One of the most crucial issues for all contractors, sub-contractors and consultants to consider when entering into contracts is how to limit their liability for losses they cause their employer to suffer. The 5 key issues to consider when limiting and excluding liability are as follows:

1. Caps on Liability

A contractual provision which caps your total liability at a pre-determined level will provide you with valuable certainty about the level of your financial exposure in the event a claim is made against you.

A cap on liability is particularly important in cases where you are asked to provide an indemnity to your employer because indemnities can extend normal legal principles relating to damages, potentially requiring you to assume liability for any loss suffered as a consequence of your breach, even if that loss was not foreseeable at the time you entered into the contract.

Caps on liability can be either total caps (i.e. encompassing all financial loss that the employer might suffer) or partial caps (i.e. covering most types of loss, but subject to certain exclusions such as, for example, losses caused as a result of a failure to comply with environmental laws). Clearly, a total cap is preferable, but whether this is achievable will depend on the nature of the project and the parties’ respective bargaining power.

It is not always easy to decide what level liability should be capped at. This is an issue which is often debated at length in pre-contract negotiations. One of the most common methods is to cap liability at the value of the contract sum. However, for very low or very high contract values, it may be more appropriate to agree on a percentage or a multiple of the contract value.

Another common way of limiting liability is to link the cap on liability to the value of the limit of indemnity on a professional indemnity insurance policy. However, anyone opting for this method must remember that not all losses which their employer might seek to recover may be covered by the professional indemnity insurance. For example, professional indemnity insurance does not usually cover defective workmanship. Any loss which is not covered by the insurance will have to be met from your own financial resources.

2. Exclusion Clauses

In addition to a cap on liability, it is important to consider excluding certain types of loss. An exclusion clause could also be offered as an alternative to a cap on liability if your employer is resistant to a cap, although ideally you should aim to include both a cap and an exclusion clause.

The most common type of exclusion clause is one which excludes liability for indirect loss. Indirect loss (also known as consequential loss) is loss which arises as a consequence of a breach of contract, but which would be considered too remote to be recoverable if it were not for the fact that the parties can reasonably be supposed to have contemplated that sort of loss as being a potential consequence of a breach at the time the contract was formed. This is in contrast to direct loss, which is loss which may reasonably be considered to arise naturally from a breach of contract.

Unfortunately, clauses excluding liability for indirect loss do not always offer as much protection as the party seeking to rely on the clause would hope. For example, in the case of GB Gas Holdings Ltd v Accenture (UK) Ltd (2010), a defective automated customer billing system resulted in a gas company having to make £8m worth of goodwill payments to its customers. The court held that these goodwill payments were a direct loss flowing naturally from the breach and therefore did not fall within the scope of the clause excluding indirect loss. This resulted in the software provider facing costs of £8m which it thought had been excluded as indirect loss.

Rather than rely on a clause which generally excludes liability for indirect loss, if you are seeking to exclude a certain type of loss which you simply cannot accept liability for, it is better to include express wording in the contract to this effect.

Often, an exclusion clause will only be accepted by an employer if the clause is reciprocal i.e. each party’s liability to the other for indirect loss is excluded. This can work either for or against you, depending on whether you are the party bringing or defending the claim. However, as it is generally more likely that the employer will be bringing claims for indirect loss (e.g. if there is a defect or delay), the risk for a contractor or consultant in accepting a reciprocal exclusion clause is often fairly low.

3. Net Contribution Clauses

Under English law, if an employer suffers a loss arising from a defective building and 2 or more parties have a responsibility for that loss (say the architect and the engineer), the employer can (if it wishes) sue just one of those consultants for the full amount of the loss, notwithstanding that the consultant may only be partly responsible for the loss. The consultant that has been sued will then have to issue proceedings against the other consultant to recover a contribution to the damages he has had to pay to the employer. This is undesirable for the consultant because (a) he has to invest time and money into pursuing the other responsible consultant and (b) there is a risk that the other responsible consultant may be uninsured, unable to pay or insolvent.

A net contribution clause is a clause which limits a consultant or contractor’s liability to an amount that is fair and reasonable given the extent of their liability for the loss suffered. This takes away the risk of being held liable for losses caused by someone else. Net contribution clauses are most frequently seen in consultant appointments, although they can also benefit contractors working on traditional projects (but not design and build contractors, who have single point design responsibility).

However, it is important to note that net contribution clauses have never been properly tested in the courts, so there is no watertight guarantee that they will work.

4. Check Your Warranties!

It is essential to ensure that limitation of liability provisions you incorporate into your contract/appointment are carried through to the collateral warranties you provide to third parties. If you fail to do this, your liability to the beneficiaries of the collateral warranties will be unlimited, leaving you exposed.

The simplest way of ensuring limitation of liability and exclusion clauses are carried through into a collateral warranty is to include a “no greater liability” clause in the warranty which confirms that your liability under the warranty will be no greater than the liabilities you owe under the underlying contract/appointment.

5. What Liability Can’t You Limit?

The Unfair Contract Terms Act 1977 (“UCTA”) prohibits contracting parties from limiting or excluding liability in respect of claims relating to death and personal injury. As a result, even if you agree a total cap on your liability, any claim relating to death or personal injury will fall outside this total cap.

UCTA also states that you can only rely on a clause which excludes or restricts liability for other types of loss (e.g. property damage) caused by negligence if the clause satisfies the “requirement of reasonableness”.

A further restriction which applies solely to “written standard terms of business” (not to negotiated contracts) is that clauses excluding liability for breach of contract must also satisfy the “requirement of reasonableness”.

To satisfy the “requirement of reasonableness”, the term 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.

It is often difficult for businesses to argue that the “requirement of reasonableness” has not been satisfied because they are usually assumed to have sufficient knowledge of entering into contracts to understand what they are agreeing to. However, in the recent case of Ampleforth Abbey Trust v Turner & Townsend (2012), the court refused to uphold a clause limiting a consultant’s liability to 10% of its fees on the grounds of unreasonableness. This was primarily because the consultant had been required to provide professional indemnity insurance for almost 10 times the amount it had limited its liability to, and therefore the client was paying for insurance which was effectively worthless. This serves as a warning that in some cases a cap on liability may be overturned if it is unreasonably low.