Understanding liability caps and indemnities in agreements

Why these two clauses deserve your full attention

When you are busy delivering work, the commercial schedule gets all the attention and the legal boilerplate gets skimmed. That is understandable, but it is also where the real risk sits. A liability cap and an indemnity can each turn a modest project into a financial problem far bigger than the fee you were paid. Understanding how they work, and how they interact, puts you in a much stronger position when you negotiate.

What a liability cap actually does

A liability cap sets the maximum amount you or your client can be ordered to pay if something goes wrong. It usually sits alongside exclusions, such as a clause ruling out liability for lost profits, lost business or indirect losses. Together they answer two questions: what kinds of loss are recoverable, and how much can be claimed in total?

Watch the wording closely. A cap on "total liability" under the agreement is very different from a cap "per claim". A per-claim cap of £50,000 sounds reassuring until ten claims arrive. Check whether the cap is aggregate, whether it survives termination, and whether it applies to every obligation or only some of them.

A few things cannot be capped or excluded under English law. Liability for death or personal injury caused by negligence cannot be excluded, nor can liability for fraud. In business-to-business contracts, other exclusions must satisfy the reasonableness test in the Unfair Contract Terms Act 1977. Those protections are welcome, but they will not rescue a cap that is legally valid yet commercially painful.

Choosing a cap you can live with

There is no universal right number, but a few practical anchors help.

• Link the cap to fees. A common starting point is a multiple of the fees paid under the contract, often the total fee and sometimes two or three times it for higher-risk work.
• Check your insurance. Your professional indemnity policy has a limit. A contractual cap above that limit leaves you personally exposed for the difference.
• Think about worst-case loss. If your deliverable feeds into something safety-critical or highly regulated, no cap will feel adequate, and you may need to decline or restructure the work.
• Add a time limit. Requiring claims to be notified within, say, 12 or 24 months of completion stops problems surfacing years later, though statutory limitation periods may override weak drafting.
• Carve-outs cut both ways. Both sides usually want a list of unlimited liabilities, such as intellectual property infringement, confidentiality breaches and fraud. Keep that list short and, where possible, mutual.

Indemnities shift risk rather than limit it

An indemnity is a promise to cover a specific loss, claim or cost. Unlike a general claim for breach of contract, an indemnity is usually payable pound for pound and does not require the claimant to prove that you were negligent. That makes it a more potent obligation, not a softer one.

Read every indemnity twice and ask these questions:

• Is it mutual or one-way? A client asking you to indemnify them for all intellectual property claims, while offering nothing in return, is asking you to carry all the risk.
• What triggers it? "Any claim arising in connection with the services" is far wider than "a claim that the deliverables, used as permitted, infringe a third party's UK copyright".
• Who controls the defence? If the client settles a claim without consulting you, you may end up funding a settlement you would have fought.
• Does it override your cap? Many indemnities sit outside the liability cap entirely. That is where a generous indemnity becomes genuinely dangerous.
• Is it insured? Check whether your policy responds. Some policies exclude contractual indemnities unless they are limited and follow a standard form.

Reading the two clauses together

Caps and indemnities do not operate in isolation. A contract might cap your liability at the fees paid, then quietly carve out three indemnities that are unlimited. In practice your cap is then close to meaningless for exactly the risks most likely to materialise.

Ask for a clear statement of which obligations are subject to the cap and which are not. If an indemnity must be unlimited, narrow its scope and add a notice and cooperation process so you are told early and involved in the response. If the cap must be low, resist broad indemnities. Trade one against the other rather than accepting both.

Practical steps before you sign

• Start from your own position. Have a standard set of terms with a sensible cap and a short carve-out list, and send them with your proposal rather than waiting to receive the client's paperwork.
• Raise it early. Liability is far easier to discuss before you have quoted and agreed the shape of the work. Late objections look like leverage, not diligence.
• Keep a record. Note what you agreed, when, and why. If a dispute arises, a clear paper trail about risk allocation is worth its weight.
• Get advice when the stakes are high. A solicitor who works with small businesses can review a contract in an hour or two, which is cheap compared with an uninsured claim.
• Review annually. What was sensible for a £5,000 project may be inadequate for a £150,000 engagement with a much larger client, and your insurance cover needs to keep pace.

None of this is about being difficult. It is about making sure the risk you carry matches the reward you are being paid, so that the occasional difficult project stays a difficult project rather than becoming something worse.