What business owners need to know about indemnification and limitation of liability in commercial contracts

Before contacting me for help, a client was trying to navigate a commercial agreement and found himself stuck on two common problem areas: indemnification and limitation of liability. He wasn’t sure which party was responsible for which risks, when those risks shifted, or how the limitation of liability provision fit into that framework.

If this sounds familiar, you’re not alone. These provisions often confuse even experienced business professionals, and for good reason. They blend complex legal concepts, involve abstract risk allocation, and often reference hypothetical lawsuits that are hard to visualize. To make things even more challenging, these clauses are not symmetrical between the parties and are among the most heavily negotiated provisions in any commercial contract.

This post provides a general overview of how indemnification and limitation of liability work together in commercial transactions, such as those involving the sale of goods or services. While this information can help you better understand the concepts, it’s always best to consult qualified commercial counsel before finalizing or negotiating these provisions.

Limitation of Liability

A limitation of liability clause is a contractual tool that restricts the amount or type of damages one or both parties may recover. It can apply to:

• The entire contract,

• Specific provisions within the contract, or

• Individual transactions (for example, purchase orders under a master agreement).

Generally, parties can recover all types of damages, including both direct and indirect (consequential) damages. Without a limitation of liability clause, a party could face unlimited exposure, meaning the potential losses might far outweigh the benefits of the deal.

Most limitation of liability clauses include two key elements:

1. Waiver of consequential damages – limiting recovery to direct damages only.

2. A liability cap – setting a maximum amount one party can owe under the contract.

The specific terms of these provisions can, and should, be negotiated to reflect the realities of the transaction. For example, a seller may want to tightly limit its exposure, while a buyer may seek broader recourse. An experienced business attorney can help tailor these provisions to protect your interests and ensure the contract’s risk allocation doesn't outweigh the contract's rewards.

Indemnification

An indemnification clause shifts specific risks from one party to another. It creates an obligation for one party (the indemnifying party) to compensate the other (the indemnified party) for certain costs and expenses, usually arising from third-party claims, and sometimes from direct claims as well.

In short, indemnification is about who pays when something goes wrong. Properly drafted, it helps parties manage uncertainty and allocate risk efficiently.

A typical indemnification clause includes two main obligations:

1. The obligation to indemnify – requiring the indemnifying party to reimburse the indemnified party for covered “losses” (e.g., damages, judgments, or settlement payments).

2. The obligation to defend – giving the indemnifying party both the duty and the right to control the defense of claims that fall within the clause’s scope.

   
   

These provisions also define what events trigger indemnification (for example, violations of law or breaches of contract) and may include exceptions, such as when the indemnified party’s own actions caused the loss.

Importantly, indemnification often interacts with the limitation of liability clause. For instance, a limitation of liability may cap indemnification obligations unless expressly excluded. This intersection is a common drafting pitfall that can have significant real-world consequences if not handled carefully.

For business owners, grappling with indemnification and limitation of liability can be overwhelming (understandably so). These provisions determine who bears which risks and how much those risks are worth, often in situations that may never arise.

Your priority should be running and growing your business, not dissecting complex contract language. That’s where I come in. If you’re negotiating a commercial contract or simply want to ensure your agreement protects your interests, contact me today. I’ll help you navigate the legal details so you can focus on what you do best.