Limitation of liability clauses: how the cap is built, and where it fails

Every commercial contract allocates risk twice: once by deciding who has to do what, and once by deciding what happens when they do not. The limitation of liability clause is the second decision, compressed into a paragraph most people skim because it is written in capital letters and reads like a warning label.

A cap and an exclusion are two different clauses

This is the structural point that makes the rest of the clause readable. The cap sets a maximum recoverable sum. The exclusion removes whole categories of loss from recovery at all, however small the sum. They are usually adjacent, often in the same numbered clause, and they work in sequence: the exclusion decides which losses can be claimed, and the cap decides how much of what is left can be recovered.

How the cap figure is actually built

Four drafting choices sit inside what looks like a single number, and each moves the effective ceiling considerably.

"Consequential loss" does not mean what most people think

The distinction inherited from Hadley v Baxendale splits damages into losses arising naturally from a breach and losses arising from special circumstances known to both parties at the time of contracting. The second limb is what "consequential" or "indirect" properly describes. It is not a synonym for "large", and it is not a synonym for "lost profits".

New York's Court of Appeals made the consequences of that concrete in Biotronik A.G. v. Conor Medsystems Ireland, Ltd. (27 March 2014). A distributor sued for the profits it lost when the manufacturer recalled the product. The lower courts held those profits were consequential damages and barred by the contract's exclusion. The Court of Appeals reversed: because the pricing formula tied the manufacturer's payment to the distributor's resale price, the resale profits were the direct and probable result of the breach, so they were general damages and the exclusion never touched them.

The drafting lesson runs in both directions. If you are excluding a loss, name it — "lost profits, lost revenue, loss of anticipated savings, loss of goodwill" — rather than relying on the word "consequential" to do the work. If you are the one who would suffer that loss, the same list is exactly what you are trying to cut down.

When twelve months' fees is the wrong number

Twelve months' fees became the default in subscription contracts for an understandable reason: it is easy to calculate and it scales with the size of the deal. What it does not do is scale with the harm. The cap is set against the price of the service, and the loss is caused by what the service does.

Where a vendor will not move the general cap, the usual landing zone is a supercap: a separate, higher ceiling that applies to one category only, typically data breach or breach of confidentiality, expressed as a multiple of fees or a fixed sum. It is easier to agree than an increase across the board, because it prices the risk the buyer is actually worried about. What to check in a SaaS agreement sets out where that negotiation usually settles.

What cannot be excluded, wherever you are

Some liabilities survive any drafting. The list varies by jurisdiction more than most contract law does, so the entries below are the ones to check rather than a universal set.

• Death and personal injury caused by negligence. In the UK this is absolute: section 2(1) of the Unfair Contract Terms Act 1977 for business contracts, and section 65 of the Consumer Rights Act 2015 for consumer ones. Neither can be saved by a reasonableness argument.
• Fraud and fraudulent misrepresentation. California Civil Code § 1668 voids any contract whose object is to exempt someone from responsibility for their own fraud, wilful injury to person or property, or violation of law. Most common-law systems reach the same result by other routes.
• Gross negligence and wilful misconduct, in a number of US states. New York is the clearest: in Sommer v. Federal Signal Corp. (1992) the Court of Appeals held it is the public policy of the state that a party may not insulate itself from damages caused by grossly negligent conduct.
• Consumer personal injury in the sale of goods. UCC § 2-719(3) allows consequential damages to be limited unless the limitation is unconscionable, and treats a limitation for personal injury in consumer goods as prima facie unconscionable.
• A remedy that has failed of its essential purpose. Under UCC § 2-719(2), where an exclusive or limited remedy — repair-or-replace, most commonly — cannot deliver what it promised, the buyer gets the Code's ordinary remedies back.

Consumer contracts run on stricter rules

Everything above assumes two businesses negotiating. Where one side is a consumer, the clause is tested for fairness rather than simply enforced. In the UK the Consumer Rights Act 2015 makes an unfair term not binding, and terms limiting a trader's liability are a standing candidate. In the US, limits are tested for unconscionability and, for goods, against the UCC rules above; state consumer protection statutes add their own layer.

The practical consequence for anyone publishing website terms: a liability clause copied from a business-to-business agreement into consumer-facing terms of service is likely to be partly unenforceable, and the parts that fail are the parts you wanted most. Draft the consumer version separately.

The trap: a cap sitting below the indemnity above it

This is the combination that turns a carefully negotiated clause into decoration. Indemnities conventionally sit outside the limitation of liability clause, so a contract can pair a cap of twelve months' fees with an indemnity worded "against all claims arising out of or in connection with this Agreement" and a sentence excluding indemnity obligations from the cap. Read together those three lines make the agreement uncapped, and they are almost never on the same page.

The check takes a minute. Find the cap. Find every carve-out from it. Then find every indemnity in the document and ask whether it is inside the cap, above it on a supercap, or outside entirely. If the answer for a broad indemnity is "outside", the cap number you negotiated describes nothing that matters — the reasoning is set out in full in indemnification clauses explained.

A liability clause is not a defensive document — it is a statement of how much each side is willing to lose if this goes wrong. Read it that way and the negotiation becomes straightforward: the number should be large enough that the other side takes the obligation seriously, and small enough that they can insure it. If neither side can say what the cap would actually cover in the worst realistic failure, the clause has not been negotiated yet. Contract clauses explained covers the terms that sit around it; the service agreement and software licence templates show the clause in its usual position.