The liability clause is arguably the most important clause in a contract being notoriously the subject of dispute and yet it is the one clause that is usually drafted inadequately.
The judgment in Markerstudy Insurance Company Ltd v Endsleigh Insurance Services Ltd has served as a sharp reminder to contract drafters of the need for absolute clarity and precision when it comes to excluding liability for certain heads of loss.
A bit of revision: Hadley v Baxendale
By way of a reminder, for successful recovery of losses for breach of contract, you need to consider the two-limbed remoteness test laid down in Hadley v Baxendale. The first limb covers direct loss (losses that arise as a usual consequence of the breach). The second limb covers indirect or consequential loss (losses that arise as a consequence of the breach that are too remote, unless they were within the reasonable contemplation of the parties as a consequence of the breach).
The confusion lies in the fact that certain heads of loss are often mistakenly thought of as consequential losses (for instance, loss of profits) but can, in fact, fall into either of the Hadley v Baxendale limbs. For example, direct loss of profits is common. When it comes to interpreting exclusion clauses, courts are often faced with the same question: did the parties at the time of contracting intend to exclude a specific kind of loss in full (direct and indirect losses) or just the indirect loss?
This was the challenge for the Court in Markerstudy.
Markerstudy v Endsleigh
Under a raft of agreements, Endsleigh provided certain administration and claims handling services to Markerstudy, an insurance company writing motor business. Markerstudy alleged Endsleigh had breached the agreements over a period of time and claimed damages of some £14 million.
The court had to consider two exclusion clauses:
“1. Neither party shall be liable to the other for any indirect or consequential loss (including but not limited to loss of goodwill, loss of business, loss of anticipated profits or savings and all other pure economic loss) arising out of or in connection with this Agreement.
2. Endsleigh will not be liable to [the claimants] for any indirect or consequential loss or loss of profit or loss of business arising out of data input errors by Endsleigh put into Policy Schedules, Certificates of Insurance or Endorsements.”
The court rejected Endsleigh’s argument that it was exempt from both direct and indirect losses for the specific heads of loss referred to in each clause. It held that the heads of loss in the parenthesis were not freestanding heads of loss. Both clauses operated to exclude indirect and consequential losses only. Thus, Endsleigh was liable for direct loss of goodwill, business, anticipated profits and so forth.
The court’s approach
How the court interpreted the second exclusion clause is perhaps the most surprising, it held that the introductory phrase “any indirect or consequential loss” tainted the remainder of the clause and defined the scope of the specified heads of loss.
It is clear that the courts are still keen on operating the contra proferentem rule, demonstrating a reluctance to interpret exclusion clauses widely. If a contract seeks to exclude categories of loss directly, the drafting must say so expressly, succinctly and without ambiguity.
A lesson in drafting
Various approaches to drafting have been recommended as a break from the norm.
A tailor-made approach. Arguably the most sensible approach is to draft a tailor-made clause based solely on your client’s precise concerns, thereby limiting the remit of the exclusions to issues of relevance within the confines of the law.
Cap liability. Alternatively, you could draft in sensible liability caps. With this option, you need to be clear about whether contractual or statutory interest falls inside or outside the overall financial cap. Markerstudy makes it clear that while a clause limiting a party’s “total liability in contract” is effective to limit any contractual claim for interest, statutory interest will not be covered by the cap. If you want to limit liability for statutory interest, say it explicitly.
Heads of loss and a “catch all”. Some say it is necessary to list the excluded heads of loss, identifying whether the exclusion relates to direct or indirect losses, or both. You might then include a “catch all” provision to cover the exclusion of indirect, consequential or special loss. To be clear, the specific heads of loss should be placed before the “catch all” clause to avoid the courts from finding that the words “indirect, consequential or special” are intended to govern any heads of loss subsequently listed (as in Markerstudy).
Additionally, the “catch all” should not read “any other indirect, consequential or special loss” for fear that this might qualify the specific heads of loss listed. Of course, you would also need to spell out those liabilities that cannot be excluded by law.
Indirect losses only. If your client simply wishes to exclude liability for indirect losses, the drafting should just say that. There is no need to confuse the issue by providing an indicative list of specific categories of loss. The courts have made it clear that it is unwise to use the “indirect and consequential loss, including…” formula.
Why not adopt the inclusive approach? In other words, draft an additional provision that is explicit about what can be recovered as opposed to what can’t. All parties then understand the deal on positive recoverability from the outset.
If your client can identify specific heads of loss that it absolutely must recover, this task is made easy. You are likely to win brownie points and will, most likely, avoid a scenario where your client learns to his dismay that certain categories of intangible loss (in relation to which no recovery would be a commercial tragedy), cannot be said with certainty to fall within the category of direct loss.
In short (and at the risk of re-visiting old ground), take note: ditch the formulaic approach to liability clauses and say it like it is.
Would the following limitation of liability be considered as a catch all?
‘The company shall not be liable to the customer for any losses of whatever nature (including consequential loss) arising out of any defect in the quality of the goods, save for any loss in respect of death.’