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Limitation of liability clauses – never-ending nuisance or a smart move?

Blogs July 14, 2016

An agreement has already been reached on the product, price and schedule in the commercial negotiations. Names on the paper and the deal is done – the finish line looms already! Now just send the draft agreement to the customer for review and get the signing bubbly cooling.

Business Legal Agreements

Balancing commercial risk and business objectives

Not so fast. The draft agreement returned by the buyer contains lots of edits: “we still need to exchange ‘a few words’ about the limitations of the seller’s liability” , the buyer says.

Direct and indirect damage, consequential damage, limitation of liability, a liability cap. These terms usually pop up during commercial contract negotiations between two companies, when the discussion turns (sooner or later) to limitation of liability clauses - that is, conditions under which a contracting party seeks to limit its liability for a possible breach of contract. The following two main questions tend to arise:

  • Should the liability be limited in respect of so-called consequential/indirect damage?

  • Should the liability be capped to a certain euro amount?

In the context of sale of goods, the majority of obligations focus on the seller and thus the seller also has a greater interest in negotiating limitations of liability: a smart seller ensures that the terms and conditions of its procurement and sales contracts are in line with each other, and that the remaining commercial risk is reasonable in relation to the company’s business objectives. Typically, the seller wants to exclude liability for so-called indirect/consequential damage, because such damage is difficult to predict and carries extensive liability. For example, loss of profit arising because a contract with a third party has been lost or breached, and damage arising from the fact that the buyer has not been able to use the purchased goods in the way intended, are considered indirect damage under the Finnish Sale of Goods Act (355/1987). According to the Finnish case law (Supreme Court:2014:61), liquidated damages paid by the buyer to its own contractual partner due to delay are also regarded as indirect damage in connection with the seller/buyer relationship.

Following the limitation mentioned above, so-called direct damage remains within the scope of the seller’s liability. Direct damage is not defined as such in the Finnish Sale of Goods Act, but has been interpreted to include, for example, investigation costs incurred due to a breach of contract, additional transportation and storage costs, as well as costs arising from correcting a defect and additional costs arising from purchasing the goods elsewhere.

Limitation of liability clauses

Often, the seller also wants to limit its overall liability by agreeing on a liability cap of a certain euro amount, or by tying the maximum liability to the value of the contract or a certain part of it. This makes the risk relating to the contract more concrete. However, it is worth noticing that limitation of liability clauses are not absolute: a contracting party cannot, for example, rely on a limitation clause if the party is deemed to have caused the damage intentionally or by gross negligence. The parties may also agree that limitations of liability do not apply to all breach of contract situations – for example, in case of a breach of confidentiality.

Using appropriate limitations of liability in commercial contracts is a part of doing careful business and a way to manage the company's commercial risks. It is not only important what is sold and at what price, but also what kind of terms and conditions are related to the deal. Each deal-related risk has its price tag, which can be much greater than the price of the product sold under the contract.