Limitation of liability clauses cap damages parties can recover and exclude certain damage types. Without limitations, a service provider charging $10,000 could face $1 million in liability if service failure causes customer business losses. This fee-to-risk ratio is unsustainable. Properly structured limitations cap liability at amounts proportional to compensation—typically fees paid in the preceding 12 months—and exclude consequential damages that can exceed contract value by orders of magnitude.
What Are the 3 Components of Liability Limitations?
Limitation of Liability Structure
| Component | Purpose | Common Language |
|---|---|---|
| 1. Liability Cap | Maximum total damages | "Not to exceed fees paid in 12 months preceding claim" |
| 2. Damage Exclusions | Types of damages not recoverable | "No consequential, indirect, incidental, or special damages" |
| 3. Carve-Outs | Exceptions to cap/exclusions | "Does not apply to IP indemnification, fraud, or gross negligence" |
Liability Cap Options
Common Cap Structures
| Cap Type | Language | Best For |
|---|---|---|
| 12-month fees | "Fees paid in 12 months preceding claim" | Ongoing services (most common) |
| Project fees | "Fees paid for project giving rise to claim" | Discrete engagements |
| Total fees | "Total fees paid over contract life" | Long-term relationships |
| Fixed amount | "$100,000" | Free services, nominal fees |
| Multiple of fees | "2X annual fees" | Higher-risk services |
Consequential Damages Exclusion Template
**IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR:** (a) consequential, indirect, incidental, special, exemplary, or punitive damages; (b) lost profits, lost revenue, or lost business opportunities; (c) business interruption or loss of goodwill; (d) loss of data or cost of procurement of substitute goods or services; **EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGES** and regardless of whether claim is based in contract, tort, strict liability, or other legal theory.
Critical language: "Even if advised of the possibility" prevents arguments that foreseeable damages must be compensated despite the exclusion. Without this, the exclusion may not apply to damages the breaching party knew would result.
What Carve-Outs Should Liability Limitations Have?
Common Exception Carve-Outs
| Carve-Out | Rationale | Negotiation Notes |
|---|---|---|
| IP indemnification | Existential risk requires full protection | Almost always uncapped |
| Confidentiality breach | Data breaches can be catastrophic | Often negotiated; may have separate higher cap |
| Willful misconduct/fraud | Cannot limit liability for intentional harm | Standard; courts may impose anyway |
| Gross negligence | Serious misconduct shouldn't be capped | Often negotiated |
| Payment obligations | Fees owed shouldn't be capped | Standard for customer payment duties |
Complete Limitation of Liability Template
**LIMITATION OF LIABILITY.** (a) **Cap.** EXCEPT FOR OBLIGATIONS UNDER SECTION [IP INDEMNIFICATION], EACH PARTY'S TOTAL LIABILITY ARISING OUT OF OR RELATED TO THIS AGREEMENT SHALL NOT EXCEED THE AMOUNTS PAID BY CUSTOMER IN THE TWELVE (12) MONTHS PRECEDING THE CLAIM. (b) **Exclusion.** IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR CONSEQUENTIAL, INDIRECT, INCIDENTAL, SPECIAL, OR PUNITIVE DAMAGES, INCLUDING LOST PROFITS, LOST DATA, OR BUSINESS INTERRUPTION, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. (c) **Exceptions.** The limitations in this Section do not apply to: (i) Vendor's IP indemnification obligations; (ii) either party's breach of confidentiality; (iii) either party's willful misconduct or fraud; or (iv) Customer's payment obligations. (d) **Basis of Bargain.** THE PARTIES ACKNOWLEDGE THAT THE FEES REFLECT THE ALLOCATION OF RISK SET FORTH IN THIS AGREEMENT AND THAT NEITHER PARTY WOULD ENTER INTO THIS AGREEMENT WITHOUT THESE LIMITATIONS.
Frequently Asked Questions About Liability Limitations
Must liability limitations be mutual?
Usually yes, but asymmetric caps exist. Mutual caps are easier to negotiate. However, some contracts cap vendor liability at 12 months' fees while customer payment obligations are uncapped. The party with bargaining power often gets more favorable terms.
Can liability be completely unlimited?
Yes, but it creates uninsurable risk. Unlimited liability is rare in commercial contracts because it makes risk impossible to price and insure. Even customers with leverage typically accept some cap (often higher, like 2X annual fees) rather than no cap.
Why is IP indemnification usually uncapped?
IP lawsuits can cost $500K-$3M+ to defend. A $50K annual contract cap provides no meaningful protection against IP claims. Customers negotiate uncapped IP indemnification because vendors control their product's IP compliance and are best positioned to prevent infringement.
Do liability caps apply per claim or in aggregate?
Specify in your clause—most use aggregate caps. "Aggregate liability for all claims" establishes absolute maximum. Per-claim caps allow cumulative liability exceeding stated amount if multiple claims arise. Clarify related claims treatment: "Related claims constitute single claim."
Can AI help draft liability limitations?
Yes, AI tools like River's Limitation of Liability Generator produce enforceable clauses instantly. Select cap type, exclusions, and carve-outs. The AI generates comprehensive provisions with proper formatting and structure ready for your agreement.
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