Exclusion clauses - Commercial law
Exclusion clauses are generally found in contracts`. These types of clauses operate to exclude or restrict the rights of a party. For example, when a party to a contract wishes to limit their liability in the event that they breach the contract they will usually include an exclusion clause, limiting the amount that the other side can claim to a specified total. Sometimes, a party may include a provision attempting to exclude all liability for a certain thing that could go wrong. Exclusion clauses may also be called ‘exemption' or ‘exception' clauses. They operate for the benefit of one party to an agreement. It is always difficult for commercial contract drafters to know when an exclusion clause goes too far and might be stuck out as being unreasonable under the Unfair Contarct Terms Act 1977 (UCTA).
On 15 April 2008 the Court of Appeal handed down its ruling in the case of Regus (UK) Ltd v Epcot Solutions Ltd overturning a High Court decision that had previously caused suppliers considerable concern. The Court of Appeal decision set out some important factors that may be taken into account in determining whether an exclusion clause is enforceable and to be held valid.
The case concerned the reliance by a supplier of serviced office accommodation (Regus) on part of an exclusion clause in its standard terms of business. The part of the exclusion clause in question sought to exclude liability "in any circumstances" for "loss of business, loss of profits, loss of anticipated savings, loss of or damage to data, third party claims or any consequential losses". A further clause limited Regus' liability for other losses, damages or expenses to £50,000.
The customer (Epcot) complained to Regus about defective air conditioning in the office, and when this was not fixed by Regus, Epcot stopped paying Regus the service charges due under the agreement. Regus brought proceedings against Epcot for the amounts due to it, and in response, Epcot argued that the failure to provide air conditioning amounted to a breach of contract and counterclaimed for loss of profits, loss of opportunity to develop its business and distress, inconvenience and loss of amenity.
In order to defeat part of Epcot's claim, Regus had to show that the Exclusion Clause was enforceable in particular that it was reasonable under the Unfair Contract Terms Act 1977 (UCTA).
In a High Court judgment of May 2007, the court had ruled that although in theory it was entirely reasonable for Regus to restrict damages for loss of profits and consequential loss, the clause was unreasonable as a whole as the exclusion was so wide that it effectively left Epcot without a remedy for a basic service such as defective air conditioning. It was therefore unenforceable, leaving Regus exposed.
Regus appealed on the grounds that the High Court judge had been wrong to say that the Exclusion Clause was unreasonable under UCTA and that it should be entitled to limit its liability in that way. The Court of Appeal agreed with Regus and reversed the High Court's ruling.
The purpose of UCTA is to protect contracting parties (particularly consumers and business parties contracting on other business parties' standard terms of business) from onerous contractual provisions such as exclusion and limitation of liability clauses. UCTA imposes limits on the extent to which liability for breach of contract, negligence or other breaches of duty can be avoided in a contract.
Where a clause is contrary to the mandatory restrictions set out in UCTA or is deemed by the court to be "unreasonable", such a clause will be unenforceable.
Amongst other restrictions, Section 3 of UCTA is particularly important in the context of business to business contracts where the supplier is dealing on its 'standard terms of business'. This section provides that where a term seeks to exclude or restrict a supplier's liability for breach of contract, such a term shall only be enforceable to the extent that it satisfies the reasonableness test.
Thus, according to Section 11(1) of UCTA, in order to pass the reasonableness test, a contract term must 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".
Schedule 2 to UCTA contains a non-exhaustive list of guidelines in assessing reasonableness, which in practice the courts apply when considering reasonableness in the context of Section 3 of UCTA. Such factors include the strength of the bargaining position of the parties relative to each other, whether the customer received an inducement to agree to a particular term; whether the customer had the opportunity of entering into a similar contract without the term, whether the customer knew or ought to have known of the existence and the extent of the term and whether it was reasonable at the time of the contract to expect that compliance with a term would be practicable.
In addition, under Section 11(4) of UCTA, where a party seeks by contract to restrict its liability to a specified sum of money, the courts will looks at the resources available to that party to meet the liability should it arise and the availability of insurance cover.
‘We are not liable for any loss as a result of our failure to provide a service as a result of mechanical breakdown, strike, delay, failure of staff, termination of our interest in the building containing the business center or otherwise unless we do so deliberately or a negligent. We are also not liable for any failure until you have told us about it and given us a reasonable time to put it right.
You agree (a) that we will not have any liability for any loss, damage or claim which arises as a result of, or in connection with your agreement and/or you use of the service except to the extent that such loss, damage, expense or claim is directly attributable to our deliberate act or our negligence (our liability); and (b) that our liability will be subject to the limits set out in the next paragraph.
We will not in any circumstances have any liability for loss of business, loss of profits, loss of anticipated savings, loss of or damage to data, third party claims or any consequential loss. We strongly advise you to insure against all potential loss, damage expense or liability.
We will be liable:
-Without limit for personal injury or death;
-Up to a maximum of £1 million (for any one event or series of connected events) for damage to your personal property ;
-Up to a maximum equal to 125% of the total fees paid under your agreement up to the date on which the claim in question arises our £50,000 (whichever is the higher), in respect of all other losses, damages expenses or claims.
The meaning of ‘in any circumstances'
Counsel for the defendant submitted that the words ‘in any circumstances' were apt to include liability for fraud or liability in respect of a deliberate attempt to damage the defendant's business, this was held by the Court of Appeal to be the wrong approach to take. Lord Justice Rix Stated:
‘Clause 23 as a whole does not purport to exclude liability (in the case of the losses identified in clause 23(3)) for fraud or wilful, reckless or malicious infliction of harm. Lord Justice Rix justified this approach on the following basis:
‘Liability for fraud or malice or recklessness which is a species of either goes without saying: parties contract with one another in the expectation of honest dealing.'
In this sence it is important to distinguish between an intentional breach (which may fall within the ‘in any circumstances') and the deliberate infliction of harm (which will not). On the present facts it could be said that the actions of the claimant were deliberate in the sense that they decided not to spend money on repairs to the air-conditioning system. But that is a long way from saying that the claimant acted with a dishonest or malicious intent to inflict harm upon the defendant.
The conclusion of the Court of appeal on this issue suggest that the words ‘in any circumstances' should not be construed literally against the background of an expectation of ‘honest dealing'. Thus the words are unlikely to be held, as a matter of construction, to encompass liability in respect of the fraudulent, malicious or reckless infliction of harm.
Judge Mackie held that clause 23 was too broad to be reasonable. He sp concluded for a number of reasons. First, he held that clause 23 deprived the defendant of any remedy at all for failure to provide a basic service like air conditioning in what is the business equilavant of an hotel, not the lease of flat. Secondly, he stated taht clause 23 provided an illusion of a remedy. On its face, clause 23 provider for a limitation of 125% of the total fees paid but when account was taken of the broad wording of the exclusion of financial losses, Judge Mackie stated that ‘a business will eb unable to establish teh liability which the claimant seeks to limit'. Damages for loss of amenity was held to be ‘frail, remote and uncertain'. The possibility of such a claim did not suffice to persuade Judge Mackie that the clause was reasonable.
The Court of Appeal's view was that, contrary to what the High Court judge had said, certain limited remedies were in fact available to Epcot and had not been excluded by virtue of the Exclusion Clause. In particular, Epcot could seek damages for the diminution in value of the services promised. The cost of relocating to alternative offices or the cost of replacement air-conditioning were other possible remedies.
Assessment of Reasonableness
Rix LJ then went on to consider whether the Exclusion Clause was reasonable in light of the fact that it did not exclude all remedies. Rix LJ decided that the Exclusion Clause was reasonable on the following grounds:
-as the High Court judge had said, in principle it was reasonable for Regus to restrict damages for loss of profits and consequential losses from the categories of loss for which it would become liable when in breach of contract;
- Epcot's managing director was an "intelligent and experienced businessman" who was aware of Regus' standard terms when he had entered into the contract and had contracted before on identical terms;
- Epcot had used a similar exclusion of liability for indirect or consequential losses in his own business;
- Epcot had sought to re-negotiate terms of the contract frequently and energetically, although not the Exclusion Clause;
- there was no inequality of bargaining power. Although Regus was the larger company, Epcot made use of and took advantage of the availability of local competitors of Regus in negotiations; and the Exclusion Clause advised Regus' customers to take out insurance for the losses excluded by the
Exclusion Clause. Rix LJ felt that Regus' customers were better placed to insure themselves against their business losses rather than Regus to insure its customers. This was particularly the case as Regus' customers would frequently change and Regus was very unlikely to be in possession of the level of information relating to its customers which underwriters would require in order to provide insurance. In addition, leaving customers to obtain such insurance would enable them to choose whether, how and at what price they would wish to insure against business losses.
What is the effect of the Court of Appeal's ruling?
The Court of Appeal ruling will give some comfort to suppliers who had become nervous about excluding all financial losses in their standard terms of business following the High Court's ruling last year. The Court of Appeal has also provided some helpful guidance as to the sort of factors it will consider in assessing reasonableness. Although the facts will vary from case to case, as can be seen from the above, factors such as the parties' bargaining strength, the sophistication of the buyer and the question of who is best placed to insure the loss will all be considered. Suppliers could also benefit from including wording in their exclusion clauses advising their customers to purchase insurance for those matters in relation to which the supplier excludes liability.
Although the courts do not have power to rewrite an exclusion clause or sever words that make it unreasonable, here the Court of Appeal held that if the relevant exclusion clause had been unreasonable it could have been severed so as to level a related limitation clause intact. The two clauses, although not formally divided up into separate subclauses, were independent of each other and several different purposes. It is, however, clearly preferable for a drafter to separate out different elements of the exclusion into subclauses rather than to rely on a single all-embracing clause.
The reasonableness of an exclusion clause will always depend on the circumstances of the individual case. In the Regus case, the fact that the customer clearly understood the exclusion clause had strong bargaining position and had sought to renegotiate some of the terms, together with the courts view that it was reasonable for the customer to insure against indirect losses, led the Court of Appeal to conclude that the clause was reasonable.
In Watford Electronics Ltd v Sanderson CFL Ltd, S appealed against a decision ( 2 All E.R. (Comm) 984) that two clauses purporting to limit liability in respect of a contract it had entered into with W were unreasonable in their entirety. The contract contained an "entire agreement clause" which stated that no reliance had been made by the parties on statements or representations made by them./p>
Held, allowing the appeal, that the judge had erred in (1) failing to properly identify the scope and effect of the limit of liability clause since the clause did not attempt to exclude liability for pre-contract misrepresentation; (2) failing to treat the obligation agreed to by S in an agenda to the contract, to use best endeavours to allocate appropriate resources to the project in order to minimise potential contractual losses, as an additional obligation to those imposed by the standard terms and conditions, and (3) treating W's own standard terms of business as irrelevant since they showed that W was well aware of the commercial considerations which would lead a supplier to include limit of liability clauses. This was directly relevant to determining whether such clauses were fair and reasonable having regard to the circumstances which were, or ought to have been known to or in the contemplation of the parties when the contract was made.
In SAM Business Systems Ltd v Hedley & Co, S, a software company, claimed the sum of GBP 310,510 in respect of the outstanding licence fee for a software system which it had supplied to H, stockbrokers. H counterclaimed substantial damages for alleged defects in the system. Immediately after the system went live H experienced serious problems with it and, a year later, ceased using the system without informing S. One month later, H gave S notice that it intended to reject the system. S subsequently issued proceedings against H submitting that its liability for misrepresentation and breach of contract had been excluded under the contract and, in any event, H had failed to give timely unequivocal notice of rejection pursuant to the process specified in the contract and at the time when H did give notice of rejection it had already gained substantial benefit from it.
Held, giving judgment for S, that the exclusion clause fulfilled the requirement of reasonableness under the Unfair Contract Terms Act 1977 , Stewart Gill Ltd v Horatio Myer & Co Ltd  Q.B. 600 CA (Civ Div) applied. The parties were of equal bargaining power in terms of size and resources, it was a standard feature of the computer software industry to supply software only on stringent terms excluding all or virtually all liability and H had not even tried to negotiate more favourable terms, Watford Electronics Ltd v Sanderson CFL Ltd  EWCA Civ 317,  1 All E.R. (Comm) 696 distinguished. Accordingly, notwithstanding that S had waived an entire agreement clause, S was not liable to H for breach of contract or misrepresentation and was entitled to the balance of the outstanding licence fee. If that conclusion was wrong, H had already gained an enormous benefit from using the defective system by the time it notified S of its decision to reject it. If H had had no computer system it would have gone out of business. Accordingly, H would not have been entitled to claim all its money back from S since it had had the benefit of 17 months' service from the system, which it would not have had if it had gone through the process specified in the contract to recover its money.
The reasonableness of the clause
The narrower approach to the construction of ‘in any circumstances' combined with the concession that clause 23 did not prevent the defendant from recovering damages in respect of any diminution in the value of the services provided, had the effect of the undermining the approach which Judge Mackie had taken to the reasonableness of clause 23. This being the case, the court of Appeal held that it was entitled to take a fresh view of the reasonableness of the clause. It concluded that the clause was, in fact, reasonable.
In so concluding, the Court of appeal had regard to a number of factors. First, it held that in principle it was entirely reasonable for the claimant to restrict damage to loss of profits and consequential losses from the categories of loss for which it could become liable when in breach of contract. Second, the chief executive of the defendant was an intelligent and experienced businessman who was well aware of the claimant standard terms when he entered into the contract and the defendant's own standard terms of business contained a similar exclusion of liability in respect of indirect or consequential losses. Third, there was no inequality of bargaining power between the parties and there had been meaningful negotiation between them in relation to the terms of the contract. Although the claimant was by far the bigger enterprise, the presence of competitors who were also seeking to rent out space, gave to the defendant considerable negotiating in relation to the terms of the contract. Finally, the third paragraph of clause 23 advised the claimant's customers to protect themselves by insurance for the losses with which paragraph was concerned. In the opinion of Lord Justice Rix, it would have been easier for the customers to obtain insurance against business losses than for the claimant to seek to insure against the range of losses that could conceivably by suffered by its customers. As Lord Justice Rix observed,
‘If insurance is left to each business customer, that customer has full autonomy over whether, how and at what price he wishes to insure against business losses. If however, such losses have to be insured by Regus, then that autonomy is lost, and the expense has necessarily to be incurred and transferred to each customers on the form of the fees charged.'
On the basis of above, the Court of Appeal concluded that the claimant had proved that the third paragraph of clause 23 satisfied the requirements of the reasonableness test.
The final issue considered by the Court of Appeal concerned the severance of the third paragraph in clause 23, assuming it to be unreasonable. As has been noted, it was conceded by the defendant that the third paragraph ws severable from paragraph (and it had never been suggested that the fourth paragraph was unreasonable on its own terms). Lord Justice Rix stated that the concession was ‘well made'. While clause 23 was not divided up into separate sub-clauses, he held that it was ‘plain' that the fourth paragraph was ‘independent' of the third paragraph. He also noted that the fourth paragraph was a limitation clause rather than an exclusion clause and, as such, served a different purpose.
The willingness of the Court of Appeal to countenance severance in this context is to be welcomed. It would be rather artificial to conclude that severance is only possible in the case where the relevant sub-clauses have been separately numbered. Separate numbering may be a wise step to take but, as the present case demonstrates, it is not mandatory. Whether separate paragraphing is necessary is another matter. It is probably not necessary but the fact that the clause is broken down into separate paragraphs is likely to be of assistance in demonstrating to the court that one paragraph is independent of the other and that the invalidation of one paragraph should not result in the invalidation of other paragraphs in the same clause.