Excluding and limiting liability is a vital part of any commercial contract.
The irony, though, is that despite its importance, almost any exclusion or limitation of liability — if pored over to the nth degree — will have some ambiguity in the face of complex and often unforeseen consequences of breach.
Furthermore, judges have historically been inconsistent in their interpretation of these clauses, often straining the language beyond its literal meaning in order to allow an otherwise meritorious claim.
However, the two recent technology cases Drax Energy Solutions Ltd. v. Wipro Ltd. and EE Ltd. v. Virgin Mobile Telecoms Ltd., issued by the High Court of Justice of England and Wales on June 9 and July 31 respectively, indicate that the courts may now be taking a more literal approach to construing limitations of liability, even where this significantly limits a claimant's recoverable damages.
Only if an exclusion of liability would result in no effective recourse against the counterparty would the courts adopt a more strained interpretation.
This article examines the recent approach of the courts in more
detail, and subsequently sets out useful tips for drafting exclusion clauses to avoid the specific pitfalls identified in the case law and generally protect a contracting party's position in a dispute.
Examining the Courts' Approach to Liability Limitations
Interpreting the Limitation of Liability Clauses
The general principles applicable to interpretation of contracts under English law are well known.
The starting point, as acknowledged by the Court of Appeal of England and Wales in Federal Republic of Nigeria v. JPMorgan Chase Bank NA on Oct. 8, 2019, is as follows:
The modern approach is to ascertain the meaning of the words used by applying an objective and contextual approach ... Business common sense and the purpose of the term (which appear to be very similar ideas) may also be relevant. But the words used by the parties are of primary importance so that one must be careful to avoid placing too much weight on business common sense or purpose at the expense of the words used.
The U.K. Supreme Court confirmed in Triple Point Technology v. PTT on July 16, 2021, that part of the context to be considered when interpreting limitation clauses is that "in the absence of clear words the parties did not intend the contract to derogate from [their] normal rights and obligations."
Accordingly, ambiguity in an exclusion clause may be resolved narrowly because the exclusion clause cuts down the ambit of important obligations in a contract.
As a litigator, an exclusion or limitation clause is therefore rarely seen as a complete barrier to a meritorious claim.
It is, of course, human instinct that judges will want to try and hold contract breachers to account if possible.
There must, however, reach a point where the language is so clear that the court must accept the apportionment of risk agreed between the parties and the following judgments illustrate this point.
Drax v. Wipro: The Difference Between A Single Cap and Multiple Caps
In Drax v. Wipro, the Technology and Construction Court, King's Bench Division, or TCC, examined a limitation of liability clause contained in a master services agreement, or MSA, governing the design and implementation of a new IT system by Drax.
The project ended in failure and claims were brought by both parties against each other.
Ahead of the main trial, the court examined the impact of the following exclusion clause contained in the MSA:
The Supplier's total liability to the Customer, whether in contract, tort (including negligence), for breach of statutory duty or otherwise, arising out of or in connection with this Agreement (including all Statements of Work) shall be limited to an amount equivalent to 150% of the Charges paid or payable in the preceding twelve months from the date the claim first arose.
Notably, Drax claimed circa £31 million ($38.4 million) in damages, while Wipro counterclaimed for around £10 million.
It was, however, agreed that 150% of the charges paid came to approximately £11.5 million.
The court was therefore asked to determine if the clause provided for multiple liability caps, such that each claim brought by Drax would have its own cap or one single aggregate cap that applied to any and all claims Drax might bring, at any time, under the MSA and the various statements of work.
Perhaps unsurprisingly, noting the use of phrases such as "total liability" and "the claim," rather than "a claim" or "for each claim," the court held that the language of the clause and related provisions were a clear indicator that the clause imposed a single aggregate cap, not multiple caps.
As to business common sense and contextual considerations, Drax argued that there were multiple statements of work under the MSA, with the potential for more in the future, so a single aggregate cap didn't make business sense.
The court dismissed that argument as unrealistic. Drax had termination rights it could utilize under the MSA if the project was threatening to be a disaster.
Drax also argued that a single aggregate cap resulted in its claims being limited to one-third of their potential £31 million value didn't make business sense.
Again, the court disagreed. Although it would significantly limit Drax's claims, the clause still left Drax with not insignificant damages, while also operating as an effective limit on Wipro's liability.
Ultimately, the court recognized that by entering into the clause, Drax may not have protected itself as it could or should have done, but that was "quite different from saying that the Clause makes no commercial sense."
Accordingly, the court found that Drax's total claim was effectively limited to £11.5 million.
EE v. Virgin Mobile: The Implications of Excluding Anticipated Profits
In EE v. Virgin Mobile, the TCC examined the following exclusion of liability clause contained in a telecommunications supply contract between Virgin and EE:
Except for any damages claims by [Virgin for damage or loss arising from reckless or wilful misconduct or gross negligence] (which EE acknowledges may include claims of damages for loss of profits), and for no other damage claims whatsoever, neither Party shall have liability to the other in respect of: (a) anticipated profits; or (b) anticipated savings.
EE alleged that Virgin Media had breached an exclusivity clause in the contract, claiming damages of around £25 million in revenue that it would otherwise have earned in respect of liability for additional charges payable by Virgin Media to EE under the contract.
Virgin Media applied for a strike out or reverse summary judgment on the basis that, regardless of liability, which was denied, such losses amounted to a loss of profit, which was excluded due to the inclusion of the term "anticipated profits" in the above limitation of liability clause.
Given the clear and unambiguous language of the exclusion clause, the court found that EE's damages claim fell within the natural meaning of "anticipated profits" and was therefore excluded.
It did not matter that the parties may have intended to refer to profits arising out of contracts with third parties — commonly excluded as being indirect losses — rather than profits arising out of this agreement.
The agreement was a bespoke, lengthy and detailed contract negotiated by two sophisticated parties operating in the field of telecommunications, which had been negotiated on a level playing field.
Although that admittedly left EE without a financial remedy if Virgin Mobile breached the exclusivity clause, EE would still be paid the substantial contractually agreed minimum revenue payments.
EE could also seek effective nonfinancial remedies, such as injunctive relief, so the result could not be said to render the contract an "illusory bargain" or "a mere declaration of intent."
The court therefore gave summary judgment in Virgin Mobile's favor.
The Implications of Drafting Provisions
This recent line of case law demonstrates the courts' emphasis on the "natural and ordinary meaning" of the provision being construed, set against the factual and commercial context of the contract in question.
For this reason, it has become far more important that liability provisions, in particular, are carefully drafted to reflect the parties' commercial agreement. We set out here several practical steps on how you may do so.
1. Think ahead.
Prior to drafting, consider the various key heads of loss, and extent of each, that may be suffered under the contract. Bear in mind variations over the lifecycle of a contract, especially in technology services contracts that provide for different phases of delivery.
Consider, also, the losses that may arise under any particularly unusual or important clauses, e.g., exclusivity in the case of EE.
Would separate liability caps for each of these heads of loss be appropriate? If so, consider the interplay between the caps, and whether a breach may conceivably be caught by more than one cap, and also what exclusions of liability are relevant to each cap.
2. Structure clauses appropriately.
There are multiple ways to structure liability caps. Caps can apply as a total over the contract term, a total in a contract year, per claim, or per event — just to name a few.
Complexity is added where the agreement consists of a framework with statements of work, as liability could arise under the framework or one or more statements of work.
The suitability of a cap depends on the nature of the loss being capped, as well as the overall commercial context. It may be that a mixture is required.
As demonstrated by Drax, a single total cap over the contract term may not be appropriate for a long-term or master agreement where the potential risk may vary considerably over time, or where a claim that exhausts the cap leaves a party without an effective remedy for any future breach by the other party.
3. Define terms clearly.
Typical formulations for the cap itself are a fixed figure, a percentage of the charges under the agreement, or the greater or lower of the two. If linking the cap to charges, consider if this should include charges paid and payable.
"Payable," however, is ambiguous. It may refer specifically to amounts due but unpaid, or more broadly to amounts expected to be invoiced over the relevant period.
Consider adding a definition to clarify this point. If linking a cap to charges from the previous contract year, ensure you take into account variations in the charges from year to year and that a mechanism is included to set a reasonable cap should the claim arise in the first contract year. 4. Consider direct versus indirect losses.
It is also common to exclude indirect and consequential losses entirely, on the basis that these are too remote from the cause of the damage.
Some contracts also expressly exclude certain heads of damage, e.g., loss of profits, loss of anticipated savings, wasted expenditure, etc.
A typical source of confusion is whether these heads of losses are excluded to the extent they constitute indirect loss, or are excluded in their entirety whether direct or indirect loss. Clarity on this point in contract drafting would help avoid a dispute such as the one in EE.
5. Note carveouts.
Lastly, consider the types of losses that should neither be excluded nor limited under the contract under any circumstances, for example losses arising out of indemnities.
Customers under service contracts should also consider ensuring that losses arising out of the supplier's deliberate breach or willful default are not excluded or limited, which is a market-standard position, as these may be helpful in the event of a supplier breach.
When a dispute arises, exclusion and limitation of liability will always be an issue to be considered and potentially disputed, particularly where the losses are significant.
Claimants should therefore be aware of the courts' recent reticence to strain the natural and obvious meaning of limitation clauses where parties have other methods of enforcing their rights, such as termination or injunctive relief.
Those drafting such clauses should also be alive to the potential breaches that could flow from any key or unusual clauses in the contract and ensure that it is clear how any exclusion or limitation of liability applies to them.
This article was originally published on Law360.