Limitation of Liability Clauses: Good or Bad?

Well, it depends.

Limitation of Liability (LOL) clauses, in the correct situation, can be a useful tool in managing and limiting a firm’s risk. However, in some situations LOLs can increase a firm’s exposure to risk. With insurance rates increasing, especially for some professional disciplines, LOLs are viewed as a way to minimize the damages firms can be liable for and therefore help control insurance rates.

With an increase in the use of LOLs there has also been an increase in the legal challenges to them.  Generally courts will support a contractual obligation assuming that the parties knew and understood what they were contractually agreeing to. But courts also want to feel comfortable that the LOL is enough, as one court put it, to be an inducement for the professional to “act professionally.” In other words, was the LOL high enough that the professional would still suffer some financial harm if they were found liable for a claim. LOLs should always be reviewed by legal counsel so that they can comment on how the applicable court may view it.

We’ve seen an increase in LOLs in inter-professional agreements. This is of particular concern since often the prime agreement does not have an LOL. We had a claim for $2.5M in damages due to the negligence of a subconsultant, but the subconsultant was only obligated to pay $250k due to the LOL in the agreement. The prime professional was responsible for the $2.25M balance since they did not have a similar LOL in their agreement with the client.

It is important to note that LOLs are contractually assumed obligations. So depending on what your professional liability policy covers and excludes, and your carrier’s view of LOLs in these situations, there is a chance that damages due to the prime’s  vicarious liability for its subconsultants beyond the LOL obligation in inter-professional agreement, may not cover be covered by the professional liability policy.

Schinnerer & CNA policyholders can find more information  in our Management Advisory, Limitation of Liability as an Allocation of Risk