Restrict Financial Liability to a Specific Sum

Explain the meaning and significance of the provision in Section 11 Sub-section 4 that deals with a contract term seeking to restrict financial liability to a specific sum. How useful are the guidelines for applying the reasonableness test in Schedule 2? (4) Where by reference to a contract term or notice a person seeks to restrict liability to a specified sum of money, and the question arises (under this or any other Act) whether the term or notice satisfies the requirement of reasonableness, regard shall be had in particular (but without prejudice to subsection (2) above in the case of contract terms) to- (a) the resources which he could expect to be available to him for the purpose of meeting the liability should it arise; and (b)how far it was open to him to cover himself by insurance. As has been indicated, clauses excluding or restricting liability will frequently be ineffective under the Unfair Contract Terms Act 1977 unless they satisfy the requirement of reasonableness. It is for the party seeking to rely upon the exemption clause to establish that it is reasonable (section 11(5)) and the assessment is made against the time frame of the making of the contract. Under section 11(1) the term must have been a fair and reasonable one to have included in the contract having regard to all the circumstances which were or ought reasonably have been known to, or in the contemplation of the parties when the contract was made. The actual breach is not relevant to the reasonableness of an exemption clause, merely potential breaches within the reasonable contemplation of the parties when they contracted[5]. There are guidelines in schedule 2. For historical reasons, they are only relevant by ‘legislative prescription’ when the requirement of reasonableness is applied by sections 6 or 7, but they are a list of factors which the courts have recognised to be generally factually relevant to the requirement of reasonableness, under whichever section it is applied[6]. There is also further specific guidance as to the treatment of clauses which limit liability in section 11(4). In relation to such clauses, regard is to be had to the resources available to the proferens to meet potential liability and how far it was open to that party to obtain insurance cover. In general, the courts have indicated the relevance of considering the insurance situation eg whether the exemption clause placed the risk of some problem with performance on the person best able to insure and whether the allocation of the need to insure was reflected in the contract price[7]. Also, in Smith v Bush (1990 p.858), Lord Griffiths set out a list of four factors he regarded as generally relevant to the requirement of reasonableness – the relative bargaining power of the parties; availability of an alternative source of supply of the contract performance; the nature of the task being undertaken by the proferens (one with a high degree of risk more readily justifying an exemption clause); the practical consequences of the decision on reasonableness, having regard to the sums of money potentially at stake; the ability of the parties to bear the losses involved and the availability of insurance to meet such losses.

However, despite these statements as to generally relevant factors, the limited nature of the role of the appellant court in this context should be noted. Recognising that the type of weighing of factors which is required in applying the requirement of reasonableness means that there is scope for a ‘legitimate difference of opinion as to what the answer should be’, the House of Lords has indicated that ‘the appellate court should treat the original decision with the utmost respect and refrain from interference with it unless satisfied it proceeded upon some erroneous principle or was plainly and obviously wrong’ (George Mitchell Ltd. v. Finney Lock Seeds Ltd. (1983 ), Lord Bridge at 816). Decisions on the requirement of reasonableness provide only limited guidance. The first of the specific cases to consider here is The Salvage Assn v. CAP Financial Services Ltd. (1995) which was concerned with two contracts for the design, development and supply of computer accounting software for the plaintiff marine surveying company. After two years the system was not complete and had numerous problems. The plaintiff terminated the second contract (the first being over) and sued the defendant for the contract price (GBP 300,000) and wasted expenditure (GBP 500,000). Inter alia, and the relevant point to be considered here, the defendants sought to rely upon clauses limiting their liability to GBP 25,000 under each contract. Under sections 2(2) and 3 of the 1977 Act, the question arose as to whether the limitation clauses satisfied the requirement of reasonableness. The judge

[8] took the view that (at 676) ‘Generally speaking where a party well able to look after itself enters into a commercial contract and, with full knowledge of all relevant circumstances willingly accepts the terms of the transaction, I think it is very likely that those terms will be held to be fair and reasonable.’ In the particular case, the parties were viewed as being of equal bargaining power and the contract terms as considered and negotiated over a period of time.

Had matters rested there the judge would have accepted that the defendants had established the reasonableness of the limitation clauses. However, there were additional factors to consider. In particular, the defendants had not justified the level of the limitation – it bore no relationship to the value of the contract, to the defendant’s turnover, to the level of the defendant’s insurance cover, or to the financial risk to the plaintiff.

Even more particularly, the GBP 25,000 limit was one which the defendants themselves regarded as inappropriate by the time the contracts with the plaintiffs were made (the new limit decided on was GBP 1,000,000). The judge seems to have viewed this last factor as particularly damning of the defendant’s claim that their limitation clause was reasonable, and that might seem to be self evident. However, the test of reasonableness in s11 must be borne in mind – it refers 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’ (emphasis added). The defendant’s views as to the appropriate level of limitation were obviously known to themselves but it is difficult to see how they could have been within the reasonable contemplation of the plaintiffs. Similarly, the judge considered the actual levels of the defendant’s insurance cover (GBP 5,000,000 with an excess of GBP 500,000) and again that would seem to be outside the plaintiff’s reasonable contemplation. In Flamar Interocean Ltd. v. Denmac Ltd. (1990), Potter J. made it clear that unless parties have discussed their actual insurance positions before contracting, section 11(1) only allows for consideration of the insurance that was available at the time of contracting. In the absence of such discussions, it is only the possible insurance arrangements that can have been within the reasonable contemplation of ‘the parties’ (ie both of them) at the time the contract was made. In other words much of what was considered in The Salvage Assn. case in relation to reasonableness was not relevant under the test stated in section 11(1). However, that is not to say that the decision is not justifiable. As has been indicated, under section 11(5) the burden lay on the defendants to establish the reasonableness of their clause and, as was pointed out, they had done nothing to show that the limitation to GBP 25,000 was anything other than arbitrary. In addition, whilst the specifics of the defendant’s own view of the limit and its actual insurance position were not relevant, their position more generally (eg size of the company) and the availability of insurance to them clearly were, and might be seen as indicating that the limit was not reasonable. The general point to be made is that the basis of the level of limitation in a clause restricting liability will have to be justifiable if the clause is to be found to be reasonable. The second case specifically to be considered here is St Alban’s City and District Council v. International Computers Ltd. (1995). That case arose because of the Council’s decision to install its own computer with appropriate software to deal with the implementation of the Community Charge and with the Council’s finances in general.

After taking expert advice on tenders, the Council contracted with the defendants, ICL. However, the program proved to be defective and it produced an overstatement, by about 3,000, of the population figure for the Council’s area and that led the council to claim a loss of something in excess of GBP 1.3m. The question was whether this was recoverable from ICL. Scott Baker J found a clear breach by ICL of an express term that ICL would provide software which was reasonably fit for the Council’s purpose of maintaining and retrieving a reliable register of the local community. ICL claimed to rely on clause 9(c) of their contract to limit their liability to GBP 100,000. Scott Baker J found that clause was rendered ineffective by the Unfair Contract Terms Act 1977 as ICL could not establish that it satisfied the requirement of reasonableness which was applied under section 3, inter alia. It is that conclusion which must be considered here. On appeal (St Alban’s City and District Council v. International Computers Ltd (1996)), the Court of Appeal reduced the damages payable by the defendants for reasons unconnected with the limitation clause. In relation to the application of the reasonableness test, there was reference to the limited intervention approach to be taken to appeals and the Court left that part of the decision untouched. Nourse L.J. did add that he believed ‘he would have given the same answer’ himself (at 492)). One point which should be emphasised is that ICL had mistakenly used an earlier version of their standard terms in contracting and the version current at the time of the contract with the Council limited liability to GBP 125,000, rather than GBP 100,000. This, in itself, would seem to have made it very difficult for ICL to argue that the clause was a fair and reasonable one to have included in the contract – as the higher limit was part of the standard terms ICL were then using, it could have been within the parties’ reasonable contemplation. However, whilst that error on ICL’s part must not be lost sight of, what is of more interest is the judge’s general approach to the reasonableness test. He concluded that there were four determining factors showing that the clause was unreasonable. Firstly, he referred to the parties’ unequal bargaining power. However, whilst the Council might not have been able to contract without the clause, it was in a very different situation to that of the average consumer. It had legal advisers amongst its employees, for example.

Secondly, Scott Baker J emphasised that the defendants had not justified the figure of GBP 100,000 which he regarded as small, both in relation to the potential risk and the absolute loss. Of course, against the background of their use of the wrong version of their standard terms, justifying the precise sum would have been virtually impossible for ICL, but, as has already been indicated, it would seem that in general the level of a limitation will have to be justifiable. The third point made by Scott Baker J was that ICL were well covered by insurance (an aggregate of GBP 50m worldwide) and finally, he looked at the practical consequences of the clause being effective or ineffective. He thought it more appropriate for the loss to be borne by a well insured large company than by the community charge payers of St. Albans. Again the point made above as to consideration of the parties’ actual insurance position should be remembered, but the type of cover available could be within the parties’ reasonable contemplation In addition, Scott Baker J summarised the factors which pointed to a finding that the clause was reasonable. They were ‘that bodies such as computer companies and local authorities should be free to make their own bargain, that the companies contracted with their eyes open, that limitations of this kind are commonplace in the computer industry and that [the software package] was an area of developing technology’. As has been indicated, he considered those latter factors to be outweighed by those indicating the unreasonableness of the clause and, of course, the burden of proof was on ICL to establish the reasonableness of the clause.

That weighing exercise should be considered further. In deciding that the clause was unreasonable the judge placed great emphasis on the size of the company and its insurance. However, it is usual to relate the question of insurance cover to the contract price. Was it clear that, given the risks involved in developing software, that increased liability would not have involved increased insurance costs for ICL and an increased contract price? The need to inquire into such a relationship should be emphasised. Of course, even if a defendant would have had to increase insurance cover, and costs, to increase the limit on their liability, that is not necessarily determinative of the question of reasonableness. In Smith v. Bush, (1990), the fact that surveyors would have had to increase their insurance, and charge their customers more if a disclaimer of liability was ineffective did not render the disclaimer reasonable. The practical consequences of the disclaimer being effective were such that it was regarded as unreasonable and in the St Alban’s case Scott Baker J emphasised the practical consequences of the limitation clause being effective and loss falling on the local population rather than on an ‘international computer company’. However, the appropriateness of an analogy between the situation of the consumer in Smith v. Bush and the Council in the instant case must be questioned. In Smith v. Bush Lord Griffiths noted that the surveyors were insured and said (at 858) ‘Bearing the loss will be unlikely to cause significant hardship if it has to be borne by the surveyor but it is on the other hand quite possible that it will be a financial catastrophe for the purchaser who may be left with a valueless house and no money to buy another’. The possibility of financial disaster for the individual in Smith v. Bush seems to be very different to the situation of the Council in the St Alban’s case even when it is emphasised that the burden would eventually fall on the individuals within the Council’s area. In the consumer context, exemptions are unlikely to satisfy the requirement of reasonableness and may also be subject to the test of fairness under the 1994 Regulations[9]. However, in the commercial context, it can be contended that more account needs to be taken of the special nature of software problems. In Smith v. Bush Lord Griffiths indicated that a high degree of risk in the contract performance might indicate the reasonableness of an exemption. This should be considered in the light of the difficulties in eliminating bugs from software which has been explained by analogy with chaos theory. It has been said (Lloyd and Simpson ( 1994) at 79-80) ‘It is impossible to test even the simplest program in an exhaustive fashion.

This is because of the myriad possibilities for interaction (whether desired or not) between the various elements of the program … [Chaos theory] suggests that every event influences every other event; that the beating of a butterfly’s wings has an impact upon the development of a hurricane … The theory’s hypothesis is reality in a software context. Although software can and should be tested, it has to be accepted that every piece of software will contain errors which may not materialise until a particular and perhaps unrepeatable set of circumstances occurs’. Of course, these difficulties may impact upon the content of the contractual performance in itself (eg affecting what will be required for goods to be of satisfactory quality under section 14(2) of the Sale of Goods Act 1979) (see Rowland and Macdonald (1997)), but nevertheless they should be acknowledged in relation to the question of the reasonableness of at least some exemptions. In addition, whilst a high level of insurance may be available to some suppliers, and against that background a limitation may appear to be low, before any such conclusion is reached consideration should be given to another special feature of a breach involving a software bug.

The point has been made by Lloyd (1997, at 455) ‘if one copy of a software product exhibits defects it may be extremely likely that all products will be so tainted. With manufactured products generally, most defects are introduced at the production stage and affect only a portion of the products in question. A finding that one copy of a software package is [not of satisfactory quality] might, by way of contrast, leave its producer liable to every purchaser.’ This should be relevant when levels of insurance cover are considered in addressing the reasonableness of a limitation clause.

Cite this page