Excluding or limiting liability in commercial contracts: a question of faith?

I was recently negotiating a procurement contract that brought to mind recent cases concerning good faith obligations. It occurred to me that if there is a move towards including express good faith obligations in construction contracts, should we not also consider addressing the consequences of acting in bad faith?

The key recent cases are:

Bad Faith?

My client is more familiar with civil law systems and our negotiations involved a discussion about the consequences of acts of “gross negligence or wilful misconduct” (which to my mind are akin to acting in “bad faith”) and in particular the effect of such acts or omissions on an agreed cap on liability. Specifically, should a contractor or consultant be entitled to rely on a cap on its liability when it has acted in bad faith?

Caps on liability in professional appointments have become increasingly common, in part due to pressure from insurers, and are a common feature of construction contracts. A typical provision may seek to exclude or limit liability for breach unless that liability arises directly as a consequence of fraud, gross negligence, wilful misconduct or the like.

Of course, English law does not allow a party to limit its liability for fraud or fraudulent misrepresentation. Even if it is not expressly stated in the contract, provisions capping or otherwise limiting liability will not apply where that liability arises as a result of fraudulent acts or omissions (see HIH Casualty and General Insurance Ltd and others v Chase Manhattan Bank and others). However, what if an act goes beyond “mere negligence” but doesn’t constitute fraud?

What is “gross negligence” or “wilful misconduct”?

Until relatively recently, English law did not recognise “gross negligence” as a concept distinct from negligence. However in the case of Camerata Property Inc v Credit Suisse Securities (Europe) Ltd Andrew Smith J re-visited the meaning of “gross negligence”. He concluded that although the distinction between gross negligence and mere negligence is one of degree the term “gross negligence” was clearly intended to represent something more fundamental than failure to exercise proper skill and/or care constituting negligence. His view was that, as a matter of ordinary language and general impression, the concept of gross negligence is capable of embracing not only conduct undertaken with actual appreciation of the risks involved, but also serious disregard of or indifference to an obvious risk.

In De Beers UK Ltd v Atos Origin IT Services Ltd the contract contained a limit on the defendant’s liability but it was expressed not to apply in the case of “wilful misconduct” or “deliberate default”. The court held that “wilful misconduct” was conduct by a person who knows that he is committing and intends to commit a breach of duty or is reckless in the sense of not caring whether or not he commits a breach of duty. “Deliberate default” on the other hand, was slightly narrower: it meant a default that was deliberate, in that the person committing the relevant act knew that it was a default.

In some civil law countries (such as Italy and France) it is simply not possible to exclude liability for gross negligence: gross negligence is equivalent to fraud. There is no equivalent principle in English law. In Armitage v Nurse the court considered that negligence and gross negligence differ in kind from fraud or dishonesty. This distinction can cause some difficulty for contracting parties more familiar with civil law systems.

What should you do in practice?

It is clear that if a construction contract contains a cap on the contractor’s liability but does not “carve-out” liability for losses, damages and so on arising as a result of gross negligence and/or wilful misconduct, then the contractor will not be liable for such losses over and above the cap, even if caused by its gross negligence or wilful misconduct. If it is the intention of the parties that such losses are not to fall within the cap the contract must provide expressly for this.

What is equally clear is that, notwithstanding the guidance from the courts as to what these terms mean in practice, as with all cases of contract interpretation, the relevant question in each case is not whether gross negligence/wilful misconduct are familiar concepts in English law, but the meaning of the particular expression in the relevant agreement in which the words are found. The courts will interpret the words used according to their natural and ordinary meaning in the context of that particular agreement.

If a contract refers to gross negligence and/or wilful misconduct then, in my view, it makes sense to try and define in the contract what the parties mean by these terms, rather than leaving this as a matter of contract interpretation. This, in itself, is not without difficulty: whether or not a party is “grossly” negligent or has acted with wilful misconduct will always be a matter of degree. However, this shouldn’t be a reason not to try and clarify their meaning. It perhaps goes without saying that seeking to carve out certain losses from an overall cap on liability may be met with a level of resistance from contractors/consultants and their insurers. On the other hand if the contract seeks to clarify the type of behaviour that will constitute gross negligence or wilful misconduct then this becomes a risk which can be identified at the outset and properly managed and mitigated during the course of the project.

3 thoughts on “Excluding or limiting liability in commercial contracts: a question of faith?

  1. If a contract attempts to define instances of bad faith and spell out the consequences, does it not present a risk of parties deliberately acting in bad faith because they can take a calculated risk about the consequences? Is it not perhaps better to leave some matters, especially ones which are not simply commercial (such as e.g. the consequences of delay or termination) to the discretion of courts? If a party does not know what the consequences of bad faith will be that might prove to be a more effective deterrent than if the consequences are spelled out.

  2. In passing this article raises the interesting question whether contracts should address the consequences of acting in bad faith in the light of recent case law. It then concentrates on what actually constitutes bad faith in different jurisdictions without answering the question posed. Perhaps it is implicit in the article’s conclusion that clarifying expressly what constitutes different kinds of bad faith means that they can be “properly managed and mitigated during the course of the project” that providing for the consequences of bad faith would enable parties to take the calculated risk of acting in bad faith? Bad faith is not simply a commercial risk for which it might be sensible to identify what consequences follow from it. Indeed, it might even prove to be a more effective deterrent to a party contemplating acting in bad faith not to know what the possible consequences are and to leave it to the court’s discretion to decide?

  3. The point of the contract is to have clarity on the consequences of the parties’ behaviour. If you don’t have clarity then it is difficult or impossible for the parties to reach a mutual settlement without recourse to the courts. If you want to use a term that does not have a clear judicial meaning – whether “gross negligence” or anything else – then it is usually in the best interests of both parties to spell out exactly what you think you are signing up to, and avoid the costs and uncertainty that go with court proceedings.

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