Table of Contents
In Short
- A limitation of liability clause helps protect your business from excessive claims by clearly defining the types of loss you are not liable for.
- Indirect or consequential losses can still be claimed unless specifically excluded in the contract, so ensure clarity in your wording.
- Drafting a strong and clear clause is essential to avoid disputes over which losses are covered and protect your business from unexpected liability.
Tips for Businesses
To reduce the risk of non-payment or unforeseen liabilities, ensure your contracts include a clear limitation of liability clause. Define the specific losses you will not cover, including indirect and consequential losses. Seek legal advice to ensure the clause is enforceable and appropriately tailored to the value and nature of your contracts.
When your business supplies goods or services to business customers, you take on the risk of breaching your contract and facing claims for financial losses suffered by your clients. Some of these losses may be ‘direct and foreseeable’. Others may be more remote, falling into the ‘indirect or consequential loss’ category. If your contract does not limit your liability, a customer could claim compensation for losses far exceeding the deal’s value. To protect your business, you should include a clear limitation of liability clause that defines and excludes the types of loss for which you are not prepared to accept responsibility. This includes carefully considering how liability for consequential and indirect losses should be managed. This article explains how liability clauses work, how indirect and consequential loss may apply in such provisions, and how to draft exclusions that offer your business meaningful protection from risk.
Why Should Suppliers Limit Their Liability?
A limitation of liability provision is a critical safeguard in your contracts. Without a limitation of liability clause, your business could become liable for losses far exceeding your contract value. For example, a customer might seek damages for much broader commercial harm they suffered due to your business breaching the contract, not just the cost of fixing the issue, but also additional losses, such as substantial loss, which could be significant.
An explicit liability clause can help you manage this risk. It can do this by clearly setting out the types of losses your business will not be liable for and putting a financial cap on the total amount your business would be liable to pay for a breach of contract.
The clause must be drafted carefully and tailored to sufficiently protect your business from the risks you face under your contracts.
What Considerations Apply When Limiting Indirect or Consequential Loss?
Under English law, losses are divided into two types, which are:
- direct losses: those which arise naturally from the breach; and
- indirect or consequential losses: those which result from special circumstances known to both parties but do not flow automatically from the breach.
This distinction comes from the case Hadley v Baxendale. Since indirect and consequential losses are remote, many suppliers seek to exclude their liability for these losses in their contracts. Many businesses might wrongly assume that excluding consequential loss covers all significant financial losses. In reality, losses such as loss of profit and loss of business are often classed as direct and may still be recoverable, even if your contract excludes indirect loss.
To reduce this risk, you should clearly state each type of loss you want to exclude under your contract (such as loss of profit, revenue, or reputational damage). Including these heads of loss may reduce the chance of disputes over whether a particular loss suffered by a customer is direct or indirect (e.g. where the contract excludes liability for indirect losses).
Continue reading this article below the formWhat Can Go Wrong if Your Liability Provisions are Unclear?
If you draft your limitation of liability clause unclearly, you increase the risk of a dispute over which losses your customer can recover. Ambiguous wording may make it unclear whether the clause excludes certain types of loss, especially where you have not explained whether they are direct or indirect. This kind of uncertainty can lead to expensive litigation and unexpected liability for losses you did not intend to cover. You should, therefore, use specific, straightforward language to avoid this risk.
For example, imagine you supply a key software system to your customer. The software contains a fault that causes a temporary disruption. Your customer then claims the cost of fixing the software, which directly flows from the breach and is likely a direct loss. However, they also want to claim lost profits due to missed sales during the disruption. If your clause wording is unclear about the losses you are not liable for, this could lead to costly disputes.
How Can You Draft a Strong Clause to Reduce Risk?
Exclusion and limitation clauses are only effective if they are clear, specific, and legally enforceable. You should define precisely which types of liability your contract excludes or limits and avoid vague or overly broad wording that could lead to uncertainty, enforceability issues, or disputes.
Effective drafting requires legal and commercial judgment. Your exclusions must comply with the Unfair Contract Terms Act 1977 and be reasonable in the context of your specific deal.
Key Points
Key points for you to consider include:
- setting a realistic financial cap that reflects the deal’s value and is likely to be enforceable and accepted by your customers. You might link it to the contract price or the customer’s total fees paid or payable;
- if different risks apply to a particular project, such as data loss, IP infringement, or service failures, expect your customers to negotiate higher caps on liability and plan your negotiation position; and
- listing the specific types of financial loss your business will not cover. Avoid vague references that could cause confusion and increase your exposure.
By clearly defining exclusions, you create certainty and reduce the risk of future disputes about your liability to customers.
Given how significantly these clauses affect your potential liability in a damages claim, you should invest in legal advice to gain commercial certainty and ensure your clause wording gives your business the protection it needs.
Use this checklist to ensure your supplier contracts contain all necessary terms.
Key Takeaways
Liability under contracts is a critical risk for business suppliers. A well-drafted and explicit limitation of liability clause will help protect your business from financial risk. However, you should be careful when drafting these provisions and be aware of the dangers of indirect and consequential losses. If you are unsure how to draft a clause to protect your business sufficiently, legal advice can help you draft one that protects your position and covers the losses your company may face.
If you would like advice on clauses in your contracts, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
This refers to losses that do not arise directly from a breach but result from special circumstances that both parties knew about when they signed the contract.
Not necessarily. Some losses, such as lost profits or wasted costs, may be treated as direct by the courts and could still be recoverable even if your contract excludes indirect loss.
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