IN THIS LESSON
When you are reviewing contracts as part of due diligence, it is important to review the various provisions relating to the “liability regime”.
Reviewing the Liability Regime in Contracts
When conducting due diligence on contracts, it is crucial to thoroughly review the various provisions related to the "liability regime." The liability clauses typically comprise several interconnected elements, including liability, indemnity, exclusions or limitations, consequential loss, and liquidated damages (e.g., for construction contracts). These clauses work together to allocate risks and responsibilities between the parties.
Understanding the Liability Bucket
Start by considering the types of losses a party might be responsible for in the ordinary course of business, such as:
Breach of law
Direct damages
Consequential or indirect losses
Negligence
Other potential liabilities
Parties enter into contracts to document an agreed allocation of risk and liability between themselves, deviating from the default position under applicable laws.
Reviewing Indemnity Clauses
Contracts often include indemnity clauses, where one party agrees to indemnify the other for losses arising from specific events. Common indemnity events may include:
Illness, injury, or death
Property damage
Breach of law
Other specified events
If the target company agrees to indemnify under a contract, this should be flagged as a potential risk, particularly if the indemnity is uncapped or unlimited.
Excluding or Limiting Consequential Loss
Examine whether the contract excludes or limits liability for consequential or indirect losses. It is best practice for the contract to clearly define what constitutes consequential loss, which may include:
Loss of profit
Loss of contract
Loss of revenue
Loss of opportunity
Other indirect losses
Limitations on Overall Liability
Assess whether the contract includes caps or limitations on a party's overall liability for losses. Common limitations may include:
A fixed monetary amount
A percentage of the contract price
A multiple of revenue
Other quantifiable limits
Certain types of liability may be excluded from the cap or limitation, such as liability for intentional acts, fraud, gross negligence, property damage, personal injury, work-related deaths, or insured amounts.
When reviewing the liability regime in contracts, it is essential to carefully analyze the interplay between these various clauses and ensure a clear understanding of the allocated risks and responsibilities. Additionally, you may need to refer to the relevant laws in your jurisdiction for further guidance on interpreting and applying these provisions.
