Demystifying Contract

Article Written By: Manilla

In the last few years, the pressure on the technology companies to perform has been tremendous which has resulted in over promising. Added together the environment of high stakes and less tolerance, the risks for the technology companies have grown manifold. It is in this context that contracts and the risks assumed innocuously in those contracts become paramount to identify and effectively manage them, so that it does not explode.

The confidence in managing and negotiating contracts comes from understanding the essential ingredients of contracts and mastering the fundamentals. It is in this effort that we are going to add one permanent features into our Legal Primer namely demystifying contracts wherein we intend to pick up one aspect of contract and deal with it briefly for better understanding of do's and don'ts associated with it. We have picked up one of the most talked about contractual clause LOL” which comes into discussion in almost every valuable contract negotiation.

A LOL clause is a provision in a contract that limits the amount of exposure a company faces in the event a lawsuit is filed or another claim is made. We all must have come across clauses like this: "In no event shall either party be liable for any consequential damages or that, in no event shall the direct damages shall exceed such and such amount.” Such clauses may take varied forms, some simple, some complex but all are intended to achieve twin purposes (a) excluding liability of the company from indirect damages (b) limiting the liability from direct damages within agreed limit.

Simplifically put, LOL permits contracting parties to reduce the potential for consequential, special, incidental and indirect damages and put a cap on direct damages should there be a breach of contract. LOL typically limits the liability to one of the following amounts:

(i) the compensation and fees paid under the contract

(ii) an agreed upon amount of money

(iii) available insurance coverage

(iv) a combination of two or more of the above.

1. The debate with regards to LOL clauses has been whether these clauses are enforceable. In light of catena of judgments across various jurisdictions, it has been found that by and large, law does permits the parties to negotiate such clauses; however the willingness of court to enforce the LOL clauses varies from one jurisdiction to another. The adverse jurisdiction views such clauses as an attempt to shift responsibility and bargain away legitimate liability therefore they put such clauses under much more rigorous test than neutral jurisdiction which accepts LOL as part of freedom of contract for the parties decide and agree. Since incurring liability on breach of contract is general rule and LOL comes as exception to the general rule, court in general and courts in adverse jurisdiction in particular (US courts more particularly Alaska ) usually are very strict when it comes to enforcement and in many cases it may refuse to enforce on following ground:

(a) The agreed amount is too low and unreasonable

(b) The parties' intentions were not clearly expressed.

(d) One party had unequal bargaining powers or a higher level of sophistication or it is against the public policy.

2. It should further be noted that LOL clause may not be able to cap the liability if it arises on account of certain unacceptable exclusions such as (a) personal injury (b) death (c) fraud (d) criminal act (e) fraudulent misrepresentation (f) Gross negligence (g) malafides.This position is, by and large, true with almost every major jurisdiction. In certain jurisdiction, if LOL is too broadly worded so as to include liability arising on account of any of the above unacceptable exclusions, the entire LOL clause runs the risk of being declared void. This trend is more particularly witnessed under civil jurisdiction such as Germany, Austria, Belgium, Denmark, Finland, Portugal, Spain etc. Thus there is need that LOL clauses be broken up into two to three sub parts so that if one part is declared void, rest part survives unaffected.

3. Apart from the above unacceptable exclusions, it has been seen that customer invariably ask for exclusion of breach of confidential information”, breach of third party IPR”, breach of warranty” and indemnity” from the purview of LOL. Suffice it to say that such exclusions have nothing to do with law but are subject matter of contract negotiation. Every company has its own risk appetite and based on the same, they negotiate on all these issue.

Why LOL:

(a) It is most potent tool to derisk the company from contractual liability should anything goes wrong during the performance of the contract. Without LOL, liability can take any astronomical figure and whole risk and award paradigm of business can threaten very existence of entity.

(b) Requirement of LOL in contracts is essentials from insurance perspective as well. We have Error and omission insurance which excludes onerous agreements from its application. Absence of LOL in our contract may be viewed by insurer as acceptance of onerous clauses which may be ground to deny our claim, in case any such claim arises.

How to enhance chances of its enforceability:

Taking totality of issues associated with LOL across various jurisdictions, it is advisable to take following care in drafting and negotiating LOL:

(a) It should be concise and unambiguous.

(b) It should be written in bold or capital letters so as to lend it a distinctive look and feel from rest part of the contract. This would help to avoid possible argument from opposite party that he did not have notice that agreement contained LOL.

(c) Exclude unacceptable exclusions” from purview of LOL such as liability arising from personal injury, death, fraud etc.

(d) Break LOL into two to three sub parts so that in case any one of the part is declared unenforceable, rest part still survives

(e) Follow suggestions of certain American lawyers who suggests that follow practice of mentioning (in bold) on the front sheet of contract itself that The agreement has LOL clause” .This would can lend enough robustness to LOL clause to sail through rigorous of its validity test on many counts..

LOL clause is by and large enforceable across all jurisdiction (except perhaps Alaska, US). All it requires is to be reasonable with the caps, respecting unacceptable exclusions and its inclusion in the agreement at prominent place and in prominent manner. Safekeeping history of records of negotiation is much desirable. IT contracts invariably are business critical contracts and liability for error could be huge hence it is MUST to have LOL clause in every services agreements. Any exception on this can only be taken at appropriate level as per Legal manual. Risk mitigation doctrine mandates that agreements without LOL must be on radar of top management at every stage of its subsequent negotiation or renewal hence and fresh sign off is taken in case such agreements comes up future renewal.

About the Author

Myself Manilla - law firms in India and intellectual property law firms in india

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