What Does Limitation of Liability Mean?

A limitation of liability is a powerful tool for businesses in any industry that want to manage their risk. But limitations of liability can also expose businesses to risk by limiting their ability to recover loss from another business.

In Australia, limitation of liability clauses and clauses which exclude consequential loss are common in most industries. Particularly for businesses that sell goods or services to many clients, if something goes spectacularly wrong with one client, your business may face severe financial problems if you do not have a contractual limit of liability in place.

Author: Farrah Motley, Director of Prosper Law

What is a limit of liability?

A limitation of liability clause is a clause in a contract that provides an overall limit on a business’s liability for loss or damage that is caused by that business. On the other hand, an exclusion of liability clause can, rather than or in addition to providing an overall limit on liability, restrict liability in relation to certain kinds of loss or damage.

A limitation of liability clause can be beneficial to a business that is supplying goods or services to another business and wants to ensure that if something goes wrong, the amount of money that they are potentially responsible to pay is capped at a particular dollar value.

However, a limitation of liability clause for the benefit of a supplier can be disadvantageous to a business that is buying goods or services. If the supplier, contractor, consultant or provider does something which causes harm to the business, and the amount of loss or damage exceeds the limitation of liability, the business is itself responsible for that excess loss or damage.

Consequential loss exclusion clause

A consequential loss exclusion clause is a kind of limitation of liability clause. While not necessarily putting a monetary limit on liability, a consequential loss exclusion clause may exclude liability for certain types of loss. A consequential loss exclusion clause can, in practice, significantly reduce the amount of a potential legal claim because the kinds of indirect losses that are excluded are typically the kinds that have the most financial impact (such as loss of revenue).

Consequential loss exclusion clauses are often misunderstood. They are sometimes used in circumstances where they should not be or used in a way that is not beneficial to a business and may do more harm than good.

By law, a consequential loss is a loss that is not the direct and foreseeable result of the harm caused and is not recoverable. But contracts can go beyond the legal definition of consequential loss and add additional categories that expand on this definition.

A limitation of liability will only serve to limit a business’s legal exposure if it is set out in the contract. If the contract is silent and does not state whether liability is limited, liability will be unlimited.

If a limitation of liability is not clearly stated, it may be unenforceable.

It is a fundamental principle of contract law that contractual obligations must be certain and not vague in order for them to be enforceable. This same principle applies to limitations of liability. If the limitation of liability is drafted so that it is unclear and not capable of being easily understood using its natural and ordinary meaning, it may be unenforceable and may be severed from the contract.

If your contract is governed by the Australian Consumer Law, a contractual limit of liability may be unenforceable.

Limitation of liability and consequential loss exclusions clauses may be impacted by legislation

Limits and exclusions of liability and the Australian Consumer Law

The Australian Consumer Law applies to goods or services that are bought for personal, domestic or household purposes or where the value is less than $100,000. The Australian Consumer Law provides remedies to consumers and renders unenforceable any clauses in a contract that would limit or otherwise reduce a consumer’s rights or remedies.

Because of this and depending on the wording of the limitation of liability (including where the limitation of liability does not mirror the Australian Consumer Law), the limitation of liability may not be enforceable. What’s worse, is that by including a limitation of liability in a contract, the business may be considered to be engaging in misleading and deceptive conduct by conveying to consumers that they have fewer rights than they actually do.

A limitation of liability clause may be considered an unfair contract term

Some clauses are considered unfair and because of this, there are laws in place that render those types of clauses void (i.e. you cannot rely on them and the contract is read as if they don’t exist).

A clause will be considered to be unfair if:

• It is contained in a ‘standard form contract’
• it would cause an imbalance in the contracting party’s rights or obligations;
• it is not reasonable to protect the legitimate interests of the party seeking to enforce it; and
• it would be detrimental to the other party to enforce the term.

So, if a limitation of liability clause is contained in a standard form contract and the other criteria are met, the limitation of liability clause may in the circumstances also be unenforceable.

A limitation of liability clause is not the same as an insurance clause

An insurance clause can often be confused with the limitation of liability clause. It is important to remember that any insurance requirements specified in a contract are not the same as a limitation of liability clause.

Set out below are some examples of limitations of liability clauses.

This limitation of liability clause is basic, and does not include any exclusions:

The total aggregate liability of the supplier to the client for loss or damage arising under this agreement or in connection with the services or the goods, whether under contract, tort (including negligence), under statute or otherwise act law or in equity, shall be limited to $1 million.

The features of this clause are:

• Referring to the total aggregate liability, so that the $1 million is the full amount and does not apply to each occasion loss or damages suffered
• It is questionable whether the limitation of liability would apply to a clause in the contract requiring the supplier to indemnify the client
• $1 million may be considered too high, or too low, depending on the value of the goods or services or the nature and likelihood of the risks involved in the transaction

This limitation of liability clause is slightly more detailed than the clause example above:

The total aggregate liability of the supplier to the client for loss or damage arising out of or in connection with this agreement or the goods or services, whether in contract, tort (including negligence), under an indemnity, under statute, or otherwise at law or in equity, shall be limited to $1 million. This limit of liability does not apply to loss or damage arising from:

• Personal injury or death
• Breach of confidentiality
• Infringement of intellectual property rights
• Fraud or willful misconduct

The features of this limitation of liability clause are:

• The limitation of liability unquestionably applies to the indemnities
• The limit does not apply to what are widely considered to be usual exclusions. Those are things that are generally within the control of the party and the risk for which generally should not transfer to the other party.

The limitation of liability clause example set out below is detailed and contains more features than the two examples set out above:

The total aggregate liability of the supplier to the client for any loss, damage, cost or expense, arising out of or in connection with this agreement or the provision of goods or services, whether in contract, tort (including negligence), under an indemnity, under statute or any other basis in law or in equity shall be limited to $1 million. This limit shall not apply to loss or damage arising out of or in connection with:

• Loss which is recoverable under a policy of professional indemnity insurance required to be held and maintained by the supplier under this agreement;
• Loss which would have been recoverable under a policy of professional indemnity insurance had the supply held, maintained and complied with that policy;
• Third-party property damage;
• Fraud, wilful misconduct or gross negligence or other reckless behaviour without regard to the consequences;
• Personal injury or death;
• Infringement of intellectual property rights; and
• Breach of confidentiality.

The features of this limitation of liability clause are:

• The limitation of liability does not include amounts that are or would have been recoverable under a policy of professional indemnity insurance; and
• The $1 million cap on liability would apply to uninsured loss or damage.

Loss which may fall under a public liability policy of insurance may be largely unlimited

As you can see from the above examples, there are varying degrees to which a limitation of liability may apply to any particular risk or amount of loss or damage. For this reason, it is important that before writing or agreeing to a limitation of liability, your business assesses the kinds of risks it faces, the likelihood of those risks occurring and the level of control that your business has over those risks and whether they may be insured.

If you run a business that holds professional indemnity insurance, it may also be beneficial to your business to be able to demonstrate to brokers and potential insurers that you regularly make use of limitations of liability clauses because this can have the knock-on effect of protecting insurers and encouraging them to potentially give you a lower premium in relation to the policy of insurance.

So why would anyone agree to the limit of liability clause?

In Australia, limitation of liability clauses (and, to a lesser extent, consequential loss exclusion clauses) are fairly common. By allowing your supplier to limit their liability or exclude certain types of consequential loss, they may be more willing to agree to other important contract clauses and possibly even give you a lower price for their goods or services. Also, if you have the benefit of a limit of liability in an upstream contract, you may be able to pass the benefit of that close down to your supplier without creating additional risk for you.

But what you should take care to avoid, however, is limiting a supplier’s liability for things that are wholly within their control, risks that are likely to occur, or risks which if they do occur are likely to significantly impact your business.

What you should also take care to ensure is that if you have a head contract that contains a limitation of liability, you ensure that any subcontract that contains a limitation of liability, is on back-to-back terms so that there are no gaps in liability.

For instance, if your head contract excludes loss or damage arising out of personal injury or death, your subcontract should as well. If it doesn’t, and your subcontractor causes your business loss because of personal injury or death, you only have the amount of the limit of liability. After that dollar amount is exhausted, you will be footing the bill for the rest.

If you going to agree to carve-outs, then you need to make sure that the things you are excluding from the limitation of liability clause are unlikely to happen or are things that are within your control and you can take steps to avoid.

Suppliers can fall into the dangerous trap of not paying appropriate attention to the carve-outs and agreeing to things like:

• Excluding any loss arising under an indemnity given under the contract
• Excluding any loss or damage caused by negligence
• Excluding any liability for breach of contract

These kinds of exclusions can have the effect of making the limitation of liability clause ineffective because the limitation of liability does not then apply to the kinds of loss that may arise and which may have the greatest financial impact.

• Reflects standard practice in the industry in which you are operating
• Appropriately allocates risk between the parties
• Takes into account what is within the control of each party
• Does not prejudice the terms of any insurance policy

If you are the supplier

Before you write a limitation of liability law or review a limitation of liability clause, you need to figure out what could go wrong, what your insurance covers, any relevant local legislation which may impact liability irrespective of the limitation of liability clause and you should also take into account the amount of money that is being paid or charged for the goods or services. For instance, if you are a business that is charging $1000 for your services or your goods, uncapped liability or a limitation of liability that exceeds $100,000, may be unacceptable and you may not want to take on that much with for a small return.

It may be more effective to agree to a small limit of liability (like for instance $500,000), and then have a carveout for loss or damage which may be recoverable under a policy of professional indemnity insurance. The reason for this is that professional indemnity insurance follows on from liability (and not the other way round). If the limit of liability from the supplier to the client is $500,000 and insurance will only be recoverable to the extent of the suppliers’ legal liability, there is an argument that the amount recoverable under the professional indemnity insurance will never be more than $500,000 because that is the extent of the suppliers’ legal liability under the contract.

You should also make sure that any carve-outs from the limitation of liability are tied to things that you have done wrong. For example, a carve-out for ‘loss or damage arising out of negligence’ does not specify whose negligence and so, it’s possible that the limit of liability does not apply to both the negligence of the supplier as well as the client. That’s the kind of specificity you want in a limitation of liability clause.

If you are the client

If it is your supplier that is asking for limitation of liability, the amount of money that you are paying them may be irrelevant to you and instead, you should be more concerned with the potential risk associated with their goods or services.

If you are the client you need to make sure that you have the benefits of any insurances taken out by the supplier and you want to ensure that you do not limit your recourse to those insurances. Because of this, it may be better to specify a high dollar value for the limit of liability, and not tie the limitation of liability clause to insurance amounts. This is because insurance generally follows liability and you don’t want to limit your recourse to a policy of insurance by setting out a dollar value to the limit of liability that is low and which the insurance may not go beyond.

Summary

Limitation of liability clauses and consequential loss exclusion clauses are often used in Australian contracts. They can be both a friend and a foe and, because they are complicated, it’s important to have someone who understands them to review, negotiate and write them.

How can Prosper Law help?

Prosper Law is a first-class, Australian commercial law firm. Our Director, Farrah Motley, has significant experience with limitation of liability and consequential loss exclusion clauses and can assist your business with its contract requirements.

Our fixed-fee legal services, coupled with the kind of customer experience that can only come from a wealth of legal and commercial experience, provides our Australian business clients with the reassurance to do business with confidence.

Contact us today to find out why our clients choose Prosper Law.

Farrah Motley | Director

PROSPER LAW – Australia’s Online Law Firm

M: 1300 003 077

E: farrah@prosperlaw.com.au

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