When you enter a commercial contract, you immediately expose your business to legal liability. In most cases, legal disputes or potential negligence claims can be sorted out with a few firm (but friendly) emails or through alternative dispute resolution methods such as mediation.
But in rare cases, disputes escalate to the point where litigation proves inevitable. If this happens, you want to ensure that your business's liability is limited, which is achieved by negotiating and inserting a limitation of liability clause in the agreement.
What is a limitation of liability clause in a contract?
A limitation of liability clause in a business-to-business (B2B) contract is a clause that limits the amount of damages a business must pay if a legal claim is brought.
Depending on the wording of the clause, liability may be excluded only for claims brought during the contract's timeframe or apply to certain types of claims. The limitation of liability is constrained by statute and common law, as shown below.
Why is a limitation of liability clause important?
Engaging in a commercial contract often results in the interaction of various parties. This includes employees, subcontractors, suppliers, consumers and the general public. This puts contractual parties at risk of several types of legal liability, for example:
- Breach of contract
- Intellectual property rights infringement
- Infringement of physical property
- Breach of statutory duty
- Regulatory offences
Without a clause limiting your liability, there is no constraint on the amount of damages the other side of a legal claim can recover other than those that stem from the law controlling damages. This can leave you in a critically vulnerable position and even lead to insolvency if you cannot pay for the damages.
Is a limitation of liability clauses enforceable?
The determination of whether a contractual party can exclude liability for negligence or wrongdoing depends on numerous factors.
As previously stated, statutory and common law controls have been established to prevent unfair exclusion of liability or potential liability in contracts. These controls aim to ensure that parties cannot evade responsibility for their negligent or wrongful actions through contractual provisions.
Common law limits on limitation of liability
Common law protections concerning limitation of liability are particularly important for businesses entering into non-consumer contracts as they lack the negotiating power of big companies.
Furthermore, since 1 October 2015, the consumer protection provisions of the Unfair Contract Terms Act 1977 (UCTA 1977), have been repealed, meaning businesses cannot fall back on consumer protection legislation if things go wrong.
Courts can limit the scope of a limitation of liability clause by:
- Insisting that the clause must be a contract term
- Interpreting the clause restrictively
- Disallowing any attempt to restrict liability for dishonesty on the part of the party trying to rely on the clause
However, as long as the wording is clear, a party can limit its liability for fraud by an agent or employee.
Statutory controls on limitation of liability clauses
The main legislation restricting the scope of limitation of liability clauses is the UCTA 1977.
The UCTA 1977 covers most, but not all, business to business contracts. Contracts concerning the international supply of goods are exempted from the UCTA 1977, as are English-law contracts with an international element that lack a strong connection with the UK.
If the UCTA 1977 applies, no party to the contract can limit their liability for injury or death caused by negligence. In addition, no limitation can be applied to liability stemming from the wrongful supply of goods.
However, as long as they pass the Act’s ‘reasonableness’ test, liability for the following can be limited:
- Breach of standard terms
- Breach of a contractual duty of care
- Breach of statutory terms for quality of goods
The test as to whether a limitation of liability clause is ‘reasonable’ is contained in section 11 (1), which states:
“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.”
Other statutory controls on limitation of liability clauses include:
Late Payment of Commercial Debts (Interest) Act 1998 – allows a creditor to charge 8% interest plus a small administrative cost on late payments (a contractual clause can limit this remedy). However, the wording must be clear, and another substantial remedy for late payment must be included in the agreement.
Competition law – aims to regulate and promote fair competition in the market.
One of the key objectives of competition law is to prevent dominant market players from abusing their market power and imposing unfair restrictions on smaller customers.
Does limitation of liability apply to indemnification?
In principle, liability under an indemnity can be capped; however, it will come down to a matter of interpretation.
The wording of both the limitation and indemnity clauses and the contract as a whole, the circumstances in which the contract was made, and the business intentions of the parties will all be considered by the Court when it decides whether indemnity can be capped.
Get legal assistance from LawBite
Protecting your business from legal liability is crucial, and negotiating and including a limitation of liability clause in your contracts is one of the most effective ways to achieve this.
LawBite's expert lawyers can provide you with the right legal support and help you draft a strong limitation of liability clause to protect your business. To start protecting your business from potential legal risks, book a free 15 minute consultation or call us on 020 3808 8314.