Uncapped Liability-What’s the worst that can happen?

I liken uncapped liability to staring into the abyss of a bottomless money pit. Put simply, failure to cap liability means that there is no limit to the damage a party incurs if things go wrong, and thus no limit to the money to be paid out in respect of that damage.

Liability takes different forms, namely, direct, indirect and consequential. It is not possible in law to exclude or limit liability for death or personal injury. Legally the distinction between “direct” and “indirect” losses is based on what was reasonably foreseeable or what was in the contemplation of the parties at the time when the contract was made. This was confirmed in Hadley & Anor v Baxendale & ors [1854] 9 Exch. 341:

“Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be 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 or such as may be reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result if it.”

(Editor’s “fun” fact: the case of Hadley v Baxendale (which is a firm favourite of every law student) concerned the delivery of a steam engine required to drive a mill…. in Gloucester.)

Unforeseeable loss such as economic loss, loss of profit and loss of saving are generally considered as indirect or consequential loss, also referred to as uninsurable loss. Liability and insurance levels are frequently confused to mean the same but this is not the case. A policy will have a limit on the amount that the insurance will pay out. Once this limit has been reached, no further payments will be made. When a contract does not incorporate a cap and the damages exceed the amount recoverable from the insurance, the damages still have to be paid! Exposure to uninsured loss can amount to catastrophic sums- in the worst cases uncapped liability has sunk businesses!

Suggested liability caps must be discussed and agreed with the other party to the contract. Once agreed it should be included as a written provision of the contract. If this is done correctly, it will provide protection for the term of the limitation period.

If you have managed to negotiate capped liability in your contract, it doesn’t been that you can kick back and relax just yet. When liability has been capped in the contract there is still a risk that a company could get stung via the warranties. It is important to check that any warranties connected to the contract include sufficient wording limiting the liability to the same level as the contract. Without this the warranties could expose your business to open-ended loss.

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These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.