The Thin Red Line : Limitation of Liability

A few days back, a client of our firm (local business supplier) faced a particularly difficult bundle of clauses from a Third Party contractor they needed to make a part of their project and they were required to sign-off  off these clauses before they could receive their much needed initial deposit from the Main Party they were trying to get a project approved from.

The contractor was from the Middle-East and had a particularly specific set of clauses which he insisted were ‘protecting’ his interests. Briefly the clause sought to limit liability for intentional or criminal misconduct or wilful violation of the said agreement/contract. Not having encountered  such a contractor request for  limitation on liability , the other point of worry was that the capping of liability was mercilessly low. While our team had our reservations on signing such a contract, the client was particularly upset as they needed the money from the project after this contractor would agree to work with them.

While the client went on to sign a particularly ‘hotch-potch’ set of papers, despite our warnings  and all red flags (and also suffered bankruptcy afterwards), it is useful to discuss the thin red  lines that define contractual clauses pertaining to limitation of liability.

In principle such an explicit limitation of liability is unethical and may even be legal unenforceable at all (the merits would depend on the applicable law and selected forum). I have noticed an increased use of such clauses in contracts from Chinese and Middle Eastern Companies seeking to gain set up in locations like Pakistan. In many cases, the other party is quick to judge a weakness and desperation as in this case.Later on when such clauses go to court, we may expect an English court to interpret the contract in favour of the weak party.That being said, the liberal use of the principle of freedom of contract in the common law jurisdiction is one aspect which can catch up with the suffering contractor later on.

In principle, we advise our clients and any potential clients that such a clause is not justifiable, neither from a legal standpoint nor from a business perspective as it is a large risk for the client or client company.It is also a precursor to the thesis that such clauses reduce the willingness and effort of the  counterpart to act properly and legally knowing, that they will be liable for peanuts later on.Furthermore in many jurisdictions around the world, damages caused by gross negligence or willful misconduct can not be limited; any contrary provision is totally void as such a limitation takes away the right of the aggrieved party to recover direct damages for heads of liability like ‘cost of reprocurement’, ‘cost of corrections’, ‘cost of compensating the main party.

Possible Exception in Practical Application of Such Clauses

In International Oil and Gas contracts, where negotiating power of both parties may or not be equal, we have often  seen limitation of gross negligence/willful misconduct towards the senior supervisory personnel  in international oil joint operating agreements (JOA) perhaps because the local state going into JV will often insist that an international company should only hire locally, no matter how low the standard of training or political unrest in the country which, no doubt, affects labour performance.An ironic justification of the clause would then be that the Operator of Foreign Oil Company would want to avoid paying for accidents and disasters which are a result of the local conditions like ethnic, tribal or religious issues and  having nothing to do with how the senior personnel conduct safe operations. A dark reality of the energy industry is that it is often sabotaged by local greed of the leadership and political unrest.

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