How not to be an accidental insurer

Quiz question:  Liability caps for contribution to third party claims are-

(a)   hardly understood by anybody

(b)  extremely important in contracts

(c)   a fast way to accidentally turn your company into an insurance business

(d)  very expensive if you get them wrong

(e)  all of the above.

The answer is ‘(e) all of the above’

We’ll explain carefully why you can’t just glaze over this admittedly technical legal issue.

First, let’s talk about liability caps

As a general rule, two parties to a non-consumer contract are allowed to agree that they won’t sue each other for more than a certain amount.  If SuperTel contracts to cable up and service BigCo’s new office building, they are free to include a clause like this:

The parties agree that the aggregate liability of one to the other under or in relation to this agreement or SuperTel’s services, or any act or omission of a party with respect to them, whether in contract, tort or on any other basis, shall not exceed $100,000.

Now, as long as they get the drafting right, such a cap means what it says.

• If SuperTel completes the job three months late and costs BigCo $1m, it only has to pay $100k.
• If SuperTel blows up the electrics of the whole site and it costs BigCo $500k to fix, SuperTel only has to pay $100k.

OK, so hold that thought.  Parties can agree that whatever happens under their dealings, they can never be asked to pay more than a capped amount.

Now let’s think about joint wrongdoing

Let’s say Joe Public is walking along the road and two drivers manage to have a nearby bingle, pushing one onto the footpath and hurting Joe.  And let’s say that both drivers were a bit careless, and each made some contribution to the accident happening.

For along time now, the legal rule has been that Joe has three options.

• He can sue one driver, and as long as he can prove some fault on his part, Joe can recover his full damages claim from that driver.
• Or he can sue the other driver, and as long as he can prove some fault on his part, Joe can recover his full damages claim from that driver.
• Or he can sue both drivers, and hope for judgments against each of them.

The thought to hold here is that if two people cause a third party’s loss, the third party can often sue one of them for the entire amount of the loss.

But if that happens, the person sued can say ‘Hey, you also caused this problem.  I want you to reimburse me part of what I paid Joe.’

It’s called a claim for contribution.  You say, ‘I am being sued by Joe, and the law says he can claim all his loss from me.  But I claim that you should be responsible for (say) 60% of Joe’s loss.  So I’m asking the court to order that you pay me that.’

So let’s draw the strings together.

Imagine I’m a building owner and Joe is badly electrocuted in my premises.  Joe sues me for $1m, and he’s going to win the case.

But I say that the electrical contractor Electrico is responsible for 95% of his loss.  So I say to the court, ‘I demand that Electrico pays $950k of the claim, as a contribution.’

At that moment, the contractor pulls out of the drawer the agreement I signed with it.  Sure enough, it contains a clause:

The parties agree that the aggregate liability of one to the other under or in relation to this agreement or Electrico’s services, or any act or omission of a party with respect to them, whether in contract, tort or on any other basis, shall not exceed $100,000.

Guess what ?  Electrico successfully argues that my claim for contribution is a claim ‘in relation to the agreement or Electrico’s services’.  The court says that Electrico doesn’t have to pay any more than the capped amount.

The result

The result is that:

• Joe was electrocuted.
• Electrico was 95% to blame.
• I was 5% to blame.
• I paid Joe $1m.
• Electrico contributed $100k.
• So I ended up paying $900k for damage that Electrico caused.

The lesson

There are a few.

First, it may make sense for two contracting parties to agree that they’ll cap liability for harm they cause each other, but it’s almost always crazy to agree to cap your right to claim the full contribution from the other party if you are sued by a third party.

If you agree to such a cap, you are effectively agreeing to act as an insurer for the other side.

Even if the cap is two-way, it makes no sense.  It means that liability is a lottery depending on who gets sued.  The only sensible outcome is that if a third party sues one of us, liability is decided according to normal legal rules, without caps between you and me.

Liability is complicated and – until you end up paying $900k you shouldn’t have – boring.  If you don’t really understand it and / or can’t be bothered, get a good lawyer to work on it.