Limitations of liability (and exclusions of liability) are almost invariably found in contracts. In addition to limitations on the warranty period to claim under the warranties, a supplier will normally limit its risks and exposure to liability in various other respects:
- the damages eligible for compensation: excluding indirect (consequential) damages, only damages individually exceeding a de minimis threshold and furthermore damages that are not remedied by the purchaser;
- matters affecting the purchaser’s compensation (i.e. scope of damages): aspects of own fault, mixed causation, claim-related benefits, recourse rights on third parties (e.g. suppliers);
- causation: limiting eligible damages to those being the immediate and adequate consequence of a warranty being incorrect;
- aspects managing the claim process: a purchaser’s ‘own risk, also known as a basket, which has to filled before a first claim can be made;
- (notification and) handling of third party claims that may give rise to a warranty claim;
- procedures for making warranty claims must be followed (e.g. not mere notifications of claims interrupting the contractual period of limitation but requiring that a claim is initiated).
Providing for a ‘cap’. Many contracts contain a monetary limitation of liability (a ‘cap‘). For M&A-agreements, such a cap is typically defined as a percentage of the (preliminary or adjusted) purchase price or simply a fixed amount (agreed by the same token). Normally, a cap should not apply to matters relating to ownership or entitlement to sell because it affects the entire sales transaction (and more).
For commercial contracts, such reference is not always readily determinable or the parties may have reasons to vary. Commonly used caps or limitations of liability are:
(a) a simple amount (perhaps relating to the amount ordinarily received under a purchase order);
(b) the amount of the purchase order (under which the defective products were delivered);
(c) the amount actually paid under the agreement during a period of time preceding the claim;
(d) a percentage of the amount under (c);
(e) the higher of (i) a simple amount, or (ii) a reference such as under (b), (c) or (d). The background of this is to provide substance during the initial period of time or in case of irregular deliveries; or
(f) the lower of the two references mentioned under (e). The background is of course to provide the widest possible approach to the conditions.
Any cap established in accordance with one of the above referenced amounts, will nevertheless be subject to further discussions. Solutions to overcome such discussions is to further distinguish for the risks involved (and not apply the standard one-size-fits-all clause). An example of such distinction was proposed by D.C. Toedt III:
A damages cap distinguishing the types of risk involved could be, for example:
(a) three times X for any damages that arise during the first 3 months after the later of the Signing Date or Milestone 1 having been delivered and accepted;
(b) two times X during the 9 months thereafter; and
(c) one time X thereafter until the later of 24 months after the Signing Date or 12 months after Milestone Y having been delivered and accepted.
In this example, the factor X could be:
(i) a fixed amount;
(ii) defined as the amount actually paid by customer to service provider during the 24 months preceding any claim; or
(iii) defined in any other convenient way.
In many commercial contracts in which intellectual property rights are at stake, the limitation of liability clause contains a carve-out or exception for breach of the confidentiality provision and for IP infringement claims. A very common (and between equal parties, often accepted) reference is:
…the amounts actually received by Seller under this Agreement during the twelve months period preceding the event or circumstances giving rise to a claim.
Note that in case of a claim, the customer will typically cease payment of its invoices (and in many industries, a seller will nevertheless continue its supplies, at least for a certain period of time), which makes twelve months preceding the claim relevant. Arguments to come to a higher amount (beyond one purchase order or the scope of the contract) are often established by reference to the amount that the parties order annually: in a good commercial relationship, a purchaser expects that for determining a cap on liability other supplies between the parties are also taken into account (i.e. no limitation merely to amounts paid under the agreement, let alone under a purchase order).
Carve-out cyber-security breach. A further carve-out is often made for cyber-liability: damages resulting from failing IT-security, poor software (being hacked or otherwise resulting in a data breach), poor security practices by the seller, etc. While a properly organised supplier should have this in order, the liability exposure (risk impact) is both significantly higher and the insurability under a cybersecurity insurance well-possible and common.