Negotiating Big Client Company Agreements for Emerging Companies – Part 3: Spotting Unfair Liability Clauses During Negotiations
Note: This conversation has been organized around dealing with ‘big’ clients. But many of the lessons apply to large, important vendors.
When it comes to drafting a contract with a client company, you want to be sure you’re covered in cases of legal liability. Legal liability, in short, is basically the legal responsibility to pay for another person's financial loss or harm. But since the client company is also looking out for their best interests, you’ve got to be sure to keep an eye out for unfair and one-sided terms.
Today we’re covering the issue of liability when it comes to unreasonable clauses in client contracts and what in particular you should look out for.
No Standard Disclaimer of Warranties Provision
What is this? There’s no clause disclaiming the inclusion of any warranties (i.e., promises you make about yourself or the goods et al you will provide) except those that are expressly written out in the contract.
So what does that mean and why is this unfair?
Over centuries of legal decisions, courts have established that there are certain promises (“warranties”) that a seller of goods or provider of services is presumed to make even if the applicable contract includes no language to that effect – these are known as “implied warranties.” Importantly, you can exclude these “implied warranties” from commercial contracts if you have clear language to that effect - typically known as a “Disclaimer of Warranties” provision.
The two most important implied warranties are (1) the warranty of merchantability and (2) the warranty of fitness for a particular purpose. The implied warranty of merchantability means that whatever goods you provide must reasonably conform to an ordinary buyer’s expectations – i.e., they are what you say they are. The implied warranty of fitness for a particular purpose means that the buyer (your client) can rely upon you providing goods that fit the specific needs and requests they have communicated.
Both of these implied warranties are, on their face, reasonable – you can understand why courts came up with these rules. BUT these implied warranties are also vague enough that they can give a client – especially if they have an experienced lawyer – lots of legal ammunition about why they shouldn’t have to pay your invoices or even why they have the right to sue you for damages if they are not satisfied with what you’ve provided.
As a result, when you are dealing with contracts between businesses, it is extremely standard to include a Disclaimer of Warranties provision so you do not have to take the risk of these vague, easy-to-abuse implied warranties. In other words, if a client wants you to be on the hook for something, it is industry standard that they have to actually write out in the contract what promises they need you to stand behind.
Unfortunately, however, sometimes big (and smaller) clients try to be clever by giving their vendors and suppliers a contract that doesn’t have a Disclaimer of Warranties provision. In that case, you should push back and say, “no, this is what we need – and there should be no problem with our ask here since a Disclaimer of Warranties provision is absolutely standard.”
No Exclusion of Non-Direct Liabilities Provision
What is this? Indirect damages means the damages resulting from all the knock-on effects from a contract breach on the non-breaching party – in other words, all the non-immediate consequences that might happen.
For example, if a software developer has a contract to repair a broken website by a certain date and fails to meet that deadline, the indirect damages to the client could arguably include the value of all the lost business from visitors to the client’s website who were very unimpressed by the still-broken website. It can also include other kinds of non-standard damages such as punitive damages – where a judge or jury thinks the defendant acted so badly that an extra penalty should be imposed.
When a contract does not exclude your liability for indirect damages, you can be sued – and found liable – for amounts of damages that are way out of proportion with the actual fees you charged and profit (if any) you might be able to make. For instance, the client could try and sue you for $300k in connection with a contract where your business makes $50k to do the work. And the total amount of these damages can devastate or destroy a young company. More commonly, this much bigger “threat” gives the client a lot more leverage in any negotiations you have in connection with any commercial dispute.
Because of these consequences, it is very standard to have a clause in a commercial contract that excludes all these “indirect” damages, either altogether or (more commonly) with a few justifiable exceptions – e.g., breach of confidentiality obligations, breach of data protection obligations, or for your team’s gross negligence or wilful misconduct.
Why This Is Unfair: A provision of this nature is standardly included in all commercial contracts (usually with a few exceptions as I mentioned). However, it is very one-sided when this provision is missing altogether, usually because of the massive potential liability your business would otherwise have.
No Exclusion of Non-Direct Liabilities Provision
What is this? There’s no cap on the amount you could be liable for.
Why This Is Unfair: It is commercially standard for there to be a liability cap included in a commercial agreement. So, it’s definitely one-sided and unfair when that provision is not included.
As you can imagine, unlimited liability exposes your business to potentially ruinous financial risks. Language in a contract about the limit of liability is commercially standard and should always be expected in a contract.
This is why most serious commercial contracts include a cap. Typically, the cap is the amount paid or payable to you (the vendor) in the 12 months leading up to whatever event gave rise to the client taking legal action against you. However, sometimes this cap is 24 months or 36 months. In other cases, it is a hard number (e.g., $1 million or $2 million). (Sometimes, it’s a mix: for example, amounts paid and payable in the preceding 12 months except that there is a $2 million cap for a lawsuit arising from your breach of your data protection obligations.)
As with any provisions concerning the exclusion of indirect damages, there are exceptions that can be expected, but those exceptions should be stated clearly and agreed upon in the contract. The most common exceptions from any cap are (i) if you do not comply with your confidentiality obligations, (ii) gross negligence or wilful misconduct by your team or (iii) any amounts you might have to pay in connection with any obligation you have to indemnify the client against various risks like third-party lawsuits resulting from something you did in breach of your contractual obligations.
Limitation of Liability Language that Only Protects the Client, Not Your Business as well
What is this? Sometimes these contracts are written so that any language that limits a contract party’s amount of liability only applies to the client and not also to you as the service provider/supplier/vendor.
Why This Is Unfair: At the end of the day, your business – the smaller supplier/vendor/service provider dealing with the much larger client – is the side of the deal that actually needs these limitations of liability. The reality is that, unusually, when suppliers, vendors, and service providers sue clients, it’s because they have not been paid for what they provided. Because a contract usually is clear on what amount(s) should be paid, it’s hard for the smaller company to try and make a convincing case that they deserve some much larger amount.
Missing a Prevailing Party Clause
What is this? There is no clause stating that the prevailing party in a dispute will have their legal fees covered (i.e., a “Prevailing Party Clause”). This is something you need if your contract is governed by US law (other countries like England and Canada actually have different default rules on this specific point if a contract is silent on the matter).
Why This Is Unfair: Even if you can 100% for sure win your lawsuit, the legal cost of the process may make it a completely unaffordable process. Litigation is expensive, so this can often be the easiest way big companies can make sure they can treat little companies unfairly – without it, the bigger party to the contract, with its big in-house legal team and its much bigger legal budget, is incentivized to make things as slow and expensive as possible until you simply have to give up.
To be clear, a Prevailing Party Clause can work to benefit either side to a contract (so be careful there!). But for smaller companies, legal disputes often center around the fact that your business has done the work, delivered the goods, and never got paid. So, a Prevailing Party Clause signals to the other side that ignoring your phone calls and emails about those overdue invoices won’t ultimately work because, in the end, when you sue and win, they’ll have to pay for all the legal time they made you invest in lawsuit you had to file.
The Bottom Line
Every company wants to protect their best interests. That’s why it is essential to go over each and every contract you sign to ensure that you aren’t being taken advantage of. No matter how big or small your client is, you can afford to push back where necessary in order to protect your interests.
In our next blog, we’ll cover expectations around deliverables.
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Disclaimer: This article constitutes attorney advertising. Prior results do not guarantee a similar outcome. MGLS publishes this article for information purposes only. Nothing within is intended as legal advice.