Sunday, February 13, 2011

Negotiation - Thoughts On Negotiating Limitation Of Liability Provisions

I wouldn't recommend Procurement negotiators negotiating limitation of liability provisions without their legal support, but they should understand a number of things about limitations of liability to help say no to many supplier proposals.
Rule #1 is never write a contract without a limitation of liability provision if for nothing more than to protect your company.  If there is no limitation of liability provision, your potential liability is unlimited and the other party could recover all types of damages  That alone dramatically increases the potential financial risk of the contract. If you work off the Supplier's agreement, always make sure that the limitation of liability is mutual so you are protected. Suppliers have been known to write limitation of liability sections that limit their liability but are totally silent as to Buyer's liability.

Most limitation of liability provisions contain the following:
1.     The types of damages that may be recovered.
2.     Any exclusion(s) to the limitation on the types of damages that may be recovered.
3.     Any cap on the financial liability of the parties.

Many boilerplate limitation of liability provisions are mutual in nature and exclude things like lost revenue or profits, incidental or consequential damages, and special or punitive damages. This leaves the parties to recover only direct damages. 

Since all the terms of an agreement are interpreted to be complimentary in nature, a limitation of liability provision will override terms of other provisions that may call for remedies that could be incidental or consequential in nature and limit the recovery under those provisions to only direct damages. For example, if you had a provision where if there were an excessive number of defects occurring in the field, the Supplier would pay some or all of the cost, that provision would be read in conjunction with the limitation of liability. If your limitation of liability provision only allowed the parties to collect direct damages, the only field costs you could recover would be limited to direct damages.  So the first things to remember is if you have terms where the damages would be incidental or consequential that you would want to collect, you would need to do one of two things. 

  1. Within the limitation of liability provision itself you would exclude those sections from the limitation as to the types of damages that could be awarded. 
  2. Within the specific section you would include what’s called “trumping language” showing the intent that the remedies in that section would not be limited by the limitation of liability provision. That way when the two are read together your intent is clear.

Most of the negotiation in limitation of liability sections revolves around the Supplier wanting to place a financial cap on their potential exposure.  Here are some thoughts on financial caps:

There are certain potential liabilities related to third party claims where the Buyer simply cannot cap their potential exposure. Agreeing to a cap means would limit the Supplier’s exposure, but Buyer’s exposure would be open ended. For example:
·       If a third party sues the Buyer for personal injury cause by the Supplier’s product or personnel there is no limit for what they may claim and Buyer’s cannot limit their exposure in their sales terms to their customers.
·       If a third party sues the Buyer for Intellectual Property Infringement caused by the Supplier, there is no limit on what they may claim.

In negotiating any dollar cap, Suppliers frequently want to tie that to the amount of the purchases made during a specific period or to the cost of the purchase.

There are several things to be concerned about in linking the cap to the purchases:
·       For any new Suppliers the amount of the actual purchases may be minimal, thereby providing limited protection.
·       For existing Suppliers, your exposure is not based on what you are currently purchasing, it’s based on your installed base of the affected product and your current purchases may not be sufficient to provide adequate protection.
·       You may stop purchasing from the Supplier, but the potential for claims can extend well after that.  Potential claims from third parties do not end until the Stature of Limitations on the type of claim has expired. Contract obligations may extend well beyond the end of the contract.

As to tying liability to the amount of the purchase, caps also need to take into account your potential exposure. The cost of a part or product may not have anything to do with the costs you could incur.  Let me give you an example.  You purchase a component from one supplier that costs $.01. You purchase a peripheral from another Supplier for $200.00.  Both fail at a customer location and need to be replaced?  Does the $.01 part cost you any less to replace than the $200.00 product? 

In negotiating caps one of the decisions that you need to make is whether the cap applies to a specific period or is in effect for the term of the agreement. Caps that tie to a specific term may be smaller as the cap resets each term.  Caps that tie to the term of the agreement need to be much larger and should be based upon a multiple of the cumulative amount of the purchase. If you don't do that your effective per unit protection gets reduced as volume increases over time.

If you need to agree to a dollar cap based on a multiple of a specific term's purchases, it should always include a “not less than” amount.  For example, “Three (3) times the prior year’s Product purchases but not less than Ten Million Dollars (US$10,000,000.00)”.  The reason to include a not less than amount is that it provides a minimum amount to help cover when the Supplier is new and minimal purchases have been made, or you are purchasing less volume from the Supplier because of either a change in your sourcing or a problem with their production capability like a force majeure situation. It also provides protection when you are no longer purchasing from the Supplier but contract obligations remain in effect (as long as the commitments have been written to survive the termination or expiration of the agreement.

Caps should also be consistent with the time period they are effective for. For example you might be willing to agree to a smaller cap if its measured on a "per incident" basis rather than a longer period. The longer the period of your agreement, the higher amount you need. That's simply because any claims that occur during the term will reduce the amount remaining amount that is available for protection..

I also like to exclude all warranty obligations and any insurance proceeds from any financial cap on liability.  Warranty obligations are a liability they already have when they committed to providing the warranty, so it shouldn’t be included in a cap on what's intended to cover other potential liability. It’s also an obligation that financially they have already planned for at the time of sale. You include caps to cover unplanned liability. Liability covered by insurance proceeds is not an out of pocket expense for the Supplier.

Want to learn more? The companion book "Negotiating Procurement Contracts - The Knowledge to Negotiate" is now available on


  1. Hi Jack, I would appreciate your thoughts on the following. Based on a master supply agreement for standard electronic components, which is better:
    1. A low cap including liability for direct and indirect damages with carve outs for IP infringement and breach of confidentiality carve-outs; or
    2. A high cap limited to direct damages and no carve outs

    1. Kathy, there is a post on Damages that explains the different type of damages and you should read that so you understand the differences.

      If you go with only direct damages, what you are basically limited to is being able to recover the cost of the component. Electronic components can usually range from a penny to several hundred dollars. The damage you sustain when you have a defective component will normally include 1) the cost of the component, 2) the costs of removing the affected circuit card, which could mean going to the customer's site. 3) the cost to re-work the card to rework the card to remove and replace the defective component if possible or the cost of scraping the card, and customer satisfaction issues. The cost of removing and reworking the card are consequential damages and those can be substantial. I worked a number of claims and the cost of those would run in the $700 to $800 range per card when we had to remove cards from customer systems.

      I would always want is to exclude confidentiality, epidemic defect and IP infringement out of any limitation on liability as the nature of the damages you sustain would be consequential.
      In term of Caps, I would want breach of confidentiality to be unlimited as the damages would be lost profits. In an IP infringement claim in the U.S. the courts can award treble damages for a willful infringement so if you cap that the amount should be high. Many times caps on epidemic defects may be tied to a high percent or multiple of the annual business. I want these because all of these are risks the supplier can control.

      I prefer to do separate confidentiality agreements so the limitations applicable to the purchase do not apply to confidentiality. The only way that I would go with a high amount limited to direct damages would be if all epidemic defect costs and the full amount of any IP Infringement award were specifically defined as direct damages. A smart supplier should also
      not want to have a high amount with direct damages as that opens up all breaches to that level.

  2. Hi Jack, I recently experience a serious debate among in-house attorneys regarding a similar issue and would appreciate your thoughts on the matter. The debate centered on warranty obligations and the limitation of liability. Specifically whether you can cap the company's internal spend on a limited remedy in the limitation of liability.

    For example: Company is a supplier of widgets. In the Company's negotiated agreement with Buyer, both agree to a limited remedy of repair or replace in case of defects. The limitation of liability reads "THE REMEDIES OF BUYER SET FORTH HEREIN ARE EXCLUSIVE, AND COMPANY'S LIABILITY WITH RESPECT TO ANY CONTRACT, INDEMNITY,...UNDER ANY WARRANTY...SHALL NOT EXCEED ONE HUNDRED PERCENT (100%) OF THE CONTRACT PRICE..." If Company supplies a defective widget and attempts to repair or replace the widget, can the company count their "internal costs" of the repair or replace towards the LOL cap?

  3. Anonymous - Is the supplier attempting to argue that if it delivers a defective widget that its only obligation is to spend up to the contract price fixing the defective widget? That would not be consistent with the UCC and the measure of damages for breach of warranty. It certainly is a novel argument, but I can't imagine a serious debate would be necessary.

  4. Companies try to do many things and the purpose of the blog is to have you be aware of the problems and risks so you can avoid them. As to the July 7 post, when you agree to cap liability based upon spend, it's important to consider whether that will cover all your costs. Most of the time it won't so my preference is to exclude warranty obligations from the cap. As to the July 14 post, most contracts will exclude the UCC or CISG or make it clear that specific section have priority over the UCC. For example the UCC allows for consequential damages, but the parties can agree to waive that right as part of the limitation of liability.