Understand risks and benefits
Businesses routinely use or, knowingly or unknowingly, sign contracts that contain some form of an exclusion or limitation of liability clause. While such clauses vary considerably in size and scope, for illustrative purposes only, you may have seen a clause similar to this:
“In no event will Supplier be liable for damages on any basis, of any kind or nature whatsoever arising in respect to this Agreement or for any indirect, special, incidental or consequential damages.”
So what purpose do exclusion or limitation of liability clauses serve? Perhaps, more importantly, do these clauses really work? We explore the answers to these questions below, and, in doing so, provide some tips to assist in making your exclusion or limitation of liability clauses more effective.
PURPOSE OF EXCLUSION or Limitation of Liability clauses
Inherent in all contracts is the risk of some form of liability. For example, damages resulting for non-performance of a contract, liability for lost profits or revenues, expenses incurred to fix a problem, or liability for the negligence of a contracting party. Exclusion of liability clauses are used as a means of allocating the risk of liability between the contracting parties by excluding or capping the liability of a party for certain types of damages. The party benefiting from the exclusion of liability clause is the party that would otherwise be responsible for the breach. If a contract does not contain an exclusion of liability clause, there may be no limit (except for limits as prescribed by law or general principals of law) to a contracting party’s financial exposure for a breach. Failing to adequately protect your business from certain liabilities may, and, in some cases, has led to the demise of an otherwise successful business.
DO THESE CLAUSES really work?
The short answer, of course, is — it depends. Let’s explore this further.
Not all liability can be excluded. For example, in some cases you cannot exclude or cap certain liability imposed by statute. Neither can you limit liability for breaches brought about by fraudulent or dishonest conduct. Also, our courts are not inclined to enforce exclusion of liability clauses that attempt to exclude all liability, such that a contracting party has no real remedy for a breach.
Having said that, our courts respect “freedom of contract” and the general principal that parties should be held to the bargains they have made. Therefore, as a general rule, our courts tend to give effect to exclusion of liability clauses unless there is a reason not to. So what qualifies as a reason not to? Our courts look at three main factors.
• Is the exclusion of liability clause applicable (to the facts)?
• If so, was the exclusion of liability clause “unconscionable” at the time the contract was formed?
• If the exclusion of liability clause applies and is not otherwise unconscionable, is there an overriding “public policy reason” to override the clause?
IS THE EXCLUSION of liability clause applicable?
Here, our courts will explore if the breach giving rise to the damages was actually excluded by the clause. Of course, when a dispute arises, one party will argue that the exclusion clause is clear and applies to either exclude or limit that party’s liability. The other party will try to persuade a court that it does not apply, or should not be applied, for various reasons, including that the clause is unclear or doesn’t exclude the specific liability the other party is claiming it does. In deciding between the competing interpretations put forth by the parties, our courts will consider the words used in the exclusion clause, and assess these words in the context of the entire contract as whole, and in light of its purpose and the commercial context in which the contract was made. Any ambiguities will normally be interpreted against the party who drafted the clause.
TIP: This is where your lawyers come in. To give your exclusion clause the best chance to be successful, it is essential that your exclusion clause is well drafted, using clear and unambiguous wording, and that your clause is consistent with the entire contract as a whole. Further, the clause should clearly exclude the liability that you desire it to exclude.
IS THE EXCLUSION clause “unconscionable” at the time the contract is made?
Our courts will look to protect a party from the applicability of an exclusion clause if it is unconscionable to apply the clause. More often than not, the “unconscionable” behaviour is linked to “inequality of bargaining power” between the parties, or with cases of contracts of adhesion. Courts are less likely to interfere with exclusion of liability clauses negotiated between two experienced or otherwise sophisticated commercial parties. However, if your contract is a standard form, “take it or leave it” type, or if you are dealing with an unsophisticated party that may not have a lot of business experience, our courts may find that it would be unconscionable to uphold the clause on a number of grounds. For example, a court may look at whether the exclusion clause was brought to the other (unsophisticated) party’s attention.
TIP. When dealing with unsophisticated or inexperienced commercial parties, your exclusion of liability clause has more chance of success if you bring the clause to the other party’s attention (do not try to hide these clauses in a conspicuous part of the contract), and advise the other party to get independent legal advice.
IS THERE AN overriding “public policy reason” to override the clause?
Even if the parties are sophisticated, our courts will consider whether there is an overriding “public policy reason” to invalidate the clause. For example, if you knowingly sell a defective underground pipeline to a customer, and many years later, as a result of this defect, the soil becomes contaminated resulting in health issues for local residents, our courts will not allow you to rely on the exclusion clause to shield yourself from liability. Also, exclusion of liability clauses will not be enforceable in cases of fraud or criminality.
Exclusion or limitation of liability clauses are a useful tool for allocating risks inherent in every contract. However, to give your clause a better chance of success, use clear, unambiguous and consistent language throughout your contract. Also, know who you are dealing with, as there are some important steps that you should take if relying on standard form “take-it it or leave-it” type contracts or dealing with an unsophisticated or inexperienced commercial party.