Insurance · 10 October 2016

Using a contract clause to reduce the risks in commercial transactions

contract_clauses
A contract clause can reduce or even eliminate the risks in commercial transactions

Our legal expert David Walker is providing his expert advice on all things contract law, dispute resolution and intellectual property. Step three involves a look at how a contract clause can protect firms in commercial transactions.

All commercial transactions can be risky, so you will want to reduce those risks as much as possible. There are many ways you can do this, for example you could put quality control systems in place to reduce the risk of mistakes occurring, to keep standards high and to keep clients happy. However, despite your best efforts, things may go wrong and if you can’t put them right to your client’s satisfaction, your client may try to sue you for compensation.

Defending a legal action will take up valuable time and resources, even if you win, so you should do all you can to limit your client’s ability to sue you. You should also take precautions to limit the amount that can be claimed by your client in the event that they win because losing a legal battle can force an otherwise successful company out of business.

In this article I will show you how you can reduce or even eliminate many of the risks you will face by incorporating three types of clause in your contracts. These are exclusion clauses, limitation of liability clauses and entire agreement clauses.

As you can imagine, this a huge topic. It’s also very complex and hotly debated through the courts so it’s impossible to cover everything here. We’re therefore just going to take a quick look at the situation from the supplier’s perspective in a business-to-business transaction.

Exclusion contract clause examples

As the name suggests, exclusion clauses exclude liability.

Adding a provision to your contracts excluding all liability, however it arises, is possible but it will probably be considered unfair and unenforceable if challenged by your client in court. This is because, quite rightly, our legal system doesn’t like to see an innocent party without any way of seeking compensation or redress for the losses they have suffered.

Therefore, you need to take a more reasonable approach. Instead, you could exclude liability only for specific risks where you cannot control the final outcome. For example, you could exclude all liability for any lost profits or anticipated savings your client thought they would make by having you provide your services.

Sometimes, you may wish to exclude your liability for negligence so your client’s only right to take action against you is for breach of contract. If you do, you must be very clear about this and specifically say so in the contract. However, if your negligence leads to someone being injured or even killed, you cannot exclude or limit your liability for this.

It’s a similar situation for defective products. If you manufacture or sell defective products and this leads to someone being injured or killed, you remain fully liable for the losses they suffer. You cannot limit or exclude your liability for them.

If you find yourself in a legal battle with a client, the damages they could potentially claim are huge and in many cases they could be enough to bankrupt a company. For an aggrieved client, this may even be their motivation so you need to protect yourself against this.

The reason why compensation claims can be so huge is due to the way damages for breaches of contract are calculated. If a client tries to sue you, they may not just want their money back, they may want to claim the profits they anticipated they would make following successful completion of your services. This could legitimately be many times the amount they paid for your services.

Limitation of a liability contract clause

Therefore, to protect your business you should put a cap on your financial liability to your client by including a limitation of liability clause in your contracts.

For example, you could cap your liability at a specific amount agreed between you. Alternatively, your liability could be capped at the amount paid for the services, or perhaps the limit of any insurance cover you are able to obtain.

In many cases, this is a preferable approach to take because a limitation of liability is often easier to negotiate with your client than a complete exclusion of liability. Also, the courts won’t take such a harsh approach to a limitation clause and are more likely to see it as reasonable and therefore enforceable than a complete exclusion of liability.

Entire agreement clause

The final type of contract clause I would like to look at is what’s called an entire agreement clause.

When you and your client enter into a contract, you may think it contains full details of all your rights and obligations. However, that’s not always the case. Your client may be given additional legal rights that are implied into the contract which you’re not even aware of. For example, the Sale of Goods Act implies various terms into a contract about products being of satisfactory quality and fit for purpose.

Most business don’t want their clients to be able to rely on these implied terms. They want to know for sure what they are signing up for, so they will include an “entire agreement” clause in the contract to exclude all of the implied terms as far as they can.

Another advantage of an entire agreement clause is that you can ensure that nothing you discussed during negotiations inadvertently gets incorporated in to the contract. I’ve known over zealous sales staff make all sorts of promises to close a sale so they can hit their targets even though the company has no chance of fulfilling that promise. Now, I’m by no means advocating or endorsing such behaviour, but an entire agreement clause can protect a business for the liabilities that such a sales person can create.

As I said in a previous article, terms and conditions are the unsung saviours of a business. This is particularly true when it comes to reducing and where possible eliminating risk. If you’re not using your contracts to your full advantage by limiting the risks your business is exposed to then you should start doing so now.

Miss the first articles in the series? Catch up on David Walker’s essential advice for small business owners. 

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ABOUT THE EXPERT

David Walker is the founder of Grid Law, a firm which first targeted the motorsport industry – advising on sponsorship deals, new contracts and building of personal brands. He has now expanded his remit to include entrepreneurs, aiding with contract law, dispute resolution and protecting and defending intellectual property rights.

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