What is capping of liability?

Simply put, by capping of liability, we mean stipulating a limit to the financial damages payable by a party to the contract, in the event of a breach. Commercial agreements of the current period have become very much advanced with various protective clauses, and one such clause is the “Liability Cap clause”.

Why should one cap it?

It is an effective method of managing the possible risks that might arise between the parties to a commercial contract. This clause aims to limit the extent of exposure that a business or a company faces in times of derailment from the standards or terms agreed in a contractual agreement.

Unforeseen liabilities and your protection

The said clause also helps to restrict the liability arising out of instances that are unforeseen, over which either of the parties had no control, and thus acts as a shield rightfully protecting the contracting entities.

The risk of liability is omnipresent in commercial transactions, and breaches can be intentional or unpredictable. The losses that can arise can be insured to stay on the safer side, but the claiming party can exhaust the party paying damages in the absence of a clause that specifies a cap/limit. Such an event can largely affect the financial interests of the company apart from burdening it with multiple lawsuits draining its monetary resources.

For the survival, thus, almost every company needs to include a Limitation of liability clause while drafting their agreements. Further the clause naturally curbs the monetary damage payable to the claimant which prevents a company from not only financial damage but also reputational damage as well.

What can the contracting parties do?

The parties can seek to limit their liability under the contract in a number of ways, often by excluding liability for certain types of loss by putting a financial cap on liability for such losses. It can limit the amount of damages for certain agreed losses. For instance, there can be a clear mentioning of the maximum amount of damages that can be claimed in the event of a loss or specification with regard to the nature of damages being incidental, special or consequential.

Are there any rules regulating the ascertainment of the liability limit?

There is no given set of rules to determine the monetary cap for the payment of damages and neither are there any statutory controls for the same. Therefore, contracting parties turn to the options like zeroing on a specific percentage or multiple percentages of the contract price/ payment, amount specified in the Contract.

In addition, there are options of keeping a cap for each claim or an aggregate cap. There are also options of segregating the caps based on the different types of losses (like damage to property, loss of profit/ revenue etc). And accordingly, the party whose liability is capped under the contract can have the said amount insured and thus protect themselves from financial exposure beyond their affordability.

The Liability Cap clause is an effective inclusion in a contract that may save the contracting parties from extreme financial liabilities, by virtue of limiting their financial exposure in the event of a breach of contract. To know and understand the intricacies involved in the application of the said clause please refer to our further articles on Capping of Liability Clause.

How to ascertain the terms of the clause?

The limiting of liability in commercial contracts is frequently subject to intense negotiations between the contracting parties, where they try to justify the exclusion of liability for certain types of losses or placing a financial cap on the parties’ overall liability. Often the pecuniary limit of the liability is set within the fess and compensation paid under the agreement.

What terms are to be excluded?

It is to be noted that the limitation of liability clause cannot put a cap on damages arising from any fraud, misconduct or illegal acts of the contracting parties.

What is the extent to which the liability of a contracting party can be capped?

The liability clause is independent in terms of any governing law as to the determination of the ceiling amount, thus the determination is undertaken by the contracting parties considering the following:-

• The proportional role of the party that is incorporating the liability clause for safeguarding from extensive financial damage to its company in case of a breach of the contract.
• The total fee/consideration that the contract is subject to, by the contracting party in pursuance to the concerned transaction(s).
• The maximum amount that can be claimed by the claimant in case of a breach, as specifically stated in the Contract itself or any other arrangement like no compensation but only a refund of the payments already made.
• All the above scenarios are essentially directed towards an ascertainment of the quantum of the financial damage that can probably be incurred in case of a breach.

The contracting party capping their liability can ascertain their potential liability exposure under a particular clause by including the said clause in their contract. It is immensely mandatory for such a clause to be precise and conspicuous. The said clause needs to unambiguously depict the kind of losses against which the liability of the contracting party is provided to be capped or excluded.

Further, the said clause needs to be fair in terms of comparability in pursuance to probable loss, and thus be ascertained prudently.

Despite of inclusion of the said clause, it does not provide an absolute protection against one’s liabilities under a contract, as the same can be scrutinised by the court of law, and accordingly decide its legality.

When can the capping of liability become unenforceable?

The inclusion of the limitation of liability clause needs to be considered with utmost care. The parties to a contract should be aware that if they seek to impose exclusions that are too wide or liability caps that are too low, they then run the risk of deeming the entire clause unenforceable, unenforceable before the court of law, thereby exposing the defaulting party at risk of potentially unlimited liability.

In cases where damages are too high, for instance, if damages amount to Rs. 1,20,00,00,000 /- but the limitation of liability is set to Rs. 50,000/-, the Court will most probably scrutinize the insufficiency of the damages being decided at the time of entering into the contract and refuse the enforcement of the said clause. This is because a court of law is bestowed with the responsibility of making good the losses in such cases and with a clause stating an amount many times lesser than the actual loss or damage caused, such an objective of the Court will not be fulfilled.

What does the law pertaining to unfair capping of liability say?

The provisions of the Indian Contract Act, 1872 under Section 24 provides that if any part of a single consideration for one or more objects, or any one or any part of any several considerations for a single object, are unlawful, the agreement is void. Furthermore, Section 23 of the said Act provides whether or not, an object or a consideration, is to be declared lawful and enforceable, and one such condition provided for ascertaining the legality of the object or consideration included in a contract, under the said provision is “where the court regards it as immoral, or opposed to public policy”.

In this context, a capping of liability clause ensures that parties to a contract do not become unjustly burdened due to risks that may not be commensurate with the relatively low fee or consideration that has been charged or taken by any party, thereby ensuring that the agreements entered into are fair, reasonable, and in line with public policy.

The view of the Apex Court

The Hon’ble Supreme Court in Bharathi Knitting Company v. DHL Worldwide Express Courier Division of Airfreight Ltd., while dealing with a similar clause, which limited the liability of a courier company in the event of any loss/damage caused to a shipment, provided in their terms and conditions printed on a consignment note for shipment of a package, upheld the decision of the National Consumer Disputes Redressal Commission, which limited the amount awarded to the consignor for deficiency of service, to the amount specified in the limitation of liability clause. The Court held that parties who sign documents containing contractual terms are usually bound by such contracts and rejected the contention that there was no consensus ad idem between the parties on limitation of liability.

Thus, it is crucial for the contracting parties, and in their best interests to ascertain one’s liability cap prudently in order to ensure its enforcement as and when the need arises.

CONCLUSION

Capping of liability clauses can be an important inclusion for many commercial contracts. But an inadequately and ambiguously drafted clause may fail to be enforced in the court of law and in-turn backfires at the contracting parties, exposing them to extreme financial liabilities. Whereas a well-drafted clause that is precise and conspicuous is not only enforceable in a court of law, but also allows the parties to balance their risk against the potential benefits of the contract, to procure appropriate insurance cover, and to control and predict their potential financial exposure.

Thus, it becomes very crucial as to how the parties negotiate their way through, while including the said clause in their contract, and accordingly agree on the limits of liabilities, along with the losses/risks which are associated with such liabilities.

Corrida Legal is the preferred corporate law firm in Gurgaon (Delhi NCR) and Mumbai. Reach out to us on LinkedIn or contact us at contact@corridalegal.com/+91-8826680614 in case you require any legal assistance.