Enforceability of Limitation of Liability Provisions in Commercial Agreements
“BREAKING NEWS: Enforceability of Limitation of Liability Provisions in Commercial Agreements” is likely not a recently seen headline, but despite the obvious lack of sex appeal this topic generates in the eyes of modern media, a limitation of liability clause could be the provision that makes or breaks the bank when faced with a lawsuit. Furthermore, this often-overlooked topic still remains somewhat unsettled. So what goes into a limitation of liability provision? Are these provisions even enforceable? Below is a breakdown with some tips and best practice recommendations.
Limitation of liability provisions are of tantamount importance for commercial contracting parties because without them, a party may be held liable for several different types of damages, some of them unexpected, and potentially unlimitedly liable. Not having these provisions in a commercial contract may place an unreasonably large risk on a party that outweighs the benefit of the contract.
A limitation of liability provision typically contains two parts: a waiver of damages and a liability cap.
- The waiver of damages clause typically limits a party’s exposure only to direct damages (i.e., damages suffered by a party that naturally result from the breach of the other party). This clause often disclaims any consequential, incidental, indirect, exemplary, special, or punitive damages and associated fees, lost profits, and lost revenue, among other things. These types of damages do not necessarily flow directly from the breach; they can include, for example, expenses incurred by the non-breaching party in order to avoid or reduce other direct damages resulting from the breach.
- The liability cap places a maximum limit on a party’s liability. These limits tend to be based on (1) the contract’s value (e.g., the entire value, the value over a retroactive period of time, or a percentage of the total value); (2) a party’s insurable amounts; or (3) a sum certain.
But how enforceable are limitation of liability provisions, really? Historically, there has been considerable debate regarding their enforceability, with some states finding in favor of enforceability and other states finding against it. Today, states tend to find these provisions to be an enforceable risk shifting tactic used by the parties. In Minnesota, where many Taft clients conduct business, courts have found the limitation of liability provisions to be enforceable unless they are: (1) against the law; (2) contrary to public policy; or (3) the result of a special social relationship between the parties.
- Against the Law. Limitation of liability provisions cannot be in violation of applicable law. Under the Uniform Commercial Code (UCC), one such law provides that these provisions cannot be "unconscionable." In Minnesota, where two experienced business parties have negotiated the agreement, limitation of liability provisions are presumed to be conscionable as a matter of law. To determine whether a provision is unconscionable, courts consider:
- The parties’ relative bargaining power when they agreed to the provision, and
- Whether the clause is unfairly one-sided.
- Contrary to Public Policy. Limitation of liability provisions cannot be contrary to public policy. Limitation of liability provisions that would be construed as contrary to public policy include, for example, provisions that result in harm to citizens or the state. Limitation of liability provisions that appear in consumer contracts are often found to be contrary to public policy.
- The Result of a Special Social Relationship Between the Parties. Limitation of liability provisions cannot be the result of a special social relationship between two contracting parties. This type of relationship may be found where one of the contracting parties is a semi-public entity — such as a public utility entity contracting with a common carrier.
In order to increase the likelihood that a limitation of liability provision will be found enforceable, the provision should be conspicuous (such as in capital letters in bold print) and clear and unambiguous (as courts tend to interpret ambiguous sections against the drafter).
When entering into commercial agreements in Minnesota that contain provisions that limit either party’s liability, the foregoing considerations should be top of mind. In addition, consideration should be given to each party’s rights and obligations under the contract and to the contract itself. For example, each party should consider who will be most likely to incur liability. Arguably, the buyer of goods or recipient of services is less likely to be liable than the seller of goods or service provider and, because of this, the buyer/recipient will likely want a watered down limitation of liability provision — or better yet, none at all. Lastly, the contract itself should be considered, as there is no one-size-fits-all limitation of liability provision. Each provision is tailored in some way to the contract — or even sections of the contract — itself.
A limitation of liability provision is a vital tool for a business to have in its commercial contract toolkit as it helps provide certainty as to the types of damages and the amount of liability that a party may be responsible for under a contract.
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