What is meant by "limitation of liability" in contracts?

"Limitation of liability" refers to a clause within a contract that restricts the types of damages that a party can claim if the contract is breached. This means that if one party fails to fulfill their contractual obligations, the other party's ability to seek compensation is limited only to certain predefined damages, rather than allowing for unlimited recovery for any losses incurred. Such clauses are designed to manage risk and provide clarity to both parties about their potential financial exposure, defining the extent of liability in a contractual relationship.

This concept is particularly important in commercial contracts where businesses seek to mitigate the risks associated with unforeseen events or failures. By agreeing to a limitation of liability, the parties can avoid extensive litigation costs and ensure that compensation is aligned with the expectations established in the agreement.

The other options do not accurately represent the concept of limitation of liability. For example, a clause that requires court approval does not inherently relate to how liabilities are determined or restricted. Similarly, guidelines for performance expectations and standards for defining contract terms focus on different aspects of contract law and do not pertain to the limitation of potential damages in the event of a breach.