Give your limitation of liability clause clear visibility to protect your business

A common way of apportioning risk in a contract is for the parties to exclude or restrict their liability to one another in the event of default. Such exclusions can be specified in different ways: some clauses seek to exclude liability altogether; others put a limit on liability perhaps by capping the amount payable in damages in case a breach occurs.¹

For example, a recent case² involved a cigarette filter paper manufacturer’s claim for damages of £29.68 million (36,284,245.20 U.S. dollars) arising out of destruction of property and business interruption caused by a fire.  The Scottish Session Court, based on evidence and balance of probability, concluded that the fire was caused by the supplier’s negligence in maintaining the printing equipment installed at the premises of the  cigarette filter paper manufacturer and maintained by the supplier. 

However, the Court held that the manufacturer could not claim damages for £29.68 million, because a clearly stated “limitation of liability” clause limited the supplier’s liability to the manufacturer to only £3,225.06 (3,941.34 U.S. dollars) per the maintenance contract.

The Court found that the limitation of liability clause was prominently and clearly placed in the maintenance contract which could not have escaped one’s attention and also passed the “reasonableness” test of the English law

What happened?

A fire broke out at the factory of Benkert UK limited (Benkert) and destroyed the premises.  Resultant losses amounted to £29.68 million as claimed by Benkert. The printing process involved use of two dispensers supplied and maintained under a maintenance agreement by Paint Dispensing Limited (PDL), which mixed highly flammable solvent-based ink. It was never a matter of dispute that the fire had started in the ink plant room when a spark ignited flammable solvent vapor; however, the parties disagreed as to exactly where and why the fire had likely occurred.

Benkert contended that a jubilee clip on the larger dispenser had suddenly come loose, allowing the vapor to escape.  However, PDL argued that it was more likely that a Benkert’s employee had failed to follow correct procedure while filling the smaller dispensing unit with the flammable solvent.

Based on the available evidence and balance of probabilities, the Court concluded that PDL breached their contractual and common law duty to Benkert, because they failed to recommend -- in accordance with their contractual obligations -- that the hoses and clips in the larger dispenser be replaced with metal braided hoses with swaged/swivel nut fittings that would be less likely to fail.  So, the fire ignited as a consequence of that breach. The Court also did not find any contributory negligence of Benkert in respect of its failure to carry out regular inspection of the hose connections, as alleged by PDL.

The maintenance agreement contained clause 5.3 prefaced by the following statement in capital letters:

“THE CUSTOMER’S ATTENTION IS SPECIFICALLY DRAWN TO THE PROVISIONS SET OUT BELOW”

Thereafter the clause stated as

5.3.1 the Company’s total liability in contract, tort, misrepresentation or otherwise arising in connection with the performance or contemplated performance of the Services shall be limited to the Basic Charge; and

5.3.2 the Company shall not be liable to the Customer for any indirect or consequential loss or damage (whether for loss of profit, loss of business or otherwise), costs, expenses or other claims for consequential compensation whatsoever and how so ever caused which arise out of or in connection with this Agreement.

The Basic Charge was defined in clause 1.1 as “the annual maintenance charge to be paid by the Customer to the Company as specified in the Schedule”. The Schedule specified a Basic Charge of £3,225.06 (3,941.34 U.S. dollars).

THE LAW AND THE DECISION

The Court, to test enforceability of clause 5.3 into the agreement, considered

• whether clause 5.3 limiting the liability to a modest contract price (£3,225.06) was onerous or unusual; if so

• whether the clause was fairly and reasonably drawn to the attention of Benkert, to be incorporated into the agreement; and,

• if incorporated, whether it still failed the reasonableness test under “The Unfair Contract Terms Act 1977” (“the 1977 Act”)³ of English law that was applied to the agreement.

As asserted by Benkert, clause 5.3 had failed to satisfy the requirement of “reasonableness”.

Under the 1977 Act (as the contract was governed by the law of England & Wales, although there was no material difference from the Scottish provisions) a party cannot enforce a contract term which excludes or restricts liability in respect of his breach unless that contract term satisfies the requirement of reasonableness.⁴

Section 11 of the Act, in part, states

(2) In determining……whether a contract term satisfies the requirement of reasonableness, regard shall be had in particular to the matters specified in Schedule 2 to this Act.….

(4) Where by reference to a contract term or notice a person seeks to restrict liability to a specified sum of money, and the question arises …whether the term or notice satisfies the requirement of reasonableness, regard shall be had in particular (but without prejudice to subsection (2) above in the case of contract terms) to --

(a)    the resources which he could expect to be available to him for the purpose of meeting the liability should it arise; and

(b)    how far it was open to him to cover himself by insurance.

(5) It is for those claiming that a contract term or notice satisfies the requirement of reasonableness to show that it does.

Schedule 2 of the Act provides “guidelines” for the application of reasonableness test. The following sections of Schedule 2 are relevant to the case:

(a)     the strength of the bargaining positions of the parties relative to each other, considering (among other things) alternative means by which the customer’s requirements could have been met;

(c)     whether the customer knew or ought reasonably to have known of the existence and the extent of the term (having regard, among other things, to any custom of the trade and any previous course of dealing between the parties);

(e)     whether the goods were manufactured, processed, or adapted to the special order of the customer;

The Court noted that no submission was made on behalf of Benkert asserting that clause 5.3 was not incorporated into the maintenance agreement due to inadequate notice of an unusual or onerous term. Furthermore, as demonstrated by case laws, clauses limiting a supplier’s liability to the contract price are not regarded by the courts as especially onerous or unusual.

The Court also noted that clause 5.3 had sufficient prominence in the maintenance agreement. The agreement consisted of only six pages of normally sized and spaced print plus a short schedule. In the agreement, clause 5.3 was prefaced by a warning printed in underlined capital letters.

The Court then considered the resources expected to be available with PDL to meet its liability [s11(4)(a] and how far it was open to PDL to cover itself by insurance [s11(4)(b)]. The court noted that PDL carried public/product liability insurance for a sum £5,000,000 which was far more than the limit (£3,225.06) PDL sought to impose on its liability.

The Court further observed that although it was foreseeable at the time when the maintenance agreement was entered into that a fire caused by a fault in the ink dispenser system could have catastrophic consequences, Benkert was in a much better position than PDL to assess the size of the potential claim for losses including partial or total destruction of the factory and lengthy business interruption.

Considering the circumstances, the Court concluded that PDL was permitted not to accept liability for losses which were impossible for it to quantify; and instead, it was for Benkert to cover such losses by necessary insurance arrangements. The Court also observed that there was no reason for PDL to match the liability in the agreement with their own insurance coverage, because losses incurred could far exceed the limit of the insurance coverage -- which unfortunately happened in this case.

Although Benkert’s production manager had signed the agreement but did not consider the limitation of liability in clause 5.3, Benkert were found to be familiar with such clauses and probably were aware of presence of one such clause in the agreement. Furthermore, that clause had appeared in several previous agreements between Benkert and PDL and had thereby come to form part of their normal way of doing business [Schedule 2(c)].

The court did not find anything in relation to the bespoke nature of the equipment to affect the reasonableness of the limitation of liability clause. Bargaining power was held to be neutral [Schedule 2(a)].

Though the dispensers were to some extent tailored to meet Benkert’s requirements, that did not, however, preclude Benkert from planning for their maintenance without involving PDL [Schedule 2(e)]. Per PDL, most of its customers maintained the equipment on their own.

The Court held that, PDL had discharged the onus of demonstrating that the limitation of liability in clause 5.3 was fair and reasonable having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the maintenance agreement was entered into. PDL's liability in respect of Benkert's losses was accordingly limited to the sum of £3,225.06

CONCLUSION

Terms like limitation of liability, which are often alleged as onerous or unusual, must always be given adequate prominence in the contract documents to stand out among other general terms. The degree of prominence perhaps should be directly proportional to the onerousness of the clause. Furthermore, such terms must also satisfy the test of “reasonableness” to be successful (assuming English law or a law having equitable provision is applied to the contract) if challenged as being “unreasonable”.  Therefore, in addition to have satisfied the “reasonableness” test of the English law, clause 5.3 had sufficient prominence in the contract and that had played a pivotal role in rescuing PDL from drowning in a claim of 29.68 million Pound Sterling (36,284,245.20 U.S. dollars) in damages.

ABOUT THE AUTHOR

Pallab Mukherjee, a Chartered Engineer and having a master’s degree in Construction law & Arbitration, is a commercial management expert having more than 30 years of diverse experience across Middle East and India in various industry sectors including Oil & Gas and Petrochemicals; had played pivotal roles in commercial management transformation projects. He actively promotes the profession of contract management and authors essays on contract law. He is a public speaker, mentor, and coach.

END NOTES

1. Limitation and exclusion of liability (Ashurst, 17 June 2021)
2. Benkert UK Limited v. Paint Dispensing Limited [2022] CSOH 17
3. Unfair Contract Terms Act 1977 (UTCA)
4. Caution: slippery when not read (Brodies LLP, 19 April 2022)