Indemnity vs Limitation of Liability

Two clauses doing opposite jobs

Most risk in a commercial contract is allocated by four clauses working together: warranties, indemnities, the liability cap and the insurance obligations. The indemnity and the cap pull in opposite directions.

• Indemnity. A primary promise to pay on the occurrence of a trigger — a third-party claim, a data breach, an IP infringement, a workplace injury. It can be drafted so the beneficiary recovers without proving breach of contract, sidesteps arguments about remoteness of damage, and is paid as a debt.
• Limitation of liability. A ceiling on aggregate recovery, a list of excluded heads of loss, and often a time bar for claims.

The question that actually matters: is the indemnity inside the cap?

This is where negotiations are won and lost. If the liability clause says the cap applies "notwithstanding any other provision", the indemnities are contained. If it says the cap does "not apply to liability under clause X (Indemnities)", your exposure is unlimited precisely where it is largest. We routinely see suppliers spend hours negotiating a cap down to twelve months' fees and then accept an uncapped indemnity two clauses later, which makes the cap close to worthless.

Three workable positions, in order of preference for the party giving the indemnity:

1. Indemnities sit inside the general cap.
2. Indemnities sit outside the general cap but have their own sub-cap, usually aligned to insurance.
3. Indemnities are uncapped but narrowed — limited to loss caused by your own negligence or wilful misconduct, reduced proportionately for the beneficiary's contribution, and excluding indirect loss.

Narrowing an indemnity without rejecting it

• Fault-based trigger. Indemnify for loss "caused by" your negligent act or breach, not loss "in connection with" the contract.
• Proportionate reduction. Reduce the indemnity to the extent the loss was caused or contributed to by the beneficiary or its personnel.
• Exclude indirect loss. Otherwise the exclusions in the liability clause may not reach the indemnity at all.
• Mitigation and conduct of claims. Require the beneficiary to mitigate, notify promptly, and let you take over the defence of third-party claims — otherwise you fund a settlement you had no say in.
• Insurance alignment. Confirm your professional indemnity or public liability policy responds to assumed contractual liability before you sign.

Where each clause is tested

Courts read exclusion and limitation clauses according to their ordinary meaning in the commercial context, but ambiguity tends to be resolved against the party relying on the clause. Indemnities are construed strictly too — an indemnity that does not clearly cover loss caused by the beneficiary's own negligence generally will not. Both principles reward precise drafting and punish templates.

Statute also intrudes. The consumer guarantees under the Australian Consumer Law cannot be excluded, the unfair contract terms regime applies to standard form small business contracts, and state proportionate liability legislation affects apportionment of claims for economic loss based on failure to take reasonable care.