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Contract drafting: Limitation of Liability

October 11, 2016

“But do we know what our competitors are doing?”

Anyone who has had a role in setting policy or drafting contract clauses will be familiar with that question. None of us want to establish positions that make us uncompetitive; yet we don’t want to take unnecessary risks. So no matter whether you are buying or selling, it would be really helpful to have market insight.

Until now, that has been very difficult to obtain. Groups like Marketing simply don’t know how or where to gather such data. So we often depend on scraps of information, examples we can find on the internet, or perhaps past employees of a competitor. But today, the situation is changing fast. Here is an example.

An IACCM Corporate Member sent a question last Friday, asking about norms and standards in limitation of liabilities, in particular the amount and calculation of damages. They included a sample of their current approach, related to large services and outsourcing agreements. Within 48 hours, IACCM was able to provide this answer:

“Based on review of more than 100 agreements, it is safe to say that a cap based on 12 months of aggregate charges is a norm. There are extremes where this is as low as 3 months or as high as 18 months. In some instances, the cap is based on all payments made, which might of course raise this time period, or on the amounts paid ‘over the period associated with the claim’.

One significant variant is whether the cap relates to payments made for a particular service, or under an overall transaction document, or under ‘the Agreement’ in total. Obviously these could be very different. The nature of exclusions seems relatively standard – lost profit, indirect, consequential – but you might consider not having the limit apply in certain areas – for example if there are particular covenants, or related to breaches of confidentiality. You might also have specific incremental compensation – for example, if you have a right to terminate in addition to damages, you might seek to recover associated costs.

In a multi-year or multi-service agreement, you need to be clear whether the limit applies to service periods or to individual services – in other words, during the life of the agreement, how many individual claims could be made? A key question is of course the relationship between the LoL and any clause related to Liquidated Damages or service level credits. For example, is there a point at which a service level becomes so poor that it becomes a material breach and switches from being covered under the LD provisions, to being a claim for damages? It is the norm for agreements to have such a switch, typically based on consistent under-performance at a certain percentage.

And related to this, is the calculation of damages based on gross charges, or charges net of credits, allowances etc.? The norm is relatively split on this, perhaps reflecting the relative power of the parties. Arguably, the gross amount is more equitable in that the supplier should not really face a reduced claim simply because they have performed so badly in the past!”

This is a current example of the way that technology is starting to transform the knowledge and information available to contracts and legal professionals, supporting their ability to engage in far more strategic discussions in the business. You no longer have to wait to be challenged over the clauses in your agreements, to have Sales or the business unit complain that your terms are an impediment to business results. Today, you can undertake proactive analysis that enables you to speak with confidence – and, where necessary, to challenge others in the organization who may be impeding your competitiveness and causing avoidable negotiation or tension with customers and suppliers.

If you are interested in this IACCM benchmarking service, contact info@iaccm.com. This blog is based on market analysis and nothing in it should be taken as legal advice since its applicability and use will depend on your specific needs and situation.

 

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