How else can you limit liability?
Of course, effectively managing liability is not achieved by simply including a handful of clauses in the contract - it is both a legal and commercial imperative. There are numerous other ways in which the parties to the contract can drive behaviour and seek to minimise exposure to liability.
These include various commercial levers such as undertaking proper due diligence on your counterparty, and your own ability to meet the contractual obligations, requiring guarantees (either performance guarantees by a third party (such as your parent company), or (as is common in public sector contracts), bank guarantees, effective governance and contract management to resolve disputes before they become entrenched, ensuring you and your counterparty have adequate insurance cover (discussed in more detail later in this release), finally, negotiating actively – don’t accept standard-form contracts without negotiation, and even when negotiating with larger parties, seek reasonable amendments to come up with fair positions on risk allocation.
Similarly, there are contractual solutions outside of the core liability provisions which can also minimise risk and exposure. For example, robust termination rights can help ensure that a ‘way out’ of the contract is available before significant loss or liability crystallises, ensuring a tightly defined scope is critically important in IT contracts which can cover complex and challenging projects and should help avoid disputes as to whether obligations have been properly performed, using an entire agreement clause ensures that pre-contractual documents or representations do not find their way into the overall contractual matrix, and using ‘non-reliance’ wording can prevent a potential claim for misrepresentation by ensuring that the counterparty has not entered into the contract relying on statements which have been made but not included in the contract.
A force majeure clause should excuse parties from liability if performance becomes impossible due to events outside their control, such as natural disasters, wars, pandemics, or government interventions. These clauses are very common in technology agreements, and Australian courts will generally enforce well-drafted (ie. clear and unambiguous) force majeure clauses. However, it is important that the parties agree to provide notice of the existence of a force majeure event as a condition to relying on it. In addition, the affected party should try to perform or workaround the issue as far as possible, and a termination right for the other party is appropriate in the case of a period of extended non-performance due to force majeure.
Finally, ‘liquidated damages’ clauses are an effective way of limiting liability under a contract, given that they specify the amount of compensation due if a contract is breached, often up to a maximum amount or ‘LDs cap’. Whilst the drafting of these is often necessarily complex, they can provide a neat solution for compensating the customer for a reasonably certain loss due to the other party’s non-performance or delayed performance, whilst protecting the supplier from ‘damages at large’. Remember that in Australia, liquidated damages must be a genuine pre-estimate of loss the other party is likely to suffer - penalty clauses (which impose excessive amounts) are not enforceable.
How does insurance fit in?
As we all know, one of the most important risk mitigation tools in the commercial landscape is insurance, which plays a vital role in respect of contractual or other liability a party to a technology agreement may incur. When negotiating the agreement, an organisation should consider not only its own insurance cover and the extent to which it could cover potential liability it might incur under the contract, but also the insurance of the counterparty. Rather than taking it on trust that the counterparty will, as a responsible business, ensure it holds appropriate insurance, consider imposing a contractual obligation on it to do so: specify the types of insurance the counterparty must hold, and the required levels of cover.
Typically, depending on the nature of the services or products being provided, an obligation to insure may require one or both parties to hold product liability and public liability insurance, professional indemnity insurance, workers' compensation insurance as required by applicable law and, increasingly, cyber insurance. In addition to the level ($ amount) of cover required, the relevant clause will also need to address the applicable limits to the insurance (usually either per claim or in the aggregate) and the period of time for which the insurance is required (which in some cases will need to exceed the term of the contract).
A party to a contract will often try to link the liability and insurance provisions, and put forward the position that the liability cap cannot be higher than the corresponding level of cover available under the relevant insurance it holds. In other words, it may be unwilling to accept liability for uninsured losses.
However, there is no legal reason why a liability cap cannot be higher than the level of cover of the relevant insurance held. From the point of view of the party suffering the loss, it should not be prevented from recovering a certain amount of damages for which the other party is liable simply because that party only took out a lower level of insurance cover. Ultimately, this is simply a commercial issue for negotiation between the parties.
Finally, it is important that one party has the ability to require the other party to prove that the required insurance is in place, usually by having the right to ask for a certificate of coverage or similar document.
Different sides, different perspectives
A party’s approach to the liability regime under the technology contract will be heavily influenced by whether it is the customer, buying a product, services or IT solution from the counterparty, or the supplier / vendor providing it.
From the customer’s perspective, even though it might want its supplier not to benefit from limited or excluded liability, the customer will often choose to include liability clauses where they are preparing the first draft of the contract. The reason for this is twofold: by including limitation and exclusion clauses in the document when it has ‘the pen’, the customer can control the parameters for negotiation and offer a ‘starting point’ which is relatively favourable to it, rather than allowing the supplier to simply insert its standard clause, which will heavily favour the supplier.
In particular, the customer can be clear as to which losses it wants to be able to recover by specifying a very narrow exclusion of liability clause (perhaps limiting the exclusion to ‘consequential loss’ and including a definition of that which rewinds the position back to Hadley v Baxendale second limb). In addition, if the customer itself has certain obligations and responsibilities under the contract other than payment of the fees or charges, which is often the case in a technology agreement (for example, responsibilities and dependencies to enable the supplier to perform), the customer may well want to limit its own liability for breach.
From the supplier’s perspective, as we have already noted, it will want its liability for non-performance, breach, negligence or some other issue to be limited to a reasonable amount which does not lead to an acceptable level of risk or exposure, and it will not want to be held liable for losses which are too remote. Typically, the supplier will want the cap to be set at, or less than, the economic benefit that the supplier gains by entering into the contract. The supplier will usually have ‘priced in’ a certain level of risk, and will likely have managed to mitigate the risk through appropriate insurance. Faced with a customer demanding liability provisions which are more customer-favourable than the supplier considers ‘standard’, the supplier will often seek to increase the price for the products or services to reflect the higher risk being taken on.
Our experienced Technology Law team can assist customers and vendors or technology solutions with tailored advice and strategies to optimise your position in IT contracting, including in relation to liability.
If you would like any technology law assistance, or have any questions or comments on this release, please contact Technology Special Counsel Nick Martin below.
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