8 May 2008 | Jimmy Desai

Jimmy Desai explains the importance of limitation of liability clauses - and what buyers should watch out for when drafting and negotiating contracts

Limitation of liability clauses aim to cap the amount of money recoverable in the event of a breach of contract.

Suppliers often use these clauses to strike a balance between the money they will receive under a contract and the liability they may be exposed to should something go wrong.

There are two main types of loss that may be covered: direct losses and indirect losses.

When negotiating these clauses suppliers will try to limit their liability for direct losses that result from a breach to a fixed amount, often the contract price. With indirect or consequential losses, which include the knock-on effects of a breach (such as loss of reputation to the buyer), suppliers will generally try to exclude liability for these entirely.

A recent case (Ferryways NV v Associated British Ports) reinforced two main points with regard to limitation of liability clauses. First, it is imperative that contracts clearly set out which liabilities are to be excluded. Second, a party won't be protected from liability for direct losses that flow naturally from a breach by an exclusion of "indirect or consequential" loss. This case concerned liability for the death benefit of a ship's chief officer who was hit and killed by a tugmaster vehicle controlled by Associated British Ports (ABP). It was established that ABP had breached its duty to act with reasonable care and skill under the contract, resulting in the employee's death.

A clause in the stevedoring contract [concerning the loading and unloading of ships] said where ABP was in breach of its obligations it would have no liability to Ferryways for loss suffered of an "indirect or consequential nature" including the liabilities of Ferryways "to any other party". ABP submitted that the death benefit to the next of kin was a liability "to any other party" and therefore excluded by the clause.

However, the judge held that "indirect and consequential" has a well-established meaning in contract law and it would be necessary to use "very clear words indeed" to depart from that meaning. The payment to the next of kin and repatriation expenses were a direct and natural result of ABP's breach of contract and therefore were not excluded by the clause

This decision demonstrates the need for parties to be certain about the extent of their liability when negotiating and drafting supply contracts. The devil is in the detail when it comes to limitation and exclusion clauses. Buyers should examine them carefully, particularly in contracts where a breach could have major consequences, such as IT deals, because the rights of both parties and how much they can claim for a breach of contract will be restricted by these provisions. The definition of indirect losses should not be so broad that it excludes almost all of the types of claim that a buyer could possibly make.

If a buyer has a particular concern about a loss it does not want the supplier to exclude, the buyer should ensure it is classified as a direct loss in the contract. For example, an IT supplier might define loss of data as a consequential loss and try to exclude liability for this but the buyer should have this categorised as a direct loss that it can claim for.

* Jimmy Desai is a partner at Blake Lapthorn Tarlo Lyons