Liability clauses: How can you manage your exposure?
Liability clauses are an important contractual tool designed to manage overall risk by limiting a party's potential liability for damages and they’re of crucial importance in a contract. These clauses should be carefully reviewed and are often highly negotiated.
The issue of liability is a major stumbling block where parties' interests diverge radically. Each party wants to widen the scope of their co-contractor’s liability as much as possible, while at the same time trying to reduce their own liability. This conflict of interest often draws attention to the alleged ineffectiveness of the counterparty's draft limitation of liability clause.
Against this background, the exclusion or limitation of liability in contracts is generally permitted under Luxembourg law, under some conditions.
Regardless of any exclusion or liability provisions, legal liability may arise because of a breach of contract which has caused direct damage to the counterparty, and which is directly related to the breach. Besides the breach itself, a damage and a causal link1 must be proved.
Liability clauses enable the parties to reduce exposure to the risks of a contractual liability, limit the amount of compensation, and introduce more certainty. But the law provides for some limitations, restrictions, and criteria which must be considered. So it’s important to understand the main types of liability clauses, the legal provisions that govern their validity, and the conditions of their enforceability.
1. Main types of liability clauses
Liability clauses may influence the obligation, the damage, or other aspects of the contract.
Clauses related to the obligation
These clauses tend to shape the extent of the obligations of each party:
- Disclaimer of liability: excludes all liability for a certain harm.
- Limitative clause: limits the scope of an obligation. This reduces the number of behaviors that can be qualified as a nonperformance and therefore engage liability.
Clauses related to the damage
These clauses tend to circumscribe the type of damages that can trigger a liability claim:
- Exclusion clause: excludes the right to compensation in case of nonperformance of the debtor of an obligation. This clause is valid when it meets certain conditions detailed below.
- Limitation clause: excludes certain types of damages or limits the maximum liability to a specific amount.
When drafting the clause, it’s important to note that, under Luxembourg law, liability may only arise when the breach has caused a direct damage to the counterparty.2 In other words, indirect damage cannot be compensated, unless if the parties agreed to cover it.
This solution differs from the one adopted by common law jurisdictions which admit compensation for indirect damage, such as loss of revenue.
However, the concept of indirect damage is seen differently in civil law and in common law jurisdictions. Certain damages are considered indirect in common law, but they’re considered direct damages in Luxembourg.3
A general clause excluding liability for indirect damages would not have any effect as the damage intended, while considered as indirect in other jurisdiction, might be considered as a direct damage in Luxembourg. So it’s recommended to specify exactly the types of damages to be excluded.
Other clauses that limit liability
- Penalty clause: express provision in a contract which obliges a party who has breached the contract to compensate a party affected by the breach.4
- Clauses dealing with the conditions of liability: affect the event triggering the liability, by making it easier or more difficult to prove it (for example, a clause defining which event could be qualified as force majeure).
- Clause relating to the admissibility of a liability claim: limits the period in which a party can file a contractual claim against a defaulting party.
As seen above, liability clauses can take several forms. But as they pursue a common objective, they’re subject to a common legal regime.
2. Legal conditions of validity
Luxembourg contractual law is governed by a general principle of contractual freedom. In that respect, it only limits liability clauses in case of abuses. However, special provisions are provided for in some specific liability regimes.
In the event of a breach of contract, Luxembourg courts consider how the contract was drafted. If the contract provides for sufficient compensation for the limitation of liability, the clause will be held valid
The general principle of freedom of contract enables the parties to introduce liability clauses in their agreements.
But some behaviors are considered as particularly harmful and prevent the clause from being applied. So the liability clause would not be applied in the following cases:
- Gross negligence: the negligence that the least diligent person would not have committed.5
- Willful misconduct: an intentional breach of contract.
- Breach of an essential duty: the situation in which the liability clause contradicts an essential duty i.e. an obligation which is the core of the agreement.6 In the event of a breach of contract, Luxembourg courts consider how the contract was drafted to decide if the limitation of liability applies or not. If the contract provides for sufficient compensation for the limitation of liability, the clause will be held valid.
The law specifies special provisions in certain fields. Some of them will be detailed below.
Concerning construction law, statutory warranties are provided for buildings being constructed, ranging from ten years since construction for structural damages to two years for nonstructural damages. In this context, it’s not possible for constructors7 to exclude their liability.
Regarding the liability for latent defects, a clause can be introduced to limit it. However, this clause will not be applicable if the party was aware of the defect at the time of the contract.8
In consumer law, the prohibition of unfair terms applies to liability clauses incorporated into contracts between a professional and a consumer. Although they’re not systematically forbidden, liability clauses that would create a severe disadvantage for the consumer would fall under this legal prohibition.9
Finally, product liability is subject to a very specific regime which prohibits liability clauses.
3. Enforceability of liability clauses
While mainly subject to an informed consent, the enforceability of liability clauses raises specific challenges when incorporated in contractual chains, enforced towards a third party, and in case of a foreign clause.
A clear, visible, and accepted clause
The parties have to pay attention to how the liability clause is introduced into the contract. It should be done in a way that the clause is clear, visible, and accepted.
Liability clauses are often introduced in the general terms and conditions of an agreement.
While this practice is accepted, it has to be in line with Luxembourg law.
Terms and conditions do not need to be specifically signed. But the party that intends to rely on the clause shall be able to show that the counterpart was aware of the terms and conditions and explicitly or implicitly accepted them.10
In the same vein, Luxembourg courts have decided that the limitation written on the back of an invoice was not sufficiently clear or visible. So the clause could not be applied.
Enforceability in a contractual chain
Under the general principle of privity of agreements, a contract between two parties should not be enforceable against a third party.
But there is an exception.
In a chain of contracts transferring ownership rights, the liability clause introduced in the first contract is enforceable towards the final counterpart.11
For example, a seller may apply the liability clause provided in the sale agreement to the buyer but also to the sub-buyer in case of a direct action against them.
However, in a chain of contracts in which one or several agreements do not transfer ownership rights, the liability clause is not enforceable toward the final counterparty.12
In a chain of contracts transferring ownership rights, the liability clause introduced in the first contract is enforceable towards the final counterpart.
Enforceability towards a third party
Case law admitted the possibility for a third party to an agreement to bring a case against a contracting party for the harm caused by a breach of the agreement.13
Although brought on the basis of a breach of contract, being a third party, the claimant can only engage one of the party’s tort liability to cover damage.14
So, the third party will not suffer any limitation because of a liability clause. This clause is not enforceable towards a third party.
Enforceability of a foreign liability clause in Luxembourg
A Luxembourg judge may have jurisdiction to review a foreign liability clause. While a contract may be subjected to a foreign law, the Luxembourg courts may have jurisdiction to hear the dispute arising from its execution. In that case, the Luxembourg judge will have to review the foreign liability clause.
This clause is subjected to public order and international public policy.
Case law has shown that if a foreign clause is drafted in a way that it limits liability even in the event of willful misconduct or gross negligence, the judge will not apply it.15
On the other hand, the clause expressly stating that the limitation of liability is excluded in case of a willful misconduct or gross negligence will be considered as in conformity with public policy and applied.
This solution was issued by the French case law and has not yet been confirmed in Luxembourg.
4. Key drafting considerations
- Make sure the contract is not subject to a specific liability regime (e.g. product liability).
- Use plain language.
- Identify expressly the types of liability to be excluded.
- Make sure not to exclude liability in case of gross negligence or willful misconduct.
- Make sure a meaningful remedy is still available on breach.
- If the clause is introduced in the general terms and conditions, make sure to establish evidence of the acceptance of the terms and conditions.
1 In Luxembourg, the causal link is appreciated according to the theory of adequate causation (théorie de la causalité adéquate). As confirmed by the Court of Appeal, "it is necessary to assess, with regard to each event whose causal intervention in the realization of damage is raised, whether this event, in the normal course of events and according to the experiences of life, normally leads to such a damaging effect" (Court of appeal 25 March 2005, n° 28774).
2 This is a result of Article 1151 of the Civil Code according to which damages should only include what is an immediate and direct consequence of the non-performance of the agreement.
3 Eg the loss of turnover
4 Penalty clauses are governed by Article 1152 of the Civil Code. Their amount cannot be excessive. Otherwise, the judge would moderate the excessive amount of the clause.
5 French Cour de Cassation, 29 June 2010, n° 09-11841 “Faurecia 2”
7 Although largely used, this word does not refer to a single legal concept. It refers mainly to architects, contractors who participate in the construction, and property developers.
8 See for example French Cour de cassation 27 November 2019, n°18-18.402.
9 Ravarani G., La responsabilité civile des personnes privées et publiques, Pasicrisie Luxembourgeoise, 2014, p. 801
10 Article 1135-1 of the Civil Code.
11 French Cour de cassation, 7 February 1986, n° 84-15189.
12 French Cour de cassation, 12 July 1991, n° 90-13.602 “Besse.”
13 Court of Appeal, 2 July 2008, B.I.J., 2008, p. 152
15 Court of Appeal of Rennes (France) 1 December 2017 – n° 14/07926: regarding the interpretation of a Dutch liability clause.