Limitation Of Liability Vs Indemnity Clauses

Priya runs a growing SaaS business in Melbourne. A large customer sends over a supplier agreement, and two clauses jump out: one says Priya's liability is capped at the fees paid in the last 12 months, and another says she must indemnify the customer for a long list of losses.

At first glance, the cap feels reassuring. But then Priya wonders: if the indemnity applies, does the cap still protect her?

That's a very real question. Limitation of liability clauses and indemnity clauses are two of the biggest risk-shifting tools in commercial contracts, and they don't always work together in the way you might expect.

The good news is that once you know what to look for, you can usually spot the risk and negotiate cleaner, fairer wording before you sign.

What Is A Limitation Of Liability Clause?

A limitation of liability clause is a contract term that limits how much one party has to pay if something goes wrong.

In plain English, it's the clause that says, even if we're responsible, there's a maximum amount we can be made to pay. This is often called a liability cap or contract liability cap.

For example, your contract might say:

• Your total liability is capped at the fees paid under the contract in the last 12 months.
• Your liability is capped at $50,000.
• Your liability is limited to the amount recoverable under your insurance policy.
• You won't be liable for indirect loss, loss of profit, loss of revenue or loss of opportunity.

These clauses are common in software agreements, IT services agreements, service agreements, supplier terms, consulting contracts, licence agreements and commercial contracts generally.

For your business, a liability cap can be very useful because it helps you price risk. If a $10,000 contract could expose you to a $1 million claim, you may need to rethink the price, scope, insurance or whether the deal is worth taking.

A cap also helps keep disputes more commercially sensible. Without one, your exposure may be much harder to predict.

What Is An Indemnity Clause In Australia?

An indemnity clause is a promise to cover another party for certain losses, usually if a particular risk or event happens.

In Australia, indemnities are used in many commercial contracts to shift risk from one party to another. They can be narrow and reasonable, or they can be very broad and risky.

For example, your contract might say you indemnify the other party for losses arising from:

• Your breach of the contract.
• Your negligence or wilful misconduct.
• Your infringement of someone else's intellectual property rights.
• Your breach of confidentiality or privacy obligations.
• Claims made by your employees, contractors, customers or end users.
• Damage to property or personal injury caused by your work.

Say you run a cafe in Brisbane and, under a service agreement, you hire a contractor to install new kitchen equipment. If the contractor damages your premises, you might expect them to indemnify you for the repair costs. That kind of indemnity is usually tied to a specific risk the contractor controls.

On the other hand, if the contract says you indemnify the other party for all losses arising in connection with the agreement, that can be much broader. It may pick up losses even where the other party contributed to the problem, unless the wording says otherwise.

The exact wording matters a lot. A few extra words can change whether the indemnity is limited to your fault, or whether it reaches losses that are only loosely connected to your work.

Limitation Of Liability Vs Indemnity: What Is The Difference?

The main difference is that a limitation of liability clause limits exposure, while an indemnity clause can create a separate obligation to pay for specific losses.

A liability cap is usually defensive. It tries to reduce or control the amount payable if a claim is made against you.

An indemnity is usually protective for the other party. It tries to make sure they can recover certain losses from you, often more easily than under a normal breach of contract claim.

Here's a simple way to think about it:

• Limitation of liability: Sets the ceiling on how much you may have to pay.
• Indemnity: Sets out certain losses you agree to cover.
• Exclusions: Say which claims aren't covered by the cap, such as fraud, confidentiality breaches or IP infringement.

The tricky part is that these clauses can overlap. A contract might say your liability is capped at $20,000, but also say you indemnify the customer for all losses arising from a data breach. If the data breach causes $200,000 of loss, does the $20,000 cap apply?

The answer depends on the drafting.

Can An Indemnity Override A Liability Cap?

Yes, an indemnity can override a liability cap if the contract says the cap doesn't apply to indemnities, or if the wording clearly treats indemnities separately.

This is one of the biggest traps in commercial contracts. You may see a liability cap and assume your risk is limited, but the indemnity clause or exclusions clause may quietly carve out the biggest claims.

Example: The Cap Applies To The Indemnity

Mike runs a cleaning business in Sydney. His contract says his total liability, including under any indemnity, is capped at the fees paid in the last 6 months.

A cleaner accidentally damages a client's flooring. The client claims $30,000. Mike's fees for the last 6 months were $18,000.

If the clause is drafted properly, Mike may be able to rely on the $18,000 cap even though the claim is brought under an indemnity.

Example: The Cap Does Not Apply To The Indemnity

Now imagine Mike's contract says liability is capped at $18,000, but then says the cap doesn't apply to indemnities.

In that case, the client may argue the $30,000 indemnity claim is uncapped. Mike thought he had a cap, but it doesn't help for that type of claim.

Example: Only Some Indemnities Are Uncapped

A more balanced contract might say the cap applies to most claims, but not to a few serious risks, such as:

• Fraud.
• Wilful misconduct.
• Death or personal injury caused by negligence.
• Misuse of confidential information.
• IP infringement claims caused by your materials.
• Privacy or data security breaches, sometimes subject to a higher cap.

This approach can make sense where the risk is serious and within your control. But it's still worth checking whether the carve-outs are too broad for your business.

For example, an exclusion for breach of confidentiality might sound fair. But if confidentiality is defined very widely and includes almost every piece of information exchanged during the relationship, even a minor accidental disclosure could become uncapped.

What Should Your Contract Liability Cap Be?

Your contract liability cap should match the commercial value of the deal, the risk involved, your insurance and what you can realistically afford if something goes wrong.

There's no single correct cap for every business. A $5,000 marketing project and a $500,000 software rollout shouldn't carry the same risk settings.

Common ways to set a liability cap include:

• A fixed dollar amount: For example, $25,000 or $100,000. This gives certainty.
• A multiple of fees: For example, 1x or 2x the fees paid under the contract.
• A look-back period: For example, fees paid in the previous 6 or 12 months.
• An insurance-based cap: For example, the amount recoverable under your professional indemnity or public liability insurance.
• Different caps for different risks: For example, a general cap for most claims and a higher cap for privacy or IP claims.

A fees-based cap can work well for recurring services because it moves with the size of the customer relationship. But for early-stage contracts where fees are low and risk is high, the other party may push back.

An insurance-based cap can be useful, but be careful. Insurance policies have exclusions, excesses and claim conditions. If the contract says your liability is capped at your insurance limit, but the policy doesn't respond to the claim, you may still have a problem. The wording should be checked against your actual policy.

You should also think about whether the cap is aggregate or per claim. An aggregate cap is usually safer for the party giving the cap because it limits total liability across all claims. A per-claim cap can reset each time there's a new claim, which may increase your exposure.

What Should You Negotiate Before You Sign?

You should negotiate the interaction between the indemnity and the liability cap before you sign, because that's where the real risk often sits.

It's completely normal to negotiate these clauses. You don't need to be difficult or overly legalistic. You can frame it as making sure the risk matches the deal.

Check Whether Indemnities Are Inside Or Outside The Cap

Look for wording such as:

• The liability cap doesn't apply to indemnities.
• Nothing in this clause limits liability under clause X.
• The exclusions from the cap include indemnity claims.
• Liability under an indemnity is unlimited.

If you see this, ask whether the clause drafting really needs all indemnities to be uncapped. Often, a better position is that indemnities are included in the cap, except for a narrow list of serious risks.

Narrow The Indemnity To Your Fault

If you're giving an indemnity, try to tie it to things you control.

For example, in customer contracts, instead of indemnifying the other party for all losses arising in connection with the contract, you might limit it to losses caused by:

• Your breach of the contract.
• Your negligence.
• Your wilful misconduct.
• Your infringement of third party IP rights.
• Your breach of privacy, confidentiality or security obligations.

You can also ask for the indemnity to be reduced to the extent the loss was caused or contributed to by the other party. This is a practical and fair protection.

Make Sure The Cap Covers The Right Types Of Loss

Some contracts exclude indirect or consequential loss. That can be helpful, but those phrases can still lead to arguments if they're not clearly drafted.

If particular losses matter in your deal, name them. For example:

• Loss of profit.
• Loss of revenue.
• Loss of goodwill.
• Loss of data.
• Business interruption costs.
• Costs of replacement services.

For software, data, marketing and professional services businesses, the difference between direct and indirect loss can be a big deal. Clear wording reduces room for a dispute later.

Check The Australian Consumer Law Position

You generally can't use a contract to exclude rights that can't be excluded under the Australian Consumer Law.

For some business purchases, the consumer guarantees under the Australian Consumer Law can still apply. For example, goods or services under $100,000 may be covered, and some goods or vehicles can be covered even above that amount depending on their type and use.

In business contracts, suppliers may be able to limit certain remedies in a way allowed by the Australian Consumer Law, such as resupplying services or paying the cost of resupply, if the law permits it and the wording is done properly. But a blanket attempt to avoid all liability for statutory guarantees can be risky.

You should also keep the unfair contract terms regime in mind. Since November 2023, unfair contract terms in standard form small business and consumer contracts can attract penalties under the Australian Consumer Law and the ASIC Act. For companies, the maximum penalties can be very significant, including the greater of $50 million, three times the benefit obtained, or 30% of adjusted turnover during the relevant period.

This doesn't mean every strong liability clause is automatically unfair. But one-sided indemnities, broad exclusions and harsh caps in non-negotiated contracts can create risk, especially where your customer or supplier is a small business.

Common Mistakes To Avoid

The most common mistake is reading the liability cap on its own, rather than checking how it works with the indemnity, exclusions and insurance clauses.

Here are the issues we often see in commercial contracts:

• Assuming the cap applies to everything: Many contracts carve out indemnities, confidentiality, IP, privacy, payment obligations and other key risks.
• Giving a broad indemnity for risks you don't control: If the other party causes or contributes to the loss, your indemnity should reflect that.
• Using a template without tailoring it: Templates can be a helpful starting point, but risk clauses work best when they match your services, pricing and insurance.
• Ignoring insurance: Your contract may promise more protection than your policy actually covers.
• Leaving key words undefined: Words like loss, claim, consequential loss and liability can carry a lot of weight.
• Forgetting about statutory rights: The Corporations Act 2001, Privacy Act 1988, Australian Consumer Law and ASIC Act can all affect risk allocation depending on the contract and industry.

One practical way to review a contract is to trace a realistic worst-case scenario through the document.

For example, if you run an online platform and a customer claims a data incident caused them loss, ask:

• Is there an indemnity?
• Does the liability cap apply to that indemnity?
• Is privacy or data security carved out of the cap?
• Is there a higher cap for data claims?
• Does your cyber insurance respond?
• Are you liable for the customer's lost profit or only direct losses?
• Do you have notice, mitigation and cooperation obligations?

This kind of review can feel a bit detailed, but it's often where the most useful negotiation points appear.

Key Takeaways

• A limitation of liability clause limits how much you may have to pay if a claim arises.
• An indemnity clause is a promise to cover certain losses, and it can create a major financial exposure.
• An indemnity can override a liability cap if the contract says indemnities are excluded from the cap.
• Your contract liability cap should match the deal size, risk level, insurance and your ability to absorb a claim.
• Try to keep indemnities tied to risks you control, and reduce them where the other party contributed to the loss.
• Australian Consumer Law, unfair contract terms rules, privacy laws and industry-specific obligations can affect how these clauses work.

If you'd like help with reviewing your commercial contract, negotiating liability caps and indemnities, or preparing tailored terms for your business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.