Interpretation Of Exemption Clauses

Parties often include provisions in their contracts that seek to exclude (in its entirety) or limit (to a particular level) a contracting party's liability in respect of certain types of liability or loss. These clauses can serve the useful purpose of allocating risk between the parties and thereby giving the parties certainty as to what their potential exposure is under the contract.

Clauses that seek to exclude or limit liability (referred to in this note as "exemption clauses") can operate in different ways. Clauses can be drafted so as to:

• prevent one party from being liable to the other in the event of what would otherwise be a breach of the contract;
• limit or remove a remedy for breach, for example by limiting the amount of compensation which would otherwise be payable upon a breach of contract;
• require one party to indemnify the other against the consequences of that other's default; or
• limit the time in which one party may bring a claim against the other.

Whilst parties are generally free to choose the terms upon which they wish to contract and to allocate risk as they see fit, exemption clauses can operate in a manner that may appear unfair or which may take advantage of an inequality of bargaining power. In order to address these concerns, various common law and statutory controls apply to exemption clauses.

Common law controls (developed in case law by the courts) include:

• Rules regarding the incorporation of the clause: the more onerous and unusual a clause is, the more that must be done to bring it to the attention of the other party.
• Restrictive interpretation of exemption clauses.
• Public policy against fraud: a party cannot limit liability for its own dishonesty (HIH Casualty and General Insurance Ltd v Chase Manhattan Bank [2003] UKHL 6).

Statutory controls (in a business to business context) include:

• The Unfair Contract Terms Act 1977 ("UCTA"). In summary, UCTA provides:

• For a complete bar on the exclusion of liability for death or personal injury resulting from negligence, or for the breach of statutory implied terms about title to goods;
• That any provision seeking to restrict liability for the following types of liability must be "reasonable":

• Breach of contract, when a party is seeking to restrict liability for such breach in its own standard terms (not in respect of a negotiated contract);
• Loss resulting from negligence (other than death or personal injury), as defined in UCTA;
• (Non-fraudulent) misrepresentation;
• Breach of statutory implied terms about quality of goods

• Other statutory controls can be found in the Supply of Goods (Implied Terms) Act 1973 and the Late Payment of Commercial Debts (Interest) Act 1998.

This note deals with the second of the common law controls referred to above; namely the (restrictive) interpretation of limitation of liability clauses.

Limitation of liability clauses have traditionally been interpreted strictly. However, since the introduction of UCTA, and over more recent times, the courts' traditional hostility has diminished, and the degree of strictness applied is likely to vary depending upon the extent of the limitation (so, for example, the rules will be applied more rigorously to a clause excluding a party's liability than to a clause limiting liability).

The following general principles of interpretation have been developed in the case law over time:

• Exemption clauses will be interpreted in the context of the contract as a whole, rather than in isolation.
• A real doubt or ambiguity in an exemption clause will be resolved against the party seeking to rely on the clause (i.e. "contra proferentem").
• Clear words are necessary before the court will hold that a provision in a contract takes away rights or remedies which a party would have had at common law.
• As regards attempts to exclude or restrict liability for negligence:

• Where a party has no liability to the other contracting party other than a liability in negligence, an exemption clause will usually be interpreted as limiting or excluding liability for negligence.
• Where a party's liability may realistically arise otherwise than through negligence, an exemption clause will usually be interpreted as not limiting or excluding liability for negligence unless it does so by clear words (which will most likely require the use of the word "negligent" or "negligence" or some synonym for those words).

• Prior to the introduction of UCTA, and the controls on exemption clauses brought about by that Act, there used to be a presumption of interpretation that an exclusion clause was not intended to apply to a fundamental breach of contract (in other words, a breach depriving a party of substantially the whole benefit of the contract). That is no longer the case; there is no rule of law which prevents parties from excluding or limiting liability for fundamental breach. Whether the contract does so is a question of interpretation.
• The court will be reluctant to interpret an exemption clause in a manner which effectively absolves one party from all duties and responsibilities, leaving no remedy, as "to do so would be to reduce the contract to a mere declaration of intent".
• As noted above, on grounds of public policy a contract may not exempt a party from liability for fraud. It is possible for a provision to exclude liability for the fraud of a party's agent, but it must do so in clear and unmistakable terms.
• Where a contract contains a provision excluding liability for "consequential losses", "consequential losses" will normally be interpreted as referring to losses under the second limb of the rule in Hadley v Baxendale (i.e. losses that result from special circumstances, which will only be recoverable if the other party knows of those circumstances). This means that losses under the first limb of the rule in Hadley v Baxendale (i.e. losses which arise naturally, or in the usual course of things, or that may reasonably be in the contemplation of the parties when the contract was made) will not be excluded by virtue of this wording, even if a layperson may consider those losses to be "consequential".
• The following types of clauses will be subject to the same principles of interpretation as an exemption clause:

• Time bar clauses.
• Clauses pursuant to which one party agrees to indemnify another party against the consequences of that other's liability to third parties.

In conclusion, a party looking to exclude or limit its liability should use clear and unambiguous words, and should not attempt to exclude its liability under the contract entirely or seek to exclude its liability for fraud. Doing otherwise opens the door to challenge and uncertainty.

Our glossary of key terms referenced in this guide

For ease of reference, we have summarised some key terms referenced in this guide. Click on the links to where these terms are discussed for context and guidance.

Common law: Law developed in case law by the courts. Consequential loss (or indirect loss): This term will normally be interpreted as referring to losses under the second limb of the rule in Hadley v Baxendale (i.e. losses that result from special circumstances, which will only be recoverable if the other party knows of those circumstances).

Contra proferentem: A doctrine which provides that in the event of doubt or ambiguity in the interpretation of a contract, there is a presumption against the party which put the words forward.

Exemption clause: A clause which seeks to exclude (in its entirety) or limit (to a particular level) a contracting party's liability under a contract in respect of certain types of liability or loss. UCTA: Unfair Contract Terms Act 1977 – a statute which imposes limits on which exclusion clauses can be used to avoid liability.

This piece forms part of our Contract Interpretation guide. The guide compiled by our Dispute Resolution team and looks at the meaning of some commonly used, but also commonly litigated, contractual terms. To view the full guide click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.