Allocating Risk in Contracts – Who Carries the Risk When Things Go Wrong?

Commercial contracts are not just about setting out services, pricing or delivery obligations. One of their most important functions is allocating financial risk when things do not go to plan. If that risk is not clearly understood or properly managed, businesses can find themselves exposed to significant and unexpected costs.

Risk can arise in different ways. Some risks are deliberately allocated through indemnities and limitation of liability clauses. Others arise because the law steps in where contracts are unclear or silent. For businesses that work with commercial agents, this can be particularly costly on termination.

Understanding how these risks operate, and how they interact, is essential for protecting your business.

When contracts fail to address risk allocation properly, the consequences can extend well beyond the value of the contract itself. Businesses may face claims that substantially exceed anticipated costs, or find themselves unable to enforce protections they believed were in place.

Getting risk allocation right at the outset provides clarity, supports accurate pricing and reduces the likelihood of costly disputes. It also ensures both parties understand their respective exposures before committing to an agreement.

An indemnity is a contractual promise by one party to compensate the other for specified losses. Indemnities are commonly used in commercial contracts to cover areas such as third-party claims, regulatory breaches or intellectual property infringement.

Indemnities differ from standard damages claims in several important ways:

From a commercial perspective, the biggest issue is that indemnities are frequently uncapped, meaning potential liability can be far greater than the contract value.

Before agreeing to an indemnity, businesses should carefully consider:

Poorly drafted indemnities are a common source of disputes and can significantly undermine the protection a business expects to have elsewhere in the contract.

Limitation of liability clauses are designed to place sensible boundaries around risk. They may cap overall liability, exclude certain types of loss (such as indirect or consequential loss), or allocate responsibility for specific risks.

However, these clauses do not operate in isolation. In many contracts, indemnities are carved out of liability caps entirely. This can leave businesses exposed to open-ended claims despite believing they have negotiated robust protections.

A well-drafted commercial contract should ensure that indemnities and liability limitations work together coherently, reflecting the commercial reality of the deal rather than contradicting each other.

The relationship between indemnities and liability caps requires careful attention. Where a contract includes both, businesses must understand which provisions take precedence in different circumstances.

For example, a contract might cap general liability at £500,000 but include an uncapped indemnity for intellectual property infringement. In such cases, a claim based on IP infringement could bypass the cap entirely, leaving the indemnifying party with exposure far exceeding the anticipated limit.

Businesses should review their contracts to ensure these provisions align with their risk appetite and commercial objectives.

For businesses that appoint commercial agents, termination can represent one of the highest-risk points in the relationship.

Under the Commercial Agents (Council Directive) Regulations 1993, agents are entitled to a payment when their agency comes to an end. This payment takes one of two forms:

Crucially, if the agency agreement does not clearly specify which option applies, the courts will default to compensation. This can result in substantial and unexpected financial exposure for principals who assumed termination costs would be limited.

This is a clear example of risk being allocated by law where contracts fail to address the issue properly, underlining the importance of careful drafting from the outset.

Allocating risk fairly and transparently is a fundamental part of any commercial contract. Whether through indemnities, liability caps or termination provisions, clarity at the drafting stage can prevent costly disputes and protect long-term commercial relationships.

Our Corporate and Commercial team regularly advises businesses on drafting, reviewing and negotiating contracts to ensure risks are proportionate, commercially appropriate and clearly understood. We can provide support with commercial agency agreements, terms and conditions, and protecting your position if disputes arise.

If you would like support reviewing your existing contracts or putting new agreements in place, we are here to help.

Please get in touch with our corporate and commercial team  team on 01604 344562 (Northampton) or 01908 916096 (Milton Keynes), or email info@franklins-sols.co.uk.