We’ve been busy with trust and estate work in recent weeks, but felt it was time to write another educational post on contract terms and conditions. In contrast to our series on general contracting principles, this series will more specifically cover the standard terms contained in a typical contract. I’ve drafted or reviewed more than a thousand contracts since my licensure—enough to see the common ways things slip sideways. Today’s topic is the Limitation of Liability clause.
Even if the abbreviation of Limitation of Liability is “LoL”, it’s no laughing matter. The language of this section can mean the difference between a company carrying on or going under. If you’re a small business and don’t have a Limitation of Liability clause in the general terms of your standard contract, you need one. All’s well and good until you hit that one bad customer experience that leads to legal action.
A Limitation of Liability clause accomplishes one obvious purpose and one nonobvious. The obvious purpose of a Limitation of Liability clause is to cap your liability to a customer at a predetermined maximum. Whether such a clause will hold up in litigation will be determined by applicable law, but that is a conversation for another time. The short version of that discussion is this: a reasonable Limitation of Liability clause can have a large effect on controlling your risk exposure in any given transaction.
The second purpose of the Limitation of Liability clause, which is often overlooked, is its informational function. A Limitation of Liability clause tells your customer that you’ve done your homework and know what harm they might suffer from your bad act or honest mistake. Be careful that you don’t create a liability cap substantially lower than that likely harm, or you risk having a court invalidate it under what effectively amounts to a “fairness” argument. Again, this will depend on your jurisdiction. However, by giving upfront notice of a reasonable damages cap, you provide the starting position for negotiation of a future settlement—or the court’s analysis. Plus, your customer agreed to it in writing. Unless a customer can successfully argue that you misled them into signing, or that they had no reasonable alternative, their consent to your terms carries weight.
There are exceptions to every rule, including the enforceability of a Limitation of Liability clause, but there is a lot to be gained from including a couple of sentences towards that end in your standard contract.
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Any guidance provided above is for informational purposes only and should not be treated as a substitute to retaining knowledgeable legal counsel (i.e., an attorney).
