If the caps fit…

Last month, I wrote about the difficulty of agreeing liability clauses in ICT contracts.

Discussions about who pays what to whom if something goes wrong always seem to bring out the pessimist in everyone.

There’s no one-size-fits-all solution to these issues but there ought to be a few obvious areas where agreement on liability should be easy to reach.

For the most part, a liability clause is an acceptance that, subject to various exceptions, where a party is in default it picks up the tab.

The difficult bit is what those exceptions should be.

In strict numerical terms, it ought to be universally accepted that across-the-board unlimited liability clauses are not realistic.

It’s now common practice that the exposure of a defaulting party under contract is financially limited in most cases.

There are still some areas where customers often seek uncapped liability, especially because, as ICT contracts have moved gradually closer to customers’ core functions, they are now increasingly worried about the exposure to claims from external third parties such as the customers’ own clients.

Exposure to data loss or fines based on data breaches is an example of an area where exposure is increasing, especially as the scale of such fines has grown dramatically from a ‘slap on the wrist’ to the multi-million-pound level.

Parties to contracts often distinguish between insurable and uninsurable losses when discussing which types of loss may be appropriate for uncapped liability.

A typical starting point for negotiations on financial limits is often an annual cap of 100 per cent of annual contract value and the parties negotiate up or down from there.

Having said that, there’s really no logical connection between the size of a contract and the scale of potential loss.

On some large contracts, the potential exposure to loss can be minimal; conversely, even on contracts that have a relatively small value, if the services are of the right kind, then the scale of loss can be enormous.

But proportion of contract value has come to be recognised as a handy yardstick for assessing and determining caps on liability.

Generally, it will suit a buyer of ICT services to have a single cap on liability, whereas it will tend to suit a service provider to have many small sub-divided pots of liability, with each pot being set against a particular type or cause of loss.

The common compromise is a cap set by reference to annual contract value, although that solution works less well in contracts with high start-up and low follow-on payments.