Limited Liability and the Contractual Gaslight

We’ve covered a lot of ground so far, between discussing your foundational agreements, taking a deep dive into NDAs, and reviewing your “main event” agreement: your client services agreement. And although the heat wave is somewhat behind us, let’s turn up the heat on a few critical provisions that you’ll likely see in the majority, if not all, of the agreements you encounter throughout the life of your business: indemnification, limitation of liability, and (especially if you’re a computer giant that recently experienced a global outage grounding 2,500 US flights and causing widespread panic among IT professionals) *deep inhale* . . . force majeure.

To start, depending on how they’re worded and who presents them (which is the case with literally any agreement, but stay with us), indemnification and limitation of liability provisions can either be your holy grail or worst nightmare. But fear not friends, after reading this blog post you’ll be able to more easily spot-check these provisions and set yourself up for success.

What is Indemnification, Anyway?

Imagine indemnity as your legal sidekick working in the background, ready to step in and defend your interests when the unexpected occurs. In a nutshell, an indemnification provision is a contractual promise by one party to compensate the other party for certain losses or damages. These categories can be incredibly broad, and can include all legal claims, breaches, or disputes arising from or related to the agreement, including any claims brought by a third party. For example, let’s say you hire a consultant to create a logo for you, which they do, but the logo infringes on some third party’s intellectual property rights. If that third party goes after you for infringement, you can invoke the indemnification provision, point the finger at your client, and say “hey, I need you to step in here and cover this claim, and my legal fees.”

Overall, indemnification clauses provide clarity with respect to: (1) risk allocation; (2) financial protection; and (3) party accountability. A properly drafted clause will identify which party is responsible for certain scenarios, the procedure for notifying the other party of a claim, and ultimately will provide more of a financial safety net in the worst-case scenario.

To sum it up: a provision allowing you to punt liability over to the other party . . . not bad, huh?

Indemnification Pitfalls

One of the biggest pitfalls with respect to indemnification is where it’s entirely one sided in the other party’s favor. If you’re indemnifying another party, it’s fair to want that indemnification to be mutual. Think through the ways something could go wrong and come back to haunt you, now ask for indemnification for that scenario.

Another significant pitfall is scope. A carefully drafted indemnification clause will define the scope carefully to avoid overly broad obligations that could expose your business to undue risk. A perfect example of this is an indemnification clause that requires one party to indemnify the other regardless of who is actually at fault and to what extent they’re at fault. Notwithstanding the fact that a term like this is likely unenforceable, it’s incredibly problematic. 

Be careful with indemnification clauses that are only applicable to third-party claims and situations where insurance is involved. For instance, it’s reasonable to include third-party claims in an indemnification clause (as this is how this issue typically comes up), but there may be other instances that would require indemnity even where a third-party claim does not come up. If the other party’s misconduct causes you to get hit with some sort of administrative penalty or fine, you’d probably want to be indemnified for that, and you shouldn’t have to wait for there to be a formal lawsuit or claim to demand indemnity. Additionally, you may not want to limit your right to indemnity based on whether the other party’s insurance policy will cover the claim, which is a term we have seen numerous times. Overall, it’s crucial that you read these clauses (and all contracts) very carefully to pinpoint any loopholes or open-ended terms in general.

Limitation of Liability Clauses Generally

Limitation of liability clauses do exactly what they sound like: limit liability. However, these provisions more commonly limit both: (1) categories of liability; and (2) total amount of liability. For instance, a limitation of liability clause may say that in no event is a party entitled to consequential damages (i.e., lost anticipated profits). This is because consequential damages are unpredictable, extend well beyond the direct costs of breach, and quickly add up, so you want to make sure that the only kinds of damages available to a non-breaching party are actual damages. The same goes for punitive damages, which are also unpredictable and can lead to massive exposure.

In terms of limiting total liability, these provisions may also cap total liability (in the event of breach or indemnity for instance) to a certain percentage of amounts paid under the agreement, or even a flat amount. The idea here is that if the total value of your agreement is on the lower end, you may want to limit overall exposure to future claims.

Limitation of Liability Pitfalls

Limitation of liability clauses are subject to scrutiny by the courts, and may not be enforceable if they’re too broad or unreasonable in light of the nature of the agreement. You should also be mindful of circumstances where the clause states that there will be no cap whatsoever for certain categories of breaches/damages (i.e., copyright infringement, third-party indemnity claims, willful misconduct, or gross negligence). Depending on which side you’re on, these carveouts can either help you or be incredibly detrimental.

Further, you should always look at these clauses in the context of the applicable jurisdiction. Some states are harsher than others, but generally speaking, as long as the clause is reasonable and not overly broad, it’ll be enforceable. 

Force Majeure Clauses

If the Microsoft/CrowdStrike outage messed with your internet, email, and travel plans, this one is for you. IT professionals, we feel for you, I’m sure last Friday was not fun. However, we’ll get on our soapbox real quick and tell you that this is why having a force majeure provision in your agreements is critical. A force majeure clause excuses either one or both parties from performing under the contract for acts that are beyond that parties’ control, otherwise known as “acts of God”. These provisions have been incredibly helpful during unprecedented disasters that resulted in significant business interruptions – for example, 9/11, Hurricane Katrina, and Hurricane Sandy.

Some force majeure clauses are incredibly general (i.e., you’re excused from anything that’s beyond your control), while others are incredibly specific (i.e., you’ll only be excused if one of these very specific circumstances occur, and even then, only if it is something that the parties could not reasonably anticipate or prevent). Some require the party prevented from performing to immediately resume work once the force majeure event ends, others don’t. And should a force majeure event also give a party the right to terminate the agreement? Well, that’s up to you! Regardless, if you have one of these clauses in your agreement and don’t know what it says – definitely give it another look. And, if you don’t have one at all – consider adding one.

So, there you have it. Although no business venture is without risk, these provisions are meant to help you manage risk as much as possible. Of course, the exact language and circumstances vary, and these provisions can take numerous forms (either to your benefit or detriment). As we’ve said time and time again, and will continue to say: read them, understand them, use them, and as always, if you’ve got questions, you know we’ve got answers.

~ The W + K Team