Why it is important to put a monetary limit on liability for direct damages in a contract?

Each party to a contract will be bound to observe the terms and conditions of the contract and will have to honor such party’s duties and obligations as stipulated in the contract.

Any negligence in honoring the duties and obligations by a party will amount to breach of the contract and will land such party in litigation dispute for contract breach. As a consequence breaching party may have to pay hefty penalties for damages incurred by the non-breaching party for contract breach.

The proposition of paying hefty penalties for direct damages by the breaching party can be eluded to a great extent by confining its liability to a specific amount for any kind of direct damage at the time of entering into the contract.

In general the non-breaching party will claim compensation in big numbers even for minimal damage incurred by such party due to contract breach by the breaching party.

If there is no provision in the contract to the effect limiting the liability of the breaching party to a specific amount for contract breach, then the court will determine the compensation in its discretion – In such case, the breaching party (having no other option) will have to pay the compensation as determined by the court.

The advantage of putting a monetary limit on the liability for direct damages is that the court will decide the compensation within such monetary limit depending upon the magnitude of the damage incurred by the non-breaching party.

Monetary cap on liability for direct damages will salvage the breaching party from the prospect of paying heavy penalties in cases where the magnitude of the damage can be ascertained by the court.

However, the prospect of monetary cap on liability for direct damages may not come in handy to salvage the breaching party in case the magnitude of damage is unascertainable and in case where the contract breach will expose the breaching party to unlimited liability.

Barring cases of unlimited liability, monetary cap on liability for direct damages will serve as a shield for the breaching party in contract breach cases where the loss can be clearly ascertainable.

Imposition of monetary cap on the liability for direct damages is a great way of risk mitigation associated with the breach of contracts.