The Case for Reasonable Liability Caps in Procurement

California has every reason to protect taxpayer dollars. When a state contract fails, the consequences can disrupt programs, delay services and impact the people who rely on government to work. That is why the state has long included strong indemnification and liability language in its contracts. It is a sensible precaution, in theory.

But there is a growing recognition that some of these protective measures may actually be hurting the state’s ability to deliver services effectively and affordably. In particular, the use of unlimited liability provisions in non-IT contracts creates a level of risk that deters qualified vendors from competing. That undermines the very goals we are trying to achieve: quality, fairness and value.

Let’s take a closer look. In California, non-IT contracts typically require vendors to indemnify, defend and hold harmless the state without any cap on liability. This means a contractor could be exposed to an undefined amount of financial risk, regardless of the size or scope of the project. Whether the contract is worth $50,000 or $5 million, the vendor is essentially asked to bet their business on the outcome.

It is difficult to understand why any vendor would agree to this. Many simply do not. For those who do, the assumption is often that the state will not actually pursue unlimited damages, even when a dispute arises. That may be true in practice, but in procurement, perception matters. And for many vendors, particularly small and midsized businesses, that level of uncertainty is enough to keep them on the sidelines.

Meanwhile, the firms that do accept these terms often adjust their pricing to account for the added risk. That risk premium drives up costs for the state, even if the liability provisions are never enforced. The result is fewer bids, higher prices and a shrinking pool of vendors.

What makes this more puzzling is the fact that IT contracts in California are subject to a different standard. Under Procurement Directive 401-IT, liability is capped at no more than the value of the contract, with exceptions for things like fraud or willful misconduct. These contracts, often more complex and higher risk than typical service agreements, have more predictable and balanced terms. Vendors understand what they are signing up for. They can get insurance. They can price their bids more competitively. And they are more likely to participate.

We must ask ourselves why a routine service contract should expose a vendor to more (proportionate) risk than a large-scale IT system overhaul.

Even more telling, the state rarely enforces unlimited liability clauses in non-IT disputes. In most cases, when a problem arises, the state terminates the contract, seeks reimbursement for work not performed or negotiates a resolution. Full-scale litigation seeking damages beyond the contract value is extremely rare. In practice, the clause is symbolic. But in pricing and participation, it has very real consequences.

So, what can be done? Fortunately, we hear that the Newsom administration already is taking measures to change the unlimited liability provisions. To this end, the state may want to consider the following options:

• Conform to state’s liability terms for IT contracts — California should consider applying the same liability framework used in IT contracts to non-IT agreements. Capping liability at the contract value, with standard exceptions for misconduct or gross negligence, would be a meaningful and achievable step.
• Adjust based on risk — The state should look at the risk level of each procurement and adjust terms accordingly. The state already has models for this in its security and project management standards. We can do the same with liability.
• Look to insurance — Where additional protection is needed, the state can look to insurance rather than blanket indemnity. Vendors can be required to carry higher levels of coverage for higher-risk work. That gives the state security while allowing vendors to manage their risk in a structured, predictable way.

To be clear, none of this means weakening oversight or accountability. The state has a duty to protect the public interest. But there is a difference between smart protection and excessive exposure. Unlimited liability is like buying an insurance policy you cannot afford and do not expect to use. It creates friction, not value.

By taking a more balanced approach, California can improve vendor participation, increase competition and ultimately drive better results. More bidders mean more ideas, more innovation and better pricing. It also sends a message to the market that the state wants to be a fair and reasonable partner.

This is a small change that can deliver big returns. We do not have to compromise accountability to create a more accessible, efficient and responsive procurement process. We just need to recognize that risk should be managed but not multiplied.

Let’s protect the state in a way that also strengthens our ability to serve it.