Limitation of liability clauses are crucial in contract negotiations. They set the boundaries for financial responsibility if things go wrong. Whether drafting a new contract or revising an existing one, understanding how to tailor these clauses to your specific needs is essential. 

I often start by focusing on how the liability limits should apply to each contract’s parties. This analysis looks at two primary concerns: whether to make the clause one-way or mutual and identifying the maximum liability for each party.

Whose Liability is Limited? 

When drafting a limitation of liability (LOL) clause, one of the first decisions you’ll need to make is whether to structure it as a one-way or mutual provision. This choice can significantly impact the balance of risk between the parties involved.

Initial Analysis of the Parties Covered by a Limitation of Liability Clause

Before finalizing the limitation of liability clause, closely examine who is named as having their liability limited by this provision. 

Decide whether the clause should be one-way (benefiting only one party) or mutual (applying equally to both parties). This decision depends on the parties' relative bargaining power and the nature of the transaction. Mutual clauses are more common in contracts with equal power, while one-way clauses might be appropriate when one party, such as a vendor, takes on a more significant risk.

Review how each party is protected and exposed by the liability limit structure. Ask whether that allocation makes sense for your company with this counterparty for this transaction.

Example of Limitation of Liability Clause Language:

 "Each party’s total cumulative liability for all other claims arising out of or relating to this Agreement will not be more than the maximum liability amount." This language is often used in mutual limitation clauses, setting a clear cap on liability for both parties. Cloud Services Agreement § 9.1

Your Priority Issues to Consider

• Big Picture: Recognize that the customer and vendor often do not have the same level of risk. While two-way LOL clauses are standard, they can present unique risks that each party must consider. For instance, a customer might be more concerned about the vendor’s potential failure to deliver, while the vendor might be more focused on limiting exposure to large financial claims.
• Customer Issues: If the LOL cap is one-way and you want it to be mutual, consider redlining the language from "Vendor's liability" to "Each party's liability." This change ensures that both parties are equally protected under the clause.
• Vendor Issues: Vendors should carefully evaluate whether a mutual general cap adequately covers their risks. If not, consider adding exceptions to the general cap for your top risks, such as the customer’s infringement of your intellectual property or the customer’s non-payment of fees. The vendor may want to change the provision: "Vendor's entire liability arising out of or related to this Agreement will not exceed the maximum liability amount. Notwithstanding the above, the maximum liability amount does not apply to (a) infringement of intellectual property rights to the Software or (b) breach of Customer's obligation to pay fees."

Deciding the Scope of Liability for Each Party

Once you’ve determined whether your limitation of liability clause will be one-way or mutual, the next crucial step is setting the maximum liability for each party. This cap on liability is a key component of the clause, and getting it right can prevent significant financial exposure in the event of a dispute. 

Initial Analysis of Setting the Liability Cap For Each Party

Think through the implications of the maximum liability amount. This amount represents the maximum liability for each party under the contract. Setting this cap to reflect the potential risks without exposing either party to unreasonable financial burden is essential. One of the central challenges in setting the maximum liability amount is balancing the need to protect your business with reaching a fair agreement with the other party. The cap should be high enough to cover potential damages but not so high that it exposes your business to undue risk.

Sample Language From a Limitation of Liability Clause

"Each party’s total cumulative liability for all claims arising out of or relating to this Agreement will not exceed the maximum liability amount specified as [insert specific amount]." This language provides a clear and enforceable limit on liability, reducing the risk of significant financial exposure. Common Paper, Cloud Services Agreement § 9.1

Top Issues to Consider for Customers and Vendors

• Big Issues: When setting the maximum liability amount, consider the nature of the contract and the potential risks involved. For example, a contract involving custom software development might require a higher cap than a standard service agreement. Additionally, courts may scrutinize the cap if it is perceived as unreasonably low or high, so it’s essential to justify the amount chosen based on the specifics of the contract.
• Customer Issues: s a customer, ensure that the maximum liability amount is sufficient to cover any potential losses you might incur. If the vendor insists on a lower cap, consider negotiating for higher liability limits in areas that are particularly important to you, such as delays in delivery or failure to meet performance standards. A customer might negotiate for a higher maximum liability amount if your business faces significant risks from the vendor’s performance. 
• Vendor Issues: Vendors should be cautious about agreeing to a maximum liability amount that is too high, as it could lead to significant financial exposure in the event of a breach. At the same time, the cap should not be set so low that it seems unreasonable or could be challenged in court. Vendors might also consider carving out specific exceptions where the cap does not apply, such as in cases of gross negligence or willful misconduct. A vendor might want something like this in its provision: "Vendor's total liability arising out of or related to this Agreement will not exceed the maximum liability amount, except in cases of gross negligence, willful misconduct, or infringement of intellectual property rights."

Conclusion

Drafting a well-balanced limitation of liability clause requires careful consideration of both the structure (one-way or mutual) and the specific liability caps for each party. These clauses are vital in managing risk and protecting your business from potentially devastating financial exposure. By focusing on the specific needs of both parties and clearly defining the terms of the limitation, you can create a clause that provides fair and reasonable protection. Make sure you always consider the unique risks associated with your contract and negotiate terms that align with your business objectives. With the right approach, a limitation of liability clause can be a powerful tool in safeguarding your interests in any commercial agreement.