Limitation and exclusion of liability
17 June 2021
17 June 2021
This guide sets out the principles to be considered when drafting these clauses or analysing them in a dispute.
A common way of apportioning risk in a contract is for the parties to exclude or restrict their liability to one another in the event of default. Such exclusions can take a number of forms. Some clauses seek to exclude liability altogether. Others put a limit on liability, perhaps by capping the amount payable in damages on a breach; restricting the types of loss recoverable or the remedies available; or imposing a short time limit for claims.
The general principle of freedom of contract must be balanced against public policy concerns that a party who freely undertakes a binding contractual obligation should not be equally free to absolve itself from its duty to perform that obligation. To help strike this balance, English law has developed a mix of statutory rules and case law which must be taken account of when negotiating or reviewing these clauses.
We suggest that any analysis of a particular exclusion or limitation clause should take a three-step approach:
An exclusion or limitation clause is only enforceable if it has been incorporated into the relevant contract. A party's standard terms are incorporated if they have been reasonably and fairly brought to the other party's attention. Even assuming that the "battle of the forms" has been won, if a party is trading on its standard terms an unusual or unclear exclusion clause may fail if it is not given a sufficient degree of prominence to put the other party on notice. The more unusual or onerous the clause, the more prominence it should be given.
The words used must clearly and unequivocally cover what they are intended to cover.1 The question for the court, in all cases, is whether the clause, on its true construction, extends to cover the obligation or liability that it seeks to exclude or restrict.
So, for example, if a clause aims to exclude liability for negligence, it is advisable to include an express reference to "negligence"; general words such as "any loss" or a reference to loss "howsoever caused" may not be sufficient. Although recent cases indicate that an express reference to negligence will not always be required,2 clarity on the issue will assist in avoiding litigation on the scope of the exclusion clause.
Overall, the exclusion should not be too broad in scope. A narrower, more realistic clause is more likely to be upheld by a court. Also, if the wording of a clause is ambiguous, and the standard approach to construction does not give a clear answer, it may be construed "contra proferentem". This means that the court will interpret the clause strictly and construe any ambiguity against the party seeking to rely on it. However, the "contra proferentem" rules has a very limited role to play in respect of commercial contracts that have been negotiated between parties of equal bargaining power (Persimmon Homes Ltd v Ove Arup & Partners Ltd)3.
Nonetheless, even where a contract is unaffected by the legislation described below, the common law approach to construction is not always a literalist one and limitation/exclusion clauses will not be given a literal interpretation which would otherwise produce a result at odds with the main object of the contract (Mitsubishi Corporation v Eastwind Transport Limited and Others)4.
Generally, the courts look for clear wording which unambiguously sets out the intention of the parties regarding the allocation of risk between them. They will also look to the other contractual terms agreed to ascertain the parties' intentions regarding allocation of risks and liabilities. In a commercial situation it is recognised that the parties themselves are the best judges of this and the courts will intervene only when strictly necessary. However, balanced against this is a presumption that contracting parties do not readily give up their legal rights without careful thought, and express wording is needed to show that this is in fact what they intended.5
UCTA applies to commercial situations and is the most significant statutory control in this area. UCTA regulates the exclusion and restriction of liability for breach of express and implied contractual obligations and the common law duty of care (i.e. tort). UCTA regulates terms according to the area of liability that they attempt to exclude or restrict. These areas are considered below. Certain types of contracts are outside UCTA's scope – see page 5 for more details.
From 1 October 2015, the CRA covers all aspects of unfair terms in business-to-consumer contracts which had previously been covered by UCTA and the Unfair Terms in Consumer Contracts Regulations 1999. It deals with implied terms in relation to the quality of goods and services, including digital content, and regulates attempts on the part of a trader to exclude its liability for breach. The CRA also introduced a "fairness" test. Any term which causes "a significant imbalance" in the parties' respective positions, to the detriment of the consumer and in a way which is contrary to the requirement of good faith, will be regarded as "unfair".
A term that is "unfair" is not binding on the consumer, and the consumer can treat it as struck out of the contract. The remainder of the contract will stand if it is capable of doing so according to the usual principles of severability.
It is not possible to exclude or restrict liability for death or personal injury resulting from negligence. In the case of other loss or damage resulting from negligence (e.g. financial loss or property damage), liability can be restricted, but only insofar as the term or notice satisfies the UCTA reasonableness test which is explained later in this guide. This rule applies in all circumstances, regardless of whether the term is in a contract or a non-contractual notice or whether the parties are dealing on standard terms or a bespoke contract. The rule applies regardless of whether the person to whom the exclusion is directed is a business or a consumer.
Any term of a contract which attempts to exclude or restrict liability for pre-contractual misrepresentations or which tries to limit the remedies available for misrepresentation will be of no effect save to the extent that it satisfies the requirement of reasonableness in UCTA.
This is frequently relevant in the context of "entire agreement" clauses which attempt to exclude all representations and other information disclosed during pre-contractual negotiations. Such clauses are most likely to be regarded as reasonable in situations where the pre-contractual negotiations have been complex, on the basis that both parties benefit from the certainty of setting out all relevant rights and liabilities in one document without the worry of a possible collateral warranty claim.
Beware of including an entire agreement clause which attempts to exclude liability for all misrepresentations, whether innocent, negligent, or fraudulent. Any purported exclusion of fraudulent misrepresentation will be unreasonable (Thomas Witter Ltd v TBP Industries Limited)6 and the whole clause may therefore be of no effect. An entire agreement clause should explicitly carve out fraud and fraudulent concealment from its provisions.
Section 3 of UCTA prevents the use of an exclusion clause which:
(a) excludes liability for breach of contract; or
(b) claims to permit a contractual performance substantially different from what is expected; or
(c) in respect of the whole or any part of a contractual obligation, claims to allow no performance at all (e.g. if a condition precedent is not satisfied),
unless (in each case) the clause satisfies the reasonableness test.
This rule applies where one of the contracting parties is a business contracting on the other's written standard terms. "Written standard terms" is interpreted more widely than may be expected and could catch negotiated contracts which have standard exclusion clauses inserted into them or if the counterparty refuses to negotiate the clause (see St Albans City and District Council v International Computers Ltd)7.
Commercial contracts commonly contain force majeure clauses absolving the parties from liability if some unforeseeable event occurs that renders performance impossible. Such clauses can, in practice, have the same effect as exclusion clauses and may be subject to the reasonableness test under section 3 of UCTA. Although force majeure clauses are generally regarded as reasonable, they may raise problems where they are drafted unusually widely to cover matters such as increased costs or events which are arguably within the control of the parties.
In respect of the supply of goods, services and digital content prior to 30 September 2015, the Sale of Goods Act 1979 and the Supply of Goods (Implied Terms) Act 1973 imply warranties as to title and quiet possession into contracts for the sale of goods and hire-purchase agreements which effectively confirm the seller's right to sell. Now, under section 6(1) of UCTA, liability for breach of these implied warranties cannot be excluded or restricted at all. Likewise, similar warranties which are implied by the Supply of Goods and Services Act 1982 into other types of contract cannot be excluded. A seller which knows it is unable to pass good title should therefore agree with the buyer to transfer only such title as it has, rather than purporting to transfer good title then trying to exclude liability for the breach.
The Sale of Goods Act 1979 (as amended by the Sale and Supply of Goods Act 1994) implies warranties as to the quality of goods into contracts for the sale of goods (i.e. that the goods, where sold by description/sample, must conform to that description/sample, must be of satisfactory quality and must be fit for their purpose). Similar terms are implied into hire-purchase contracts by the Supply of Goods (Implied Terms) Act 1973.
Under section 6(2) of UCTA, liability for breach of these implied terms can be excluded or restricted, but only in so far as the clause in question satisfies the requirement of reasonableness. It is likely to be reasonable if the buyer is given the chance to inspect the goods or to provide input into their design and/or manufacture. Further, the Court of Appeal has indicated that the word "condition" is required to effectively exclude these implied terms, and the words "warranties", "guarantees" or "representations" are not effective.8
The CRA deals with these topics in consumer contracts.
The requirement of reasonableness is fundamental to the operation of UCTA. A term will be reasonable if it is "a fair and reasonable one to be included having regard to circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made"9.
The five guidelines to interpreting "reasonableness" laid down in Schedule 2 to UCTA are, in summary:
However, these guidelines are not exhaustive.
Although it is stated that the guidelines apply specifically to sale and supply of goods situations, they are usually regarded by the courts as of more general application (Stewart Gill Limited v Horatio Meyer & Company Limited)10.
In business contracts, especially where the parties are of comparable bargaining power and can insure against the risks contemplated by the clause, courts are reluctant to intervene and prefer to leave the parties free to apportion the risks as they see fit (Watford Electronics Ltd v Sanderson CFL Limited)11. Nevertheless a clause which attempts to leave a customer of whatever type without a realistic remedy for a serious breach of contract runs the risk of unreasonableness (Regus (UK) Ltd v Epcot Solutions Ltd)12.
Additional principles of "reasonableness" exist at common law. What is relevant to assessing reasonableness is a matter of fact in each case. However, there are some general rules. Reasonableness is generally satisfied where there is a fully negotiated contract between parties of equal bargaining power (Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland)13. A clause limiting the amount of money recoverable is more likely to be reasonable (Ailsa Craig Fishing Co. Ltd v Malvern Fishing Co. Ltd)14 than one excluding liability altogether. Similarly, the use of small print or unnecessarily convoluted drafting is likely to be unreasonable (Stag Line Ltd v Tyne Ship Repair Group)15. Industry practice and the availability of insurance have also been persuasive (Cover Version Ltd v DHL Logistics (UK) Ltd16 and Goodlife Foods Ltd v Hall Fire Protection Ltd)17.
If an exclusion or limitation clause falls foul of UCTA, whether because it purports to exclude a type of liability which cannot be excluded, or it is not "reasonable", it will be of no effect. The court must look at the clause as a whole.18 It will not rewrite the clause to substitute an acceptable alternative. In other words, liability for the event in question will be completely uncapped, subject only to the usual rules regarding remoteness and causation. On the other hand, no sanctions such as fines apply to anyone using an invalid clause.
The problem of a clause being partly valid and partly invalid under UCTA is a difficult one with no clear-cut answer. Although this is a complex area, the practical implications are much simpler. The risk of an entire exclusion or limitation of liability clause being unenforceable can be minimised by drafting it, using sub-clauses, as a series of separate "terms" easily distinguishable from one another. Avoid the use of a single, broad clause which addresses all issues together.19
Broadly, UCTA does not cover insurance contracts; contracts relating to the creation, transfer or termination of intellectual property rights; contracts relating to the formation, dissolution or constitution of a company or to the rights or obligations of its members; contracts relating to the creation or transfer of securities or rights in securities; contracts relating to the creation, transfer or termination of an interest in land; certain marine/shipping contracts; or employment contracts. There are, however, certain savings for consumers under marine/shipping contracts, and for employees under employment contracts (Schedule 1).
UCTA does not extend to "international supply contracts" either. Broadly, these are contracts under which possession or ownership of goods passes and which envisage that goods will be carried between different states or those with offer and acceptance in different states. 20 Contracts for the international supply of services remain within the control of UCTA, assuming English law is the applicable law in the contract. As a result, suppliers can be a lot bolder in excluding their liability under contracts for the cross-border supply of goods in comparison with providers of services (section 26).
In addition, the key provisions of UCTA will not apply where English (or other UK) law only applies because that is the governing law chosen by the contracting parties. So, if the contract includes an English governing law provision, but would otherwise have been governed by a non UK law, sections 2 to 7 and 16 to 21 will not apply (section 27).
The first step is to consider whether the impact of UCTA can be minimised or even avoided altogether. Because standard terms or clauses will attract section 3 of UCTA and the reasonableness test for any restriction of contractual liability, consider whether a bespoke, individually negotiated contract may be a better way to address this. In all cases, however, clear and simple drafting is important.
A "blanket" exclusion which prevents, as opposed to merely limits, recovery of damages even for a serious default is not automatically ineffective. The broader the exclusion, though, the clearer the wording must be for it to be effective.21 However, wherever it is commercially acceptable, parties might consider limiting liability rather than seeking to exclude it altogether, as a sensible cap on liability is more likely to be upheld than a blanket exclusion.22
Liability for warranties which have been given expressly should not be excluded. Liability should never be excluded for dishonesty (e.g. fraud or fraudulent concealment), although it is possible to distinguish fraud or dishonesty by an agent in the performance of the contract (Frans Maas (UK) Ltd v Samsung Electronics (UK) Limited)23.
It is common to see clauses which accept liability for limited types of loss or damage but which attempt to exclude or restrict liability for "indirect", "consequential" and/or "economic" loss. "Indirect" and "consequential" losses are widely accepted as the same thing, i.e. losses which fall under the second limb of Hadley v Baxendale (1854) 9 Ex. 341. Under that second limb only loss that can reasonably be supposed to have been in the contemplation of both parties at the time the contract was made can be recovered.24 Only the type of loss needs to have been in the contemplation of the parties at the time, not the amount of loss.
Whether an exclusion of "consequential loss" catches financial loss such as loss of profits depends on the circumstances of the contract in question. In many cases such losses will be direct25 (for example where they can ordinarily be expected to flow from a breach) and in some they will be indirect. (Note, however, that losses which were outside the contemplation of the parties will be too remote to be recoverable in any event.)
One approach is to exclude identified, defined categories of loss (e.g. wasted management time; loss of production, business, or expectation; or the cost of getting items from another source). However, this can produce tortuous drafting. An alternative method is to accept liability for all losses, whether direct or indirect, but subject to a sensible financial cap.
Defining contractual obligations more widely can assist in reducing the potential for a breach of contract, for example, agreeing to perform a contract within a range of dates rather than setting a specific date on which performance must take place, or promising to use reasonable endeavours rather than an absolute obligation.26
Exclusion clauses can take a variety of forms. Rather than expressly excluding liability, some clauses seek to limit the type of loss which is recoverable or the remedies available. An example of such a clause would be a seller providing a buyer with a right of repair or replacement in respect of defective products rather than a right to reject the goods.
Another possibility is to put a time limit upon the period in which defects may be notified or legal proceedings issued (e.g. no liability unless buyer notifies the seller of any damage to delivered goods within 28 days of delivery). Clauses like this are limitation rather than exclusion clauses and, as such, are not construed so strictly as blanket exclusions of liability. Nonetheless, care should be taken in standard form contracts to ensure that they are reasonable.
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.