How to Decide a Commercial Contract's Liability Limits
How to Set Liability Limits in Commercial Contracts
I wish I had an easy rule for you about setting the maximum liability in a commercial contract.
Industry standards provide a starting point, but I encourage you not to stop there. Always analyze to make sure the provision works for your deal.
A Four-Part Framework for Determining Liability Caps
Here's the four-part framework I use:
- I evaluate whether we are more or less likely to cause damages that may occur under this agreement. It can depend on the seller's scope, the buyer's involvement in the design, and how the end customer will use the product.
- I consider the proportionality of potential damages. Are we both going to suffer if something goes wrong, or will one side bear the brunt?
- I look at risk factors. What are the performance requirements, the potential for third-party claims, creditworthiness, and reputation of the counterparty, and risks with these goods?
- I think about risk mitigation. Is this cap within our insurance? Are there exceptions to the cap? Can we shift liability to a third party? Do we have systems in place to mitigate the risk?
Think through the real-world risk and exposure first. Then ensure your maximum liability provision aligns with that risk and exposure.
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