Limiting and excluding liability

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 clauses can take a number of forms. Some 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 escape without consequences if it fails 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:

• Is the clause incorporated into the contract?
• Is the liability in question covered by the clause?
• Are there any cases or legislation regulating its effect?

Incorporating the clause

An exclusion or limitation clause is only enforceable if it has been incorporated into the relevant contract. The party putting forward the clause most do what is reasonably sufficient to bring it to the other party's attention, even if the recipient does not read it. A party will generally be bound by a contract it has signed, or if it has clicked to accept online terms¹. A clause may also be incorporated through a course of dealing between the parties. Even assuming that the contract is in place, an unusual or onerous exemption 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.

Covering the liability in question

The words used must clearly and unequivocally cover what they are intended to cover.² 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,³ it is far better to be clear about this to avoid argument, and possibly litigation, on the scope of the exemption clause.

Excessively wide or ambiguous wording

Exemption clauses are, in principle, construed in accordance with the general principles of interpretation.  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 in case of any inconsistencies. 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.⁴

Overall, the exemption should not be too broad in scope. A clause which leaves some recourse available to the non-breaching party is more likely to be upheld than a blanket exclusion. Even where a contract is outside the statutory controls described below, the common law approach to construction is not always a literalist one and exemption 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 Others⁵).

Although the courts will not apply an artificial approach to construing exemption clauses, if the standard approach to interpretation does not give a clear answer to an ambiguous clause, 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" rule is now a last resort with a very limited role to play in commercial contracts that have been freely negotiated between parties of equal bargaining power (Persimmon Homes Ltd v Ove Arup & Partners Ltd).

Statutory controls

The Unfair Contract Terms Act 1977 (UCTA)

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 6 for more details.

Consumer Rights Act 2015 (CRA)

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. 

Applying the Unfair Contract Terms Act 1977

Negligence

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.

Misrepresentation

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 Limited⁶) and the whole clause may therefore be of no effect. For this reason many entire agreement clauses explicitly carve out fraud and fraudulent concealment from their provisions.

Breach or non-performance of contract

Section 3 of UCTA prevents the use of an exclusion clause which:

1. excludes liability for breach of contract; or
2. claims to permit a contractual performance substantially different from what is expected; or
3. 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. A document will cease to be "written standard terms" if there are "more than insubstantial variations"⁷ - in practice, those which affect the parties' rights and obligations (Pinewood Technologies Asia Pacific Ltd v Pinewood Technologies PLC⁸). 

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.

Breach of terms implied by law

Title

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 terms 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. Under section 6(1) of UCTA, liability for breach of these implied terms cannot be excluded or restricted at all. Likewise, similar terms 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. 

Quality of goods

The Sale of Goods Act 1979 (as amended by the Sale and Supply of Goods Act 1994) implies terms 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, to be effective, an exclusion of these terms must specify that it covers "conditions" – a clause which refers to "warranties", "guarantees" or "representations" is not sufficiently comprehensive.⁹ 

The CRA deals with these topics in consumer contracts. 

The "requirement of reasonableness" under UCTA

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".¹⁰

The "reasonableness" guidelines

The five guidelines to interpreting "reasonableness" laid down in Schedule 2 to UCTA are, in summary:

• the relative strengths of the parties' bargaining positions;
• whether the customer received an inducement to accept the term;
• whether the customer knew or should have known that the term was included;
• in the case of a term excluding liability if a condition is not complied with, the likelihood of compliance with that condition at the time the contract was made; and
• whether the goods were made or adapted to the special order of the customer.

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 Limited¹¹).

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 Limited¹²). 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 Ltd¹³). 

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 ¹⁴). A clause limiting the amount of money recoverable is more likely to be reasonable (Ailsa Craig Fishing Co. Ltd v Malvern Fishing Co. Ltd¹⁵) 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 Group¹⁶). Industry practice and the availability of insurance have also been persuasive (Cover Version Ltd v DHL Logistics (UK) Ltd ¹⁷ and Goodlife Foods Ltd v Hall Fire Protection Ltd¹⁸).

Clauses falling foul of UCTA 

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.¹⁹ 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.²⁰

Contracts outside UCTA control

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.²¹ 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). 

Drafting points

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. 

General considerations

• Use unambiguous wording.
• Identify expressly the types of liability to be excluded (e.g. "negligence").
• Exclusions by implication will not be effective and so should be made explicit.
• Take care that general words such as "other" and "including" do not put a misleading gloss on a clause.
• Make sure that a meaningful remedy is still available on breach.
• Use separate, precise clauses which break down the issues for easy analysis and to aid severability.
• A severance clause should be included in the boilerplate clauses of the contract.
• Consider inserting an express obligation for the parties to obtain insurance cover.
• If appropriate, keep records of the fact the clause has been negotiated and why the parties agreed what they did (although note that such records are rarely admissible in any subsequent dispute as to the meaning of the clause).
• Monitor the sector. A clause is more likely to be reasonable if it reflects industry practice.

A realistic approach 

A stringent exclusion which prevents, as opposed to merely limits, recovery of damages even for a serious default such as a repudiatory breach is not automatically ineffective. The broader the exclusion, though, the clearer the wording must be for it to be effective.²² 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 exclusion²³ and the courts are reluctant to accept clauses which defeat the entire purpose of the contract. 

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) Limited²⁴).

A specific approach for indirect/consequential loss

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.²⁵ Only the type of loss needs to have been in the contemplation of the parties at the time, not the amount of loss. Remember, however, that losses which were outside the contemplation of the parties will be too remote to be recoverable in any event.

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 direct²⁶ (for example where they can ordinarily be expected to flow from a breach) and in some they will be indirect. 

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). A more straightforward method is to accept liability for all losses, whether direct or indirect, but subject to a sensible financial cap. 

Redefining contractual duties 

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.²⁷ Similarly, limiting the scope of what is required may be better than accepting a wider obligation and then trying to exclude liability for its non-performance.

Other approaches

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 more likely to be seen as acceptable than blanket exclusions of liability. Nonetheless, care should be taken in standard form contracts to ensure that they are reasonable.