“Take responsibility for the risks that you control.” This is a common rationale used to justify the allocation of risk in contract negotiations. Stated another way – “If a loss is the result of your actions you should be willing to step up and take responsibility for the resulting damage.” This position sounds reasonable. However, accepting this view will probably leave you vulnerable to claims that far exceed your commercial expectations.
Business transactions contain many standard elements. The parties outline a scope of work or services. They stipulate the commercial basis that forms part of the consideration for their contracts. They allocate the responsibility and liability for risks that are easily defined or largely unknown. Buyers and sellers compete to shift the risks and benefits to their advantage using a variety of arguments and concepts. Standing on its own the concept of “damages” includes not only direct damages but consequential or incidental damages. Unless qualified, accepting responsibility for damages caused by your actions can leave you exposed to all damages including both direct and consequential damages.
Most sellers have a keen eye to identifying potential direct damages – the damages resulting “directly” from their actions. Direct damages, being closely connected to the seller’s services or products, are generally easier to visualize and evaluate. But direct damages are not the whole story. It is often the potential for consequential damages that creates the biggest liability risk. Consequential damages are not a direct result of an act but rather a “consequence” of an initial act. Sometimes consequential damages are also referred to or include special, indirect, incidental or secondary damages. These indirect damages, being further removed from the seller’s services or products, are generally harder to visualize and evaluate. Examples of typical consequential damages include: loss of use, loss of revenues, loss of profits, costs associated with removal and replacement of goods or products, loss of reputation, interest, etc. These damages are available as compensation for a breach of contract if within the reasonable contemplation of both parties at the time of contracting. The Uniform Commercial Code describes the basis for recovery as follows:
UCC § 2-715. Buyer’s Incidental and Consequential Damages.
(1) Incidental damages resulting from the Seller’s breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expense incident to the delay or other breach.
(2) Consequential damages resulting from the Seller’s breach include:
(a) any loss resulting from general or particular requirements and needs of which the Seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and
(b) injury to person or property proximately resulting from any breach of warranty.
Typically a seller seeks to limit its total liability exposure by carefully drafting warranty provisions, properly insuring its business, and sometimes capping its liability to a specific dollar amount. Another good practice is to seek a mutual or reciprocal disclaimer of consequential damages that suits the risks of a particular transaction. A sample provision is presented below:
Disclaimer of Consequential Damages: Notwithstanding anything to the contrary elsewhere in this Agreement, in no event shall either party be liable to the other for special, consequential, incidental, secondary or indirect damages, including but not limited to, such damages resulting from loss of use, loss of data, loss of actual or anticipated profits or revenues, loss of business reputation or opportunity, loss by reason of shutdown, non-operation or increased expense of manufacturing or operation, cost of capital, damage or loss of property or equipment of CLIENT, or claims of customers of CLIENT, whether such liability arises out of delay, contract, warranty, tort (including but not limited to negligence), strict liability or otherwise.
Note: The sample provisions above are for illustration purposes only and are not intended for use without appropriate review in your jurisdiction.