Market trends and liability clauses: what we are seeing and what we are negotiating

23rd January 2019

This article is about business-to-business commercial contracts governed by English law in sectors where the norm is to have provisions limiting liability of at least one party. The focus is on the cut-and thrust of drafting and negotiating liability clauses. It ignores consideration of the Unfair Contract Terms Act.

The size of the HCR commercial team means we see enough contracts to observe market norms and spot trends. As we will explore below, market norms don’t necessarily correlate with good practice, but they are influential, especially in the final round of negotiating controversial provisions.

It pays to know, with a reasonable degree of confidence, whether one is pushing for a position that is normal or an outlier. Until a few years ago, it was easier to sustain that confidence. What we see now with predictable regularity is that customer negotiation teams (led by a procurement professional or a lawyer) vehemently insist that no other supplier is objecting to the customer’s preferred regime, and the supplier team is equally assertive in its support of the supplier’s stance. Caught between them, the supplier’s sales person starts to worry that the deal will be lost because their lawyer looks obstructive. Their counterparts on the customer team listen to the debate and are reluctant, often, to say anything in the debate for fear of  saying anything inconsistent with a position that seems so strenuously held. The net result is an unseemly and unhelpful impasse which is difficult to traverse when each side is so adamant about what is normal.

Who will blink first? How do they compromise when each party is worried about giving ground?

Meanwhile, juxtaposed with the trends in negotiating behaviour, we see cyclical trends in the approach taken by the courts to the interpretation of liability clauses. It’s expedient to pick up the story with St Albans DC v ICL in 1996, where the software developer left the court with a bloody nose after failing to sustain a liability clause in relation to software that left the Council miscalculating revenue raised from the Community Charge. There followed cases where the courts interpreted liability and exclusion clauses with varying emphasis. Often, the contra proferentem rule was used to cut down a liability clause. That rule required ambiguity in an exemption clause to be resolved against the party seeking to rely on it. Other cases (notably British Sugar v NEI Products, a 1997 Court of Appeal decision) suggested it was necessary to adopt increasingly comprehensive text for liability clauses to defeat narrow interpretations.

Drafting reliable clauses became a trip-hazard for commercial lawyers. Hindsight and the fine arguments of senior counsel in the appeal courts tended to reveal ambiguity that eluded the original drafting team. No wonder, therefore, that contract drafters were wary of departing from the latest long clauses handed down in law firm precedents.

The judicial pendulum seems to be swinging the other way now. Jackson LJ in the Court of Appeal’s decision in the Persimmon Homes v Over Arup decision ([2017] EWCA Ca Civ 373) upheld Ove Arup’s interpretation of an exclusion clause, citing that the contra proferentem rule now has a very limited role in commercial contracts negotiated between parties with equal bargaining power. The Court supported an earlier decision of Lord Neuberger MR in K/S Victoria Street v House of Fraser (Stores Management) [2011] EWCA Civ 904.

The judicial decisions have not closed the opportunity to at least try to undermine liability clauses, so practitioners will continue to do what they can to draft clauses that don’t invite creative interpretation. Ken Adams, author of “A Manual of Style for Contract Drafting”, contends that trying to draft contracts based on judicial decisions is the wrong approach, and that practitioners would do well to adopt clearer drafting and try to end what he calls dysfunction in traditional contract language. Adams rejects the notion of tested contract language. He would certainly challenge the wisdom of looking to market norms to find best practice. Nevertheless, it remains the case that market norms are perceived as a safe place to be when two commercial parties are straining their relationship when trying to reach agreement.

The remainder of this article is about what we observe in practice. Readers should refer to the more thorough analysis of Ken Adams and others to decide how far misguided the norms might be (try out his blog, ‘Adams On Contract Drafting’). Admittedly, HCR only sees contracts where one of the parties has sought legal advice, but readers of this article come from that set.

The most significant new norm has been accelerated by GDPR: there is a pronounced call (from customers) for unlimited liability for breaches of data protection and confidentiality provisions, typically accompanied by wide indemnity provisions to displace common law damages. But we also observe that it’s equally common for suppliers to resist, and this seems to be less apparent. When acting for suppliers where any element of data processing is at large, we tell them to expect customers to say that unlimited liability for data protection breaches has been accepted by all their other suppliers. Unless we are consistently and unusually good at pushing back successfully against calls for unlimited liability (modesty forbids saying more), it’s not true that suppliers are generally conceding unlimited liability. Instead, what we observe is that suppliers are responding with special liability caps for such claims that are higher than the general liability cap for other contract breaches.

In contracts with annual revenue is greater than, say, £100,000, we are seeing liability caps for data protection expressed as multiples of annual charges ranging from 125% to 500%, but the most frequent range is 150% to 300%. For contracts with lower annual charges, we often see liability caps for data protection breaches expressed as a specific sum (£500,000 is not uncommon). The norms are still developing. We expect to see the concept of special liability caps remain common, but it’s too early to say where the market norm will settle on the quantum. The author’s prediction is 200% but your mileage might vary. Indeed, we are now seeing some suppliers volunteering higher caps for data protection as part of the standard terms, hoping to reduce arguments.

We are also seeing more frequent challenges to liability caps for contract breaches per se. It’s fair to say that the supplier community most frequently adopted caps set at 100% of annual charges. In projects where the customer has some negotiating power, we see customers asserting caps at higher levels and the parties frequently compromising at 125% or 150%. In some sectors, caps are set as specific amounts. Unsurprisingly, round figures like £100,000 and £1,000,000 frequently abound.

The curious thing about liability caps is that parties seem to be putting more effort into negotiating the quantum of the cap than the drafting of how the cap applies. Multiple permutations are possible, but the two frequent options are: (i) a cap that applies per event or series of linked events and (ii) an aggregate cap. The aggregate cap can create drafting traps that too often go unnoticed because ‘aggregate’ is used without careful thought about what is being aggregated. Some people prefer to see an aggregate cap as a limit on the total of all liability for all claims that could be made in the life of the contract. Let’s call that a ‘contract aggregate’. Problems arise when the contract aggregate is expressed as a multiple of 12 months’ charges. There’s no inherent reason why a contract aggregate cannot be thus capped, but often one sees text that uses words such as ‘12 months preceding the claim’ or other words that are predicated on liability for a claim, rather than all claims aggregated. Especially in contracts where charges vary from year to year, we have found a high incidence of vague wording to describe aggregates combined with caps formulated on a ‘per claim’ basis.

How about developing the idea of an annual aggregate?

Most liability clauses are settled based on caps applying to all claims in a 12-month period or per claim, rather than based on contract aggregates. We find the attachment to a contract aggregate goes away when the parties consider whether it’s likely that a contract would survive without termination after even one claim of such substance that caps are being asserted. Conceptually, an aggrieved party might hang around to bring multiple claims in successive years if the defaulting party continues to aggrieve, but it seems unlikely.

As a result of the judicial application of the contra proferentem rule and the rules from Hadley v Baxendale drummed into law students, the established wording of many exclusions clauses inherited through law firm precedents will feature words qualifying the exclusion along the lines of “…even if caused by that party’s negligence or breach of contract…” and “…even if that party was advised that the loss would probably result…”. Recently, we have seen more contract reviewers strike out those words. It’s never terribly clear why the reviewer wants to strike them. Is it because they seem too stark and objectionable, or is it because the reviewer thinks the wording is a redundant archaism, or is it because the words are alien to a reviewer who might come from a civil law jurisdiction? It’s arguable that the text isn’t needed if the remainder of the clause is well drafted and left to have its natural meaning. But, if the wording is present and then one party seeks to strike it, the dilemma is this: does the deletion of the text merely signify recognition that the text was redundant, or does it show an intention of the parties to dilute the application of the exclusion clause? If the clause is unambiguous, it ought not to matter (because the natural meaning of the clause should be applied without enquiring into evidence about the parties’ intentions). On the other hand, if the clause is later scrutinised and found ambiguous, the dilemma comes to the fore. One can avoid the problem by modernising the clauses; by trying to maintain the text once it is there; or, by conceding the deletion with a documented comment about the text being redundant rather than an admission that the exclusion doesn’t apply to negligence or breach of contract.

We also see more contracts listing gross negligence and wilful defaults as exceptions in the list of items for which there is no exclusion or limitation of liability. These concepts merit a separate article. For now, we merely observe the trend and report how it usually ends. The worry (for suppliers) is that ‘gross negligence’ arguably does not have the settled meaning that it’s perceived to have (perceptions that are stronger among US lawyers). The concept of ‘wilful default’ sounds appealing when parties contemplate a blatant deliberate act. Underneath, there is a spectrum of conduct which extends into examples the author frequently uses to justify resisting this category of unlimited liability. How does it end? Our experience is that the most frequent outcomes are (i) a party agrees to remove references to these concepts or (ii) the drafters spend more time trying to define the concepts so that they become acceptable.

If we wanted this article to be longer, we would add two more usages. We mention them only briefly so readers are alert to them and might consider further research. The first of those is a trend for contracts to include numerous and wide indemnity provisions, as if common law damages are not reliable. The second is a trend to include a long list of losses that are deemed to be direct losses. About indemnity provisions, the author feels bound to observe that they proliferate because they look compelling rather than because the drafter had made an educated assessment of why common law damages would be inadequate. That’s not to say that all indemnities are over-indulgent, but rather that they should be specific and objectively justifiable. We caution against the particularly toxic mix of wide indemnities for GDPR breaches combined with unlimited liability. About the list of direct losses, we think they have their place but should be specific to the project and should not become boilerplate provisions.

The final observation derives from a comment earlier in this article. We observe that more time, angst and legal prevarication hinders negotiation of liability clauses if one or both parties asserts a market norm that is not in fact a norm. Even if the advisers on both sides of the table know the reality, it is unhelpful for other members of both teams who accept an assertion at face value. How can they reach agreement when any compromise seems inconsistent with the apparent legal advice. Managing expectations of one’s own team is the antidote.

This article does not constitute legal advice. Specific legal advice should be taken before acting on any of the issues covered.