Managing liability in commercial contracts

Whether you are a customer or a supplier, the apportionment of risk between you and your counterparty is one of the key features of any contract you enter into. Both parties want to ensure that their respective interests are protected, so agreeing how risks are borne and which party is liable for what risks under the contract can require negotiation and compromise.

Why does liability matter?

The respective liabilities of contractual parties are important because they dictate which party is liable for losses which occur as a result of something particular going wrong during performance of the contract. Each transaction carries risks which mean that a party could incur liability for a host of reasons including:

  • Breach of contract;
  • Negligence;
  • Misrepresentation;
  • Infringement of property rights (e.g. physical and/or intellectual property);
  • Breach of statutory obligations (e.g. data protection); and/or
  • Infringement of third party rights.

Every contract has its own specific risks, which should be assessed on a case-by-case basis.

What are the main laws to be concerned about?

The Unfair Contract Terms Act 1977 (UCTA) and the Consumer Rights Act 2015 (CRA) are the main statutes that regulate the use of exclusion and limitation clauses in the UK. UCTA applies to business-to-business (B2B) contracts, whilst the CRA applies to business-to-consumer (B2C) contracts.

UCTA

UCTA applies to any contractual provision which seeks to limit the liability of a party to a B2B contract, whether directly or indirectly – it doesn’t just apply to exclusion or limitation clauses which are clearly marked as such, and so all of the provisions in a given B2B contract need to be reviewed in order to assess whether UCTA applies. For example, UCTA could apply to provisions relating to non-performance or substantially different performance of contractual obligations.

UCTA provides that no contractual clause can exclude or limit liability for death or personal injury resulting from “negligence”, which under UCTA means the breach of either (i) an obligation to take reasonable care or exercise reasonable skill in performance of a contract arising from the express or implied terms of the contract; or (ii) any common law duty to take reasonable care or exercise reasonable skill.

UCTA Reasonableness Test

In the case of loss or damage (other than death or personal injury) resulting from negligence as defined under UCTA, any exclusion or limitation clause will only be enforceable if it passes the UCTA reasonableness test, which is whether it is fair and reasonable to include the term in the contract considering everything known to the parties, or which the parties should reasonably have known, at the time they made the contract.

The reasonableness of including an exclusion or limitation clause is therefore assessed at the time the contract is made, not when a party has been negligent under UCTA and is seeking to rely on an exclusion or limitation clause. The party seeking to rely on the exclusion or limitation clause bears the burden of proving that it passes the UCTA reasonableness test.

Whether or not it is reasonable to include an exclusion or limitation clause in a contract is a question of fact to be determined on a case-by-case basis. For example,  a limitation clause which has been fully negotiated between two businesses of similar bargaining power is more likely to pass the UCTA reasonableness test, whereas standard terms imposed by a dominant party without negotiation are less likely to satisfy the test.

Some of the factors to consider when assessing the reasonableness of an exclusion or limitation provision include:

  • Whether a party is seeking to impose standard terms with exclusion and/or limitation provisions which favour its position, or both parties have negotiated a balanced contract.
  • The relative bargaining strength of the parties, and whether the customer could meet its requirements through alternative means, e.g. by using another supplier.
  • Whether the customer received an inducement in order to agree to the provision, e.g. a lowered price in comparison to other potential suppliers, or if no concessionary benefits were offered.
  • Whether the provision is customarily used in the trade or in previous dealings between the parties, in which case the customer should be aware of the use of the provision.
  • Where the provision excludes or limits liability if a condition is not complied with by the customer, whether it was reasonable at the time of the contract to expect that it would be practicable for the customer to comply with the condition.
  • Whether the goods have been made to the special bespoke order of the customer – if so it may be reasonable for the supplier to exclude or limit liability for problems caused by adhering to the customer’s specifications.

The CRA

The CRA applies to any contract between a trader and a consumer for the supply of goods, digital content or services to the consumer. For the purposes of the CRA, a consumer is any individual acting for purposes which are wholly or mainly outside that individual’s trade, business, craft or profession whereas a trader acts in the course of their trade, business, craft or profession. If the status of an individual as a consumer is disputed, the burden of proof lies with the trader.

The CRA provides that an unfair term in a consumer contract will not bind the consumer. A term is unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer. The fairness of a term is determined by taking into account the nature of the subject matter of the contract and by referring to all circumstances existing when the term was agreed to and all of the other terms in the contract (or any other contract) on which it depends.

The CRA has a detailed list of terms which may be considered unfair, these include terms which:

  • Exclude or limit the trader’s liability in the event of death or personal injury to the consumer as a result of an act or omission of the trader; or
  • Have the object or effect of:
    • inappropriately excluding or limiting the legal rights of the consumer in relation to the trader or another party in the event of total or partial non-performance by the trader of any of its contractual obligations, including the option of offsetting a debt owed to the trader by the consumer against any claim which the consumer may have against the trader;
    • authorising the trader to dissolve the contract on a discretionary basis where the same facility is not granted to the consumer, or permitting the trader to retain sums paid for services not yet supplied by the trader where it is the trader who dissolves the contract;
    • enabling the trader to alter the terms of the contract unilaterally without specifying a valid reason in the contract;
    • enabling the trader to alter unilaterally without a valid reason any characteristics of the goods, digital content or services to be provided, or giving the trader the right to determine whether goods, digital content or services supplied are in conformity with the contract; or
    • limiting the trader’s obligation to respect commitments undertaken by the trader’s agents, or making the trader’s commitments subject to the consumer’s compliance with a particular formality.

What liabilities can you limit/exclude?

Some liabilities cannot be excluded, whilst others cannot be excluded where UCTA or the CRA apply.

B2B Contracts

You cannot exclude liability for fraud, death/personal injury caused by lack of reasonable care/negligence or supplying goods without the right to do so.

There are certain liabilities you can limit if the relevant contractual provision passes the UCTA reasonableness test e.g., negligence (including breach of a common law or contractual duty to take reasonable care or exercise reasonable skill) and breach of statutory terms regarding the quality of goods (any clause seeking to limit liability in relation to the quality of goods, their fitness for purpose or conformity with any description or sample will be interpreted strictly).

B2C Goods

The CRA provides that a trader cannot restrict the statutory rights of a consumer relating to the characteristics of the goods, including that the goods:

  • are of satisfactory quality;
  • are fit for purpose;
  • are as described and conform with any samples provided or models demonstrated; or
  • are installed correctly (where installation is necessary).

The trader must have the right to sell the goods to the consumer. The consumer should receive good title and be able to enjoy quiet possession of the goods free from any encumbrance. The goods should be delivered as agreed between the parties or without undue delay, and risk in the goods remains with the trader until they are delivered.

B2C Digital Content

The CRA provides that a trader cannot restrict the statutory rights of a consumer relating to the characteristics of digital content, including that the digital content:

  • is of satisfactory quality;
  • is fit for purpose; or
  • matches any description of it given by the trader to the consumer.

The trader must have the right to supply the digital content to the consumer.

B2C Services

The CRA provides that a trader cannot restrict the statutory rights of a consumer relating to the delivery of services, including that the services are:

  • performed with reasonable skill and care;
  • reasonably priced or priced as agreed between the parties; or
  • performed either as agreed or within a reasonable time.

Anything said or written by the trader to the consumer relating to the trader or the services is treated as a term of the contract if the consumer takes it into account when deciding to enter into the contract or making decisions relating to the service after entering into the contract, subject to any qualification the trader made known to the consumer on the same occasion, or any change which the parties have expressly agreed upon.

What should you include in your exclusion/limitation clause?

You should minimise your exposure to risks which are too remote, risks you cannot control (e.g. actions of third parties) and risks in relation to which you may not be able to afford liability.

Damages for breach of contract are only recoverable for losses which were within the contemplation of the parties at the time the contract was entered into – other losses are too remote. It is therefore common to exclude liability for indirect or consequential loss, although as this type of clause is open to interpretation it is best to expressly list specific indirect losses in relation to which you wish to exclude or limit liability.

It is also common for a party seeking to minimise its exposure under a contract to cap its liability for some or all risks in relation to its performance of the contract, e.g. a party may cap its liability at the value of the transaction or use a percentage of this value. It is important that the method by which the cap is calculated is set out in the contract as well as what liabilities are accepted by that party subject to the cap.

The contract should also make it clear whether the liability cap is separate to, or includes, other sums which may be due from the party under the contract such as liquidated damages or statutory interest.

A cap cannot be so low that it is unreasonable. Under UCTA, the court will consider the effect of the relevant clauses as a whole taking into account all circumstances, so a cap which provides some level of compensation for loss suffered is more likely to be found reasonable. Likewise, the cap should not be unnecessarily low compared to the level of insurance cover which the relevant party has, although given the circumstances it can be reasonable for that party to set the cap as a percentage of its insurance cover for certain risks.

Finally, do not assume that a liability cap which is agreed upon in negotiations will pass the UCTA reasonableness test as it may not be reasonable when the relevant factors are considered.

What about insurance and indemnities?

For each transaction you should consider which party is better placed to insure against the specific risks associated with performance of the contract, e.g. losses anticipated in transaction, making good any guarantees, recalls of faulty goods etc. You also need to avoid invalidating applicable insurance cover, for example by accepting liability for loss or failing to disclose that amended standard terms have been used – you should check the policies to make sure you are aware of your obligations.

Where the insurance cover for a particular risk is provided by your counterparty, consider requiring your interest to be noted on their policy so that you will be notified if the policy is cancelled or nearing expiry. You should ask to see the relevant policy documentation and oblige your counterparty to maintain the policy by making any necessary renewal payments and not doing anything to invalidate the cover.

If UCTA applies, the respective ability of each party to insure against specific risks is relevant when assessing applicable exclusion or limitation provisions for reasonableness.

It is important to highlight that a contractual obligation to insure against a risk does not by itself make the counterparty responsible for paying up when that risk is realised. You should therefore ensure that there is also an indemnity provision which compels the counterparty to pay for your losses in relation a given risk.

What it is appropriate to indemnify against will vary on a contract-to-contract basis and it is unlikely that you will convince the counterparty to indemnify you against all loss, but it is important that the indemnity is considered for the same risks as insurance to achieve your aims in drafting the contract and protecting your interests. Without the indemnity provision the counterparty may be able to argue against paying you for loss in the event of a particular risk being incurred.

How we can help

We have extensive experience negotiating, drafting and reviewing all aspects of commercial contracts, including exclusion and limitation provisions. We can help you ensure that your interests are protected before you sign up to a contract.  For further information, please contact us.

Disclaimer: This article is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this article.