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

Negotiation - Thoughts on Negotiating Notices

In every contract certain notices may be required.
·       For breach of the agreement (a cure notice)
·       To terminate the agreement for breach (if they fail to cure)]
·       To terminate without cause
·       To cancel or reschedule an order
·       To end of life a product or service
·       For any lead time changes
·       For product or service changes
·       For other changes, such as location work is performance, change to subcontractors or material suppliers.
·       For the exercise of options, such as extension of the term.
·       To advise the other party that a condition precedent or condition subsequent has been met
·       Notices of shipments or pulls
·       If you have a self extending agreement, notice is required to advise the other party of the intend to not have it self extend.

Most notice provisions simply address:
1.     The party that notices must notified.(As people change its wise not to specify a specific person. You could list a person or their successor or you could list a specific position title of Group).
2.     How notices must be communicated. (Some notice may require a formal writing that is sent by a means showing proof of delivery other notices may be agreed to be sent electronic such as EDI signals).
3.     When notices are effective (posting or receipt). (This is determines when the period provided for in the Notice commences)

Individual sections that contain notice requirements will specify the minimum period required before the action described in the notice can take effect.  For example if you agree to a thirty-day cure period for breach, the Supplier has 30 days in which to try to cure before a termination notice can be given. After sending a notice to cure a breach, the Buyer is not obligated to terminate the agreement. If they choose to terminate the agreement, the termination notice does not have to terminate the agreement immediately.  A termination date in the future may be specified. The party providing notice may provide a longer period than is required by the contract, they just can’t provide a lesser period.  Notices may also be for rights or duties. For example, if a Supplier had a right to end of life a product or service and the contract required six months notice, they could provide a year's notice if they wanted.  If the provision of a notice is a duty, that requires a notice. If notice is tied to a right, the party with the right does not have to exercise the right or provide notice if it opts not to exercise the right.  

For a notice to be effective, it must follow the agreed requirements for its delivery that are defined in the Agreement. If it doesn’t, technically the notice never occurred, and if the notice never occurred, what you were trying to protect (like an option) wouldn’t be protected or what you were trying to manage (like a termination) wouldn’t be recognized.