This article is written by Shivani Varade who is pursuing a pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho
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If your dry cleaner damages your suit worth Rs. 20,000, how much compensation can you claim from him? As a customer, you may want full compensation for the loss of your suit, but such a commitment is illogical for the dry cleaner as he charges merely Rs. 1000-2000 for his services. Therefore, the dry cleaner gives you a slip including a term saying, “The service provider’s liability in any eventuality shall not exceed (a particular amount).”
He limits his liability for any mishaps by setting a limit to protect himself from undertaking the risk of paying the full price of the suit.
The term included by the dry cleaner is called the limitation of the liability clause, which anticipates that there will be a breach of contract, and then limits the liability for that breach. This shows, if you engage in any kind of contract, you should have a working understanding of the effect of limitations of liability clauses to protect your business from unforeseen liabilities.
This article aims to provide an overview of the meaning, importance and drafting of limitation or exclusion of liability clauses generally found in commercial contracts.
Exclusion of liability clause
Exclusion of Liability or Exclusion clause does exactly what it sounds like: seeks to exclude the liability of one of its parties. It provides that a party has no liability if the contract is breached. Exclusion clauses are found in many different areas of everyday life. For example, an exclusion clause typically found in car parking looks like, “All vehicles parked at owner’s risk. No liability accepted for any loss or damage”.
Sample of an exclusion clause
We exclude any and all liability, injury, damages, or cost caused to your property, products, individuals, or the like, whether directly or indirectly as a result of our negligence or the failure or malfunction of the Service Provider’s systems or components for any purpose.
Limitation of Liability clause
A ‘limitation of liability ’ or ‘liability’ clause, is defined as a disclaimer for a contract that limits the conditions under which the breaching or the disclaiming party may be held liable for loss or damages. It defines the limit of damages for both parties in the contract, which may be claimed in cases of loss or damage.
Simply, a ‘limitation of liability ‘ clause is a term in a contract that answers the question-“If this goes wrong, how much will you owe me?” It aims to specify and narrow down the type and amount of recoverable damages to a reasonable level of risk that the parties will agree for doing business together.
Samples of limitation Clauses
- The Agent’s total liability to the Principal for any damages or expenses claimed by the Client in connection with this Agreement shall not exceed the fees collected by the Agent, given that any such allegation is made within 20 (twenty) days of the Agreement’s termination.
- The Service Provider’s total liability for any lawsuits, injuries, expenses, or damages arising out of or relating to this Agreement will be limited to the fees earned by the Service Provider under this Agreement or Rs. 20,000 (Rupees twenty thousand), whichever is less. Only lawsuits involving a loss or injury over Rs. 5,000 (Rupees five thousand) will be allowed to be pursued by the Client.
Importance of Exclusion or Limitation of Liability Clause in a Contract
As these clauses are used to manage the risks involved, there is no financial cap on the damages a party may seek in case of a breach in absence of limitation nor exclusion clause in a contract.
The important reasons for having a limitation or exclusion clause in place are-
Protection to small service providers-
The service provider’s profit margin on his services in many cases may not support taking an unlimited risk in case of any damage or breach. Thus, the rationale behind the limitation clause is to protect the service provider from undertaking risk which may not be commensurate with the small charges that he may be charging for doing a particular task or handling a thing (as cited in the dry cleaner’s example above).
Legal protection from potential liability-
Your customers or vendors may hold your company responsible for unforeseeable damages and losses, i.e. indirect or incidental losses, which are outside the scope of reasonable control. However, under common principles of law, parties to a contract are typically held liable for only foreseeable damages that occurred as a result of incidents that you might and should have predicted and managed.
The limitation or exclusion clause reaffirms that no party may be held liable for damages under such cases. As a result, the business is protected from the costs and effects of misdirected litigation.
Limit and cap the monetary amount of potential damages-
If you are faced with a valid claim by a wronged party for which you must now pay damages, you may consider relying upon insurance to safeguard your interests. However, not all claims are insurable and they could take have a significant toll on your funds. Thus, a limitation of liability clause may explicitly specify a limit on the amount of possible damages that can be sought and to which a business is exposed.
Enforceability of Limitation or Exclusion of Liability Clause
As a general rule, courts will refuse to enforce the liability or exclusion clause in the following cases:
- Unclear expression of intentions of the parties to the contract
- The ambiguous wording of the clause
- Contrary to a public policy or statute
The enforceability of limitation of liability clauses is not absolute (especially in cases of gross and willful negligence on the part of the service provider) and is determined by the facts of each case.
In the case of contracts where parties are found to have unequal bargaining power, it is important to be careful of the possibility that courts may refuse to enforce clauses excluding or limiting liability, which are found to be unconscionable.
Governing law on Limitation of Liability Clause
Although there is no explicit legislative prohibition in India against contractually excluding or restricting liability for damages, Section 23 of the Indian Contract Act, 1872 states that the consideration or object of an arrangement is unlawful if it is of such a nature that, if allowed, would defeat the provisions of any law or if the court considers it to be immoral or contrary to public policy. A contract with an unlawful object or consideration is considered void.
If the contract has a “limitation of liability” clause that specifies a particular amount to be paid if the contract is breached, the stated penalty can be enforced under Section 74 of the Indian Contract Act, 1872. However, the penalty imposed in this scenario would not exceed the penalty provided in the contract provision. For example, if the contract specifies that the maximum compensation granted is Rs. 20,000/-, the penalty cannot be more than Rs. 20,000/-.
- Central Inland Water Transport Corporation v. Brojo Nath Ganguly Brojo Nath Ganguly
[AIR 1986 SC 1571] In 1986, in the case of Central Inland Water Transport Corporation v. Brojo Nath Ganguly Brojo Nath Ganguly, the Supreme Court established the principle that courts may not impose an unreasonable clause in a contract entered into between parties who do not have equal bargaining power, as they are void from being opposed to public policy.
However, the court ruled that this principle does not apply where the parties’ bargaining power is equal or nearly equal. This means that, when a stronger party completely excludes its liability in the event of any breach of the agreement, it exploits the interests of the weaker party. Such an exclusionary clause may not be enforceable by Courts.
However, if the parties have equal negotiating power, i.e. if both the parties are businessmen, this principle is not applicable and such an absolute exclusion clause may be enforceable.
- Simplex Concrete Piles (India) Limited v. Union of India
[108 (2003) DLT 732]
The Delhi High Court in the case of Simplex Concrete Piles (India) Limited v. Union of India addressed the question of whether contractual provisions would prohibit an individual from seeking damages that he is otherwise entitled to under the law.
In this case, the court looked at a clause in a government construction contract that prohibited a contractor from making a claim for compensation if work was delayed and the deadline was extended due to unforeseen circumstances. The court held that-
- Under Section 23 of the Contract Act, clauses that prohibit a contractor from seeking damages that he is entitled to under Sections 55 and 73 of the Indian Contract Act, 1872 are void.
- Individuals may waive a law that is made for their benefit, but when the law has a public interest/public policy aspect, such rights arising from the law cannot be waived because the law becomes a matter of public policy/public interest.
Drafting your Exclusion or Limitation of liability clause
To properly draft a limitation clause, it is necessary to define the contract’s risks as well as the potential losses that could result from those risks. While drafting the clause, you must consider asking yourself the following questions:
- What could go wrong in this transaction?
- How likely is it that a contract would be broken?
- How much is it likely to cost? Is it anything I could afford?
- Are there any economic risks associated with this contract and/or the sector in particular?
Once you’ve determined the level of risk, make sure to draft your limitation clause in simple, clear and unambiguous language. Particularly, the limitation clause should set out the following:
- The damages that each party is willing to pay without limit, e.g. fraud, death, and personal injury.
- The amount of losses that each party is willing to cap (the cap can be different for different types of loss). This limit can be set based on the parties’ level of insurance, the contract’s value, or the potential amount of harm caused by a breach of contract.
- Losses that each party eliminates, i.e. specific losses for which a party would not be held responsible, such as a loss of profit or revenue. However, keep in mind that death and personal injuries caused by negligence will still be liable. Any provision that excludes these would be unenforceable.
- As a general rule, the liability should always be capped to a reasonable amount, and you should make sure that a meaningful remedy is still available for the recovering party.
Additionally, one should avoid the following assumptions while drafting the liability clause-
- Your insurance coverages will protect you from having to pay anything out of pocket in the event of a breach of contract-
Be cautious as many insurance policies specifically exclude coverage for liability assumed by contract, such as indemnification obligations.
- You’re at an advantage if the contract is “silent” on the amount of damages recoverable for a breach-
If the contract is “silent” on the cap on damages, it implies that there is no cap on damages.
- A company who insists on having a limitation of liability clause is untrustworthy or wants to avoid responsibility for their actions-
Untrue. Limitation of liability is supposed to be an efficient way of pegging the risks of a given transaction to the actual value the parties take away from it. Therefore, one should be more careful of the folks who casually agree to take on unlimited liability as they may deceive their customers when the actual breach occurs.
To be effective, the limitation or exclusion clauses should be written as valid and reasonable enough to be enforceable. Therefore, with a well-drafted and clear limitation clause, you can benefit your company’s legal and financial interests in the forthcoming business relationships. So, the next time you are reading or drafting a contract, don’t overlook the limitation or exclusion of the liability clause. Instead, ensure that you consider all the fundamentals mentioned above before proceeding with any commercial contract.
Limitation of liability clauses is like rubber boots in a lightning storm. Tread carefully here and be sure to check with your lawyer to ensure that your company’s interests are properly secured.
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