GUIDANCE NOTE

HOW TO DRAFT AN EXCLUSION &/OR LIMITATION OF LIABILITY CLAUSE

1 INTRODUCTION

1.1 Quite often, the drafting of the exclusion/limitation of liability clause is regarded by the client as pure

“legal boilerplate” and not, as it really is, a key part of the commercial deal.

1.2 A standard clause will often be briefly discussed in isolation from the commercial terms in the contract. Usually, it will exclude liability for “consequential loss” and “loss of profits” and limit all other liabilities

under the contract to a specified sum and record that liability.

1.3 There will probably be a short discussion to the effect that the enforceability of the clause cannot be guaranteed and things will be left at that.

1.4 What is wrong with this approach?

1.5 An important function of a commercial contract is to allocate risk between the contracting parties. For

example, in a computer systems supply agreement, it is vital to draw the line between those aspects of the system‟s performance for which the supplier agrees to take responsibility and those which are at the customer‟s risk.

1.6 The role of the exclusion/limitation of liability clause is, so far as permissible, to draw that line in valid and enforceable terms.

1.7 Of course, contract may contain a number of provisions which are, in substance, exclusion or limitation of

liability provisions. For example, in a computer supply contract, the clause dealing with testing and acceptance may also include provisions that exclude liability for non-performance where the functionality in question had been tested and accepted by the customer.

1.8 But whether exclusion or limitation of liability provisions are contained in one or several contract clauses, care needs to be given to them.

1.9 Health Warning: Please note that this guidance note does not constitute legal advice.

2 FIVE STEP APPROACH

2.1 In a nutshell, you should follow the following five-step approach in drafting exclusion or limitation of liability provisions:

2.2 Step 1: Identify the express and implied obligations to be covered by the clause(s).

2.3 Step 2: Remember rules of contract construction. Unless the exclusion clause is clearly worded, the

Courts will often find that the clause is invalid. If they do, then the issue of the enforceability of the clause under UCTA 1977 does not even arise.

2.4 Step 3: Be aware of liabilities that cannot be excluded – see UCTA 1977

2.5 Step 4: Decide whether you are advising on a business to consumer or business to business contract – as the footnotes show, many exclusion clauses will be void in the case of consumer contracts whereas those in business to business contracts will be subject to the reasonableness test.

2.6 Step 5: Draft the exclusion/limitation of liability clause.

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3 STEP 1: IDENTIFYING THE OBLIGATIONS

3.1 There are basically five categories:

3.1.1 Those that arise under an express contract term.

3.1.2 Those that arise under a contract term that is implied by statute e.g. those implied under the Supply of Goods (Implied Terms Act)Act 1973, the Sale of Goods Act 1979, the Unfair Contracts

Terms Act 1977 and the Supply of Goods and Services Act 1982.

3.1.3 Those that arise under a contract term that is implied by common law e.g. a term as to quality and fitness of purpose.1

3.1.4 Those that arise in tort e.g. under the law of negligence.

3.1.5 Those that arise as a matter of strict liability under statute e.g. Occupier‟s Liability.

3.2 This Guidance Note focuses on the first four categories.

3.3 Generally speaking, implied terms only operate where there are no corresponding express terms in the contract.

3.4 So before even considering the issue of exclusion and limitation of liability clauses, you need to identify

the express and/or implied terms that are going to be the subject of your exclusion and limitation of liability clauses.

3.5 Obviously, these terms vary according to the nature of the goods or services supplied. But typically, they include the following issues:

3.5.1 Title

3.5.2 Quality.

3.5.3 State and condition.

3.5.4 Freedom from defects, errors, bug etc.

3.5.5 Reliability

3.5.6 Functionality.

3.5.7 Conformity with customer‟s requirements, whether stated or apparent to the supplier.

3.5.8 Performance criteria

4 STEP 2: REMEMBER RULES OF CONTRACT CONSTRUCTION.

4.1 In Pegler Limited v. Wang (UK) Limited, heard in Technology & Construction Court on 25 February 2000,

the Court determined that, on a proper construction of the contract, liability for delayed or non-performance was not covered by the exclusion clause. The clause only covered default after supply of the computer system.

1 Per Sir Iain Glidewell in St. Albans City Council v. ICL [1995] FSR 686. He held that ‘software’ did not constitute ‘goods’

within the SGA, a disk holding it which was sold or hired would constitute goods. However, a term as to quality or fitness

for purpose was to be implied at common law.

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4.2 “Consequential Loss” – this is often confused – or, rather, used to cover, loss of profits not arising in he

ordinary course. In Pegler v. Wang Judge Bowsher followed the distinction drawn in the earlier cases

between loss of profit falling within the first limb of Hadley v. Baxendale (i.e. those which flow as a natural consequence of the defendant‟s breach of contract) and those within the second limb (i.e. those which are „special‟ in the sense that they could not have anticipated by the defendant, such as those that

would arise from an exceptional and particularly lucrative contract).

5 STEP 3: BE AWARE OF LIABILITIES THAT CANNOT BE EXCLUDED – SEE UCTA 1977.

5.1 See UCTA 1977 re: negligence liability (s.2). If a party “deals as consumer”, then liabilities implied into

the contract for the sale of goods under SGA and SGSA re: quality, fitness for a particular purpose, conformity with description cannot be excluded. If the customer is not a business customer, then the validity of the clause will depend upon whether it satisfies the reasonableness test. (s. 6). Presumably, if

the contract contains express provisions dealing with those liabilities, the position is the same.

5.2 If a contract is on the supplier‟s “written standard terms of business” - see the Salvage Association case (Salvage Association v. CAP Financial Services [1995] F.S.R. 654 – or is a consumer contract, then the

supplier cannot exclude or limit liability when he is in breach of contract or claim to render a substantially different contractual performance from that reasonably expected or not to perform at all (s.3)

5.3 NB: Section 3 of UCTA will cover express terms and contract terms implied by statute and common law. So although section 6 would not apply to a contract for the supply of services (because it only covers goods), section 3 would apply to contract terms implied into a contract for the supply of services – see

above as long as it is on the supplier‟s “written standard terms of business.”

6 STEP 4: DECIDE WHETHER YOU ARE ADVISING ON A BUSINESS TO CONSUMER OR BUSINESS TO BUSINESS CONTRACT

6.1 If it is „b2b‟, the exclusion and limitation of liability clauses will need to satisfy the „reasonableness test‟ in UCTA2

7 STEP 5: PROCESS FOR DRAFTING THE EXCLUSION/LIMITATION OF LIABILITY CLAUSE

7.1 Remember that in the case of a „b2b‟ contract, the exclusion or limitation of liability clause will need to satisfy the reasonableness test so bear this in mind in the drafting process If it is a consumer contract, be aware of the exclusion or limitation of liability provisions that will be void.

7.2 In relation to exclusions that you wish to incorporate, you can either put them all in one exclusion clause or deal with them in the same clause that deals with the liability. For example, in a clause relating to the provision of customer data, include an exclusion for errors in data that were obtained by the supplier

from a third party. This „case by case‟ approach is probably appropriate to a supplier agreement that has extensive supply obligations. It might be particularly appropriate to the consequences of late supply.

7.3 For more „generic‟ forms of liability such as loss of profits, that should be included in the exclusion/limitation of liability clause. Remember that consequential loss does not automatically include loss of profits. If it is intended to seek to exclude liability for loss of business profits whether or not

arising in the ordinary course of business, then say so. Alternatively, it may be preferable to seek to

2 Summarise ‘test’

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exclude liability for loss of profits not arising in the ordinary course3 but to limit liability to for other loss of profits to a specified sum.

7.4 Assuming the contract contains express provisions that correspond with the terms that would otherwise by implied by law, it would be prudent from the supplier‟s perspective to include a provision as set out in 8 below.

7.5 Unless you are under pressure to keep the contract short, it is good practice to expressly state that liability is not excluded for death or personal injury caused by negligence.

7.6 The limitation clause should include an overall monetary limit and a time limit. This needs to be fixed in

the light of the circumstances of each contract including the following factors:

The value of the contract

The respective bargaining powers of the parties

The amount of insurance available to the supplier

The availability of alternative sources of supply.

8 THE EXCLUSION AND LIMITATION OF LIABILITY CLAUSE

8.1 The clause can begin with an acknowledgement of that liability is not excluded for death or personal injury caused by negligence. This could be in the following form:

“The liability of ……”

8.2 Assuming the contract has excluded particular types of liability on a clause by clause basis as recommended above, then there will be no need to repeat them in the clause (e.g. exclusion of liability

for delays caused by the customer. If not, then appropriate exclusions need to be incorporated in the exclusion clause.

8.3 Assuming the contract has included terms, conditions and warranties that would otherwise be implied into the contract, then it will be sensible to include the following clause:

“Except as expressly……….”

8.4 The clause should then, if desired, deal with the issue of consequential loss. A possible clause is:

“[Neither party] [The Supplier] shall be liable for any loss of profits or loss of business [whether or not arising in the ordinary course of business] as a result of any breach of contract, breach of duty or other default [by the other party] [by the Supplier]”

8.5 The clause should then deal with the limitation of liability in money and time, other than in relation to

liabilities as mentioned in 8.1

Laurence Kaye

Laurence Kaye Solicitors

3 If desired, the contract could expressly record that the parties agree that [X] and [Y] would not be regarded as arising in the

normal course of business.

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© Laurence Kaye 2008 T: 01923 352 117

E: laurie@laurencekaye.com www.laurencekaye.com http://laurencekaye.typepad.com/

This guidance note is not intended to be exhaustive and it does not constitute or substitute legal advice, which should be sought on a case by case basis.

Please feel free to copy or make available this guidance note without modification in print or electronic form for non-commercial purposes. If you do so, please include this disclaimer and copyright wording with attribution. If you want to re-publish or make the whole or part of this guidance note available in a commercial service or

publication, please contact the author at laurie@laurencekaye.com.