Exclusion Clause: What It Is and When To Use It

icon-contractExclusions are among the most important clauses in a contract, along with confidentiality clauses, force majeure, and dispute resolution clauses. The language in these sections must be neither overly flexible or too stringent. Developing ideal positions and standard guidelines for writing these clauses is an important first step. For ensured compliance, however, artificial intelligence (AI) is the answer.

The exclusion clause of a contract represents an area of potential risk. Are you protected with legal AI

What Is an Exclusion Clause in Contract Law?

In contract law, exclusion clauses aim to exclude or limit a party’s liability in the event of default. While exclusions can be among the most hotly contested and negotiated portions of a contract, they are found in nearly every type of agreement. There may be a cap on damages, a short time limit for filing claims, or restrictions placed on the types of recoverable losses available. However, these clauses can be difficult to uphold in court if the language seems undefined or unfair.

What Are the Rules of Constructing an Exclusion Clause?

When constructing the exclusion clause, companies must take care to:

  • Avoid ambiguity - If there is any uncertainty about the exclusion clause meaning, the court will issue a legal doctrine known as “contra proferentem,” which goes against the party responsible for the exclusion. 

  • Consider the contract’s purpose - Using the “main purpose rule,” the court will eliminate an exemption clause that seems antithetical to the contract’s main purpose.

  • Allow the counterparty to complete their responsibilities - Contracts must meet basic requirements for fairness, avoiding overlapping and contradictory provisions and efforts to undermine fairness.

How Are Exclusion Clauses Commonly Used?

Exclusions that limit liability may include common cases such as: 

  • A true exclusion - which recognizes the potential for the breach but includes reasonable care to perform duties on one party and not the other. For instance, a company may limit the categories of damages or use or exclude all incidental damages entirely. 

  • A limitation clause - which limits the amount that can be recovered in a breach of contract, regardless of the actual loss. Limited liability places a cap on the amount of “reasonable” damages payable related to a percentage of the deal. Sometimes a minimum damage threshold is necessary for a party to pursue legal action.

  • A time limitation - which states that actions must be initiated within a specific time period or the right to recovery is waived. Often, a maximum period of five years is assigned to any claims arising from the breach of contract. 

Why Is an Exclusion Clause Important in Risk Analysis?

No matter the type of contract, exclusion clauses can either save significant money for the company or open up the potential to pay a lot of money. In consumer contracts, a lack of exclusions can land a company on the bankrupting end of a class-action lawsuit. For mergers, these limitations can be deal-breakers. 

What Automated Contract Review Can Do with Exclusion Clauses

Automated AI helps corporate legal departments handle exclusion clauses in several key ways:

  • Ensures Compliance - Companies can set rules for exclusion clauses in an AI Digital Playbook, including preferred language, acceptable variations, and boilerplate fallbacks. Once digitized, legal tools can extract individual clauses from current drafts and compare them with the contract playbook to maintain adherence to company standards. The use of such tools can be especially helpful when training new staff members.

  • Risk Ranking - Legal AI technology employing Natural Language Processing (NLP) and machine learning can assess and rank clauses, such as the exclusion clause, according to a risk metric. Red color-coding can indicate a high level of risk, while yellow color-coding can designate language that may contain ambiguity, omissions, or deviation that suggests moderate risk. Green color-coding could suggest that the language is appropriate as-is.

  • Automates Changes - Acceptable changes to the exclusion clause can be automated with “if/then” conditional directions. Drafts that fall out of line with company standards can be auto-corrected without any further human input. Entire batches of documents can be updated at once, automatically switching company policy to preferred positioning. 

  • Reduces Time, Increases Accuracy - Computers are especially good at meticulously—and rapidly—combing through large data sets. Rather than spending days reviewing a contract, legal staff leveraging AI technology can accomplish the task in less than five minutes. The total time spent reviewing contracts can be reduced by over 90%.   

LexCheck can help your corporate legal department reduce risk with exclusion clauses while maximizing legal team efficiency. Reach out to us at sales@lexcheck.com to learn more, or request a demo to experience the technology first-hand.

gary-sanghaGary Sangha | Founder & CEO

Gary Sangha is the Founder and CEO LexCheck. He's a serial entrepreneur and an academic. Gary previously founded Intelligize, a legal technology company that was acquired by LexisNexis. He's affiliated with the University of Pennsylvania and Stanford University and started his career as an attorney at Shearman & Sterling and White & Case.