Key Takeaways

  • A limitation of damages clause caps exposure and often excludes indirect categories (consequential, incidental, punitive, lost profits) while leaving direct damages recoverable unless expressly excluded. 
  • Typical caps include fixed-dollar caps, fee-based caps (e.g., 12 months’ fees), or caps tied to what was paid under the contract—see the “limitation of damages clause example” below. 
  • Most jurisdictions do not allow parties to limit liability for gross negligence, intentional misconduct, or fraud—so these are commonly carved out. 
  • Caps/exclusions are often mutual and may include “supercaps” for certain high-risk obligations (e.g., confidentiality or IP infringement). (Supported by industry practice materials noting sample limitation language in commercial contracts.) 
  • Placement and conspicuous incorporation matter: referencing GTCs within the main agreement improves enforceability and clarity of the parties’ intent. 
  • Courts focus on contract purpose and wording; overly broad exclusions that swallow the bargain risk narrow interpretation. (Use clear drafting and targeted carve-outs.)

A limitation of damages clause is a contractual agreement where parties either exclude or limit the availability of damages that statutory law otherwise entitles them to.

What Is a Contractual Limitations on Damages?

Setting limits on the damages one party can receive is very important, as it allows the parties to adequately assess and control their business risks when entering into an agreement.

Many commercial contracts have some type of damage limitation clause. Although these clauses are often used, they sometimes cause some legal difficulties, such as the following:

  • Determining the respective interests of debtors and creditors
  • How to fairly balance either party's freedom against mandatory legal provisions

Contractual limitations on damages are different from general “liability limitations” or “exemption clauses” which absolve a party from liability in that they exclusively relate to damages.

Types of Damages, Typical Exclusions, and a Limitation of Damages Clause Example
 

  • Direct vs. indirect damages. Direct damages compensate for the value of the promised performance and are typically recoverable unless expressly excluded; indirect categories (e.g., consequential, incidental) are frequently excluded along with punitive damages and lost profits. 
  • Common exclusion list found in commercial contracting: indirect/consequential, punitive, lost profits, incidental—with an explicit note that direct damages usually remain. 
  • Why parties use the clause. Businesses cap exposure and set predictable risk; a cap equal to amounts paid is a common approach. 

  • Limitation of damages clause example (sample language you can adapt):

    Limitation of Damages. Except for the Carve-Outs below, each party’s aggregate liability arising out of or relating to this Agreement will not exceed the fees paid or payable by Customer under this Agreement in the 12 months preceding the event giving rise to liability. Neither party will be liable for indirect, consequential, incidental, special, exemplary, or punitive damages, including lost profits or revenue, arising from or related to this Agreement, even if advised of the possibility of such damages. Carve-Outs: the foregoing cap and exclusions do not apply to liability for gross negligence, willful misconduct, or fraud. 

  • Notes: “Gross negligence/intentional misconduct/fraud” carve-outs reflect the general rule that such limitations are not enforceable in most jurisdictions. 
  • Practice materials also present annotated sample clauses showing how commercial contracts routinely limit damages. 

Agreements on Damages and Incorporation

The parties entering into a contract need to agree on the limitation of damages clause. Such an agreement cannot be formed unless there is a relationship between the debtor and the creditor. As long as all parties agree to the content in the clause, it's usually simple enough to include a limitation of damages in the contract.

It's possible for contract terms to be implied by each party's conduct. However, basing a limitation of damages just on conduct is rarely done, and setting terms is generally determined by examining previous dealings between the involved parties on the same terms. Just because the parties may have a personal relationship or established goodwill doesn't mean that a limitation of liability can be assumed.

You'll often find limitations on damages in a contract's general terms and conditions (GTCs). One party may have a standard set of terms and conditions that it includes in many contracts. However, they're only effectively included when the agreement itself refers to them.

In a civil law system, a GTC provision that's considered so outlandish that it couldn't have reasonably been expected won't be considered a valid part of the contract. In a common law system, however, a party must show that fraud or misrepresentation has occurred before escaping the consequences of signing a contract.

Likewise, when one party claims it didn't understand the GTCs of a contract he signed, he will have to prove to the court that the agreement is radically different from the one that the party meant to sign and that it wasn't a careless mistake.

Setting the Cap and Incorporating the Clause (GTCs, Mutuality, and Supercaps

  • Cap structures you’ll see in practice:
    • Fixed-sum caps (e.g., $X per claim or in the aggregate).
    • Fee-based caps (e.g., amounts paid/ payable in the prior 12 months). 
    • Tiered or “supercap” models (standard cap applies generally; a higher cap for particular high-risk obligations like confidentiality or data security). (Supported by industry templates describing sample limitation language common to commercial deals.) 
  • Exclusions to pair with a cap. Spell out excluded categories (indirect/consequential, punitive, lost profits, incidental). If you intend to exclude direct damages, say so expressly. 
  • Mutuality. Buyers often seek mutual caps/exclusions, not just seller-only protections, to keep risk balanced.
  • Where to place it. Many companies put limitations in GTCs and incorporate those terms by reference in the order form or master agreement—be sure the main agreement clearly references the GTCs to avoid disputes about incorporation. 
  • Negotiation cues.
    • Seller-leaning: lower cap (e.g., 6–12 months’ fees), broad exclusion list, tight list of carve-outs.
    • Buyer-leaning: higher cap (e.g., total fees), narrower exclusions, expanded carve-outs (e.g., confidentiality, IP infringement, data breach, indemnities).
  • Sample “fee-based” phrasing (for context): clauses commonly cap liability at “the total amount paid for the specific goods/services involved in the breach.” 

Interpretation and Construction

Contractual limitations on damages are interpreted the same as other contractual provisions. The goal is to figure out the parties' intentions. There are various ways to arrive at the contractual intent.

You start by looking at the wording that the parties use. You should also look at how the various provisions are organized and the agreement's purpose. These factors may be more important than a strict interpretation of the language.

For instance, if an exemption clause is so general and broad in scope that if applied, it either would defeat the contract's purpose or create an absurdity. The court would then have to figure out the meaning to give effect to the contract.

In Anglo-Saxon tradition, there are rules to strictly interpret exclusion clauses, and these rules are frequently applied.

When a contract provides both a limitation of liability and a warranty, special consideration must be taken. In this case, one clause may prevail over the other. For instance, the court may find that the warranty is included in the main portion of the agreement, while the limitation of liability clause is an annex to the standard terms of the contract.

However, when a party gives a warranty, but doesn't assume liability for warranty breach at the same time, then the warranty should be treated as consistent with the liability limitation.

Because contracts are legally binding documents, it's vital to fully understand what you're agreeing to before you sign one. With all of the various provisions, fine print, and additions that a contract might have, it's important to take your time and read over everything carefully. Consult with an expert in contract law if you're unsure so that you're completely informed before you agree to any terms.

Enforceability Pitfalls, Carve-Outs, and Drafting Checklist

  • Public-policy limits. Most jurisdictions do not enforce clauses that purport to limit liability for gross negligence, intentional misconduct, or fraud—make these explicit carve-outs. 
  • Avoid over-breadth. If exclusions are so sweeping that they defeat the contract’s basic purpose, courts may construe them narrowly; tie exclusions to specific categories (e.g., consequential/lost profits) rather than “all damages.” 
  • Clarity on “direct” vs “indirect.” Direct damages are typically recoverable; indirect categories are commonly excluded—define terms or give examples (e.g., lost profits as consequential) to reduce ambiguity. 
  • Drafting checklist:
    • Choose the cap (fixed amount, fees-based, or hybrid) and state whether it is per claim or aggregate. 
    • List excluded categories (consequential, incidental, punitive, lost profits) and clarify treatment of direct damages. 
    • State carve-outs (gross negligence, willful misconduct, fraud; consider confidentiality, data security, or IP infringement depending on the deal). 
    • Confirm mutuality unless there’s a justified asymmetry.
    • Ensure clear incorporation of GTCs and conspicuous presentation. 

Need help tailoring a limitation of damages clause to your deal or state law? You can find and engage a vetted attorney on UpCounsel.

Frequently Asked Questions

1) What’s the difference between limiting damages and limiting liability?

Limiting damages targets recoverable categories and amounts (e.g., excluding consequential damages or capping recovery). Limiting liability can be broader, sometimes attempting to bar liability altogether—courts scrutinize broad exemptions closely. 

2) Are direct damages usually excluded?

No. Direct damages are typically recoverable unless expressly excluded; most clauses exclude indirect categories like consequential, incidental, punitive, and lost profits. 

3) Can we limit liability for gross negligence or intentional misconduct?

Generally, no—most jurisdictions won’t enforce limitations on gross negligence, intentional misconduct, or fraud; draft explicit carve-outs. 

4) What cap do parties most commonly use?

A cap tied to what the buyer paid under the contract (e.g., fees in the prior 12 months) is common because it aligns risk with contract value. 

5) Where should the clause live—GTCs or the main agreement?

Either can work. If using GTCs, incorporate them clearly in the main document so the limitation applies and is conspicuous to both parties.

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