What is an Exclusion Clause in Contract Law

In a business-to-business context, a common way of apportioning risk is for the parties to exclude or restrict their liability to one another in the event of default. Some clauses seek to completely exclude liability, whereas others limit it. This may be, for example, by capping the amount payable in damages in the event of a breach, or by restricting the types of loss recoverable or the remedies available.

Understanding how to incorporate enforceable exclusion and limitation of liability clauses can be crucial when negotiating or drafting such clauses, so as to adequately balance the rights and obligations of both parties. 

This article examines the question of ‘what are exclusion clauses?’ – providing a brief overview of some of the main legal principles involved. However, before entering into any business-to-business contract, expert legal advice should always be sought.

What are exclusion clauses and when are they not permitted?

An exclusion clause is a contractual term that excludes or limits liability, the latter often being referred to as a limitation of liability clause.

It is not possible, however, for the parties to simply exclude or limit liability in any way they chose, not least in an unreasonable way. Exclusion and limitation of liability clauses are subject to both statutory and common law controls. 

In particular, the Unfair Contract Terms Act 1977 regulates the exclusion and limitation of liability in both negligence and for breach of contractual obligations. Under the 1977 Act, liability can never be excluded or limited for the following:

  • death or personal injury caused by negligence.
  • implied terms as to title and quiet possession under the Sale of Goods Act 1979, the Supply of Goods (Implied Terms) Act 1973 and the Supply of Goods and Services Act 1982.

For public policy reasons, it is also not possible for a party to exclude or limit liability for its own fraud, either in inducing the other party to enter into the contract through fraudulent misrepresentation or during the course of it.

What are exclusion clauses and when are they permitted?

For business-to-business contracts, the following types of liability can be excluded or limited by way of specific contractual provision:

  • loss or damage other than death or personal injury resulting from negligence. Where a contract term purports to exclude or limit liability for negligence, a person’s agreement to or awareness of it is not of itself to be taken as indicating his or her voluntary acceptance of any risk.
  • implied terms as to conformity of goods with description or sample, or relating to their quality or fitness for a particular purpose under the 1979 and 1973 Acts. This covers both sale of goods and hire-purchase.
  • in contracts where the possession or ownership of goods passes under or in pursuance of a contract not governed by the law of sale of goods or hire-purchase, implied terms as to conformity of goods with description or sample, or relating to their quality or fitness for purpose. This primarily covers corresponding terms implied under the 1982 Act relating to contracts for services where goods are also supplied.
  • liability by reason of pre-contractual misrepresentation or any exclusion of any remedy available by reason of such a misrepresentation, other than for fraudulent misrepresentation.
  • where one of the parties is a business contracting on the other’s written standard terms, the other cannot exclude or restrict liability for breach of contract, nor claims to permit a contractual performance substantially different from what is expected, or claims to allow no performance at all.

This list is by no means exhaustive, rather it provides statutory examples of when exclusion clauses are expressly permitted, albeit only to the extent that the term satisfies the requirement of reasonableness.

What are exclusion clauses and what is the requirement of reasonableness?

Any exclusion or limitation of liability clause will be subject to a requirement of reasonableness. It is for those claiming that a contract term satisfies this requirement to show that it does. The test of “reasonableness” is set out under section 11 of the 1977 Act. This provides that:

“the term shall have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made”.

In assessing reasonableness, regard should be had to the following guidelines set out under Schedule 2 of the 1977 Act:

  • the strength of the bargaining positions of the parties relative to each other, taking into account, among other things, alternative means by which the customer’s requirements could have been met.
  • whether the customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons, but without having a similar term.
  • whether the customer knew or ought reasonably to have known of the existence and the extent of the term, having regard, among other things, to any custom of the trade and any previous course of dealing between the parties.
  • where the term excludes or restricts any relevant liability if some condition was not complied with, whether it was reasonable at the time of the contract to expect that compliance with that condition would be practicable.
  • whether the goods were manufactured, processed or adapted to the special order of the customer.

In addition, where a term of a contract seeks to limits liability to a specified sum of money, the cost and availability of insurance may be relevant in an assessment of reasonableness.

Although the 1977 Act provides that these guidelines apply specifically to contracts involving the sale and supply of goods, they are usually treated as having more general application. Further, these statutory guidelines are not exhaustive.

What are exclusion clauses and what are the effects of falling foul of the reasonableness test?

If an exclusion or limitation clause falls foul of the statutory provisions under the 1977 Act, either because it purports to exclude a type of liability which cannot be excluded, or because it falls foul of the requirement of reasonableness, it will be ineffective. The court will not rewrite the clause to substitute an alternative, rather liability will become completely uncapped, subject to the usual rules relating to the recovery and assessment of damages.

The risk of an entire exclusion or limitation of liability clause being unenforceable can be minimised by drafting it, using sub-clauses, as a series of separate terms easily distinguishable from one another. 

In business-to-business contracts, clauses are far more likely to be enforceable, and be construed less strictly, if they limit liability rather than exclude it entirely. However, as the wording of exclusion clauses tends to vary so much, many cases turn on their specific facts.

What are exclusion clauses and when are they outside the control of the Unfair Contract Terms Act 1977?

There are in fact a number of contracts to which the 1977 Act, and therefore the test of reasonableness, does not apply. Broadly speaking, these include:

  • international supply contracts
  • contracts of insurance
  • contracts relating to interest in intellectual property rights
  • contracts relating to interests of land
  • contracts of employment, except in favour of the employee
  • contracts relating to the formation, dissolution or constitution of a company or to the rights or obligations of its members.

In circumstances where the provisions of the 1977 Act do not apply then, subject to common law and any industry-specific rules, the parties are free to draft whatever exclusion or limitation they may agree. 

Legal advice in relation to the question ‘What are exclusion clauses?’

Exclusion and limitation of liability clauses are a sensible way of allocating risk but need careful and expert drafting if they are to be enforceable. 

In the event that such clauses are not properly incorporated into the contract, are excluded by statute or at common law, or fall foul of the reasonableness test, they will be ineffective. Accordingly, the liability which the clause purported to exclude or limit will become completely uncapped.  In these circumstances, the financial and other consequences for you and your business could be significant. 

By seeking legal advice prior to entering into a contract, your legal adviser can help you with the following matters during the negotiation and drafting process:

  • incorporating the clause into the contract
  • ensuring that the liability in question is covered by the clause
  • identifying any cases or legislation regulating its effect
  • applying the requirement of reasonableness

By fully understanding ‘what are exclusion clauses?’ you can agree on a contract that adequately balances the rights and obligations of both parties.

Legal disclaimer

The matters contained in this article are intended to be for information purposes only. This article does not constitute legal advice and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought. 

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