The Difference Between a Limited Liability Clause and an Indemnity Clause

Most small businesses consider potential claims and lawsuits when contracting with customers and suppliers. A company may insert provisions for limitations of liability and indemnity clauses, depending on the nature of the contract and type of work involved. Limitations of liability generally protect the vendor being paid under the agreement, while indemnity language benefits either party, depending on the risks of future claims arising from the services being provided.

Limited liability clauses, sometimes known as exculpatory clauses, cap the liability of one of the parties to the contract. They are enforced in most states under general rules of freedom of contract. Companies providing services to others may insert language into a written agreement setting the company's maximum liability at the amount the company is paid under the contract. For example, a small business being paid $1,500 for software services may demand that its liability under the contract be capped at $1,500.

An indemnity clause requires one or both parties to an agreement to defend the other party and potentially pay any claims or lawsuit settlements or judgments. This responsibility can include an obligation to pay attorney fees and legal costs. Larger companies frequently use their leverage in agreements with smaller companies to insist on indemnity language in the larger company's favor. A smaller company generally has to decide whether or not the income from the agreement justifies the risk of accepting the indemnity language.

A limited liability clause applies to claims from outsiders as well as from claims brought by the companies making the contract. A limited liability provision can even protect a company that totally fails to fulfill its obligations, limiting the other party's recourse to repayment of the money paid. Indemnity provisions focus on shifting the risk of paying and defending third party claims from one party to another. An indemnity clause would most likely not prevent one party to the contract from suing the other for failure to perform.

A small business eager to contract with larger companies has to determine whether to accept indemnity provisions. In making this determination, the small-business owner should consider her insurance coverages and limits. Comprehensive insurance and high insurance limits may lead the small business to accept the risk. Small businesses providing services must also consider whether asking for a limited liability clause in their favor will cause other companies to distrust their competency and presume that they do not stand behind their work.