Limitation of Liability Provisions in Contracts

by Robert Goodman

Provisions can severely restrict damages to which customers may be entitled…review with Care.

Carlos owns a clothing store (“Clothing Incorporated”). Clothing Incorporated entered into an outsourcing agreement with Software Worldwide to facilitate e-commerce purchases of Clothing Incorporated’s clothing lines.

A billing dispute arose between Clothing Incorporated and Software Worldwide, which escalated into a war of words between Carlos and the President of Software Worldwide, Simply Bleeker. Ultimately, Simply directed that Software Worldwide suspend Clothing Incorporated’s access to Software Worldwide’s platform, resulting in several days’ worth of lost business, resulting in lost profits.

While the Agreement between Clothing Incorporated and Software Worldwide described situations in which Software Worldwide could suspend access to its platform, a billing dispute was not one of them.

Angry about Software Worldwide’s intentional conduct, Carlos reviewed the software licensing agreement between Clothing Incorporated and Software Worldwide to see if his company could sue Software Worldwide for lost profits. He encountered the following provision:

“Except for any claims against Vendor arising out of its alleged gross negligence or willful misconduct, the amount of damages to which customer may be entitled shall be limited to the licensing fees paid to vendor over the six months’ immediately preceding the accrual of customer’s claim. Except as stated in the previous sentence, customer shall be precluded from being awarded consequential or indirect damages, including lost profits.”

Puzzled by this limitation of liability provision, Carlos approached his trusted attorney, Saul Goodman (who knows everything), for advice. Saul’s take was the following:

Where parties to a contract negotiation have relatively even bargaining power, courts will, generally, enforce the terms of a resulting agreement, including a provision limiting the potential liability to which a party may be exposed, the precondition being that the language of the provision is clearly identified in the Agreement. Very often an exception to a liability limitation is where the conduct is particularly egregious, amounting to “gross negligence” or “willful misconduct.”

If these terms are not defined in the agreement, courts will look to the governing state law to find out how the terms are defined. But defining these terms by trying to ascertain the local law may not be an easy task as definitions can vary from state to state. Saul looked to the forum selection and choice of law provisions of the Agreement between Clothing Incorporated and Software Worldwide to conclude that New York law applied.

While the terms “gross negligence” and “willful misconduct” appeared in varying contexts in New York case law, Saul concluded that the central concept behind grossly negligent conduct was that it was conduct that evidenced a failure to use even slight care or conduct that is so careless as to show a complete disregard for the rights and safety of others. “Willful misconduct” occurs when a person intentionally acts or fails to act knowing that the conduct will probably result in injury or damage.

Referring to a commentator on New York law, Saul alerted Carlos to a case involving a software developer who also alleged improperly terminated software services damaging the customer. It was reported in that case that the court held that such conduct did not rise to the level of gross negligence or willful misconduct under New York law because physical harm or damage to property was not implicated. The court admonished that the best practice was for the parties, themselves, not the courts, to define the contours of their limitation of liability provision.

A commentator on Illinois law, likewise, noted that the problem with the parties’ leaving the definition of these terms to an analysis of local law was that precedents could be decades old. For example, under Illinois law, the definition of “gross negligence” still contemplated the reckless disregard of a person’s safety and the safety of others. Would the reckless termination of a software service constitute “gross negligence” under such a standard? Maybe not.  Moreover, determining such a question could require a trial before a judge or jury, a process that may neither be swift nor inexpensive.

The Takeaway:

  • Limitation of Liability provisions are generally enforceable so parties should not ignore them.
  • Where parties agree to exceptions to the application of such limitations, i.e., exceptions like conduct rising to the level of “gross negligence” or “willful misconduct,” ideally, these terms should be defined in the agreement. For example, if the unjustified termination of a software platform is intended to constitute willful misconduct or gross negligence, the definition of these term should clearly cover such conduct.
  • The risk of deferring to state law in defining exceptions to limitations of liability provisions is that state law may defer to outdated definitions that fail adequately to consider innovations in commerce, including the risks associated with the use of software platforms.

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