Contractual caps on the liability of a business must usually be reasonable if they are to be enforceable under English law. There are various tools the courts use to control liability caps, but the Unfair Contract Terms Act 1977 is probably the most important. UCTA applies to most business contracts, but there are exceptions (e.g. contracts of employment).
This post looks specifically at the position of liability caps in business-to-business contracts under UCTA.
Section 2 of UCTA says:
“(1) A person cannot by reference to any contract term ... exclude or restrict his liability for death or personal injury resulting from negligence.
(2) In the case of other loss or damage, a person cannot so exclude or restrict his liability for negligence except in so far as the term or notice satisfies the requirement of reasonableness.”
Negligence is given a broad definition in Section 1(1) of UCTA:
“(1) For the purposes of this Part of this Act, “negligence” means the breach — (a) of any obligation, arising from the express or implied terms of a contract, to take reasonable care or exercise reasonable skill in the performance of the contract; (b) of any common law duty to take reasonable care or exercise reasonable skill (but not any stricter duty); (c) ...”
This definition of negligence is sufficiently broad that any general cap on contractual liability – i.e. one which purports to apply to any loss or damage resulting from any breach of the contract – will likely restrict liability in relation to negligence. It follows that such caps must be reasonable if they are to be enforceable.
What is reasonable? Section 11(1) of UCTA gives some guidance on that question:
“In relation to a contract term, the requirement of reasonableness for the purposes of this Part of this Act ... is that 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.”
Liability cap-specific guidance is given in Section 11(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 (under this or any other Act) whether the term or notice satisfies the requirement of reasonableness, regard shall be had in particular ... 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.”
Additional factors to be taken into account in applying the reasonableness test are set out in Schedule 2 to UCTA. Whilst UCTA does not expressly relate these factors to the reasonableness test under Section 2, the courts have applied the factors widely. In the context of liability caps, relevant factors under Schedule 2 include:
- the relative strength of the parties' bargaining positions;
- whether the relevant party had an inducement to agree to the liability cap;
- whether there was an alternative contract that the relevant party could have accepted, that did not include a similar liability cap; and
- whether the relevant person knew or ought reasonably to have known of the existence and the extent of the liability cap.
In practice, businesses often select a liability cap by reference to the level of insurance they have for the relevant risk. Liability caps below the level of insurance cover may be vulnerable to the argument that, because the business protected by the cap has already taken steps to deal with the risk – namely, taking out insurance – it cannot possibly be reasonable for that risk to be passed on to the other party. However, care needs to be taken. The risks covered by a standard contract of insurance will rarely match-up with the risks under a particular contract. Moreover, pre-existing insurance cover for a particular risk is not necessarily the same thing as the available insurance referred to in Section 11(4).
Another consideration is the value of the contract in question. It seems fair and reasonable that low value contracts should be able to include lower liability caps than high value contracts. Under one-off contracts, liability caps are often set at or around the level of the contract price. Under ongoing contracts, liability caps are often set at or around 12 months' worth of fees. But these practices are not blessed by UCTA, and depending upon the circumstances such caps could be adjudged unreasonable.
In practice, there is a great deal of uncertainty about what is reasonable. In order to determine the reasonable level of a liability cap, or to assess whether a particular cap is enforceable under UCTA, you will need to consider all the circumstances surrounding the contract. In respect of any particular liability cap, there will be a range of values that are likely to be unreasonable, a range of values that are borderline, and a range of values that are likely to be reasonable. The selection of an appropriate value will often involve the weighing of the risk that the cap would be found to be unenforceable, as against the likelihood that the cap will ever be subject to judicial scrutiny. Standard business-to-business T&Cs sometimes include caps that are known to be likely to be held to be unreasonable, on the basis that the vast majority of disputes will be settled out-of-court, and claimants will be as uncertain of the outcome as defendants.