With shortages and supply chains under pressure, it has never been more important for terms of trading to be both well set out and robust.
A sensibly drafted contract will, as a rule, impose certain rights and obligations on the parties and should contain provisions in respect of consequences of potential breaches of the contract.
What follows is a summary both in terms of enforcing a breach and limiting liability for one.
Breaches and remedies
Any breach of contract will usually occur where one party has failed to fulfil an obligation under the contract. However, there are 2 key kinds of breach to bear in mind, they are:
- Material breaches (i.e. ones which go to the heart of the contract) may be treated as repudiatory breaches by the innocent party. This means that the innocent party can terminate the contract and sue the breaching party for damages; or
- Immaterial breaches may entitle the innocent party to claim damages but will not entitle them to terminate the contract.
So what remedies are available to the innocent party? These tend to be either available at law or under the contract and the main ones include:-
- Termination – the innocent party may wish to consider bringing the contract to an end. NB this is be considered carefully, to avoid a situation where the party in breach asserts wrongful termination.
- Damages – these are intended to compensate the innocent party and restore them to the position that they would be in but for the breach and must be provable, in terms of showing a connection between the breach of contract and the loss suffered.
- Liquidated Damages – this can occur in a contract whereby parties agree to a fixed sum or formula for calculation of damages in the event of a breach and can remove the uncertainty that arises if a court is required to determine the value of damages. Care needs to be taken when drafting a liquidated damages provision to ensure it does not fall foul of the common law rule against penalties, because penalties are unenforceable. Under English law, damages are supposed to be compensatory and a clause that seeks to impose an excessive or unconscionable payment for breach of an obligation may be challenged as a penalty. Some important issues to consider when assessing penalties under English law are:
- The trigger for the liquidated damages payment must be a breach of contract for the rule against penalties to apply. If the clause is drafted so as to avoid linking the payment to a breach, it cannot be challenged as a penalty. To give 2 examples, a contract could be drafted so that if one party terminates before the expiry of a fixed term, this would be deemed to be a breach of contract and a fixed sum must be paid by the contract-breaker, linking the payment to a breach of the fixed-term commitment.
However, if a clause is drafted so that one party has an option to terminate the contract (and if that party wishes to exercise that option, the contract-breaker will pay an exit fee), this type of option cannot be assessed as a penalty because the payment it is not linked to a breach, but merely linked to a contractual option to terminate early.
- English courts do as a rule allow a fairly generous margin when assessing if a clause could be a penalty and are reluctant to strike out a clause in a negotiated commercial contract between parties of equal bargaining power.
There are, of course, other considerations to bear in mind where non-performance is due to circumstances beyond a party’s control, for example if the contract has been frustrated or any force majeure provisions within the contract (dealt with in an earlier update).
Limiting liability and losses
Somewhat unsurprisingly, limitations and exclusion of liability are usually the most heavily negotiated and contentious clauses in a contract.
Commercially, the supplier is looking to control its liability and the buyer will want the supplier to have unlimited liability if possible.
The starting point is statute and more particularly the Unfair Contract Terms Act 1977 (UCTA), which confirms that, in a business to business contract, a party can never exclude its liability for:
- death or personal injury caused by its negligence; and
- the implied term as to title and quiet possession in section 12 of the Sale of Goods Act 1979 or section 2 of the Supply of Goods and Services Act 1982.
Do please note though that any other damage caused by negligence is subject to the reasonableness test in the UCTA plus that for public policy reasons, a party can never exclude or limit its liability for losses arising as a result of fraud.
A key area that suppliers nearly always seek to exclude are liabilities that are deemed too remote.
At English law, there are 2 types of losses:
- Direct loss is loss that directly flows from the breach and arises as a natural result of the breach.
- Indirect (or consequential loss) is loss that is more remote but can be recovered if the loss was reasonably in the contemplation of the parties at the time they made the contract as the probable result of the breach.
Suppliers will as a rule generally seek to exclude their liability for indirect loss and it is important to be aware that common types of financial loss such as loss of profit can be either direct or indirect loss depending on the facts of a case.
Any such financial loss exclusion or limitation will be subject to the reasonableness test in the UCTA if excluding or limiting liability for negligence, or liability for breach of implied conditions, or any exclusion of liability when contracting on standard terms.
It is common for suppliers to also seek to place a financial cap on their liability. Any such financial cap will be subject to the reasonableness test in the UCTA if the financial cap applies to liability for negligence, liability for breach of implied conditions or any limitation of liability when contracting on standard terms.
Section 11(4) of the UCTA specifically applies where a party is seeking to restrict its liability to a specified sum of money. When assessing if the financial limitation satisfies the requirement of reasonableness, consideration should be given to the resources of the party seeking to limit liability and how far that party was able to cover itself by insurance.
Another area often contested around liability are indemnities. An indemnity is classified as a debt claim because a party agrees to pay a sum of money when the specific loss occurs. A debt claim is different from a damages claim because the common law rules that apply to damages claims, such as the obligation on a party to mitigate its loss and the requirement that the loss is not too remote, do not apply to debt claims.
Please note that there are no statutory controls on indemnities. However, if the indemnity is drafted in such a way that it enables one party to avoid its liability in damages to the other party then it will be treated as an exclusion or limitation clause and the UCTA will apply.
Conclusions
With some supply chains under pressure, while good communications and being upfront about a delay in delivery, or delivery of fewer products than a party is contractually obliged to supply is the clearly good commercial practice (as mentioned in the last update) will help, having an overview of the basic position at law from both enforcing breach and protecting liability is useful to assess the contract and also to amend/negotiate/create better terms of trading for the future.
Please get in touch if we can help with this.
Regards to all
Roger
