Limitation of liability clauses: what UK founders need to know

What a limitation of liability clause does

Without a limitation clause, a party that breaches a contract is generally liable for the losses that flow naturally from the breach, or that both parties would reasonably have contemplated when they signed. That could be a very large number.

A limitation clause usually does three things:

• Excludes certain types of loss entirely, such as loss of profits or indirect loss
• Caps total liability at a fixed amount or a multiple of fees
• Carves out some liabilities from the cap altogether, so they remain unlimited

What can't be excluded

English law does not allow every liability to be excluded. Liability for death or personal injury caused by negligence cannot be excluded or limited, and liability for fraud cannot be excluded either. Well-drafted contracts state this expressly.

Beyond that, the Unfair Contract Terms Act 1977 can apply to business contracts made on one party's standard terms. Some exclusions must satisfy a "reasonableness" test. Courts generally respect clauses agreed between commercial parties of similar bargaining power, but a clause that is unclear or extreme carries risk for the party relying on it.

Setting the cap

Caps are commonly set at the fees paid or payable in the twelve months before the claim, or at a fixed sum. Ask yourself two questions: what is the realistic worst-case loss if the other side fails, and does the cap come anywhere close to it?

A cap based on fees can be very low for a small contract that touches something critical, such as a cheap tool that holds all your customer data. In those cases, a fixed minimum amount ("the greater of the fees paid and £X") is a sensible ask.

Also check whether the cap applies per claim, per year, or across the whole contract. These produce very different results over a multi-year relationship.

Indirect, consequential and lost profits

Many contracts exclude "indirect or consequential loss". Under English law, these words have a narrower meaning than most people assume: they usually refer to unusual losses that wouldn't arise in the ordinary course of things. Direct losses can still be recovered.

The more significant exclusion is often loss of profits, revenue, data or goodwill, which may be listed as excluded "whether direct or indirect". If you're a customer, losing the ability to recover lost data or wasted expenditure can leave you with very little. Consider asking for those categories to be recoverable, at least within the cap.

Carve-outs: what sits outside the cap

It's common for certain liabilities to sit outside the general cap, either unlimited or subject to a separate, higher cap. Typical examples include:

• Breach of confidentiality
• Data protection breaches (often a "super cap")
• Intellectual property infringement indemnities
• Wilful default or deliberate abandonment of the contract
• Non-payment of fees (from the supplier's side)

As a supplier, beware of agreeing to unlimited liability for these items without thinking about your insurance and your business's ability to absorb the exposure.

Is it mutual?

One-sided clauses are common in standard terms. A supplier's template may cap its own liability tightly while leaving the customer's liability unlimited. Asking for the cap and exclusions to apply equally to both parties is one of the simplest and most widely accepted changes.

How indemnities interact with the cap

An indemnity is a promise to cover a specific loss, usually pound for pound. If an indemnity sits outside the liability cap, it can expose you to unlimited liability through the back door. Read the indemnity and limitation clauses together, never separately.