This article has been written by Deena Nawab, pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.com.
With the growing need to fulfill business transactions between any two parties, a contract falls as a legal obligation. There are more signs of a written contract than an oral one. A contract to be specific must not be vague and must contain all essential clauses. A written contract varies based on the specific performance to be done. A written contract must include all the essential clauses, keeping in consideration the future consequences. The parties must consider, what will happen if things do not happen in accordance with the general terms and conditions in the contract.
In this article, the author has discussed the importance of liability clauses in a vendor agreement. A vendor agreement in short is a contract entered for one’s business and between the vendors. A vendor agreement aims to provide a better understanding to the parties in terms of payment, deliveries, minimizes future risk, and specifies limitations to the vendor. Laying down the obligations on the parties and consequences if the party fails to meet, the expectations set forth in the contract. Vendors now are increasingly relying on this clause to reduce the amount of liability upon them. But, the author has proceeded with distinguishing between a liability clause and indemnification clause for clarity and better understanding at the first instance.
Difference between limitation of liability clause and indemnity clause
Depending on the nature of the contract, a company has the liberty to add liability and indemnity clauses. A limitation liability, in layman terms, means a limit imposed on the liability of a party in a contract, intending to limit damages.
- For instance, say, ‘A’ is a builder and he is paid $10,000 by his client for additional wooden ceilings and marble tiles to be used for constructing a building. ‘A’ can insert a limitation of liability clause limiting his liability to $10,000 if there arise any uncertainties. Which may be caused by any loss or damage due to any mishappening, the client hereby virtue of the insertion of liability clause in a contract cannot reimburse more than $10,000.
Therefore, the parties negotiate to limit the liability of the party indemnifying, if there arises a breach of contract which may exceed the contract price. On the other hand, an indemnity clause gives one party the liberty to ask for compensation or file a lawsuit against the other contractual party if there have been any monetary/physical damages arising in violation of the terms of the contract. The party can file a lawsuit against the other infringing party.
This clause mandates the parties to pay an amount in a lawsuit as settlement or jury award. The party, against whom a lawsuit has been filed, can also be held liable to pay the winning party’s legal expenses incurred so far. This shall also include the attorney’s fees and other possible legal costs and expenditures. Using the above example, if the newly constructed building’s roof falls upon a tenant causing him an injury, the client can sue the builder, he shall also be held liable to indemnify for the damages caused due to the collapsed wall, with no limitation on the liability.
Vendor agreement and its essential clauses
A vendor agreement is a contract that lays down provisions, required to be complied with by the vendor and the specific performance of certain work to be done by the vendor. This agreement is between a business owner who hires a person (called as ‘vendor’) requiring certain work to be done, say for the delivery of goods/services and the vendor performs such work.
For the better regulation of a business and to run the business smoothly and efficiently, a supply of adequate materials must be present. Which may include; internet services, courier services, raw materials for product manufacturing and so on. The supply may also be required for various purposes like, for instance, office supplies or for the production and manufacturing of a product based on the business that is being carried out.
Therefore, to maintain the supply chain, vendor agreement has been given significant importance. This agreement avoids the dispute between the parties, which may arise in the course of supply by the vendor. The vendor agreement lays down the rights and duties upon the business owner and the vendor, making this of paramount importance. This agreement further helps to reduce the risk of future disputes and lawsuits.
Some of the essential clauses to be included in the vendor agreement
- A clear description of the product or scope of services: A vendor agreement should always contain clear and detailed information. This clause shall describe the specifics of the product or the services being provided. At times, a ‘Statement of Work’ is attached to a vendor’s agreement, which provides all the necessary details for the efficient engagement of the purpose of the agreement.
- The payment clause: A clause regarding the ‘payment’ must be specified. This clause puts forth the structure of payment, amount to be paid to the vendor for supply of products, any matter regarding the amount, and so on.
- The time duration: A ‘time duration’ clause must be included, this clause must be brief about the duration of the business relationship between the business and the vendor. The agreement is for a fixed term which may need to be renewed based on the wishes of the parties. This clause must also include a situation upon which the agreement may be terminated before the expiration of the period of contract by serving a notice to the party.
- Warranty clause: A clause regarding the ‘warranties’ must be included, the warranties which have been agreed by the vendor to provide the business. This warranty may be against infringement of IPR for the business, the ability of the vendor to avail goods and services.
- Limitation of liability clause: A clause regarding ‘limitation of liability’ is essential in vendor agreement for the vendor. This clause safeguards the vendor since it limits his liability in the cause of delay in delivery due to his negligence or fraud. The business through this clause may claim damages if the action of the vendor causes damage to the business.
- Dispute resolution method: A clause for ‘dispute resolution method’ must be included i.e., in case of a dispute between the parties, whether the parties implement the dispute through arbitration seating’s and the seat of the arbitration must also be mentioned. The court that will have jurisdiction along with the laws applicable on both must be mentioned.
Importance of liability clause in the vendor agreement
In vendor agreement, a limitation of liability clause is necessary, as it sets up a monetary limit if the vendor fails to perform his duty as laid under the agreement. Assignment on the amount of liability to be imposed on the party comes into question here.
In vendor agreement, a liability clause is set up in a manner that firstly limits the amount the vendor will pay, to the other party in contract i.e., the registered company under any circumstances. This clause is stated as THE VENDOR IN NO WAY WILL BE LIABLE TO THE (NAME OF THE REGISTERED COMPANY) FOR MORE THAN (Amount specified), this is a fixed number.
Secondly, the clause must include as to what the vendor will compensate for, this clause must be like: THE VENDOR IN NO CIRCUMSTANCE WILL BE LIABLE FOR ANY DAMAGES IF INDIRECT, SPECIAL OR CONSEQUENTIAL CIRCUMSTANCE ARISING FROM OR RELATED TO THE AGREEMENT. This clause mandates to hold the vendor liable only for the damages that are direct and predictable. A limitation of liability clause in vendor agreement, seeks to cap a party’s liability in a contract.
One-size fit approach
Emphasis must be laid upon as to whether there is a one size fit approach of liability clause in all agreements. The answer is No, one size fit- all approaches may not be applied in the same manner to different agreements. Let me explain with an example, as to how the limitation of liability shall differ based on circumstances.
The liability of a delivery man failing to deliver 6 quarters of milk to a family every day differs compared to that of the failure of a milk delivery company, to deliver gallons of milk to an ice-cream factory within the stipulated time. The delivery man here is the supplier/vendor under a vendor agreement, the supplier must supply the products essential to the business owner which in this case, is the ice cream factory.
In the first scenario, the failure on part of the supplier to supply milk to the family would only cover minor damages. This shall include the cost of the family driving to the store along with the cost of replacement of the milk, which wouldn’t exceed more than $50. However, in the second scenario, there’s a huge dependence of the ice cream factory on the milk supplier. Unavailability of which results in the damages of not just replacement of milk but also foreseeable loss of profits and sales in a day. Since no ice cream can be produced without any milk. This fault on the part of the supplier can trigger contractual terms leading to monetary penalties which can easily reach up to thousands of dollars.
In the first scenario, limitation of liability is not worth worrying about but however, in the second scenario, is it? The milk producer should be wise enough to add a limitation of liability clause in the agreement. This inclusion of a cap on the damages would limit the damages to be compensated for, by the milk supplier. If a limitation of liability clause is not included, the ice cream factory would want to unfairly retrieve back all the damages, including indirect loss. And shall recover all categories of damages, for which the milk supplier cannot be held liable.
Dealing with limitation of liability clause in the vendor agreement
Sufficient steps may be taken to deal with the limitation of liability clause when in a contract, all of which have been stated below-
- Firstly, having a repo with the vendor creates a better understanding for the company registered. Enabling to become aware, as to where the vendor is coming from and the root cause for the inclusion of limitation of liability clause. This would allow the company/business to respond well to the vendor’s issue rather than a hypothetical version of the vendor’s issue created by the company. During the contract negotiation process, the dialogue between the parties can help the company to create goodwill with the vendor.
- Secondly, considering whether entering into this contract with the vendor serves best interest to the business. There are several vendors who would provide the same services, but before choosing a vendor what the company knows about the vendor must be taken into consideration. Presumptions as to whether the vendor has significantly provided the company with raw materials, leaving a track of success. Or, the vendor has led to a mess in performing his functions to the company or in transactions with any companies in different towns and states.
- Thirdly, considering whether the amount stated in the liability clause adequately protects the company when there is a breach of the contract on part of the vendor. There must be reasonableness for the amount of liability cap in the contract.
- Fourthly, if there’s a conclusion that coming into contract with the chosen vendor is best for the company. Then the next step is to consider how the limitation of the liability clause interrelates with the rest of the clauses in the contract. For instance, whether the limitation of liability clause interrelates to the payment structure of the contract. A vendor has nominal liability exposure in the contract during its early stage when he has not been paid much, the liability here is limited to the amount paid under the contract. In general, limiting liability to the overall amount of the contract instead of the amount paid under the contract gives rise to an unlikely situation. The company here would recover more for the damages beyond just recovering its actual amount for the damages caused. An indemnification clause might be adversely affected by a limitation of liability clause. The indemnification clause would be of much less use if the vendor has to fully indemnify the company but there has been an inclusion of low liability cap in the contract.
- Fifth, after considering the above aspects, consider if the inclusion of the limitation of liability clause is not called out to be “unfair” by the vendor. There are higher chances that the vendor may suggest the clause to be “unfair” and that “unlimited liability risk must be borne by the vendor”. A mutual limitation liability clause may be applied, this must be fair on both of the parties thereby avoiding the other to be aggrieved over the recovery amount that has been negotiated between them.
Drafting is the key
The enforcement of a limitation of liability clause is valuable and drafting is a key for this. For efficient drafting of this clause, the following guidelines must be looked into-
- The clause must be conspicuous: Use boldface print or underline the clause. The clause may also be placed apart from the rest of the text, the other party must be aware of its existence.
- The language must be clear and concise: The clause must be clear and not vague, it must relate to the contract as a whole.
- Negotiate the clause: A discussion must be held with the vendor and negotiate if there is any inconsistency. Keep the drafts of any revisions that were made to the limitation of liability clause, as proof that the clause was negotiated. A third party is not bound with the contract. The contract is only enforceable against the party to the contract.
Therefore, a vendor agreement enables the parties to build trust, improving reliability, and ensuring a timely supply of products. If there is any deficiency in products delivered, the customer can claim to recover the same under the vendor agreement. The inclusion of the limitation of liability clause, prevents the vendor to be held responsible for any loss or damages indirectly arising out of this agreement. In the absence of limitation of liability clause, the vendor would be held liable for all the damages, irrespective of whether or not caused by his negligence. The addition of the limitation of liability clause must be in relation to the other clauses. Whereas, the liability of the owner due to his negligence for any loss that occurred, must be limited to the payment amount only. Therefore, a well-written limitation of liability clause in the vendor agreement would reduce the risk of liability to be imposed on the vendor. Thereby, disabling the business owner to unfairly seek compensation for the damages from the vendor for which he isn’t entitled.
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