Exclusion Clauses and Limitations of Liability in Business Contracts

Exclusion clauses are a common feature of professionally drafted contracts. These clauses seek to partially exclude or limit liability of either one or both parties under the contract by expressly stating that liability will not arise in a party or will be limited for named or all defaults under the agreement.

Exclusion clauses & Limitations of Liability

Rules of interpretation of contracts state that exclusion clauses must be clearly expressed and unambiguous, or they will be ineffective; they are also construed against the party seeking to rely on them. Due to the nature of exclusion clauses, as a method of balancing excesses in attempts to limiting liability, the Unfair Contract Terms Act 1977 (“UCTA”) regulates the use of such clauses in contracts and operates to render excessive exclusions of liability and/or limitations of liability inoperative.

Incorporation of Terms

The exclusion clause must form part of the contract between the parties. In Chapleton v Barry UDC [1940] 1 KB 532, it was held that the exclusion clause the defendant sought to rely on was ineffective as it was written on the back on a receipt and therefore did not form part of the contract. Whether such a clause does form part of the contract requires a legal analysis of the documents that form part of the contract. Where it is not clear it is a question of law and contractual construction.

Contracts which are signed

A distinction can be made between contracts which are signed and unsigned. Where a contract has been signed, unless there has been a misrepresentation by the party relying on it, the exclusion clause will form part of the contract. In the case of L’Estrange v Graucob [1934] 2 KB 394 the plaintiff bought an automatic machine from the defendants on terms contained in a ‘Sales Agreement’ which she signed, but did not read. When she discovered the machine was defective, she tried to make a claim but the defendant was able to rely on an exclusion clause incorporated into the written contract.

Contracts which are unsigned

Where a contract has not been signed, reasonable notice of the exclusion clause must be given to the other party before they enter into the contract, otherwise it will not form part of the contract. In the case of Olley v Marlborough Court Ltd [1949] 1 KB 532, the hotel’s exclusion clause excluding liability for the theft of the claimant’s fur coat due to their negligence was held to be ineffective as the claimant did not receive notice of the clause until after she had entered into the contract with the hotel at their reception. Where reasonable notice is deemed to be sufficient, the clause will be effective and the party affected by it will be bound by it.

Course of dealing

Parties will be assumed to have knowledge of an exclusion clause which has existed as part of previous dealings between the parties, even where notice of the clause is not given on every occasion. The party seeking to rely on this must prove that there has been a consistent course of dealing for this inference to be drawn in future dealings where notice is not provided. In Spurling (J) Ltd v Bradshaw [1956] 2 All ER 121 the exclusion clause was held to be effective, because even though the claimant had not received notice of the exclusion clause on that particular occasion, he was aware of it through his previous dealings with the defendants.

Common knowledge

In limited circumstances, even where no notice has been given and without a previous course of dealing, an exclusion clause may still be incorporated into the contract and be effective. This usually applies where the parties share a common basis, for example where they both belong to a particular trade and are familiar with the terms of that trade. This is illustrated in the case of British Hire Corp. v Ipswich Plant Hire Ltd [1974] 1 All ER 1059, where the parties were in the same line of business and the exclusion clause which existed was common. The fact that the defendant had not seen the clause before they commenced work did not render it ineffective.

Unfair Contract Terms Act 1977 (“UCTA”)

General

UCTA is the main statutory provision which regulates exclusion clauses and can either render a term effective, ineffective or subject to the test of reasonableness. It applies to business liability as between businesses or a business and a consumer. Therefore, if parties are not acting in the course of a business, say for example a contract between two private individuals, they can exclude liability. UCTA applies most often to exclusion clauses in the course of a business in three situations:

1. Negligence;
2. Consumer transactions;
3. Standard Term Contracts.

There are a number of relevant factors to be taken into consideration when dealing with exclusion clauses, including: the type of contract; the identity of the parties; the subject matter of the contract and the presence or absence of a foreign element.

Where UCTA applies, an exclusion clause will either be held to be effective or ineffective, unless the test of reasonableness is satisfied.

The Test of Reasonableness

Section 11(1) UCTA 1977 applies the test of reasonableness to exclusion clauses by asking whether ‘is it a fair and reasonable [exclusion clause] to be included, having regard to the circumstances which were, or ought reasonably to have been, known to or in contemplation of the parties when the contract was made’.

In having regard to whether a clause is in fact reasonable, the court must consider:

1. The bargaining position of the parties;
2. Whether the party was aware of the existence and/or the extent of the clause;
3. The circumstances surrounding the transaction;
4. Whether goods were made to order for the buyer;
5. Where liability is excluded if a particular term is not complied with, was it reasonable to assume at the time that the condition could be practicably performed.

It is for the person who asserts that a term is reasonable to show that it satisfies this test (s.11 (5)). Where the test is satisfied, the exclusion clause will be effective.

Negligence

Section 2(1) UCTA imposes a complete ban on any exclusion clause attempting to exclude liability for death or personal injury caused by negligence:

‘A person cannot by reference to any contract term or to a notice given to persons generally or to particular persons exclude or restrict his liability for death or personal injury resulting from negligence.’

‘Negligence’ is defined under s 1 as a breach of a contractual obligation to exercise reasonable care and skill, or breach of a common law duty, or breach of a duty of care arising out of the Occupier’s Liability Act 1957.

However, under s 2(2) liability for any other loss or damage caused by negligence can be excluded provided it satisfies the reasonableness test.

Consumers

Section 3(1) and (2) UCTA prevents the use of an exclusion clause to exclude liability for any breach of contract including deviation or complete failure to perform a contract, wholly or partly, unless it satisfies the test of reasonableness.

Standard Term Contracts

This type of contract is where a contract is made between one party acting in the course of a business and another party (who can also be acting in the course of a business or be a consumer) and they contract on the other party’s “written standard terms of business”.

Where such standard terms of business contain an exclusion clause, it will only be effective if it satisfies the test of reasonableness. The protected party contracting on the other party’s standard terms is afforded the same protections as a consumer under s.3, even if they are acting in the course of a business themselves. This is due to the inequality of the bargaining positions of the party.

Where the parties do have an equal bargaining position and have entered into a contract freely, they are free to negotiate terms which restrict liability for any breach of contract, howsoever arising and s 3 will have no application.

Closing Comments

There are different views as to the purpose of exclusions clauses. On the one hand it could be argued that exclusion clauses are merely a device for defining the exact obligations of the promisor, however on the other hand it could be argued that they are used as a defence mechanism against any breach of contract. Whatever their purpose, provided they are constructed and incorporated properly in accordance with UCTA, they will be effective.