20 Apr

Limiting liability in commercial contracts is an important topic. It's also quite complex. One of the main ways to limit liability is to include in a contract a specific cap on how much one party will be liable to another party if there's a breach of contract. 

Here is some general (and non-exhaustive) guidance on contractual limits of liability before looking at some specific examples:

In order for an exemption clause to be effective, it must be: 

  • clear and unambiguous; and
  • over the liability or obligation in question.

Generally, the party seeking to rely on the limiting clause has to prove that it covers the liability or obligation in question. 

If a clause is so broad that it defeats the main purpose of the contract, the courts may limit or modify the clause to the extent necessary to give effect to the main object and intent of the contract. 

If an exemption clause leaves a party with no effective remedy, the courts may apply an alternative interpretation if available.

Certain types of liability cannot be limited or excluded by law, including for death or personal injury caused by negligence, implied terms as to title, fraud and fraudulent misrepresentation.

Certain types of liability can only be limited or excluded to the extent the reasonableness test in Unfair Contract Terms Act 1977 (UCTA) is satisfied. A term will be reasonable if it is "a fair and reasonable one to be included having regard to circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made". 

The five guidelines to interpreting "reasonableness" laid down in Schedule 2 to UCTA are, in summary:

  • the relative strengths of the parties' bargaining positions;
  • whether the customer received any inducement to accept the term;
  • whether the customer knew or should have known that the term was included;
  • in the case of a term excluding liability if a condition is not complied with, the likelihood of compliance with that condition at the time the contract was made; and
  • whether the goods were made or adapted to the special order of the customer.

Here are some of the ways contractual liability may be capped:

Fixed sum limit: The simplest form of financial cap is a fixed amount, for example, £1m. Where appropriate, this formulation is always preferable as it leaves no room for ambiguity.

The cap may be linked to the value of the level of insurance held by the supplier, the value of the contract or to the potential amount of any damage which may be caused by a breach.

Liquidated damages limit: Liquidated damages (LDs) are an agreed sum to be paid by one party for a breach of contract. They must be a genuine pre-estimate of the value of the loss or damage that the other party will sustain as a result of the breach. Often, LDs find a place in construction contracts and are framed as a £ rate per day or other period.

Liquidated damages clauses must be clear and whether they are to be separate from, or in addition to, any other liability cap.

Variable sum limit: Liability limits are very commonly linked in some way to the charges paid or payable by the customer. 

In most cases, this will be favourable to a supplier on the basis that it need only hand back the sums that it has received. In this way, it is an effective way for suppliers to balance risk against reward. 

Customers who are concerned they may suffer losses in excess of the amount that they have paid to the supplier may want insist on a multiple of the contract value, e.g. 150%. 

Where no payment is due during an initial contract period, the wording could specify that the limit will be the greater of the amounts to be paid and a fixed sum. 

Alternatively, an initial fixed cap could apply for a defined period, followed by a cap linked to charges after that period, when linking the cap to amounts paid or payable is likely to provide a higher cap.

Defined period limit: The cap may apply in relation to a defined period, such as a calendar year. 

This is often linked to the consideration, so that claims are limited in that period to the amount paid in the same period. The period needs to be clearly defined and that it is clear whether the trigger for a claim falling in that period is the point at which the claim is made (or when notice of the claim is given) or the point at which the circumstances giving rise to the claim took place. 

Different limits for different types of loss: Although suppliers will want the lowest limit possible in relation to all types of claim, distinguishing between different types of loss can be a useful tool to address a customer’s specific concerns while balancing its risk on other types of claim. 

A party needs to consider the nature of the contract and do an assessment of the risks and the likely damage. For example, if a supplier may cause significant damage to a valuable database, the customer may wish to impose higher limits (or no limit at all) in relation to data loss. 

Sometimes, higher limits are specified in relation to claims relating to damage to tangible property. This is primarily due to the availability of enhanced insurance limits for that type of damage.

Legal Notice:

Publisher: Atkins-Shield Ltd: Company No. 11638521
Registered Office: 71-75, Shelton Street, Covent Garden, London, WC2H 9JQ

Note: This publication does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. The information contained in this document is intended to be for informational purposes and general interest only.


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