The Best (And Cheapest) Insurance Against Unforeseen Loss: Limitations on Liability
By Steven T. Lovett, Partner, Stoel Rives LLP.
As essential and common as limitation of liability clauses are, lawyers still see with surprising frequency disputes where the defendant did not have such a clause in place. Limitation of liability clauses look like something this:
LIMITS OF LIABILITY. NEITHER PARTY SHALL BE LIABLE FOR ANY INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR CONSEQUENTIAL DAMAGES ARISING OUT OF THIS AGREEMENT, HOWEVER CAUSED AND UNDER ANY THEORY OF LIABILITY (INCLUDING NEGLIGENCE), EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES AND NOTWITHSTANDING THE FAILURE OF THE ESSENTIAL PURPOSE OF ANY LIMITED REMEDY.*
The following scenario is intended to highlight why such clauses are the best, and cheapest, insurance against unforeseen loss.
A Common Scenario
It’s Monday morning at 9 am. You get a panicked call from a footwear manufacturer downstate. The component you supply that customer is critical to the operation of machinery essential to both his manufacturing lines. He tells you that Line 1 went down Sunday due to failure of that component, and Line 2 just went down for the same reason. They are wear parts not covered by warranty. To his surprise, the customer found that the only back up he has on site is a part removed last time he upgraded the machine and it is no longer operable.
Both his lines are down until you can get new parts installed at his plant. You tell him to shoot over a PO for the two critical components, at $2,500 per part plus $700 for expedited service and installation, and you will get a service person to his plant with the parts by 1 pm. With an hour to install each component, your service tech will have Line 1 up by 2 pm and Line 2 up by 3 pm. You receive his PO and respond with an invoice for $5,700 for parts and service.
Neither the PO nor the invoice include terms and conditions.
Within a half hour, your service tech has loaded the van is heading downstate. Then the fun starts: At 11:30 am, two hours into his run, the tech calls to say that the van has broken down on a barren stretch of highway, a good half hour from a service station. You figure it will take at least three hours to get a tow truck out, tow the van back to the service station and then fix it (if they have the parts). By then it would be 2:30 and he would still over an hour away from the customer’s factory. Your other techs are out on calls, so you send your office manager to drive to the van, pick up the driver, the components and the necessary tools, and drive on the customer’s plant. That way, the tech should arrive and begin work by 2:30, 3 pm at the latest.
Sure enough, your two employees arrive at the customer’s shoe plant at 2:45 pm ready to install the parts. Except the tech misread the paperwork and only brought one component. Due to the delays, Line 1 isn’t back up until about 5 pm, a two hour delay. But by the time you can get the additional component to the plant and have it installed on Line 2, it’s 9 pm, six hours later than expected.
What’s Your Exposure Without A Limitation Of Liability Clause In Place?
As a consequence of your failure to timely deliver and install the product, your customer lost two hours on Line 1 and six hours on Line 2. His profits are about $10,000 an hour per line, or $80,000 in lost profits for the eight hours in lost line time. That $5,700 job, which was worth maybe $3,000 to you after time and costs, just exposed you to almost twenty times that in damages.
That is why you must always have in your contracts a clause disclaiming consequential and incidental damages and limiting your liability to, say, the cost of the part or the cost of the job. It can be as simple as including that term in standard terms and conditions on the back of your standard invoice (be sure to include those on all electronic invoices and on your website, too). A limitation on liability clause is the cheapest insurance you can get against unforeseen legal exposure.
*Provided as an example only. Consult with a lawyer familiar with your business and jurisdiction to ensure effectiveness of such a clause to your situation.
About the Author: Steven T. Lovett is a partner with the law firm Stoel Rives LLP. Based on Steve’s partnership with the RVCF, he’s happy to provide free initial consultations to RVCF members. Steve focuses on commercial disputes between competitors and within the supply chain.