May 29, 2023
By the time a client approaches a lawyer for the review of a contract, the major business terms have typically already been negotiated – leaving the lawyer the work of protecting the client by capturing the business terms and including additional terms that may not have been considered by the client.
While every provision of a contract warrants careful consideration in review, certain clauses in particular demand extra consideration given their impact on risk and who should bear it.
Limitation of liability and indemnification clauses are present in nearly every commercial contract and can strongly impact the allocation of risk among the contracting parties.
To understand the importance of these two clauses, and why careful and professional consideration of both is key to mitigating contract risk – continue below.
The primary objective of a limitation of liability clause is to allocate and minimize risk.
This is often achieved by limiting the amount of money or damages owed by one party to the other and restricting the type of damages or claims available to an aggrieved party.
To illustrate, some limitation of liability clauses in contracts between a supplier and a client may include a broad clause that limits the liability of the supplier up to a maximum value of the sum actually paid by the client to the supplier under the contract.
Liability can lead to large financial losses.
Let’s say, for example, a client company pays a total amount of $10,000 to a supplier for product. The client company then sells the product to a third party. Unfortunately, the product malfunctions resulting in a loss of $20,000 for the third party.
In this scenario, the third party then sues the client because the product it received from the client malfunctioned and caused the loss. Naturally, the client would want to avoid paying for the loss borne by the third party – and would want the supplier to cover the loss since it manufactured the product.
However, depending on the wording of the clause and the other terms of the contract, the limitation of liability clause could cap the liability of the supplier to the client at $10,000.
In this case, the supplier is only required to pay $10,000 to the client, leaving the client responsible for the additional $10,000 to the third party. The inclusion of this limit against the liability of the service provider offers significant protection to the supplier at the expense of the client.
Had the contract been thoroughly reviewed by the client, the clause could have been adjusted to shift more risk onto the supplier for losses caused by malfunctions of its product.
Frequently found in contracts, the second risk allocation clause, the indemnification clause, is one of the most negotiated and at times contentious components of a contract.
In short, indemnification is an undertaking (a promise of sorts) by a party (the indemnifying party) to compensate the other party (the indemnified party) against potential losses or damages typically claimed by a third party, but also at times from direct claims by the indemnified party.
Indemnity provisions can be mutual, or flow solely from one party to the other. In a mutual indemnity, both parties may agree to compensate one another for losses contemplated by their agreement or for losses arising from the breach of a term or condition of the agreement.
Conversely, in a one-way indemnification, only one party provides an indemnity in favour of the other party.
Imagine you own property with commercial tenants. You then hire a snow removal company to clear the snow and salt your property. As the landlord in this situation, you would be wise to ensure that the contract between yourself and the snow removal company contains an indemnity provision.
This is because the provision could require the snow removal company to indemnify the landlord for any claims made by a third party resulting from the negligence or nonperformance of the snow removal company.
In other words, if a third party (such as a tenant’s employee) slips, falls and sues, the indemnity provision can function to obligate the snow removal company to compensate you for the loss you suffered.
Limitation of liability clauses and indemnity clauses are just two of a long list of clauses that consume much of a commercial lawyer’s thoughts and attention.
Being trained in identifying risk, a commercial lawyer can protect your interests by identifying and addressing these clauses in a contract that may place an unreasonable risk on you, the client.
We know navigating business structure, contracts, and insurance can be difficult, especially if you don’t have a business background.
If you’re looking for advice tailored to your business, our experienced partners at Mann Lawyers provide legal support for businesses of any size.
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