Limitation of liability is always an issue when negotiating commercial agreements – and such a matter is much more pressing when dealing with capital goods and infrastructure, where consequences of failure to perform may be of significant proportions.

When your business revolves on capital goods you are dealing with the core business of your customer. Failure to perform according to the original plan may ultimately impose a cutoff of the buyer’s production and a directly impact his capabilities to generate revenue. Same goes for infrastructure, where even a temporary mishap may impose to buyer severe consequences over the development new projects and, to some extent, the development of a whole region.

First of all, let us put the legal issues at a side: Limitation of liability clauses on private agreements are fully lawful and there is no debate on such a substance. Brazilian Civil legislation prohibits a full exclusion of one’s liability by means of contract but does not, in any way shape of form, prohibit the parties to establish a limitation to what they may consider reasonable.

And unfortunately there is debate of whether a limitation of liability clause would be lawful under the Brazilian public procurement law (L 8.666/93). However being such statute specifically states that suppliers are entitle to compensation and maintenance of the original economical balance of the agreement. There is also the fact, the purpose of a public procurement agreement is not commercial (hence not to obtain profit) and there is strong argument that a claim to obtain profit losses with strictly governmental entities would be without cause. These are, of course, only mitigating factors.

Hence the most commonly negotiated limitation of liability clauses establish an aggregated cap over a percentage of the contract (i.e. 5%, 10% or 100% of the contract amount), and exclusion of what has been named as indirect and consequential damages in particular – and most importantly – profit loss.

Why Sellers should thrive for a proper limitation of liability is pretty obvious: First of all, no company is able to sustain the full consequences of a major customer stoppage. Telecom carriers, for instance, are some of
the highest worldwide grossing sectors, having a great multitude of suppliers necessary to fully maintain network stable. Should disruption occur in a minor equipment it is very unlikely that even the most financially successful manufacturer would be able to endure the full blow of customer’s liability.

In addition, all estimation on profit losses can only be applied to a certain degree of certitude. No one may ensure, with absolute certainty, what would be the amount of revenue that a customer would reasonably have acquired should the contract have been performed as expected.

Any decision in such a regard is most likely to resemble an “educated guess” than an actual mathematical deduction. Not to mention the inevitable discussion on whether the Buyer should have incurred in additional investments to serve as backup, and therefore would also be to blame for its own losses. In short: discussing profit losses by major corporations is one of the easiest ways  to enter into expensive litigation.

Why Buyers should accept a reasonable limitation of liability clause, may not be that obvious, but is just as critical. Please consider that the purpose of making a smart investment is not to protect yourself for unforeseeable risk but rather to extend one’s capabilities to generate revenue. Companies aim to be profitable after all.

If a Buyer decides that it shall not accept a limitation of liability clause and exclusion of indirect damages/profit losses from any of its suppliers what it is requesting is for the latter to assume all risk relating to its production. Sellers then have only two options at their disposal: a) to ignore the risk that they are exposing themselves to; b) reevaluate their price accordingly, as to compensate for the risk of not performing.

Suppliers that assume risk without properly assessing consequences are hardly reliable ones. If the worst should happen, they are more likely to pursue litigation than live up to their responsibilities. Excuses, excuses, excuses are bound to arise. All the same, when the inevitable negative outcome ultimately unfolds, such inconsequential suppliers simply do not have enough resources to assume the consequences of their full liability.

Either way Buyer finds himself adrift, without being able to properly and timely carry out an agenda that was depending on such an “easily negotiated agreement”. Revenue and cash flow suffer.

Choosing only responsible Suppliers that are willing assume full liability, all the same, is not the best solution for Buyer. In order to properly evaluate risk under a full liability context Seller has to estimate what are the consequences of his failure to perform. What is the cost of Buyers full installation? What is its expected capability to generate revenue with such assets? How much benefit is he expecting to receive with the undergoing project? What are his figures?  – And for that matter, would Buyers really want to open their books to suppliers, exposing privileged and sensitive information?

These are of course very complicated questions that are likely not to be evaluated during an offer presentation. Seller is just too focused on figuring out the engineering and making the project happen that it simply does not have enough time to make this kind of estimation. His best choice may be to play it safe and increase his contingency. Prices rise exponentially.

One should also consider that Buyer does not depend on a single supplier to make his business run – He need several ones. If all suppliers are accounting for Buyer’s whole production line and capacity to generate revenue, Buyer is expensively paying several companies (companies that have very little expertise in assessing risk) to ensure the continuity of his installations, productivity and future income simultaneously and repeatedly.

Wouldn’t it be so much better for Buyer to accept a reasonable limitation of liability and reliably account himself, just one single time, for his installations and income? All this with the benefits of knowing the factual background of his business and strategic planning for the future?

This does not mean, by any means, that Buyer should accept every limitation of liability clause as proposed. The negotiated of limitations of liability have to be reasonable, taking in consideration of nature of each business, and eventually project by project. A limitation of liability must not be an escape route for companies acting on bad faith, that a are willing to leave their customer stranded, facing the consequences of their carelessness in executing agreements. Buyer must make sure of that.

Depending of the sector a limitation of liability may state a 100% of contract price cap, 10% per cent of Contract Price cap, 2% of Contract Price cap. Generally speaking, the exclusion of profit losses is appropriate – but the limitation of liability should not apply in view of tort and gross negligence.

There is no doubt: a limitation of liability is the very best way for parties to distribute risk over the execution of their agreement, each one assuming what they are more capable to control and mitigate, so that Seller may present its very best price for its very best product.

And wouldn’t that be in Buyer’s best interest?

José Augusto Oliveira is associated lawyer at Tess Law Firm.