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.