The parties to a commercial agreement often try to manage their risk by inserting clauses into the contract stating that one or both of the parties' liability - for example, where there is a breach of contract - is limited or restricted in certain ways.
For example, a supplier of services will often limit its liability to the value of those services. Similarly, a party selling goods to another party may include a clause excluding the seller's liability for loss of profit, or for indirect/consequential loss.
Despite the obvious benefits of including clauses restricting the extent of a party's liability under a contract, a recent Court of Appeal case has highlighted the pitfalls when trying to rely on such clauses.
The Kudos case
On 7 February, the Court of Appeal found in Kudos Catering (UK) Limited v Manchester Central Convention Complex Limited  EWCA Civ 38, that on the facts and the particular wording of the contract, a clause which excluded a party's liability for loss of profits did not apply where that party had failed to perform the contract.
Manchester Central Convention Complex (MCCC) appointed Kudos in 2007 under a five-year contract to provide catering services.
Clause 18.6 of the contract stated that MCCC 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'.
MCCC asserted that Kudos had materially breached the contract, and terminated in July 2010. Kudos argued that this was an unlawful termination, and claimed £1.3m in lost profit, to reflect the amount which Kudos believed it would have earned during the remainder of the contract.
Although the High Court ruled that clause 18.6 effectively excluded MCCC's liability for loss of profit, the decision has been overturned by the Court of Appeal. The reasons for the Court of Appeal's judgement, which held that Kudos could in fact recover its lost profits from MCCC, include the following key points:
- clause 18 was headed Indemnity and Insurance - the exclusion of loss of profit was 'buried' in this clause, and the court held that the exclusion applied only in the context of defective performance rather than total failure to perform
- if effective, clause 18 would have deprived Kudos of any real remedy in the event of default by MCCC. Therefore, if clause 18 were to be interpreted literally (i.e. to exclude loss of profit for any type of default - including deliberate repudiatory breach), the contract would have been 'entirely devoid of contractual content' and would be contrary to business sense
- if the parties had intended to exclude liability for loss of profit in the event of refusal to perform the contract, the court said that this should have been set out unambiguously in a stand-alone clause.
Top tips for drafting exclusion clauses
In addition to the Kudos case, there have been a string of important decisions relating to exclusion clauses in recent years.
Applying the lessons learned from these decisions, businesses should bear in mind the tips set out below when negotiating exclusions and limitations of liability in commercial agreements.
Don't rely on an exclusion of 'indirect/consequential loss'
The courts have interpreted the meaning of 'indirect loss' narrowly in various cases, including GB Gas Holdings Limited v Accenture (UK) Limited and others  EWCA (Civ) 912. The impact of this has been that various types of loss have all been recoverable as direct losses, and an exclusion of liability for indirect loss has not reduced the liability of the party seeking to rely on the exclusion clause.
Break down your exclusions of liability into separate sub-clauses
In Markerstudy Insurance Company Limited and Ors v Endsleigh Insurance Services Limited  EWCH 281 (Comm), the court found that the following two clauses only excluded liability for indirect/consequential loss of goodwill, profit and business, etc (rather than excluding liability for all loss of goodwill, profit, business and so on):
- 'Neither party shall be liable to the other for any indirect or consequential loss (including but not limited to loss of goodwill, loss of business, loss of anticipated profits or savings and all other pure economic loss) arising out of or in connection with this Agreement'.
- 'Endsleigh will not be liable to [the claimants] for any indirect or consequential loss or loss of profit or loss of business arising out of data input errors by Endsleigh put into Policy Schedules, Certificates of Insurance or Endorsements'.
The use of the words 'indirect or consequential loss' in each instance 'contaminated' the heads of loss, which came after them. In order to avoid this, we suggest using sub-clauses to clearly separate the different heads of loss for which you wish to exclude liability.
Use unambiguous wording to clarify whether your exclusion of liability should apply when there has been no performance/deliberate breach
Although the Court of Appeal confirmed in the Kudos case that (contrary to a 2009 decision in the High Court in NETTV v MARHedge) there is no presumption that an exclusion clause will not apply to deliberate breach, the courts are likely to interpret widely drafted or draconian exclusions as narrowly as possible.
Therefore, if the parties do intend to exclude certain types of liability (for example in relation to loss of profit) for deliberate breach as well as defective performance, this should be clearly stated.
Take heed of the potential impact of the Unfair Contract Terms Act 1977 (UCTA)
As a result of UCTA, exclusions of liability for death/personal injury resulting from negligence, for fraud or fraudulent misrepresentation and for breach of implied covenants as to title in the Sale of Goods Act 1979 will be void.
Certain types of exclusions (which differ depending on whether the contract is business to business or business to consumer and whether it is negotiated or on one party's standard terms) will be subject to the 'reasonableness test'.
This test asks: "is the term fair and reasonable having regard to the circumstances which were, or ought reasonably to have been, known to or contemplated by the parties when the contract was made?" If a mistake in your exclusion clause renders it void or unreasonable, it will be struck from the contract, which could result in your potential liability for various heads of loss being unlimited.
Consider whether the innocent party will have an adequate remedy for breach
One of the issues highlighted by the Court of Appeal in Kudos was that if the exclusion of liability for loss of profit applied to non-performance - as MCCC tried to argue - Kudos would have had no effective remedy.
So if you are drafting a wide-ranging exclusion of liability, it is worth considering what remedy the other party will be left with. Whether applying the UCTA reasonableness test or their powers of contractual interpretation, the courts will not look favourably on a clause that seeks to remove any remedy for failure to perform or for defective performance.