Compare and Contrast

Effectiveness of Risk Allocation

Clauses in the UK

No party really wants to subject itself to unknown liability. Contracts

are intended to reflect appropriate risk allocation between the parties
and to clearly delineate potential liability in the various scenarios that
can arise. Often, contracts do not do this adequately and the courts
are full of cases dealing with situations that were either not envisaged
or where the parties disagreed on the meaning of clauses (or the
commercial impact of clauses) which they have agreed.
Parties seeking to define the limits of their liability at the outset need
to be aware of the fluctuating common law (including interpretation
rules, implied terms and the like) and the risk of statutory intervention.
Often, it is not simply what the contract sets out in writing, but what it
does not say that can cause issues in practice.
This note considers risk allocation clauses in the context of
business-to-business contracts within England and Wales. Consumer –– A court should be very slow to reject the natural meaning of
contracts and international contracts are outside the scope of this a provision as correct simply because it appears to be a very
note. This is a wide topic, so the points considered in this note are imprudent term for one of the parties to have agreed, even
of general application and we cover the following risk allocation ignoring the benefit of wisdom of hindsight
methods in outline only:
–– When interpreting a contractual provision, one can only take
a. Some general observations into account facts or circumstances which existed at the
time that the contract was made, and which were known or
b. Liabilities that cannot be excluded of limited
reasonably available to both parties
c. Caps on/limitations of liability
–– In some cases, an event subsequently occurs which was plainly not
d. Exclusions of liability intended or contemplated by the parties, judging from the language
e. Use of indemnities of their contract; in such a case, if it is clear what the parties would
have intended, the court will give effect to that intention
f. Use of time bar provisions / conditions precedent
–– Service charge clauses are not to be subject to any special rule
g. Statutory restrictions of interpretation (this point was specific to the case at issue)
a. Some general observations • Other principles which can be gleaned from case law in relation to
exclusion or caps/limitation clauses include that:
Some general principles to be aware of:
–– Any doubt or ambiguity arising when an exclusion or cap/
• Clauses in contracts dealing with risk allocation should be
limitation clause is invoked may well be resolved against the
expressed clearly and without ambiguity in order to be effective.
party seeking to rely on that clause
In 2015, Lord Neuberger, now the president of the Supreme Court,
considered the court’s approach to contractual interpretation –– Whilst it may seem an obvious point, it is for the party seeking
in the case of Arnold v Britton when considering purportedly to rely on the exclusion or cap/limitation clause to show that
ambiguous drafting. He identified seven factors that a court will the clause is capable of covering the liability that he or she
have regard to: believes it excludes.
–– The reliance placed on commercial common sense and b. Liabilities that cannot be excluded or
surrounding circumstances should not be invoked to undervalue
the importance of the language of the provision which is to be limited
construed Legislation and case law have held that certain liabilities arising as
–– The less clear the relevant words are, or the worse their a result of the following cannot be excluded or limited:
drafting, the more ready the court can properly be to depart • Fraud
from their natural meaning
• Death or injury caused by negligence
–– Commercial common sense is not to be invoked retrospectively
• Supplying goods without the right to do so
A party seeking to limit liability for its own fraud will be unable to
do so on public policy grounds. Fraud in this context will involve an
element of dishonesty, as liability for a careless act is capable (with
appropriate drafting) of being limited and, therefore, does not fall
within the definition of fraud. You should note that limiting liability
here is by reference to a party’s own personal fraud. Provided
the wording is specific enough, a party may limit liability for the
dishonesty of its employees, agents or sub-contractors.
Liability for injury or death resulting from negligence cannot be
avoided (s.2 of the Unfair Contract Terms Act 1977 [UCTA]). Only the
victim of the negligence is protected (or, in the case of their death,
those claiming on the deceased’s behalf). Financial claims in respect
of negligent conduct, where neither party is themselves the victim,
may successfully be excluded.
Under s.6 of UCTA, statutory implied terms imposed by the Sale of
Goods Act 1979, relating to the buyer’s right to receive goods free
from encumbrances and to keep the goods after transfer may not be
excluded or restricted. Liabilities for breach in respect of goods not
conforming with their description may only be restricted or excluded
to the extent that such an exclusion or restriction is reasonable.
Similar restrictions are implied in respect of hire purchase contracts
under the Supply of Goods (Implied Terms) Act 1973.
Although rare to see in practice, it is also not possible to exclude
or restrict liability for illegality. If a contract has been tainted by
illegality, the contract is void.
c. Caps on/limitation of liability
Obviously, there are rules applicable to types of loss and/or
damage that are recoverable under or in connection with a contract
(e.g. in the law of tort), including consideration of issues such as
remoteness, causation and foreseeability. All that is outside the
scope of this note, but assuming there is a liability, the use of
clauses which attempt to cap/limit liability are fairly common in
England and Wales and are, generally speaking, enforceable.
Indeed, many of the standard forms of contract include caps on
liability for contractors/professionals. Depending on the nature
of the construction or engineering project, they may, for example,
relate to:
• Caps on liquidated damages for delay – whether per section or
for the whole of the works – which may be linked to termination
rights
• Caps on liquidated damage for failure to achieve certain KPI’s or
deliverables – which may be linked to termination rights
• Overall caps on general damages
• Caps arising on a termination scenario
It is less common to see caps in favour of the Employer on the basis
that there is typically a Contract Sum and more limited grounds for
loss and expense/compensation event type claims. That said, it is
not uncommon in more sophisticated contracts to cap the Employer’s
liability in relation to termination for convenience or Employer
default scenarios, particularly where there is a funding element to
the overall transaction.
Likewise, it is not uncommon for certain liabilities to be excluded
from any cap – for example, intellectual property infringements
or liabilities for which insurance cover should be in place by the
relevant insuring party. Each contract would need to be considered
in its own right.
Aside from the limits referred to in section (b) above, parties may
limit their liability arising as a result of negligence so far as such a
limit is reasonable.
Whilst the courts continue to seek to ascertain what the parties
have decided between themselves, as set out below, the test as to
for whether liability for negligence has been successfully excluded
has been laid out in case law.
d. Exclusions of liability
An exclusion clause, separate from a limitation clause, is a clause
which seeks to totally exclude liability in respect of a form of loss,
rather than cap liability at a set amount.
Broadly speaking, an exclusion clause generally seeks to exclude
one or both of the two types of losses which arise from a breach of
contract: direct losses and indirect losses.
Direct losses have been described as those arising naturally or in
ordinary circumstances from the breach. Indirect losses or losses,
which are sometimes referred to as “consequential losses”,
are generally understood to mean losses that would have been
contemplated by someone with knowledge of special circumstances.
A commonly held misconception is that loss of profit will always
be an indirect or consequential loss. On the contrary, English courts
can and have held that loss of profits can be a direct loss. Limiting
liability by reference to indirect or consequential loss alone is,
therefore, risky (at best) and it is recommended that when seeking to
limit liability for any type of financial loss, that these are specifically
considered and excluded rather than by using generic terms.
Successfully excluding indirect and consequential loss, whilst not
uncommon in process and engineering contracts, is a task that
requires special thought and consideration before putting words
down on paper.
Negligence
When considering clauses purporting to exclude or limit liability
for negligence, the court’s general starting position is that as it is
“inherently improbable” that one party would want to allow the
other party to exclude his liability for negligence.
However, even if wording specifically pertaining to negligence is
not included in the contract, the courts have still held that some
phrases may be interpreted widely enough so as to allow liability
for negligence to be excluded. The cases turn on the wording on
the relevant contracts. If it is the intention of the parties to exclude
liability for negligence, it is advised to expressly do so. Uncertainty
is not a desirable state of affairs for negotiating parties particularly
given the importance of the issue.
A note for those reading from other jurisdictions, unlike numerous civil
law jurisdictions, gross negligence is not generally recognised as a
separate legal concept from “ordinary” negligence in English law.
e. Use of indemnities
Indemnity provisions are fairly common in construction and
engineering contracts and typical examples relate to damage to
property or intellectual property infringement but may also cover
interference with other party rights.
Readers should note that the use of the term “indemnity” or
“indemnify” can give rise to different limitation periods and despite
what may be perceived to be a common understanding, may not
actually result in all losses (however remote) being recoverable
on a “pound for pound” basis and may also not avoid the so called
“duty to mitigate” losses. As with all things, precision of drafting is
crucial.
As well as indemnifying for breach, an indemnity clause may
constitute a promise by one party to bear the financial risk or pay
an amount to the other in respect of an event occurring. In such
circumstances, no breach of contract is required.
Indemnities can also be capped (or carved out of caps), so it is
recommended that this is considered on a contract-by-contract basis,
alongside the extent of any insurance coverage and who should
bear, for example, responsibility for any shortfall or underinsurance
or failure to notify claims.
f. Use of time bar provisions/conditions
precedent
Notice provisions as a condition precedent to successful claims
are fairly common in construction and engineering contracts in
the UK or applying English law. For example, the FIDIC imposes an
obligation on a contractor to submit a notice within 28 days and the
NEC requirement is for a compensation event to be notified within
eight weeks. Many standard form contracts expressly state what the
consequences will be for failure to notify within the stipulated time,
e.g. that the contractor will not be entitled to an extension of time or
loss and expense or cost. Some standard forms are not quite so well
defined. In the UK, clearly drafted time-bar provisions are generally
enforced.
That said, there are, however, tales of caution with standard forms
and bespoke clauses alike since the triggers for commencement of
the relevant timescale are often not always clear. They may link to
subjective knowledge of the contractor (which may be difficult to
prove), they may be linked to what a reasonable contractor should
have been aware of at the time (again difficult to prove) and they
may allow more than “one bite of the cherry” since an event may not
actually cause delay or disruption until a later date, particularly if
there are mitigation steps or other events or circumstances occurring
at the same time or if the event is continuing. A clause may not,
therefore, have the effect intended. Some contracts also include
“look-ahead” provisions with the use of warning notices and risk
registers and reflect entitlement based on when a notice should
have been given. As with all contracts, precision is required.
For those serving notices, they should check the notice provisions in
the contract carefully – including the method of service and date of
deemed delivery as these are often overlooked in practice and may
create a barrier to recovery.
g. Statutory restrictions
UCTA
Exclusion or limitation of liability clauses, which can take on various
forms, have been the subject of various legislative interventions.
UCTA regulates the extent to which business-to-business contracts
can exempt liability where one party has contracted on the other’s
standard terms of business. In such a situation, an exclusion or
limitation clause will only apply to the extent that such a clause is
reasonable.
The reasonableness test is set out at s.11(1) of UCTA:
“In relation to a contract term, the requirement of reasonableness
for the purposes of this Part of this Act, is that the term shall have
been a fair and reasonable one to be included 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.”
Further guidance in respect of reasonableness is provided for by five
guidelines laid down in UCTA:
a. The strength of the bargaining positions of the parties relative to
each other, taking account (among other things) alternative means
by which the customer’s requirements could have been met –
supplemented material
b. Whether the customer received an inducement to agree to the
term, or in accepting it had an opportunity of entering into a
similar contract with other persons, but without having to accept
a similar term
c. Whether the customer knew or ought reasonably to have known
of the existence and extent of the term (having regard, among
other things, to any custom of the trade and any course of dealing
between the parties)
d. Where the term excludes or restricts any relevant liability if some
condition is not complied with, whether it was reasonable at the
time of the contract to expect that compliance with that condition
would be practicable – supplemented material
e. Whether the goods were manufactured, processed or adapted to
the special order of the customer
The time for determining the reasonableness of the term is the
time at which the agreement was made. This is to ensure that the
reasonableness of a clause is not decided by virtue of the damage
caused.
There is a wealth of case law providing illustration of the above
principles but these are based on the specific circumstances and the
particular contract in question.
 Take away points
• Managing potential liabilities should be a key
consideration for all businesses and should be considered
as part of the risk profile when considered contracts.
• There are a number of possible ways to manage and
control risk in a contract governed by English law.
• Contracts need to be precise in order to manage and
control such risks.
• Using shorthand terms such as “consequential loss” to
seek to avoid or exclude liability for loss of profit, revenue
and the like should be avoided.
• Contracts in the UK depend not just on what is written
in the contract, but also on an understanding of rules of
interpretation, the relevant case law and understanding of
statutory implied terms. These are all fluctuating.
• As always, parties should take particular care to ensure
they understand the impact of having contracts which
involve parties from different jurisdictions or where the
location of the project or services/works performed are in
a different country as this may have a significant impact
on the contract/risks regardless of the choice of governing
law.

Contact

Ray O’Connor
Partner, London
T +44 207 655 1422
E ray.oconnor@squirepb.com

The contents of this update are not intended to serve as legal advice related to individual situations or as legal opinions
concerning such situations, nor should they be considered a substitute for taking legal advice.

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26515/03/17