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Limiting Liability part 2: What can be excluded?

This article looks at exclusion clauses and how to ensure that they are effective and enforceable.  

Some exclusion clauses seek to exclude liability altogether whilst others seek to exclude certain specific heads of loss, such as loss of profit or loss of business. A clause that seeks to exclude liability altogether is likely to be viewed as unreasonable and therefore unenforceable. It is therefore vital when negotiating such clauses to know what is important to your business and to take a sensible and practical approach which protects those interests without going too far.

There is of course a wealth of case law which looks at the criteria that an exclusion clause must satisfy in order to be upheld. In this article we are not able to discuss all of the relevant case law, but we strongly recommend that you keep up to date on the latest developments as this can greatly impact the enforceability of your exclusion clauses.

All’s fair in commercial contracts

The law recognises that a party may limit its liability for loss; however, this is not without restrictions. Many exclusion clauses are subject to the test of reasonableness set out in section 11 of the Unfair Contract Terms Act 1977 (UCTA). Under section 3, the UCTA reasonableness test applies to business to consumer contracts and standard business to business terms and conditions, but does not govern bespoke business to business contracts.

The UCTA reasonableness test stipulates that any exclusion clause must be “fair and reasonable … having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.” Unfortunately while Schedule 2 of UCTA stipulates some factors which may be relevant to an assessment of reasonableness (such as bargaining power, ability to insure or if there has been any inducement to accept an exclusion), UCTA does not define what is actually meant by “reasonable”. This means that ultimately it is a matter for the courts to decide and each case will turn on its own facts.

As a general rule, a complete exclusion of liability will be deemed unreasonable but a cap on liability may be considered reasonable. If an exclusion clause is found unreasonable, it will be deemed wholly unenforceable. This will mean the party seeking to exclude their liability will be liable for all of the other parties’ loss recoverable on ordinary principles.

Therefore, as tempting as it can be to try and exclude liability on a broad brush basis, any attempt at a blanket exclusion clause is highly likely to fail the reasonableness test. A narrower and more considered approach which focuses on the specific and real risks for your business is, in the long run, likely to provide more effective protection.

Drafting tip: when drafting an exclusion clause, separate out the different heads of liability which you are seeking to exclude, so to increase the chance that if one head of loss is considered unreasonable the remainder of the clause will be enforceable.

What kind of things can you exclude liability for?

There are two types of loss under a contract, direct and indirect.

Direct loss: Direct loss is a loss arising naturally, that is, according to the usual course of things, from the breach of contract, and is therefore reasonable and foreseeable. For example, if you contracted to provide a customer a system to a particular specification, but failed to do so, the costs the customer incurred buying a replacement system would be considered a direct loss. 

Indirect loss: Indirect losses are those which arise from a special circumstance of the arrangement and which were reasonably supposed to be in the contemplation of the parties at the time they made the contract as a probable result of the breach. So, in the same scenario, if your customer had told you that they needed the system to be fully operational by May in order to fulfil a contract with a key client but they lost that contract because you failed to supply a compliant system, the value of the lost contract might be considered an indirect loss.

Nine out of ten times parties will seek to exclude liability for indirect loss and this can be a good starting point for limiting your liability. A supplier will also typically be concerned with restricting its liability for certain types of financial loss such as loss of profit, loss of revenue, loss of anticipated savings. The reason for this is two-fold.

  1. The customer may be better placed to protect against such liability (for example, by relying on business interruption insurance)
  2. The potential costs could dwarf any margin the supplier could achieve under the contract. There is a common misconception that such financial losses will always be indirect or “consequential” losses. The courts, however, have shown willingness to interpret direct loss quite widely 

Drafting tip: when negotiating any exclusion clause make sure that you think about the types of losses which you wish to exclude and to clearly list these out. Any ambiguity is likely to be construed against the party seeking to rely on the clause.

Entire agreement clauses

An entire agreement clause is another way to limit exposure under a contract as it ensures that no document or representation outside of the contract is binding.

A typical entire agreement clause may state that no other documentation or representations (both oral and written) or other terms and conditions form part of the contract and that neither party has relied on any representation in entering into the contract.

Although common, any entire agreement clause must be carefully thought through. For example, if you have relied on statements the other party has made during the tender stage about their ability to perform the contract, then an entire agreement clause which includes a statement of non-reliance would prevent you from bringing a claim if crucial statements made during the tender process proved to be untrue.

What can’t you exclude liability for?

Certain statutory rules mean that it is impossible to exclude or limit liability for personal injury or death caused by a party’s negligence or fraud or fraudulent misrepresentation.

Overall, as with caps on liability, there is no definitive answer for how to draft your exclusion clauses as the circumstances and nature of the contract will be key. Exclusion clauses are commonly negotiated so it is important to constantly be alert to changes in the law and always bear in mind the businesses’ commercial goals.

This article is part of a series on limiting liability. In part 1 we focussed on caps on liability in commercial contracts and provided hints and tips for drafting and negotiating these clauses. Please read Limiting Liability Part 1: How long is a piece of string? for more information. 

Authors: Sophie McKibbin & Catherine Harrison 

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

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Craig Chaplin

Partner - National Head of Commercial & Competition

I am a Partner and Head of the Commercial & Competition Team.