Limitation of Liability Clauses in Contracts

What limitation of liability is, and why it must be negotiated upfront

Limitation of liability is the parties’ agreement on the maximum scope of liability a party bears upon breach of contract. Instead of leaving compensation to be determined entirely after the incident (with all the uncertainty of proving damage), the parties set in advance the “ceiling” and “floor” of liability.

The practical value of this clause shows clearly in contracts with cascading risks: a delayed shipment may cost the counterparty a large contract with a third party; a software bug may halt an entire production line. A limitation of liability clause brings predictability for both sides: the service provider knows the maximum risk exposure for pricing and insurance; the buyer knows the scope of protection to decide whether additional safeguards are needed.

The crux: this clause only works when negotiated and recorded before the contract is signed. After an incident, no party will agree to limit the other side’s liability.

Legal framework: how far does the law allow limitation?

Vietnamese law respects the parties’ freedom to agree on liability for breach, but sets certain limits:

• Penalty for breach as agreed by the parties (Article 418 of the Civil Code 2015): the penalty level is as agreed, except where relevant laws provide otherwise. The parties may agree that the breaching party bears only the penalty, or both penalty and damages — if only the penalty is agreed without more, the breaching party bears only the penalty.
• 8% penalty cap in commerce (Article 301 of the Commercial Law 2005): the penalty for breach of a contractual obligation must not exceed 8% of the value of the breached contractual obligation. This is the point most violated by contracts drafted on foreign templates — international forms are usually unaware of this cap.
• Damages (Article 419 of the Civil Code 2015; Articles 302–304 of the Commercial Law 2005): the breaching party compensates actual, direct losses and the direct profits the aggrieved party would have earned absent the breach. This very burden of proving damage is why parties want to agree a cap in advance.
• Relationship between penalty and damages (Article 307 of the Commercial Law 2005): where a breach penalty is agreed, the aggrieved party may apply both penalty and damages, unless the law provides otherwise. Clause design must calculate total liability from both remedies, not look at each in isolation.

Common techniques for limiting liability

In actual negotiations, limitation of liability is designed using one or a combination of these techniques:

• Absolute cap by contract value: e.g. “Party B’s aggregate liability shall not exceed 100% of the total contract value” or a lower ratio such as 50% or 30%. This is the most common technique for its simplicity and ease of calculation.
• Cap per event or per year: instead of one cap for the whole contract, the parties may set a cap per breach event, or an annual aggregate cap. This technique suits framework contracts and long-term service contracts with multiple independent tranches.
• Exclusion of indirect and consequential damages: the parties agree to exclude liability for damage not directly arising from the breach — e.g. lost profits under third-party contracts, reputational damage, opportunity costs.
• Limitation by type of obligation: different caps for different groups of obligations — e.g. a low cap for delay, a higher cap for quality breaches.
• Deductible: the breaching party is liable only for damage exceeding a threshold — similar to insurance deductibles. This technique filters out minor claims and focuses on material breaches.

These techniques may be combined in one overall clause. What matters is precise language: does “aggregate liability” include the breach penalty, how is “indirect damage” defined, does the cap apply per party or to both.

Designing penalty and damages mechanisms together with the cap

A limitation of liability clause does not stand alone — it must be designed consistently with the penalty and damages mechanisms:

• State clearly whether both apply: under Article 418.3 of the Civil Code 2015, both penalty and damages require express agreement. If the contract states only the penalty and is silent on damages, the breaching party bears only the penalty.
• Does the cap include the breach penalty: the limitation clause should state whether the maximum aggregate liability includes both the penalty and damages, or applies only to damages. If unstated, the parties will dispute the total calculation when an incident occurs.
• Deduct amounts already paid: provide a set-off mechanism — e.g. penalty amounts already paid are deducted from total damages — to avoid the breaching party paying twice for the same loss.

A complete clause structure usually has three layers: (1) breach penalties for specific acts (within the legally permitted cap); (2) damages based on actual proof; (3) an aggregate cap on total liability. The three layers must be written so they do not contradict each other.

Hard-to-limit cases: boundaries requiring caution

Not all liability can be limited by agreement. When drafting a limitation clause, enterprises should be cautious about these boundaries:

• Intentional acts or fraud: the law does not allow a party to agree to exclude liability for its own intentional wrongdoing. A limitation clause should be understood as applying to negligent, inadvertent breaches in performance.
• Breach of fundamental contractual obligations: if the breaching party fails to perform the core obligation for which the contract was concluded (e.g. the contractor does not build, the supplier does not deliver), invoking a limitation clause to pay only a small fraction may be challenged.
• Liability to consumers: consumer protection law usually restricts enterprises’ ability to agree on liability limitations.
• Mandatory statutory liability that cannot be excluded by agreement: some liabilities are mandatory under law (e.g. product safety liability in certain sectors) — agreements excluding them risk invalidity.

The safe approach: in the limitation clause, state clearly the exclusions from the cap — i.e. the cases where the cap does not apply.

Relationship with indemnity clauses and insurance

Limitation of liability usually comes with two supporting mechanisms — indemnity clauses and insurance — and all three must be designed consistently:

• Indemnity clause: a party’s undertaking to indemnify the other for losses arising from defined events (e.g. IP infringements). The key question: is the indemnity obligation subject to the general liability cap, or is it an exception? This must be stated expressly.
• Insurance: the contractual liability cap should be considered together with each party’s insurance coverage. Enterprises should require counterparties to evidence valid insurance as a contract condition.
• Order of application: when an incident occurs, the usual sequence is: insurance pays first (if any), then the indemnity and limitation clauses apply to the remainder. Stating this sequence in the contract avoids disputes over who pays first.

Negotiating limitation of liability with foreign counterparties

With foreign counterparties, limitation of liability clauses are often more complex due to differences in legal systems and practice:

• Governing law: the permissible extent of a limitation clause depends on the law governing the contract. A clause perfectly valid under English law may face issues under Vietnamese law — particularly the 8% penalty cap in Article 301 of the Commercial Law 2005.
• Language: terms like “consequential damages” and “indirect losses” have no fully equivalent concepts in Vietnamese law. Bilingual contracts should define these terms clearly.
• International standards: EPC and FIDIC contracts usually have built-in limitation mechanisms per international standards. When applied in Vietnam, they must be reviewed to ensure no conflict with mandatory Vietnamese law — especially in projects with state elements or tendering.
• Dispute resolution: a limitation clause only matters if the dispute resolution body recognises it. An arbitration agreement (e.g. at VIAC or international arbitration) must be drafted clearly enough for the tribunal to apply the limitation clause when computing liability.

Common drafting mistakes

• One-sided limitation only: the clause limits only one party’s liability — creating an imbalance that may be challenged on fairness grounds.
• Cap disproportionate to actual risk: a cap set too low strips the clause of protection for the aggrieved party; too high and the liable party cannot accept it.
• Undefined terms: using phrases like “indirect damage” or “aggregate liability” without definitions — each side understands them differently and disputes are inevitable.
• Conflicts between clauses: the limitation clause says the cap is 50% of contract value, but the indemnity clause in another chapter requires full uncapped indemnification.
• Copying foreign templates verbatim: as analysed, international templates do not account for the 8% penalty cap and Vietnam-specific rules. Every foreign template must be reviewed and adapted before use.

Frequently asked questions

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