General

The limitation of liability is an issue that is hotly negotiated in most commercial contracts and construction is no different. It can, however, sometimes be overlooked where unamended standard form contracts are used. Parties often rely on the standard form clauses as having the "authority" of being tried and tested and drafted with the benefit of the knowledge and experience of the industry. Unfortunately, such reliance can prove perilous as they may not always adequately deal with the commercial risks of a particular project.

Clauses governing contractual liability fall into three main categories: risk, indemnity and exclusion clauses. Risk clauses assign the risk of certain events to one of the parties to the contract so that it is clear, from the outset, who will bear the liability of that risk occurring. Indemnity clauses involve one party agreeing to make good a loss suffered by the other. Exclusion clauses refer to those clauses that seek to exclude or limit a liability that one party may owe to the other. This note will focus on exclusion clauses.

Exclusion Clauses

Exclusion clauses are clauses relied upon by a party, who would otherwise owe a liability, to limit or exclude that liability. It is virtually impossible to eliminate the risk of a breach of contract occurring. A contracting party, however, may wish to manage its liability should any problems arise. This is normally achieved by imposing a financial cap on liability and/or excluding certain heads of liability altogether.

Parties are generally free to agree whatever they choose in relation to excluding liability. Great care and attention needs to be paid to the drafting of exclusion clauses in light of their importance and the fact that they are subject to specific common law rules of interpretation.

Contra Proferentem and Negligence

The Contra Proferentem rule provides that, where there is any ambiguity in the meaning of an exclusion clause, the clause will be interpreted against the person who drafted or tendered the document. This is a well established principle and the courts have indicated that, where a party wishes to exclude or limit his liability, he must do so in a clear and unambiguous manner.

A good example of where the contra proferentem rule will be exercised is where a party seeks to exclude liability for negligence. In such an instance, the party must expressly use the term "negligence" or an appropriate synonym. Reliance on a generic "all claims" clause without an express reference to negligence will not suffice. Indeed, it has been held that if a clause is wide enough to cover both negligence and another head of damage, where no express reference to negligence has been made, the court will not enforce the clause as being effective in respect of limiting liability for negligence. In order to avoid this pitfall, any such clause should make reference expressly to negligence and then deal with other tortious liability.

Direct and Indirect Loss

It is important to consider the types of loss that you are seeking to limit or exclude. For example, losses can be lassified as direct or indirect. The case of Hadley v Baxendale (1854) is the authority for determining whether a loss arising from a contract breach is direct or indirect. This case gave rise to the "two limb" test, explained below.

Where one party is in breach of contract, the other party will be entitled to recover, in respect of that breach:

(a) the loss that would fairly and reasonably be considered to arise from such a breach in the usual course of things; or

(b) the loss that, at the time of contracting, was within the reasonable contemplation of the parties as a not unlikely result of the breach.

The first limb of the rule relates to direct loss and what naturally flows from the breach. Such direct losses (and which, for the avoidance of doubt, can include loss of profit) are often the greatest head of damages and it is important to try and anticipate what might reasonably arise, as a result of a breach, in order to deal with liability for such events. What is a direct loss will depend on the nature and facts of any given case and the knowledge of the parties at the time the contract was made.

The second rule in Hadley v Baxendale, as outlined above, applies to loss that is greater than or different from that which would be expected in normal circumstances. In essence, it is a loss that is "special" or "exceptional". Under the second rule, the party in breach must have had actual knowledge of the special circumstances, at the time the contract is entered into, that would give rise to a particular type of "special" loss for that breach.

It is worth noting that the rules are not mutually exclusive and the loss that may be covered by either rule will depend on how the relevant breach of contract is characterised and the degree of knowledge of the circumstances the parties are assumed to have.

Limiting your liability

Whilst the best approach is to avoid a breach of contract altogether, there are some simple considerations that can assist in managing your potential liability. In every situation, where a contract is being negotiated, you should consider what losses are likely to be incurred and what is important for recovery or exclusion in respect of those losses, in the event of a breach of contract. It is important to identify the concerns of the parties and the relevance of the exclusion clauses to those concerns. The types and heads of loss to be excluded should be considered i.e. direct/indirect, negligence, and whether any overall caps on liability should be included. Clauses should be drafted clearly and unambiguously and, if the need arises, all heads of loss to be excluded should be listed so that parties cannot argue about what was meant at a later date.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.