A limitation of liability clause is one of the provisions used in contracts for the purposes of allocating and managing risk between the parties. The economics of a contractual relationship for vendors of outsourced services call into question whether the pursuit of a relationship without a cap on exposure is even worthwhile.
There are different ways to manage the risk of liability. A limitation of liability clause can seek to cap the total amount of damages a party can be held liable for to the other party under the contract. Alternatively, a limitation of liability clauses can seek to limit the types of damages a party can pursue, eliminating consequential damages rather than direct damages. Still other limitation of liability provisions relate to certain types of claims that can be pursued. The enforceability of these provisions as drafted in the contract is far from certain.
Limitation of liability clauses that seek to cap liability will use a formula, like a fraction or multiple of the fees paid pursuant to the contract, a total dollar amount irrespective of fees, the amounts provided for by insurance or a combination of the above.
The enforceability of a limitation of liability clause is not a matter of interpreting legislation crafted by the legislative branch. Instead, it is interpreted through the lense of the common law – the law made by courts with prior decisions. There is no uniform interpretation.
A limitation of liability clause is considered an “exculpatory clause” by the Courts because it seeks to release or waive all of a portion of liability in advance of the facts giving rise to the claims. Courts are hesitant to enforce provisions which waive future claims that are unknown. Since this provision prospectively waives all or part of some claims in the future, it is subject to additional scrutiny by courts.
A limitation of liability clause will likely be strictly construed against the party benefiting by the clause. If the language is unclear, ambiguous or subject to multiple interpretations, the court will likely adopt the interpretation that least beneficial to the party for whom the limitation of liability clause was intended to benefit. Caution should be applied when crafting the language of the limitation of liability so that it does not contradict provisions relating indemnification, limitation of remedy, liquidated damages and other risk allocation provisions. Since the provision is likely to be narrowly construed (or deemed void in the worst case scenario), this is not a provision you want to cut and paste from an internet located form.
Many courts have refused to enforce the limitation of liability provision if it finds the clause to be against public policy or fails of its essential purpose. If the clause can be interpreted to include a waiver of liability for gross negligence (i.e. undertaking monitoring security while lacking appropriate tools for monitoring) or intentional conduct (claiming to monitor security knowing that you will not), the Court will likely find the provision is against public policy and refuse to enforce the provision. Court determinations of public policy may be a bit nebulous and more opinion than established criteria. If the court finds it to be against public policy, then the provision is out and may even nullify the remainder of the contract.
If the limitation of liability is so broadly written that it acts as a release for negligent conduct in addition to gross negligence, reckless or intentional conduct, courts may not enforce the clause at all – even for a simple claim of negligence.
If one party to the contract is barred from recovering damages from the other party’s breach or failure, rendering them without any remedy, is there even a contract? The mutuality of obligations is a requirement for real consideration to support the contract’s enforceability, rendering the contract void. Additionally, a court may determine that the application of the provision is unconscionable because it is so unfair and unjust.
The likelihood of a court determining the contract is unconscionable, unfair, vague or otherwise unenforceable is increased if there is a disparate bargaining position between the parties.
Some jurisdictions refuse to enforce a limitation of liability clause too. For example, the Alaska Supreme Court in City of Dillingham v. CH2M Hill N.W. found the limitation of liability clause violated the Anti-Indemnification statutes. In Lucier v. Williams, New Jersey finds these provisions to be unenforceable in certain circumstances (like a home inspection contract without recourse for damages to the buyer) finding it was a contract of adhesion between disparately positioned parties (expert vs. consumer) and fails for its underlying purpose. Other states, like Wisconsin, Montana, Minnesota, Georgia, Florida and California, are incredibly critical of these provisions and are less likely to enforce them.
See my podcast on this topic – https://tfafinski.podbean.com/mf/play/kj87uy/LOL.mp3