7 Ways Limitation of Liability Can Transform Your Business Risks

Hi! In this post, I’ll guide you through everything you need to know about the limitations of liabilities clause, including why it’s important and tips on how to draft it.

Let’s explore it together.


The Meaning of Liabilities

Liability‘ in a transaction means the legal responsibility of one party towards the other.

If I were to sell you a product that doesn’t work as promised, then I would be responsible for any losses you may incur. In this case, the “Limitation of Liability” clause would come into play.

Having a liability cap in place would shield me from potential losses by limiting the amount I would be responsible for paying if something were to go wrong.

What is a Limitation of Liability Clause?

Assume you work as a software developer, and if your application causes your client’s website to go down for a few days, they may take legal action against you and demand compensation for all the profits they lost during that downtime. However, if you had included this clause in your contract, your liability could be limited to the amount they paid you for the software, which may be significantly less than their lost profits.

It’s of utmost importance to use crystal clear wording in such clauses because any interpretation of unclear wording may lead to legal disputes.

Your contract should expressly state that “In the event of any failure of the software, the Developer shall only be liable up to the price received by them for the software.

Why Does One Need it?

All transactions involve risk of some kind, and this clause is about managing the financial part of those risks.

It’s impossible to predict and manage every potential problem; you may have unlimited liabilities, but with this clause, you set a limit on potential damages to manage the financial impact of that problem and provide financial certainty.

Some say they have a long established relationship and a good understanding with their client; therefore, there is no need to think so negatively.


Yes, they may be right, but impact matters more than likelihood. A default may have huge costs, even if the chances of it happening are low.

Only one black swan event is sufficient to wipe out a century’s worth of fortune.

  • Example: If a small business has a product or service that is valued at $10,000, but a failure could potentially cause a client to lose $1 million, would the business be financially capable of covering such a loss? Even if we put aside the payment issue, do you think they will have the ability to defend themselves in a lawsuit?

No, but this could limit their liability to the contract value or a defined amount, helping them prevent a single contract dispute from bankrupting their business.

Remember, a limit of liability clause doesn’t plan for failure, but sometimes things go wrong, even with good intentions. So, it’s like insurance that protects.

You might not require it, but it’s comforting to know that it’s there in case you do.

What Are “Caps” and “Exclusions”?

Limitation liability clauses work through “caps” and “exclusions”.

A cap (like a ceiling) is the maximum amount that can be claimed.

If a clause states that “Liability shall not exceed the price paid for the service,” it means it is caped.

On the other hand, an exclusion is something that is specifically left out of the liability.

  • Example: “The Developer is not liable for any indirect or consequential damages,” it means that if the software malfunctions due to inefficient operation by the staff in a way that is specifically prohibited, then you are not responsible for paying your client’s losses (of any type) because those losses are excluded from your liability.

Difference between “Caps” and “Exclusions”

Broadly, both limit liability, but there’s a fundamental difference:

The cap covers any claims resulting from your service or product that are due to negligence, breach of contract, or any factors other than the buyer’s fault.

The exclusions vary; they refer to willful misconduct or gross carelessness, which is a clear disregard for the rights or safety of others.

Drafting commercial clauses like this either way depends on your specifics and what your local laws dictate.

Types of Contractual Liabilities

Below are a few examples of when one party to the contract is liable to the other.

Situations where a Liability Limit MAY PROTECT

Breach of contract: This occurs when one party fails to fulfill any term of a contract without a valid reason.

  • Example: You signed a contract with a supplier to deliver goods by a specific date. Late delivery is a breach of contract.

Negligence: This is when someone’s carelessness harms others.

  • Example: If a customer slips on a wet floor that should have been cleaned in your store and gets hurt, they might sue you for being negligent.

Misrepresentation: This is when someone gives false information that makes another person lose something.

  • Example: If a business lies about their product’s abilities, it’s a misrepresentation.

Situations where Limited Liability MAY NOT PROTECT

Intellectual Property Rights Infringement: This is using someone else’s copyrighted or patented material without permission. If one is found guilty, they may have to pay high fines that a liability clause may not limit, especially if the infringement was intentional.

Breach of Statutory Duty: This occurs when someone doesn’t fulfill a legal obligation.

  • Example: A company could be responsible if they did not follow safety regulations and an accident happened. When a breach can result in non-contractual regulatory penalties, a liability limitation clause might not fully protect the company.

Regulatory Offenses: These are violations of government established laws or regulations, and limitation of liability may not apply depending on the seriousness and type of the offense.

If someone is hurt or killed due to negligence, most jurisdictions will not allow limitations on liability.

Courts don’t accept liability limitations in cases of fraud or intentional misconduct.

  • Example: If someone does something fraudulent or harmful, they cannot use a limitation of liability clause to avoid the consequences.

Law of Limitation of Liability

There are legal limits on how much liability you can limit in a contract, similar to how local governments have regulations on building height limits.

There are rules to make sure things are fair and no one takes an unfair advantage.

There are Two Types of Legal Limits.

  1. Statutory: The law sets statutory restrictions, such as speed limits. They limit liability clauses according to explicit laws, and laws vary as per jurisdiction.
  2. Common Law Limits are unwritten rules that come from court decisions. A court can rule a limit of liability clause unenforceable if it’s deemed unreasonable or unconscionable. So, it’s important to know the precedents in your jurisdiction.

In the US, the enforceability of limited liability clauses can vary across different states. Each has different approaches to upholding these clauses.

  • Example: With the help of the California Consumer Financial Protection Law, California is known for being consumer-friendly and tends to scrutinize these clauses more closely.

UK law limits liability clauses through the Unfair Contract Terms Act 1977 (UCTA), which states that a business cannot avoid responsibility for death or injury caused by negligence, and the Consumer Rights Act 2015, which protects consumers from unfair contract terms.

Laws do affect how much a limitation of liability clause can be enforced, and if a clause violates these rules, it will probably be unenforceable.

Our aim should be to create a contract that is fair, enforceable, and can withstand legal challenges. Therefore, first we need to know the laws of the land.

Qualifications and Carve-Outs

Think of your liability limitation clause as a strong castle. It’s strong and reliable, and it’s designed to keep you safe, but like in castles, your qualifications, carve-outs, and exceptions are the hidden doors and secret passages.

Qualifications are the conditional clauses in your contract, and they change how your limitation of liability clause applies in certain scenarios or conditions. It means the limits of liability clause can be used when a specific condition is met and both parties have complied with certain pre-agreed contractual obligations.

Carve-outs are exceptions where the party can be fully liable. Imagine these as hidden routes that allow someone to bypass your castle’s defenses. They usually apply to cases of gross negligence or willful misconduct.

So, it’s like, carve-outs create exceptions, and qualifications specify conditions for the clause to apply. They both define the limits of your contract’s protection.

Remember, it’s all about balance. A fair contract doesn’t overreach but protects the interests of all parties involved, and a limitation liability clause is not unbreakable, even though it can provide strong protection. Carve-outs can help bypass it. Pay close attention to these exceptions when drafting or reviewing a contract.

4 Tips to Draft Your Liability Limit in Contract

Writing a liability limitation clause is like making a bulletproof suit for your business. It requires attention to detail.

Follow these guidelines to write a strong clause.

  • Tip 1: The clause should be clear and easily comprehensible. Writing in plain language is always better. The clause should be easy to find in the contract and not hidden in small text. It’s important to be clear about limitations so everyone is well informed and knows what they’re signing up for.
  • Tip 2: The clause needs to be specific to your business and contract context. To avoid unnecessary legal disputes due to ambiguity, make sure your clause clearly specifies the types of damages it covers and excludes (direct and indirect) and the limits of your liability.
  • Tip 3: Don’t include pointless exclusions. Avoid being too broad when writing a clause, as it may seem unreasonable and could be unenforceable in court. So, use inclusive language, and please qualify the details of the situations that the clause covers instead of simply mentioning what it excludes.
  • Tip 4: Think in terms of the entire contract. Make sure the clause matches the tone and content of the contract because it’s not a separate document, and choose the best liability limitation for your company by considering your business nature, the risks involved, the financial impact of a breach, and industry standards.


How can you make sure your clause is enforceable?

The clause must be fair, reasonable, and balanced. Courts enforce clauses that are fair to both parties, clearly specify the types of damage and their limitations, and follow the laws and regulations of the land.

These clauses can sometimes be difficult to enforce, like steering a ship through a storm, but with the right knowledge, one can even navigate through rough seas.

Courts do not favor unfair or unreasonable clauses, such as those that limit liability for serious wrongdoing like gross negligence, willful misconduct, or fraud, which could be a concern for a court and cause one’s liability clause to not provide the protection they expect in those circumstances.

Liability exclusion can be tricky. This means getting rid of liability for specific things, and Courts expect businesses to take responsibility for their actions, especially regarding their core obligations.

  • Example: You enter a shop with a sign that says, “Not responsible for any injuries.” It’s a disclaimer. It’s unacceptable; the shield needs to be reasonable and not cover everything.

Courts consider reasonableness when evaluating limited liability clauses. Some jurisdictions have tests to determine what is reasonable.

Can this clause be enforced against third parties?

Contract terms, like limited liability clause, only apply to the parties who signed the contract. Usually, only the beneficiaries of a contract can enforce its terms.

Can it protect employees from personal liability?

When employees act within the scope of their employment, their employer’s limitation of liability clause generally protects them. However, this depends on the circumstances and local laws in your area.

Courts often do not enforce liability clauses that are deemed unreasonable, overly broad, or unclear.

What about reckless conduct?

Courts usually do not support a clause that limits liability for reckless or intentional harmful actions. If an employee intentionally sabotages a client’s project, a liability limitation clause will not protect their business.

Pros and Cons of Limitations of Liabilities


  • Risk Management: They limit your company’s financial exposure in case of unforeseen circumstances or disputes, providing a safety net.
  • Cost Predictability: They help your business predict legal costs and apply them to your budget and pricing.
  • Encourages Performance: They encourage both parties to fulfill their responsibilities, leading to a better business relationship.


  • Could Damage Business Relationships: One needs to be transparent and negotiate carefully to avoid creating distrust; otherwise, an unfair or overly restrictive liability limitation clause can harm your business relationships.

It’s important to balance protecting your business while maintaining good relationships with partners and clients, and for this, you’ll need to be honest and open when discussing these clauses and aim for a fair compromise.

Keep in mind that the information provided here is general and may vary depending on your jurisdiction. It’s a good idea to consult a lawyer regarding your specific circumstances.

Examples of Liability Clauses

Example 1: General Limitation of Liability

The Company’s total liability in contract, tort (including negligence or breach of statutory duty), misrepresentation, or otherwise arising in connection with the performance or contemplated performance of this Agreement shall not exceed the Price paid for the Goods.

The limit of liability clause for the company is the price paid for the goods if there is an issue, but this clause may not be enforceable if the court finds it unfair or unconscionable, particularly in consumer contracts, due to its nature of being very broad without qualifying anything.

Example 2: Exclusion of Consequential Damages

Under no circumstances shall the Company be liable to the Client for any indirect, consequential, incidental, punitive, special, or exemplary damages or losses which the Client may incur in connection with this Agreement, regardless of the type of claim or the nature of the cause of action.

This clause limits, i.e., excludes “consequential” damages, which are indirect losses not caused directly by a breach but are a result of the breach. For example, if a software malfunction caused a business to lose profits, those lost profits would be referred to as consequential damages, which are being limited in this case.

In the U.S., some jurisdictions may not accept this exclusion due to the specifics of it being too broad or unfair. In some states, the courts may require the clause to stand out clearly in the contract, such as by using bold or uppercase text.

Example 3: Carve-Out for Willful Misconduct

Nothing in this Agreement shall limit or exclude either Party’s liability for death or personal injury caused by negligence, for fraud or fraudulent misrepresentation, or for any other liability that cannot be excluded by law.

This clause prevents limiting liability by allowing a carve-out for actions that are unacceptable, like fraud or intentional wrongdoing.

Example 4: A Well-Qualified Limitation of Liability

The Service Provider shall take reasonable care to deliver the package on time, but if they fail to deliver the package on time, inclusive of the grace period, due to their negligence, the Service Provider shall not be liable for any indirect losses that the Client may incur, such as lost profits or missed opportunities related to the late delivery of the package, but the Service Provider may provide a refund only up to the delivery charges received by them.

This clause is drafted by following best practice, i.e., it first qualifies a relevant business event before limiting the liability. Such carefully drafted clauses have a higher likelihood of being enforced because they are difficult to prove as unjust (given that they are able to prove that their negligence wasn’t reckless).

7 Options to Limit Potential Liability for Your Business

Let’s talk about how to reduce your business’s liability. Here, we apply theory to practice!

1) Risk Assessment and Management

  • Prevention is the best defense. To limit liability, identify your business’s vulnerable areas. You need to assess the risks of your operations thoroughly. Identify possible issues and prepare for them. I hope you’ll agree that it’s safer to be a careful pessimist than a naïve optimist.

2) Proactive Contract Management

  • Prevention is better than cure. It’s an old saying, but it’s true. Make sure to review your contracts regularly to ensure they align with your current business operations and any changes in the law. Managing contracts proactively can help prevent liabilities.

3) Negotiation

  • To make sure your limitation of liability clause is fair and enforceable, it’s important to listen to your partner’s concerns and work together to address them.

4) Insurance

  • It catches you when you fall. Limit Liability Insurance policies can provide additional protection beyond this clause. Talk to your insurance provider to find the right coverage for your business’s risks.

5) Non-insurable Claims

  • Limitation of liability clauses can help manage risks that are difficult or impossible to insure against.

6) Alternative Dispute Resolution (ADR) Mechanisms

  • We do not always need to go to court to resolve a dispute. Using ADR mechanisms like mediation or arbitration in your contracts can help you resolve disputes more easily and peacefully, which may reduce your liability.

7) Compliance with Laws

  • It’s important to follow the law. One cannot use not knowing the law as an excuse. Performing compliance checks and audits regularly can prevent legal issues.

Limitation of Liability Clauses in Practice

Final Thoughts

In business, expect the unexpected. A good limitation of liability clause can greatly benefit your business, like a safety net, seatbelt, or helmet, but keep in mind that this shield is not magical.

Successful business transactions depend on the people involved and the trust they have in each other because a contract is more than just a document; it’s a promise.

Respect it, and it will serve you well. I wish you luck!

Now I’d like to hear from you:

Any questions or comments about the Limitation of Liability clause? Or is there something missing on this page?

Either way, feel free to leave a comment below.

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