Who Pays When Things Go Wrong (Four Contract Concepts Every Business Must Understand)

We have sat in hundreds of negotiation rooms across multiple jurisdiction. Every single time, the same fight happens. Not about price. Not about scope. The fight is always about one question:

“If something goes wrong, who pays and how much?”

That question breaks into four answers. Four concepts. Here is what each one means and where things go wrong.

Concept 1: Service Credits (A Small Discount for Small Failures)

You pay someone to run your computer systems. They promise 99% uptime. One month, the system is down more than it should be.

You get a small discount on next month's bill. That is a service credit.

It is not compensation for your losses. It is just the provider saying: “We did not deliver what we promised, so we will charge you less”. Service credits handle everyday problems. They keep the relationship going without dragging lawyers into the room.

Concept 2: Liquidated Damages (A Pre-Fixed Amount for Serious Failures)

The provider promised to deliver a new system by 1st March. They are two months late. You lost money because of the delay.

But how much did you lose? That is hard to prove. It takes months in court.

So instead, both parties agree at the start: “If delivery is late, the provider pays ₹1 lakh per week of delay”. No arguments later. The number is already fixed. That fixed number is called liquidated damages.

One important point: the amount must be reasonable. If a court finds it is a punishment rather than a genuine estimate of loss it can reduce it.

Concept 3: Limitation of Liability (Maximum Anyone Will Ever Pay)

Sometimes big mistakes happen. A data leak. A system crash lasting days. Losses running into crores.

But if a small company can lose everything because of one mistake on a ₹5 lakh contract, no small company would ever take on work.

So contracts include a ceiling that the most either party will ever pay. That ceiling is called limitation of liability. Usually it is linked to the contract value, for example 12 months of fees. Some things sit outside the cap, like fraud or physical injury or IP Infringement or confidentiality breach, etc.. But for normal commercial claims, the cap is the boundary.

Concept 4: Insurance (Someone Else's Money)

The provider buys an insurance policy. If the provider makes a mistake, the insurance company may cover the cost.

But insurance does not always pay. The policy has exclusions, conditions and limits. Insurance is a safety net, but it has holes.

The Trap: Keeping the Door Open for More

Here is what we have seen in almost every contract from large customers. The customer adds this language: “Service credits and liquidated damages are without prejudice to any other rights or remedies available to the Customer”.

In simple words: “I will take the credits. I will take the LDs. AND I can still claim more damages on top”.

This is dangerous for providers. The provider thought they were fixing the cost of failure. But the customer has kept the door open to claim more, sometimes for the same failure.

Three Safeguards Every Provider Must Insist On

1. Sole and exclusive remedy. The contract must say that service credits are the only remedy for SLA failures and LDs are the only remedy for the specific breach they cover. This closes the door to additional claims for the same event.

2. No double-dipping. State clearly: the customer cannot claim service credits, liquidated damages and general damages for the same failure. One remedy per failure and not three stacked on top of each other.

3. Cap on credits and LDs. Put a monthly ceiling on service credits (for example 15% of monthly fees) and a separate cap on LDs (for example 10% of total contract value). Without these caps, a bad month can wipe out the provider's entire revenue from the contract.

Why Insurance and Limitation of Liability Must Stay Separate

We have seen customers say: “Your insurance covers ₹5 Crore. So let the liability cap also be ₹5 Crore”.

It sounds logical. But it is wrong. Here is why the market keeps them separate:

Insurance is not guaranteed money. The insurer can refuse the claim. Many things can go wrong: Exclusions, late notification, policy conditions. Policies also change every year. If the liability cap is tied to insurance, the provider's legal exposure shifts every time the insurer changes terms.

Insurance is shared across all clients. That ₹5 Crore is not reserved for one customer. It covers all clients, all claims, all year. One large claim and there is nothing left for others.

The correct approach: Keep the liability cap based on what makes commercial sense usually a multiple of fees. Keep insurance as a separate obligation. Do not link one to the other. The cap is the contractual boundary. Insurance is how the provider funds its risk. They serve different purposes.

The One Thing to Remember

Service credits handle small problems. Liquidated damages handle serious ones. Limitation of liability is the final ceiling. Insurance is the backup fund. Together, they answer: "Who pays, how much, and from where?"

Treat them as one system. Not four separate paragraphs drafted by four different people. That is where contracts break.

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The writer is a senior legal counsel with experience advising businesses across multiple jurisdiction on commercial contracts and risk allocation.