Exclusion Clauses. Welcome

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1 Welcome Managing risk by limiting liability under a commercial contract is a concept most clients welcome, but does it really work? Exclusion clauses can be effective, but careful consideration of the detail of the drafting is essential to avoid misinterpretation. We start with the general principles and then look more closely at how solicitors may use exclusion clauses to limit their liability. Andrew Nickels Exclusion Clauses An exclusion clause (sometimes referred to as a limitation or exemption clause) attempts to exclude or limit one party s liability, or seeks to limit the other party s rights or remedies, such as: Force majeure matters beyond one s control Exclusion of remedies (e.g. specific performance, payment set-off rights) or conditions to remedies (e.g. return of defective goods) Exclusion of consequential or indirect losses, loss of profits, revenue, expected savings Financial cap on overall liability and/or caps on different liabilities (e.g. a supplier of services limiting its liability to the value of those services) Entire agreement clauses and non-reliance upon prior representations Time bars on claims Exclusion of certain warranties, conditions or other terms implied by statute or otherwise. To be effective, an exclusion clause must: 1) Be incorporated into the agreement; 2) Cover the liability in question; and 3) Not be prohibited by statute or other law, e.g. the Unfair Contract Terms Act 1977 (UCTA), the Unfair Terms in Consumer Contracts Regulations 1999 or the Consumer Protection Act UCTA does not apply to some contracts, such as insurance, land and intellectual property contracts. If there is no written contract signed by the parties, it can be difficult to decide what terms are incorporated into the contract. Even if there is a formal contract in place, an exclusion clause in the main body of the contract may inadvertently be overridden by specific provisions in the schedules expressed to override the main body of the agreement. 1

2 Interpretation two recent cases 1 The Kudos case The decision of the Court of Appeal in February 2013 in the case of Kudos Catering (UK) Limited v Manchester Central Convention Complex Limited [2013] EWCA Civ 38 highlighted the pitfalls of relying on exclusion clauses. The Court of Appeal held that on the particular wording of a contract, a clause which excluded a party s liability for loss of profits did not apply where that party had failed to perform the contract. Manchester Central Convention Complex Limited (MCCC) appointed Kudos in 2007 to provide catering services under a five-year contract. Clause 18.6 of the contract stated that MCCC would have no liability for loss of goodwill, business, revenue or profits, anticipated savings or wasted expenditure (whether reasonably foreseeable or not) or indirect or consequential loss. MCCC terminated in 2010, asserting that Kudos had materially breached the contract. Kudos argued that the termination was unlawful and claimed 1.3m in lost profit. The High Court ruled clause 18.6 effectively excluded MCCC s liability for loss of profit but the Court of Appeal disagreed and ruled that Kudos could recover its lost profits. Why? The reasons given by the Court of Appeal were: Clause 18 was headed Indemnity and Insurance the exclusion of loss of profit was buried in this clause and the court held that the exclusion only applied in the context of defective performance rather than total failure to perform If effective, clause 18 would have deprived Kudos of any real remedy in the event of default by MCCC. A literal interpretation of the clause (to exclude loss of profit for any default including deliberate repudiatory breach) would render the contract entirely devoid of contractual content and thereby contrary to business sense If the parties had intended to exclude liability for loss of profit in the event of refusal to perform the contract, the court said this should have been set out unambiguously in a stand-alone clause. 2 The Markerstudy case In the case of Markerstudy Insurance Co Limited v Endsleigh Insurance Services Limited [2010] EWHC 281 (Comm), the defendant, Endsleigh, were retained by Markerstudy to provide claims handling services. Markerstudy alleged numerous breaches amounting to losses totalling 14m. Endsleigh sought to rely on an exclusion clause stating Neither party shall be liable to the other for any indirect consequential loss (including but not limited to loss of goodwill, loss of business, loss of anticipated profit or savings and all other pure economic loss) arising out of or in connection with this Agreement. Markerstudy claimed that by virtue of this clause, Endsleigh was exempted from liability for indirect and consequential losses only. Endsleigh claimed that it was also exempted from direct losses falling under the heads of loss specified in the clause, and further claimed that the clause in the contract providing that their total liability in contract, tort, misrepresentation, restitution or otherwise, be limited to the aggregate amount of fees received under the contract (approximately 3.9m) included any claims for interest. On interpretation of the exclusion clause, the court found in favour of Markerstudy and stated that The use of the phrase including but not limited to is a strong pointer that the specified heads of loss are but examples of the excluded indirect loss. In respect of the cap, the court found in Endsleigh s favour in relation to contractual claims for interest. However, statutory interest was said to be of a different character not a liability in contract but a statutory liability arising from the court s discretion and therefore did not fall within the cap. 2

3 Unfair Contract Terms Act 1977 Under the provisions of UCTA, exclusions of liability for death/personal injury resulting from negligence, for fraud or fraudulent misrepresentation and for breach of implied covenants of title in the Sale of Goods Act 1979 will be void. Certain types of exclusions (which differ depending on whether the contract is business to business or business to consumer, and whether it is negotiated or on one party s standard terms) will be subject to the reasonableness test under section 11 of UCTA (see below). If a mistake in your exclusion clause renders it void or unreasonable, it will be struck from the contact, which could result in your client s potential liability for various heads of loss being unlimited. Drafting tips When drafting an exclusion clause, consider the precise structure of the clause carefully, being mindful of the fact that an entire clause can be contaminated if the intended heads of claim are not separately identified. Commercial negotiations are the preparation for any contract, and risk allocation is an important issue which should be discussed in detail by the parties at the outset. Following the reasoning in the Kudos case, if you are drafting a wide-ranging exclusion of liability, it is worth considering what remedy the other party will be left with. Whether applying the UCTA test of reasonableness or their powers of interpretation, the courts will not look favourably on a clause that (i) seeks to remove any remedy for failure to perform or for defective performance or (ii) results in one party taking all the risk. Limitation clauses must be drafted expressly and explicitly preferably in a stand- alone clause with an appropriate heading. The Kudos case confirmed that there is no presumption that an exclusion clause will not apply to deliberate breach. However, the courts are likely to interpret widely drafted or draconian exclusions as narrowly as possible. If the parties intend to exclude certain types of liability (such as loss of profit) for deliberate breach as well as defective performance, this should be clearly stated. The term indirect or consequential loss is not a precise term; it should only be used at the end of a clause as a final catch-all to avoid potential contamination of the entire clause. The clause in the Markerstudy case above should have read: Neither party shall be liable to the other for any: a) loss of goodwill; b) loss of business; c) loss of anticipated profit or savings; d) pure economic loss; or e) any indirect or consequential losses arising out of in connection with this Agreement. Similarly, if Endsleigh had wanted statutory interest to be included in the cap, it should have stated this explicitly in the clause. 3

4 Limiting solicitors liability 1 Professional conduct considerations Outcome 1.8 of the SRA Handbook states that clients have the benefit of your compulsory professional indemnity insurance and you do not exclude or attempt to exclude liability below the minimum level of cover required by the SRA Indemnity Insurance Rules. Indicative Behaviour 1.8 suggests that if you seek to limit your liability to your client to a level above the minimum required by the SRA Indemnity Insurance Rules, ensuring that this limitation is in writing and is brought to the client s attention, tends to show you have achieved this Outcome and therefore complied with the Principles. Relevant recognised bodies and relevant licensed bodies (i.e. ABSs, limited companies and LLPs) cannot limit their liability below 3m for any one claim. For sole practitioners and partnerships, the minimum is 2m for any one claim. 2 Legal considerations Liability for fraud or reckless disregard of professional obligations cannot be excluded or limited. Section 60(5) of the Solicitors Act 1974 renders void any provision in a contentious business agreement purporting to exclude a solicitor s liability for negligence. Attempts to limit liability for negligence in respect of non-contentious work are governed by section 2(2) of UCTA. 3 Types of contractual limitation Limiting the solicitor s duty of care to his client or excluding the duty altogether except for loss suffered as a result of the solicitor s wilful misconduct, bad faith or fraud Limiting the remedies available to the client in respect of a breach of contract or duty Whilst solicitors normally take responsibility for direct losses flowing from any breach, any liability for indirect or consequential losses can be expressly excluded in the limitation clause. The distinction between direct and indirect losses is not always clear specifying the types of loss which are excluded (e.g. loss of profits, loss of goodwill, loss of opportunity) will offer less scope for dispute. Limiting the time within which a client may bring a claim Currently, a claimant has six years from the date of the defendant s breach of contract to bring a claim. In tort, the claimant has six years from the date of sustaining the loss, or, if later, three years from the date of awareness of his loss, subject to the long-stop of fifteen years. It is possible to limit the claimant s time further for example, by including a term which provides that in all cases, whether contract or tort, the client has, say, three years from the date of awareness of his loss to bring his claim and subject to a long-stop of, say, four years from the cause of action accruing. Limiting the amount recoverable for a breach of contract/duty, i.e. a financial cap Such clauses are more common where the sums involved in a particular transaction (e.g. the consideration in a property acquisition) may exceed the firm s indemnity cover or where a specific project has an unusual degree of risk associated with it because of its novelty or complexity (e.g. opinion letters or legal due diligence reports on corporate transactions). Further, where a solicitor is giving advice in conjunction with another professional, with the result that he may be jointly liable to the client, a proportionality clause can be included, stating that the solicitor is only liable to the extent that he actually caused the loss. 4 The reasonableness test Under Section 2(2) of UCTA, a contract term which seeks to exclude or restrict liability for negligence is of no effect unless it satisfies the requirement of reasonableness set out in section 11, namely that the term must be a fair and reasonable one 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. If challenged, it will be for the solicitor to establish the reasonableness of the limitation. 4

5 Section 11(4) of UCTA provides that where a contractual term seeks to restrict liability to a specified sum of money, the question of whether the requirement of reasonableness has been satisfied must take into account the resources which the person seeking to impose it could expect to be available to him for the purpose of meeting the liability should it arise, and how far it was open to him to cover himself by insurance. What is relevant here is the availability of insurance cover rather than the actual insurance position. The fact that the solicitor insures himself for substantially more than the limitation should not, in itself, establish that the limitation is unreasonable. Given the claims made nature of professional indemnity insurance, it should be remembered that the current level of cover may not be available in the future when a claim may be made against the firm, or when a circumstance is notified to insurers. 5 Reasonableness guidelines Schedule 2 of UCTA sets out the relevant factors to be considered: a) The strength of the bargaining position of the parties relative to each other, taking into account (among other things) alternative means by which the customer s requirements could have been met. [In the context of commercial transactions, in many cases the client will have substantial bargaining power, for example, because of its corporate size and financial strength or its ability to instruct the firm s competitors if it dislikes the firm s proposed terms. (In Watford Electronics v Sanderson (2001), the Court of Appeal stated that the courts should be slow to interfere with limitation clauses negotiated by commercial parties at arms length.) There may, however, be particular circumstances where such apparent bargaining power may be diminished, for example, where time pressures leave the client in a weak position. (In St Albans City & District Council v International Computers (1996) the Court was prepared to take into account the suggestion that the claimants were over a barrel because of a tight timetable.)] b) Whether the customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons, but without having to accept similar terms; c) Whether the customer knew or ought reasonably to have known of the existence and extent of the term (having regard, among other things, to any custom of the trade and any previous course of dealing between the parties.) The SRA Handbook clearly states that any limit of liability must be in writing and brought to the client s attention. It is important to be able to demonstrate that your client was made fully aware of the existence, scope, and terms of the limitation clause. In the event it is challenged, your firm s position will be strengthened if you can demonstrate the reason for the introduction of the limitation was explained to the client in simple terms, and more so, if the client took independent legal advice on the limitation clause itself. It is not sufficient to simply have the limitation set out in the small print of your Terms of Business which you send to a client with your engagement letter it is unlikely that your client will have read them. Some firms refer to the limitation in bold type or in a different colour in the engagement letter in a section headed Limitation of our liability or similar. It is good practice to use the sending of the engagement letter as an opportunity to engage with your clients on the financial limitation you are seeking to impose explain the limitation in detail and ask the client to call you to discuss should the need arise. It is the practice of some larger firms seeking to limit liability to insist clients take independent legal advice. The mere inclusion of a limitation/exclusion/ disclaimer in your terms of business will provide no guarantee that your firm s liability will in fact be limited in the manner stated. However, what such a clause will offer your firm is the opportunity, in relation to the particular engagement, to prove that the limitation is reasonable if it is challenged. If there is no limitation clause, it s an opportunity lost! Remember, however, that a well drafted engagement letter, setting out precisely what your firm will and will not be undertaking, remains the most practical and effective means of limiting your firm s exposure. 5

6 Marplace (Number 512) Limited v Chaffe Street [2006] EWHC 1919 (Ch) is the only substantive decision on the subject of limiting the liability of solicitors. The defendant solicitors were retained as part of a team of professionals advising the claimants, who were experienced businessmen, on the acquisition of a clothing company. The team included accountants and corporate finance advisers, who project managed the deal and, with the claimants, dealt with its financial structure. It was a critical part of the deal for the claimants to ensure that the company would continue to receive payments for certain clothing stock post-completion. However, after the agreement had been exchanged, the claimants learnt that the company had entered into a deal to have payments, which would have been paid postcompletion, paid pre-completion, in effect accelerating the payments. As a result, the agreement fell through. The solicitors engagement letter contained a liability cap that said: You agree... our maximum aggregate liability to you in the event of professional negligence on any matter in relation to which we are instructed shall be 20m. It added: Should you want to vary these limitations we shall be pleased to discuss it with you but we reserve the right to vary our fees accordingly. The court upheld the cap as reasonable for the purposes of the UCTA test because: the clients were familiar with limitation of liability clauses in professional contracts; the clients had discussed the limitation provision with the solicitors and it had not been imposed upon them; the retainer included a provision concerning discussing variation of the cap; the cap was determined on reasonable commercial principles, taking into account insurance cover and its expense as well as the circumstances of the transaction; and the bargaining positions of the client and firm were equal. Who to contact solicitors@risk Editor: Andrew Nickels Telephone: riskman@uk.zurich.com Sales Telephone: Sales fax: Claims helpline: Claims fax: Zurich Financial Lines London Underwriting Centre, Third Floor, 3 Minster Court, Mincing Lane, London EC3R 7DD NP (10/13) RRD The material contained is issued by Zurich and does not establish, report or create the standard of care for solicitors, nor does it represent a complete analysis of the topics presented or constitute legal advice. It is intended to highlight issues which may be of interest to our customers. Readers should conduct their own appropriate research on how to act in any particular case. Zurich Insurance plc. A public limited company incorporated in Ireland Registration No Registered Office: Zurich House, Ballsbridge Park, Dublin 4, Ireland. UK branch registered in England and Wales. Registration No. BR7985. UK Branch Head Office: The Zurich Centre, 3000 Parkway, Whiteley, Fareham, Hampshire PO15 7JZ. Zurich Insurance plc is authorised by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. These details can be checked on the FCA s Financial Services Register via their website or by contacting them on Our FCA Firm Reference Number is Copyright Zurich All rights reserved. Reproduction, adaptation, or translation without prior written permission is prohibited except as allowed under copyright laws.