(By Guo Yaojie)Businesses may encounter contract risks in the course of regular business operation. Increasingly more businesses have become aware of the importance of risk prevention and started to put focus on risk control and prevention. Liability limitation clauses are often seen in contracts. What do liability limitation clauses mean? How do they work? What about the validity of liability limitation clauses in contracts? To find answers to these questions, read this article.
1.General liability limitation clauses
Liability limitation clauses mean contractual clauses that limit future liability of one party or both parties. Liability limitation clauses are intended to limit risks arising from claims for damages against businesses and define the scope of indemnification. Explicit and valid liability limitation clauses can effectively limit a company’s losses arising from claims for damages.
Here are some frequently used examples for liability limitation clauses:
（1）Set an upper limit on damages in liability limitation clauses:
Example 1: “Unless otherwise provided herein, for the benefit of the Parties, in no event shall the total amount of damages arising from a breach of this Agreement payable by either Party to the other Party exceed RMB 1 million”.
Example 2: “Unless otherwise stated in an agreement between the Parties, if you do not buy an insurance on the original value of the consignment, SF Express shall be liable for your actual losses that equal to no more than seven times the delivery fee…….If you buy and pay for the insurance, SF Express will pay actual losses in proportion to the insured amount in case of breakage or shortage or in case of a complete loss of your goods, no more than the value stated in the insurance bought upon the consignment being handed over to the consignor”.
（2）Include clauses stating that incidental, special or consequential damages are excluded (or set an upper limit on direct damages) in liability limitation clauses
Example: “SF Express shall not be liable for paying any indirect loss of potential profits, use, business opportunities, etc. connected with the consignment”.
（3） Limit the liability of a company to other parties to a contract in liability limitation clauses
Example: “In no event shall a company be held liable to buyers for damages caused by third parties unless the company’s action or inaction is related to a deliberate or severe negligence, fraud or deliberate illegal activity”.
2.Effect of liability limitation clauses
(1) Effect of general liability limitation clauses
Liability limitation clauses are a kind of liability exemption clauses that limit legal liability of one or more parties. Considering arbitrary and mandatory qualities of breach and infringement liabilities, the validity of liability exemption clauses is based on the principle of autonomy in private law and the principles of good faith and compliance with laws, public policies and good customs in civil law.
Therefore, the effect of liability exemption clauses varies in different situations. Generally speaking, liability exemption clauses that are in accord with public policies and completely voluntarily agreed by the parties involved after full discussions are legally accepted as valid. For example, in (2017) Z.G.F.M.Z. No.431 civil judgement of the Supreme People’s Court, (2017) J.02M.Z.No.9884 civil judgement of the Beijing No.2 Intermediate People’s Court and (2013) Y.G.F.M.Z.Z.No.00258 civil judgement of Chongqing High People’s Court all the courts decided that liability limitation clauses were valid.
However, liability exemption clauses that seriously violate the good-faith principle and public interests are prohibited by law to avoid abuses of liability exemption clauses, serious harm of interests of any of parties involved and adverse impact on contractual transactions.
Article 53 of the Contract Law of the People’s Republic of China (“Contract Law”) provides that liability exemption clauses in a contract that would cause (i) physical harm to the other party to the contract or (ii) damage to the other party’s property due to a deliberate act or gross negligence shall be deemed as invalid. This provision is basically intended to prevent adverse consequences of any violation of public policies and social ethics regardless of small differences in the above two cases.
As liability limitation clauses are essentially used to fix and allocate future risks between parties to a contract, mainly exempting and limiting liability arising from incidents that may occur after the signing of the contract, none of the parties involved can conceal real risks that existed or continue before the signing of the contract, which is the basis on which liability limitation clauses are executed and an essential element in the good-faith principle. There are specific provisions in law against liability exemption clauses that violate the good-faith principle. For example, Article 32 of the Interpretation of Issues Connected with Application of Law to Dealing with Sale and Purchase Contract Cases (“Legal Interpretation about Sale and Purchase Contracts”) provides that if the seller fails to inform the buyer of defects in goods sold due to a deliberate act or gross negligence, the court should not decide to reduce or exempt the seller’s liability of warranty for the defects as set out in the contract. This exception to cases of reducing or exempting the seller’s liability of warranty on defects in goods sold reflects the requirement of civil law that parties involved should follow the good-faith principle.
The fifth issue in 2019 of the Official Report of the Supreme Court published a real case relating to liability limitation clauses – (2017) H.01.M.Z.No.9095 Civil Judgement of the Shanghai No.1 Intermediate Court, stating that the real estate developer concealed the existence of risks that may prevent the house transfer from being timely completed at the time of signing the contract with the ability to change the deadline for the house transfer so that the house buyer reasonably believed that the developer had committed to the deadline for the house transfer, which fully absorbed the actual conditions for performing the schedule that the developer was aware of, the original risks would disappear in time and the deadline for the house transfer would be met if there was no further cause for liability exemption. The scope of risk transfer agreed by the parties to a contract includes risks that may appear during the performance of the contract, not including actual conditions that are considered when setting the deadline for the house transfer. For this reason the liability limitation clauses did not apply to real risks that are not disclosed at the time of contract execution and the developer lost the case when the court finally decided that risks that threatened the house transfer at the time of contract execution could not be waived on the basis of the liability limitation clauses. We can see from this case that to protect the interests in trust of persons doing business with a company, the company should inform them about related liability limitation clauses, especially major risks incurred in which case the liability limitation clauses apply, or otherwise the liability limitation clauses may not be in full effect.
Liability limitation clauses voluntarily executed through consultation between parties thereto are generally accepted as legally valid. If the clauses seriously harm public interests or violate the good-faith principle, they will be legally deemed as invalid.