Limitation of Liability

A limitation of liability clause in a contract limits the amount of money or damages that one party can recover from another party for breaches or performance failures. In other words, the clause can put a cap on the number of damages the organization will have to pay under certain circumstances.

The limitation of liability provision may apply to the entire business arrangement or may be limited to only certain breaches or failures, depending on the parties’ agreement, as reflected in the specific wording of the contract.

Example: How a Limitation of Liability Works

A general contractor (GC) is hired to build a commercial building and subcontracts with several vendors. In each of its contracts with subcontractors, the GC includes a limitation of liability clause stating that if the general contractor is terminated, subcontractors cannot recover lost profits against the general contractor.

Unfortunately, the GC is fired. The new general contractor keeps most subcontractors, but parts ways with the painter. The painting contractor would have earned $25,000 in profits, which it will now lose due to the original GC's firing. Nevertheless, because of the limitation of liability clause, the painting company can not recover the lost profits from the original GC.

While courts will generally uphold limitation of liability clauses, it’s important to remember that some states do not uphold these provisions under certain circumstances. Therefore, it’s important to analyze the issue with your attorney.

Why Do Contracts Include Limitation of Liability?

Think of a limitation of liability clause as a financial guardrail. Without one, a small mistake on a project could snowball into a lawsuit that threatens your entire business.

Companies include these clauses to create predictability. When you sign a contract, you want to know your worst-case scenario. If something goes wrong, how bad could it get? A limitation of liability clause answers that question upfront, so both parties understand the risks before any work begins.

These clauses also make deals possible that otherwise wouldn't happen. A software vendor, for example, might hesitate to take on a Fortune 500 client if a single bug could expose them to millions in damages. But with a liability cap in place, say the total fees paid under the contract, the vendor can take on the work without betting the entire company on a flawless delivery.

Types of Limitation of Liability Clauses

Not all limitation of liability clauses work the same way. Here are the most common types you'll see:

Liability caps set a maximum dollar amount one party can recover. This is often tied to the contract value. For example, "liability shall not exceed the total fees paid in the 12 months preceding the claim." Some contracts use a fixed number instead, like $500,000 or $1 million. Watch for whether the cap applies per claim or for all claims combined. That detail can change the risk a lot.

Exclusion of consequential damages removes certain types of losses from the table entirely. Contracts often list examples such as:

• lost profits
• lost business opportunities
• lost of reputation / goodwill
• business interruption
• loss of data

These can dwarf the actual contract value, so many parties agree upfront to exclude them. One nuance, what counts as "consequential" can be argued, which is why contracts usually name specific examples instead of relying on labels alone.

Mutual vs one-sided limitations matter too. In mutual limitation, both parties are subject to the same cap. In a one-sided clause, only one party gets protection. Vendors often push for one-sided limitations in their favor, while savvy buyers negotiate for mutual terms.

Carve-outs are exceptions to the cap. Even with a limitation of liability in place, certain acts, like breaching confidentiality, infringing intellectual property or gross negligence may still expose a party to unlimited damages. These carve-outs protect against the most serious harms.

What Limitations of Liability are Unenforceable?

Courts generally respect limitation of liability clauses, but they're not bulletproof. There are situations where a court will throw them out entirely.

Gross negligence and willful misconduct typically can't be limited away. If a party acts recklessly or intentionally causes harm, most courts won't let them hide behind a liability cap. The logic is simple: you shouldn't be able to contract your way out of consequences for truly bad behavior.

Fraud is another deal-breaker. If one party lies or deceives the other to get them to sign the contract, the limitation of liability clause (along with much of the contract) may be unenforceable.

Personal injury and death often can't be limited, especially in consumer contracts. Public policy in most states prevent companies from capping liability for physical harm to people.

Unconscionable Limits comes into play when a clause is so one-sided that it shocks the conscience. If a massive corporation buries an extreme limitation of liability in fine print and the other party has no real ability to negotiate, a court may refuse to enforce it.

State laws vary significantly here, so what's enforceable in Delaware might no fly in California.