Drafting exclusion and limitation of liability clauses

David Lowe: Hi everyone and welcome to our webinar about limitation and exclusion clauses. I am David Lowe I am the partner who leads our commercial contracts team and I spend my whole time negotiating and drafting limitation exclusion clauses.

Sean Adams: And I am Sean Adams, I am a partner in our commercial litigation team and I spend my time helping people fight over limitation and exclusion clauses and seeing how they apply in practice when parties come to rely on them.

David: So Sean is here to keep me honest because of course I can say whatever I like because I don't have to deal with when they go wrong, and so Sean is here to remind us that when it goes wrong it really does matter what is in your limitation and exclusion clause.

Now the reason why we are having a focus on this today is because there has been an important court of appeal case on limitation exclusion clauses in the summer of 2022, and we thought it would be useful to step back from that case and look at limitation and liability clauses more generally to understand the context of that case.

To do that we thought it would be helpful to go through a template clause and so you will find a link on our website to that template clause that we are going to use today to discuss and go through.

Sean: So assuming you have all been able to find that clause, which is always a good start, let's start right at the beginning.

So David you are the person that drafts these things, when you start putting pen to paper where do you start first, what is the first thing that goes in there?

Download an Example limitation of liability clause

David: Well, I can almost, sort of, do it with my eyes closed which is nothing in this agreement excludes or limits a parties liability for death or personal injury arising from negligence and then something about fraud and then something about fraudulent misrepresentation.

That is often the first clause that you will find in any limitation liability clause and the reason it is there is well under UCTA the Unfair Contract Terms Act you cannot in a contract exclude or limit your liability for death or personal injury arising from negligence.

The courts have indicated very frequently that under public policy grounds you cannot exclude liability for your own fraud and there was a case that said if you didn't expressly mention fraudulent mis rep then your entire agreement clause might fall down so it is routine to mention that you don't exclude or limit the liability for that.

Sean: That all makes sense David and if you can draft that with your eyes closed I think that probably suggests it falls into the category of being so obvious that the question could be asked does it even need to be there at all? Do you need to spend the first third of a page putting in that clause when the law does the job for you?

David: Yes it's a good comment and we would all rather have less words in our contracts. There is a school of thought that says, as you said Sean, that if the law already says you can't exclude liability why do I need to write that all down again. It is just there in the fabric, in the background, we don't need to say it again.

It would be a bold lawyer to decide not to bother putting that clause in because we don't quite know what happens if you don't put it in and none of us really want to be the test case going to the supreme court to find out for certain how it falls.

So although probably if you don't put the clause in you will be fine, you don't know it, you don't want to be the test case, so therefore we all put it in and of course nobody objects to putting those words in, everyone accepts they are standard words, nobody argues about them. So you just put them in really to be safe.

Sean: That makes sense.

David: So Sean turning to the next clause up in our template is a long list of stuff that possibly heads have lost that you might want to consider excluding in certain situations. One of them is wasted expenditure and that is a recent addition to our template.

Where has that come from?

Sean: Yes and that has come out of the new case from earlier this year that you mentioned at the top. So that has come out of the Soteria and IBM case which was the big case that went to the court of appeal this summer or this Easter on limitation of liability clauses. That case was all about a very large IT contract worth, sort of, £50,000,000 to put the IT system in place and then another £125,000,000 over the next ten years to maintain it and run it.

Big fall out between the parties, the system wasn't delivered on time. All of this then ended up playing out in the courts.

One of the really big money items and when I say big money about £80,000,000 ended up turning on this single point, was whether Soteria could bring a claim for their wasted expenditure, being the money they had wasted paying IBM and other expenses despite never receiving the system that they contracted to buy.

The judge at first instance found that they had prima facie a good wasted expenditure claim so they had a good claim for about £120,000,000 I think it was of wasted expenditure but then proceeded to kick out the entirety of that claim on the basis of a limitation of liability clause that said there would be no liability for loss of profits, revenue or savings. You might be thinking in your head, well hold on you haven't said there anything about wasted expenditure and I can see in our clause we have got profit revenue and savings as separate things and that was effectively the conclusion that the court of appeal came to earlier this year really focussing on the wording of this limitation clause and saying there is no reference in there to wasted expenditure. Various other reasons as well but actually reinforcing the approach that the courts will take when reading these clauses generally which is to say these are carefully negotiated clauses between parties, we are only going to interpret that the same way as we would interpret a contract generally and if you have not said in there you are excluding wasted expenditure and the consequence of a contorted decision to the contrary is you lose an £80,000,000 or £120,000,000 claim we are not having that.

So the court reversed that decision, Soteria claim stood and I suspect as a result of the big money that turned on that that is precisely why we now see wasted expenditure here as a standalone thing to consider when you are looking at negotiating that list of exclusions.

David: So if you don't say it you don't get it basically.

Sean: I think that is absolutely right. If you are not clear about what it is you are excluding and particularly where you are talking about really onerous consequences on one party where that is, sort of, playing out in practice and, of course, it is always going to be with the benefit of hindsight, clarity and the courts are really looking at the wording here.

David: And that is the challenge isn't it because it is only with hindsight do you discover what was the liabilities and risks that perhaps you should have been managing with your words and it is inevitable in my view that you could end up not putting quite the wording when you drafted the contract to deal with the risk that eventually happens and so I am a bit cynical about this. I sort of wonder whether you would ever put the right word in to suit the court if the court was determined to give the other party a remedy.

Sean: This is why I chose to sit on this side of the fence I get to look at things with 20:20 hindsight. I don't have to look into my crystal ball.

David: And that is why certainly as a drafter I am, sort of, wary of just simply adding extra things in a clause to take out and exclude because I sort of feel it is inevitable and I end up not including a word that really matters on the day which you will be arguing about Sean in the court so I think this emphasises to me my personal approach which is to be wary of long complicated clauses because they are too easy to fail and it might be better for parties just simply to focus on the key exclusions and the cap and accept that everything else they are liable for subject to the cap.

Sean: Absolutely and that I suppose brings me quite nicely on to the next clause in our precedent here which is jumping out at me probably going in the opposite direction because having talked about the importance of clarity and brevity I see that we have got in there and it will be very common to people who are negotiating and reading these clauses we have got a reference to indirect special or consequential loss and all three of those things I'm intrigued to see what you think as to whether they all need to be in there.

David: Yes, so, of course, this is the exclusion of indirect loss clause and I need to check, just query, why they will put three words, David Lowe doesn't like using three words when one will do so why has he got three words in here. And actually the case law says that indirect and consequential loss means the same thing so there is a case that specifically says consequential loss means indirect loss and indirect loss means a second dealing with Hadley and Baxendale which is you can only recover that if you have got special knowledge and so that effectively means the parties need to have specifically agree liability for any kind of losses.

So the word consequential isn't needed because it means the same as indirect but we put it in all the time because everyone does and it will look slightly odd if you didn't and once you have agreed the principal to exclude indirect loss it is easy to agree it. Now, of course, that word consequential causes confusion with our commercial colleagues who read the word consequential as its normal natural meaning and as something that arises as a consequence and that is not what it means. It has got a special legal meaning of indirect loss.

Special loss, well the only reason it is in there is because you just normally see it in there and I have to say I really struggled to find exactly what special loss is. There is a concept of special loss in tortious liabilities and various things like that but what does it mean in a contractual area, to be honest I don't know, it is only put there because that is what you normally put in there and certainly I am starting to think not to bother putting that word in and actually certainly in short form contracts, you know, just a short letter form contract I am quick to strip the wording back to just indirect loss and not mention the word special or consequential.

All of this begs the question just want is indirect loss when you actually have litigation, what does fall into that pot? Sean, what is it?

Sean: Yes, and in a couple of minutes what is indirect loss. I mean you have already covered the technical legal version of it David which is it is that limb two of the Hadley and Baxendale test but without straying into giving everybody a legal seminar for the next half hour on 1850s case law, I think probably the best way for practical purposes to look at it is actually to realise that what is indirect loss in a practical sense is really much more limited than direct loss as a result of recent cases.

So whilst people might think of direct loss and indirect loss as sort of 50:50 or two halves of the possible liability actually direct loss is a much bigger pool given the way the courts have interpreted that.

A case of GB Gas back in about 2011 found that direct loss really can extend beyond what you might normally think if you were seeing both of them as an equal share but direct loss in that case extended to ex gratia goodwill payments to customers. It was stationery to update the customers about the issues that were being faced, it was additional borrowing charges, all that sort of stuff so actually in practical terms whilst it is obviously important to think about any exclusion that you are putting in even if that is just an exclusion of indirect loss really when you come down to fighting about these things the pool of stuff that gets kicked out by saying there is no blame for indirect loss is probably not as big as you might think.

David: Yes and so certainly suppliers are keen to exclude indirect loss really because we just don't know what it is and I am worried that if it does manifest itself it is uncontrollable, unpredictable and therefore could be a very large number so as a supplier you are worrying about something that might never happen but you are worried so you want to exclude it. I certainly say to customers that I don't think it is a big deal for them to agree to exclude it because GB Gas showed that probably almost anything they ever think of as being reasonably obviously consequence in the circumstances going to be direct loss and not excluded so it should be an easy give to give the supplier something they really want to agree to an exclusion of indirect loss. And I certainly find it is, sort of, market standard now to normally in most contracts to agree to an exclusion of indirect loss.

Sean: That makes sense.

So to move on to our last clause and you gave everybody who is still with us a little bit of a hint earlier as to where you think really the meat of the commercial bargaining is around these provisions. Would that be this final provision around the cap by any chance?

David: Yes it is. It might be last but it is the most important one. It is the cap, that is the daddy of all of this. I am a big fan of concentrating on the cap. I think when you look at the case law generally caps are upheld.

In fact, if I remember rightly Sean in your IBM case the cap, albeit a very high £80,000,000 cap, worked even though the exclusion of the wasted expenditure didn't. Is that right?

Sean: It is yes spot on.

David: So I think the judge in IBM has been listening to my talks and training and followed by philosophy because by making it the centrepiece it makes it a commercial issue and therefore we can draw our commercially colleagues in to what is a fair allocation of risk between the parties? What should be the cap on liability? How much is it? And that will change depending on type of contract, the bargaining parties, the insurance that is available, the market sector you are in, but at least it gets a commercial discussion going about this, about what is otherwise a complicated legal area.

Now, I said if you put a cap in it works, that is slightly misleading because there is a lot of discussion about whether caps on liability need to be reasonable. The reason for that is because under the Unfair Contract Terms Act there is a requirement on [B to B] contracts, when you on somebody's standard terms of business that any exclusion or limitation of liability in the standard terms of business must be reasonable and therefore any cap must be reasonable.

So that is why there is always a bit of angst about the cap being reasonable because you set it too low, that might be unreasonable and suddenly the supplier goes from a low cap on liability to no cap on liability and customers will be quick to point out suppliers at risk to make the supplier a bit more nervous and increase their cap to what the customer thinks is reasonable.

But many of you will be thinking well hang on standard terms of business that doesn't really sound like a negotiated outsourcing agreement for example surely standard terms of business is just back of invoice, small print, T&Cs of sale kind of territory and indeed if you go back to before 1996 that was indeed what everyone thought that you only worried about the up to reasonable requirement in standard terms but then we had a case, another IT case Sean, one of your favourites I'm sure, ICL and St Albans where it was found that although the contract was negotiated the specific liability clause hadn't been negotiated, was on ICL's standard terms, therefore had to be reasonable and that particular cap was unreasonable and struck out and ICL was suddenly left with an uncapped liability and so ever since then in 1996, ever since 1996 we have all collectively worried about whether our caps are reasonable or not.

I do wonder whether if that case happened again today whether the courts would be so quick to knock it out. Certainly Sean my observation is the court seems to focus on what the words mean as opposed to using the big bazooka of UCTA to knock out the cap.

Would that be your perception?

Sean: Yes I would agree with that. I think we have probably come quite a long way in the last 25 years or so in terms of how the courts looking at these cases and interpreting them and I would be quite surprised if that was the results there in what was otherwise a heavily negotiated contract.

David: Sean is here ready to take on your case in supreme court to test this and make new law and get ICL and St Albans overturned but of course that is why nobody has challenged it because of course that costs quite a lot of money and time and nobody wants litigation unless they really have to so it is uncertain when that case will be overturned and when the high water mark it established drops a bit so that we can be a bit more confident.

One day it will but it has been around already for 26 years now so who knows, who knows when that will be knocked out.

Anyway I hope that you all found that a useful canter through a typical liability clause and in particular covering this year's IBM case and the context in which it applies.

Very much enjoyed doing this, look forward to hearing from you.