What is a liability?

Legal liability is exposure to claims: who can sue whom, under which law and for what remedy. It allocates responsibility. Accounting liability is a financial reporting item measured under AASB standards. Under the current AASB Conceptual Framework it is a present obligation of the entity to transfer an economic resource as a result of past events, and an obligation is a duty the entity has no practical ability to avoid.

The two do not always line up. A legal exposure can exist before it is recognised in the accounts, which is what a contingent liability is, and a guarantee given for someone else's debt sits in that category. Conversely, an accrued liability such as a warranty provision involves no dispute at all.

Contractual liability arises from failing to perform a contract, such as delivering late and the customer claiming lost sales. Negligence liability covers harm caused by carelessness, for example a contractor's defective installation damaging property. Statutory liability comes from legislation, including consumer guarantees and misleading conduct claims under the Australian Consumer Law enforced by the ACCC.

Vicarious liability makes an employer answerable for an employee's wrongful acts at work, such as a delivery driver's accident. Product liability covers injury or loss from defective goods. Contingent liabilities are potential future obligations like guarantees or pending litigation, and material ones must be disclosed. Directors and officers carry personal exposure for insolvent trading and breaches of statutory duties.

A limitation clause caps recoverable damages, often at the fees paid over a set period. An exclusion of consequential loss removes downstream losses such as lost profit, lost opportunity or reputational harm. Carve-outs keep certain things outside the cap: fraud, wilful misconduct, death or personal injury, confidentiality breaches, intellectual property infringement and liabilities that cannot be excluded by law.

An indemnity is a promise to make the other party whole for a specified loss, often third-party claims, sometimes regardless of fault, and it is frequently drafted to sit outside the cap. Survival clauses keep these obligations alive after termination, and insurance clauses require parties to hold public liability, product liability, professional indemnity or directors' and officers' cover to back them.

Consumer guarantees cannot be contracted out of in consumer contracts, and unfair contract terms can be declared void, and since the 2023 reforms proposing, applying or relying on one in a standard form consumer or small business contract can also attract civil penalties. Employment entitlements, workplace safety and superannuation obligations cannot be signed away. Courts rarely enforce clauses that try to excuse deliberate wrongdoing, death or personal injury.

Directors cannot contract out of insolvent trading liability under the Corporations Act, although safe harbour protection and statutory defences can apply where a director takes a course of action reasonably likely to lead to a better outcome. Certain tax, superannuation and environmental obligations can also attach personally to a director who is knowingly involved. Accurate records, cash flow forecasting, documented professional advice, proper board minutes and current directors' and officers' insurance are the usual protections.