Limiting your contractual liability enables you to manage risk, keep prices competitive, and limit financial exposure in the event of a claim. It also means adequate insurance or other security is in place if things go wrong.
This article covers ways in which contracting parties can limit exposure, as well as some common pitfalls, which mean that certain liability caps might not be worth the paper they are written on. I have used the NEC4 ECC, FIDIC White Book and IChemE Silver Book, all published in 2017, to illustrate where the market is today1 .
The most obvious way to limit financial liability is to include an express liability cap in your contract. Liability may be capped at a specified figure, as a percentage or multiple percentages of the contract price. See, for example, the FIDIC White Book:
“The maximum amount of damages payable by either Party to the other in respect of any and all liability, including liability arising from negligence, under or in connection with the Agreement shall not exceed the amount stated in the Particular Conditions.”2
The NEC4 ECC adopts a similar approach at Option X18.5, limiting liability to an amount specified in the Contract Data. Another approach is to cap liability at the level of PI cover, as with the RIBA Standard Form of Appointment used for Architects in the UK.
When negotiating liability caps there are various factors to consider. Firstly, is it a ‘per claim’ cap, or aggregate? To ensure certainty, this needs to be expressly set out. For example “The total aggregate liability of the Consultant to the Purchaser... shall not exceed [£££]”3
Secondly, are there separate caps for different types of losses? And are these included in the general cap or not? NEC4 ECC for example separately caps consequential loss, damage to property and latent defects.
Does the cap apply only to loss or damage under or in connection with the contract? Or, as with NEC4, does it apply to all loss or damage “whether in contract, tort or delict and otherwise”?
In the UK, you cannot exclude or restrict liability for death or personal injury resulting from negligence.4 Other liabilities resulting from negligence can only be capped or excluded if the contractual clause passes the ‘reasonableness test’.5 If you are dealing on standard terms of business (which may, in certain circumstances, include standard form contracts6) liability for breach cannot be excluded unless it is reasonable to do so. What is reasonable will depend on the facts. Factors may include bargaining positions of the parties, alternative options available, and whether an inducement was given to agree to a particular term.7 Also in the UK, liability for fraud cannot be limited.8
Middle Eastern Civil Codes allow contracting parties to fix or limit compensation for breach. However, the courts retain a supervisory power. In the UAE, courts can ‘vary’ contracts to the effect that compensation payable mirrors the loss which was actually suffered. In theory, this would enable courts to set aside liability caps if a much greater loss was actually suffered.9
Carve Outs: Traps for the Unwary
When fixing the level of a liability cap, you must carefully consider anything which is excluded from that cap. For example, the FIDIC White Book carves out financing charges, and says that “manifest and reckless default, fraud, fraudulent misrepresentation or reckless misconduct by the defaulting Party” will not be included in the cap.
Costs and losses flowing from breach of anti-bribery or corruption provisions might be excluded from a cap, including sums payable on termination (possibly including the costs to complete the works).
Another example is indemnities, which are often carved out from limits of liability and can be a trap for the unwary. The IChemE Silver Book, for example, excludes indemnities against third party claims for infringement of IP rights, death, personal injury or property damage10. The 2nd edition of the FIDIC Yellow Book, currently in pre-release version, carves out an indemnity from the contractor in relation to “any errors in the design of the works and other professional services which results in the works not being fit for purpose”11, meaning contractors could have unlimited liability for fitness for purpose.
In EPC Contracts, employers often seek to exclude insured losses from liability caps. This means money paid out by Project or CAR insurance will not count towards the liability cap. The rationale is that if the employer pays for the CAR policy, they still want the full benefit of the liability cap. If that is to be the case, it must be reflected in the level of the cap, otherwise contractors might find themselves facing uninsured losses of 100% (or more) of the contract price.
Employers might think this is a bonus – the higher the liability cap, the more they can hope to recover. But if a contractor cannot afford to bear that level of uninsured loss, thereby leading to insolvency, the employer’s recovery will be limited anyway, as a matter of fact, and the project will be riskier for everyone.
In addition to capping liability, you can choose to exclude certain categories of liability altogether. The most common example is consequential losses, such as loss of profit, revenue, business, which are capped in NEC4 ECC, and excluded altogether in the FIDIC White Book and IChemE Silver Book. Particular care is however needed in the drafting of these provisions, especially in light of a recent shift in the judicial interpretation of the term ‘consequential losses’ in contracts to give it the more natural meaning, as opposed to a restrictive, specific legal meaning which had been the traditional view for many years.12
You may wish to exclude categories of loss or damage which are remote, or where the extent of the potential loss or damage is too nebulous to price. Commonly, loss or damage not covered by PI Insurance will also be excluded: asbestos, pollution, contamination and terrorism.
More generally, an exclusive remedies clause in a contract will exclude parties’ rights to common law damages, meaning exposure is limited to compensation payable under the terms of the contract.13
Other Ways To Limit Liability
While liability caps and exclusion clauses will provide maximum certainty, there are other steps you can take to limit your exposure.
Liquidated damages pre-determine the compensation payable in the event of certain breaches of contract – usually failure to complete on time, or failure to achieve performance or output criteria. Of course, while LDs effectively cap liability, the flip side is that they are payable even if the actual loss suffered is less than the agreed rate – even if the loss is zero.
Where additional costs are claimed under a construction contract, pre-agreeing to fixed rates in BOQs will provide some degree of certainty. Conversely, requiring a claimant to prove the actual cost it has incurred will place a brake on potential exposure. More so if a party is only entitled to recover costs which are “reasonably incurred and properly vouched”. Such wording would mean that the party would not only have to prove that the costs were actually incurred, but also that it was reasonable to do so. The FIDIC Red Book achieves this by defining the “Costs” which a contractor can claim as: “all expenditure reasonably incurred (or to be incurred by the Contractor), whether on or off the Site, including overhead and similar charges, but does not include profit.”
Liability can also be limited by restricting the obligations you undertake to deliver. For example, an obligation to use “reasonable skill and care” will usually be less onerous than guaranteeing “fitness for purpose” or output or performance criteria. Likewise, an obligation to use “reasonable endeavours” in order to achieve something is more limited than undertaking to use “best endeavours”. Best endeavours require you to incur cost or act in a way which might be contrary to your commercial interests. Reasonable endeavours are more limited, allowing you to balance your contractual obligations against other commercial considerations.
Limits on liability are commonplace in international contracting. However, in the 10 years since the global financial crash, the levels at which these limits are pegged have gradually increased. While employers might be tempted to push for higher caps, this might be false economy if the contractor can’t absorb that risk. Similarly, contractors might agree to a high financial cap, only to aggressively restrict their obligations elsewhere in the contract, such that there is little prospect of the cap ever being reached.
When you are negotiating limits on liability, you should consider the value of the contract, your role in the project, and the potential risk if things go awry. Caps fixed at a specific figure will provide greater certainty, but might not be appropriate if a contract will run for a prolonged period, or if the scope of work is likely to change significantly.
You should always take legal advice to ensure limits on liability are properly drafted and enforceable under the law of the contract. It is important to understand the extent of your exposure, and how any limits will interplay with other provisions in the contract.