A well-run business must manage the risks that it faces and there are many ways in which this can be done. Contractors protect themselves against the financial consequences of being sued with indemnity insurance. However, there are restrictions on the cover available. Contractors may therefore find themselves underinsured or uninsured in the event of a claim. Consequently, they cannot simply rely on their insurance; they must also actively manage liability through other means.
English common law limits the damages recoverable in the event of a breach of contract to damages which:
"may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things from such breach of contract itself, or such as may 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."(1)
However, when this principle is applied to major projects in the modern era (eg, energy and other revenue-generating projects), it can lead to results which contractors are not prepared to underwrite, as the recoverable losses could be extensive.
Consequently, caps on liability are common in international projects. The first thing to consider is the basis on which the cap applies (eg, in the aggregate or on some other basis, such as a cap per claim arising from the same originating cause, which may reflect insurance cover available to the contractor) and what exclusions should apply. Although liability cannot be excluded or restricted in relation to damages for death or personal injury, parties to a contract can agree to limit any other liability that they may incur to each other, (eg, for breach of contract or negligence). This can be done in a variety of ways. One method – now accepted by many clients – is to agree a figure (ie, a financial cap), beyond which the contractor will not be liable.
Liability Caps
A cap on liability limits the amount of the contractor's liability to its client. The amount of the cap can be expressed as a fixed sum or a percentage of the fee.
Where possible, any proposed cap should be drawn to the attention of the other party to the contract. Preferably, it should be discussed and specifically agreed. If this is done, it is much more difficult for the other party to successfully challenge the cap in court. In the case of a contract of appointment, the contractor should explain to the client how the cap will operate and how it is calculated.
Where repeat work is undertaken for the same client, any cap should be negotiated and agreed for each commission. Records of the discussion – as well as any correspondence – should be retained, particularly where the other party is not legally represented. Again, it is helpful to include a note of how the cap was calculated.
Further, the level of cap employed in any particular engagement should be determined by reference to the factors that the court takes into account in determining the reasonableness of any liability limitation. If a court is required to consider the