Limitation of damages: Overview, definition, and example
What is limitation of damages?
Limitation of damages refers to a clause or provision in a contract that caps or restricts the amount of compensation that can be awarded for damages in the event of a breach or failure to meet the terms of the agreement. This clause is typically included to protect one party from excessive financial liability and to provide predictability regarding the potential costs of non-performance. Limitation of damages clauses can specify limits on direct, indirect, consequential, or punitive damages and are often used in contracts to set a maximum amount that can be claimed by the other party.
For example, a supplier and a customer may agree that, in the event of a breach, the supplier’s liability will not exceed the total amount paid by the customer for the specific goods involved in the breach.
Why is limitation of damages important?
Limitation of damages is important because it provides clarity and protection for the parties involved in an agreement. Without such a clause, a party may be exposed to unforeseen or disproportionate financial risks, especially in cases where damages could be substantial or unpredictable. By capping liability, businesses can better manage risk, avoid excessive costs, and ensure that they are not held financially responsible for losses that are disproportionate to the value of the contract.
For businesses, a limitation of damages clause helps reduce the risk of financial ruin or excessive loss due to events outside of their control. For clients or customers, it ensures that any potential damages are limited to a reasonable amount, providing more certainty and transparency in business relationships.
Understanding limitation of damages through an example
Imagine a software company that enters into a contract with a client to provide a custom software solution. The contract includes a limitation of damages clause that states the company’s liability for any breach of contract will be limited to the amount the client paid for the software. If the software fails to perform as expected, the client cannot claim more than the original price paid, even if the failure results in significant operational losses for the client.
In another example, a construction company agrees to build a commercial building. The contract specifies that if the company delays the project or fails to meet certain standards, their liability for damages is limited to a fixed amount, such as the cost of repairs or a specific percentage of the contract value. This prevents the construction company from being exposed to large, unpredictable claims for consequential losses.
Example of a limitation of damages clause
Here’s how a limitation of damages clause might appear in a contract:
"In no event shall the liability of [Party A] for any claim, loss, or damage arising out of this Agreement exceed the total amount paid by [Party B] under this Agreement for the specific goods or services involved in the claim. [Party A] shall not be liable for any indirect, incidental, or consequential damages, including loss of profits, arising from the breach of this Agreement."
Conclusion
Limitation of damages is a key contractual provision that helps mitigate financial risk by capping the amount one party may be required to pay in the event of a breach or failure to fulfill the terms of a contract. It provides predictability and security for both parties by ensuring that damages are proportionate to the scope and value of the agreement.For businesses, including a limitation of damages clause is essential for managing potential liabilities and protecting against excessive financial exposure. For clients or customers, it offers transparency and assurance regarding the maximum potential impact of a breach, creating a fairer and more balanced agreement.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.