Limitation of liability in a contract

What happens to the contract price when a limitation of liability is not agreed upon

The default statutory rule under Czech legislation is unpleasant for suppliers: if a party breaches a contractual obligation, they must compensate the other party for the resulting damage (Section 2913 of the Czech Civil Code). Contractual liability is strict (not based on fault) – the liable party can only be released from it in the event of an extraordinary, unpredictable, and insurmountable obstacle. Both actual damage and lost profits are compensated (Section 2952 of the Czech Civil Code), provided they represent distinct financial harms and the injured party proves their occurrence and causal link.

In practice, this means that a software supplier for a project worth two million CZK can, in the event of an error causing a disruption to the client's operations, be liable for tens of millions in lost profits. Without a limitation of liability clause, they bear this risk in full, and no professional indemnity insurance policy on its own relieves them of the obligation to pay the difference if the insurance coverage limit does not cover the damage. This is precisely why limitation of liability is a fundamental component of any IT contract, the remaining content of which is discussed in our article on ordering custom software or SaaS.

The second consequence of the absence of a limitation clause is permanent uncertainty regarding the actual scope of risk during the project pricing stage. A supplier who does not know the maximum amount they might have to pay in the event of a dispute will either not factor the risk into the price at all, or will estimate it disproportionately high, making the project more expensive even where the actual risk is not that high.

The third consequence, which companies often underestimate, is the impact on negotiations with insurance companies. When setting the limit of insurance coverage, a professional indemnity insurer often takes into account what contractual liability limits the company standardly agrees with its customers. A company without a unified limitation policy may thus pay more for insurance than it actually needs, or conversely, remain underinsured for projects where it neglected to agree on a limitation of liability at all.

What should be included in a limitation of liability clause

A well-drafted limitation of liability clause has four elements that are often neglected or mixed up in practice. The first is the actual financial cap, usually expressed as a multiple of the contract price or as an amount derived from the remuneration paid over a certain period. The choice between the two calculation methods depends on whether it is a one-off delivery with a clear price, or a long-term relationship with variable monthly performance, where the remuneration for the last year is a more reliable basis than the price of an individual order.

The second element is defining what type of damage the cap applies to and what damages are excluded from compensation entirely. In IT and technology contracts, the exclusion of lost profits, loss of business opportunity, or loss of data is frequently agreed upon. However, it is advisable to explicitly define terms like "indirect" or "consequential damage" in the contract, as the Czech Civil Code does not work with them as independent legal categories, and without a definition, their meaning becomes a subject of dispute.

The third element consists of exceptions to the cap, i.e., situations to which the limitation does not apply at all. Typically, this involves harm caused intentionally or through gross negligence, harm caused to a person's natural rights, particularly health, and breach of confidentiality – the first two exceptions are mandated by law under Czech legislation, while others are added by companies themselves as a concession to make the rest of the clause more negotiable.

In the case of a breach of confidentiality, companies often agree on a separate, higher cap independent of the general limit for other damages, as the leak of sensitive data or trade secrets can have an impact completely unrelated to the contract price. Companies apply the same logic to damage to third-party property, where a general cap derived from the price of an IT project in the range of hundreds of thousands of CZK clearly does not correspond to the actual risk that such a breach could cause.

The fourth element is the relationship of the limitation to other penalty mechanisms in the same contract, especially contractual penalties. Without a clear agreement on whether the contractual penalty is counted towards the cap or is a separate, independent claim, a dispute arises precisely when it matters most.

How successful companies set up limitations of liability

A proven structure derives the cap from the contract price, not from a flat-rate amount. In IT and consulting contracts, the cap is often linked to the remuneration paid or payable for a certain period, such as the preceding twelve months; the specific multiple depends on the risk level of the performance and the bargaining power of the parties. For deliveries with a higher risk of property damage, the cap is usually set separately and higher.

The second feature of a functioning clause is a so-called two-tier cap: a lower limit for ordinary breaches of contract, and a higher or no limit for selected categories of material breach, typically breach of confidentiality, alongside exceptions mandated by law. This structure gives the supplier certainty regarding routine risks, while guaranteeing the customer that the most serious breaches will not remain practically unpunishable.

The third feature is an explicit agreement on the relationship of the limitation to contractual penalties, liability insurance, and claims under other legal titles, such as unjust enrichment or rights from defective performance. Contracts that do not address this relationship end in a dispute over whether the cap covers all claims combined or each separately.

The fourth feature is the regular updating of the limitation in framework agreements with recurring orders. A company that has a single framework cap for an entire multi-year relationship, regardless of how the volume of orders grows over time, risks the cap becoming disproportionately low compared to the actual value of what the parties deliver to each other, precisely when it should protect them the most.

Conversely, a warning sign is a cap set as a single sentence without defining the types of damage and without any relation to other provisions in the contract. Such a clause looks simple in the text of the contract, but in a dispute, it turns out that it does not cover exactly what the supplier expected, because the court must interpret it without the support of a clearly described scope.

What the law excludes from contractual freedom

Contractual freedom in setting a liability cap is not unlimited. No regard is given to an agreement that pre-emptively excludes or limits the obligation to compensate for harm caused to a person's natural rights, or caused intentionally or through gross negligence; no regard is also given to an agreement that pre-emptively excludes or limits the right of a weaker party to compensation for any harm, and the right to compensation cannot even be validly waived in these cases (Section 2898 of the Czech Civil Code).

For B2B contracts, this means a firm rule in practice: the cap must not limit compensation for harm caused intentionally or through gross negligence, regardless of how low it is otherwise set. Last year, the Supreme Court explicitly concluded that this is an absolutely mandatory rule that also applies to contractual liability, and that such a part of the agreement is disregarded as if it had not been agreed upon (judgment File No. 28 Cdo 1551/2025). Outside of these cases, the scope of liability can be contractually limited, even to an amount significantly lower than the actual damage.

The question of who is the "weaker party" in a specific relationship within the meaning of this provision is assessed according to the circumstances of the specific contractual relationship. The mere difference in the size of the businesses or the use of a standard form contract is not decisive on its own, although whether the supplier had a realistic opportunity to negotiate the terms of the limitation is among the circumstances the court takes into account.

Whether a specific cap setting will stand in a given contract depends on the bargaining position of both parties and how sensitive the performance covered by the contract is – which is why the Czech legal team at ARROWS law firm always assesses this for each specific relationship, rather than relying on a universal clause template.

Relationship of limitation of liability to contractual penalties

Limitation of liability and contractual penalties address two different things, and mixing them into a single sentence is a common mistake that weakens the clause in practice. A contractual penalty secures a specific obligation, and the creditor can demand it regardless of whether they suffered damage as a result of the breach of this obligation (Section 2048 of the Czech Civil Code). Conversely, a limitation of liability limits the amount of compensation for actually incurred damage, not the penalty for the breach itself.

How these two categories are confused in practice and what this means for the possibility of a court reducing an unreasonable penalty is discussed in our article on the moderation of contractual penalties. The difference between the two concepts is also fundamental to how the court approaches them in a dispute over their validity.

If a contractual penalty is agreed upon, the creditor is not entitled to compensation for damage resulting from the breach of the obligation to which the penalty applies (Section 2050 of the Czech Civil Code); this is a default rule from which the parties may deviate. Therefore, if a contract contains both a contractual penalty for late delivery and a liability cap for damages, it must explicitly state whether the penalty is counted towards the cap and whether the claim for damages should be preserved alongside it.

Without a deviating agreement, the statutory rule applies: the creditor is not entitled to compensation for damage from the same breach alongside the penalty. If the customer wants both, they must explicitly agree on preserving the claim for damages. Conversely, the supplier may find that the limitation does not apply to the penalty at all, because the cap clause only referred to "compensation for damage", not to contractual penalties as such.

Therefore, the parties can agree on a joint aggregate cap for damages and contractual penalties, but it is necessary to precisely define which other claims are counted towards it. A general formulation stating that the cap covers all claims under the contract without distinction can have unintended consequences – it then becomes disputable whether it also covers the refund of the price after withdrawal, unjust enrichment, or a price discount for defective performance. A clear list gives both parties certainty about the maximum possible exposure from the entire contractual relationship.

How to negotiate a limitation of liability

The first step is to determine what risk the contract actually covers and derive the cap from the real value of this risk, rather than from a general template taken from another project or the internet. A delivery carrying a risk of production downtime for the customer requires a differently set cap than a one-off consulting service with no operational impact on their business.

The second step is to explicitly list the excluded types of damage, typically lost profits, and discuss them with the customer as a separate negotiation item, rather than hiding them in a general formulation. A customer will often agree to the exclusion of lost profits more easily than they would to a low overall cap, as they perceive the difference between the two concessions differently, even though the economic impact may be comparable.

The third step is to align the limitation of liability with the contractual penalty and professional indemnity insurance so that all three mechanisms work together rather than against each other. A liability cap set higher than what the insurance policy covers leaves the supplier with uncovered risk, which they should either reduce or consciously acknowledge and reflect in the price.

The fourth step is to address the exceptions to the cap so that they are sufficiently specific while not expanding the risk beyond the statutory minimum. An exception formulated too broadly, such as "any breach of an important obligation," in practice effectively defeats the purpose of the entire limitation clause, as the customer can then claim that the exception applies to most disputes. For deliveries of machinery and technological units, the limitation must also be aligned with the quality guarantee and claims for a discount on the price of the work, which are discussed in our article on claiming a discount due to a machine defect.

The fifth step, which is often omitted, is the regular review of the limitation clause when extending or expanding the contract. The scope of performance, project value, and risk change over the course of a long-term relationship, but the cap remains the same unless explicitly modified by the contracting parties – and this is precisely the moment when the limitation ceases to correspond to the reality of the relationship without anyone noticing.

The limitation of liability is, however, just one of the provisions assessed during a review of the entire contract, alongside other clauses on liability, penalties, and termination. What such a review should cover and what is most frequently forgotten is described in our article on what a commercial contract review should contain.

Risks of limitation of liability in a contract

Summary

Without a limitation clause, compensation for damage resulting from a breach of contract is not limited by the price of performance and can also include lost profits. This article has shown that a liability cap can be validly set even significantly below this threshold, but not in a way that limits compensation for harm caused intentionally or through gross negligence, and that the limitation must be strictly distinguished from a contractual penalty.

Two decisions are crucial for company management. First, what risk a specific project carries and what cap corresponds to it, rather than what cap the company uses across all contracts as a flat rate. Second, how the limitation fits into the rest of the contract – into the contractual penalty, insurance, and the exceptions required by law.

The Czech legal team at ARROWS law firm prepares and negotiates limitation of liability clauses based on the risk of each specific project, aligns them with contractual penalties and liability insurance, and verifies their validity before the contract is signed, whether for a one-off delivery or a long-term framework relationship. Write to us at consultation@arws.cz or review our contracts and negotiation practice.