Using contracts to control financial exposure

24/03/2011

By Henar Dyson, Senior Associate in Corporate & Commercial

All businesses should consider if there is scope in their contracts for controlling potential financial exposure to customers.

When contracting, a business accepts certain responsibilities, for example, to deliver products or services to a certain standard. If the business falls short of the required standard, it could face claims for financial loss from its customers. One way of dealing with this is to seek to limit by contract the amounts recoverable by any customer bringing a claim.

What liabilities can be limited?

The most common types of liability are for:

• breach of contract, for example, where a supplier contracts to deliver goods, but the goods are damaged or faulty;
• negligence, for example, where a professional agrees to provide advice, but performs below the standards expected;
• misrepresentation, where untrue statements are relied on by a customer, inducing a customer to agree a contract.

Other types of liability can be limited, but the limitation must be reasonable in order to be effective. For example, if the strength of the bargaining position of each party is relatively even, with both sides advised by lawyers, the limitations are more likely to be reasonable.

Where a contract is between a business and a consumer, there is less scope for a business to limit its exposure.

What liabilities cannot be limited?

Total exclusions of liability should be avoided as they are regularly found to be ineffective, leaving the supplier exposed.

Liability cannot be limited for loss resulting from:

• breach of certain terms implied into the contract by law, for example, that the seller owns the goods being sold;
• death or personal injury caused by negligence;
• fraud or fraudulent misrepresentation;
• damage to property or injury caused by defective products used by consumers.

Steps to take

Exclusions and limitations of liability are complicated contractual provisions. Whilst each matter must be considered on its own facts, here are some general tips to bear in mind:

• do seek to include limitation clauses, where practicable, but obtain appropriate legal advice when drafting them;
• fully consider the likely exposure of your business if something goes wrong - draft the clauses accordingly;
• include an overall limit on liability that is no less than the value of the contract. If it can be linked to insurance cover, it is more likely to be reasonable;
• provide alternative remedies in the contract, for example, replace or repair faulty goods;
• ensure that there is a good customer care procedure operating in the background. Train staff not to admit fault and to be diplomatic.