Key Takeaways

  • A limitation clause caps the damages one party can claim against another, commonly used in IT, design, and service agreements.
  • These clauses can cover liability for direct, indirect, or consequential damages, and may include carve-outs for exceptions like gross negligence or IP breaches.
  • Enforcement varies by jurisdiction and hinges on factors like clarity, fairness, and negotiation.
  • Drafting strategies include using plain language, specifying covered liabilities, and retaining negotiation documentation.
  • Businesses should align limitation clauses with risk assessments and insurance coverage.

A limitation clause, also called a limitation of liability clause, is a stipulation in an agreement that helps ensure that a company is not held liable for more than they agreed to be responsible for.

What Is a Limitation Clause?

Limitation clauses are an important part of contracts. They are where the contract spells out what each side will be held responsible for under the specific terms and conditions also outlined. Contracts are formed surrounding general stipulations, basically what is being sold or agreed to, and the limitation clause covers what a party will owe to the other if they don't hold up their end of the agreement. This consequence is also called a liability.

Most businesses and contractors will want to include limitation clauses in all of their contracts because they are always taking a risk when entering into an agreement. Rather than allowing the risks in an agreement to have the potential to wipe out their company, business owners can use the limitation clause to make a cap or limit to what they can be forced to pay in damages. Sometimes this limit will work for any claims that might come up throughout the period of the agreement, other times it will only cover particular types of legal issues.

If a company with a limitation clause in their contract is sued by a contractor, their clause might limit the contractor to only taking the amount for payment they originally agreed upon, rather than additional damages. This means businesses are able to enter into contracts without worrying about massive risks with each one. If every contractor agreement could put you out of business, it would be hard to weigh those risks.

Likewise, independent contractors can benefit from limitation clauses. Design and IT contracts frequently use limitation clauses.

Say an architect built a skyscraper under a design contract with a global manufacturing company, and five years later, a design flaw pops up in the build. If that architect included a limitation clause in their contract, the manufacturing company could only hold the architect liable for the amount they agreed on for the project. So, if the architect charged an $80,000 fee to design the building, that's all the company could sue them for.

IT contracts like distribution, service-level, and software license agreements use limitation clauses to keep the IT creator protected from massive damages. So if their software design fails and costs the company they designed it for money, the limitation clause will likely cap the damages owed to the company by the software developer to whatever they were originally paid for their work as stipulated in their software agreement.

Whether you find yourself as the person drafting the agreement or signing it, you should always be sure to carefully review and possibly negotiate the limitation clause. The clauses only apply to the parties legally included in the agreement, so they don't protect others who may be involved in a project, but not in the contract.

Types of Limitation Clauses

Limitation clauses vary in scope and structure depending on the contract and the nature of the business relationship. Common types include:

  • Cap on Damages: A fixed dollar amount or percentage of the contract value that limits the total financial liability.
  • Time-Based Limitation: Liability may only apply to claims made within a specific time frame after a breach or termination.
  • Exclusion of Specific Damages: Often excludes indirect, consequential, punitive, or special damages (like lost profits or data loss).
  • Carve-Outs: Exceptions to the limitation, such as for willful misconduct, gross negligence, or intellectual property infringement.

By using these variations, parties can customize limitation clauses to reflect their tolerance for risk and the value of the transaction.

How Are Limitation Clauses Enforced?

Some argue about the enforceability of limitation clauses. Certain states do not enforce such clauses because they view them as a non-negotiable part of the contract, also called adhesive. If a contract is adhesive or an adhesion contract, this means that the party who drafts the contract holds all of the cards and the other party has little opportunity to negotiate.

Many states do enforce limitation clauses in contracts because they see them as an attempt to avoid risks. Usually, limitation clauses are enforced unless:

  • Provisions were unclear or ambiguous
  • Intentions of either of the parties entering the contract were not obviously stated
  • One of the parties used unfair bargaining abilities or were much more sophisticated than the other
  • The provision was prohibited by a statute or public policy

Common Reasons Limitation Clauses Fail

Even a well-drafted limitation clause may be rendered unenforceable if certain legal or practical issues arise. These include:

  • Lack of Mutual Negotiation: Clauses inserted unilaterally without negotiation may be considered unconscionable or adhesive.
  • Ambiguity or Overbreadth: Vague or overly broad terms may lead courts to invalidate the clause.
  • Violation of Public Policy: Some jurisdictions prohibit limitations on liability for personal injury, consumer rights, or intentional wrongdoing.
  • Failure to Carve Out Critical Risks: Courts may strike down clauses that attempt to limit liability for fraud, criminal acts, or fiduciary breaches.

To avoid invalidation, businesses should ensure the clause is specific, balanced, and clearly communicated during negotiations.

How to Limit the Liability of a Business

If you want to limit your company's risks by using a limitation clause, you'll need to draft your contracts carefully.

When forming a business contract, be sure to help make it enforceable by:

  • Making sure the limitation clause is clear and obvious
  • Using concise and easily-understood language
  • Discussing the limitation clause to be sure that there is a chance for negotiation
  • Holding onto all drafts of the contract to show any revisions for proof of negotiation

Strategic Considerations for Businesses

Limitation clauses should be approached with a strategic lens, balancing legal protection and business practicality:

  • Small Vendors vs. Large Clients: Smaller service providers may push for tighter limitations due to risk exposure, while enterprise clients may demand carve-outs.
  • Cross-Border Agreements: International contracts should reflect local enforceability standards and applicable governing laws.
  • Contract Lifecycle Management (CLM): Using CLM platforms can help automate clause templates, flag high-risk language, and ensure compliance.

In highly regulated or high-risk sectors like healthcare or finance, consult legal counsel to ensure clauses meet industry standards.

Real-World Example of a Limitation Clause

Here is a sample clause that demonstrates how businesses might limit their liability:

“Notwithstanding anything to the contrary in this Agreement, the total aggregate liability of either party for any and all claims arising out of or related to this Agreement shall not exceed the total fees paid under this Agreement during the six (6) months immediately preceding the event giving rise to such liability. In no event shall either party be liable for any indirect, incidental, consequential, or punitive damages, including but not limited to lost profits or data.”

This language uses both a monetary cap and excludes consequential damages, offering a layered approach to limiting exposure.

Best Practices for Drafting Limitation Clauses

To increase the likelihood that a limitation clause will hold up in court, consider the following best practices:

  1. Define Key Terms Clearly: Specify what constitutes “liability,” “damages,” and “claims.”
  2. Include a Dollar Cap: Use a fixed amount, contract value multiple, or a percentage to cap damages.
  3. Use Carve-Outs Thoughtfully: Common carve-outs include IP breaches, breach of confidentiality, and fraud.
  4. Align with Insurance Policies: Ensure caps align with your professional liability or cyber insurance coverage.
  5. Make It Conspicuous: Use formatting (e.g., bold, all-caps) to highlight the clause in the contract.
  6. Maintain Version Control: Keep documentation of drafts and revisions to demonstrate fair negotiation.
  7. Tailor to the Relationship: Avoid a one-size-fits-all approach—adjust the clause based on the value and complexity of the contract.

Frequently Asked Questions

  1. Is a limitation clause legally enforceable in every state?
    No. Enforcement varies by jurisdiction. Some states may void such clauses if they're found to be unconscionable, vague, or against public policy.
  2. Can a limitation clause protect against gross negligence or fraud?
    Generally not. Courts often exclude protection for gross negligence, willful misconduct, or fraudulent actions, even if the clause attempts to cover them.
  3. What’s the difference between limitation and exclusion clauses?
    Limitation clauses cap the amount of liability, while exclusion clauses attempt to eliminate liability for certain types of damages altogether.
  4. Are limitation clauses necessary in small business contracts?
    Yes. Even small businesses benefit from limiting liability, especially in service-based or tech-driven contracts where risks may be high.
  5. Can a limitation clause be negotiated?
    Absolutely. Negotiation is a key factor in enforceability. Courts may not uphold the clause if one party had no opportunity to negotiate it.

If you need help with a limitation clause, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.