Authors: Partner | Lawyer Guy Leonard and Associate Heidi Magnussen
Commercial parties entering into an agreement – whether it is an agreement for the sale of goods, a distribution agreement, or a cooperation agreement – will generally be concerned about the liability they may incur arising from their contractual obligations. Exclusion clauses can be found in nearly all such ‘business-to-business’ contracts, and both parties will have a separate interest in drafting the clause in such a way as to minimise their own liability if things should go wrong. However, not all liabilities may legally be limited.
Controls on limitation clauses under English law
Since parties may not always have equal bargaining power, English law stipulates different ways to restrict the effect of unfair limits on liability. A party’s liabilities are usually divided into:
- Liabilities you cannot limit.
- Liabilities you can limit if you mention them expressly.
- Liabilities you can limit if the clause is clear enough.
- Liabilities you can limit by a reasonable clause if UCTA applies.
A restriction of liability that offends these controls is normally unenforceable. The rest of the contract remains enforceable under the principle of severance, which applies even to contracts lacking an express severance clause.
Liabilities you cannot limit
Some liabilities simply cannot be limited, and a clause that purports to do so will therefore be void. This is the case for fraud (dishonesty) by a contracting party.
Moreover, where the Unfair Contract Terms Act 1977 (“UCTA”) applies to the contract the contracting parties may not limit their liability for injury or death caused by a lack of reasonable care, or for supplying goods without the right to do so.
It is common practice to preserve these liabilities, or some of them, expressly in the contract. It is, however, doubtful whether there is any legal need to do so.
Other contractual clauses falling within the ambit of UCTA will be valid only if they pass the reasonableness test set out in section 11(1) of the Act. This includes clauses limiting liability for breach of standard terms, negligence, misrepresentation etc.
A clause will only pass the reasonableness test if it was fair and reasonable to include the term in the contract, considering everything the parties knew or should reasonably have contemplated when they entered into the contract. The test is easily satisfied in a fully-negotiated clause between commercial parties of roughly equal bargaining power, especially if both parties understood the risks and were advised by lawyers.
The more prominent, heavily negotiated and well understood the clause, the more likely it is to be upheld. The test is harder to satisfy in standard terms, especially if the limitation clauses are not prominent. However, reasonableness will always depend on the facts and context of the transaction.
UCTA will apply to most ‘business-to-business’ agreements, but not all. For instance, international contracts are often exempt. UCTA is designed to regulate limitation clauses in the UK; it is not meant to interfere with international trade. Thus contracts for the international supply of goods are completely exempt from UCTA’s controls. English-law contracts with an international element are also exempt if they lack a strong connection with the UK.
UCTA also partially exempts shipping contracts (charterparties, carriage of goods by sea, salvage and towage). If UCTA applies to the contract, i.e. it is a contract with sufficient connection with the UK, the parties cannot limit liability for personal injury or death caused by negligence, but the UCTA reasonableness test will not apply to the contracts.
Liabilities you can limit if you mention them expressly
Some liabilities must be limited expressly, and a general limit on liability arising out of the agreement will not affect them. Specifically, these are liabilities arising from negligence and breach of statutory implied conditions in sale of goods, e.g. the requirements that goods are of satisfactory quality and that they are fit for any purpose made known to the seller.
Therefore, if a party wants to limit its liability for negligence or breach of implied terms, specific reference to these liabilities and their exclusion/limitation needs to made in the contract. A general exclusion wording, without specific reference to such liabilities will not be sufficient.
Liabilities you can limit if the clause is clear enough
Some liabilities can be limited by clear wording - that is, they are effective if they survive restrictive interpretation. These are liabilities arising from dishonest or deliberate breach by another person. In this respect, it is important to note that a party cannot limit liability for its own dishonesty, but may limit its liability for the dishonesty of an employee, agent or sub-contractor.
English law lays down a complicated set of rules for the exclusion/limitation of liability. It is therefore important to take care when drafting provisions that seek to limit or exclude liability for particular types of default. In this analysis, it is also sensible to verify whether UCTA would apply to the relevant agreement.
In our next newsletter, we consider the exclusion of special, indirect, incidental or consequential losses under English law and the potential traps and pitfalls that may arise in seeking to exclude such liabilities from a contract.