10 Minute Guide: understanding limits and exclusions of liability (1)
Negotiations often get bogged down while the lawyers argue about liability: why is it important and what are the essential points for business people to understand?
Introduction to the issues
It is normal to have some caveat at
the end of short guides like this, advising readers to take professional
advice before acting on the contents of the guide. Perhaps in this case,
it would be as well to have the caveat upfront - because the law in
this area can change very quickly, leading swiftly to changes in practice.
Do make sure you check the latest position with your adviser. The assumption
in this note is that you are dealing with another commercial undertaking
- different and more stringent rules apply if you are dealing with consumers.
In short - this is not an area for the part-timer, do get some proper
legal advice. This guide will only give you the basics.
Is this stuff important?
Perhaps this is a strange question
to pose at the beginning of this guide: if you are reading it, it must
be important. Yet so often the really important points can get lost
in a tangle of lawyers' points about drafting and law.
There are really two ways of looking
at it. First, setting out the limits and exclusions of liability marks
out who is liable for what when things go wrong. In reality, you are
saying what each party should be responsible for when it comes to taking
out its insurance. In that sense, it is important for your business
to have clear statements of what you could be liable for in each commercial
contract: it could short-circuit large claims being made against your
business (or at least make them difficult to bring).
Secondly, by setting out maximum liabilities,
you are saying something about the risk profile of your business as
a whole. This is important when it comes to such things as raising finance:
no-one is going to provide money to a business which has not made proper
provision for limiting its risk in its commercial contracts. Due diligence
is often made of commercial contracts precisely to ascertain whether
the business' risk profile is acceptable to the investor.
Basic considerations
Probably no area of law or drafting
gets IT lawyers so exercised as when it comes to drafting or negotiating
limitations or exclusions of liability. Why should that be? There are
basically two problems:
- courts tend to be very precise
in interpreting limitations and exclusions of liability, construing
them against the interest of the party relying on them (normally the
supplier or service provider)
- the operation of the Unfair Contract
Terms Act 1977 (often referred to as “UCTA” and pronounced “UCK-tar”)
makes unreasonable limitations and exclusions of liability ineffective
in some cases, and so exposing the supplier or service provider to open-ended
liability if those clauses are struck down
So the wording of such clauses has
be spot-on, added to which, even if they are precise, they face the
constant threat of being struck down because of UCTA. Moreover, the
attention given to them by lawyers has led to their being in many cases
a central point of disagreement in negotiations, involving not just
the lawyers but commercial people in their consideration and drafting.
What the Unfair Contract Terms Act 1977 says
UCTA lays down a number of principles
which have to be taken into account. The more important ones are as
follows:
- it is not possible to exclude liability
for death or personal injury resulting from negligence
- as regards limiting or excluding
liability for other losses arising from negligence, such limitations
or exclusions have to be “reasonable”
- you cannot exclude liability for
the implied terms relating to title and quiet possession (to be honest,
this is not one which is normally contentious in IT contracts)
- you can exclude or limit liability
for other implied terms relating to the quality or fitness for purpose
of goods but only if those exclusions or limitations are “reasonable”
- if one party is relying on its
“written standard terms of business”, any exclusions or limitations
have to be “reasonable”
- if you are excluding or limiting
liability for any pre-contractual misrepresentations, then those exclusions
or limitations again have to be “reasonable” (UCTA makes an amendment
here to the original Misrepresentation Act 1967)
BSkyB v EDS and the question of fraud
The general law provides that you cannot
exclude liability for your own fraud, and contracts frequently provide
that nothing in the contract is intended to do so. (This is a precaution
against one line of cases which held that clauses which on their face
excluded liability for fraud could not be relied on - these cases are
probably no longer good law, but the practice has continued. For the
same reason, it is common to see a clause making clear that liability
for death or personal injury caused by negligence is not excluded or
limited.) A well-known case of fraud was the BSkyB v EDS case
recently, when fraud meant that EDS could not rely on its limitations
or exclusions of liability and faced a claim for some ?700 million
(settled on appeal for over ?300 million).
Some legal wrinkles in the Unfair Contract Terms Act 1977
You should also be aware that parts
of UCTA do not apply to international supply contracts - so some modern
contracts dealing with international procurements, for example, might
fall outside UCTA.
Another legal wrinkle is that UCTA
was drafted before the modern technological age, so it talks a lot about
goods, but says nothing about software; from one important case, a possible
conclusion is that where software is not “goods”, it has to be regarded
as a service (e.g. where it available for download only), so some parts
of UCTA relating to excluding or limiting liability for implied terms
as to goods might not apply. Having said which, similar principles have
been found to apply to software under the general law, and other principles
flow from the Supply of Goods and Services Act 1982. In any case, UCTA
would still apply when it came to excluding or limiting liability for
pre-contractual misrepresentations or when considering “written standard
terms of business”. These are very complex issues going beyond the
scope of this brief guide.
Understanding some difficult expressions in the Unfair Contract Terms Act 1977
Some words and phrases above have been
put in quotes, because they need to be carefully understood.
- “written standard terms of business”:
some contracts are routinely signed without ever being read, others
are extensively negotiated and go through numerous iterations and re-drafts.
In between, there are standard contracts which receive just a few changes.
How far does something have to be re-drafted before it ceases to be
“written standard terms of business”? There is no absolute rule,
but it does appear that a set of terms could still be considered “written
standard terms of business” even though they have received some input
from the customer. It will be a question of fact and degree in every
case.
- “reasonable”: UCTA itself points
to some factors that should be considered in understanding this expression
and the courts have routinely considered them and others in determining
whether a term satisfies the requirement of reasonableness. These factors
include
- Strength of bargaining position
(note that this does not mean that you only look at the parties' respective
size - a smaller purchaser might have lots of choice, and be able to
impose its own terms on a much larger supplier in a competitive tender,
for example)
- Availability of insurance (in
practice, the courts are extremely interested in this question, and
drafting of terms should take place against an understanding of the
insurance position)
- Whether the customer knew or
should have known of the terms limiting or excluding liability (note
that it is not a legal requirement in this country to put exclusions
or limitations of liability in CAPITAL LETTERS - this is a practice
that has come across from the USA)
- What terms does the customer
contract on? If a customer is trying to invoke UCTA to knock down an
exclusion of loss of profits, then a court will have less sympathy if
that customer's own standard terms include an identical exclusion
There has been a marked swing in the
direction of the judicial breeze in recent years. Some years ago, it
was common for judges to strike down the limitations and exclusions
typically used by IT companies. However, that has recently changed,
and it now seems that the courts are far more likely to uphold the straight
meaning of a limitation clause - note that a complete exclusion of a
particular liability is still very likely to face far stricter judicial
scrutiny than just a limitation.
Some essential points to look out for
What should you look out for? There
are many points to be made here, but in trying to draft a limitation
or exclusion with the best chances of survival, the main things to look
at are as follows:
- Don't try to exclude fraud or liability
for personal injury or death caused by negligence; while it is a wearisome
legal technicality, it is best to have a separate clause carving these
out
- Do be precise about what you are
trying to say. This is an area where legal technicalities abound, so
a limitation of damages might not apply to a claim for a return of money
paid (because that is the “price”, not “damages”)
- Do consider each deal as a one-off,
as UCTA looks at reasonableness in the context of when the contract
was made. Limitations and exclusions are part of a total deal, and should
be treated as such, not some rarefied area for academic legal analysis
- Do keep drafts and records of negotiations,
as they could well be useful in showing that the negotiation was a fair
one with give and take, leading to terms that are “reasonable” in
the circumstances, or even that the final result was no longer “written
standard terms of business”
- Don't try a blanket exclusion of
all liabilities - these are a fair target and courts would probably
strive to find a way around them or use UCTA to break them down - remember
the effect of a defective clause is that you have no protection at all,
as you are left with unlimited liability
- Do try to look at the sorts of
losses likely to arise from a contract and make some attempt to limit
them having regard to the “reasonable” factors
- Do consider specific exclusions
as they may still be appropriate, such as an exclusion of loss of profits,
where the court may well hold that this is the sort of thing the customer
could get its own insurance for (and there are some recent cases showing
that the courts are sympathetic to this sort of exclusion)
- Do have regard to insurance cover,
and make this explicit in the contract where appropriate - a court is
more likely to say a limitation or exclusion was “reasonable” if
a clause made it clear that the customer was responsible for taking
out its own insurance for that sort of loss
- One recent case shows that very
clear wording is needed to exclude or limit liability for loss resulting
from a party effectively walking away from a contract
An important point: consequential loss and loss of profits
One last point - it relates to a myth
about the meaning of what is often called “consequential” or “indirect”
loss. Many people (still) think that these expressions include or even
refer to loss of profits or failure to make anticipated savings - THEY
DO NOT. If you wish to exclude liability for these sorts of losses,
then you must say so explicitly, as it is now clear law (and has been
for some time) that the expression “consequential or indirect loss”
does not of itself include loss of profits or failure to make anticipated
savings.
Remember, this guide will not equip
you to draft a clause capable of defeating the finest legal minds in
the land - but it will help you to understand the issues at stake and
take part in the negotiations while appreciating what the lawyers are
talking about and why that is important to your business.
Notes
(1) Copyright Richard Stephens 2010.
The law is stated as at 22 October 2010.
This note is intended to provide general
information about legal developments in England & Wales and you
should not apply any of the advice or information contained in it to
specific situations without seeking professional advice first.