Contractual mechanisms for regulating, reducing or eliminating your liability

Introduction

A contracting party that is in a dominant commercial position will often attempt to regulate, reduce or eliminate the less dominant party’s right to sue for breach of contract and for acts or omissions of the dominant party that might entitle the weaker party to obtain a legal remedy. Such clauses take almost endless form and they may be expressed as exemption clauses, disclaimers, time limits, provisions excluding the operation of specific legislation, indemnity clauses or statements that certain factors will beat the weaker contracting party’s risk.

Limitation and exclusion of liability clauses

In many instances, it is lawful to limit or exclude altogether your liability for breach of contract and tortious acts and omissions as well as certain other liabilities arising under the general law and statute. Having said this, there are certain instances where the dominant contracting party cannot limit or exclude its liability in relation to the weaker contracting party because the law provides the weaker party with rights and remedies that cannot be compromised by the terms of the contract. Good examples of this are certain consumer law rights or guarantees that arise under the Australian Consumer Law.

Having regard to the above, if you, in your capacity as a party to a contract, assume an obligation or make a representation/warranty that gives rise to a liability then you should consider the following:

Capping your liability – this ensures that the maximum aggregate amount that the other contracting party can recover from you in respect of all claims and liabilities (inclusive of interest and legal costs etc) arising out of or relating to particular circumstances is capped at an ascertainable dollar sum. The ideal position is where the capped liability is effectively underwritten by liability insurance to at least the value of the cap.

Setting an end date to bringing claims – this ensures that your liability for losses etc suffered or incurred by the other contracting party cease at a particular time that ends prior to the statutory time limit for bringing a claim against the party in default (in very simplistic terms, this is six years from the date of breach in the case of a contract claim, and six years from the date on which measurable damage was first suffered in the case of a negligence claim). This type of clause does not relieve you from liability in respect of proceedings that have been instituted against you by the other contracting party prior to the applicable date.

Excluding your liability to the maximum extent possible – this type of clause excludes rights and remedies that the other contracting party would otherwise have against you. For example, by excluding any right on the part of the other contracting party to sue for certain breaches of contract or to claim certain types of damages such as consequential or indirect losses.

Disclaimers – can take almost endless form. One common disclaimer in sale of business contracts is a stipulation that the buyer did not rely upon certain information or statements of the seller in determining whether to sign the contract for sale. Such stipulations do not operate as an absolute bar to a claim for misrepresentation, but they can be relevant in challenging the credibility of a plaintiff/buyer, if it relied upon the impugned information and statements. A prudent buyer will choose to eliminate this risk by including express warranties and/or indemnities in the sale contract that are not expressed to be subject to such stipulations.

Do exclusion and limitation of liability clauses really work?

Yes, they do – subject to the operation of certain pieces of legislation and in very particular situations where the general law will grant relief from such provisions (ie they will be struck down by a court order, often on the grounds that they are unconscionable or unfair). Two particular pieces of legislation (but by no means the only ones) that have been construed in a way which prevents a person from enforcing a contract with another in a way which reduces or eliminates altogether that person’s liability is section 18 of the Australian Consumer Law (which creates a liability for engaging in misleading or deceptive conduct), and state and territory occupational, health and safety legislation (which holds employers liable for breaching certain duties to their employees and others).

The key take-away when considering exclusion clauses generally is that the wording matters. Careful attention must be paid to the scope or application of the relevant clause. For example, a stipulation that operates to limit a contracting party’s liability for non-performance of its contractual obligations may not extend to claims that arise in tort or in equity, or that arise in the law of restitution.

Liquidated damages clauses

Liquidated damages clauses are included in contracts to provide the measure of damages that the party not in breach of its contractual obligations will be paid by the party in breach should certain defined breaches occur. If a liquidated damages clause exists, the plaintiff/applicant should seek those damages and not sue for damages at large. The benefit of such clauses lies in the fact that the party not in breach does not have to prove its actual loss. This is a significant benefit because it simplifies the recovery process by avoiding the need to resort to complicated rules of law for the assessment of damages. It is not uncommon for parties to agree in the contract to an absolute cap on the amount of liquidated damages that the plaintiff/applicant can recover under the liquidated damages provision.

Force majeure clauses

A force majeure clause suspends or excuses a contracting party from its obligations during the occurrence of specified events. The common law does not recognise any doctrine of force majeure and so it is up to the contracting parties to agree that the occurrence of an event will excuse a party from its obligation to perform.

A force majeure clause prevents a party from being in breach of the contract and hence it can be a very useful provision if consideration has been given to the type of events that qualify as force majeure events.

Compulsory dispute resolution clauses

These clauses require a contracting party to submit to a dispute resolution or expert determination procedure before they can enforce their rights in the courts. Sometimes they can take the form of a provision that refers the dispute to an expert who then determines the dispute once and for all. Such provisions can prove popular with contracting parties because when the provisions are followed correctly, the expert’s decision is final and binding on the parties and cannot be overturned by a subsequent application to the court.

Indemnity rights – what is a contract of indemnity?

In the High Court case of Bofinger v Kingsway Group Limited, the court stated:

‘In its widest sense, that apparently used by Buckley LJ in Orakpo, an indemnity includes a contract obliging one person to make good the loss suffered by another, and contracts of guarantee and those of insurance fall within that description.’

In Andar Transport Pty Ltd v Brambles Ltd (another High Court case), Kirby J said:

‘Indemnity clauses are provisions that purport to exempt one party from civil liability which the law would otherwise impose upon it. They are provisions that shift to another party the civil liability otherwise attached by law to the first party. Self-evidently this is a serious thing to do or to attempt to do.’

A clause may be an indemnity clause even though the words ‘indemnity’ or ‘indemnify’ and other grammatical forms of these words are not used. The key is that if the clause has the effect of shifting to another party the civil liability otherwise attached by law to the first party, then it will be construed as an indemnity clause.

Why do contracting parties use indemnity clauses?
  • To shift civil liability to the other contracting party/parties.
  • When a plaintiff sues pursuant to a contract of indemnity, it is a claim for a money sum or a liquidated sum and not damages. This is desirable because it is easier to sue for a monetary sum rather than sue for damages.
  • The terms of the indemnity clause determine when the obligation to pay pursuant to the obligation to indemnify arises – this may be before the promisee (the person who receives the benefit of the indemnity right) has made a payment to a third party.
  • There is no requirement to mitigate loss (ie linked to the fact that the action is a claim for money or a liquidated sum); and the principles relevant to the assessment of damages, namely causation (March v Stramare HCA 1991 and remoteness (ie Hadley v Baxendale – two limbs of ordinary loss and special loss), are irrelevant. However, courts have a tendency to construe indemnity clauses very strictly and therefore when the court construes the clause(s) it must determine the extent or scope of the clause, and therefore principles of remoteness play a de facto role in determining the extent of the indemnitor’s liability to the indemnitee.
  • The terms of the indemnity and the contract as a whole may extend the indemnitor’s obligations to pay/indemnify the promisee in respect of consequential loss or damage for which the promisor may not otherwise be liable pursuant to the ordinary principles of remoteness of loss expounded in Hadley v Baxendale.
Third party guarantee

This is a very common commercial solution. Importantly, the guarantee needs to be documented (the law requires it to be in writing) and correctly signed to be effective (preferably as a deed). Guarantees are only worthwhile if the guarantor has the money/assets to meet its obligations under the guarantee. If the guarantor does not have the money/assets to meet its obligations under the guarantee, then the guarantee is probably worthless. The guarantor’s obligations can be contained in a separate instrument of guarantee or be incorporated into the main contract. If the latter approach is preferred, then the guarantor will be a party to the main contract.

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DISCLAIMER

This article is general commentary on a topical issue and does not constitute legal advice. If you are concerned about any topics covered in this article, we recommend that you seek legal advice.

The Authors

Simon Jay

PARTNER, MELBOURNE