This is the first part of a three-part series re-evaluating the significance of the liability cap clause in contracts with an emphasis on limiting financial exposure and keeping in mind the aftermath of the pandemic. This financial year has in addition to changing the approach of business has also re-asserted the significance of certain contractual clauses such as liability cap clauses and force majeure, which were earlier not given due attention.
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, ed 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 liabilit’, 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 onthe different types of lc -ses (like damage to property, loss of profit/ revenue etc). And according 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 which may save the contracting parties from extreme financial liabilities, by virtue of limiting their financial exposure on the event of 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.
Kindly refer to Part 2 to know what constitutes of a liability cap clause in a contract which will be released shortly.
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