Chapter 6 - The Regulation of Terms in a Contract (Exclusionary, Limitation and Indemnity clauses)

Chapter 6 – The regulation of the terms of a contract

McKendrick Chapter 11 Pg. 178-187 – Exclusion clauses

Most frequent type of exclusion clauses are those which seek to exclude liability for breach of contract or negligence, or which seek to limit liability to a specific sum.  Another type of clause is an indemnity clause.

Exclusion clauses: defense of definition?

Courts have traditionally seen exclusion clauses as performing a defensive function – a defense to a breach of contract.

The functions of exclusion clauses

1)      Help in the allocation of risk under the contract

2)      Help reduced litigation costs by making clear the division of responsibility between the parties

3)      Used in standard forms and contracts which reduce the cost of negotiations and of making contracts

Although the benefits, exclusion clauses benefit the strong in favor of the weak, which explains the restrictive approach the courts have adopted in treatment of exclusion clasuses

An outline of the law

A contracting party that wishes to include an exclusion clause must overcome 3 hurdles:

1)      The exclusion clause must be properly incorporated

2)      The exclusion clause, properly interpreted, must cover the loss which has arisen

3)      There must be no other rule of law which would invalidate the exclusion clause

Historically courts relied on extensively on 1 and 2, since the courts did not have the power to hold exclusion clauses invalid because they were unreasonable.  Hence, they sight to achieve such a goal by the indirect means of adopting a restrictive approach towards their incorporation and interpretation.

Now since the adoption of the statutory powers of the Unfair Contract Terms Act 1977 (UCTA), the courts rely more on 3.

Incorporation

At the first stage it must be shown that the exclusion clause was validly incorporated into the contract.

McKendrick Chapter 9 Pg. 149-155  Sources of contractual terms

Bound by your signature?

·         L’Estrange v Graoucob [1934] – A person is bound by a document which he signs, whether he reads it or not, or understands it or not.  This rule does not hold if the signature has been procured by fraud or misrepresentation, or where the defense of non es factum has been made. The trend in England is towards the ruling of L’Estrange

·         Non es factum – “This is not my deed”. It renders a deed void so a third party cannot obtain good title under it.  Applies in only 3 narrow conditions:

1)      It extends to those who are permanently or temporarily unable though no fault of their own to have without explanation any real understanding or purport of a particular document whether that be from defective education, illness or innate incapacity.

2)      The difference between the document as it is and as it was believed to be must be radical or substantial or fundamental

3)      The defense is not available where there was carelessness by the party signing the document

·         Grogan v Robin Meredith Plant Hire [1996] – A clause in a separate document may be incorporated if it has contractual effect, even if not signed. If not, then even a signature does not matter.

·         Tilden Rent-a-Car Co v Clendenning (1978) Ontario Court of Appeal – A signature can only be relied upon as evidence of genuine consent when it was reasonable for the party relying on the singed document to believe that the signer did assent to the onerous terms posted.

Incorporation of written terms

There is a restrictive approach to incorporation, particularly to exclusion clauses.

Three hurdles must be overcome before such terms can be incorporated:

1)      Notice of the terms must be given at or before the time of concluding the contract. Essential to conclude the precise moment at which the contract was concluded. Olley v Marlborough Court - hotel check in case.

2)      The terms must be contained or referred to in a document which was intended to have contractual effect. Chapleton v Barry ­– deck chair rental case

3)      Reasonable steps must be taken to bring the terms to the attention of the other party.  Parker v South Eastern Railway - £10 limitation jacket case.  Also Denning’s “red had rule”

·         Interfoto Picture Library v Stiletto Visual Programmes – Held that a party which seeks to incorporate into a contract a term which is particularly onerous or unusual must prove that the term has been fairly and reasonably drawn to the attention of the other party.

Incorporation by a course of dealing

Terms may be incorporated by a course of dealing which is both regular and consistent.

Chapter 11

Construction of exclusion clauses

At the second stage it must be shown that the exclusion clause, properly interpreted or constructed, covers the loss that has arisen.

Exclusion clauses have been interpreted more rigorously or restrictively, under which the exclusion clause is interpreted strictly against the party seeking to rely on it, which led to the following rule:

Contra Proferentem rule – any ambiguity in the exclusion clause is resolved against the party seeking to rely on it.  Wallis, Son and Wells v Pratt and Haynes [1911]; Andrews Bros v Singer and Co [1934]; Houghton v Trafalgar Insurance Co [1954]

Ailsa Craig Fishing Co Ltd v Malvern Fishing Co Ltd [1983] – The house of Lords held that in the case of limitation clauses, the contra proferentem rule did not apply with the same rigor as in the case of exclusion clauses.

Some support for a more clement approach can be found in some English cases, namely Photo Production Ltd v Securicor Transport Ltd [1980]; Bank of Credit and Commerce International SA v Ali [2001].  It should be noted that the existence of the contra proferentem rule was not doubted in these cases; the court was saying that it will operate only in cases of genuine ambiguity and that future exclusion clauses should be given a more natural construction.

However, there are 2 situations in which particular rules of construction are employed by the courts:

1)      Where one party seeks to exclude liability for his own negligence

2)      Where he seeks to exclude liability for a ‘fundamental breach’

Negligence liability

The courts regard it inherently unlikely that one party will agree to allow the contracting party to exclude liability for his own negligence. To give effect to this, the courts have evolved 3 specific rules of constriction, which emanate from the Canadian Steamship Lines v The King [1952] case:

1)      If the clause must contain language which expressly exempts the party relying the clause.  This test must be fulfilled by using a word which is synonym for negligence, such as ‘any act, omission, neglect or default’.  Preferably the use of the word ‘negligence’ directly.

If rule number 1 is not satisfied, then rule 2 and 3 must act together – they serve as a double hurdle.

2)      The court must consider whether the words are wide enough in their ordinary meaning to cover negligence on the part of the party relying on the exclusion clause. Examples are ‘any act or omission’ or ‘any damage whatsoever’.  If a doubt arises as to whether the words are wide enough, the doubt must be resolved against the party relying on the clause.

3)      Once the second rule has been satisfied, the court must consider whether the exclusion clause may cover some kind of liability other than negligence.  If there is, then the clause will generally be confined to its application to that alternative source of liability and will be held not to extend to negligently inflicted loss.  In The Raphael [1982] it was held that if the alternative source of liability was ‘fanciful or remote’ it would not prevent the exclusion clause covering liability in negligence.

The essence of these rules is that the court is looking for specificity in exclusion clauses from negligence.

Fundamental Breach

The second situation in which the courts have evolved specific rules of interpretation is where the breach of contract by the party relying on the exclusion clause is of a fundamental nature. 2 distinct approaches have been adopted:

1)      The rule of law approach, under which it was not possible under a clause to exclude liability for certain breaches of contract which were deemed to be fundamental – this has been discarded

2)      The rule of construction approach – the question whether an exclusion clause covered a fundamental breach was a question of construction, under which the clause was interpreted against the party seeking to rely on it.  The more serious the breach, or the consequences of the breach, the less likely it is that the court will interpret the exclusion clause as applying to the breach, unless the language is clear and specific in its effect.

Other common law controls upon exclusion clauses

1)      A party cannot rely on an exclusion clause, the effect of which he as misrepresented to the other party. Curtis v Chemical Cleaning and Dyeing Co [1951]

2)      An exclusion clause which is contained in a written document can be overridden by an express inconsistent undertaking given at or before the time of contracting. Couchman v Hill [1947]

The courts have no power to strike down an exclusionary clause because it is unreasonable.

The Unfair Contract Terms Act 1977 (UCTA)

The basic intention of the act is to regulate the use of exclusionary contract terms.

Parliament must define what constitutes an exclusion or a limitation clause and the courts must in tern interpret that definition. The focus is therefore upon the form of the exclusion clause rather than upon the substance of the contract taken as a whole.

If the clause falls within the scope of the act, then it will be subjected to the reasonableness test (unless it’s declared by the act to be void).

Negligence liability

The first issue which the Act deals with are attempts to exclude or restrict liability for negligently inflected loss.

1)      It only applies to ‘negligence’.  It does not apply to attempts to exclude or restrict liability which is strict (liability which arises irrespective of fault). It is applicable if the act was inadvertent, intentional, directly or vicariously.

2)      It is confined to ‘business liability’

3)      It is not confined just to contracts, it also extends to non-contractual notices which purport to exclude or restrict liability for negligence.

4)      2(1) voids any term which attempts to exclude or restrict liability for negligence causing death or personal injury.  2(2) exclusions for damages other than death or personal injury are only valid if they satisfy the requirement of reasonableness.

5)      ‘Jurisdictional’ issues - Section 2 is drafted in defensive terms, it assumes there has been a breach of duty, and does not appear to extend to clauses which define the obligations of the parties.

a.       Phillips Products Ltd v Hyland and Hamstead Plant Hire Co Ltd [1987] – Excavator hits wall, using defendant’s equipment and driver.  Condition 8 of the contract stated that the defendant’s driver should be regarded as the claimant’s employee, and the claimant should be responsible for all claims arising in connection to negligence owing to the driver. The defendant’s were held guilty, in part using section 13(1) of the Act which extends the scope of section 2(1) to encompass ‘terms and notices which exclude or restrict the relevant obligation or duty’.

b.      The problem with 13(1) is the extent to which it applies to duty-defining clauses. As can be seen in the below examples.

c.       Thompson v T Lohan (Plant Hire) Ltd [1987] – Same scenario as above, but the driver’s negligence caused the death of Mr. Thompson. The widow recovered damages from the general employers who then sought to recover an indemnity from the hiring employers under Condition 8 (above). The hiring employers tried to use section 2(1) of the act to bar Condition 8 (as above), but it was held that Condition 8 was not caught by section 2(1), and so, it was effective in transferring liability to the hiring employers.

d.      The vital distinction between these two cases is whether it sought to exclude liability towards the victim of the negligent act.

                                                               i.      In Thompson, Condition 8 did not attempt to exclude liability towards the victim of the driver’s negligence, the issue was whether the liability could be transferred from the general employers to the hiring employers.

                                                             ii.      In Phillips, Condition 8 was relied upon in an effort to exclude liability towards the victim of the driver’s negligence.

e.       Scottish Special Housing Association v Wimpey Construction UK Ltd [1986]- ‘Form or Substance’ debate – should the court look at the form of the clause or the substance of the clause.  If the ‘form’ is looked at in the case, it is an insurance clause, leaving it outside of the Act.  If the ‘substance’ is looked it, it’s an exclusionary clause, which means it falls within the scope of the Act.

Liability for breach of contract

Section 3 of the Act regulates clauses which seek to exclude or restrict liability for breach of contract. This section only applies to two types of contracts:

1)      Where one party ‘deals as a consumer’.  Note that when a contract is made ‘in the course of’ a business, it is only done so where it is integral to the business or forms part of its regular course of dealings.

2)      Where one party ‘deals… on the other’s written standard terms of business’.

a.      ‘Standard’ – stated in Chester Grosvenor Hotel Co Ltd v Alfred McAlpine Management Ltd (1991).  The question is ‘one of fact and degree’.  The greater the negotiation of important terms of the contract, the more likely it is that the contract will fall outside the scope of section 3.

b.      ‘Deals’ – Held that it means “makes a deal”, irrespective of any negotiations that may have preceded it.  Negotiations over standard terms do not take it out of section 3 provided that the contract in the end is entered on those standard terms.

c.       ‘Other’s’ – Based on British Fermentation Products Ltd v Compare Reavell Ltd [1999], the terms must be those of the defendants’ and not that of Model Forms of contracts.

Section 3(2)(a) – the party relying on the exclusion term, cannot by reference to any contract term ‘when himself in breach of contract, exclude or restrict any liability of his in respect of the breach except in so far as the contract term satisfies the requirement of reasonableness’.  Liability means ‘business liability’.  This section is cast in defensive terms since it assumes the existence of a breach.  Section 13(1) is not available to apply to duty-defining clauses for Section 3.  Duty-defining terms are caught by Section 3(2)(b).

Section 3(2)(b) is in regards to situations other than a breach of contract, because if there was a breach of contract, it would be caught by 3(2)(a).  How can ‘reasonable expectations’ [found in 3(2)(b)(i)] be identified?

1)      Timeload Ltd v British Telecommunications plc [1995]

2)      Peninsula Business Services Ltd v Sweeney [2004] – the clause ‘simply defined the limits’ of the claimant’s rights and did not purport to ‘cut down or restrict his rights in any way’. Limited 3(2)(b).  It is suggested that the approach in Peninsula is the preferable approach and that a court ought to attach considerable weight to the terms of the contract when identifying the reasonable expectations of the parties unless it can be demonstrated that the party relying on the contract was unaware of the term of the contract and could not reasonably be expected to have been familiar with it.

In contracts for the sale or hire-purchase of goods, the implied terms as to title cannot be excluded or restricted by reference to any contract term (s.6(1))

The seller’s implied undertakings as to the conformity of goods with the description or sample, or as to their quality or fitness for a particular purpose, cannot be excluded or restricted by reference to any contract terms as against a person dealing as consumer, although as against a party dealing otherwise than a consumer the latter liabilities can be excluded or restricted by reference to a contract term provided by the term satisfies the requirement of reasonableness (ss.6(2),(3)).

1)      All attempts to exclude or restrict these implied terms are caught by UCTA, nto simply those which seek to exclude or restrict a business liability under section 1(3)(2.6(4))

2)      The Act directs the courts to have regard to specific matters in considering whether such a term is reasonable (s.11(3)) and Schedule 2).

Indemnity Clauses

An indemnity clause is a clause under which one contracting party promises to indemnify (reimburse) the other for any liability incurred by him in the performance of the contract.

1)      Section 4(1) states that any persona dealing as consumer cannot be required, as a term of the contract, to indemnify another in respect of liability that may be incurred by that other for negligence or breach of contract, except to the extent that the term satisfies the requirement of reasonableness.  Applies only where the party required to give the indemnity deals as a consumer

2)      No application to commercial indemnity clauses such as in Phillips v Hyland and Thompson v Lohan (above), which is why it was necessary to invoke Section 2

Attempts at evasion

The act contains a number of controls upon attempts to evade the application of the Act. Two are worthy of note:

1)      Section 13(1).  This subsection does not have independent effect: its function is to extend the scope of Section 2 and 5-7.  Section 13(1) is open to criticism in that it fails to provide any guidance as to the extent to which it applies to duty-defining clauses (see above).

2)      Section 10, which states that a term excluding or restricting liability, which is contained in a separate contract rather than in the contract giving rise to the liability, is ineffective in so far as it attempts to take away a right to enforce a liability which under the act cannot be excluded or restricted.

The reasonableness test

Reasonableness is to be assessed at the date of making the contract, not the date of breach. The onus lies on the party relying on the exclusion clause to show that it is reasonable (s.11(5)). 

The question of the reasonableness of a particular clause is a highly discretionary one and the courts have not been wholly consistent in the exercise of their discretion.

There are a number of points which can be advanced with a degree of certainty:

1)      The court must ascertain the meaning of a clause before deciding whether or not it passes the reasonableness test.

a.       A wide interpretation may incline a court towards the conclusion that the clause is unreasonable

b.      A narrower interpretation may lead it to conclude that the clause is reasonable

2)      The court will have regard to the clause as a whole in deciding whether or not it is reasonable: the court does not have regard only to that part of the clause which is being relied upon by the party seeking to exclude or restrict liability.

3)      The court does not have the power to sever the unreasonable parts of an exclusion clause from the reasonable parts, leaving the later in force.

a.       It is unwise to rely upon a single all embracing exclusion clause.  It is much safer to separate out the different elements of the clause into sub-clause so that a failure of one part will not necessarily invalidate the entire clause.

b.      The courts are willing to make use of severance where a lengthy contractual term is capable of being broken down and considered in its constituent elements, at least in the case where the different parts of the clause are held to be ‘independent’ of one another, or where ‘the different parts are performing different functions’.

4)      The importance of equality of bargaining power: the greater the equality of the bargaining power of the parties, the more likely it is that the clause will pass the reasonableness test.

5)      The insurance consequences of the clause should always be brought before the court (the availability of insurance at the time which the contract was concluded).  The fact that the defendant has chosen to insure itself for a sum substantially in excess of the limitation clause in the contract does not itself establish that the limitation clause is unreasonable.

6)      Contracting parties should abandon widely drafted exclusion clauses, especially those which undermine the express promises which have been made under the contract.

7)      The way in which the clause is enforced in practice.  The fact that the defendant has not always enforced the clause in practice does not mean that the clause is inevitably unreasonable.  The position is otherwise where there is recognition in the industry that reliance on the clause is unreasonable.  A court is likely to infer from the fact that the clause was not enforced in practice was because the clause was unreasonable.

8)      It is not advisable to include two very different types of loss within the same limitation clause.

9)      The advantages which can be obtained by the use of limitation clauses rather than exclusion clauses. Limitation clauses are more likely to succeed than exclusion clauses.  An attempt should be made to provide some objective justification for the selection of the figure of limitation.  A failure to adduce such evidence might incline a court towards the conclusion that the clause is unreasonable.

Excepted contracts

The act does not apply to certain contracts, such as contracts for insurance and contracts which concern the transfer of an interest in land.  Section 26 provides that the limits imposed by the Act on the extent to which a person may exclude or restricts liability by reference to a contract term do not apply to liability arising under an international supply contract, nor are the terms of such a contract subject to the reasonableness requirement under section 3 or 4.  International supply contract is defined as a contract for the sale of goods where possession or ownership passes and is made by parties whose place of business are in the territories of different states. One of the following conditions must be satisfied:

1)      The goods, at the time of conclusion of the contract, are in the course of carriage, or will be carried from the territory of one state to the territory of another

2)      The act of offer and acceptance have been done in different states

3)      The contract provides that the goods will be delivered to a different state than where the goods originated.

In section 26(4)(c) the goods must be delivered ‘to’ that country.  The goods must have been delivered from a country which was outside that territory. The phrase ‘made by the parties’ in section 26(3) is a reference to the principals to the contract in question and not to the agents.

Section 27(1) states that, where the law applicable to a contract is the law of any part of the UK only by choice of the parties, sections 2-7 of the Act do not operate as part of the law applicable to the contract.  27(2) states that the controls contained in the Act cannot be evaded by the choice of a law outside the UK as the governing law if it appears that the choice of law was imposed wholly or mainly to enable the party imposing it to evade the operation of the Act of where one of the parties deals as a consumer, was then habitually resident in the UK and the essential steps for making of the contract were made in the UK.

Chapter 17.6

The Unfair Terms in Consumer Contracts Regulations 1999

The Regulations are not confined to any particular type of terms, such as the UCTA which is confined essentially to exclusion, limitation and indemnity clauses.

The Regulations emanate from the EC Directives.  This is important for the following 2 reasons:

1)      The drafting of the Directive itself is not a model of clarity

2)      The European Court of Justice adopts a much more purposive or teleological approach to interpretation

London Borough of Newham v Khatun [2004] concluded that the Directive and the Regulations do not apply to contracts relating to land.

The aim of the Directive and the Regulations is to regulate unfair terms in contracts concluded between a seller or supplier and a consumer.

The core of the Regulations is found in the definition of   ‘unfair term’, which has been negotiated in an adhesion contract (a term which has not been ‘individually negotiated’), as contained in Regulation 5(1).  To fall into the Regulations, there must be several requirements:

1)      ‘Individually negotiated’:  A term in the contract must not have been ‘individually negotiated’.  A term has not been individually negotiated ‘where it has been drafted in advance and the consumer has therefore not been able to influence the substance of the term’ (Regulation 5(2)).  Even if several parts of a contract have been individually negotiated, the Regulations can still apply to parts that have not been negotiated.  The burden of proof is on the seller of supplier to show that the term has been individually negotiated.

2)      ‘Unfair term’:  Schedule 2 provides an ‘indicative and illustrative list of the terms which may be regarded as unfair’, with an emphasis on ‘may’ – this is a grey list not a black list.
No assessment must be made of fairness of any ‘core term’ or the ‘essential bargain’ which the parties have made, insofar as these terms are in ‘plain, intelligible language’.  A ‘core term’:

a.       Defines the main subject matter of the contract

b.      Concerns the adequacy of the price or remuneration, as against the goods or services supplied in exchange

The ‘essential bargain’ test is a narrow & restrictive one, is a matter of fact, and will operate to exclude from the fairness test only those terms which ‘can genuinely be viewed as representing the consensus between the parties and thus a genuine reflection of freedom of contract’.

The leading decision on this is General of Fair Trading v. First National Bank [2001]

When a term is held to be unfair, the consequence is that it ‘shall not be binding on the consumer’ but ‘the contract shall continue to bind the parties if it is capable of continuing in existence without the unfair term’.  If there is any doubt about the meaning of a written term, the interpretation most favorable to the consumer shall prevail – similar to the contra proferentem  rule.

3)      ‘Good faith’:  Although this was included in the 1994 Regulations, it was struck out of the 1999 Regulations, but is still in effect through Regulation 6(1), which states that the unfairness of a contract term shall be assessed ‘taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent’.  It can be viewed as a subsection of ‘unfair term’

Munkenbeck & Marshall v. Harold [2005]; Bryen & Langley Ltd v. Boston [2005]

a.       The identity of the party putting forward the term is of considerable significance.

b.      When the term is put forward by the consumer, or the consumers professional advisers, the term is extremely unlikely to be unfair

c.       When the term is put forward by the contractor, the term may be held to be unfair.  The contractor must be prepared to assume the burden of providing the fairness of the term, and show that the term has been brought to the attention of the consumer and the consumer has understood its implications.

Unfair term is defined using two phrases:

1)      ‘Good faith’: Not a standard generally employed in English contract law, but was expressed clearly in General of Fair Trading v. First National Bank [2001]

2)      ‘Significant imbalance’ – leans more towards substantive imbalance than procedural imbalance. In General of Fair Trading v. First National Bank [2001] it was decided that procedural imbalance cannot stand alone, and it can only be found to be ‘unfair’ when it leads to substantive imbalance.

The consumer will have to show both an absence of good faith and significant imbalance before a court will conclude that a term is ‘unfair’.

The Regulations are confined in their scope to consumer contracts, and are kept out of the commercial sphere.

The Regulations are enforced by the Director General of Fair Trading, who can seek an injunction against any person appearing to him to be using or recommending use of an unfair term in contracts concluded with consumers, and can also take them to court.