School children were once taught to ‘Keep It Simple Silly’ – a principle which means that most things work best if they are kept simple and straightforward, rather than made overly complicated.

The K.I.S.S principle is particularly relevant when it comes to limitation of liability clauses, especially when you consider their potentially dire consequences.

What is a Limitation of Liability clause?

A limitation of liability clause allows one party to exclude or cap their liability for losses and financial damages suffered by the other party. This cap is often described as “artificial” because without a limitation clause, a party’s liability is unlimited.

The limitation of liability clause decides how much you are liable to pay. You can control how much liability you will accept (if any at all) for your breach of contract or negligent acts in your consultancy agreement. You must however ask for and negotiate these clauses into your retainer, as any limitation of liability clause in your favour is an advantage.

Why is clear drafting important?

Courts in Australia have stated that that limitation of liability clauses must be clearly drafted if they are to be effective, particularly when excluding liability for a consultant’s negligence. Therefore, for a clause to “work”, the High Court has said you must draft the clause clearly as it will be interpreted “…according to its natural and ordinary meaning” and “…read in light of the contract as a whole”.

Your Professional Indemnity Insurance

Limitation of Liability clauses are common in consultancy agreements and appear across a range of commercial contracts. A limit of liability is not to be confused with a limit of indemnity. A limit of indemnity is the maximum amount your insurer will pay out for any one claim. A limit of liability is the maximum amount you have agreed to pay.

From an insurance perspective, you should avoid agreeing to a limitation of liability clause in your client’s or sub-consultant’s favour wherever possible. Most insurance policies contain a broad exclusion which states that claims will not be covered if you have waived, prejudiced, excluded, or limited a right of recovery.

Consider the following scenario:

Clever Consultant entered into an agreement with Client. Clever Consultant however makes a costly error and is found to be responsible for the cost of rectification work. That cost is $3,000,000. The bad news for Clever Consultant is that the limit of indemnity with her professional indemnity insurer is $2,000,000, leaving her potentially liable for the $1,000,000 shortfall in insurance coverage. The good news for Clever Consultant is that she wisely limited her liability in her agreement with Client to the amount of her insurance limit, being $2,000,000. Clever Consultant had a clear and commercial worded limitation of liability clause in her agreement, and it was therefore effectively applied. Clever Consultant is now only liable to pay the excess to her insurer and nothing more.

How to be like Clever Consultant

It is therefore important to use limitation of liability clauses wisely. A clause which completely excludes any liability can be difficult to negotiate (and likely deemed an unfair contract term), therefore you should consider a default position and be able to justify it to your client.

One option you might consider is to align your limitation clause with your insurance indemnity limit and any exclusions noted on your policy. For example, if your limit is $1,000,000 and your policy excludes ACP’s, you should negotiate a clause which limits your general liability to $1,000,000 or less and excludes all liability for ACP’s.

It is for you to decide what the limitation limit should be in the context of each project. Some options are as follows:

1. Accept no liability whatsoever (which is unlikely to be upheld in Court).

2. Limit your liability to the amount of your fees for the project, or multiples thereof.

3. Limit your liability to the amount of the limit of your professional indemnity insurance at the time you sign the contract.

4. Limit your liability to the amount of the limit of your professional indemnity insurance at the time the claim is made.

A practical approach you may implement is to prepare a checklist which is updated annually in line with the renewal of your professional indemnity insurance policy. When considering your own checklist, you may wish to include the following:

1. Your policy limit.

2. The exclusions noted on your policy.

3. The endorsements or extensions noted on your policy.

4. The amount of your fee for the project.

5. The risk profile of the project.

6. Where possible, avoid agreeing to a limitation of liability clause in your client’s or sub-consultant’s favour.

The checklist should then be referred to when negotiating a limitation of liability clause in each project.

In conclusion, remember to apply the K.I.S.S. principle to your limitation of liability clauses. Perhaps now is the time to check your retainer, and ask – am I the Clever Consultant?

You may be interested in our upcoming informed Beginnings webinar on 23 November. The webinar will further explain both the benefits and risks associated with limitation of liability clauses, among other crucial topics on Risk Management.

Filomena Maffi
Risk Manager

This article is only general advice in respect of risk management. It is not tailored to your individual needs or those of your business, nor is it intended to be relied upon as legal or insurance advice. For such assistance you should approach your legal and/or insurance advisors.