This article initially ran in the April 2023 issue of the Rockford Chamber’s VOICE.
Contracts allocate risks. The role of a contract attorney is to ensure that the client understands how risks are being allocated so that the client can make an informed decision. In this article, I will focus (in no more than seven hundred words) on three provisions that expressly allocate liability: (1) warranty; (2) indemnification; and (3) limitation of liability.
Role of the Uniform Commercial Code
The Uniform Commercial Code (the “UCC”), a version of which has been adopted in every state, applies to all contracts for the sale of goods. Although service contracts are not subject to the UCC, provisions that were drafted with the UCC in mind tend to appear in service contracts as well. The UCC, which dates to 1942, was intended to make it easier to do business across all fifty states by creating a standard set of rules that apply to contracts for the sale of goods. Some of the provisions in the UCC are mandatory, but some are “background rules” from which the parties may expressly opt out.
The UCC imposes very broad warranties on sellers unless the parties agree to limit those warranties by “conspicuous” language. Most sellers try to limit their warranties to a warranty that their products or services comply with the specifications provided in writing to the seller prior to contract execution, and that the materials (for goods) and workmanship are free from defects. Buyers, particularly larger buyers, often ask for very broad warranties, including design warranties and warranties that the goods are fit for their intended purpose. Both of those warranties are risky for sellers, because they guarantee that the products will work (even if the buyer provided the specifications and the seller simply met those specifications). Those warranties should only be given by a seller if the seller actually designed and developed the product specifically for the buyer’s application, and the buyer relied on the seller’s expertise to design the products for that application. In all cases, it is critical for sellers of goods to “conspicuously” disclaim any warranty other than the express limited warranties in the contract.
The other warranty issues that should be addressed are defining a warranty period and limiting warranty liability. Most sellers try to limit their warranty liability to repairing or replacing the defective product or services or issuing a credit to the buyer. Many sellers seek open-ended warranty liability, which can include the cost of line shutdowns and field repairs.
The use of indemnification provisions in contracts has exploded recently, with little understanding of what they mean. An indemnification provision requires a party to do exactly what an insurance company does—it requires one party to “defend, indemnify and hold harmless” the other party from defined categories of losses. Often, though, the indemnifying party has no insurance that will backstop that undertaking. Most standard Commercial General Liability (“CGL”) policies include an endorsement that provides coverage for “insured contracts,” which is limited to an agreement to indemnify a third party from losses for personal injury (including death) and damage to tangible property resulting from the insured’s acts or omissions. Many indemnification provisions being proposed these days include purely economic losses, including requiring the seller to “indemnify” the buyer from any breach of contract (which, by definition, would include a breach of warranty).
The “market” provision for parties that understand these issues limits the indemnification undertaking to losses resulting from (i) personal injury, (ii) damage to tangible property, and (iii) intellectual property infringement claims (if whatever is being purchased includes any intellectual property component).
Limitation of Liability
Under the common law, a party who breaches a contract is liable for all of the damages that naturally flow from that breach, including incidental, consequential and special damages. That is also the background rule under the UCC. Like warranties, though, the UCC allows the parties to limit their liability by contract. Most sellers try to limit their warranty liability (as discussed above), and in many instances the parties expressly agree that neither party will be liable under any circumstances for any incidental, consequential or special damages (many first drafts of contracts from large companies impose this limitation on the buyer’s liability, but not the seller’s).