Limiting liabilityProhibition on exclusions and limitations
What liabilities cannot be excluded or limited by a supplier in a contract?
Limitations and exclusion of liability are often the most contentious and heavily negotiated clauses in a contract. Commercially there is an incentive on the supplier to seek to control its liability and conversely the buyer will want the supplier to have unlimited liability.
The Unfair Contract Terms Act 1977 (UCTA) confirms that, in a B2B context, a party can never exclude its liability for:
- death or personal injury caused by its negligence; and
- the implied term as to title and quiet possession in section 12 of the Sale of Goods Act 1979 or section 2 of the Supply of Goods and Services Act 1982.
For public policy reasons, a party can never exclude or limit its liability for losses arising as a result of fraud.
There are no rules on excluding liability for gross negligence or wilful default.
Direct and indirect loss
Suppliers nearly always seek to exclude liabilities that are deemed too remote. English law distinguishes between direct loss and indirect loss (often called consequential loss). Direct loss is loss that directly flows from the breach and arises as a natural result of the breach. Indirect or consequential loss is loss that is more remote but can be recovered if the loss was reasonably in the contemplation of the parties at the time they made the contract as the probable result of the breach.
Suppliers will as a rule always seek to exclude their liability for indirect loss.
Suppliers should be aware that, in many cases, common types of financial loss such as loss of profit can be either direct or indirect loss depending on the facts of a case. To exclude all loss-of-profit claims, an exclusion clause must clearly indicate that loss of profit is excluded whether arising directly or indirectly.
Any such financial loss exclusion or limitation will be subject to the reasonableness test in the UCTA if excluding or limiting liability for negligence, or liability for breach of implied conditions, or any exclusion of liability when contracting on standard terms.Financial caps
Are there any statutory controls on using financial caps to limit liability for breach of contract?
It is common for suppliers to place a financial cap on their liability. The Unfair Contract Terms Act 1977 (UCTA) confirms that the reasonableness test in UCTA will apply when assessing whether the financial cap is reasonable and therefore enforceable. Any such financial cap will be subject to the reasonableness test in the UCTA if the financial cap applies to liability for negligence, liability for breach of implied conditions or any limitation of liability when contracting on standard terms.
Section 11(4) of the UCTA specifically applies where a party is seeking to restrict its liability to a specified sum of money. When assessing if the financial limitation satisfies the requirement of reasonableness, reference must be made to the resources of the party seeking to limit liability and how far that party was able to cover itself by insurance.Indemnities
Are there any statutory controls on indemnities used to cover liability risks in contracts?
A true indemnity is classified as a debt claim because a party agrees to pay a sum of money when the specific loss occurs. A debt claim is different from a damages claim because the common law rules that apply to damages claims, such as the obligation on a party to mitigate its loss and the requirement that the loss is not too remote, do not apply to debt claims.
There are no statutory controls on indemnities. However, if the indemnity is drafted in such a way that it enables one party to avoid its liability in damages to the other party then it will be treated as an exclusion or limitation clause and the Unfair Contract Terms Act 1977 (UCTA) will apply.Liquidated damages
Are liquidated damages clauses enforceable and commonly used in your jurisdiction?
Liquidated damages clauses are commonly used in commercial contracts.
Care needs to be taken when drafting a liquidated damages provision to ensure it does not fall foul of the common law rule against penalties, because penalties are unenforceable. Under English law, damages are supposed to be compensatory and a clause that seeks to impose an excessive or unconscionable payment for breach of an obligation may be challenged as a penalty.
Some important issues are relevant when assessing penalties under English law:
- English courts allow a fairly generous margin when assessing if a clause could be a penalty and are very slow to strike out a clause in a negotiated commercial contract between parties of equal bargaining power.
- The trigger for the payment must be a breach. If the clause is drafted so as to avoid linking the payment to a breach, it cannot be challenged as a penalty. For example, a contract could be drafted so that if one party terminates before the expiry of a fixed term, this would be deemed to be a breach of contract and a fixed sum must be paid by the contract-breaker, linking the payment to a breach of the fixed-term commitment. Alternatively, the clause could be drafted so that one party has an option to terminate the contract, and if that party wishes to exercise that option, the contract-breaker will pay an exit fee. This type of option cannot be assessed as a penalty because the payment it is not linked to a breach, but merely linked to a contractual option to terminate early.
- The rule against penalties does not apply to primary obligations in a contract. A primary obligation is a term in the contract that must be observed for valid performance. A secondary obligation applies when a primary obligation has been breached, for example, the breach of a primary obligation to supply goods by a particular date triggers a secondary obligation to pay liquidated damages. In this scenario, the secondary obligation can be assessed to see if the amount of the liquidated damages is extravagant and unconscionable and therefore a penalty. In a recent UK case, the Supreme Court held that a payment clause was a primary obligation to pay a sum of money, and the ability of a party to withhold a sum of money if the other party breached the contract could not be challenged under the rule against penalties, because the withholding mechanism was merely an adjustment of the primary payment obligation.
Law stated dateCorrect on
Give the date on which the information above is accurate.
1 April 2020.