General legal information, published for everyone. It does not apply the law to anyone’s particular situation and is not legal advice. Laws change and differ by place; check the primary sources below.
Quick summary
- Liability for breach starts with the contract's actual words; courts read the agreement as a whole.
- The default remedy is money damages that put the injured party where performance would have.
- Damages are generally limited to losses that were foreseeable and that could not reasonably have been avoided.
- Indemnification clauses shift certain losses, often including third-party claims, from one party to another.
- Limitation-of-liability clauses cap or exclude damages, but courts in many states will not enforce them for fraud, gross negligence, or intentional misconduct.
What it means
A contract allocates risk between the parties. Some of that allocation is explicit, in clauses that say who pays for what. The rest comes from default rules of contract law that apply when the contract is silent.
Questions about liability under a contract therefore usually involve three steps: what the relevant clause says, how the law of the governing state interprets that kind of clause, and what the facts show about performance and loss.
Key terms
- Breach
- Failure to perform a contractual duty when performance is due.
- Material breach
- A breach serious enough to deprive the other party of much of what it bargained for, which may allow that party to suspend performance or end the contract.
- Expectation damages
- Money that puts the injured party in the position it would have been in had the contract been performed.
- Consequential damages
- Indirect losses, such as lost profits, that result from a breach because of the injured party's particular circumstances.
- Mitigation
- The principle that an injured party cannot recover losses it could have avoided with reasonable effort.
- Indemnification
- A promise by one party to cover specified losses or claims suffered by the other, often including defense costs.
- Limitation of liability
- A clause that caps the amount of damages or excludes certain types of damages.
- Liquidated damages
- A pre-agreed amount payable on breach, enforceable if it is a reasonable estimate rather than a penalty.
How the law works
Interpreting the contract
Courts aim to give effect to the parties' intent as expressed in the written agreement, reading it as a whole and giving terms their ordinary meaning. Defined terms, the order-of-precedence clause, and any integration ("entire agreement") clause affect what counts as part of the contract. When language is ambiguous, courts may consider outside evidence, and some states construe ambiguities against the drafter.
Breach and materiality
Non-performance of a duty when it is due is a breach (Restatement (Second) of Contracts § 235). Whether a breach is material depends on factors including how much of the expected benefit the injured party loses, whether it can be adequately compensated, and whether the breaching party is likely to cure (§ 241). A material breach may excuse the other party's performance; a minor breach generally supports only a claim for damages.
Damages and their limits
The general measure of damages is the injured party's expectation interest (§ 347). Damages are limited to losses the breaching party had reason to foresee when the contract was made (§ 351, following Hadley v. Baxendale (1854)), to losses that could not have been avoided with reasonable effort (§ 350), and to amounts proved with reasonable certainty (§ 352). Attorney's fees are generally not recoverable unless a contract or statute provides for them (the "American rule").
Indemnification clauses
An indemnity clause specifies who indemnifies whom, for what losses (for example, third-party claims arising from a party's negligence or intellectual-property infringement), and how claims are handled (notice, control of the defense, cooperation, and settlement approval). Many states require clear and explicit language before a party can be indemnified for its own negligence, and many states limit indemnity in construction contracts by statute. The scope words matter: "arising out of" is generally read more broadly than "caused by."
Limitation-of-liability and exclusion clauses
These clauses commonly cap total liability (for example, at fees paid in the prior twelve months) and exclude consequential, incidental, or punitive damages. They are often generally enforceable between businesses, but frequently exclude certain obligations from the cap, such as indemnities, confidentiality breaches, and payment obligations. Many states will not enforce limitations for fraud, gross negligence, or willful misconduct. For sales of goods, UCC § 2-719 allows remedies to be limited but treats a limitation of consequential damages for personal injury from consumer goods as prima facie unconscionable.
Liquidated damages
A clause fixing damages in advance is enforceable if the amount is reasonable in light of the anticipated or actual loss and the difficulty of proving loss; an unreasonably large amount is an unenforceable penalty (Restatement (Second) of Contracts § 356; for goods, UCC § 2-718).
Examples
Hypothetical example
A late delivery and a capped contract
A software vendor's contract caps its liability at the fees paid in the previous twelve months and excludes lost profits. A customer whose launch is delayed by the vendor's outage would generally be limited to direct damages within the cap, unless an exception in the clause or the governing state's law applies.
Hypothetical example
An indemnity for third-party claims
A marketing agency agrees to indemnify its client against claims that the agency's content infringes a copyright. If a photographer sues the client over an image the agency supplied, the indemnity clause, including its notice and defense procedures, would govern whether the agency must defend and pay.
Common questions
Is every breach of contract grounds to terminate?
No. Generally only a material breach, or a breach that the contract itself makes a termination event, allows the other party to end the contract. Many contracts require written notice and an opportunity to cure first.
Are limitation-of-liability caps always enforceable?
Not always. Courts look at the clause's wording, the governing state's law, whether the parties were businesses or consumers, and whether the claim involves fraud, gross negligence, or intentional misconduct.
What is the difference between "indemnify" and "hold harmless"?
The phrases are often used together. Some courts treat them as meaning the same thing; others read "hold harmless" as also protecting against the indemnified party's own liability. The surrounding language usually controls.
Which state's law decides these questions?
Usually the state named in the contract's governing-law clause, if courts honor it. Without one, conflict-of-laws rules decide which state's law applies.
Important distinctions
Direct vs. consequential damages
Direct damages flow naturally from the breach (the cost of replacing the promised performance). Consequential damages depend on the injured party's circumstances (such as lost profits from a delayed project). Many contracts exclude consequential damages but not direct damages.
Indemnity vs. limitation of liability
An indemnity adds an obligation to cover certain losses; a limitation clause restricts how much one party can recover from the other. Contracts often carve indemnities out of the liability cap.
Primary sources
- CaseHadley v. Baxendale, (1854) 9 Exch. 341, 156 Eng. Rep. 145England (adopted throughout the U.S.)The foreseeability limit on damages.
- StatuteU.C.C. § 2-718Liquidated damages (sales of goods)United States (model code adopted by states)
- StatuteU.C.C. § 2-719Contractual modification or limitation of remedy (sales of goods)United States (model code adopted by states)
Secondary references
- Secondary sourceRestatement (Second) of Contracts §§ 235, 241, 347, 350–352, 356 (1981)United States (general)Widely cited statement of common-law contract rules on breach, materiality, and damages.
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- Last updated
- Oct 8, 2026
- Jurisdiction
- United States (general contract law; state law governs)
- Written by
- House Legal editorial (AI-assisted)