Briefly

TRANSCRIPT

00:07
Adam Stofsky
David, I'd like you to talk about the issue of liability caps or limitations on liability in contracts. I know these can be the source of a lot of confusion, also a lot of negotiation. Can you explain what they are and why they're important?

00:23
David Tollen
Yeah. The liability cap, it really does an odd thing. It says no matter what a court thinks is fair and just in terms of how much the breaching party owes in damages to the other party, we're not going to go that high, or at least if it's above a certain threshold, we're not going to go above. So the most, you know, at the most simple level, liability is set at $100,000 in a contract between you and me. And if I breach the contract and my breach causes you a loss of $200,000, it doesn't matter. It's only $100,000 because we've agreed on that in advance. If my breach causes you $50,000 in loss, the liability cap never comes into effect. It doesn't matter because it's above that level. So it doesn't set a floor, it sets a ceiling.

01:20
Adam Stofsky
So why would a company use a liability cap? What's the purpose? Don't you want to be able to make yourself whole if the contract is breached?

01:31
David Tollen
It's become really common, and it's worth asking, why. What is the purpose? Don't we trust our judicial system to come up with right answers? I think one of the answers is that people don't entirely trust the judicial system, and there's runaway jury verdicts and all kinds of stuff like that. I think it's also the case that a lot of merchants, vendors, a lot of people doing business under contracts find that they can't manage the uncertainty of liability without any maximum, that if they have some kind of maximum, they have a more manageable amount. So. And in fact, usually the limit of liability protects the merchant. It can go both ways, but it's usually there to protect the merchant. So I think it just makes their businesses more manageable. But there's always an interesting argument. Why don't we trust the.

02:33
David Tollen
Why don't we trust the system? That said, in some segments like technology, the limit of liability is so universal that if you're the customer, you can argue it all you want, you're probably not going to get anywhere because everyone's doing it. Most vendors can't be talked out of it.

02:49
Adam Stofsky
David, can you explain sort of a common limitation liability provision like in a technology contract? What does it look like, and what is it actually protecting the vendor? Against.

03:01
David Tollen
Yeah, there's almost always two elements to the limit of liability. The first one is the simpler one. It's the dollar cap. It just, you fix an amount. It could be you can just write out the amount in the contract, $100,000, or you can write out a formula like fees for the last year. And what it does is, you know, I sell you software and my software breaks and doesn't operate. And I had, you know, I promised that it would. As a result, you have all kinds of expenses. You got to replace the software, you got to do the process differently, whatever it might be, and it ends up costing you twice the amount of the limit of liability, 200. And, you know, and you've got a limit of 100.

03:47
David Tollen
What the clause very simply means is despite the fact that you legitimately lost that money, you can't get more than half of it. You can only get the hundred thousand dollars that the clause lists. So it's an arbitrary limit on the amount that the parties agree to in advance. And then the other part, the restriction on consequential damage, it's often called. It's actually really indirect and consequential damages is a subset of. It is really complicated and actually not that many lawyers understand it. Even among those who think they do.

04:20
David Tollen
What it basically says at a very high level is, you know, that software I provided to you breaks down those losses I just mentioned, you can get up to that dollar cap, up to that hundred thousand dollars, the cost of having to work around it, buy other software, whatever it might be, stuff that's normal and would be expected for this type of software breakdown. But what also happens is during the period the software is down, you lose your biggest sale of the year. And that's a huge loss to you. That's going to be excluded under the exclusion of consequential and other indirect damages. At least it should be under theory that that's really not predictable, that's not something that is a normal outcome. And so it's arguably consequential damages. And the contract specifically excludes those types of damages.

05:17
Adam Stofsky
So to summarize in a kind of standard modern limitation liability provision, you'll have a cap on regular old contract damages of some amount, whether it's a fixed amount or a formula, and then a complete exclusion on all those other kinds of, you know, consequential and indirect damages. And the cap there is essentially zero.

05:41
David Tollen
That's right. It's saying you cannot have this type of Damages. So it's overlapping protection for the vendor or it's usually the vendor that's protected. It could go both ways. They, they really do overlap because you could have, you know, the dollar cap applies to any kind of damages at all, while the consequential damages and other indirect damages restrictions says none of this type of damages. Dollar cap is not relevant.

06:08
Adam Stofsky
This may be more of a business question than a legal one. But why is it seems like there's a lot of controversy over these provisions. Maybe it feels like a big deal because it's sort of all. It's about your, the outward potential, the potential sort of ultimate risk you might have when you sign a whole bunch of contracts. But it seems to me that it's actually maybe a good area to negotiate because the odds of these lawsuits are probably pretty low. So why is it a challenge for a business to kind of individually negotiate limitations on liability in its contracts?

06:43
David Tollen
So I think the way to look at it is it's typical to negotiate the amount of the dollar cap, but the rest is not very often negotiated and at least in the technology world and in several other industries. And the reason is it's become so universally done that the customer might not like it, but they're not going to get a deal without the limit of liability from the vendor's competitors either. I mean, it's just market forces have said not really negotiable. That doesn't mean you can't negotiate the amount. It's hard to negotiate the amount though of the dollar cap because it's kind of arbitrary in the first place.

07:28
David Tollen
I mean, people tend to get into arguments about what's fair and it's not a really helpful way of looking at it makes it harder to negotiate these things than it really needs to because it's not exactly about fair. It's about coming up with an arbitrary number that each side can live with. And that doesn't give you a lot of guidance, a lot of principle to guide a negotiation.

07:52
Adam Stofsky
Interesting. Do companies ever give larger liability caps on areas of kind of particular risk or interest to their customers? Do you ever see that?

08:07
David Tollen
Sure. Yeah. If the, if the customer is concerned about a particular type of loss, the limit of liability clause could do a couple things. It could give a higher dollar cap, it's going to be 3x the dollar cap for that kind of loss. Or it could say the limit of liability doesn't apply at all. Like a lot of times non disclosure or confidentiality obligations, the terms will exclude the limit of liability or Exclude that from the limit of liability. So it doesn't apply at all to that type of loss. That's common. Particularly if the vendor knows in advance these are key concerns of our customers, sometimes their standard form will do something like that, will have exceptions to the normal limit of liability.

08:50
Adam Stofsky
What are some common exceptions? Data breaches and data privacy.

08:55
David Tollen
Data breaches are. I don't often see unlimited liability for that, but you often see a higher dollar cap for that. So it's the same consequential and other indirect damages restriction, but a higher dollar cap, that half is higher, maybe three times. And then as I mentioned, non disclosure obligations, confidentiality, very often that's a zero dollar cap. I mean, dollar cap doesn't apply. No limit of dollar cap applies to that. Yeah, yeah, exactly. So both of those are relatively common.

09:30
Adam Stofsky
Right. And so if you as a vendor have a higher cap, a higher limitation liability, you are both providing some kind of confidence and coverage to your customer. They will be covered, but also kind of signaling some confidence. You're saying, you know what, we know our security practices are so good that we're willing to take a higher cap here.

09:50
David Tollen
Yeah. You're either, you're either you're expressing confidence or you're expressing market forces which kind of have made you do it when you'd rather not. It's going to be one or the other or both.

10:01
Adam Stofsky
Right. Very interesting. All right, David, anything else to say on this kind of complex issue of liability caps?

10:09
David Tollen
Well, I'll repeat my key advice, which is if you're negotiating it, don't get bent out of shape over what's fair. It's. It's arbitrary from the start. I mean, if you were really going to say what's fair, you'd say, well, we'll leave it to the court. We'll leave it to interpretation of what the losses are. The lawyers negotiating a settlement. In the case of a dispute, you've sort of agreed that you're not going after fair, you're going after arbitrary. And in a way that sort of removes some of the venom from the negotiation. You say, okay, we're just trying to come up with an arbitrary number that fits the needs of both parties and calm down and work that out.

10:46
Adam Stofsky
Right.

10:47
David Tollen
Good advice.

10:48
Adam Stofsky
Thank you, David.

10:50
David Tollen
Thank you.