What do in-house counsel really need to know about exclusion clauses?
By Douglas Bishop , Peter Keel and Norman Lucas
When drafting an exclusion clause you must carefully consider what clause will best serve your interests.
How do exclusion clauses operate?
Exclusion of liability clauses operate:
- for risk allocation purposes: parties can agree on appropriate allocation of risks between them by excluding (such as excluding liability for a certain type of loss (loss of profits, punitive damages)), limiting (including limiting liability to a certain amount) or qualifying (such as requiring warranty claims to be made within a specified time frame) a party's rights under a contract. If the parties understand the risks they have been asked to accept, they can better allocate those risks to the party who is best placed to manage those risks.
- to define obligations under a contract: by stating what services and/or acts a party will not be liable for, an exclusion clause helps to define the scope of services under a contract.
- to attempt to limit liability for "misleading and deceptive conduct": while parties cannot contract out of section 52 of the Trade Practices Act (TPA), exclusion clauses are often included in contracts in an attempt to break the causal link between the misleading and deceptive conduct and a party's loss.
A party's ability to rely on an exclusion clause will depend on applicable common law principles (including principles of interpretation that apply to exclusion clauses) and the TPA and State Fair Trading legislation.
How can exclusion clauses protect against "misleading or deceptive conduct"?
Exclusion clauses will not protect against "misleading or deceptive conduct" under section 52 of the TPA or the equivalent provisions in the State Fair Trading legislation. However, an exclusion clause may be relevant to section 52 in terms of whether a party relied on a representation to enter into a contract.
Where a party who claims to have been misled or deceived wants to recover damages (or some other remedy) as a result of misleading and deceptive conduct, the party will need to show that the damage was caused by reliance on the conduct. Whether an exclusion clause will operate to protect the party who is seeking to rely on it is a question of fact.
An exclusion clause, if effectively drafted, will break the reliance nexus where it provides the party to whom the misrepresentation was made with ample information, so that it would be difficult for that party to claim that it relied on the misrepresentation in entering into the contract.
So, how can I obtain maximum protection from an exclusion clause?
When drafting an exclusion clause you must carefully consider what clause will best serve your interests. You should also take into account any industry-specific rules and ensure that the exclusion clause:
- is incorporated into the contract before it is signed;
- is consistent with insurance provisions and indemnity clauses where the exclusion clause is part of an overall risk apportionment mechanism. For example, an exclusion clause that only excludes liability for negligence and damages will arguably not exclude a party's liability under an indemnity provision.
- is not so broad that it removes the legal characteristics of a contract from the agreement. For example, if an exclusion clause seeks to completely protect a party from liability for non-performance, it may destroy any consideration that the liable party was to provide in exchange for the other party's promises;
- precisely identifies the types of loss the party wishes to exclude (such as loss of profit, lost revenue, negligence and third party claims) without relying on terms such as "direct", "indirect" or "consequential". The meanings of these terms have become less clear at law and their use in contracts may have unintended results unless they are clearly defined. For example, where lost revenue flows directly from a breach of contract and a clause merely excludes "consequential or indirect loss (including lost revenue)", there is a risk that direct loss of revenue will not be excluded;
- is unambiguous, to ensure that it is read in the context of a contract as a whole and interpreted according to its natural and ordinary meaning, taking into account the parties' intentions. In the case of ambiguity, an exclusion clause will be construed contra proferentem, that is, it will be construed strictly against the person seeking to rely on it; and
- is brought to the attention of the party entering into the contract, particularly in circumstances where an exclusion clause is unusual or unreasonable. It is good practice to make the exclusion clause subject to an express acknowledgment that the party entering the contract has obtained legal advice on the clause.
Checklist: Exclusion clauses
- Timing - insert the clause before the contract is signed
- Consistency - the clause must sit well with other risk apportionment clauses
- Scope - ensure the clause is not too wide so as to destroy consideration
- Precision - identify the specific types of loss to be excluded
- Interpretation - the clause must be read in the context of the contract as a whole
- Acceptance - the party entering into the contract must specifically acknowledge the clause.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.