Limitation of liability clauses

All contracts, in particular commercial transactions, carry a risk of liability. Legal liability can arise from:

• a breach of contract - a party fails to execute their contractual obligation
• negligence - a party's conduct fails to meet a reasonable duty of care and causes harm to someone (eg a car manufacturer makes a mistake in designing a car and the design defect results in a car accident)
• misrepresentation - a party makes a false statement of fact that leads to the conclusion of a contract (eg as to the quality of goods)
• infringement of IP rights - a party infringes upon another party's intellectual property rights (ie copyright, trade mark, patent or design right)

A limitation of liability clause serves to limit the amount and types of compensation one party can recover from the other party. It caps the liability incurred by one party and reduces the risk of a claim by the other party.

For example, a website user suffers loss because they relied on information provided on that website. A limitation of liability clause in the Website's terms and conditions could limit the liability of the website owner (ie the user can only recoup up to a certain amount).

Limitation of liability clauses are used to manage the risks attached to a contract. In the absence of a limitation clause, there is no financial limit on the damages a party can ask for. Parties wishing to reduce exposure to the risks of a contract should include an express limitation of liability clause.

The law imposes restrictions in the application of limitation of liability clauses. In particular, the extent to which liability can be limited is dependent on whether the contract involves a consumer or not.

Business contracts

When the contract is between two businesses, limitation of liability clauses are prohibited under the Unfair Contract Terms Act 1977 (UCTA) in the following circumstances:

• death and personal injury caused by negligence
• breach of contract and misrepresentation
• breach of terms implied by the law that are not expressly mentioned in the contract (eg the quality and fitness for purpose of goods should be guaranteed even if there is no express term in the agreement)

However, regarding a breach of contract, misrepresentation and breach of implied terms, it is possible to limit the parties' liability if the limitation clause is 'reasonable'. When considering whether a clause is reasonable, the courts will take into account factors such as the parties relative bargaining position or the information available to the parties when the contract was made. For example, a limitation clause that caps liability to the value of the contract is more likely to be reasonable than one that excludes liability altogether.

Consumer contracts

Limitation of liability clauses in business-to-consumer contracts are less likely to be enforceable than in business contracts. Indeed, any contractual provision that imposes an imbalance between the parties to the detriment of the consumer is considered unfair and is prohibited. To be enforceable, the liability clause will be subject to the reasonable test (described above), and if the court considers that the restriction of liability is unreasonable, it won’t be binding on the consumer.

To draft a limitation clause properly, it is important to precisely identify the risks attached to the contract and the subsequent losses that may arise from such risks. Consider asking yourself the following questions:

• What could possibly go wrong with this transaction?
• How likely is a breach of contract to happen?
• How much might it cost? Could I afford it?
• Are there any economic risks attached to this contract and/or to that particular industry?

Once you've assessed the level of risk, make sure to draft your limitation clause in clear and unambiguous wording. In particular, the limitation clause should set out:

• the losses each party accepts to compensate without limit (eg fraud, death and personal injury).
• the losses each party accepts to cap and the amount of damages a party will be liable for. The clause should list precisely which losses will be capped and what the cap should be (the cap can be different for different types of loss). The cap may be determined according to the parties' level of insurance, the value of the contract or the potential amount of damage a breach of contract may cause.
• the losses each party excludes totally (ie specific losses that a party will not be liable for, such as a loss of profit or revenue). However, remember that death and personal injury caused by negligence can never be excluded from liability. If these are excluded, any such clause will be unenforceable.

As a general rule, the liability should always be capped to a reasonable amount, and you should make sure that a meaningful remedy is still available for the recovering party.

Ask a lawyer if you need help in the drafting of your limitation of liability clause.