Contract liabilities for beginners and business owners

In simple terms, a contract is a legally binding agreement. In a business context, it outlines the exchange of goods, services, money and/or property between two or more businesses.

There are many terms which are negotiated within a business contract, one of the most important being liabilities. In this blog, I’ll explain contract liabilities for beginners: what they are, why your business should take them seriously and how you can make the right decision.

What is contract liability?

Contractual liability means that one business agrees to pay for any losses or damages caused by another party.

This is useful when one or more businesses enter into a contract, and sub-contractors come into play. Here’s a fictional example of when contract liability is beneficial for a business:

For example: Pegasus Inc. is an IT services company that specialises in migrating businesses to the cloud.

They’ve recently entered business with a new client, Abacus, an accounting firm.

As part of their migration, Pegasus Inc. need to provide Abacus with new equipment – to do this, they choose to work with a wholesale supplier, Zeta Trade.

Zeta Trade will deliver and install the new hardware. The question is — if Zeta Trade do this incorrectly and cause damage to Abacus’s IT environment — who should be responsible?

To protect themselves, Pegasus Inc. requires Zeta Trade to enter into a contract with an indemnity agreement. In this agreement, Zeta Trade is held financially responsible for any losses or damages caused by their own negligence. This protects Pegasus Inc. from liability in any potential lawsuit, effectively transferring the risk onto Zeta Trade.

This is just one example of contractual liability – there are many variations in how liability can be assigned in a contract, and the best way to understand how your business should assign liabilities by consulting a specialist lawyer.

What happens when contractual liabilities are challenged?

To protect yourself, it’s important to include clauses that limit your liability. This means limiting the amount of compensation that can be claimed when a breach of contract occurs. Breaching contract can occur when a service or good isn’t delivered, for instance if an SLA is breached. When a breach of contract occurs, this can leave your business open to:

• Direct losses

  This is loss that is a direct result of a breach of contract e.g. having to pay for replacement goods that were ordered under contract and not received.

• Indirect losses

  This is a loss that has occurred indirectly because of a breach of contract e.g. compensation for the time lost as a result of not receiving goods promised under contract.

While compensation claims for direct losses are difficult to contest, as they breach defined contract terms, claims for indirect losses are more often disputed. This could be due because certain circumstances were not specified before the contract was signed, for example, if goods were not delivered and the business claims compensation for future goods.

Limiting your liabilities

A contract must include clauses that limit your liability – but how do you know what’s reasonable? On occasion, contracts include clauses that exclude all liability on their part, meaning that they can’t be held responsible for any loss due to negligence or otherwise.

While this might seem like an ideal solution to protect your business, it’s not quite that simple.

When using this kind of clause, it’s essential that it’s made clear to any other party and agreed upon, as the court will only uphold clauses that both parties were aware of. The Unfair Contract Terms Act 1977 was created for precisely this reason – to limit how easy it is to use limitations and exclusions of liability in commercial contracts.

The best solution is to limit your liabilities as effectively as you can with a specific sum, like the total cost of goods or services provided.

Putting a cap on liabilities can be beneficial, but it’s important to note whether the cap is per claim or aggregate. Choosing the correct language in your contract clauses makes an enormous difference.

So how can you ensure that your contracts are fit for purpose and will protect your business?

Struggling with contract liabilities?

As a law firm with years of not only commercial but also technology law experience, Law 365 is perfectly suited to creating contracts that help businesses stay safe and grow. Our goal has always been to change the way that businesses access legal services, making them more accessible and easier to understand.

Using modern business technology and specialised experience, we offer subscription-based and one-off services that help businesses take control of their legal processes and grow sustainably.

Get in touch with Law 365 today to find out what we could do for your business.