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Limitation of Liability: Why the L.O.L clause is no laughing matter

View profile for Robert Taylor
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Imagine that every single word you said aloud was taken literally, and if you misspoke - you couldn’t correct yourself. If you accidentally said you wanted large, not small, two sugars, not one, a single, not a return or no bag rather than one bag, you’d have to stick with your original, accidental choices. If this was the way of the world, you would take time to consider every word before you spoke, just in case a statement had potential to be misinterpreted.

Thankfully, we’ve got a little bit more freedom to falter in our conversations. However, when it comes to commercial contracts, every word counts. Should a dispute arise between businesses, it’s this contract that will act as a road map for the judge to determine an outcome. If your contract isn’t well drafted, explaining what you meant vs. what you said won’t help you protect your interests.

When entering into a commercial agreement, it’s not uncommon and is in fact wise for one or both parties to insert a Limitation of Liability clause into the contract, restricting the extent of their liability should the other suffer loss of business, profits or revenue as a direct result. It’s no surprise that it’s the subject of intense negotiation and a common cause for dispute; since the issue at stake is the level of risk involved in the agreement.

Despite this, the Limitation of Liability clause is one that is usually drafted inadequately.

L.O.L: you drafted it wrong

In a legal context, a liability is a responsibility to compensate for some failure to perform according to an established stipulation. A Limitation of Liability clause exists in a commercial contract to restrict the amount of compensation owed in case of performance failure. It’s likely that you’ve encountered a clause like this before - usually, it’s all in capital letters and sounds like this:

[Enter company name here] WILL NOT BE LIABLE FOR THE DAMAGES OF ANY TYPE YOU EXPERIENCE THROUGH OUR PRODUCT/SERVICE, SO REGARDLESS OF WHAT HAPPENS TO YOU, HOW MUCH MONEY YOU LOSE OR PAIN AND SUFFERING YOU EXPERIENCE, YOU CAN ONLY HOLD US PARTIALLY RESPONSIBLE BUT THE COMPENSATION WON’T BE VERY GOOD, SORRY (NOT SORRY.)

(Please note: if this is actually what your Limitation of Liability clause looks like, seek help.)

While the Court recognises the need for businesses to insert liability clauses into their commercial contracts, this is not without restriction. In order for the clause to be enforceable, it must pass the test of reasonableness set out in section 11 of the Unfair Contract Terms Act 1977 (UCTA). The UCTA Reasonableness Test sounds like the name of a really boring game show, but is in fact a method of determining whether or not terms of a clause should be upheld. The test states that any exclusion/liability clause must be: “fair and reasonable … 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.” However, UCTA does not actually define what is meant by “reasonable.” That means ultimately, it's up to the Court to decide.

Due to the complexities involved with this clause, it’s no surprise that many businesses fail to make the necessary liability provisions within their commercial contracts. After all, most business owners don’t have time to spend their days reading about the ins and outs of contract law. However, if you are drafting or reviewing a contract you don’t understand - it’s a good idea to get advice.

The Curious Incident of Kudos and the Contract

In a recent case (Kudos Catering (UK) Ltd v Manchester Central Convention Complex Ltd [2013] EWCA Civ 381) the Court of Appeal highlighted the dangers of widely drawn exclusion clauses.

It all started in 2007, when Manchester Central Convention Complex decided to appoint Kudos Catering under a five-year contract to provide their catering services. Neither side could have predicted how that relationship would turn out (spoiler: it didn’t end well).

When they agreed to provide their catering services, Kudos signed a commercial contract that included a clause on the limitation of MCCC’s liability. The clause (point 18.6 to be precise) stated that they 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’.

Everything was going well until 3 years in, when MCCC terminated the contract, claiming that Kudos had materially breached it. But Kudos did not agree, and felt that the termination had been totally unlawful. So, they claimed £1.3m in lost profit to reflect the amount they would have earned during the remaining 2 years.

If you’re wondering how the Limitation of Liability clause didn’t stop Kudos from claiming lost profit, you probably feel the same as MCCC did when the outcome was being decided (but definitely not as gutted.) However, a closer look into the structuring and wording of the contract proves just how easy it is to make an error in drafting this clause. Although the High Court ruled that clause 18.6 effectively excluded MCCC's liability for loss of profit, the Court of Appeal overturned the decision on the basis that:

  • The clause was “buried” in a section titled Indemnity & Insurance
  • If the clause did exclude all liability for loss of profit, it would effectively deprive Kudos of any sanction for a breach of contract by MCCC, which would render the contract an unenforceable statement of intent
  • If the parties had intended to exclude liability for loss of profit in the event of refusal to perform the contract, this should have been made clear in a separate clause, according to the court.

So you see: the slightest mistake can mean that things don’t quite turn out the way you expect them to. However, rather than having to drink a slightly sweeter tea or having to carry your shopping home because you failed to ask for a bag, you’re paying out a large sum of money to compensate the other parties loss.

Drafting your Limitation of Liability clause

When it comes to drafting your Limitation of Liability clause, there are several ways to approach it.

  • Liability Caps
    Since the Court tends not to look favourably on a total exclusion clause, including a clause with a financial cap on liability will have a good chance at being held as reasonable, depending on the amount you set the limit. This amount will depend on the value of the contract and potential liabilities of both parties, but is typically a percentage of the value. When drafting a liability clause with a cap, it’s essential to state clearly whether the limit is based on the annual or total amount due under the contract.
     
  • Heads of Loss
    Depending on the level of risk involved, you may want to agree on using sub-clauses to separate the caps on the various heads of loss. For example, if you were particularly worried about damage to property, this could be subject to a sub-clause with it’s own cap. This will ensure that there is no room for misinterpretation by the Court. As well as this, you may want to add a “catch all” provision that covers any indirect or consequential losses – however, this should be placed after your specific heads of loss provisions in the contract to avoid the Court assuming your “catch all” governs the following list of heads of loss.
     
  • Consequential/Indirect Losses Only
    Indirect or Consequential loss was originally defined in the Hadley v Baxendale case of 1854 as “losses likely to arise from special circumstance of the case”, such as the loss incurred as a result of being unable to use business property or equipment. Should you simply want to exclude or minimise liability for this kind of loss, it’s essential that it be clearly stated in the contract.
     
  • The Tailor-Made Clause
    Arguably the best way of protecting your interests in this area of a commercial contract is by drafting a tailor made clause that reflects your precise concerns. Should you need assistance in negotiation, you can rely on our dedicated team to ensure your clause protects your interests.

How our business lawyers can help you

At 360 Business Law, we are experts in contract law. Unlike you, our days are consumed by reading the ins and outs of commercial contracts, so we know what makes a clause valid and how to avoid the potential pitfalls when drafting one.

When it comes to Limitation of Liability clauses, we’ve seen it all: from the complete exclusions to those that barely limit any damage at all. When you instruct one of our specialists, our priority will be to help you draft a robust Limitation of Liability clause that accurately reflects your circumstances, objectives and requirements and leaves no room for misinterpretation. 

The first step will be for our lawyers to gain an understanding of your business and what you hope to achieve as well as what you are aiming to avoid. Next, we will determine the best approach in drafting the Limitation of Liability clause to ensure your interests are protected.

That way, you won’t have to worry should an issue arise.

When you subscribe to our subscription service, you cut out the risk of rising fees. Instead of uncertainty, you receive our specialist commercial law advice packaged into one fixed monthly fee. The subscription costs will be determined by your need, and the service will be personal and tailored to your requirements. However, if you only need occasional project work our hourly rate work is the way to go – our hourly rate fees are fixed at £135.00 per hour (excl VAT)

 

Get in touch with us today to find out how we can help your business. Either write to us through our simple enquiry form or call us on 01276 804432.

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