Contractual limits of liability are often seen as the saviour for businesses, giving them a guaranteed way to protect themselves against claims if and when something goes wrong. However, there are also pitfalls for the unwary that can leave a contracting party without the level of protection they expected when they entered into the contract – or without any protection at all. In this article, we consider two recent cases on limits of liability and provide some guidance on how to avoid these pitfalls.

Ensuring the terms are agreed

It is not unusual for parties to begin to perform their contractual duties before the contract has been fi nally agreed. Often, the main terms concerning price and scope of services have been agreed, and so the parties proceed, even though they have not signed a contract. The case of GHSP Inc v AB Electronic Ltd [2010] EWHC 1828 (Comm) gives a clear warning to any party wishing to limit its contractual liability about the dangers of proceeding in this way.

The facts of the case are as follows. The claimant, GHSP, designed and manufactured electro-mechanical control systems for motor vehicles. The defendant, AB Electronic, manufactured automotive sensors. In 2004, GHSP approached AB to supply certain components to be incorporated into their control systems, intended for sale to Ford. In September 2006, AB supplied a defective batch of sensors to GHSP, which led to the failure of the control systems GHSP then supplied to Ford. Ford made a substantial claim against GHSP, who sought to recover all of its losses from AB.

When GHSP and AB had fi rst started doing business, they had exchanged their standard contract documents, but had never agreed precisely which terms would govern their relationship. The fi rst point that had to be resolved in the action was therefore whether the contract between GHSP and AB incorporated GHSP’s standard terms (which provided that AB would have unlimited liability under the contract); or AB’s standard terms (which provided that AB would have no liability under the contract); or some other conditions.

The parties did agree that, if neither party’s standard terms applied, then there was clearly still a contract and that contract would be governed by the Sale of Goods Act 1979, so would therefore include an implied term that any goods supplied by AB to GHSP would be of satisfactory quality.

At the hearing, the judge found that AB was familiar with GHSP’s standard terms, because it had received a copy and because GHSP had referred to them on numerous occasions in the period during which AB had been supplying the sensors to GHSP. However, AB had never signed a contract incorporating those terms. The lack of AB’s signature on the document might not have mattered, had it not been for the fact that AB had also provided GHSP with a copy of its own standard terms and conditions, and had continually referred to those terms during the period of supply. It was therefore clear that, whilst AB had been aware of GHSP’s terms, it had not intended to contract on the basis proposed by GHSP. However, it was equally clear that GHSP had intended that its terms and conditions would apply to the contract and that it did not accept either AB’s standard terms of contract, or the limit of liability set out in those terms.

In the circumstances, the judge found that neither party’s standard terms applied to the contract, because it was clear from the facts of the case that neither party had ever intended to accept the other side’s conditions. As a result, if there had been some form of contract between the parties (which must have been the case, given that, for about two years, AB had been supplying, and GHSP had been accepting and paying for, the sensors), then it had been agreed on the basis of the Sale of Goods Act. The contract therefore included a term that the sensors would be of satisfactory quality and, if AB was in breach of this term, it would be liable to GHSP for all losses that fl owed from that breach, subject to the usual rule of whether those losses where foreseeable at the time the contract was made.

Some commentators suggest that this outcome is harsh on AB, because it was clear from the contractual dealings that AB had never intended to supply good to GHSP on terms other than its own standard terms, incorporating a limit of liability. It would seem strange if a supplier who invariably contracted on its own terms, and who would not have agreed a contract that did not include a limit of liability, should face unlimited liability because it started to supply the goods before the contract was fi nalised. However, it would be equally strange for a company like GHSP, which had clearly never had any intention of allowing its supplier to limit its liability, to be faced with such a limit as and when there was a problem with the good supplied. The decision clearly demonstrates the risk to suppliers of proceeding with a contract without fi rst agreeing its terms. Whilst there may be a clear difference of opinions between the two parties as to which terms and conditions should apply, simply ignoring the issue will not give the supplier the protection it wants. As the judge put it, “both sides buttoned their lips, or fastened their seatbelts, and hoped that there would never be a problem, or that, if a problem arose, it would be a small enough one that, with goodwill, it could be settled ‘on a case by case basis’”. As it turned out, when Ford made a claim for millions of pounds against GHSP, it was never going to possible to resolve its claim against AB on that basis. This case therefore provides a stark warning to anyone supplying goods of the importance of getting the terms agreed upfront, to prevent any arguments later about whether a contractual limit of liability can apply.

This warning applies just as much to businesses who are supplying services, such as facilities management, because section 13 of the Supply of Good and Services Act 1982 provides that any contract for the supply of services in the course of business will include an implied terms that the supplier will exercise reasonable care and skill when supplying those services. Whilst the Act does allow parties to agree express terms to exclude that implied term, or to limit its effect, if the contract is not agreed, then any such exclusion or limit will fall away and the service provider will be liable to the other party for any losses caused by a failure to meet that implied term.

Ensuring the limit covers interest

One of the benefi ts of a contractual limit of liability is that the party knows what the worst-case scenario will be if and when it faces a claim. However, as the case of Markerstudy Insurance Company Ltd & Others v Endsleigh Insurance Services Ltd [2010] EWHC 281 (Comm) demonstrates, it is vital to ensure that the clause properly covers all potential losses, including statutory interest, or that certainty may be lost.

This case concerned a contract between the claimants, a number of insurance companies, and Endsleigh, who had agreed to provide the claimants with certain administrative and claims handling services. The claimants brought an action against Endsleigh, claiming losses of about £14m for alleged breaches of contract. Endsleigh sought to rely on a term in the contract, limiting its liability to just under £3.9m. One of the issues between the parties was whether the contractual limit, which applied to Endsleigh’s “total liability in contract” included interest (the value of the claim for interest was signifi cant in itself, as the alleged losses had occurred over a period of about seven years). Endsleigh argued that the cap must include all losses, including interest, whilst the claimants argued that it did not.

In the judge’s view, whilst Endsleigh was right about any contractual interest, liability for which clearly arose out of the contract, the limit did not apply to statutory interest. Under section 35A of the Supreme Court Act, the court has an inherent jurisdiction to award interest on any debt or damages “at such rate as the court thinks fi t”, for the period between the date on which the contract was broken and the date of judgment or payment. As the judge put it: “Statutory interest is of a different character. It is not a ‘liability in contract’ but a discrete statutory liability arising from the exercise of the court’s discretion...Accordingly, in my judgment, it is excluded from the cap.” Endsleigh’s liability to the claimants could therefore exceed the agreed limit of £3.9m.

In this judgment, the judge noted the importance of drafting any exclusions so that they are totally clear. When deciding what a limit of liability clause does or does not cover, if the wording has any ambiguity, the court will always decide any issues on how the clause should be construed against the party seeking to rely on it (applying what is known as the ‘contra proferentum’ rule). Had the limit of liability specifi cally excluded liability for statutory as well as contractual interest, then this problem would not have arisen. However, because the clause referred only to liabilities in contract, Endsleigh found itself exposed to a claim that was far larger than it had ever envisaged.

Of course, there are many other pitfalls that can defeat the application of limit of liability clauses, not least the test of reasonableness set out in the Unfair Contract Terms Act 1977. However, these cases both demonstrate the risks that businesses may face even if the clause is fair and reasonable and therefore enforceable. The main lesson to be learnt is to ensure that the clause is properly agreed and that it covers all potential liabilities. Only then can you be sure that you have the cover you expect, to avoid any nasty surprises (and costly litigation) should a problem arise with the client.