In this article, Kashish Sinha pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses Limitation of Liability clause and its enforcement under Indian contracts.
A contract executed between two parties consists of a certain set of promises in lieu of consideration. But parties can choose to perform and provide consideration without any existence of a contract as well, so what purpose does a contract serve? The essence of any contract between two parties is liability which may be enforced upon the party which defaults on its obligations under the contract. This liability allows a party to recover costs for any defective or incomplete performance as may have been set out. Absence of affixation of liability would have resulted in the contract having no legal, or practical, value whatsoever.
But can a contracting party seek to limit its liability, or absolve itself in certain circumstances? For instance, if a dry-cleaning service accidentally damaged an expensive dress, seeking full compensation for such service for the dress would, in effect, bankrupt such a service provider. In such situations, parties to a contract may choose to include limitation clauses within the contract. These limitation clauses seek to limit the liability which can be imposed upon the party contravening the contract. An example of such a clause existing within the contract includes:
For a dry cleaning service
“XYZ Dry Cleaners shall be liable for a maximum compensation of Rs. 1,000/- for any damage which may have been caused as a result of the service provided”.
The existence of such a clause ensures that even if the dress may cost in thousands, or lakhs, the liability of the service provider is limited to only Rs. 1,000. The limitation, incorporated on part of the dry-cleaning service provider, ensures that he or she does not lose commercial value in providing such a service. It ensures that the service provider is liable for the damage in proportion to the service provided and not for the entire transaction of purchasing the dress. Incorporation of such a clause in the contract (which may include a receipt in the present instance) also ensures that the party using such a service cannot feign ignorance and accepts the risk which may be associated with the service itself.
Liability can be limited in two ways: in terms of money by ensuring liquidated damages are agreed upon, as was the case in the dry cleaning instance or by the time period, i.e. by limiting the time period in which the damage caused in service can be remedied. We shall be attempting to go through the legal understanding of these type of limitations, and also understand the difficulties that may actually arise in enforcing these clauses.
Limitation of liability in terms of money
If the “limitation of liability” clause exists within the contract which stipulates a certain sum of money which is to be paid when the contract is breached, such stipulated penalty can be enforced under Section 74 of the Indian Contract Act, 1872. However, the penalty being enforced in this situation would not exceed the penalty which has been stipulated within the clause of the contract.
For instance, if the clause of the contract stipulates that the maximum compensation provided will be Rs. 10,000/-, then the penalty cannot exceed Rs. 10,000/-.
An important thing to understand while drafting such a limitation of liability clause is that the penalty is to be determined keeping into account a fair estimation of damages which would amount from the breach. The money stipulated cannot reach exorbitant levels such that the penalty would exceed the damage caused.[1] For instance, one cannot claim a penalty of Rs. 10,000/- on a damage caused on a dress which itself cost only Rs. 500/-.
This leads us to the second principle of drafting such a clause, that it should specify a maximum amount, but state that the penalty shall not exceed that particular amount. This is to ensure that the balance between the breach actually caused and the penalty to be levied is actually maintained, and the courts on their discretion can determine the value of the penalty to be levied to the breach actually caused. If the clause includes “not exceeding Rs. 10,000”, it allows any amount less than 10,000 to be levied as well depending upon the circumstances of the breach. But if the clause is worded as “Rs 10,000 shall be paid for breach” it would result in Rs 10,000 being levied for even the smallest of breaches, thus causing a disproportionate penalty to be levied.
Thus the two important requisites which always have to be considered include (i) a reasonable amount actually being stipulated as the penalty. (ii) an upper threshold being attached to such an amount.
Additionally, limitation clauses may be specific for breaches for specific nature. For instance, a dry cleaner can specify a sum of money of unclean laundry or a higher sum for excessive bleaching etc.
Limitation of liability in terms of timeline for damages to be enforced
Limitation clauses which restrict liability only for the timeline in which breach is to be enforced are under contemplation of Section 28 of the Indian Contract Act. In its initial version, it was held that such clauses which sought to reduce the time available for enforcement of rights under the Contract Act would not violate the Act and hence can be upheld. This proposition was also affirmed in the case of The New India Assurance Co Ltd v Radheshyam Motilal Khandelwal[2] by the Bombay High Court.
However, the 97th Law Commission Report clarified that Section 28 did not allow the parties to stipulate their own time for limitation, which the Courts were allowing through the ‘prescription’ route, i.e. a situation where parties were allowed to extinguish a right to sue if not exercised within a certain time. The earlier Section 28 provided for contracts to be held void only if it barred exercising of a legal right, and did not bar extinguishing an entire right in itself, if not exercised.
The prescription of a time duration merely extinguished a ‘right’, it did not interfere with the ‘remedy’, as Section 28 sought to prohibit.[3] However, Section 28 itself was amended in 1997, which then disallowed parties to stipulate time within which such rights would be extinguished which would result in the discharge of the liability of the parties themselves. A number of decisions since then have resulted in clauses limiting the time in which such rights can be enforced as void.[4]
However, a new amendment (Banking Laws Amendment Act, 2012) provides for an exception to this section, which provided for allowing banking and financial institutions in agreements for guarantee to provide a time limitation clause as long as it is one year within the date of occurrence of such an event.
As a result, liability cannot be restricted in terms of time for the contracting parties, unless one of the contracting parties is a bank or a financial institution which is carrying out a guarantee contract. Even in such a scenario, the bank or financial institution cannot stipulate a time which is less than one year post the occurrence of event on which such a guarantee was provided.
Limitation clause application in various other provisions
Under the Consumer Protection Act, a limitation of liability clause has been considered to be valid to which the parties have specifically agreed.[5] However, if the clause is considered to be unconscionable in nature, i.e. that it does not balances the interests of both the parties, then such a clause may not be enforced.[6]
Standard form contracts in e-commerce
A growing concern in this arena arises through the existence of standard form contracts which are constantly used by the e-commerce players. These contracts may consist of certain limitations of liability which would reduce the liability the platform may have to incur in case of deficiency of services from such players. The reluctance of the consumer to read and understand these contracts makes such liability susceptible to be accepted without understanding of actual implications.
As a result, it has been suggested on various forums mechanisms which would impose timelines before the customer is allowed to agree the contract, so as to ensure that he or she attempts to read such a contract, or placing such limitation clauses near the agreement part of the contract.
Conclusion
Limitation of liability clauses are one of the best sources of indicators of what the contracting parties intended to execute as a part of their contract. For contracts which may be considered unconscionable or unbalanced between both the parties, the nature of such a clause helps in understanding the balance existing between these parties. But a lot regarding such clauses depend upon how they are actually executed between the parties, and how well they are drafted. It is important to understand the significance of both determining the liability proportional to the breach caused and ensuring that the liability is an upper limit while drafting a limitation on liability. It is also a keen concern to avoid ambiguities and nullities in contract by not drafting any time limitations unless one of the contracting parties is a party eligible under Section 28, Limitation on liability of contract is here to stay!
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References
[1] ONGC v Saw Pipes (2003) 5 SCC 705.
[2] The New India Assurance Co Ltd v Radheshyam Motilal Khandelwal AIR 1974 Bom 228.
[3] National Insurance Co. Ltd v Sujir Ganesh Naik AIR 1997 SC 2049.
[4] Explore Computers Pvt Ltd v Cals Ltd 131 (2006) DLT 477.
[5] Bharathi Knitting Company v DHL Worldwide Express Courier (1996) 4 SCC 704.
[6] Maruti Udyog v Sushil Kumar Gabgotra (2006) 4 SCC 644.
