Minimising risk in contracts — excluding and limiting liability

Exclusions and limitations of liability are often included in contracts as a way of minimising a party’s potential exposure to loss. Accordingly, they are usually subject to significant negotiation.

Here, solicitor and commercial law specialist Andreas Petrou provides a brief overview of what these clauses mean and what to look out for in your contracts.

What are exclusions and limitations of liability?

A contract is an agreement between parties that sets out the nature and extent of obligations that each party is responsible (or ‘liable’) for. Unfortunately, things don’t always go as planned. For example, if a party is in breach of its obligations, it may be at risk of a claim from the other party in respect of that breach.

Without an express exclusion or limitation of liability clause, the party that was in breach would have unlimited liability. This means that there would be no financial limit in the contract on what the other party might recover. Therefore, if the other party had incurred significant losses, they could recover the entire amount.

This presents a significant risk for parties to a contract. That’s why express clauses are included that exclude and limit liability. This is often achieved with reference to an overall financial cap, so that each party knows what their maximum ‘exposure’ is.

Drafting exclusion and limitation of liability clauses

While it may be tempting for a party to try and exclude all losses under a contract, there are legal rules and principles that dictate what can legally be excluded or limited.

A badly drafted exclusion or limitation of liability clause that doesn’t account for these rules could mean that the entire clause is unenforceable, which would result in the party being subject to unlimited risk again.

In B2B (business to business) transactions, UCTA (the Unfair Contract Terms Act 1977) operates to prevent a party from excluding or limiting its liability for any losses arising from its own negligence completely for death or personal injury — and for any other losses, only where the exclusion or limitation satisfies the reasonableness test.

An exclusion or limitation clause must also satisfy the reasonableness test under UCTA where a party is using its standard terms of business and wants to exclude or restrict its liability for breach of contract.

A clause satisfies the reasonableness test under Section 11 of UCTA where “the term shall have been a fair and reasonable one to be included 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”.

Parties must be careful when drafting B2B exclusion and limitation of liability clauses to ensure that they don’t fall foul of UCTA requirements.

Financial caps

Parties often seek to limit their liability with reference to an overall financial cap. This can go some way to satisfying the reasonableness test in B2B contracts, with losses limited to an amount rather than excluded completely (the latter being more likely to be deemed ‘unreasonable’).

The cap may be linked to levels of insurance that a party can obtain in respect of the potential losses, the price of the contract itself (or a percentage of it) or the level of charges within the previous financial year. The cap may also apply to any one claim or a party’s total aggregate liability for all claims under a contract.

The position reached often depends on the bargaining strength of the parties, though an eye should always be kept on UCTA requirements to ensure that the cap is not at risk of being deemed unreasonable and therefore unenforceable (for example, if the cap is too low — bearing in mind the particular circumstances of a contract and the potential losses that might be incurred).

However, it’s important to remember that some losses can’t legally be limited, including death and personal injury. Some parties to a contract may also seek to exclude certain losses from any cap, such as TUPE liabilities or indemnities, or potential losses that would greatly exceed the cap (such as fines for data protection breaches). Therefore, while a cap is very useful, it may not be a catch-all solution. Further, when reviewing a contract, it’s critical to understand what lies outside of the scope of any such cap.

Careful consideration

This is only a brief overview of some of the matters relevant to exclusion and limitation of liability clauses. Drafting such clauses is far from straightforward — there have been many cases over the years concerning these clauses and what losses parties have been able to legitimately exclude or limit. Careful consideration should always be paid whenever you come across these types of clauses in contracts.

If you need to discuss any type of commercial contract, our team can help you to get them ‘right’ and ensure that they will help to achieve your business objectives.