Nearly every system in your automobile is controlled by onboard computers these days, especially your engine and transmission functions.

'Fail Code' conditions, or 'Limp Mode', happens when the vehicle computer recognizes a problem in it's logic. When an expected signal value from a sensor is sent to the computer and is not within the computer's programmed specifications, 'secondary' programs are activated by the computer to strive to protect the transmission from any damage the improper sensor signal might cause to occur, be signaling, or contribute to.

In other words, the computer is always expecting certain signal values from certain sensors i.e. the temperature sensor, the speed sensor, the throttle position sensor or MAP sensor, etc. As long as these signals are what it would normally expect for the current operating conditions and are normal based on all the other signals it is receiving from other sensors, it acts normally and accordingly.

If the computer, all of a sudden, receives some crazy signal from one of the sensors that is out of the normal range expected from this sensor, it is programmed to go into 'emergency' or 'secondary' measures.

These emergency measures vary depending on the severity of the defective signal. All of this is preprogrammed into the computer's logic by the manufacturer. The manufacturer has decided that as long as a certain parameter of a particular signal is sent from a sensor to the computer, all is well. The manufacturer decided that if this signal is higher than their highest parameter or lower than their lowest parameter, something is wrong with that sensor and the computer should make someone aware of the situation and take action to try to 'save' the vehicle systems or powertrain.

What type of action does the vehicle's computer take?

Well, perhaps the computer will simply cause the 'check engine' light to come on. The signal variation wasn't severe or critical enough to indicate any mechanical failures but the vehicle's operator is made aware that he or she should have the vehicle checked out electronically to see if a minor sensor has broken down or is starting to deteriorate and send the odd irratic signal. This type of condition is commonly referred to as a 'soft code'. Normal functions are not affected but if the repair is not made, performance or fuel efficiencies might suffer. Perhaps the sensor only malfunctioned one time and all other times was fine. This might be an early warning of a sensor that is beginning to fail or maybe it's a matter as simple as a loose connector or connection.

But sometimes, the signal needed to perform all operations normally is so far out of specification that the computer has no choice but to go into a more critical 'survival' mode. With vehicle transmissions, when the computer detects an obvious, dangerous signal value of this sort it will cause the internal tranny-fluid-line-pressure to default to 'high pressure' (in order to protect clutches and bands). The computer also turns off the transmission's electronic shift solenoids which in turn causes the unit to default to a single gear only (usually second or third). All normal signals to vary and control line pressure are overridden and everything defaults to 'full on' so a hazardous 'slipping' condition within the clutch pack cannot occur easily. This theoretically (and practically) is so that the vehicle's driver can get the damaged vehicle to the next town for repairs.
This condition is commonly called 'Limp Mode' for this reason --- rather than being stranded, you're able to limp to the next town in either second or third gear, with full tranny line pressure being applied, so that the clutch guts won't slip on your trip in and your vehicle will move along slowly but steadily to a service center... hopefully.

By the way, interestingly and just as a side note, if the cable harness going to your transmission was ever to become detached, severed or damaged, your transmission would also go into 'limp mode'. (A situation that occurred for a friend of mine while he was out bush trailing).

The vehicle's computer would immediately sense that it has lost contact with the transmission and would set the codes and send 'limp mode' signals to the tranny. But because the harness is severed between the computer and the transmission, no computer signals will reach the transmission. These sent signals, however, would have had the identical affect on the transmission as what taking away supplied power to the shift and line pressure solenoids has as in the case of a transmission harness being detached or cut. Due to the engineered voltage strategies of the solenoids, the transmission simply defaults to a single gear and line pressure defaults to high, all in order to 'limp' you home.

A Throttle Position Sensor (TPS) that improperly sends a reading that it is wide open when in fact it is physically closed would be detected by the computer as being illogical when it compared this reading with the vehicle speed sensor that perhaps is showing very slow vehicle speed, at the time. The signal in this case, by itself, can't be considered wrong but when put against all the other sensor signals of the system might not make sense and cause a computer concern. The computer, at this point, unable to 'trust' the collection of signals because together they are not making sense in it's logic, will simply go to limp mode in the transmission, as well, to protect it. It will make the operator aware that something is wrong with one of the sensors, through a dashboard indicator light of some sort ('checkengine' light perhaps) and a mechanic's attention is needed to correct the situation.

This Fail Code Condition will show up as a certain 'code' reading on a mechanic's computer scanning tool. This code will be cross referenced to a table from the manufacturer and represent a problem with a particular sensor or a group of sensors or system. It gives the mechanic a better idea of where the problem has showed up and which systems or sensors are involved in the malfunction. The table of codes and what each one means, is commonly programmed right into the scanner tool, for quick and easy reference.
i.e. the scanner tool might tell the mechanic that the computer has thrown a code "35" which is the "transmission fluid temperature sensor" and might give the mechanic the recommended values this sensor should provide and what it in fact provided...

In your electronic transmission, many important functions are controlled by the computer. Shift timing, sequence, feel, line pressure are controlled. The information from the vehicle speed sensor affects fuel injection, fuel mixture, ABS, transmission operation, etc. Load information of your engine is commonly taken primarily from the TPS (throttle position sensor) or the MAP sensor (manifold absolute pressure). This controls transmission shifting and downshifting when stepping on the gas or climbing hills.

A regular scanning of the computer for any set 'hard' or 'soft' codes is something routinely done by most good tuneup shops these days during scheduled service checkups.