Drafting Advice: Understanding Exemption and Exclusion Clauses
Types of Exemption Clauses
Businesses use contracts to govern sales of goods or services; however, every business knows that the risk inherent in each transaction does not end after payment is made and goods or services are delivered. The parties to a contract will each seek to restrict the amount of liability for which they are responsible through various contract terms, often referred to as exemption or exclusion clauses. These can be found under various headers, including “limited liability,” “limitation of liability,” “exclusion clause,” or “limitation clause.”
What is an Exclusion Clause
These clauses exclude or limit a party’s liability for the use of goods or services. While both parties want the transaction to go smoothly, goods or services may break in an unexpected way, causing party damage. Or, they may be used in a way unintended by the other party, again resulting in damages. Either way, exemption clauses are emergency clauses meant to outline what happens to each party when it all goes wrong.
Exemption clauses accomplish this purpose in several ways. Exclusion clauses eliminate a party’s liability for categories of damages or use. For example, a party can eliminate any liability for the use of the goods or services by the other party in a manner that is negligent or grossly negligent according to the terms of the contract. Or, a party could exclude all incidental damages. However, the types of whole-scale exclusions can result in heated negotiation and are often limited to only the worst of situations.
Limited liability generally refers to a damages cap or minimum. These can be the most hotly negotiated portions of a contract, especially when included in master agreements. However, they are included in almost every contract of importance. A damages cap limits a party’s damages up to a certain dollar amount, which can be expressed as either an aggregate amount (e.g. $2 million) or a percentage or multiple of deal value.
A minimum is an amount of damages that a claim needs to reach before the other party will assume liability for it.
These limitations can be tailored to suit almost any contract. For example, businesses can agree to super caps for certain essential claims and lower caps for less essential ones. Minimums can be aggregate (total claim value) or individual (for each claim) and can be either tipping (the business will assume liability for the entire claim, including the amount under the minimum) or deductible (the business will assume liability only for the amount over the minimum).
Finally, in addition to monetary caps, liability obligations can be limited in duration (e.g., claims will only be recognized up to five years after the termination of the contract).
Importance of Exemption Clauses in Contract Law
Incorporating these clauses into a contract can have long-lasting consequences for both parties. No matter the type of contract, whether MSA or M&A or any other, the right combination of exemption clauses can save a company a lot of money or put the company on the hook.
They can be make-or-break clauses. For example, in a merger contract, limiting environmental claims in duration could result in a buyer be on the hook for massive damages discovered after the deal is over that were caused by the seller. That could cause a company to go out of business.
Practitioners should familiarize themselves with these clauses, and the ways that they can use them to help or protect their clients. Knowledge and materiality qualifiers can be used to further exclude liability.
A proactive approach to mitigating potential fallout arising from breach of contract is to include an exclusion clause to incorporate into the contract. Liability clauses keep businesses safe from any financial ramification associated with a contract dispute. From a strategic standpoint having an exemption clause as part of the contract is always a good idea.
Advanced software can be used to find and quantify existing exemption clauses among a business’s contracts and ensure the right ones are included in your new contracts. For more information on exemption clauses or contract management software, reach out to professionals at Evisort. For more information about different types of contracts why not read this article about non-disclosure aggreements and how to draft them.
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