Understanding Liability Clauses in Contract Drafting: The Role of Consequential Loss Exclusions:
At Mutai Advocates LLP, we routinely advise clients on the nuances of contract drafting. Today, we turn our attention to a critical but often overlooked component: liability clauses, with a specific focus on the exclusion of consequential loss.
What Is a Liability Clause?
A liability clause is a fundamental part of any commercial contract. Its primary function is to allocate risk between the contracting parties by defining who bears responsibility when something goes wrong—whether that’s financial loss, damage, or failure to perform contractual obligations.
For example, if Party A suffers a loss due to Party B breaching the contract, the liability clause determines whether, and to what extent, Party B must compensate Party A.
Strategic Drafting Based on Position
The drafting of a liability clause will typically depend on which party you represent:
- If acting for the party procuring services: the goal is usually to keep the scope of liability as broad as possible. This ensures that the service provider is held accountable for any breaches or losses that may arise.
- If acting for the service provider: the objective is to limit exposure, often by narrowing the scope of liability and introducing caps, carve-outs, or exclusions—such as for consequential losses.
Negotiating these clauses requires a careful balance of interests and a deep understanding of commercial risks. A well-drafted liability clause should be fair, commercially reasonable, and tailored to the specific nature of the transaction.
Focus: Excluding Consequential Loss
One of the most common ways to limit liability in a contract is by excluding consequential loss. But what exactly does this mean?
Consequential loss refers to indirect or secondary damages that occur as a result of a breach but are not the immediate or direct result of it. Common examples include:
- Loss of profits or revenue
- Loss of business opportunities
- Business interruption
- Reputational damage or loss of goodwill
- Loss of production or use
Why Do Parties Exclude Consequential Loss?
Excluding consequential loss serves several important commercial and legal purposes:
- Limits Unpredictable Liability: These losses can be difficult to foresee or quantify. Exclusion helps parties avoid liability for damages that were not within their reasonable contemplation.
- Facilitates Insurance and Risk Planning: Defined liability helps parties assess their exposure and secure appropriate insurance coverage.
- Promotes Commercial Certainty: Knowing the boundaries of financial liability allows parties to plan and budget accordingly—crucial in high-value or complex projects.
- Avoids Liability for the Other Party’s Business Losses: Without exclusions, a breach could lead to claims for lost revenue or damage to the other party’s reputation—often far exceeding the value of the contract itself.
- Simplifies Dispute Resolution: By narrowing the scope of recoverable damages, parties reduce the risk of prolonged disputes about what can and cannot be claimed.
Legal Considerations: Definition Matters
The interpretation of “consequential loss” can vary by jurisdiction:
- Under common law: the term is often construed as referring to losses that arise from special circumstances known to both parties at the time of contracting.
- In other jurisdictions: the interpretation may differ and can even be broader.
Because of this ambiguity, it is good practice to expressly define "consequential loss" within the contract, ensuring both clarity and enforceability.
In Summary
Excluding consequential loss from liability clauses is a strategic tool that helps contracting parties control risk, clarify expectations, and avoid potentially disproportionate financial exposure. However, these clauses must be carefully drafted to reflect the commercial realities of the deal and the applicable legal framework.
If you need assistance in drafting or reviewing a liability clause—or any part of your contract—our experienced team at Mutai Advocates LLP is here to help.
