How to draft a Limitation of Liability Clause?

In the corporate world, each company will have a separate devoted team to monitor the legal/compliance aspects of such company. One part of such legal/compliance aspect is to ensure company compliance with the terms and conditions of the contracts entered and executed by such company.

Each party to a contract will have to observe dedicated set of duties and obligations allocated to such party under a contract. As long as the parties are in observance of the contractual terms and conditions things will be very smooth and sweet for the parties.

However, for any reason, if a party fails to honor its duties and obligations then the trouble in paradise will occur as breaching party will have to assume the financial liability for the loss suffered by the non-breaching party.

To reduce the magnitude of the financial liability it is vital to incorporate the Limitation of Liability provision (LOL) into the contractual terms and conditions.

LOL will be instrumental in risk mitigation from legal/business perspective and also to protect the economic/business interest of a party.

The fundamental concept to learn under the LOL is the direct and indirect/consequential damage as the financial liability of the breaching party will be determined based on connection (direct/indirect) of the damage with act/omission of the breaching party.

Direct damage is the damage which is the direct reflection of any act/omission of the breaching party.

Indirect/Consequential damage is the damage which is not direct reflection, but remotely connected to act/omission of the breaching party.

Direct damage can be instantly visible upon the breach of the contract. On the other hand, non-breaching party may have to establish a proof of indirect/consequential damage to the satisfaction of the court.

LOL will be combination of provisions to govern and regulate the financial complications resulted from the direct/indirect acts of the breaching party.

There are certain basic aspects (listed below) to be considered in drafting a Limitation of Liability provision:

Monetary cap on Direct Damages:

• Imposition of a monetary cap on the financial liability for direct damages will reduce the financial quantum of the liability.
• ·No monetary cap on the financial liability may result in heavy financial burden on the breaching party even in cases of minimal damage.
• Monetary cap on the liability will take the prospect of unlimited liability out of the equation for cases wherein the financial damage to the non-breaching party can be minimal to moderate and can be ascertained.

Indirect damages disclaimer:

• Along with monetary cap on financial liability to integrate disclaimer on the indirect damages into LOL clause is also equally imperative.
• The objective of indirect damages disclaimer is to reduce the exposure of breaching party to financial liability for indirect/ consequential/incidental damages.
• Barring few exceptional cases, presence of Indirect damages disclaimer will provide maximum immunity to the breaching party from liability associated with indirect/ consequential/incidental damages.
• However, in exceptional cases if the court has strong reason to ignore the indirect damages disclaimer then it may award damages to the parties for indirect/consequential damages in its discretion.

Unlimited liability:

• In certain cases, it will be improbable to ascertain the quantum of financial damage incurred by the non-breaching party. It is imperative to identify such cases as part of exceptions to the LOL to safeguard the economic interest of non-breaching party.
• Any attempt to forceful application of LOL in unlimited liability cases will be prejudice to the economic interest of the non-breaching parties as they will be exposed to unascertainable loss/damage.
• Moreover, the court may also not entertain such forceful application of LOL in unlimited liability cases.

These three aspects will balance the legal/economic interest of the parties involved in the contract.

Monetary cap on financial liability for direct damages will reduce the risk of financial burden on the breaching party and will ensure a fair compensation to the non-breaching party.

Sample language: In case of breach of contract by a party, the maximum aggregate liability of the breaching party will be limited to an amount of INR 50, 000.

Indirect damages disclaimer will serve as immunity to breaching party from the financial liability for indirect/consequential damages incurred by the non-breaching party.

Sample language: Each party hereby expressly agrees and acknowledges that each party shall not be liable to the other party for any kind of indirect, consequential, punitive and special damages occurred due breach of the contract.

Unlimited liability prospect will protect the economic interest of non-breaching party in cases where the magnitude of financial damage suffered cannot be ascertainable.

Sample language:  Notwithstanding anything contained in the Agreement, the limitation of liability shall not be applicable in the cases:

a) A party breach of its confidentiality obligation;

b) Breach of representations and warranties by a party;

c) A party breach of  its indemnity obligations; and

d) Breach of license terms and conditions by a party.

LOL provision is the only way out to limit the financial liability of party in the matter of contract breach. In drafting a LOL provision, it is vital to strike right balance amid the economic interest and economic liability of the parties.

Balance amid the economic interest and economic liability of the parties can be achieved via incorporating the vital aspects (Monetary cap on financial liability for direct damages, Indirect Damages disclaimer and exceptions to the LOL provision) into the LOL provision.