Limitation of liability clauses, explained

If something goes badly wrong under a contract, the limitation of liability clause decides how much you can recover, or how much you might have to pay. It is one of the most negotiated clauses in any commercial agreement, and one of the easiest to skim past. Here is how it works.

The two parts of the clause

Most limitation of liability clauses do two things.

1. They exclude certain kinds of loss. Typically “indirect, incidental, special or consequential damages”, and often lost profits, lost revenue or lost data. These are the knock-on losses that flow from a breach, rather than the immediate cost of it.

2. They cap everything else. The cap sets the most one party can owe the other in total. It is usually tied to the fees, for example “the fees paid in the twelve months before the claim”.

How big should the cap be?

There is no single right answer, but the cap should reflect what is really at stake. A cap of twelve months of fees is common in services and software agreements. A cap of one or three months of fees is low.

Example: under a services agreement worth $18,500 a month, a three-month cap means the most the customer can ever recover is about $55,500, even if the provider’s failure costs far more.

If you are the customer, a low cap shifts the risk of the provider’s mistakes onto you. If you are the provider, an uncapped or very high cap can expose you to losses far larger than the contract is worth.

Carve-outs: what the cap shouldn’t cover

Some liabilities are usually carved out of the cap, either left uncapped or given a separate, higher cap (sometimes called a super cap). Common carve-outs include:

• breach of confidentiality or data protection obligations,
• indemnities, especially for intellectual property infringement,
• gross negligence, fraud or wilful misconduct,
• death or personal injury caused by negligence, which many legal systems don’t allow you to limit anyway.

Without a carve-out for data breaches, for example, a provider who leaks your customers’ data might owe you no more than a few months of fees.

Is it mutual?

Read whose liability is limited. A clause that says “In no event shall Provider’s liability exceed…” protects only the provider. If the customer’s liability is left uncapped, the risk is entirely one-sided. Ask for the cap and the exclusions to apply to both parties.

Watch the interaction with indemnities

An indemnity is a promise to cover the other side’s losses from certain events. If an indemnity sits outside the cap, it can be unlimited. That can be right for something like IP infringement, but a broad, one-sided indemnity that is also uncapped (for example, covering “any and all losses arising from your use of the services”) can expose you to far more than the contract is worth.

What to ask for

If you are the customer:

• raise the cap to at least twelve months of fees,
• carve out data breaches, confidentiality and the provider’s indemnities,
• make the cap and exclusions mutual.

If you are the provider:

• keep a cap tied to fees, and exclude indirect and consequential loss,
• make sure your own indemnities are limited to third-party claims you actually cause,
• avoid uncapped liability for ordinary breaches.

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How Baxendale helps. Baxendale checks the cap on liability, uncapped exposures and indemnities on every contract, from your side of the deal. When a cap is low or one-sided, it quotes the clause, explains what it means in money terms where it can, and drafts the wording to ask for.

This article is general information, not legal advice. For a specific agreement, speak to a qualified lawyer.