By Gary Smith

If you’ve read our blog on indemnification, you already know that contracts can shift legal responsibilities from one party to another. But did you know you can also reduce or even cap your own liability? Limiting your liability in a contract can help you avoid paying for unforeseen damages, like lost profits, special damages, or someone else’s mistakes. In this post, we’ll break down how to strategically limit your liability, what to watch out for in vendor and customer agreements, and how to make sure you’re not left holding the bag.

What Kinds of Damages Could You Be Liable For?

There are numerous damages out there.

• You’ve got direct damage resulting from something you did or didn’t do.
• You’ve also got damages for the consequences of what you’ve done.
• There could be lost profits, lost opportunities, and lost contracts.
• There could be punitive damages or other “special” damages that someone may get you to pay.
• You may have to pay someone else to redo what you did.

You may be surprised at all the damages you may have to pay.

How to Limit Your Liability in a Contract

How can you limit this vast menu of choices for liability?

At a minimum, you should include a section in your contract that states you aren’t liable for special, consequential, indirect, punitive, etc., damages.  Negotiate that you should only be responsible for the direct damages you cause.

You may also negotiate that your liability for direct damages or breach of the contract is limited.  You might include a cap on your liability to the amount you were paid under the contract.  You might set a cap based on the proceeds your insurance policies pay for the damage.

You should expect there to be limits to your limits.  The limits may not apply if the damage happened because of your gross negligence or intentional misconduct.  The limits may also not apply to any indemnification obligations you have under the contract.

Be aware that an indemnification exception may be broad enough to make the limitations on liability useless.

Limiting Others Liability

When you establish limits on your liability, others will likely want to do the same.  It seems fair to have the same limitations on liability apply to everyone under the contract.  Right?

Be careful when you do this.  For example, you may not want your customer’s total liability to be limited to what the customer has actually paid you.  While limits may be appropriate for both parties to a contract, these limits must reflect the actions taken by each party under the contract.

How Your Contracts Should Work Together

Each contract you sign isn’t independent.  You can’t negotiate limitations of liability (or indemnification) in one contract without knowing how it impacts your other contracts.

You should understand if your contracts allow you to pass liability up the chain.  If you’ve agreed to indemnify your customer, has your vendor agreed to indemnify you the same way?  Are the limitations on liability the same with your customer and your vendor?  Are you stuck holding the bag because your vendor was able to get you to agree to something your customer won’t agree to do?

Let Venn Law Group Help You Protect Your Business

Venn Law Group can help you understand how you may currently be holding that bag.  We can help you understand how your contracts with vendors, contracts with customers, and insurance coverage work together—or don’t.  Contact us today to learn how we can help protect your business.

Gary W. Smith has over 20 years of experience providing legal counsel and innovative solutions to business owners and management teams. His focus areas include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.