Exclusion Clauses

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Managing risk by limiting liability under a commercial contract is a concept most clients welcome, but does it really work? Exclusion clauses can be effective, but careful consideration of the detail of the drafting is essential to avoid misinterpretation. We start with the general principles and then look more closely at how solicitors may use exclusion clauses to limit their liability.

Welcome

Andrew Nickels

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An exclusion clause (sometimes referred to as a limitation or exemption clause) attempts to exclude or limit one party’s liability, or seeks to limit the other party’s rights or remedies, such as:

• Forcemajeure–mattersbeyondone’scontrol

• Exclusionofremedies(e.g.specificperformance,

paymentset-offrights)orconditionsto

remedies(e.g.returnofdefectivegoods)

• Exclusionofconsequentialorindirectlosses,

lossofprofits,revenue,expectedsavings

• Financialcaponoverallliabilityand/orcapson

differentliabilities(e.g.asupplierofservices

limitingitsliabilitytothevalueofthoseservices)

• Entireagreementclausesandnon-relianceupon

priorrepresentations

• Timebarsonclaims

• Exclusionofcertainwarranties,conditionsor

othertermsimpliedbystatuteorotherwise.

Tobeeffective,anexclusionclausemust:

1) Beincorporatedintotheagreement;

2) Covertheliabilityinquestion;and

3) Notbeprohibitedbystatuteorotherlaw,e.g.theUnfairContractTermsAct1977(UCTA),theUnfairTermsinConsumerContractsRegulations1999ortheConsumerProtectionAct1987.UCTAdoesnotapplytosomecontracts,suchasinsurance,landandintellectualpropertycontracts.

Ifthereisnowrittencontractsignedbytheparties,itcanbedifficulttodecidewhattermsareincorporatedintothecontract.Evenifthereisaformalcontractinplace,anexclusionclauseinthemainbodyofthecontractmayinadvertentlybeoverriddenbyspecificprovisionsintheschedulesexpressedtooverridethemainbodyoftheagreement.

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1 The Kudos case

ThedecisionoftheCourtofAppealinFebruary2013inthecaseofKudos Catering (UK) LimitedvManchester Central Convention Complex Limited[2013]EWCACiv38highlightedthepitfallsofrelyingonexclusionclauses.

TheCourtofAppealheldthatontheparticularwordingofacontract,aclausewhichexcludedaparty’sliabilityforlossofprofitsdidnotapplywherethatpartyhadfailedtoperformthecontract.

ManchesterCentralConventionComplexLimited(MCCC)appointedKudosin2007toprovidecateringservicesunderafive-yearcontract.Clause18.6ofthecontractstatedthatMCCCwouldhave“noliabilityforlossofgoodwill,business,revenueorprofits,anticipatedsavingsorwastedexpenditure(whetherreasonablyforeseeableornot)orindirectorconsequentialloss”.MCCCterminatedin2010,assertingthatKudoshadmateriallybreachedthecontract.Kudosarguedthattheterminationwasunlawfulandclaimed£1.3minlostprofit.TheHighCourtruledclause18.6effectivelyexcludedMCCC’sliabilityforlossofprofitbuttheCourtofAppealdisagreedandruledthatKudoscouldrecoveritslostprofits.Why?

ThereasonsgivenbytheCourtofAppealwere:

• Clause18washeaded“IndemnityandInsurance”–theexclusionoflossofprofitwas“buried”inthisclauseandthecourtheldthattheexclusiononlyappliedinthecontextofdefectiveperformanceratherthantotalfailuretoperform

• Ifeffective,clause18wouldhavedeprivedKudosofanyrealremedyintheeventofdefaultbyMCCC.Aliteralinterpretationoftheclause(toexcludelossofprofitforanydefault–includingdeliberaterepudiatorybreach)wouldrenderthecontract“entirelydevoidofcontractualcontent”andtherebycontrarytobusinesssense

• Ifthepartieshadintendedtoexcludeliabilityforlossofprofitintheeventofrefusaltoperformthecontract,thecourtsaidthisshouldhavebeensetoutunambiguouslyinastand-aloneclause.

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Interpretation – two recent cases

2 The Markerstudy case

InthecaseofMarkerstudy Insurance Co LimitedvEndsleigh Insurance Services Limited [2010]EWHC281(Comm),thedefendant,Endsleigh,wereretainedbyMarkerstudytoprovideclaimshandlingservices.Markerstudyallegednumerousbreachesamountingtolossestotalling£14m.Endsleighsoughttorelyonanexclusionclausestating“Neitherpartyshallbeliabletotheotherforanyindirectconsequentialloss(includingbutnotlimitedtolossofgoodwill,lossofbusiness,lossofanticipatedprofitorsavingsandallotherpureeconomicloss)arisingoutoforinconnectionwiththisAgreement”.Markerstudyclaimedthatbyvirtueofthisclause,Endsleighwasexemptedfromliabilityforindirectandconsequentiallossesonly.Endsleighclaimedthatitwasalsoexemptedfromdirectlossesfallingundertheheadsoflossspecified

intheclause,andfurtherclaimedthattheclauseinthecontractprovidingthattheirtotalliabilityincontract,tort,misrepresentation,restitutionorotherwise,belimitedtotheaggregateamountoffeesreceivedunderthecontract(approximately£3.9m)includedanyclaimsforinterest.

Oninterpretationoftheexclusionclause,thecourtfoundinfavourofMarkerstudyandstatedthat“Theuseofthephrase“includingbutnotlimitedto”isastrongpointerthatthespecifiedheadsoflossarebutexamplesoftheexcludedindirectloss.”Inrespectofthecap,thecourtfoundinEndsleigh’sfavourinrelationtocontractualclaimsforinterest.However,statutoryinterestwassaidtobeofa“differentcharacter”–notaliabilityincontractbutastatutoryliabilityarisingfromthecourt’sdiscretion–andthereforedidnotfallwithinthecap.

UndertheprovisionsofUCTA,exclusionsofliabilityfordeath/personalinjuryresultingfromnegligence,forfraudorfraudulentmisrepresentationandforbreachofimpliedcovenantsoftitleintheSaleofGoodsAct1979willbevoid.Certaintypesofexclusions(whichdifferdependingonwhetherthecontractisbusinesstobusinessorbusinessto

consumer,andwhetheritisnegotiatedorononeparty’sstandardterms)willbesubjecttothe“reasonablenesstest”undersection11ofUCTA(seebelow).Ifamistakeinyourexclusionclauserendersitvoidorunreasonable,itwillbestruckfromthecontact,whichcouldresultinyourclient’spotentialliabilityforvariousheadsoflossbeingunlimited.

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OCTOBER2013@Unfair Contract Terms Act 1977

Drafting tips• Whendraftinganexclusionclause,considertheprecise

structureoftheclausecarefully,beingmindfulofthefactthatanentireclausecanbecontaminatediftheintendedheadsofclaimarenotseparatelyidentified.

• Commercialnegotiationsarethepreparationforanycontract,andriskallocationisanimportantissuewhichshouldbediscussedindetailbythepartiesattheoutset.FollowingthereasoningintheKudoscase,ifyouaredraftingawide-rangingexclusionofliability,itisworthconsideringwhatremedytheotherpartywillbeleftwith.WhetherapplyingtheUCTAtestofreasonablenessortheirpowersofinterpretation,thecourtswillnotlookfavourablyonaclausethat(i)seekstoremoveanyremedyforfailuretoperformorfordefectiveperformanceor(ii)resultsinonepartytakingalltherisk.

• Limitationclausesmustbedraftedexpresslyandexplicitly–preferablyinastand-aloneclausewithanappropriateheading.

• TheKudoscaseconfirmedthatthereisnopresumptionthatanexclusionclausewillnotapplytodeliberatebreach.However,thecourtsarelikelytointerpretwidelydraftedordraconianexclusionsasnarrowlyaspossible.Ifthepartiesintendtoexcludecertaintypesofliability(suchaslossofprofit)fordeliberatebreachaswellasdefectiveperformance,thisshouldbeclearlystated.

• Theterm“indirectorconsequentialloss”isnotapreciseterm;itshouldonlybeusedattheendofaclauseasafinalcatch-alltoavoidpotentialcontaminationoftheentireclause.

TheclauseintheMarkerstudycaseaboveshouldhaveread:

“Neitherpartyshallbeliabletotheotherforany:

a) lossofgoodwill;

b) lossofbusiness;

c) lossofanticipatedprofitorsavings;

d) pureeconomicloss;or

e) anyindirectorconsequentiallossesarisingoutofinconnectionwiththisAgreement.”

Similarly,ifEndsleighhadwantedstatutoryinteresttobeincludedinthecap,itshouldhavestatedthisexplicitlyintheclause.

1 Professional conduct considerationsOutcome1.8oftheSRAHandbookstatesthat“clientshavethebenefitofyourcompulsoryprofessionalindemnityinsuranceandyoudonotexcludeorattempttoexcludeliabilitybelowtheminimumlevelofcoverrequiredbytheSRAIndemnityInsuranceRules”.IndicativeBehaviour1.8suggeststhat“ifyouseektolimityourliabilitytoyourclienttoalevelabovetheminimumrequiredbytheSRAIndemnityInsuranceRules,ensuring that this limitation is in writing and is brought to the client’s attention”,tendstoshowyouhaveachievedthisOutcomeandthereforecompliedwiththePrinciples.

Relevantrecognisedbodiesandrelevantlicensedbodies(i.e.ABSs,limitedcompaniesandLLPs)cannotlimittheirliabilitybelow£3mforanyoneclaim.Forsolepractitionersandpartnerships,theminimumis£2mforanyoneclaim.

2 Legal considerations

• Liabilityforfraudorrecklessdisregardofprofessionalobligationscannotbeexcludedorlimited.

• Section60(5)oftheSolicitorsAct1974rendersvoidanyprovisioninacontentiousbusinessagreementpurportingtoexcludeasolicitor’sliabilityfornegligence.

• Attemptstolimitliabilityfornegligenceinrespectofnon-contentiousworkaregovernedbysection2(2)ofUCTA.

3 Types of contractual limitation

• Limiting the solicitor’s duty of care to his client or excluding the duty altogether except for loss suffered as a result of the solicitor’s wilful misconduct, bad faith or fraud

• Limiting the remedies available to the client in respect of a breach of contract or duty

Whilstsolicitorsnormallytakeresponsibilityfordirectlossesflowingfromanybreach,anyliabilityforindirectorconsequentiallossescanbeexpresslyexcludedinthelimitationclause.Thedistinctionbetweendirectandindirectlossesisnotalwaysclear–specifyingthetypesoflosswhichareexcluded(e.g.lossofprofits,lossofgoodwill,lossofopportunity)willofferlessscopefordispute.

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Limiting solicitors’ liability

• Limiting the time within which a client may bring a claim

Currently,aclaimanthassixyearsfromthedateofthedefendant’sbreachofcontracttobringaclaim.Intort,theclaimanthassixyearsfromthedateofsustainingtheloss,or,iflater,threeyearsfromthedateofawarenessofhisloss,subjecttothelong-stopoffifteenyears.Itispossibletolimittheclaimant’stimefurther–forexample,byincludingatermwhichprovidesthatinallcases,whethercontractortort,theclienthas,say,threeyearsfromthedateofawarenessofhislosstobringhisclaimandsubjecttoalong-stopof,say,fouryearsfromthecauseofactionaccruing.

• Limiting the amount recoverable for a breach of contract/duty, i.e. a financial cap

Suchclausesaremorecommonwherethesumsinvolvedinaparticulartransaction(e.g.theconsiderationinapropertyacquisition)mayexceedthefirm’sindemnitycoverorwhereaspecificprojecthasanunusualdegreeofriskassociatedwithitbecauseofitsnoveltyorcomplexity(e.g.opinionlettersorlegalduediligencereportsoncorporatetransactions).Further,whereasolicitorisgivingadviceinconjunctionwithanotherprofessional,withtheresultthathemaybejointlyliabletotheclient,a“proportionalityclause”canbeincluded,statingthatthesolicitorisonlyliabletotheextentthatheactuallycausedtheloss.

4 The “reasonableness” testUnderSection2(2)ofUCTA,acontracttermwhichseekstoexcludeorrestrictliabilityfornegligenceisofnoeffectunlessitsatisfiestherequirementofreasonablenesssetoutinsection11,namelythatthetermmustbeafairandreasonableonehavingregardtothecircumstanceswhichwereoroughtreasonablytohavebeenknowntoorinthecontemplationofthepartieswhenthecontractwasmade.Ifchallenged,itwillbeforthesolicitortoestablishthereasonablenessofthelimitation.

Section11(4)ofUCTAprovidesthatwhereacontractualtermseekstorestrictliabilitytoaspecifiedsumofmoney,thequestionofwhethertherequirementofreasonablenesshasbeensatisfiedmusttakeintoaccounttheresourceswhichthepersonseekingtoimposeitcouldexpecttobeavailabletohimforthepurposeofmeetingtheliabilityshoulditarise,andhowfaritwasopentohimtocoverhimselfbyinsurance.Whatisrelevanthereistheavailabilityofinsurancecoverratherthantheactualinsuranceposition.Thefactthatthesolicitorinsureshimselfforsubstantiallymorethanthelimitationshouldnot,initself,establishthatthelimitationisunreasonable.Giventhe“claimsmade”natureofprofessionalindemnityinsurance,itshouldberememberedthatthecurrentlevelofcovermaynotbeavailableinthefuturewhenaclaimmaybemadeagainstthefirm,orwhenacircumstanceisnotifiedtoinsurers.

5 “Reasonableness” guidelines

• Schedule2ofUCTAsetsouttherelevantfactorstobeconsidered:

a) Thestrengthofthebargainingpositionofthepartiesrelativetoeachother,takingintoaccount(amongotherthings)alternativemeansbywhichthecustomer’srequirementscouldhavebeenmet.

[Inthecontextofcommercialtransactions,inmanycasestheclientwillhavesubstantialbargainingpower,forexample,becauseofitscorporatesizeandfinancialstrengthoritsabilitytoinstructthefirm’scompetitorsifitdislikesthefirm’sproposedterms.(InWatfordElectronicsvSanderson(2001),theCourtofAppealstatedthatthecourtsshouldbeslowtointerferewithlimitationclausesnegotiatedbycommercialpartiesatarmslength.)Theremay,however,beparticularcircumstanceswheresuchapparentbargainingpowermaybediminished,forexample,wheretimepressuresleavetheclientinaweakposition.(InStAlbansCity&DistrictCouncilvInternationalComputers(1996)theCourtwaspreparedtotakeintoaccountthesuggestionthattheclaimantswere“overabarrel”becauseofatighttimetable.)]

b) Whetherthecustomerreceivedaninducementtoagreetotheterm,orinacceptingithadanopportunityofenteringintoasimilarcontractwithotherpersons,butwithouthavingtoacceptsimilarterms;

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OCTOBER2013@c) Whetherthecustomerkneworought

reasonablytohaveknownoftheexistenceandextentoftheterm(havingregard,amongotherthings,toanycustomofthetradeandanypreviouscourseofdealingbetweentheparties.)

• The SRA Handbook clearly states that any limit of liability must be in writing and brought to the client’s attention.

• It is important to be able to demonstrate that your client was made fully aware of the existence, scope, and terms of the limitation clause. In the event it is challenged, your firm’s position will be strengthened if you can demonstrate the reason for the introduction of the limitation was explained to the client in simple terms, and more so, if the client took independent legal advice on the limitation clause itself. It is not sufficient to simply have the limitation set out in the small print of your Terms of Business which you send to a client with your engagement letter – it is unlikely that your client will have read them. Some firms refer to the limitation in bold type or in a different colour in the engagement letter in a section headed “Limitation of our liability” or similar. It is good practice to use the sending of the engagement letter as an opportunity to engage with your clients on the financial limitation you are seeking to impose – explain the limitation in detail and ask the client to call you to discuss should the need arise. It is the practice of some larger firms seeking to limit liability to insist clients take independent legal advice.

• Themereinclusionofalimitation/exclusion/disclaimerinyourtermsofbusinesswillprovidenoguaranteethatyourfirm’sliabilitywillinfactbelimitedinthemannerstated.However,whatsuchaclausewillofferyourfirmistheopportunity,inrelationtotheparticularengagement,toprovethatthelimitationisreasonableifitischallenged.Ifthereisnolimitationclause,it’sanopportunitylost!Remember,however,thatawelldraftedengagementletter,settingoutpreciselywhatyourfirmwillandwillnotbeundertaking,remainsthemostpracticalandeffectivemeansoflimitingyourfirm’sexposure.

• Marplace (Number 512) LimitedvChaffe Street [2006] EWHC 1919 (Ch)istheonlysubstantivedecisiononthesubjectoflimitingtheliabilityofsolicitors.Thedefendantsolicitorswereretainedaspartofateamofprofessionalsadvisingtheclaimants,whowereexperiencedbusinessmen,ontheacquisitionofaclothingcompany.Theteamincludedaccountantsandcorporatefinanceadvisers,whoprojectmanagedthedealand,withtheclaimants,dealtwithitsfinancialstructure.

Itwasacriticalpartofthedealfortheclaimantstoensurethatthecompanywouldcontinuetoreceivepaymentsforcertainclothingstockpost-completion.However,aftertheagreementhadbeenexchanged,theclaimantslearntthatthecompanyhadenteredintoadealtohavepayments,whichwouldhavebeenpaidpost-completion,paidpre-completion,ineffectacceleratingthepayments.Asaresult,theagreementfellthrough.

Thesolicitors’engagementlettercontainedaliabilitycapthatsaid:“Youagree...ourmaximumaggregateliabilitytoyouintheeventofprofessionalnegligenceonanymatterinrelationtowhichweareinstructedshallbe£20m.”Itadded:“Shouldyouwanttovarytheselimitationsweshallbepleasedtodiscussitwithyoubutwereservetherighttovaryourfeesaccordingly.”ThecourtupheldthecapasreasonableforthepurposesoftheUCTAtestbecause:

• theclientswerefamiliarwithlimitationofliabilityclausesinprofessionalcontracts;

• theclientshaddiscussedthelimitationprovisionwiththesolicitorsandithadnotbeenimposeduponthem;

• theretainerincludedaprovisionconcerningdiscussingvariationofthecap;

• thecapwasdeterminedonreasonablecommercialprinciples,takingintoaccountinsurancecoveranditsexpenseaswellasthecircumstancesofthetransaction;

• andthebargainingpositionsoftheclientandfirmwereequal.

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Thematerialcontainedin@riskisissuedbyZurichanddoesnotestablish,reportorcreatethestandardofcareforsolicitors,nordoesitrepresentacompleteanalysisofthetopicspresentedorconstitutelegaladvice.Itisintendedtohighlightissueswhichmaybeofinteresttoourcustomers.Readersshouldconducttheirownappropriateresearchonhowtoactinanyparticularcase.

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Editor:AndrewNickelsTelephone:02076483698

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