UK: Effective Exclusion Clauses: Ensuring They Work - Excluding And Limiting Liability

Last Updated: 14 September 2009
Article by Abbie Goldstone

Liability provisions are often the most contentious and heavily negotiated terms in commercial contracts and it is therefore important to ensure that they are drafted correctly. Such clauses might limit a party's liability by excluding some types of loss totally from the scope of the contract, or by placing a cap on the recoverable loss. When drafting or negotiating exclusion clauses there are various factors that should be taken into account in order to ensure that the term will be enforceable. This article considers some of those issues and also looks at what recent conclusions the English courts have come to in respect of exclusion clauses.

The Reasonableness Test

Exclusion clauses must be carefully drafted to ensure that the potential losses that may be incurred will in fact be recoverable by the innocent party. Many exclusion clauses will only be valid if they are reasonable in accordance with the test laid out in the Unfair Contract Terms Act 1977 (UCTA). Provisions which must pass the 'reasonableness test' include: those which attempt to exclude loss caused by negligence (except for death or personal injury which cannot be excluded at all); any term by which a seller attempts to limit his liability where the other party is a consumer or has contracted on the seller's standard terms; and any limits on liability for misrepresentation (except fraudulent misrepresentation which cannot be excluded at all).

UCTA provides that a term will be reasonable if it was a fair and reasonable one to have been included in the contract having regard to the circumstances known (or which ought reasonably to have been known) to the parties at the time of making the contract. The legislation also sets out a non-exhaustive list of factors to consider in assessing reasonableness.

B2B Contracts

Since 2001 and the ruling in Watford Electronics Ltd v Sanderson CFL Ltd (2001) the courts have frequently upheld exclusion clauses in business to business contracts, particularly where the contract has been thoroughly negotiated by the parties. The approach appears to be to allow businessmen to contract as they wish. In Watford the Court of Appeal held that where experienced commercial parties agree on an allocation of risk, the contract price reflects such allocation, and there is no inequality of bargaining power, the courts should be very cautious before concluding that such an agreement is unreasonable.

Excluding Liability For Fraud

As stated above, under UCTA, liability for fraudulent misrepresentation cannot be excluded. In the case of Thomas Witter Ltd v TBP Industries Ltd (1996) the court held that a clause which excluded liability for misrepresentation was ineffective and could not be upheld because it excluded liability for fraud by not distinguishing between fraudulent, negligent and innocent misrepresentation, and therefore also excluded fraudulent misrepresentation.

This decision has since been thrown into question by last year's case of Regus (UK) Ltd v Epcot Solutions Ltd (2008) in which Regus attempted to rely on the exclusion clause in its standard terms of business, which included a purported exclusion of Regus's liability for loss of business, loss of profits, loss of anticipated savings, loss of or damage to data, third party claims or any consequential loss 'in any circumstances'.

Here the judge found the clause was so extensive it effectively deprived Epcot of any remedy for breach and the use of the words "in any circumstances" excluded liability for fraud and deliberate damage, making the clause ineffective. However, the Court of Appeal reversed this decision and held that the exclusion clause did not exclude the obvious and primary measure of loss for the breach, which was the diminution in value of the services promised. It concluded that the words 'in any circumstances' did exclude intentional acts of Regus but did not extend to fraud or malice. An exclusion clause will not be considered invalid simply because it does not mention fraud and such a view must be at odds with the parties' intentions. Liability for fraud, malice or recklessness must be very clearly excluded because it goes without saying that parties contract with one another with an expectation of honesty.

This case therefore seems to reverse the Witters decision and only time will tell whether draughtsmen will continue to specifically carve out fraud from exclusion clauses.

Standard Exclusions

Contractual parties, particularly suppliers, are often keen during the negotiation process to carve out from the contract, liability for an array of different types of loss, the effects of which are often not properly considered. When exclusion clauses become 'standard' often parties fail to adequately consider whether the list of loss which they have excluded is, in actual fact, the very loss that they may wish to recover. As an example, a customer contracting for the supply of IT services should be reluctant to include an exclusion for loss of data, when the supplier will have direct access to the customer's IT systems. Further, whilst parties are usually keen to exclude indirect and consequential loss, they should consider carefully what this actually means in practice.

Construing Exclusions Clauses

Earlier this year the case of Internet Broadcasting Corporation Ltd (t/a NET TV) v MAR LLC (t/a MARHedge) (2009) potentially changed the way that exclusion clauses should be drafted. In this case the claimant sued for loss of profits after the defendant terminated their contract and, so the claimant asserted, wrongfully and deliberately committed a repudiatory breach of contract. The defendant admitted that it had wrongfully repudiated the agreement but sought to rely on the limitation of liability clause which excluded liability for loss of profits. The court held that the exclusion clause did not cover the deliberate personal repudiatory breach of contract committed by the defendant and therefore the defendant was liable to the claimant for the losses that it claimed.

The High Court held that a stricter approach should be taken when construing exclusion clauses where the wrongdoing is personal to the wrongdoer, rather than, for example, an employee or contractor. In the NETTV case the defendant's president was deemed to be the company's 'controlling mind' and his actions were distinguished from those of an employee. The court held that there would have to be very clear strong language to persuade a court that the parties intended the words to cover a 'deliberate personal repudiation'. The court also raised the issue of insurance, because this type of risk would not be easily insured. Therefore, if contractual parties want to exclude or limit liability for personal repudiatory breaches, or indeed repudiatory breaches of any kind, they must expressly state this intention in the contract.

As the court stated in Regus, most contractual parties would, as least at the time when the contract is entered into, expect honest dealings from the other party and it is hard to imagine a situation when parties would expressly wish to exclude liability for deliberate non-performance of contractual obligations.

Conclusions

Rather unhelpfully it seems that most cases will be decided on their particular facts and it can therefore be very difficult, if not impossible, to predict how a court would rule in respect of a limitation of liability clause. The more recent judicial trend appears to be to allow businessmen to contract as they wish and for the courts to intervene as little as possible. Most parties would not sign a contract if they thought that an exclusion clause was unreasonable. Therefore, and particularly if a contract has been negotiated, it would not be sensible to subsequently claim that an exclusion clause is unreasonable unless there is a very good reason for doing so – and it makes sense to base this decision on the UCTA reasonableness test.

In terms of drafting exclusion clauses, it is prudent to ensure reasonableness rather than negotiating aggressively and ultimately including an onerous clause which effectively excludes one party's liability for breach of all its contractual obligations and which is at risk of being struck out by a court and deemed not to create a contract at all.

www.lg-legal.com

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