Drafting limitation and exclusion of liability clauses
Once the risks have been identified, a party can then determine its position on liability. Whether a party is drafting the relevant clauses itself, or reviewing what the other side has put forward, careful consideration must be given to those contract provisions which set out the position on what liability is excluded entirely, what liability is limited, and any exceptions to the exclusion and limitation of liability.
As the name suggests, an exclusion clause is be used to completely exclude specific types of liability, such as liability for ‘indirect’ or ‘consequential’ loss, which we will cover in greater depth later in this release.
Similarly, the limitation of liability clause sets out the ‘cap’ on liability, ie one or both party’s maximum exposure under the contract (subject to any agreed exceptions). The amount of the cap will usually be fixed by reference to a specific dollar amount (eg. $1,000,000) or defined by reference to an objective measure, such as the total contract value, or the total fees paid by the customer over a specific period of time.
It is not unusual in technology contracts for certain types of liability to remain uncapped. Often, liability for breach of confidentiality, or the supplier’s liability for intellectual property infringement claims against the customer arising from its use of the technology supplied, will sit outside of the liability regime, which no limitation and all types of loss recoverable
Excluding indirect and consequential loss
Now, let’s head down the rabbit hole that is excluding liability for ‘indirect’ or ‘consequential’ loss. A party to a technology agreement (typically the supplier) will often want to exclude liability for ‘indirect’ or ‘consequential’ loss, not wanting the risk of taking on open-ended, vague or unlimited types of liability.
So what does ‘indirect’ or ‘consequential’ loss actually mean? To answer that, we have to take into account the evolution of the Australian courts' approach to the interpretation of this type of clause. The traditional approach to defining consequential loss in Australia came from the leading UK case of Hadley v Baxendale (from way back in 1854), which held that damages were not recoverable if too remote. The decision in that case categorised, somewhat arbitrarily, losses into two distinct ‘limbs’:
• "[Losses] such as may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things, from such breach of contract itself" (referred to as the first limb).
• "[Losses] such as may fairly and reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it" (referred to as the second limb).
The traditional approach of the courts to interpretation has been that when parties sought to exclude "consequential loss" in a clause, the parties were referring to the second limb.
However, courts in Australia have departed from the traditional Hadley v Baxendale approach to the concept of "consequential loss" and the position is continuing to evolve. In the Victorian Court of Appeal decision, Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] the court took the approach that the use of the phrase "consequential loss" in the exclusion of liability clause in the contract at issue was intended to have its ordinary and natural meaning. Accordingly, the court drew a new distinction between:
• normal loss, which is loss that every plaintiff in a like situation will suffer, and
• consequential loss, which is anything beyond the normal measure, such as profits lost and expenses incurred through breach.
Under this approach, the concept of "consequential loss" would cover a wider range of types of loss than was the case under the traditional second limb approach. As a result, where a contract excluded liability for "consequential loss", the exclusion was broader and therefore the various type of damages that would be recoverable pursuant to a claim would be reduced.
Subsequently, the Supreme Court of Western Australia, in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356, also rejected the Hadley v Baxendale approach. However, it also failed to endorse the new approach taken in the Peerless case by commenting that Peerless was not intended to essentially rewrite the law on consequential loss and create a new construction principle to apply universally. Consequently, there is still considerable uncertainty about the approach a court will take to interpreting an exclusion of liability clause covering "consequential loss". Most likely, the meaning of "consequential loss" in each new case will be considered by a court as a matter of construction of the relevant contract before it.
So, what is the best way to approach exclusion clauses in light of the relatively recent developments and the ambiguity they create? In short, it is vital that the parties draft clearly and specifically in relation to which types of liability they intend to be recoverable and what liability will be excluded. In other words, list in the relevant clause all the categories of loss or damage that you want to exclude. Typically, this may cover things like loss or profits or anticipated savings, loss of reputation or goodwill, special, punitive or exemplary damages, and even loss of data. Quite often, tagged on to this list at the start or the end will be the words “indirect loss or damages, and consequential loss or damages” which can be considered an each way bet! However, the key takeaway is that any exclusion clause should be drafted so that each individual type of loss which is to be excluded is listed separately from the language that excludes consequential or indirect loss more generally.
Are there any restrictions on what liability can be limited or excluded?
The law has established certain limits on what an exclusion clause can achieve. Many of these are based on a public policy argument.
For example, it would be against public policy to allow contract parties to exclude liability for misleading or deceptive conduct, or for fraud, and any clause which attempts to do so will be void and unenforceable.
In addition, an exclusion clause cannot have the effect of creating a blanket exclusion of liability for breach of all of the party's obligations under the contract, which would effectively render performance of the contract as optional, and would completely undermine the contractual force of the party's primary obligations.
Thirdly, in some cases, a B2B contract for the supply of goods or services can still fall within the scope of the ACL, and a party cannot contract out of liability for certain ACL breaches such as the goods or services not meeting the implied consumer guarantees, and nor can it contract out of the Unfair Contract Terms regime under the ACL.
The importance (and risk!) of indemnities
Indemnities are an important feature of Australian contract law. As with the limitation and exclusion of liability clauses, an indemnity serves as a risk allocation tool, offering reassurance that one party will compensate the other for certain losses or liabilities. A party granting an indemnity is agreeing to make whole the other party if a particular event or circumstance occurs, so an indemnity is essentially an agreement to cover loss and damage suffered by the other party without there being any breach of contract or negligence.
As such, this alters the common law or statutory rights of parties: remoteness principles don’t apply, and there is no obligation to mitigate loss. It is therefore advisable to think long and hard before giving indemnities. Indemnity clauses can be complex and, if not carefully drafted, may have unintended and far-reaching consequences.
An indemnity commonly seen in technology agreements is given by the supplier in favour of the customer, and provides cover for any claim by a third party that the customer’s use of the solution or software provided by the supplier infringes that third party’s intellectual property.
A word of warning – it is by no means unusual for a third party IP infringement indemnity to be an exception to the limitation (and even the exclusion) of liability provisions, meaning that a supplier can face significant exposure if such a claim does arise.
Our experienced Technology Law team can assist customers and vendors or technology solutions with tailored advice and strategies to optimise your position in IT contracting, including in relation to liability.
If you would like any technology law assistance, or have any questions or comments on this release, please contact Technology Special Counsel Nick Martin below.
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