When seeking legal advice on a contract, clients often have already negotiated the major business terms. At this stage, it is the responsibility of a corporate lawyer to protect the client’s interests by ensuring the inclusion of essential terms and addressing any potential risks that may have been overlooked.
While it is essential to carefully review every provision of a contract, certain clauses require additional scrutiny due to their significant impact on risk allocation and liability.
Two clauses that commonly appear in commercial contracts, namely the limitation of liability and indemnification clauses, play a crucial role in determining how risks are distributed among the parties involved.
To fully grasp the significance of these clauses and to effectively mitigate the inherent risks of business contracts, it is imperative to give these clauses thorough and professional consideration.
The Limitation of Liability Clause
The main purpose of a limitation of liability clause is to manage and minimise risk in a contractual agreement.
This is typically achieved by imposing restrictions on the amount of money or damages that one party is obligated to pay to the other, as well as limiting the types of damages or claims that the aggrieved party can pursue.
For instance, in contracts between a supplier and a client, the limitation of liability clause may contain a broad provision that restricts the supplier’s liability to a maximum value equivalent to the sum paid by the client under the contract.
Importance of Careful Assessment of Limitation of Liability Clauses
Liability can potentially result in substantial financial losses.
To illustrate this point, let’s consider a scenario where a client company pays $10,000 to a supplier for a product. Subsequently, the client sells the product to a third party, but unfortunately, the product malfunctions, causing a loss of $20,000 to the third party.
In this case, the third party initiates legal action against the client, seeking compensation for the loss incurred due to the malfunctioning product. Naturally, the client would prefer to avoid bearing the responsibility for the third party’s loss and instead expects the supplier, as the product manufacturer, to assume liability.
However, depending on the specific wording of the clause and other terms within the contract, the limitation of liability clause could cap the supplier’s liability to the client at $10,000.
Consequently, the supplier would only be required to pay $10,000 to the client, leaving the client accountable for the remaining $10,000 owed to the third party. By incorporating this liability limit, the supplier enjoys significant protection at the expense of the client.
Had the client sought a lawyer to review the contract, it would have had the opportunity to identify the legal consequences of such a clause and to negotiate and modify the clause to allocate more risk onto the supplier for losses resulting from product malfunctions.
The Indemnification Clause
Indemnification clauses, commonly present in contracts, constitute an alternative category of risk allocation clauses and are often subject to negotiation and potential disagreements between negotiating parties.
In essence, indemnification involves one party (referred to as the indemnifying party) undertaking the responsibility to compensate the other party (referred to as the indemnified party) for potential losses or damages. These losses are typically claimed by a third party, but in some cases, they may also arise from direct claims by the indemnified party.
Indemnity provisions can be mutual, where both parties mutually agree to compensate each other for losses outlined in their agreement or any losses resulting from a breach of the agreement’s terms and conditions. On the other hand, unilateral indemnification involves only one party providing indemnity in favour of the other party.
Safeguarding Your Interests with an Indemnity Clause
To provide an alternative scenario, let’s consider a situation where you own a property with commercial tenants and hire a cleaning company to maintain cleanliness on your premises. As the landlord in this scenario, it is important to ensure that the contract between you and the cleaning company includes an indemnity provision.
This provision would specify that the cleaning company is obligated to indemnify you against any claims brought forth by third parties due to their negligence or failure to perform their cleaning duties properly.
In practical terms, if a third party, such as an individual visiting one of your tenants, suffers an injury or damage and decides to initiate legal action, the indemnity provision can require the cleaning company to compensate you for the losses you incurred as a result of the incident.
What Should You Do Before Signing Limitation of Liability and Indemnity Clause?
Before signing the contract, it is crucial to take certain steps to protect your interests and mitigate potential risks. Here are some key actions you should consider:
- Understand the Scope: Thoroughly read and comprehend the clause. Pay close attention to the language used, as it will define the obligations and responsibilities of each party in case of specified losses, damages, or legal claims. If there are any ambiguous terms or provisions that you do not fully understand, seek clarification from a corporate lawyer.
- Assess the Risks: Evaluate the potential risks associated with the contract. Identify the types of losses or damages that could arise and assess their potential impact on your business. Consider whether the clause adequately cover these risks and ensures that you are appropriately protected. When in doubt, a corporate lawyer will be able to assist with the identification and assessment of any contractual risks found within an agreement.
- Evaluate the Financial Implications: Carefully analyse the financial consequences of the clause. Assess the extent of your financial liability and determine whether it is reasonable and proportionate to the risks involved. Evaluate whether the indemnification provisions align with your business’s financial capabilities and risk tolerance.
- Seek Professional Advice: Engage a qualified corporate lawyer to review the contract and the clause. They can provide expert guidance and ensure that your interests are adequately protected. A lawyer can assess the fairness, legality and validity of the clause, negotiate any necessary amendments with the other party, and also advise you on the potential implications of signing the contract.
- Negotiate Fair Terms: If you identify any concerns or gaps in the clause, negotiate with the other party to reach a fair and balanced agreement. This may involve modifying the language, adjusting the scope of indemnification, or addressing any disproportionate liabilities. Effective negotiation can help ensure that the indemnity clause aligns with your business goals and risk management strategy.
- Consider Insurance Coverage: Assess whether obtaining insurance coverage could provide an additional layer of protection against potential risks and liabilities. Consult with an insurance specialist to determine the most appropriate insurance policies for your specific business needs and evaluate how they interact with the clause.
- Document Everything: Maintain clear and comprehensive records of all communications, negotiations, and modifications related to the clause. This documentation will serve as evidence of the agreed-upon terms and can be invaluable in case of any disputes or claims in the future.
In the context of Singapore law, mitigating contract risks requires a comprehensive approach. By focusing on key clauses such as limitation of liability and indemnification, and seeking professional legal advice, businesses can protect themselves from potential liabilities and ensure a fair allocation of risk.
Please note that this article does not constitute express or implied legal advice, whether in whole or in part. For a Consultation or if you simply require more information, email us at email@example.com.
Contributions to this article were made by the following lawyers:
Walter Alexander, Director & Head of Corporate Legal
Jerial Tan, Associate