News & Views

Excluding liability in commercial contracts

The first American astronaut in space, Alan Shepard, said how sobering it was to look down on Earth and realise his safety was in the hands of the lowest bidder for a government contract. Not all commercial contracts involve rocket science, of course, but it always makes sense to try to exclude certain financial and operational liabilities in them whenever you can.

The most common form of liability occurs when one party fails to perform its contractual obligations. This can include failing to provide or pay for agreed goods or services, missing contractual deadlines, or supplying goods or services that do not meet the agreed standards. Less commonly, liability can arise from a party’s negligent actions or omissions that cause loss or damage to the other party, or if one party has provided false information (misrepresentation) that induced the other party to enter into the contract.

Without limitations on liability, a party to a commercial contract could be liable for the full scope of damages suffered by the other party, regardless of the magnitude of fault on their part. Liability clauses in contracts can define the extent of the parties’ responsibility when things go wrong, meaning that both parties gain clarity and predictability.

Excluding liabilities from a contract

Parties can explicitly exclude liability for certain types of losses. Common exclusions include:

• Excluding indirect or consequential loss – indirect or consequential loss refer to losses that are not the natural results of the breach in the usual course of things but arise from a special circumstance of the case. These are only recoverable as damages for breach of contract if the paying party was in a position to know of the ‘special circumstance’ when it made the contract.
• Excluding loss of goodwill - like consequential loss, this aims to exclude liability for damage to a party's reputation or customer relationships.
• Excluding loss of anticipated savings - this excludes liability for losses based on expected but unrealized cost reductions.

The ‘indirect or consequential loss’ pitfall

Parties seeking to exclude ‘indirect or consequential loss’ often assume this covers all financial losses except direct financial losses. However, this widely used phrase has a well-established but counter-intuitive meaning in English law. The pitfall for contracting parties is not the nature of losses but in their foreseeability. Losses such as loss of profit and loss of goodwill may still be recoverable, even if the contract excludes ‘indirect’ loss because they are the usual, predictable, and foreseeable results of a breach.

So, contracting parties should not assume that, by excluding indirect or consequential loss, they have done enough to limit liability for financial loss. They should take care when drafting and negotiating exclusions to consider the types of loss that may be incurred as a result of a party failing to perform the contract and clearly state the type of loss being excluded (e.g. loss of data, damage to reputation, loss of profit or revenue). Drafting appropriate provisions which aim to exclude the relevant categories of loss can help avoid arguments later down the line about whether a loss was ‘direct’ or ‘indirect’.

Exceptions to the exclusion of liability 

Certain types of liability cannot be excluded (or limited) under English law. For example:

• Death or personal injury resulting from negligence - any attempt in a contract to restrict or exclude liability for death or personal injury resulting from a party's negligence is ineffective. This applies to both business contracts and consumer contracts.
• Fraud or fraudulent misrepresentation by a party inducing contract formation - a clause seeking to limit a party's liability for its own fraud is void as a matter of public policy where the fraud induces contract formation. This applies to all contracts.

The power of precise contract wording

The drafting of commercial contracts, and exclusion clauses in particular, requires precision and a thorough understanding of their potential implications to ensure they are effective and enforceable. Involving your legal advisers in such contract negotiations is likely to prove a valuable investment and save you money in the long run.

For further information, please email Megan Crone or Philip Bowers or call 0151 906 1000.