemed direct damages and not consequential, special, etc.

[5] Willful, tortious destruction of property includes, for example, intentional and wrongful erasure or corruption of computer programs or -data.

[END OF EXAMPLE]

Using this kind of systematic approach, if the parties decided to address additional risks in the contract, they could just add rows to the table.

The parties could also add columns to the table: Instead of including a single column for “consequential damages, etc.,” they could add separate columns for consequential damages, incidental damages, punitive damages, lost profits, lost revenues, and so on.

To be sure, if the non-drafting party won’t care much about the limitation of liability anyway, then including such detailed limitation language could actually hinder the overall negotiations.

But remember, by hypothesis we’re talking about contract negotiations in which the limitation language is indeed going to be carefully negotiated — in which case this kind of systematic approach will almost always make sense.

Comments on this entry are closed.

  • Ken Alexander April 18, 2010, 2:33 pm

    Good suggestion to use a table. One of the most common problems I see is failure to clearly distinguish between indemnity obligations for liabilities to 3d parties and damage obligations or limitations for contract parties and their affiliates.

  • Patrick Grant July 29, 2011, 10:07 am

    Good practical advice. But I am confused about one point: instead of the suggestion to possilby add more columns re consequential, incidental, punitive damages, etc., why are those not listed under the FIRST column? Why isn’t the SECOND column titled something like: “Treatment” or “Excluded/Not Excluded”?

  • D. C. Toedt July 29, 2011, 1:28 pm

    Good point, Patrick — the first column should probably be re-labeled “Harm [vice Damages] arising from the breach.”