Limitation of liability clauses: how to read the clause that sets your worst case

Most commercial contracts contain a clause, usually headed ‘Limitation of liability’, that answers a simple question: if something goes wrong, what is the most each party can be made to pay? It is often the most important clause in the document and the one read least carefully. Whether you are signing a customer’s terms or a supplier’s, read it as a series of separate parts, because that is how it will be argued over if there is ever a claim.

The parts of a typical clause

The cap is the headline figure. Liability may be limited to a fixed sum, a multiple of the fees, or the fees paid in a period such as the previous 12 months. Check whether it applies per claim, per year or in total over the life of the contract, and whether it applies to both parties equally. A cap tied to fees paid can be very low in the early months of a contract.

The exclusions remove certain types of loss altogether, most often ‘indirect or consequential loss’ and ‘loss of profit’. The courts have traditionally read ‘indirect or consequential loss’ narrowly, as covering only losses that would not arise in the ordinary course of things from the breach. Lost profit is often a direct loss, so a party that wants to exclude it needs to say so expressly. Read what is excluded, and then ask what is left for you to claim.

The carve-outs are the liabilities that sit outside the cap, commonly indemnities, breaches of confidentiality or data protection obligations, and wilful default. Their effect can be larger than the cap itself.

“Read what is excluded, and then ask what is left for you to claim.”

What the law will not let you exclude

Some liability cannot be excluded or limited, however the clause is drafted. Under the Unfair Contract Terms Act 1977, a business cannot exclude liability for death or personal injury caused by its negligence, or for breach of the implied term that a seller has the right to sell the goods. Liability for fraud, including fraudulent misrepresentation, cannot be excluded either. Well-drafted clauses list these expressly.

Where one business deals on the other’s written standard terms, the Act also requires clauses excluding or restricting liability for breach of contract to satisfy a requirement of reasonableness. Courts look at matters such as the parties’ bargaining power, whether the customer could have bought elsewhere without the term, whether the risk could have been insured, and the resources available to meet the liability. Between businesses of similar strength that have negotiated the terms, courts are generally slow to interfere. Different rules apply to contracts with consumers.

Questions to ask before you sign

• What is the cap, and does it reflect what is actually at stake under this contract?

• Is the cap per claim, per year or in aggregate, and does it apply equally to both parties?

• Which losses are excluded, and are loss of profit, revenue or data among them?

• What sits outside the cap, and could an uncapped indemnity expose the business to more than the contract is worth?

• Does our insurance cover the liability we are accepting, up to the level of the cap?

• If these are our own standard terms, would the clause look reasonable to a court?

Eleanor advises owner-managed companies on commercial contracts, including negotiating these clauses with larger customers and suppliers.