I think we hit the 'gotta refund & make nice' button first and it works for the most part--I mean not too many circumstancs warrant more than that unless it's a health issue huh.
I think more than the fear of being sued, people refund to preserve their good name. So much of this business is word of mouth, it can be devestating to have dissatisfied customers out there telling everyone about their bad experience. I think most decorators know the difference between when they've done a less-than-great job (for whatever reason) and when someone's just a PITA, fishing for a discount. I do agree with you though, I think that there is a slim chance of actually being sued, barring a true catastrophe that any reasonable decorator would probably 'make right' before it got to the lawsuit stage. It would be very cost prohibitive to sue over the price of your typical cake.