If a supplier's goods turn out to be defective, arrive late or fail in use, how much can you actually recover? In most supply agreements the answer is set by the limitation of liability clause rather than by the size of your loss. A sensible cap lets both sides price and insure the risk. A one-sided one can leave you carrying losses that were really the supplier's to bear.
What a liability cap does
A cap puts a ceiling on the total one party has to pay if things go wrong. A typical version says the supplier's total liability arising under or in connection with the agreement will not exceed the greater of £50,000 and the price paid for the goods in the previous 12 months. Caps usually sit alongside an exclusion of certain types of loss, such as lost profit and indirect loss, and a list of carve-outs that aren't capped at all.
Suppliers insist on caps because the price of goods is often small compared with the damage they can cause further down the chain. Say you buy £100,000 of components for products you sell on under a £1 million contract. If the components fail and your customer claims against you, you'll want to pass that claim up to your supplier. Without a cap, the supplier's exposure bears no relation to what it was paid, and it will either price that in or refuse to deal. With one, both of you know where the line is, and you can decide whether to insure the gap.
Common types of liability cap
A fixed sum. Liability capped at, say, £250,000. It is clear, but it doesn't move if the contract grows, so a cap that looked generous in the first year can look thin by the third.
A figure linked to the price. For example, 100% or 150% of the charges paid or payable in the 12 months before the claim. This scales with the relationship, but look at the reference period. A cap based on charges paid in the previous 12 months can be very low if something goes wrong early in the contract, which is why buyers often ask for the greater of a fixed sum and a price-based figure.
Separate caps for different claims. Some agreements set a higher cap for defective goods, product recall or data breaches and a lower general cap. This is often a workable compromise when the supplier won't move on the general figure.
The legal limits in business contracts
Businesses have a lot of freedom to allocate risk between themselves, but the Unfair Contract Terms Act 1977 limits it in some important ways.
Liability for death or personal injury caused by negligence can't be excluded or restricted at all. Other exclusions and limits of liability for negligence, and exclusions or limits in one party's written standard terms of business, are only valid if they satisfy the reasonableness test. In a sale of goods, the implied term that the seller has the right to sell the goods can't be excluded, and the implied terms about description, satisfactory quality and fitness for purpose can only be excluded or restricted so far as that is reasonable.
Some limits come from elsewhere. A party can't exclude liability for its own fraud. An exclusion of liability for misrepresentation has to satisfy the reasonableness test under the Misrepresentation Act 1967. And liability to people injured by defective products under the Consumer Protection Act 1987 can't be excluded.
The Consumer Rights Act 2015 is a separate regime for consumers, and it stops traders excluding most consumer rights. If you're buying for your business, it won't help you.
Is the cap reasonable? The legal test
The question is whether the term was a fair and reasonable one to include, given the circumstances the parties knew about, or ought reasonably to have had in mind, when the contract was made. It is judged at that point, not with hindsight once the loss has happened.
The Act sets out guidelines that courts treat as relevant, including the relative bargaining strength of the parties, whether the buyer could have got the goods elsewhere without a similar restriction, whether the buyer knew or ought reasonably to have known about the term, and whether the buyer was given something in return for accepting it, such as a lower price. Where a term limits liability to a specified sum, the court also has to consider the resources the supplier could expect to have available to meet the liability and how far it could have covered itself by insurance.
In practice, courts are generally reluctant to interfere with limitation clauses agreed between commercial parties of similar strength who had the chance to negotiate. The test has more bite where a large supplier imposes its standard terms on a small customer, or where the cap is so low it leaves the buyer with no real remedy. Even so, you shouldn't plan on a court rescuing you from a cap you agreed to. The time to deal with it is before you sign.
Exclusions of indirect and consequential loss
Most supply agreements say neither party is liable for indirect or consequential loss, and many go on to exclude loss of profit, revenue, business, goodwill or data. In a lot of disputes these exclusions do more work than the cap, because lost profit is often the largest part of a buyer's claim.
English courts have traditionally read “indirect or consequential loss” narrowly, as covering losses that arise from special circumstances rather than in the ordinary course of things. On that reading, profit you lose as a natural result of defective goods may not be caught by those words alone. That is why suppliers' clauses usually exclude loss of profit expressly, often “whether direct or indirect”. Read the list carefully. If it excludes all loss of profit and revenue, a defect that halts your sales may leave you with a claim for little more than the cost of the goods and of replacing them.
Not having read the clause won't usually help. A business that signs a contract is generally bound by its terms. Where they are the supplier's standard terms the reasonableness test still applies, but that gives you an argument, not a guarantee.
Carve-outs from the cap
Some liabilities sit outside the cap because the law requires it, principally death or personal injury caused by negligence, and fraud. A well-drafted clause says so expressly rather than leaving it to the statute.
Others are commercial choices. Buyers commonly ask for uncapped or separately capped liability for breach of confidentiality, infringement of intellectual property (particularly an indemnity against third-party IP claims), breach of data protection obligations and deliberate abandonment of the contract. Some agreements also carve out “gross negligence”, but English law has no settled meaning for that phrase, so if you want the carve-out, define what it covers.
Check that the cap works both ways where it should. A clause that caps the supplier's liability but leaves yours unlimited, beyond your obligation to pay the price, is common and worth querying.
Negotiating a reasonable cap
Start with your realistic worst case. If defective goods could stop your production, trigger claims from your own customers or force a recall, work out roughly what that would cost and compare it with the cap on offer. That gives you something concrete to negotiate from, rather than a general complaint that the cap is too low.
Then look at the structure as well as the number. A “greater of” formula, a higher cap for defective goods or recall costs, or a narrower loss of profit exclusion may be easier for the supplier to agree than a bigger single figure. Ask what insurance the supplier holds and what it covers, because a cap set well below the supplier's own cover for that risk is hard to justify. And look at your own insurance, since some of the risk above the cap may be better covered on your side.
If you want to see how the cap, exclusions and carve-outs in a particular agreement fit together, you can upload the supply agreement to QuickLegalCheck for a review.
Related: what the supply agreement review covers, and a complete sample report.