Limiting liability in standard terms: cause for concern?

Practitioners may wish to reconsider their approach to drafting standard terms after the High Court found that various limitation of liability clauses in standard term business-to-business contracts were unreasonable under the Unfair Contract Terms Act 1977 (UCTA)[1].

While the court found that there was no liability on the specific facts of the case, the implications of some of the court’s statements may give practitioners pause for thought.  In particular, the court suggested that a clause will be unreasonable if it would deny a buyer any remedy in certain circumstances, even if it has the right to replacement or limited compensation in other circumstances. The court also suggested that an attempt to exclude consequential loss will be unreasonable if it is in the parties’ contemplation that any direct loss to the buyer would be greater than the mere cost of replacing the goods.

This article first appeared in the August 2015 issue of PLC Magazine (www.practicallaw.com/3-617-5308) and is reproduced with the permission of the publisher.  

The dispute

International Decorative Services (IDS) brought an action against Hillmead Joinery (Swindon) Limited to recover the price of various goods that it had sold and delivered. Although Hillmead admitted the claim, it counterclaimed for around £367,000, alleging that some of the products were defective; namely, laminate sheets that were to be attached to panels. Hillmead had incorporated the sheets into a product that it supplied to a third party.  IDS argued that the limitation of liability clauses in its standard terms protected it from Hillmead’s counterclaim.

The decision

After considering the specific circumstances of the case and the factors set out in Schedule 2 to UCTA, the court found that all of IDS’s purported limitations were unreasonable. However, the court concluded that the laminate sheets were of satisfactory quality and there was no obligation on IDS to supply goods fit for purpose so, on the facts, there was no liability to exclude or limit.

Satisfactory quality 

The court found that IDS’s attempt to exclude the statutory implied term of satisfactory quality was unreasonable.  The court relied in particular on the facts that:

• There was no other term or warranty in the contract that replaced this implied term.

• The parties were not of equal bargaining power, based on the difference between their respective turnovers (Hillmead’s was £2 million while IDS’s was £111 million) and IDS's reluctance to negotiate its standard terms. 

• The goods were not of an agreed specification or a special order and IDS was not aware of the ultimate purpose for which the goods would be used. These factors might otherwise have justified an exclusion of the statutory implied term.

Reporting defects

IDS attempted to exclude all liability if Hillmead failed to inspect and report defects within three working days.  The court commented that a clause will not satisfy the reasonableness test if it seeks to transfer all the risk of liability to a buyer that fails to inspect and report precisely that which the seller could and should previously have observed for itself.

The fact that the term sought to exclude all liability in a particular circumstance was fatal. This was despite the fact that the contract did provide for replacement goods to be supplied, or compensation to the invoice value, if Hillmead reported defects in accordance with the contract.

Replacing goods

The court found that IDS’s attempt to limit liability in all circumstances to the replacement of goods, or their invoice value, was unreasonable. The court relied in particular on its findings that the parties were of unequal bargaining power and, at the time the contract was made, it was within their contemplation that any direct loss suffered by Hillmead was likely to be greater than just the cost of the goods, as they were component parts. This reasoning applied despite the fact that the parties' knowledge would likely be the very reason that a supplier would seek to limit its liability.

Consequential loss

IDS’s attempt to exclude all liability for consequential loss also failed the test of reasonableness. Again, the court was critical of a provision that sought to exclude all liability for a particular loss rather than impose a limit. There was also an indication that, given that the standard term limiting liability to replacement goods, which had less serious implications for Hillmead, had been held to be unreasonable, this clause, which had more serious consequences, was also likely to be unreasonable.

Practical implications

Cases concerning the application of UCTA will turn on their own facts. However, it is noteworthy, and somewhat unusual, that the court found that all of the terms designed to limit liability, including some fairly common terms, failed to satisfy the UCTA reasonableness test. In particular, the following practical points arise from the decision:

• When drafting an exclusion of implied terms in business-to-business standard terms, it is advisable to include some other alternative remedy if the implied terms are to be successfully excluded.

• Excluding all liability in any one circumstance is likely to be problematic. In this case, a clause of this kind was unreasonable even though the standard terms offered replacement of the goods or compensation limited to the invoice value of the goods in other circumstances; this was not sufficient to allow the full exclusion to operate.

• Should a supplier wish to include a provision regarding the inspection and reporting of defects, this should be structured carefully so as to afford the buyer a reasonable opportunity to discover any defects following delivery.

• Controversially, the exclusion of consequential loss was held to be unreasonable and, therefore, ineffective. It is common practice to include such provisions and they had previously been thought to be generally enforceable.

• The manner in which the exclusion of consequential loss was considered also suggests that an attempt to exclude consequential loss in standard terms risks being unreasonable when it is in the contemplation of the parties that any direct loss will be greater than the costs of replacing the goods, despite the fact that such an anticipation would be the very reason that a supplier would seek to limit its liability to replacement or the value of the goods.

The court’s comments were obiter and some of them, particularly in relation to consequential loss, are surprising in light of common practice. However, taken at face value, the statements made in the judgment may cause practitioners to reconsider their approach to drafting standard terms

Suppliers may wish to consider whether they would prefer the certainty of accepting some limited overall liability for all losses, whether direct or indirect, rather than seeking to exclude all liability in certain circumstances and risk these clauses being unenforceable. 

[1] IDS Building Distribution Ltd (t/a International Decorative Services) v Hillmead Joinery [2015] EWHC B7.