No party really wants to subject itself to unknown liability. Contracts are intended to reflect appropriate risk allocation between the parties and to clearly delineate potential liability in the various scenarios that can arise. Often, contracts do not do this adequately and the courts are full of cases dealing with situations that were either not envisaged or where the parties disagreed on the meaning of clauses (or the commercial impact of clauses) which they have agreed.
Parties seeking to define the limits of their liability at the outset need to be aware of the fluctuating common law (including interpretation rules, implied terms and the like) and the risk of statutory intervention. Often, it is not simply what the contract sets out in writing, but what it does not say that can cause issues in practice.
This note considers risk allocation clauses in the context of business-to-business contracts within England and Wales. Consumer contracts and international contracts are outside the scope of this note. This is a wide topic, so the points considered in this note are of general application and we cover the following risk allocation methods in outline only:
a.Some general observations
b.Liabilities that cannot be excluded of limited
c.Caps on/limitations of liability
d.Exclusions of liability
e.Use of indemnities
f. Use of time bar provisions / conditions precedent
g.Statutory restrictions
a.Some general observations
Some general principles to be aware of:
Clauses in contracts dealing with risk allocation should be expressed clearly and without ambiguity in order to be effective. In 2015, Lord Neuberger, now the president of the Supreme Court, considered the court's approach to contractual interpretation in the case of Arnold v Britton when considering purportedly ambiguous drafting. He identified seven factors that a court will have regard to:
- The reliance placed on commercial common sense and surrounding circumstances should not be invoked to undervalue the importance of the language of the provision which is to be construed
- The less clear the relevant words are, or the worse their drafting, the more ready the court can properly be to depart from their natural meaning
- Commercial common sense is not to be invoked retrospectively
- A court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight
- When interpreting a contractual provision, one can only take into account facts or circumstances which existed at the time that the contract was made, and which were known or reasonably available to both parties
- In some cases, an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract; in such a case, if it is clear what the parties would have intended, the court will give effect to that intention
- Service charge clauses are not to be subject to any special rule of interpretation (this point was specific to the case at issue)
Other principles which can be gleaned from case law in relation to exclusion or caps/limitation clauses include that:
- Any doubt or ambiguity arising when an exclusion or cap/ limitation clause is invoked may well be resolved against the party seeking to rely on that clause
- Whilst it may seem an obvious point, it is for the party seeking to rely on the exclusion or cap/limitation clause to show that the clause is capable of covering the liability that he or she believes it excludes.
b.Liabilities that cannot be excluded or limited
Legislation and case law have held that certain liabilities arising as a result of the following cannot be excluded or limited:
- Fraud
- Death or injury caused by negligence
- Supplying goods without the right to do so
A party seeking to limit liability for its own fraud will be unable to do so on public policy grounds. Fraud in this context will involve an element of dishonesty, as liability for a careless act is capable (with appropriate drafting) of being limited and, therefore, does not fall within the definition of fraud. You should note that limiting liability here is by reference to a party's own personal fraud. Provided the wording is specific enough, a party may limit liability for the dishonesty of its employees, agents or sub-contractors.
Liability for injury or death resulting from negligence cannot be avoided (s.2 of the Unfair Contract Terms Act 1977 [UCTA]). Only the victim of the negligence is protected (or, in the case of their death, those claiming on the deceased's behalf). Financial claims in respect of negligent conduct, where neither party is themselves the victim, may successfully be excluded.
Under s.6 of UCTA, statutory implied terms imposed by the Sale of Goods Act 1979, relating to the buyer's right to receive goods free from encumbrances and to keep the goods after transfer may not be excluded or restricted. Liabilities for breach in respect of goods not conforming with their description may only be restricted or excluded to the extent that such an exclusion or restriction is reasonable.
Similar restrictions are implied in respect of hire purchase contracts under the Supply of Goods (Implied Terms) Act 1973.
Although rare to see in practice, it is also not possible to exclude or restrict liability for illegality. If a contract has been tainted by illegality, the contract is void.
c.Caps on/limitation of liability
Obviously, there are rules applicable to types of loss and/or damage that are recoverable under or in connection with a contract (e.g. in the law of tort), including consideration of issues such as remoteness, causation and foreseeability. All that is outside the scope of this note, but assuming there is a liability, the use of clauses which attempt to cap/limit liability are fairly common in England and Wales and are, generally speaking, enforceable.
Indeed, many of the standard forms of contract include caps on liability for contractors/professionals. Depending on the nature of the construction or engineering project, they may, for example, relate to:
- Caps on liquidated damages for delay whether per section or for the whole of the works which may be linked to termination rights
- Caps on liquidated damage for failure to achieve certain KPI's or deliverables which may be linked to termination rights
- Overall caps on general damages
- Caps arising on a termination scenario
It is less common to see caps in favour of the Employer on the basis that there is typically a Contract Sum and more limited grounds for loss and expense/compensation event type claims. That said, it is not uncommon in more sophisticated contracts to cap the Employer's liability in relation to termination for convenience or Employer default scenarios, particularly where there is a funding element to the overall transaction.
Likewise, it is not uncommon for certain liabilities to be excluded from any cap for example, intellectual property infringements or liabilities for which insurance cover should be in place by the relevant insuring party. Each contract would need to be considered in its own right.
Aside from the limits referred to in section (b) above, parties may limit their liability arising as a result of negligence so far as such a limit is reasonable.
Whilst the courts continue to seek to ascertain what the parties have decided between themselves, as set out below, the test as to for whether liability for negligence has been successfully excluded has been laid out in case law.
d.Exclusions of liability
An exclusion clause, separate from a limitation clause, is a clause which seeks to totally exclude liability in respect of a form of loss, rather than cap liability at a set amount.
Broadly speaking, an exclusion clause generally seeks to exclude one or both of the two types of losses which arise from a breach of contract: direct losses and indirect losses.
Direct losses have been described as those arising naturally or in ordinary circumstances from the breach. Indirect losses or losses, which are sometimes referred to as "consequential losses", are generally understood to mean losses that would have been contemplated by someone with knowledge of special circumstances.
A commonly held misconception is that loss of profit will always be an indirect or consequential loss. On the contrary, English courts can and have held that loss of profits can be a direct loss. Limiting liability by reference to indirect or consequential loss alone is, therefore, risky (at best) and it is recommended that when seeking to limit liability for any type of financial loss, that these are specifically considered and excluded rather than by using generic terms.
Successfully excluding indirect and consequential loss, whilst not uncommon in process and engineering contracts, is a task that requires special thought and consideration before putting words down on paper.
Negligence
When considering clauses purporting to exclude or limit liability for negligence, the court's general starting position is that as it is "inherently improbable" that one party would want to allow the other party to exclude his liability for negligence.
However, even if wording specifically pertaining to negligence is not included in the contract, the courts have still held that some phrases may be interpreted widely enough so as to allow liability for negligence to be excluded. The cases turn on the wording on the relevant contracts. If it is the intention of the parties to exclude liability for negligence, it is advised to expressly do so. Uncertainty is not a desirable state of affairs for negotiating parties particularly given the importance of the issue.
A note for those reading from other jurisdictions, unlike numerous civil law jurisdictions, gross negligence is not generally recognised as a separate legal concept from "ordinary" negligence in English law.
e.Use of indemnities
Indemnity provisions are fairly common in construction and engineering contracts and typical examples relate to damage to property or intellectual property infringement but may also cover interference with other party rights.
Readers should note that the use of the term "indemnity" or "indemnify" can give rise to different limitation periods and despite what may be perceived to be a common understanding, may not actually result in all losses (however remote) being recoverable on a "pound for pound" basis and may also not avoid the so called "duty to mitigate" losses. As with all things, precision of drafting is crucial.
As well as indemnifying for breach, an indemnity clause may constitute a promise by one party to bear the financial risk or pay an amount to the other in respect of an event occurring. In such circumstances, no breach of contract is required.
Indemnities can also be capped (or carved out of caps), so it is recommended that this is considered on a contract-by-contract basis, alongside the extent of any insurance coverage and who should bear, for example, responsibility for any shortfall or underinsurance or failure to notify claims.
f.Use of time bar provisions/conditions precedent
Notice provisions as a condition precedent to successful claims are fairly common in construction and engineering contracts in the UK or applying English law. For example, the FIDIC imposes an obligation on a contractor to submit a notice within 28 days and the NEC requirement is for a compensation event to be notified within eight weeks. Many standard form contracts expressly state what the consequences will be for failure to notify within the stipulated time, e.g. that the contractor will not be entitled to an extension of time or loss and expense or cost. Some standard forms are not quite so well defined. In the UK, clearly drafted time-bar provisions are generally enforced.
That said, there are, however, tales of caution with standard forms and bespoke clauses alike since the triggers for commencement of the relevant timescale are often not always clear. They may link to subjective knowledge of the contractor (which may be difficult to prove), they may be linked to what a reasonable contractor should have been aware of at the time (again difficult to prove) and they may allow more than "one bite of the cherry" since an event may not actually cause delay or disruption until a later date, particularly if there are mitigation steps or other events or circumstances occurring at the same time or if the event is continuing. A clause may not, therefore, have the effect intended. Some contracts also include "look-ahead" provisions with the use of warning notices and risk registers and reflect entitlement based on when a notice should have been given. As with all contracts, precision is required.
g.Statutory restrictions UCTA
Exclusion or limitation of liability clauses, which can take on various forms, have been the subject of various legislative interventions. UCTA regulates the extent to which business-to-business contracts can exempt liability where one party has contracted on the other's standard terms of business. In such a situation, an exclusion or limitation clause will only apply to the extent that such a clause is reasonable.
The reasonableness test is set out at s.11(1) of UCTA:
"In relation to a contract term, the requirement of reasonableness for the purposes of this Part of this Act, is that the term shall have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made."
Further guidance in respect of reasonableness is provided for by five guidelines laid down in UCTA:
a.The strength of the bargaining positions of the parties relative to each other, taking account (among other things) alternative means by which the customer's requirements could have been met supplemented material
b.Whether the customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons, but without having to accept a similar term
c.Whether the customer knew or ought reasonably to have known of the existence and extent of the term (having regard, among other things, to any custom of the trade and any course of dealing between the parties)
d.Where the term excludes or restricts any relevant liability if some condition is not complied with, whether it was reasonable at the time of the contract to expect that compliance with that condition would be practicable supplemented material
e.Whether the goods were manufactured, processed or adapted to the special order of the customer
The time for determining the reasonableness of the term is the time at which the agreement was made. This is to ensure that the reasonableness of a clause is not decided by virtue of the damage caused.
There is a wealth of case law providing illustration of the above principles but these are based on the specific circumstances and the particular contract in question.
For those serving notices, they should check the notice provisions in the contract carefully including the method of service and date of deemed delivery as these are often overlooked in practice and may create a barrier to recovery.
Take away points
Managing potential liabilities should be a key consideration for all businesses and should be considered as part of the risk profile when considered contracts.
- There are a number of possible ways to manage and control risk in a contract governed by English law.
- Contracts need to be precise in order to manage and control such risks.
- Using shorthand terms such as "consequential loss" to seek to avoid or exclude liability for loss of profit, revenue and the like should be avoided.
- Contracts in the UK depend not just on what is written in the contract, but also on an understanding of rules of interpretation, the relevant case law and understanding of statutory implied terms. These are all fluctuating.
- As always, parties should take particular care to ensure they understand the impact of having contracts which involve parties from different jurisdictions or where the location of the project or services/works performed are in a different country as this may have a significant impact on the contract/risks regardless of the choice of governing law.
For further information on this topic please contact Ray O'Connor at Squire Patton Boggs by telephone (+44 121 222 3000) or email ([email protected]). The Squire Patton Boggs website can be accessed at www.squirepattonboggs.com.
This update has been reproduced in its original format from Lexology – www.Lexology.com.