Introduction
Down toward the bottom of a Service Agreement, it is common to find a few provisions in ALL CAPS that reads like an excerpt from a legal dictionary. These clauses are as important as they can be impenetrable.
This section breaks through the jargon with the information you need to know and how to better negotiate these clauses.
Limitation of Liability
Limitations on the Types of Liability
One of the clauses you’ll want to keep an eye out for is a limitation on the types of liability the contract parties can be held responsible for. A typical clause reads something like this:
It’s tough to parse, but this clause says that if there is a lawsuit, the Client cannot be liable for certain types of damages, namely, indirect, special, incidental, consequential, exemplary or punitive damages. Put another way, this clause ensures that liability is only determined with respect to the contractual bargain and not other business consequences (many of which may not be foreseeable).
By way of example, if you order a steak medium-rare and it arrives well done, a clause like this means your remedy is either to have the steak redone or taken off the bill (the bargain). You don’t get to sue the steakhouse for a weekend’s worth of lost enjoyment and punitive damages for over-cooking your steak.
Now let’s talk about a few negotiating points:
- Mutual. It is totally acceptable for this clause to apply to both Agency and Client. If it is one-sided favoring Client, you have an easy edit and a good argument to make this work both ways. This is a key issue and appears on our .tl;dr Ten Key Issues
- List of Damages. Look for the list of excluded damages to include indirect, special, incidental, consequential, exemplary, and punitive damages. The sample language above contains all of these types of damages. This is appropriate. Relatedly, make sure the list includes lost profits. The sample language above is missing this important limitation.
- Notice Ineffective. Ideally, you’d like to see a clause that states that the limitations apply even if the liable party has been advised that such damages are possible.
- Make Conspicuous. Finally, these provisions generally need to be “conspicuous” to be enforceable. To most lawyers, this means written in ALL CAPS. While this was the only way to do it when all we had were typewriters, we fortunately have choices now. Bold text, larger text, text in a shaded box are equally conspicuous. I’d avoid betting on just italics to make something conspicuous.
This clause serves the important purpose of limiting the scope of potential liability the contract bargain struck by the parties and not some other theory of liability.
Limitations on the Amount of Liability
With or near the clause limiting the types of liability is often a clause limiting the amount of liability. Like limitations on the types of liability, this important clause appears on our
Clauses limiting the amount of liability are important to ensure that the scale of responsibility under a contract isn’t out of whack. For example, it is entirely possible for a small, three-person Agency to do design work for a Client like Apple, Nike, or Facebook. The scale of the Client in these situations is completely out of proportion to that of the Agency. If something went haywire, the scope of damages for a company like Apple, Nike, or Facebook could be astronomical. A clause like this right-sizes potential liability to an amount appropriate for the scope and nature of the work.
The amount of the liability cap is the key negotiating point. The following are typical points along a range from most Agency favorable to least Agency favorable along with a couple general negotiation points.
- Profits. The most Agency-favorable cap would be to limit damages to the profit portion of Agency’s fee. Should the worst happen and you end up paying damages, at least you break-even on the project.
- Fee. The next most favorable cap for an Agency is to set it at the total contract fee. This is probably the most typical cap. For longer term contracts, its typical to set the cap at the total fees paid over some period, 12 months is typical.
- Insurance. The next point on the spectrum would be to cap damages at the amount of available insurance. Depending on coverage limits, this might be a lower cap than the fee. If you do set the cap based on insurance, the Agency should be sure to describe it as the amount of insurance collected by Agency. This way, if insurance doesn’t pay or pays a limited amount, the cap is limited accordingly. A cap tied to insurance is less common in my experience.
- Fee Multiple. Next on the spectrum is a cap at some multiple of the fee. Keeping the multiple lower is your goal here. Don’t limit yourself to whole multiples of the fee: a 1.5x multiple is better than a 2.0x multiple. Also, the point above about stating the cap as a multiple of fees collected applies equally here.
- No Cap. Obviously, this is the least favorable to an Agency. A contract without this type of clause arguably has no cap.
- Make Mutual. Like limitations on the amount of liability, it is completely appropriate for the clause to benefit both Client and Agency. Do not accept a one-sided limitation of liability clause that only limits liability for Client. Also, if it is a mutual cap on liability and the cap is set at fees paid or profits, be sure the clause makes clear that Agency’s ability to collect its fee (and possibly attorney fees) is not also capped (see example below).
- Keep Conspicuous. Also, like other liability limitations, this clause should be “conspicuous”. I recommend bold text.
Clients are in a much better position (and are differently motivated) to manage liability for the scale of their business. Use these tips to ensure that Agency isn’t unfairly shouldering liability for the scale of Client’s business (something over which Agency has no control).
Limitations on Limitations
With both types of liability limitations, more sophisticated Clients will ask for a list of carve outs: certain things that the limitation doesn’t cover. The following is a typical list of the exceptions a Client might request (all of which are reasonable):
- indemnification obligations (most notably, infringement indemnification);
- Breach of warranties regarding non-infringement
- breach of confidentiality obligations;
- breach of provisions regarding Client’s data confidentiality and security requirements;
If the limitation of liability clause presented to you contains these exceptions, you’ll have a hard time getting them removed. If the clause does NOT contain these exceptions, you are typically better off not offering them. Even on a mutually limitation of liability clause, the exceptions generally work to Client’s benefit rather than Agency. But critical with an indemnification exception is to ensure that you've properly negotiated the indemnification clause especially regarding intellectual property. See this the section about Intellectual Property Indemnification.
Sample Language
A fairly negotiated limitation of liability provision incorporating many of the above recommendations might read like this:
Disclaimer of Warranties (AS IS Provision)
A typical warranty disclaimer looks something like this:
The purpose of the AS IS clause is quite simple: to ensure that only the express, written warranties (i.e., promises) about Agency’s work are the ones being relied upon by Client. This isn’t Agency disclaiming the quality of its work. Rather, this is just the Agency saying, “if you want specific promises about our work, let’s put them down in black and white” (instead of wondering what some judge may infer).
Sometimes warranty disclaimer looks like this:
The words “AS IS” are equivalent to the words “DISCLAIMS THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE”. Sometimes the clause contains both formulations. This handbook refers to both as the AS IS disclaimer.
A few thoughts when negotiating the AS IS clause.
- Be Sure It Is Included. The primary negotiating point is to ensure the clause is present. This is one of the other critical provisions from the tl;dr Ten Key Issues
- Mutual. Its ok for this clause to be mutual. To be sure, the clause is of less importance to the Client since they typically aren’t providing the Agency goods and services. But hey, if the Client agrees to including the clause simply by making it mutual, go for it.
- Title. You’ll sometimes disclaimer of the “implied warranty of title”. Removing that language is a fair thing for the Client to request. If you must give up the reference to title to keep the AS IS language, that’s an OK trade.
- Noninfringement. You’ll also sometimes see this clause attempt to disclaim the “implied warranty of noninfringement”. A Client won’t like to see disclaimer of non-infringement. Better than trying to add a noninfringement disclaimer to the AS IS clause, you should see the sections about andIntellectual Propertyfor ideas how to address these issues.Indemnification
Remember, the purpose of the AS IS clause is to limit the scope of promises about the quality of services and deliverables to only those written in the agreement. If Client pushes back about a warranty disclaimer, the proper response is to ask the Client what specific warranties the Client is looking for. Once the client identifies those things, you can discuss whether the Client’s requests are appropriate for the situation and document them accordingly.
A very simple AS-IS clause might read like this:
Conclusion
Limitations on liability and warranty disclaimers are powerful protections for an Agency. If your client refuses to include either or both provisions, that doesn’t mean the deal is off. Rather, you need to make a business judgment.
If you have a good relationship with the Client, the work is routine, and the project low-risk, then you may not be giving up much by losing these clauses. However, if the work is complicated or if the Client is difficult, these clauses can be extremely important. Doing custom back-end development for a Fortune 500 businesses or venture backed startup is certainly higher risk than a rebrand and website for local retail chain.
Lastly, if you can’t get the provisions you want, remember the point we made in