Exemption clauses are a way to minimize the potential consequences of breaching a contract.
Most legal agreements have them; they’re not an unusual feature.
That said, they’re not always easy to understand, so let this article be your guide.
We’re going to look at what contract clauses are generally, exemption clauses specifically, the benefits and drawbacks, and the different types.
We’ll also show you how PandaDoc can help you streamline the contract creation process.
Key takeaways:
- Exemption clauses in a contract aim to limit or remove the liability of a party if something goes wrong.
- They can facilitate fair and balanced contractual arrangements between parties.
- Exemption clauses allow both parties to assess the balance of risk more clearly, but they can lead to an unequal distribution of risk.
- You can simplify the entire contract creation process with reliable contract management software.
What are contract clauses?
Exemption clauses are a particular type of contract clause — but what is a contract clause on a general level?
Contract clauses are the building blocks of a legal agreement.
They set down conditions that determine the requirements and validity of a contract.
There are numerous types of contract clauses, and they can be very detailed and specific.
Including lots of clauses certainly makes contracts longer, which can sometimes make them appear overwhelming.
However, by breaking conditions down into specific chunks, their aim is actually to clarify the agreement, spelling out particular responsibilities, terms, rights, obligations, deadlines, and (pertinent to this article) exemptions.
Examples of contract clauses include non-compete clauses, non-disclosure clauses, escalation clauses, copyright clauses, and of course, exemption clauses…
What exactly are exemption clauses?
Exemption clauses are a specific type of contract clause.
They’re a common contract feature and are especially ubiquitous in commercial contracts (where one party provides a product or service to another).
The aim of exemption clauses is to limit or remove the liability of a party if something goes wrong.
Most contracts entail a degree of risk. What happens, for example, if the product, experience, or service that one business is providing to another goes wrong in some way?
How liable is that party to make remedies (e.g., pay damages) to the other party if they breach the contract for some reason?
Exemption clauses counterbalance some of this risk (for one party, at least). They can be complicated and contentious.
For example, they may be unfair, benefitting one party above the other. Indeed, for this reason, they’re sometimes viewed unfavorably by law courts, i.e., as an attempt by one party to abdicate responsibility if things go wrong.
However, more positively, contract clauses can shield a party from potentially crippling damages resulting from circumstances they have no control over.
For example, one party may encounter difficulties providing its service, thus breaching the contract. Luckily, exemption clauses can add nuance to individual liability in these circumstances.
Irrespective of whether they always seem one hundred percent fair or not, one thing that’s important about contract clauses is that they’re ultimately enforceable so long as they meet certain legal requirements.
The importance and function of exemption clauses in a contract
Exemption clauses can play a significant role in a contractual relationship. They act as a mechanism for managing risk and allocating responsibility between the parties in a contract.
They define boundaries of liability, too, allowing one or more of the parties to protect their interests and mitigate potential losses or damages.
By clearly delineating the scope of liability, exemption clauses establish predictability and certainty in contractual relationships.
Moreover, they can facilitate fair and balanced contractual arrangements, allowing parties to allocate risks according to their respective bargaining power and commercial circumstances.
Here are some hypothetical scenarios that might warrant exemption clauses.
Imagine a software developer who’s hired to develop a new application. They include an exemption clause in their contract that limits their liability for particular delays, errors, or problems with the software once deployed. This clause acknowledges the inherent complexities of software development and protects the provider from unreasonable and unlimited liability for unforeseen issues.
Alternatively, imagine a shipping company contracted to transport cargo. They include an exemption clause in the shipping contract that limits their liability in the event of extreme weather or natural disasters, piracy, or political turbulence. The clause aims to exempt the shipping company from liability for events over which it has little to no control.
Or picture this. A construction company is hired to build a commercial property. As part of the contract, they include an exemption clause limiting their liability for delays caused by unforeseen difficulties (e.g., supplier issues) or problems with the finished building if it’s not maintained to a particular standard. This exemption clause protects the contractor from bearing the entire burden of unexpected yet unfortunate circumstances.
Finally, think about landlords including exemption clauses to limit their liability for minor, day-to-day maintenance issues. In doing so, they can focus on providing the necessary infrastructure while tenants assume responsibility for less significant tasks. This could potentially mean a more efficient, convenient, and transparent arrangement for both parties.
In these examples, the exemption clauses allow one party to manage their risks, plan accordingly, and avoid incurring substantial financial losses due to factors outside their control. Without the inclusion of these exemption clauses, the risks and potential costs of the contractual relationship may outweigh the benefits.
The upside of exemption clauses for the party they protect is obvious. However, whether or not they result in a balanced and fair agreement for both parties is often a contentious question.
Exemption clause benefits and drawbacks
Like any other contract clause, particular legal goals can be secured using exemption clauses.
Importantly, their use can entail both advantages and disadvantages for one or both parties to the agreement.
Let’s consider the benefits first.
The ability to limit or exclude liability can protect parties from excessive risks
Exemption clauses precisely delineate risks and allow parties to assess the balance of risk more clearly. This may be crucial in high-risk sectors or complex business transactions.
Exemption clauses can make the risks of certain activities more manageable; without them, some business deals may not make commercial sense.
Have a mechanism to negotiate and assess the balance of risk
Exemption clauses can also provide a mechanism for both parties to negotiate and assess the balance of risk.
They provide a means, theoretically, for them to find an arrangement through which the stakes are mutually and satisfactorily shared between them.
Set out various ‘what if’ future scenarios
Exemption clauses can set out various ‘what if’ future scenarios too.
By doing this, carefully drafted clauses can help prevent legal arguments down the road.
Again, in theory, exemption clauses enable all parties to enter an agreement with their eyes open.
When implemented correctly, exemption clauses are legally enforceable.
However, these benefits aren’t necessarily inherent in all exemption clauses. Whether or not they exist depends on how they’re used in the contract. The devil is in the detail.
Indeed, there are also several potential drawbacks of exemption clauses that it’s equally important to be aware of.
Lead to an unequal distribution of risk between the parties
They can lead to an unequal distribution of risk between the parties.
For example, one party may have more power, leverage, or knowledge than the other and use this to implement an exemption clause that unfairly advantages their interests.
The weaker party may then feel compelled to accept an unfavorable exemption clause — for example, conceding to the clause to secure the contract and their business.
This may leave them with a disproportionate share of the risk if something goes wrong.
Must meet strict conditions to be legally valid and enforceable
It’s also vital to realize that exemption clauses must meet strict conditions to be legally valid and enforceable.
If something goes wrong, an unenforceable clause is worthless; when needed most, it simply dissolves.
Courts won’t always interpret exemption clauses as the drafter intended
In addition, even when exemption clauses are legally valid and enforceable, courts won’t always interpret them as the drafter intended.
Law courts in most jurisdictions will scrutinize them closely and follow them narrowly. This can result in unintended and sometimes surprising rulings (more on this below).
Difficult to understand
Given all this complexity, contract clauses can also be difficult (even overwhelming) to understand —especially for a non-legal-specialist — and may sometimes seem to contradict other aspects of the agreement.
While you’ll probably be fine if you work for an organization with an experienced legal team, many smaller businesses do not have this luxury.
In short, exemption clauses need careful handling to ensure that drawbacks and benefits are mutually managed.
What are the different types of exemption clauses?
There are different types of exemption clauses that are used to achieve specific legal goals.
Let’s now consider the two most important ones to be aware of.
1. Exclusion of liability clauses
Exclusion clauses aim to exclude certain types of liability altogether.
They specify particular events, damages, or losses for which a party won’t be held liable.
For example, an exclusion clause may state that a party isn’t responsible for any indirect or consequential damages resulting from the contract.
These exclusion clauses are relatively common.
For instance, in a consumer goods contract, the supplier may include an exemption clause stating they’re not responsible for any harm or damage resulting from the product if it’s used in a particular way (e.g., deviating from the instructions).
Law courts are typically wary of exclusion clauses, subjecting them to a lot of scrutiny.
They need to be watertight to endure this and be applied as the drafter intended.
2. Limitation of liability clauses
These clauses cap the liability that one party can be held responsible for in cases of breach or loss.
They often specify a maximum monetary amount or percentage of the contract value that the liable party will be obligated to pay.
The liability isn’t excluded; instead, they limit the financial impact of it.
For example, a company might include a limitation clause stating that they’ll only pay up to $1,000 in the event of injury or damage.
Thus, the limitation clause accepts a degree of liability but attempts to limit the level of risk this involves.
3. Indemnity clauses
This allocates certain risks and liabilities between parties.
It typically specifies that one party agrees to indemnify, defend, and hold harmless the other party from any losses, damages, claims, or expenses arising out of the contract or related to specific actions or situations.
The purpose of an indemnity clause is to shift the financial burden or responsibility for certain risks from one party to another.
By including one in a contract, the indemnitee seeks protection and assurance that they will be compensated or protected if certain defined events or circumstances occur.
The legality of exemption clauses
Complex legal considerations arise when dealing with exemption clauses.
Exemption clauses must be correctly ‘incorporated’ into the contract to be legally valid.
The clause should be explicitly agreed upon by the parties and included in the written contract (or referred to as an integral part of the agreement).
An exemption clause may be deemed invalid and unenforceable if this isn’t the case.
However, validity alone isn’t enough.
When drafting and negotiating a contract, it’s also critical to ensure that the clause is likely to achieve (in a court of law) its intention.
This requires careful consideration of how a law court might interpret it.
Make no mistake: exemption clauses are typically examined very closely by courts in the event of litigation. So, when drafting one, bear in mind the following points.
Courts tend to interpret exemption clauses strictly
Courts tend to interpret exemption clauses strictly, narrowly, and against the party seeking to rely on them.
They’ll examine the language and wording of the clause to ensure it’s unambiguous, and any ambiguity or uncertainty in it may well cause problems.
Courts also consider the reasonableness and fairness of exemption clauses
If a clause falls short here, it may be deemed invalid and unenforceable.
Factors such as the bargaining power of the parties, the nature of the transaction, and the potential consequences of the exemption clause are taken into account when assessing its reasonableness.
Moreover, different jurisdictions will impose particular requirements, so you must know which laws apply to your contract.
For example, in some jurisdictions, certain liability types can’t be excluded (especially regarding personal injury or death caused by negligence).
The legal issues arising from this can thus be complex. Professional legal guidance is obviously ideal to ensure clauses are properly incorporated.
This also makes certain that clauses are clear, unambiguous, and reasonably enforceable in the event of a dispute.
Carefully crafted templates can be of great assistance when creating contracts containing exemption clauses.
Simplify your contract creation with PandaDoc’s contract management software
Contracts help companies to grow and take on new business.
They allow organizations to assess and manage the level of risk that deals and opportunities may involve.
In short, they can offer the predictability and legal security that all businesses crave.
Nevertheless, these benefits are by no means a given, and drafting and negotiating robust contracts can be a challenging process.
PandaDoc can streamline the entire process with a library of professionally designed contract templates that can be customized to suit specific business or sector needs.
Make drafting exemption clauses simpler by utilizing a content library and adding approved stipulations.
With PandaDoc, signing contracts is easy, and parties can electronically sign contracts from anywhere.
Moreover, PandaDoc’s automation capabilities can streamline your workflows by setting up automated notifications and reminders for stakeholders to speed up negotiations.
Let PandaDoc help you ensure a smoother, simpler, and less error-prone contract creation experience.
Disclaimer
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