The first article in this series emphasized the need for thoughtful, strategic consideration when using boilerplate in contracts in order to minimize the likelihood of a problem down the road. This segment addresses three widely used contractual terms to illustrate the point: limitations on liability, merger (also known as integration), and indemnification. Too often, these concepts and provisions are given only casual consideration since they relate to that unpleasant scenario where a controversy might develop between the parties in the future. However, given the considerable cost and uncertainty of corporate and commercial litigation, it is wise at the point of contract formation to press the fast-forward button, to engage in prospective risk management and to minimize the chances of encountering unforeseen pitfalls.
Limitations on liability clauses are used to limit a party’s potential exposure to claims made by counterparties. These preemptive, contractual provisions preclude a litigant from recovering consequential and special damages, which include lost revenue and profits and other indirect damages that do not flow directly from the breach of the parties’ agreement but are otherwise available if they were reasonably foreseeable at the time of contract execution. The liability limitations are common and generally enforced by courts to the extent they are negotiated at arm’s length. But the impact of these contractual clauses may be extreme because garden-variety compensatory damages arising from the contract (which are often limited) may be all that is available under the circumstances. As a result, the practical consequences of a possible breach of contract (lost business, for example) should be evaluated in advance to determine whether the waiver or inclusion of these potential damages, in connection with a limitation of liability clause, is an acceptable business risk and, if so, to what extent.
Viewed from a different perspective, the failure to include a merger clause might be just as dangerous. If it is in the party’s best interests to insulate the contract terms from potential parol evidence — based on a course of dealing, oral representations or other extrinsic matter unrelated to claims of fraud — a merger clause is needed. As with all boilerplate-related decisions, it is important for the draftsperson to consider how the parties’ relationship is likely to unfold. While courts generally respect the terms of a merger clause, that deference is beneficial only if the language used achieves the desired result. The inclusion or purposeful omission of a merger clause should have a targeted objective based upon the calculated likelihood that extrinsic matter, such as course of conduct and other considerations, will favor your side in the event of a dispute.
Finally, be thoughtful about contractual indemnification. You may not be receiving what you think you bargained for in the agreement. Many believe that an indemnification holding a counterparty harmless against “all claims and damages, including attorneys’ fees relating to the indemnifying party’s breach of contract” entitles the indemnified party to recover its legal fees in actions for breach of contract directly against its counterparty. Looks may be deceiving. This indemnity provision, in actuality, does not permit a direct claim by the indemnified party for breach of contract and attorneys’ fees. Under New York law, attorneys’ fees are not recoverable unless expressly agreed upon by the parties. The parties’ indemnification agreement must be “unmistakably clear” that it was intended to apply to disputes against counterparties, rather than third-party claims against the indemnified party. While it has become common practice in many commercial circles for injured parties to rely on general indemnity clauses to recover legal fees, the indemnified party must prove that the indemnity was intended to apply to disputes between the parties. The better, safer practice is to include a separate provision awarding attorneys’ fees to the prevailing party in the event of a dispute. These issues should be addressed directly during contract negotiations, not after your counterparty has breached the contract and you find yourself without a meaningful legal fees provision.