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Protecting Your Assets from Liability: Part I – Proper Sale/Supply Contract Drafting

Three main controls on liability risk

If you run a business you personally, and the business, are subject to liability risk.  Controlling liability risk involves three main elements:

  1. Insurance
  2. Having proper sale/supply contracts which minimise your liability.
  3. Holding business and personal assets in the correct legal structures.

Concerning point 2, we offer free sale/supply contract health checks. Email your standard contract terms to stephen@fortunaadvisors.com.au and request a health check.

Point 3 will be covered in Part II of this article, to be released next week.

 

Insurance

Insurance is a vital part of any liability control strategy. It may not cover all risks to which you are exposed, however. Even if it did, the premiums may be excessive. To implement an effective insurance strategy, you need to understand your liability risks, outlined in the remainder of this article. Insurance is largely beyond the scope of this article. You should have a good broker, and consult with them regularly about whether your cover remains adequate. To discuss your business and personal insurance needs, contact Mili Aggarwal at our related practice Fortuna Advisory Group mili@fortunaadvisors.com.au

 

How liability risks can arise

It is “well-known” that “directors are not liable for their company’s debts.” Many people thus feel secure running their business behind the “corporate veil”. But that statement is only partly true. It is true that if your company signs a contract, something goes wrong and it cannot pay or cannot supply the goods/services, the directors and shareholders are not personally liable under the contract. But the company itself would be liable. A resulting lawsuit may see it lose plant and equipment, which it needs to continue to trade. (And, of course, if you are a sole trader or in a partnership, you don’t even get to that “first base” of liability protection.)

Inability to pay debts in a downturn is only one of the key liability risks which business owners face. Many suppliers require their customers’ directors to sign personal guarantees. If your company supplies goods or services, there is a problem with them and your customer/client suffers loss as a result, they are not limited to just suing your company for breach of contract.

If your company supplies goods and services it also has a duty, under the unwritten law of negligence, to take reasonable care to ensure that harm is not suffered by the customer, or anyone else who may be affected. If you run say, an electrical business, you owe that duty to anyone who could be injured as a result of wiring you install.

If the company breaches this duty, not only is the company liable (under the contract and/or in negligence) but so is any individual who caused the company to breach its duty. This often includes the directors.  If the company is under-insured or has insufficient assets to meet the claim, but the directors are well off, a person who has suffered harm will often sue them as well.

 

Limiting liability through proper contract drafting

A well-drafted supply contract will seek to protect the company, directors and other employees against personal liability for negligence.

Many liability “exclusion” clauses in contracts are inadequate to achieve that purpose. They look like they were either written by a non-lawyer, or downloaded from the Internet from another country with different rules.

Courts will enforce liability exclusion clauses if worded properly, but they are subject to harsh scrutiny. Courts often find “holes” in these clauses and allow claims to succeed anyway.

Certain laws, like the Australian Competition and Consumer Act (ACCA), impose liability for “Consumer” and other transactions. A “Consumer” transaction includes many contracts with a value of less than $40,000 (regardless of the goods or services supplied). So even business-to-business sales may be covered.  You cannot reduce your liability under the ACCA for a “Consumer” transaction.

It you make false or misleading statements designed to induce the customer to purchase your goods/services, it is very difficult to exclude your liability by contract drafting. There are some steps that can be taken in the contract to seek to reduce it, however. The best protection is to ensure that your claims about your goods/services are true, are made only in writing, and that you can easily prove them.

A proper liability exclusion clause should address all of the following issues:

  • Place a dollar limit, or a limit as a percentage of price/fees paid, on your liability.
  • Exclude liability for indirect or consequential loss and loss of profits.
  • Exclude or limit liability imposed by statute, to the maximum extent permitted by the statue.
  • Exclude liability for claims in “tort” (the law of civil wrongs that operates in parallel to the contract). It is critical that “negligence” is mentioned specifically.
  • Specify that the customer/client must not sue the suppliers’ directors or employees in connection with the contract or the goods/services. (These clauses must be drafted carefully to ensure that that the directors, who are not a party to the contract, can actually take the benefit).
  • Include an indemnity from the customer/client against liability incurred by the supplier or its directors if any of the customer/client’s directors, employees or end-customers sue. (Note, this will not bind the third parties associated with the customer/client. The protection is only as good as the customer/client’s ability to pay out under the indemnity.)
  • If your customer/client has made you give them an indemnity this should, at least, be tightly restricted in the liability limitation clauses. Otherwise an indemnity may expose you to open-ended liability.

As you can see from the above, the best-worded exclusion clause will not protect you against all liability. Therefore you should also ensure that a successful claimant cannot force you to sell business or personal assets to meet their claim. This is covered in Part II of this article “Asset Protection”, to be released next week.