Liability caps

In many jurisdictions, the legal relationship between a lawyer and a client is a complex one. One of the reasons why is that it is governed by several areas of law and regulation. For example, contract law is relevant to the engagement terms between a lawyer and a client, and provides a basis on which a client can sue the lawyer if the lawyer breaches the engagement terms and causes loss to the client (for a discussion about damages or compensation for breach of contract, see China Business Law Journal volume 4 issue 2, page 76: Compensate or indemnify?).

In addition, a lawyer may be liable to a client in tort – i.e. independently of contract law – if the lawyer is negligent and the negligence causes loss to the client. Further, there are duties, obligations and requirements that arise as a result of the special nature of this relationship (for a discussion about fiduciary duties in common law jurisdictions, see China Business Law Journal volume 3 issue 1, page 94: Duty or obligation?) and also as a result of the professional rules of conduct to which lawyers are subject.

Lawyers need to take great care when advising clients, preparing legal documents and providing legal services generally. Their potential liability for mistakes and negligence is often unlimited and increases with the size of the deal and the legal complexities.

There are several ways in which lawyers manage their potential liability. One way is through professional indemnity insurance, which is compulsory in most jurisdictions. However, insurance only provides protection up to the insured amount and does not provide unlimited protection. Another way that lawyers manage their potential liability is to limit claims to the assets of the law firm and to insulate partners from personal liability. This is why lawyers practise through limited liability partnerships in many jurisdictions (for a discussion about limited liability partnerships, see China Business Law Journal volume 4 issue 6, page 89: Partnership).

A further way in which lawyers manage their potential liability is by inserting a liability cap in their terms of engagement. These caps are designed to limit liability, whether arising pursuant to a contract or otherwise, to a specified amount. A liability cap provision often appears alongside a “proportionality” provision. The proportionality provision protects law firms and lawyers in circumstances where other advisers (e.g. accountants) are also liable, but the lawyers have to bear more than their proportionate share of the loss because the client has agreed to exclude or limit the liability of the other advisers.

An example of each clause appears below:

Proportionality

Where other persons advise you on a matter, there is a risk that we will be prejudiced by any limitation or exclusion of liability that you agree with any of those other persons. This is because if we and such other persons are liable to you for a loss that you suffer, such a limitation or exclusion of liability may have the effect of requiring us to pay more than our proportionate share of the loss and limit the amount that we can recover from that other person by way of indemnity or contribution. Accordingly, you agree that to the extent permitted by applicable law, if we incur any liability to you arising out of or in connection with the matter, whether in contract, tort or otherwise, we will not be liable to you for any amount that we would respectively have been entitled to recover from that other person by way of indemnity, contribution or otherwise, but are unable to recover because you agreed with them an exclusion or limitation of their liability.

Limitation of liability

You agree that our aggregate liability to you arising out of or in connection with the matter will be limited to [amount] (the “Liability Cap”). Accordingly, our aggregate liability to you in respect of all claims by you arising out of or in connection with the matter, whether in contract, tort or otherwise, will be limited to the amount of the Liability Cap.

As set out below, there are several issues that lawyers should bear in mind when they seek to impose liability caps.

A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia.