The parties to civil engineering and construction contracts, particularly for energy projects, manufacturing facilities, process plants, waste processing and similar projects, increasingly try to fix a “final frontier” for their exposure to claims, using a limit of liability clause.
Last summer’s GB Gas Holdings (referred to as Centrica) v Accenture reminds us about how limits of liability will be interpreted and, as an employer or contractor, it is important you go some way to understand the effect of your limitation of liability provision.
In January 2002, Centrica contracted with Accenture to design, supply, install and maintain a new IT system called the Jupiter System. Unfortunately, the performance of the new billing system was not stellar, suffering considerable delays.
In March 2006, the parties entered into an amended agreement to release an amended billing system (release 3B). However, by June 2006 a considerable number of errors had emerged, which resulted in increased numbers of customer accounts that were not billed and falling customer satisfaction.
In February 2007, Centrica notified Accenture of certain “Fundamental Defects” in the billing system. However, Accenture refused to take any steps to rectify the errors, arguing that there were no Fundamental Defects in release 3B and the notification letter was ineffective.
The contract also included a limit of liability:
“16.2 Consequential Loss
…in no event shall either Party be liable whether in contract, tort (including negligence) or otherwise in respect of any of the following losses or damages:
16.2.1 loss of profits or of contracts arising directly or indirectly;
16.2.2 loss of business or of revenues arising directly or indirectly;
16.2.3 any losses, damages, costs or expenses whatsoever to the extent that these are indirect or consequential or punitive;…”
Centrica issued proceedings and the Commercial Court handed down a judgment on preliminary issues in November 2009, which Accenture appealed. The Court of Appeal handed down its judgment in July 2010, where Longmore LJ gave a resounding endorsement of the trial judge’s findings.
Centrica’s claims included:
- £18.7 million for distribution charges (on the basis it was charged for gas on an estimated consumption rather than actual consumption because the distributors were not provided with meter data for about 15% of its customers).
- £8 million in compensation it paid to its customers to reflect the billing difficulties and poor customer service.
- £2 million in additional borrowing charges due to the late billing or non-billing of customers.
- Other sums incurred in chasing debts, additional stationery and correspondence costs.
The court was asked to determine a number of preliminary issues, including interpreting what breaches could amount to a Fundamental Defect, what was the correct basis for calculating damages for a Fundamental Defect and whether any of the classes of loss claimed were excluded.
The modern approach to interpreting contract clauses was set out by Lord Hoffmann in Investors Compensation Scheme v West Bromwich Building Society. When interpreting a clause, the court aims to ascertain:
“the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.”
The background knowledge or matrix of fact may include:
“absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.”
In relation to the limitation clause, the words “directly” and “indirectly” refer to the first and second limb of the rule in Hadley v Baxendale. An exclusion of “indirect” and “consequential” loss only excludes the second limb: so-called special knowledge loss. It does not exclude liability for damages that are the “direct” or “natural result” of a breach.
In addition to considering the contract, the court was provided with material that Centrica claimed constituted the matrix of fact. The court also took account of the events leading up to the conclusion of the amendment agreement (including the previous disputes between the parties) and heard oral factual and expert evidence.
As part of the evidence it was common ground that:
“…a retail concern’s billing system is at the heart of the concern and is business critical because cash flow will be significantly impacted if the system does not work.”
Taking account of this background knowledge, the court found in favour of Centrica on the construction of the warranty provision. A fundamental breach of warranty could be constituted by individual breaches and the consequences of the fundamental breaches could be aggregated for determining whether there was a “severe adverse effect” on Centrica’s business.
The court found that the contract would have had to use considerably clearer words before it would conclude that Centrica had relinquished its right to recover common law damages. The court interpreted the phrase “shall have a claim for damages for a Fundamental Defect” to mean:
“a claim for damages at large at common law for a fundamental breach of [the warranty provision] which causes a severe adverse effect on [Centrica’s] Business”.
Finally, the court was asked to determine whether the losses claimed by Centrica were excluded by clause 16.2 (the limit of liability). In relation to Centrica’s claims the court found:
- The distribution charges were not a claim for loss of revenue and arose as a direct result of the errors. Clause 16.2 did not prevent Centrica recovering those losses. The same was true for other claims for chasing debts, additional stationery and correspondence costs.
- One of the purposes of the new billing system was to improve customer relations and customer services. The compensation claims arose as a direct result of the errors in the billing system and were therefore recoverable.
- The new billing system was at the heart of Centrica’s business. Therefore, any delay in issuing bills or failure to issue bills was bound to have an adverse impact on Centrica’s revenue, so this loss fell within the first limb of Hadley v Baxendale and was not excluded by clause 16.2.
In order to avoid being tripped up by what might be a “black hole” of interpretation, here are some of the issues you should consider when drafting or negotiating a limitation clause:
- Identify the commercial concerns of the client, that is those losses which would be significant to its business and which it would want to recover
- What types of loss are to be excluded? Usually it’s the employer’s losses that are limited, but there may be reason to limit the contractor’s loss, such as loss of profit if part of the works was subsequently not required. Consider possible sub-contractor and supplier losses. Ensure both parties understand the heads of loss they will and will not accept.
- What heads of loss are to be excluded? Take care to specifically exclude particular heads of loss, if that is what the parties require. Widely drafted wording such as an exclusion of “indirect or consequential losses”, which are intended to cover the second limb of Hadley v Baxendale, may not exclude loss of profit or revenue where such losses are considered to be “a direct loss” or “in the contemplation of the parties” when they entered into the contract. A judgement on whether a loss is a “direct loss” or an “indirect or consequential loss” can only be made on a context-specific basis. Here, the court held that ex gratia payments to consumers can (in principle) amount to direct losses.
- Should a claim for loss be subject to notice provisions? If so, should a proper notice be a condition precedent to making a claim?
- Should there be a cap on any losses? If so, should it be for a fixed period or aggregate over the duration of the contract? Should the cap differ for different types of loss? If the cap is fixed to the value of works completed, should there be a minimum liability?
- What liabilities can’t be excluded? Usually liability for fraud, negligently caused death or personal injury can’t be excluded and, if they are, a limit of liability clause may be void.
- How does the limitation clause interface with the insurance arrangements for the particular contract? The regime relating to loss apportionment should be consistent with such insurance requirements. Therefore, consider the treatment of uninsured losses and insured losses alongside any caps relating to those losses.
So, as you can see, there is a galaxy of issues to be considered; but in these tough economic times, whether your contract is a ‘Jupiter’ or more modestly sized, you can be sure that a limit of liability clause will be negotiated hard and enforced without mercy.