Liability 101: Liability clauses in technology and outsourcing contracts

Risk allocation

The purpose of a liability clause is to allocate risk. While the negotiations often centre around legal principles and drafting, risk is ultimately a commercial issue, the appetite for which is driven by commercial imperatives. 

Each party will be seeking to minimise its own financial exposure under the contract, while at the same time ensuring that it has adequate recourse to the other party for potential losses. 

What goes into a liability clause?

How a business approaches the allocation of risk in a liability clause depends on a number of factors, ranging from the industry in which the parties operate, the governing law and the parties’ bargaining position.  

The approach is likely to vary jurisdictionally.  For example, in technology and outsourcing contracts governed by US law (or drafted by US parties), liability provisions may be drafted not as a series of exclusions, but rather, in the form of an indemnity allocating risk.

From an English law perspective, a liability clause in a technology or outsourcing contract typically includes the following provisions (it is worth noting that liability provisions may be scattered throughout the contract and are not always contained in a single “Liability” or “Limitation of liability” clause): 

• Unlimited liability: A clause providing for those instances where limitations and exclusions of liability are disapplied so that a party can be liable.
• Excluded liability: A clause providing for the types of losses that cannot be claimed. (Sometimes this is accompanied by a so-called “assumed losses” clause, which sets out the kinds of losses that can be claimed); and 
• Financial caps: The maximum amounts that can be claimed from a party (except where its liability is unlimited). 

We discuss each of these in turn. 

Unlimited liability

This clause sets out the situations where the parties have agreed that neither party may rely on the financial caps and exclusions set out in the contract (including where the parties cannot limit or exclude liability as a matter of law):

• Where the law prevents a party from limiting or excluding its liability: In the UK, the Unfair Contract Terms 1977 provides that liability cannot be limited or excluded for death or personal injury resulting from negligence (nor for certain breaches of the Sale of Goods Act 1979).  As a matter of public policy, the common law sometimes also provides that liability cannot be limited or excluded (e.g., in the case of fraud in some circumstances).  Where the law does not permit it, liability should not be limited or excluded, as otherwise there is a risk that the whole liability clause could be found to be unenforceable (especially where, because of the way it has been drafted, it is not possible for the court to “sever” the unenforceable part of the clause).
• Negotiated positions: The parties may agree to disapply the financial caps and liability exclusions, reflecting the facts and the risks that arise under the contract. For example:
  • In licences and other service contracts based on proprietary technology, the service provider may have uncapped liability for losses resulting from infringement of third-party intellectual property rights (which is usually framed as an uncapped indemnity given by the service provider). 
  • Providers of SaaS or cloud platforms may insist on their users accepting uncapped liability (also usually in indemnity form) for infringement of third-party rights or for breach of law caused by the data they upload to the platform. 
  • Amounts payable by the customer under the contract, such as the licence or service fees, are typically excluded from the ambit of the liability caps and exclusions. The customer may want the same principle to apply to amounts payable by the service provider, such as service credits or liquidated damages for delay, but this can be contentious. 

Excluded losses

This clause lists the types of losses a party is unable to claim (that is, excluded losses).  

When a party is calculating its losses that arise “under” (that is, from a breach of contract) or “in connection with” (that is, in tort) the contract, it will only be able to claim the types of losses that the contract permits.  Technology and outsourcing contracts almost invariably exclude liability for indirect or consequential losses, but the parties often agree that certain other losses are excluded too, regardless of whether they are direct or indirect.  

These may include (among others): 

• Loss of profit or revenue.
• Loss of goodwill.
• Loss of opportunity.
• Wasted expenditure.
• Loss of data.

As at the date of publication, a market-standard position typically excludes liability for these types of losses. Some favour both parties and so are seen as less contentious. For example, excluding “loss of profit or revenue”:

• Protects the service provider against liability for the impact of service failures on the customer’s profits.
• Protects the customer from liability for the service provider’s loss of revenue where there is an early termination of the contract by the service provider due to the customer’s breach. 

The list of excluded losses should always be considered on a case-by-case basis so not to prevent a party from claiming the kinds and types of losses that are most likely to flow from the other party’s breach.

For example, a well-advised customer would not accept a “loss of data” exclusion in a scenario where data processing or storage is a central component of the service provider’s activities.  

Assumed losses clauses

Technology or outsourcing contacts sometimes include a clause dealing with so-called “assumed losses”, which sets out specific types of losses that the parties have agreed are to be recoverable even though they might otherwise be excluded on the basis that they:

• Are indirect or consequential losses; or
• Would otherwise be covered by another specifically excluded category of loss.

Such clauses are typically drafted unilaterally in favour of the customer. They have traditionally been more common in business process outsourcing contracts than in licences and other technology-driven contracts but are now more frequently included in contracts for business-critical platforms. 

Financial caps on liability

This clause provides for the maximum amount for which a party is liable where claims arise under the contract.  There is no magic formula for what a party’s liability cap should be - it is ultimately a commercial decision for each party based on an assessment of risk versus reward.  That said, liability limits are often derived from market norms which differ depending on the nature of the technology or outsourcing in question.

Common approaches we see in technology and outsourcing contracts include:

• Linking maximum liability to a multiple of the service fees and/or, a fixed amount, or to an amount that reflects the relevant party’s insurance coverage.
• Caps on liability that vary depending on the scenario in which the claim arises.  For example, breaches of data protection obligations may have a larger liability cap than for other breaches of the contract (this is another example of a so-called “super cap”). 

While there are many other aspects of liability not dealt with here, the main principle to bear in mind is that liability caps should reflect the risk and reward under a contract. 

A service provider will be reluctant to accept a liability cap that is out of proportion to the revenue it receives from the customer and the profit margin it can make from that revenue.  On the other hand, the customer may argue that a cap exceeding such revenue is justified because of a particular risk presented by the services or technology.

In any event, the caps should be high enough to incentivise performance; if its caps are too low, the relevant party may consider that it is easier to walk away from the contract than to perform the contract.  

Other considerations

There are, of course, a number of other principles and aspects to liability clauses that are not addressed here, including: 

• Whether the liability caps and exclusions apply not only in relation to a party to the contract, but in relation to its affiliates and other members of that party’s group who might be providing or receiving the services.
• Whether claims are time-barred (i. e. a time limit on when claims must be brought by); and
• Whether claims under or in connection with a contract involving group members must be funnelled, so only one party of a group may make claims (including on behalf of other group members), and such claims may only be made against the other party (and not other members of its group). 

Overall, liability clauses need to be carefully considered so that risk is allocated to the party best able to ameliorate that risk.