Limitation of liability provisions are standard in almost every contract and are essential in helping the contract parties limit their risk. These provisions typically contain a broad disclaimer of consequential damages and a cap on direct damages; however, it is common practice to exclude certain types of damages from such disclaimers and/or caps.
The reason certain exclusions are commonly accepted (as negotiated by the parties) is that if certain damages were not excluded or “carved out” of standard disclaimers of and caps on liability, certain breaches of the contract would have either no remedy or a substantially inadequate remedy. For example, most liability provisions limit liability for incidental, punitive, indirect, special, exemplary, extraordinary, or consequential damages or lost profits, and cap liability at a fixed number—e.g., the amount of fees paid under the contract (during an agreed upon time period), or the amount of fees paid under the contract for the event giving rise to such liability (during an agreed upon time period).
If a contract contains disclaimers and limitations similar to those set forth above, the parties should consider excluding or “carving out” the below provisions from such disclaimers and limitations for the following reasons:
- Confidential Information and Breach of Data Security Obligations: If confidential information is disclosed despite the confidentiality obligations and restrictions in an agreement, the confidential information may lose its inherent confidentiality and related protections. For instance, if proprietary information or trade secrets are disclosed by a party, it is unlikely they could get put back in the proverbial “box” and retain such protections. In such an instance, the damages could be large. If a limitation of liability provision excludes recovery for consequential damages (which is the most likely type of damage upon disclosure of confidential information), the disclosing party will not be able to recover any damages if the other party breaches its confidentiality obligations under the agreement. If a party breaches its data security obligations, and sensitive information is accessed or disclosed, the resulting damages could be considered consequential damages and could also be much greater than the negotiated cap on liability. Therefore, breach of such provisions should also be considered when negotiating carveouts to limitations of liability. The receiving party generally wants to limit and/or cap its liability in the event of a data breach since the potential damages are so great, but the standard limitations are often not rationally related to the potential damages in connection with a data breach, so this point is often negotiated. Based on the above, it is common for parties to carve out breaches of the confidentiality obligations and data breach from the limitation of liability provisions, although if the potential damages are large, the parties often agree to a “supercap” or higher cap on damages for such breach, which offers a middle-ground approach for the parties somewhere in between no damages and unlimited damages for such breach.
- Intellectual Property: Similar to confidential information, if a party is not sharing any intellectual property or granting any intellectual property licenses under the agreement, carving such provisions out of the limitation of liability provisions is not essential. However, if a party is providing a license to its intellectual property, breach of the intellectual property ownership or license provisions could have an adverse effect on the licensor and should be excluded from any limitations on liability. For instance, if the licensee breaches the license restrictions, the liability to the licensor could be extremely damaging and costly. Since the damage to a party in this instance can be large, carving these provisions out of the disclaimer of consequential damages and/or the cap on damages can provide an adequate remedy in the event of a breach.
- Indemnification: Indemnification provisions act as a remedy for a non-breaching party against third-party claims brought against the non-breaching party based on something the party in breach is responsible for. Carving out indemnity provisions from a limitation of liability cap varies depending on what a party is indemnifying the other party for. For example, if a party is indemnifying the other party for infringement of intellectual property under the agreement, the party who is receiving the indemnification should carve out such provisions from the cap because third party claims are inherently consequential damages. Infringement cases can be extremely costly, and parties do not want to be responsible for costs to participate in disputes between the infringing party and a third party based on the use of such third party’s intellectual property if such party is using the intellectual property in accordance with the terms of the agreement it entered into.