Have you limited your liability today?

October 7, 2016

You have just finished negotiating the key terms of a new business venture.  The last thing either party wants to discuss are the potential risks of the venture not being successful.

Although unpleasant, addressing the risks associated with a new business venture at the beginning can prove to be a valuable investment in the long run.

Written contracts are essential to risk management.  One way to manage risk through a written contract is to include a provision that limits the potential liability of the parties.  When drafted correctly, limitation of liability provisions can be a valuable tool to managing your company’s exposure to liability.

There are two primary ways to limit liability through contract.  One way is to limit the amount of liability exposure.  An example of limiting the amount of liability is to negotiate a cap on the total amount of recoverable damages on certain types of claims or on all potential claims.

A second, and perhaps more tailored way, to limit liability is to limit the type of liability to which the parties could be subject. Most often, contracts that limit the type of liability allow for recovery of direct damages, but disallow recovery of indirect damages.

Direct damages are the proximate result of a party’s breach; i.e. losses that flow naturally and usually from the breach (without the intervention of intermediate cause).  For example, if a supplier breaches a supply contract by failing to deliver $100 in parts to a manufacturer, and the manufacturer has to buy replacement parts from a different supplier for $125, manufacturer can make a reasonable argument that supplier owes it $25 in direct damages.

By contrast, indirect damages flow indirectly from a party’s breach.  Some examples of indirect damages are:

Type of Indirect Damage Description
Lost profits: Lost profits are profits that the non-breaching party fails to realize because of the breach.

Example: Lisa agrees to provide advertising services to Rich for six months at $100 per month. After only one month, Rich reneged on the contract and refused to accept additional work from Lisa, even though Lisa was ready, willing and able to provide services. Lisa has a reasonable argument to recover $500 in lost profits as direct damages from Rich.

Special damages:

 

Special damages typically equate to economic losses such as loss of earnings; property damage; and medical expenses that result from a party’s breach.
Punitive damages: Punitive damages are discretionary tort-based additional damages (beyond the actual damages caused by a wrongdoer’s conduct) generally awarded to punish or deter egregious conduct, not to compensate the non-breaching party.
 

Consequential damages:

 

 

 

Consequential damages are all contractually recoverable damages that do not:

  • Fit within the category of either incidental or direct damages; and
  • Normally and necessarily flow from a breach of this nature (instead, they arise from specific nature of either the particular breach or the claimant’s circumstances).

Common consequential damages include:

  • Lost profits;
  • Damages relating to third-party claims;
  • Loss of use of contracted goods;
  • Interest;
  • Attorneys’ fees;
  • Property damage; and
  • Personal injury.

 

Whether it limits the amount of liability, the type of liability, or both, a limitation of liability clause can be an effective tool to limit risk between parties at the outset of a business relationship.

However, limitation of liability clauses can be complicated and are often the subject of negotiation for parties concerned about properly protecting their business.  In order to maximize the effectiveness and enforceability of a limitation of liability clause, it is important that the clause is drafted with care for the specific risks of the particular business relationship at issue.  Hiring the right counsel is essential to effectively limiting your liability through contract.  If you have any questions about how you can limit your liability today, please contact the Sophia K. Pappan of Strassburger McKenna Gutnick & Gefsky at (412) 281-5423 or spappan@smgglaw.com.

Sources:

Practical Law Article: Damages for Breach of Commercial Contracts Checklist, Practical Law Checklist 5-555-7166.

Kevin M. Gorenberg and Steven M. Richman, Drafting Enforceable Limitation of Liability Clauses in Business Contracts, Strafford CLE, March 16, 2016.

13 Pa. Stat. and Cons. Stat. Ann. § 2719

3A Summ. Pa. Jur. 2d Torts § 41:348 (2d ed.)