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HOW TO CAP YOUR CONTRACTUAL LIABILITIES.

HOW TO CAP YOUR CONTRACTUAL LIABILITIES.

 

Insurance rarely covers all your contractual liabilities. The best way to know what you’re liable for under a contractual indemnity is to include a financial cap.

A common problem with broad indemnity clauses is that you can be excluded from relying on your insurance policies or your liability may exceed the amount you’re insured for.

We’ve previously discussed some ways that you can manage your liability like incorporating proportionate liability in your contracts. We’ve also talked about why assuming responsibility for consequential losses is a bad idea. However, the most straightforward way of limiting your loss is simply to include a financial cap.

What is a financial cap?

 A financial cap is the maximum amount that you will be liable for under a contract. Some contracts automatically include financial caps for one or both parties (for example, Australian Standard AS 4122-2010 which outlines General Conditions of Contract for Consultants).

Why is a financial cap useful?

 A financial cap is worth its weight in gold because it provides you with a definite, pre-agreed maximum limit on your liability. This is important if you’re relying on your insurance policy to cover your liabilities.

Many people think that their insurance policies will cover all of their liabilities, but they often contain conditions and policy exclusions. For example, insurance policies may exclude:

  • Anything that goes beyond your liability at law;
  • Fines, taxes, penalties and other consequential loss; and
  • Acts or omissions which are dishonest, fraudulent, criminal, or malicious.

These exclusions and any limits on your insurance will be your uninsured liability. A financial cap can apply to your total liability or just your uninsured liability.

How do you get a financial cap?

You should always negotiate a financial cap into your contracts. If the contract is silent, there is no cap – meaning your liability is unlimited.

There are several ways to calculate a financial cap, like making it:

  • All or part of the contract price;
  • A fixed monetary amount;
  • The limit of any insurance you’re required to maintain; or
  • A combination of any of these.

If the financial cap is only for your uninsured liability, it must be an amount that you can afford to pay ‘out of pocket’.

What if I already have a financial cap in my contract?

Check whether the financial cap applies to all of your liability or just your uninsured liability. If it covers your uninsured liability then make sure you can afford to pay the amount of the cap. Sometimes the cap is set too high on the belief that it will be covered by insurance, but this is not always the case.

What if the financial cap doesn’t apply to all types of liability?

If a contract contains a financial cap, check whether there are any areas of liability that it doesn’t apply to.

Some ‘carve-outs’ from the financial cap may be reasonable, but they can also reduce the benefit of having the cap in the first place. Some common carve-outs include:

  • Fines, penalties, taxes, and other consequential losses: These types of losses are typically not covered under insurance policies, and should be subject to the financial cap.
  • Personal injury or death/ property damage: This type of loss is typically covered under insurance policies. But you should try to cap your liability for any uninsured loss in case the insurance policy doesn’t cover it or the amount of the policy is exhausted.
  • Breach of IP rights or moral rights: It’s typical for this to be carved out of a financial cap. It’s often expected that each party will take reasonable steps to ensure they’re not breaching another party’s IP.
  • Wilful misconduct or wilful breaches, fraudulent or criminal conduct: This is a reasonable carve-out and should not be subject to a financial cap.

What happens when the other party will not negotiate fairly?

If the other party does not allow you to negotiate a financial cap or the terms of the cap are unfair, you could qualify for protection under the unfair contract regime. This means you may be able to lodge a complaint with the ACCC or your relevant state or territory fair trading agency (like Fair Trading NSW). You can also challenge the legal operation of the cap as an unfair contract term. If you’re successful, the term will be unenforceable by the other party.

It’s a good idea to review your existing contracts to see what liability you have and determine whether your financial caps are fair. If you would like any assistance doing this, get in touch - we’d be happy to help.

Lydia Carstensen

April 2019

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