Net Contribution and Financial Caps on Liability

Net Contribution and Financial Caps on Liability

ACE wishes to thank Griffiths & Armour, an ACE Insurance Affiliate, for its contribution to ACE s risk management guidance note series. This note on limiting liability in appointments supports a number of measures that ACE would recommend members seek to achieve in their own contracts wherever possible, including financial liability caps, excluding consequential loss and the inclusion of a well drafted net contributions clause. The West v Finlay case, summarised in the note, is a particularly useful development on net contributions clauses, an area with only limited judicial guidance to date. Griffiths & Armour complements this case law development with their own experience of handing claims and the impact of liability limitation provisions on the outcomes. Please go here for ACE s guidance on contracts and risk management. Please be aware that ACE and Griffiths & Armour present this guidance note to assist ACE members with managing their commercial risk. It is, however, not intended as and is no substitute for specific independent legal advice. ACE recommends that independent legal advice is taken in any individual case and before pursuing a course of action. Net Contribution Clauses The aim of a net contribution clause ( NCC ) is to see that a consultant is only liable for its fair share of a loss and cannot be expected to pick up the contribution other parties have made to that same loss. It seeks to modify the law on joint and several liability, which would otherwise automatically apply in situations where a loss has been caused by multiple parties. The principle of joint and several liability is best explained by way of an example. Suppose that a loss of 100,000 was incurred by a developer and it was found that the architect was 30% responsible for the loss and the contractor 70% responsible. In such circumstances, joint and several liability would allow the developer to pursue either the architect or the contractor for the full amount of his loss. He could, therefore, recover the full 100,000 loss from the architect, who would then be entitled to pursue the contractor for a 70% contribution. However, if the architect is unable to enforce a contribution claim against the contractor for some reason (e.g. because the contractor has ceased trading), he or his insurers would be left significantly out of pocket. NCCs had not been tested by the Courts (save for a Scottish case in 2009) until the case of West v Ian Finlay & Associates 1 in 2014 in which the Court of Appeal held that a net contribution clause was enforceable. The background to the case can be found in the case study here. How net contribution clauses can assist in managing claimants expectations The fact that NCCs have rarely been tested by the Courts (the Finlay case is the only court case in England and Wales to date), despite the fact that they are relatively common and appear in many standard forms of appointment 1 West & Anor v Ian Finlay & Associates (A firm) [2014] EWCA Civ 316 (27 March) PAGE 1

and collateral warranty, suggests that they are generally accepted and understood in the industry. Our experience of dealing with out of court settlements reflects this. NCCs are rarely challenged by claimants and, during the early stages of a claim, they can prove to be very helpful in managing a claimant s expectations of what they might hope to recover from the consultant alone. Our next claim example illustrates the benefits of this in practice. The claim related to a small new build residential development and highlights what can happen when NCCs are included within appointment documents. Go here for details. Dealing with net contribution clauses in contract A complaint often made by clients when net contribution clauses are proposed by consultants is that they shift the risk of insolvency of another member of the project team to the client. The problem with this argument is that it presupposes that the professional team is somehow better placed to manage the solvency risks of the remainder of the team. In reality, the client is in a far better position to do so. The client has control over whom it appoints and can ensure that it appoints organisations of repute carrying adequate balance sheets and/or levels of insurance. Some key points to consider when negotiating a net contribution provision with your client are as follows: It is the client who chooses the contractor and the rest of the professional team. Why should the consultant bear the risk of the poor workmanship by the contractor if, for instance, the client selects his contractor on a lowest cost basis? It is the client who determines on what terms the team is to be engaged. You have no control over whether the rest of the project team are appointed on equal terms to yourself. Why should you bear the risk of the client not being able to recover a proportion of loss from another team member solely because he has accepted a lower cap on liability from that party than the cap applying in your own appointment? It is the client who can insist on appropriate insurances, performance bonds etc. The clauses are used widely in the industry and appear in many standard industry appointments and collateral warranties. Limitations of liability Limiting liability in contract, by way of a financial cap or other means, is becoming increasingly important, especially as we face rising claims costs associated with more complex construction disputes. PAGE 2

Although liability cannot be excluded or restricted in relation to damages for death or personal injury, parties to a contract are otherwise free in principle to agree to limit any other liability that they may incur to each other, e.g. for breach of contract or negligence. Inserting a financial cap, thereby defining the maximum amount for which you will be liable, is still the most commonly accepted form of limitation of liability clause. It is important to remember that agreeing to maintain a certain level of professional indemnity cover in your contract will not serve to limit your liability in any way. That can only be achieved by way of a separate provision for that specific purpose. We can look at some claims where a financial cap clause in the original appointment document has successfully limited the insured's exposure: Case Study on benefits of a financial cap on liability No. 1 Click here Case study on benefits of a financial cap on liability No. 2 Click here Other limitation clauses It is not only defined caps on liability which provide protection. Exclusions with regard to particular types of loss can also be a valuable risk management tool. This claim arose in relation to the remediation of land contaminated by a neighbouring site. Conclusion It is becoming more common to see financial cap clauses being included in appointment agreements and collateral warranties and these provisions can pay dividends in the event of a professional negligence claim arising. Any proposed cap must be drawn to the attention of the other party to the contract and a figure discussed and negotiated with them and this process recorded. By doing so, it is much more difficult for the other party to successfully challenge the cap in court. Also, it is important to bear in mind that any limitation of liability will have to satisfy the test of reasonableness under the Unfair Contract Terms Act 1977. What is reasonable depends on the circumstances of each case. PAGE 3

The type of cap under a contract should be considered. It may operate on an each and every claim basis, so that each claim could be to the full value of the limit. Alternatively, it might be drafted so that it applies on an aggregated basis. An aggregate cap, limiting your total liability under that agreement would be our recommendation, as it provides the better level of protection. PAGE 4

Each project has to be looked at on its merits and a number of factors should be considered, including: the nature and extent of the risks of the project, having regard to its size, complexity etc; an assessment of the damages that would be payable in the event of a claim in negligence (e.g. the cost of repeating the work/construction costs); the resources that the consultant could be expected to have available to meet any liability; any previous dealings between the parties; the amount and cover available to the consultant under his PI policy. Great care needs to be taken in drafting clauses capping liability. In the event of a dispute over the meaning of the wording any ambiguity will be construed against the person seeking to rely on it. Legal advice should therefore be sought on the wording of the clause itself. We recommend the use of industry standard wordings such as those from the ACE Conditions. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 5

Net Contribution Clauses Case Study 1 Mr and Dr West, respectively a successful banker and academic neuroscientist, appointed Ian Finlay & Associates ( Finlay ) as architect in connection with the refurbishment of their property in Putney. Maurice Armour (Contracts) Limited ( Armour ) was appointed as contractor. Shortly after completion of the works the Wests identified significant damp problems, principally attributable to poor workmanship by Armour, but partly due to poor supervision by Finlay. Armour became insolvent and the Wests issued a claim against Finlay for the entirety of their losses which exceeded 800,000. Finlay s appointment contained a net contribution clause with the following wording: Our liability for loss or damage will be limited to the amount that it is reasonable for us to pay in relation to the contractual responsibilities of other consultants, contractors and specialists appointed by you. The court at first instance held that Finlay was liable, and (crucially) that the NCC did not reduce Finlay s liability. The courts reasoning was that the wording of the clause was ambiguous and should therefore be considered in the context of Regulation 7(2) of the Unfair Terms in Consumer Contract Regulations ( UTCC ) which states that If there is doubt about the meaning of a written term, the interpretation which is most favourable to the consumer shall prevail. The Court held that the reference to other contractors in the NCC could be construed as referring not to Armour, but to other contractors with whom the Wests were proposing to enter into separate contracts outside of the ambit of the main building contract. As that was the most favourable interpretation to the Wests, that interpretation should prevail in accordance with the provisions of regulation 7(2) of the UTCC. Finlay appealed the decision. The Court of Appeal held that consideration should be given to the normal meaning of the words: Here, the meaning of the words is crystal clear. We do not accept there is any ambiguity. The NCC is saying that [Finlay s] liability for loss or damage was to be limited to the amount that it was reasonable for it to pay having regard to the contractual responsibilities of other consultants, contractors and specialists appointed by [the Wests]. There was no limitation on the words other consultants, contractors and specialists appointed by [the Wests], and they must be taken to mean any such persons, including the any main contractor ultimately appointed, but of course excepting [Finlay] itself (because of the use of the word other ). In finding that the wording of the clause was clear, the Court held that there was then no need to refer Regulation 7(2) of the UTCC Regulations. However, the Court did consider the effect of Regulation 5(1) of the UTCC Regulations to assess whether the clause was fair. Regulation 5(1) states A contractual term which has not been individually negotiated shall be regarded as unfair if, Griffiths & Armour Professional Risks acts as manager for the professional contrary indemnity to division the requirement of Griffiths & of Armour. good faith, it causes a Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial significant imbalance in the parties rights and obligations This document does not present a complete or comprehensive statement arising of fact under or the law, the nor contract, does it constitute to the detriment legal advice. of It the is intended only to PAGE 6

consumer. Whilst it was accepted that the clause had not been individually negotiated and that (in effect) it operated to the detriment of the Wests, it was also accepted that the principle of good faith had been satisfied since the clause was prominently displayed within the agreement, and the parties were of equal bargaining power. The key issue therefore was whether the clause caused a significant imbalance to the parties rights: In other words, it is necessary to consider whether the NCC was so weighted in favour of [Finlay] as to tilt the parties rights and obligations under the Agreement significantly in [Finlay s] favour. Whilst the Court found that the clause created an imbalance, it found that this imbalance was not significant for the following reasons: 1. Net contribution clauses are commonplace in standard forms of professional appointments; 2. The clause would not be regarded as unusual in a commercial contract; 3. It would be the Wests who would make the final decision regarding the appointment of the contractor and (given Mr West s background in banking) would be alive to the fact that financial stability of the contractor was of importance. Consequently the Court allowed the appeal and held the net contribution clause to be enforceable. Whilst this case is undoubtedly good news for consultants and their professional indemnity insurers, the irony is that the increased awareness in the industry generated by the sheer amount of column inches dedicated to the case is likely to make it more difficult to persuade would-be clients to accept their inclusion in an appointment. However, point 3 above does provide some rationale for negotiating purposes and this is covered in further detail below. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 7

Net Contribution Clauses Case Study 2 The claim related to a small new build residential development and highlights what can happen when NCCs are included within appointment documents. The developer had engaged a consulting engineer to undertake civil, structural, mechanical and electrical services under the standard Association for Consultancy & Engineering (ACE) Conditions of Engagement and an architect was engaged under the standard Royal Institution of British Architects (RIBA) appointment. Both ACE and RIBA appointments contained NCCs. A contractor was appointed separately and the developer also contracted with a warranty provider to provide home warranties for each of the houses on the development. Some years after completion of the development numerous defects were discovered, most of which related to inadequacies with the first floor joists and supports and the lack of appropriate lateral restraint straps and strutting as required by the Building Regulations. The property owners brought a claim against the developer and they also made calls upon the home warranties. The home warranty provider funded the remedial works required and then sought to recover those costs from the developer. The developer in turn sought to pass on the warranty provider s and property owners claims to the contractor and the professional team. In total, the amounts claimed came to over 2m, roughly half of which related to the remedial costs incurred by the home warranty provider and the remainder to the property owners consequential losses. It seemed fairly clear that the main cause of the defects was poor workmanship by the contractor. The developer s case against the architect and consulting engineer was based on an allegation that they had failed to note the defects during site inspections and that these failures amounted to negligence. The contractor then went into liquidation, leaving the architect and consulting engineer as the only possible targets for the developer s claim. One point of note here is that, although the exact relationship was murky, it appears that there was a degree of common ownership between the developer and contractor and the more cynical amongst us might conclude that the contractor s liquidation suited the developer s aims quite well. Ordinarily, the developer would have been able to recover his entire loss from the architect and/or consulting engineer on the principles of joint and several liability. However, the consulting engineer and architect sought to argue that a large number of defects were workmanship Griffiths related & and Armour properly Professional attributable Risks Ltd to is the an appointed contractor. representative Given that of Griffiths both parties & Armour had which the is authorised benefit of and a NCC regulated in their by the Financial appointments, Griffiths & Armour. they argued that they could not be held liable for the contractor s contribution to the loss, but only for that part of the loss properly attributable to their negligence. PAGE 8

The claim went to mediation and the developer accepted that, if the case had gone to trial then the NCCs would probably have prevented him from recovering the full loss from the two consultants. A settlement was reached at mediation whereby the consultants each paid a contribution of 20% to the total loss. There is little doubt in this case that had the architect and consulting engineer not had the benefit of NCCs in their appointments, the developer would have been in a position to press for a much bigger settlement and it is our considered view that the NCCs saved the two consultants well over 1m. It is also likely that the case would have been more difficult to settle out of court and therefore our legal costs would also have been significantly higher. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 9

Simple benefits of a financial cap on liability A consultant was appointed by a developer to undertake various environmental surveys in respect of the redevelopment of former brickworks into housing. The site itself included the former brickwork buildings and various stockpiles of materials, some visible and some buried. The consultant s standard terms and conditions limited the consultant's liability to five times the contract price. The contract price was 7,000 and therefore the consultant's liability was capped at 35,000. Following construction of five dwelling houses, asbestos was discovered in the gardens of the properties in 2006. The developer was registered with a home warranty provider. The developer went into liquidation and assigned any rights under the contracts with the consultant to the home warranty provider. In 2009, the warranty provider sought to recover from the consultant the cost of removal/remediation of the asbestos which was estimated to be in excess of 1m. Given the limitation arguments and the strong cap on liability, the home warranty provider was persuaded to discontinue its claim altogether. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 10

Simple benefits of a financial cap on liability No.2 This claim arose in relation to a project for the redevelopment of a brownfield site for use as a waste processing facility. The site was to include a building to house plant for the production of energy from the waste processing. The consultant had been appointed by the owner of the site (a waste processing company) to prepare schematic designs for the facility and prepare a planning application for the submission to the local authority. The local authority subsequently granted limited planning permission for the site, allowing it to be used for business, general industrial, storage and distribution purposes However permission was not granted for the site to be used for energy production from the waste processing operation. The site owner alleged that the failure to secure the desired planning permission was the direct result of the consultant s negligence in preparing the planning application. As a consequence of the local authority s decision in relation to the initial planning application, the site owner had to prepare a second planning application. The subsequent claim against the consultant comprised sums for loss of profit totalling approximately 2m and costs of around 120,000 for the preparation of the second planning application. Although our client s original planning application had made clear reference to the proposal to create energy from waste, the precise method to be used by the site owner had yet to be decided when the application was submitted with the result that the application had been vague on this point. There was a lack of documentary evidence to show that the consultant had given the site owner appropriate advice regarding the risks of submitting a planning application without adequate information on the energy from waste proposal, so there was no doubt that the consultant had an exposure to the site owner s claim. However, the consultant s appointment contained a cap on liability to a level of 200,000, which had been agreed with the site owner at the start of the project as representing a reasonable cap on the consultant s liability. Once this had been drawn to the site owner s attention, settlement negotiations were quickly brought into focus and settlement agreed in a relatively short period of time at a sum of 150,000 plus a contribution to the site owner s legal costs. Not only had the liability cap potentially saved the consultant and his insurers a significant amount of money, arguably it was also one of the main drivers for a speedy settlement, limiting the amount incurred by both sides in legal and dispute resolution costs. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 11

This claim arose in relation to the remediation of land contaminated by a neighbouring site A parcel of land owned by a local authority was being developed for the construction of a new civic centre when contamination was discovered in the ground. The contamination originated from a neighbouring site where a petrol filling station had previously stood. The owner of the neighbouring site accepted the contamination spread from their land. They agreed to remediate the local authority site and pay compensation to the local authority for its losses. Our client (the consultant) provided advice to the neighbouring site owner on the remediation strategy, and was then subsequently appointed to design a remediation strategy for both the local authority site and the former filling station. The remediation strategy proposed that the sites could be remediated within fixed timescales and within target contamination levels which were subsequently agreed with the local authority. Of significance is that the consultant s appointment contained an exclusion of liability for any consequential losses. During the remediation works, the consultant alleged that the site owner caused further contamination to occur with the result that it would be impossible to achieve the remediation target levels within the agreed timescale. A dispute ensued during which the consultant s fees were withheld and the firm s appointment was subsequently terminated. The dispute proceeded to arbitration which was initiated by the consultant as a claim for unpaid professional fees in the region of 735,000. The site owner counterclaimed, contending that no fees were payable to the consultant at all as the consultant s remediation strategy had been inadequate and was incapable of achieving the target remediation levels. The site owner claimed that costs of 6m had been incurred in settling claims with the local authority and also with the tenant of the former filling station site in respect of the failure to remediate the sites to the agreed targets and within the agreed timescales. The site owner sought recovery of these costs from the consultant. The consultant s defence team felt that the consultant had a reasonable defence to some aspects of the site owner s claim. However, they also concluded that the target levels set out by the consultant in the remediation strategy had been unrealistically ambitious given the site conditions and level of contamination. Nevertheless, it was felt to be worthwhile continuing with the arbitration. In the event, the arbitrator favoured the evidence provided by the site owner and found against the consultant, concluding that the owner had not caused further contamination and that the remediation strategy and the target levels suggested by the consultant had simply been unachievable. In his award, the arbitrator rejected the consultant s fee claim and ordered that the consultant should pay the direct costs of remediating the sites to the agreed levels. However, he upheld the exclusion of consequential losses in the consultant s appointment and Griffiths awarded & Armour the site Professional owner nothing Risks Ltd in is respect an appointed of consequential representative of losses. Griffiths & Armour which is authorised and regulated by the Financial PAGE 12

While the consultant was still held liable for a significant sum, the exclusion of liability for consequential losses reduced the consultant s liability in this case by a very significant amount. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial PAGE 13