Understanding liability clauses: a comprehensive guide for B2B businesses

Managing risk is essential for UK businesses, and liability clauses offer a structured way to limit potential damages in commercial contracts. In this guide, our legal experts will cover the key aspects of liability clauses, provide practical tips and share real-life examples. Whatever your industry, understanding how to navigate these clauses effectively is crucial. Let's dive in!

What is a liability clause?

A liability clause is a provision in a contract that defines the extent to which a party is legally responsible for damages or losses resulting from a breach of contract or other issues. It specifies the types of claims that can be made and sets limits on the financial exposure for the parties involved. For this reason, these clauses are often referred to as "limitation of liability" clauses.

A well-drafted liability clause can be the difference between being liable for £1,000 or £1 million. By establishing clear limits in your commercial contracts, you can effectively protect your business interests at the outset of your contractual relationship.

Example:

A logistics company, QuickLogistics, signs a contract with a client for the transportation of goods. The contract includes a liability clause stating QuickLogistics will not be liable for consequential or indirect losses, loss of profits or business opportunities, resulting from breaches of contract, such as delays in deliveries. If a delivery is delayed and the client loses £50,000 in potential sales due to stock shortages, QuickLogistics cannot be held accountable for those lost profits. By excluding liability for these types of losses, QuickLogistics significantly limits its financial risk under the contract.

What happens if a B2B contract doesn't include a liability clause?

Every commercial transaction carries inherent risks, and the absence of a well-defined liability clause can leave your business exposed to unlimited financial consequences. If a B2B contract does not include a liability clause, the party that breaches the contract could be held fully responsible for all losses suffered by the other party. This means there is no financial limit on the damages they might have to pay.

In the UK, damages awarded in legal disputes do not always reflect the contract's value. Without a proper limitation of liability clause, a breach of contract could result in substantial claims that leave your business vulnerable. By establishing clear limitations on each party’s responsibilities and maximum financial compensation, a well-drafted liability clause enables businesses to manage risks effectively during disputes or breaches, protecting their financial interests.

Key aspects of liability clauses

Liability clauses typically focus on two main areas:

• What you can be sued for: This includes defining the types of damages or losses for which your business can be held responsible.

• How much you can be sued for: You can set a maximum financial liability cap, limiting the compensation your business must pay if a claim arises.

These limitations help quantify your company’s risk, ensuring that liability remains manageable and proportionate to the nature of the contract.

Limiting or excluding certain losses or damages

Losses that you cannot exclude

While it's essential to know which losses can be excluded from liability, some cannot be avoided regardless of contract terms. Under English and Welsh law, you cannot exclude liability for:

• Fraud and dishonesty: Parties to a contract cannot limit their liability for fraud or fraudulent misrepresentation.

• Negligence resulting in death or personal injury: Liability for negligence causing death or personal injury cannot be excluded.

• Breach of contractual duties: You cannot exclude liability for all breaches of contract, i.e. there must be a meaningful remedy available to the other party.

Example:

NewTech Ltd, an IT services provider, contracts with a client to implement a new data management system. While the contract includes a liability clause limiting NewTech's liability for certain losses, it cannot legally exclude liability in all situations. For instance, if NewTech’s project manager intentionally misrepresents the software's capabilities, prompting the financial institution to invest in unnecessary infrastructure, NewTech could not exclude liability for fraudulent misrepresentation.

Losses that you can exclude

When drafting your liability clause, it’s crucial to state the types of damages or losses for which you are not liable.

Common exclusions in commercial contracts include:

• Indirect or consequential losses: These are losses that aren't the direct result of a contract breach; they occur due to specific circumstances the other party couldn’t have predicted unless they were informed about them upfront. For example, if a supplier fails to deliver machinery on time and the client loses an anticipated contract with a third party as a result, this lost contract might be considered an indirect loss if the supplier was unaware that such a contract depended on the timely delivery of the machinery.

• Loss of revenue, profits, or business opportunities: If a breach of contract results in the other party losing income, profits, or potential business prospects, you cannot be held responsible for compensating those financial losses.

• Wasted expenditure: This can include expenses like materials, resources, or time invested that no longer provide any value because the contract was breached.

Example:

Consider a software company, CodeSolutions, that signs a contract with a client to provide a new software platform. The contract includes a liability clause that excludes liability for indirect losses. If the software experiences unscheduled downtime and the client claims they lost business opportunities and sales as a result, CodeSolutions could argue that they are not liable for those lost business opportunities, as their liability clause specifically excludes indirect losses.

Including certain losses

While it’s essential to exclude specific losses that you do not wish to be responsible for, you may also want to identify losses you are willing to accept responsibility for.

Typical losses that are included in the liability clause of commercial contracts often cover direct and foreseeable damages that arise as a result of a breach. Aside from the losses that cannot be excluded by law, these might include:

• Direct losses: These are immediate and obvious consequences of a breach, such as the cost of replacing defective goods or fixing faulty services.

• Damage to property: Liability for physical damage caused to the other party’s property due to the breach is often included.

• Legal costs: If a breach causes one party to incur legal expenses, the liability clause might cover these costs or provide an indemnity for specific breaches of contract. You can find out more about indemnities here.

Example:

Imagine a construction company, UltraBuild, damages a client’s property due to faulty equipment. Since the contract’s liability clause covers property damage and related legal fees, UltraBuild is responsible for the repair costs and any legal expenses the client incurs as a result.

To see a sample limitation of liability clause, check out one of Docue's commercial contract templates. Each contract includes model clauses drafted by lawyers, designed to favour the party drafting the agreement.

Capping your liability

Can liability be capped to a specific amount?

Yes, liability can be capped by setting a specific limit, which restricts the amount your business would need to pay if a breach occurs.

What is a liability cap?

A liability cap sets a maximum limit on the amount one party can recover from the other in the event of a breach of contract, providing businesses with certainty and predictability regarding their financial exposure. For example, a contract might specify that a supplier’s liability is capped at 125% of the fees paid in the previous 12 months or at a fixed sum like £100,000. This ensures that, even if a breach occurs, the potential financial risk remains manageable and proportionate to the contract’s value.

When setting a liability cap, consider the following:

• Reasonableness: The cap should provide a meaningful remedy for breaches while protecting your business from excessive claims.

• Structure: Caps can either be a fixed sum or a percentage of the contract’s value, often based on fees paid over a specific period.

• Insurance: It's important to ensure your liability cap does not exceed your insurance coverage, as this could leave your business exposed to claims beyond your financial protection.

Business-to-business vs. business-to-consumer contracts

When drafting liability clauses, ensure they are reasonable and comply with applicable laws to ensure enforceability.

It's crucial to differentiate between B2B and B2C contracts when it comes to liability. B2B contracts offer more flexibility in terms of limiting your liability, allowing businesses to negotiate terms that are reasonable, based on mutual agreement. However, liability clauses in B2C contracts are heavily regulated.

In the UK, B2B liability is governed by the Unfair Contract Terms Act 1977, which includes a “reasonableness” test for limitations. For B2C contracts, consumer protection laws, such as the Consumer Rights Act 2015, prohibit unfair or unclear liability clauses, ensuring consumers are not disadvantaged.

This blog is intended to provide insights into liability in B2B commercial contracts only.

Tips for drafting effective liability clauses

When drafting liability clauses, it’s important to establish clear, fair, and enforceable terms that protect your business while providing clarity to all parties involved. Consider the following tips:

• Be clear and unambiguous: Clearly define what losses are excluded and the extent of liability to avoid misunderstandings.

• Draw the other party's attention to it: Ensure that the liability clause is visable and not hidden in the fine print. This helps to guarantee that all parties understand their responsibilities and potential liabilities.

• Ensure it is reasonable: Set terms that are fair and proportionate to the risks involved. Establish a liability cap that balances risk and aligns with industry standards, ensuring it reflects the potential impact of the service provided.

Conclusion

In summary, navigating liability requires a balance between protecting your business and providing reasonable remedies in case of a contractual breach. A well-drafted liability clause serves as a safeguard, minimising risk and ensuring long-term success in your business relationships.

Please note that while this blog offers valuable insights, it is not and should not be taken as legal advice.

How can Docue help?

Docue’s commercial contract templates are fully customisable and include dynamic liability clauses that are automatically drafted in favour of the party creating the contract. Docue is easy to use and allows you to create a commercial contract tailored to your business in minutes. Our lawyer-drafted guidance notes are designed to help you through the process, ensuring your business has a consistent and streamlined approach to liability. Once completed, you can sign your contracts electronically and store them (and other documents!) using Docue's secure storage feature, Docue Drive.

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