Supplier's Corner #4 - Truth & Consequences

Here's a universal truth. The exclusion of consequential damages is arguably the most important clause in your contracts.

Whether you are in the oil service industry, renewables industry, or general industry doesn't matter - you are a supplier of goods and probably services. You are not in the business of oil exploration, power generation or any other end product for that matter. That is unless you are applying Japanese keiretsu principles to your business philosophy, which I am guessing you don't.

Here's a second universal truth. As a supplier you may be making good money, but your revenues are nowhere near the revenues of your end customer. That is particularly evident in the oil industry, but normally equally true in any industry.

Here's a third universal truth. Higher revenue equals larger consequences. I am talking about the risk of loss, loss of production, loss of revenue, loss of opportunity, loss of contracts and so on. It comes in many forms and answers to many names. A common term is consequential or indirect loss. Think about the revenue loss of an oil major - your customer - from having to shut down a production platform for a couple of weeks or even days. Now, do I have your attention?

There are many factors involved in pricing of goods and services, but risk versus reward should be paramount. If your customer doesn’t offer to share the revenue from the production, why should you share the risk of his potentially exorbitant loss of the same revenue. The final universal truth is, you shouldn't, and most customers accept this - but you need to make sure that the contract explicitly excludes such liability. Here's a few tips on the subject.

Firstly, make sure that the contract actually includes an exclusion clause at all.

Secondly, take a good, close look at the governing law of the contract. There is no universal definition of the losses in question that fits all jurisdictions. The phrases "consequential" and "indirect" carries different legal meaning in different legal systems. Consider this - loss of profit can be both a direct and a consequential loss under English law, depending on the circumstances. Hence, a simple exclusion for consequential/indirect loss is not sufficient. You need to carefully define the types of loss that shall be excluded, make sure that your contract/legal advisor understand the inherent risk of your business, make an analysis and define the types of loss that have the potential of being exorbitant.

Thirdly, make sure that the exclusion clause overrides all other clauses in the contract. "Notwithstanding" is a word you probably don't use a lot, but it is a key word to start with if you want to make sure that your exclusion efficient.

Fourthly. Consider this. Your customer may not be the end customer, they may have affiliates and they surely have other suppliers involved in the project. And then there's all others, the third parties. They may all suffer consequential loss because of your actions or omissions. And, they are not parties to the contract, hence, they do not have to respect an exclusion of liability clause. There are two ways to go about this. The first you will find in Supplier's Corner #1. The other is to include an indemnification from your customer for any claims for consequential loss from these outsiders.

Lastly, be on the lookout for clauses dealing with gross negligence and willful misconduct. That is a topic in itself for another time. But for now, just remember that your exclusion for consequential loss should preferably apply regardless of whether any of the parties have acted with gross negligence or willful misconduct, and that there may be limits in the background law on the party’s ability to limit such liability.

So, how do you negotiate all of this. Well, the good news is that most of this is in line with common industry practice, especially in the oil industry. The bad news is that industry in general is under pressure due to a difficult market. Firstly, it could be helpful to point out just how large the gap between risk and reward will be if consequential loss is included. Secondly, the liability could easily wipe out your company, and it is never in the customers interest that a supplier disappears. Lastly, the exclusion is mutual, and it is after all a sensible allocation of risk. Sound contracting should never be based on how far a supplier is willing to lean out of the window, especially in dire times like these.