Negotiating a Vendor’s Limitation of Liability Clause
When clients come to me to consider suing because of a tech deal that has gone bad, the single worst lawsuit killer is often the “standard” limitation of liability clause found in a vendor’s form agreement. It never ceases to amaze me how people don’t pay attention to these clauses as they blithely sign-off on a one-sided agreement. It’s just one little clause and yet it can cause so much damage.
Here’s an example of the type of provision that you’ll see in tech agreements:
“The liability of vendor to customer for any reason and upon any cause of action related to the performance of the work under this agreement whether in tort or in contract or otherwise shall be limited to the amount paid by the customer to the vendor pursuant to this agreement.”
Yes it’s heavily slanted in favor of the vendor—it’s the vendor’s form. I draft them just as one sided when I’m representing a vendor so that I protect MY client. As I always say, he who drafts sets the agenda.
Judges Can Read
Now, if you sign off on a clause like that because you figure that your lawyer will find some technicality to overcome it later when a problem develops then I’d say to you, don’t depend on it. As a generalization, the clause means what it says and says what it means. Judges can read and will probably enforce it as it’s written. Judges are not in the habit of rewriting commercial contracts.
That’s your job when you’re negotiating your deal.
It’s the Norm
When you negotiate your agreement and tell the vendor that the limit of liability has to go, you’re likely to get a blank look. You know, it’s the same look you get from your kids when you remind them that they haven’t given you your change after you sent them off on an ice cream run.
I know that what I say when I represent a vendor and the other side pushes back on the limitation of liability clause being so slanted in the vendor’s favor. I say things like “Limits of liability are the norm.” “Everybody uses them.” “We’ve never done a deal without one.” “We’d have to increase the price dramatically because of the additional risk we’d be assuming.”
Ironically, all of this is true. So, we’re done, right? Wrong. A skilled and experienced negotiator can make all the difference here.
While it is to some extent the norm to see limits of liability in tech, telecom, and outsourcing deals, it’s not necessarily true that they’re all as onerous as my example. While getting the vendor to remove it completely may be like climbing Everest, making it fairer isn’t necessarily as hard if you ask for the right things.
If your vendor won’t eliminate the limit of liability provision, you start by pecking at it. There are many way to do this, some of which I briefly discuss below.
In my example, the vendor’s liability is “limited to the amount paid by the customer to the vendor pursuant to this agreement.”
Let’s say we have a $5,000,000 deal cooking, which calls for 24 equal payments over 24 months as work progresses. Let’s say that after the first month it becomes clear that the work they’re doing is causing more harm than good, so you rightly refuse to make your second payment. Finally, let’s say that they’ve somehow caused damages worth $1,000,000.
You might think that you could successfully seek damages of up to $5,000,000 (the amount that’s going to be paid to the vendor pursuant to the agreement). However, you are not likely to prevail because you’re limited to the amount you’ve paid to date-- i.e. a refund. So, as written, no matter what they do and no matter how bad it is, the most you get is the amount you’ve paid to date (one month of fees in our example). They risked nothing!
My first attempt to chink their armor would be to ask them to limit liability to the total value of the contract to them ($5,000,000), not the amount paid to date. Failing that, I might ask for some multiple of the amount paid to date.
However, these two examples above assume that the vendor’s total liability to you will nicely match the total value of the contract to them. That’s unlikely, so you should also consider asking for a multiple of the total value to them. You know the scope of what they’re providing to you, so put some thought into all the ways they could potentially harm your company while providing goods and services to you. How high does that number go? Ask for it or something even higher and then negotiate downwards as appropriate.
Another approach is “reciprocity.” In fact, I’d say that no single word is more important in moving a one-sided agreement toward the middle than reciprocity. What’s good for them is good for you. Don’t be embarrassed to ask. They certainly weren’t embarrassed to make it one-sided to their advantage.
The idea is that the most that they can ever recover from you is equal to the most you can recover from them. Why should they have a protective limit, but not you? They won’t like that, but it’s hard to argue against the proposal’s inherent fairness. Still, they are likely to ask for an exception from the liability cap for the fees you owe them. In most cases, that’s fair.
Yet another approach is to create exceptions or “carve outs” for the vendor’s liability on several issues. The most important is often creating an exception for infringing intellectual property. In the example as written, if they “create” software for you and you are sued for millions for infringing some third party’s copyright, you pay unknown millions. Then when you seek indemnity, you find that your indemnification is limited by the limitation of liability provision to a fraction of what you paid to the third-party. That's fundamentally not fair.
Another common carve out is an exclusion for any third party’s property damage or bodily injury claim. As with the copyright situation, it seems inherently unfair that you should pay unlimited amounts of money to a third party because of something your vendor did, but then your recovery is limited by your contract.
Yet another common carve out is an exclusion from the limitation of liability relating to your vendor’s breach of their (hopefully heavily negotiated) IT security and privacy obligations in the agreement. If your vendor suffers a data breach and your customer’s personally identifiable information winds up on the Internet, your vendor should be on the hook for the total amount of damages, not some arbitrarily capped amount. Cleaning up the situation is going to be hard enough. If you’re also out of pocket for something the vendor did (or didn’t do), it only makes things worse.
There are a lot of other common exceptions to pursue during your negotiations. Vendor’s breach of confidentiality, indemnity obligations beyond intellectual property infringement, gross negligence, recklessness, willful misconduct, intentional breach of the agreement, violation of law, or obligation to provide you with credits under the agreement. However, you won't get them if you don’t ask for them.
It’s almost a waste of time to put effort into negotiating a contract to have it emasculated by a one-sided limitation of liability clause. Don’t let that happen to you. While it may be true that these types of clauses are “normal,” don’t assume that the one in their proposed agreement has dropped from the heavens as the only way it can be.