Understanding Liability Caps in UK Law

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What is a Limitation of Liability Clause?

In the realm of commercial drafting, a Limitation of Liability clause is a strategic provision that sets a maximum ceiling on the amount one party has to pay to another in the event of a loss or breach of contract. Without this safeguard, a single error could theoretically lead to insolvency.

These clauses are designed to distribute risk fairly between the parties, ensuring that the potential financial exposure is proportionate to the value of the transaction.

The Danger of Unlimited Liability

One of the most common mistakes in commercial negotiations is agreeing to unlimited liability. By signing a contract without a cap, you are essentially betting your entire business on the perfect execution of that agreement. Under English law, if a contract is silent on liability, the defaulting party could be held responsible for all losses that were reasonably foreseeable at the time of the contract.

Expert Note:

"Never sign a contract that exposes your company to risks that exceed your net worth or your professional indemnity insurance limits."

The UCTA 1977 and the 'Reasonableness' Test

Under the Unfair Contract Terms Act 1977 (UCTA), liability caps in business-to-business contracts must satisfy the requirement of reasonableness. A court will look at several factors to determine if your cap is valid:

  • The relative bargaining power of the parties.
  • Whether the customer received an inducement to agree to the term.
  • Availability of insurance to cover the potential loss.

Practical Advice: Setting the Cap

How do you determine the right number? At TideMark Contracts, we generally recommend setting caps based on one of the following benchmarks:

Percentage of Fees

Capping liability at 100% or 200% of the annual contract value is a standard industry practice.

Insurance Alignment

Ensure the cap does not exceed your Professional Indemnity (PI) or Public Liability insurance coverage.

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