Learning Outcomes
After reviewing this article, you will be able to explain and distinguish indemnities, limitation clauses, and liability caps in commercial contracts. You will know their legal functions, drafting considerations, and key pitfalls. You will be able to identify typical legal risks, spot what is effective or problematic in these clauses, and apply the core principles to problem scenarios for the SQE2 exam.
SQE2 Syllabus
For SQE2, you are required to understand how substantive clauses allocate risk, particularly indemnities, limitation clauses, and caps. In your revision, focus on:
- The nature and function of indemnity clauses in commercial contracts
- The difference between indemnities, exclusion, and limitation clauses
- How limitation clauses and caps operate (including enforceability and drafting pitfalls)
- The legal controls on enforceability (such as Unfair Contract Terms Act 1977)
- Advising clients as to risk allocation in common contractual scenarios
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the effect of an indemnity clause compared to a warranty?
- What statutory test governs whether a limitation of liability clause in a B2B contract will be enforceable?
- Why do commercial contracts include liability caps, and what factors may undermine their effectiveness?
- If an exclusion clause purports to limit liability for death caused by negligence, is it enforceable under English law?
Introduction
Substantive risk allocation clauses shape the distribution of legal and commercial risk in most business contracts. For SQE2, you must be able to explain what indemnities, limitations, and caps actually achieve, how they are different, and the main legal pitfalls that come up in practice. This article covers their core functions, enforceability, and key issues to watch for.
Key Term: indemnity
A promise to compensate another party for specified losses or liabilities, often on a pound-for-pound basis, typically triggered by a defined event or breach.Key Term: limitation of liability clause
A contract term that restricts or limits a party’s liability for certain breaches or events, often by setting a monetary cap or excluding types of damage.Key Term: liability cap
A specific maximum monetary amount stated in a contract beyond which a party is not liable for claims, usually relating to contractual obligations.Key Term: exclusion clause
Any contractual provision that seeks to exclude a party’s liability for certain events or types of loss.Key Term: Unfair Contract Terms Act 1977 (UCTA)
Legislation that controls the effectiveness of exclusion and limitation clauses in business and consumer contracts under English law.
Indemnities
Indemnity clauses are used to shift risk for defined losses, often in commercial, corporate, and technology contracts. Unlike warranties, indemnities typically require payment of the indemnified amount as a debt, not just damages subject to legal proof of loss. Indemnities may respond to third-party claims, specific breaches, or non-fault events. Precise drafting is essential to define the losses covered and trigger conditions.
Worked Example 1.1
A supplier contract includes: "The Supplier shall indemnify the Customer against all losses arising from any claim that the goods breach third party intellectual property rights." The goods are found to infringe a third party patent. What is the effect of the indemnity?
Answer:
The supplier must reimburse the customer for all losses arising from the claim: damages, settlement amounts, and reasonable legal costs. The customer does not need to prove "remoteness" or other common law damage limits—unless the clause says so.
Revision Tip
Indemnities are usually interpreted strictly, with the benefit going to the indemnified party. If the clause is badly drafted, coverage may be narrower than intended.
Limitation and Exclusion of Liability Clauses
Limitation and exclusion clauses aim to reduce the risk of open-ended or disproportionate liability. They can specify an upper limit (a cap), exclude entire categories of damages (e.g., consequential loss), or exclude liability for certain types of event. However, they are subject to legal restrictions.
Key Term: consequential loss
Indirect losses flowing from a breach, as distinguished from direct loss; often excluded through a specific clause.
Exam Warning
If a clause seeks to exclude liability for death or personal injury caused by negligence, it is void under UCTA—do not overlook this rule in exam scenarios.
Scope and Structure
Typical structure:
- A general cap on damages (e.g., total contract price)
- Exclusion of indirect or consequential losses
- Exclusion of liability for specific events
- Carve-outs for things like death or personal injury, fraud, or deliberate default
The drafting must be clear and specific. Ambiguity is resolved against the party seeking to rely on the limitation (the "contra proferentem" rule).
Worked Example 1.2
A contract clause states: "The Supplier’s total liability for any claim arising under the contract shall not exceed £50,000, except for liability that cannot be limited by law." A fire caused by supplier negligence results in loss of life and property damage of £200,000. Is the £50,000 cap effective?
Answer:
The cap is effective only for property damage claim(s); it is void for personal injury or death for which liability cannot be limited under UCTA.
Enforceability and Statutory Controls
The Unfair Contract Terms Act 1977 governs whether exclusion and limitation clauses are enforceable.
- Clauses excluding liability for death or personal injury by negligence are void (UCTA, s2(1)).
- Clauses limiting liability for negligence, or breach of implied term as to quality under SGA 1979, must be reasonable to be enforceable (UCTA, s2(2) and s6).
- "Reasonableness" considers bargaining power, insurance, and what was practical at the time of contract.
Key Term: reasonableness test (UCTA)
The statutory standard in UCTA requiring limitation or exclusion clauses to be fair and reasonable in all circumstances, assessed at contract formation.
Worked Example 1.3
A software licence purports to exclude all liability for loss of data, including where caused by the supplier’s own negligence. Is this enforceable?
Answer:
The clause is void if it excludes liability for death or personal injury. For property or economic loss, it will only be effective if reasonable under UCTA.
Revision Tip (Enforceability)
In SQE2 problem questions, always consider: (1) Has the clause been clearly incorporated? (2) Does UCTA apply? (3) If so, can the clause pass the reasonableness test?
Liability Caps
A cap is a contractual limit on a party’s aggregate liability. Caps are used in almost all modern commercial contracts and are usually set by reference to price, insurance, or other commercial factors. However, caps typically do not apply to certain types of liability, such as fraud or death/personal injury.
Drafting pitfalls include:
- Failing to exclude liability for uncapped risks (like fraud or deliberate breach)
- Not clarifying if the cap is aggregate or applies per claim
- Ambiguous cap wording being construed against the drafter
The best practice is for the cap to operate as a "ceiling" for all claims except for specifically identified exceptions (e.g., deliberate wrongdoing).
Worked Example 1.4
A clause states: "The maximum liability per claim shall not exceed the contract price." Is this an aggregate cap or a per claim cap?
Answer:
"Per claim" caps the maximum liability for each separate claim. There is no overall aggregate cap unless expressly provided.
Exam Warning (Liability Caps)
If the contract covers activities over a long period (e.g., a service agreement), check that the cap cannot be circumvented by splitting claims or by claims arising in different periods.
Drafting Best Practice
Clear, precise wording is essential. Best practice includes:
- Stating if caps apply "in aggregate" or "per claim"
- Excluding non-excludable liability (e.g., fraud)
- Defining what is and is not included in the cap (interest, legal costs, etc.)
- Ensuring the cap does not operate as an unlawful penalty
Key Point Checklist
This article has covered the following key knowledge points:
- Indemnity clauses are a contractual promise to compensate for specific losses. They differ from warranties/damages in practical and procedural effect.
- Limitation and exclusion clauses restrict or exclude liability, but are controlled by the Unfair Contract Terms Act and reasonableness.
- Liability caps are specific monetary limits and must be drafted with care to cover intended claims.
- Excluding or limiting liability for death/personal injury caused by negligence is void under English law; other exclusions are subject to a reasonableness test.
- The effectiveness of these clauses depends on clear drafting and compliance with statutory controls.
Key Terms and Concepts
- indemnity
- limitation of liability clause
- liability cap
- exclusion clause
- Unfair Contract Terms Act 1977 (UCTA)
- consequential loss
- reasonableness test (UCTA)