IHL Construction

IHL June 2003

Iain Murdoch looks at different ways in which liability can

be limited in a construction contract and analyses approaches

taken in some of the standard forms currently available

Iain Murdoch is a solicitor in the construction and engineering department at Speechly Bircham

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Limitations of liability in construction contracts

onstruction projects often runover budget and/or programmeand the contract will determinewhich party takes responsibility.

Sophisticated clients and contractors areincreasingly aware of the nature of the risksassociated with their projects and bothstandard form and bespoke contractsaddress allocation of risk in more and more detail.

Various factors will affect the allocationof each risk, including political issues, the availability and economics of insurancecover, commercial bargaining power and the nature of the individual project. Often, a party is prepared to take a risk only if it knows its exposure is not open-ended, and limitation of liability is frequentlyaccepted as going hand in hand withapportionment of risk. This briefing looks at how liability can be limited in English law construction contracts (and particularlysome of the standard forms) and at what is, and is not, acceptable in the eyes of the law.

Overall caps on liabilityCommercially, a total cap on liability is

the best way for a contractor to limit its total exposure. Some standard formconstruction contracts, particularly thoseused in the plant and process sector, contain express caps on the total loss which may be recovered from the contractor.For example:

‘The total liability of the Contractor to theEmployer, under or in connection with theContract other than under Sub-Clause4.19 [Electricity, Water and Gas], Sub-Clause 4.20 [Employer’s Equipment andFree-Issue Material], Sub-Clause 17.1[Indemnities] and Sub-Clause 17.5[Intellectual and Industrial PropertyRights], shall not exceed the sum statedin the Particular Conditions or (if a sum isnot so stated) the Contract Price stated inthe Contract Agreement.’

(FIDIC Conditions of Contract forEPC/Turnkey Projects – extract fromclause 17.6.)

FIDIC (the International Federation ofConsulting Engineers) holds the view, inrecommending terms for turnkey contracts,

that there should be a total limitation on thecontractor’s liabilities, which can be agreedat any level by the parties if they so wish,but otherwise will default to the contractprice. FIDIC also recommends that certainspecific risks are not subject to this cap. Ofthose identified above, third-partyindemnities and intellectual propertyinfringement claims are commonly foundoutside such a cap.

The new ACE (Association of ConsultingEngineers) suite of engineers’ appointmentsalso provides for a total cap on liability, asdoes the RIBA (Royal Institute of BritishArchitects) standard form of architect’sappointment:

‘In any action or proceedings broughtagainst the Architect under or inconnection with the Agreement whether incontract, negligence, tort or howsoever theArchitect’s liability for loss or damage inrespect of any one occurrence or series ofoccurrences arising out of one event shallbe limited to… the sum… stated in theAppendix…’

(RIBA SFA/99, condition 7.3.)

C

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The maximum liability of the architect is to be an agreed sum. This is also the level of insurance which the architect agrees to carry. Perhaps given the link toinsurance, RIBA has drafted an ‘each andevery claim’ limitation, such that anarchitect’s total liability for separate anddistinct breaches or acts of negligence issubject to the agreed cap in each and everycase, rather than overall.

Clauses of this nature prevent a partysuccessfully claiming damages in full forlosses suffered. Without contractuallimitations, recovery would be limited onlyby the financial means (perhapsstrengthened by insurance or third-partyguarantee backing) of a defendant (subjectalways to the general rules as torecoverability of damages).

Simplistically, such clauses work againstthe client as the potential claimant. So whydo clients accept them? First, if a contractis, by its very nature, high-risk, then withoutsome way of capping its liability, a well-advised contractor or consultant may not beprepared to take on all the risks. Secondly, acontract which clearly allocates risk butwhich limits a consultant or contractor’sliability for those risks may be moreeconomic to take on (even with a contractorpricing for risks allocated to it), resulting in alower cost to the client. An example of thisoccurs in most PFI projects, where thepublic sector will usually wish to pass all ofthe construction risk to the private sector.This gives a benefit in terms of certainty andresponsibility but, in return, the risktransferred will usually be capped. This willnormally be a requirement of theconstruction company, which may often findthat the capital cost of the project actuallyexceeds its balance sheet.

Consequential lossOther forms of limitation relate to types ofloss and typically have one particular aim –to exclude ‘consequential losses’. It isconsequential losses which may be the most unpredictable and, on certain projects, the most significant. Whatconstitutes consequential loss will dependupon the circumstances. Often, those whorefer to consequential loss are particularlykeen to exclude loss of profit, but the courts have held that loss of profit may be a direct loss, at least in some cases.Without definition in the contract, the courts generally allow claims for directlosses to be all those ‘arising naturally’

from the breach of contract (see Hadley v Baxendale and British Sugar v NEI Power Projects).

An example of a limitation clause is thefollowing, giving the parties the ability to capcertain types of losses at an agreedmaximum:

‘... the Contractor’s liability for loss of use,loss of profit or other consequential lossarising in respect of the liability of theContractor in clause 2.5.1 [Contractor’sdesign liability] shall be limited to theamount, if any, named in Appendix 1...’

(JCT Standard Form of Building Contractwith Contractor’s Design, 1998 edition –extract from clause 2.5.3.)

This clause addresses loss of profitseparately but does not limit the client’sright to claim damages for direct losses for remedying defects in the building’sdesign and/or construction. Likewise, ifconstruction (rather than design) works werenot completed in accordance with thecontract, the losses of the client incompleting those works could berecoverable, whatever their nature andvalue, subject to the usual common lawrules and the remainder of the contract.However, where a design defect means thatthe client cannot use its new building, orthat a lucrative opportunity to make a profithas been lost, ‘loss of use’ and/or ‘loss ofprofit’ claims would succeed only up to theamount of any agreed cap.

As well as simply adding certainty in thesense of being able to judge the ‘worst-case’scenario under the contract for thecontractor and the ‘best-case’ recovery forthe client if things do go wrong, this draftingis also influenced by the availability ofinsurance at economic levels against risks ofthis nature.

DelayOther types of losses which may be limitedare those arising from delays. The JCT (JointContracts Tribunal) clause above alsoprovides that any liquidated and ascertaineddamages payable by the contractor for delayare not affected by the cap. Such liability isdealt with by reference to the date forcompletion with late completion (subject toextensions of time) allowing the client toclaim such damages at the pre-calculatedrate. The existence of an agreed contractuallevel of damages for late completion, at a

fixed rate, can also act as a limitation of thecontractor’s liability. Large plant and PFIconstruction contracts will, typically, containa separate overall cap on delay damages.

Entire agreement clausesEntire agreement clauses are included toprovide for certainty in the terms of the

contract. After a long negotiation, it may bein both parties’ interests to agree that certainterms and conditions alone define theirrelationship. Parties do not want to be liablefor statements or initial predictions whichare not incorporated in the contract. It isimperative in contracts containing such aclause to be sure that all key terms and keydocuments are included or expressly referredto. The following is a typical clause:

‘The Contract constitutes the entireagreement between the Purchaser and theContractor with respect to theperformance of the Works and supersedesall prior negotiations, representations oragreements relating thereto, whetherwritten or oral, except to the extent thatthey are expressly incorporated in theContract. No changes, alterations ormodifications to the Contract shall beeffective unless the same shall be inwriting and signed by both parties.’

(IChemE Red Book, third edition, Article 2.)

Whilst there are conflicting views as towhether such a clause is a limitation orexclusion clause in the strict sense, there areclearly circumstances where the effect ofsuch a clause, if enforceable, will be toexclude any right to rely on pre-contractualrepresentations.

It is clear that the above clause will notbe allowed to exclude liability for fraud,including any fraudulent misrepresentation.Claims that a pre-contractual representationis fraudulent are relatively rare, in partbecause of the high burden of proof thatmust be demonstrated if fraud is to be

FIDIC holds the view, in recommending

terms for turnkey contracts, that there

should be a total limitation on the

contractor’s liabilities.

IHL June 2003

IHLConstruction

Case references

Hadley v

Baxendale

(1854) 9 Exch 341

British Sugar v

NEI Power

Projects

(1998) 87 BLR 42

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claimed in court. More common is that aclaim was made negligently, or honestly butmistakenly.

Section 3 of the Misrepresentation Act 1967 imposes a reasonableness test(the same reasonableness test which applies under the Unfair Contract Terms Act 1977 (UCTA)) if a contract is to exclude

liability for such a negligent and falsestatement. However, the Court of Appeal’sview (see EA Grimstead & Son Ltd v Francis Patrick McGarrigan) is that entireagreement clauses are neither limitation or exclusion clauses, so the reasonablenesstest does not apply (see Zanzibar v British Aerospace (Lancaster House) Ltd for the contrary view). The Court, in EAGrimstead & Son Ltd, also commented that it was fair and reasonable for a contract to compel the parties to seek their remedies within a contractualframework, to the exclusion of reliance onpre-contractual representations. It is fair tosay that the courts might look differentlyupon such an exclusion in a contract with aconsumer, but in business to businesstransactions it seems that such a clausewould not be subject to a reasonablenesstest and would stand.

Death and personal injury caused by negligenceA recent bespoke contract contained thefollowing provision:

‘The Contractor shall indemnify and holdharmless the Owner from all costs,claims, damages, expenses, losses,liabilities and penalties… of every kindand nature resulting from personal injuryto any person employed by the Contractorarising directly or indirectly out of or inconnection with the performance of theContract without regard to the causethereof, including… the fault ornegligence... or breach of duty… of the Owner.’

Section 2(1) UCTA states that:

‘A person cannot by reference to anycontract term or to a notice given topersons generally or to particular personsexclude or restrict his liability for death orpersonal injury resulting from negligence.’

The above clause may, at first glance,fall foul of s2(1). However, in commercialcontracts, it may be possible to providecontractually for one party to bear the risk ofpersonal injury or death occurring, even ifcaused by the other party’s negligence.

Fox LJ held, deciding upon a termexcluding liability for death or personal injuryas between two commercial parties (‘A’ and‘B’), that liability to the injured individual (‘X’):

‘… is the only relevant liability in thecase… and that liability is still inexistence and will continue untildischarged by payment… Nothing isexcluded in relation to the liability, andthe liability is not restricted in any waywhatever. The liability of [A] to [X]remains intact. The liability of [A] to [B]was sought to be excluded.’

(Thomson v T Lohan (Plant Hire) Ltd.)

In summary, A and B can place risks ofinjuries, even those caused by their ownnegligence, on one or the other of them asthey see fit, so long as they do not seek toexclude or restrict either of their liabilities toX if they injure him.

This analysis can only be relied upon fordealings between companies. Certainly withrespect to consumers, and probably withrespect to professional partnerships, becausethe contract would then be with anindividual(s), attempts to exclude liability fordeath or personal injury caused bynegligence to such individual or individualswould be struck out of contracts by theeffect of UCTA.

Intervention by the courtIn addition to the statutory rules which mayaffect such terms, the courts have developeda body of law to ensure that limitations andexclusions are rigorously examined. If thecourts feel that there is ambiguity, they willallow this to benefit claimants rather thandefendants, which will rely on such a termto limit their liability.

As well as generally interpretingexclusion clauses against those that seek to

rely on them, the courts are particularly waryof attempts to exclude liability fornegligence. Indeed:

‘In case of other loss or damage [otherthan as set out in s2(1), above], a personcannot so exclude or restrict his liabilityfor negligence except in so far as the termor notice satisfies the requirement ofreasonableness.’

(Section 2(2) UCTA – this briefing doesnot deal with the UCTA reasonablenesstest, but there is a substantial body ofcase law on this issue, plus usefulstatutory guidance in schedule 2 to theUCTA.)

As a guide, if a clause is intended toexclude or limit liability for negligence, itshould do so expressly.

Insurance and liabilityWhilst insurance and limitations of liability clauses are conceptually separate,when analysing limitations of liability in any contract in terms of risk to the parties involved, they are both an integralpart of any such analysis. Contractual caps on liability can follow the limits ofcover under insurance policies, andinsurance polices can be seen as mitigatingthe contracting parties’ risk by passing therisk and cost of certain events on to a third-party insurer. Liability is notautomatically capped at an agreed indemnityinsurance limit unless there is expressprovision to this effect.

ConclusionEven where the parties have chosen aparticular standard form, there can often bea negotiation on key terms without an overallappraisal of risk.

By considering the placement of risk and simple but effective caps and limitationsof liability where appropriate, the parties will know what they are costing whenagreeing a price and the final negotiations of the contract may be simplified and the contract itself may become more cost-effective.

This review has identified some of thelimitations that are frequently negotiated.There are of course many other risks that canarise. The best approach is to try to identifyand address individual risks in your contractand remember that capping liability at anappropriate level can benefit all parties. IHL

IHL Construction

IHL June 200332

In addition to the statutory rules… the

courts have developed a body of law

to ensure that limitations and

exclusions are rigorously examined.

Case references

EA Grimstead &

Son Ltd v

Francis Patrick

McGarrigan

(Unreported, 27

October 1999)

Zanzibar v

British

Aerospace

(Lancaster

House) Ltd

[2000] 1 WLR

2333

Thomson v T

Lohan (Plant

Hire) Ltd

[1987] 1 WLR 649

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