Limitation clause excluded a party’s liability for loss of profit

27 October 2023

The court found that the exclusion was not subject to the Unfair Contract Terms Act and did not exclude only indirect loss.

The clause appeared in two contracts, which had been based on one party’s standard form of contract but sufficiently negotiated that they were no longer on “standard terms”.

Four key take-aways

  • A business party wishing to rely on a clause in its written standard terms of business excluding liability to another business party for breach of contract can do so only if that clause satisfies the test of “reasonableness” under the Unfair Contract Terms Act 1977.
  • Any variation to a party’s standard terms of business will mean that the parties are no longer dealing on that party’s standard terms and UCTA will not apply in this context.
  • The courts will interpret an exclusion clause using ordinary contractual interpretation principles. However, a court will start from the position that a party does not intend to give up valuable rights unless it has agreed to do so with clear wording.
  • When structuring an exclusion clause, it is important to specify what types of loss and liability are being excluded or limited. In particular, the contract should specify whether both direct and indirect economic loss are being excluded, or merely indirect economic loss.

What happened?

Pinewood Technologies Asia Pacific Ltd v Pinewood Technologies plc [2023] EWHC 2506 (TCC) concerned two reseller agreements made between the claimant (Pinewood Asia) and the defendant (Pinewood Tech).

The agreements set out the framework under which Pinewood Asia would resell Pinewood Tech’s automotive dealer management system (DMS) within certain territories in Asia.

To support Pinewood Asia in doing so, Pinewood Tech agreed to keep Pinewood Asia informed about further releases and development for the DMS, and to ensure the DMS met local legal requirements and vehicle franchise standards. Pinewood Asia argued that Pinewood Tech also owed it an implied obligation to develop items necessary to ensure it could sell the DMS in the local territories.

Pinewood Asia alleged that Pinewood Tech breached these obligations and brought legal proceedings. It claimed that, as a result of the breaches, it was unable to onboard further customers, leading to a loss of profits.

In its defence, Pinewood Tech pointed to a clause in the reseller agreements that stated as follows:

“Subject to Clause 16.1, Pinewood [Tech] excludes, in relation to any liability it may have for breach of this Agreement, negligence under, in the course of or in connection with this Agreement, misrepresentation in connection with this Agreement, or otherwise howsoever arising in connection with this Agreement, any such liability for: (1) special, indirect or consequential loss; (2) loss of profit, bargain, use, expectation, anticipated savings, data, production, business, revenue, contract or goodwill; (3) any costs or expenses, liability, commitment, contract or expenditure incurred in reliance on this Agreement or representations made in connection with this Agreement; or (4) losses suffered by third parties or [Pinewood Asia’s] liability to any third party.”

In particular, Pinewood Tech alleged that paragraph (2) of the clause above excluded any liability on its part for any loss of profit suffered by Pinewood Asia. See box “What is an exclusion clause?” below for more information on exclusion and limitation clauses.

What is an exclusion clause?

An exclusion clause is any term of a contract that attempts to exempt a party from liability.

The term may attempt to remove all liability, no matter the amount, in which case it is typically referred to simply as an exclusion clause.

Alternatively, the term may attempt to pare back the scope of liability in some way, such as by carving out specific sub-types of liability or by restricting liability to a specified monetary amount. In these cases, the term is usually referred to as a limitation clause.

The only difference between an exclusion clause and a limitation clause, in this sense, is the degree or extent to which they restrict a party’s liability. Although that may be a factor in considering whether the term is “reasonable” under the Unfair Contract Terms Act 1977 (UCTA) (see box “What is the effect of the Unfair Contract Terms Act 1977?” below), in all other respects, exclusion clauses and limitation clauses are treated and interpreted in the same way.

In theory, a term can exclude or limit any kind of liability. This could be liability for (for example) negligence, misrepresentation or breach of contract. An exclusion clause can be broad, applying to all kinds of liability, or narrow, excluding only certain types of liability.

However, there are certain types of liability that can never been excluded or limited. These include liability for fraud, liability for death or personal injury arising from negligence (if UCTA applies) and most, if not all, types of criminal liability.

In practice, it is common to structure exclusion and limitation clauses carefully so that it is possible to see which kinds of liability are being excluded. For example, parties might agree to exclude liability for indirect loss, but not for direct loss. Similarly, parties may agree to exclude liability for economic loss but not for physical damage.

When examining exclusion and limitation clauses, the courts will apply standard principles of contractual interpretation.

If a clause is unequivocal and clear, the court will apply it literally. However, the court will not uphold even a clear exclusion clause if it would defeat the main object of a contract or create “commercial absurdity”. This might be the case if a party attempts to exclude all liability of any kind whatsoever, reducing the contract to nothing more than a statement of intent.

If a clause is ambiguous, the court will look at the surrounding text of the contract and the factual context in an attempt to understand what the parties intended to exclude or limit.

Having said that, the courts have historically been prepared to start from the assumption that parties will not cut down or remove their own legal remedies unless they use clear language to that effect. Indeed, the more valuable the right the term attempts to restrict, the clearer the term will need to be.

This has often resulted in courts interpreting exclusion and limitation clauses “narrowly”, so that they exclude or limit liability to the least extent permissible by the wording of the clause.

Pinewood Asia argued that the reseller agreements had been made on Pinewood Tech’s written standard terms. As a result, it said, the Unfair Contract Terms Act 1977 (UCTA) applied and the exclusion Pinewood Tech sought to rely on was enforceable only if it was “reasonable”. Pinewood Asia argued that the exclusion was not reasonable and so Pinewood Tech’s liability for loss of profits was not excluded. See box “What is the effect of the Unfair Contract Terms Act 1977?” below for more information on this.

Finally, Pinewood Asia argued that, even if the exclusion was valid and enforceable, it excluded Pinewood Tech’s liability only for indirect loss of profit, because paragraph (2) had to be read together with and subject to paragraph (1). See box “What are “direct” and “indirect” loss and loss of profit?” below for more information.

What is the effect of the Unfair Contract Terms Act 1977?

The Unfair Contract Terms Act 1977 (UCTA) is designed to moderate and, in some cases, nullify clauses that attempt to limit a party’s liability under a contract. UCTA applies not only to flat-out exclusion and limitation clauses, but also to clauses that have the effect of excluding liability, such as reverse indemnities.

UCTA applies only to business contracts (although it can apply between legal entities and between individuals). Generally speaking, UCTA no longer applies to consumer contracts – these are instead dealt with by the Consumer Rights Act 2015.

UCTA also does not apply to certain specific types of contract, most notably insurance contracts, as well as contracts to transfer land, intellectual property or securities.

As a result, UCTA for the most part applies to goods and services contracts between two businesses – so-called “B2B” contracts. (This can include the sale of an entire business if structured as a sale of its assets and undertaking, rather than a share sale.)

In some cases, UCTA simply outlaws an exclusion or limitation of liability. For example, it is not possible in law to exclude or limit liability for:

  • death or personal injury resulting from negligence; or
  • breach of the implied term in section 12 of the Sale of Goods Act 1979 that the seller of goods has title to the goods.

In other cases, an exclusion or limitation of liability is valid only if it satisfies the “reasonableness” test. For example, a party can exclude or limit the following types of liability, but only if the exclusion or limitation satisfies the reasonableness test:

  • liability for negligence (other than negligence resulting in death or personal injury);
  • liability for their own breach of contract, if the contract is made on that party’s written standard terms of business; or
  • liability for breach of any implied term under section 13, 14 and 15 of the Sale of Goods Act 1979, which all relate to the description or fitness for purposes of goods.

UCTA sets out certain matters which are relevant when deciding whether a clause is reasonable. These include:

  • the strength of the parties’ respective bargaining positions;
  • whether the customer received an inducement to agree to the term;
  • whether the customer knew or ought reasonably to have known of the term; and
  • whether goods were manufactured, processed or adapted to the special order of the customer.

However, this list is not exhaustive, and the court can consider any matter it considers relevant.

The court therefore had to consider the following questions.

  • Did UCTA apply to the reseller agreements? Given that the exclusion clause related to liability for breach of contract, this meant in turn asking: were the reseller agreements on Pinewood Tech’s written standard terms of business?
  • If UCTA did apply, was the exclusion reasonable?
  • If UCTA did not apply, was the exclusion effective? Did it actually, on its wording, exclude liability for all types of loss of profit, or only (as Pinewood Asia alleged) for indirect loss of profit?

Were the reseller agreements on Pinewood Tech’s standard terms?

The court held that the reseller agreements had not been made on Pinewood Tech’s written standard terms of business.

UCTA does not define the term “written standard terms of business”, and so the judge looked at previous case law to understand what this means. She concluded that a contract is on written standard terms if:

  • it comprises a stock of written conditions drawn from as a matter of routine;
  • those terms are used for all, or nearly all, of a party’s contracts of a particular type without alteration;
  • they are adopted or imposed “more or less automatically” without consideration or negotiation specific to the individual case in which they are used; and
  • there have been no more than insubstantial variations to those terms (such as filling in blanks).

In essence, to amount to “written standard terms of business”, the terms need to be used in practice across multiple transactions and undergo no substantive amendment. An agreement that starts out life as a “standard template” or “standard precedent” will not amount to standard terms if it is subsequently altered through negotiation.

In this case, it was clear that the reseller agreements had initially been generated using the standard form of reseller agreement on Pinewood Tech’s systems, which it had used for reselling arrangements in other territories.

However, Pinewood Asia had negotiated a handful of changes to that standard form, including introducing service levels with which Pinewood Tech was to comply, creating a new right of first refusal for Pinewood Asia if Pinewood Tech wished to appoint a reseller in a different territory, and making the prohibition on assignment in the contract reciprocal (rather than merely in Pinewood Tech’s favour).

The judge said that these amendments were “clearly substantive”. As a result, the reseller agreements were not on Pinewood Tech’s standard terms and so UCTA did not apply. The exclusion clause was, therefore, not subject to the “reasonableness test” in UCTA.

One for the lawyers…

In deciding whether there had been substantive variations to Pinewood Tech’s standard form of reseller agreement, the court considered a fourth amendment.

This amendment involved changing an obligation for Pinewood Asia to use “best endeavours” to secure as many customers as possible to one of using “all reasonable endeavours”.

This was not argued before the court, but the judge accepted that this change, taken in isolation, was not material.

There has been a good volume of case law on the meaning of the phrases “reasonable endeavours”, “best endeavours” and “all reasonable endeavours”. Comments from previous cases have suggested that the last two phrases mean, essentially, the same thing.

The fact that the judge, in this case, felt that this change was not material might suggest that she, too, felt that there is little, or no, real distinction between “best endeavours” and “all reasonable endeavours”. However, as what is merely a passing note in a decision on summary judgment, it is important not to place too much emphasis on this.

What was the effect of the exclusion clause?

The court found that the wording of the exclusion clause was clear.

Pinewood Asia had argued that the effect of the clause was to remove any substantive remedy, thus neutering the contract. However, the judge held that the clause did not attempt to exclude all liability under contract, but only certain types of liability set out in the different sub-paragraphs of the clause.

What is more, the court found that the different sub-paragraphs of the exclusion clause were independent and should be read separately. As a result:

  • sub-paragraph (1) excluded Pinewood Tech’s liability for “special, indirect or consequential loss”, namely loss falling within the second limb of Hadley v Baxendale (see box “What are “direct” and “indirect” loss and loss of profit?”), including any indirect loss of profit; and
  • sub-paragraph (2) excluded its liability for all loss of profit, whether indirect or direct.

There was nothing in the exclusion clause to suggest that sub-paragraph (2) was a sub-category of sub-paragraph (1), and the court was not prepared to read such a concept into the clause.

What are “direct” and “indirect” loss and loss of profit?

It is common, in commercial contracts, to see references to the concepts of “direct loss”, “indirect loss” and “consequential loss”.

In law, however, these terms have no real meaning. When it comes to losses arising from a breach of contract, there are only two types of loss, which derive from the case of Hadley v Baxendale [1854] EWHC Exch J70.

  • Losses that flow directly from the breach of contract (the “first limb” of Hadley v Baxendale).
  • Losses that do not flow directly from the breach of contract but which were in the reasonable contemplation of the parties when they entered into the contract (the “second limb” of Hadley v Baxendale).

Case law following Hadley v Baxendale has refined and reshaped these categories to some degree, but the essence of these two types of loss remains today and it is common to refer to the two limbs.

When a contract refers to direct loss, this is usually a reference to the first limb. Similarly, when a contract refers to indirect loss, this is normally a reference to the second limb.

Importantly, these two categories relate not to the way the loss manifests itself in the real world, but rather to how remote the loss is from the breach of contract.

Another way to categorise losses is to describe them by reference to how they manifest themselves in the real world. In this sense, it is possible to distinguish two types of loss.

  • Physical loss or damage. This includes (for example) death or personal injury, damage to buildings or machinery, or damage to goods or property.
  • Economic loss. This includes any loss that does not manifest itself physically. It includes loss of profits, loss of bargain or opportunity, damage to goodwill, and loss in the market value of property (even though there is no physical damage to the property).

Economic loss itself can be pure, in the sense that it arises independently of any physical damage. An example might be damage to a person’s goodwill as a result of using their business name in breach of a covenant not to do so.

Alternatively, economic loss can be consequential, in the sense that it is economic in nature but arises as a result of some physical damage. An example might be a loss of customers and revenue arising as a result of faulty plant or machinery. (The physical loss, by contrast, would be the amount required to repair the plant or machinery.)

In this sense, loss of profit is a type of economic loss, but it could be direct or indirect, as well as “pure” or “consequential”.

However, in all cases, it is important to remember that every contract needs to be interpreted in its own context. Although using familiar terms such as “direct”, “indirect”, “consequential” and “loss of profit” can be useful, there is no guarantee the courts will read the terms in the same way for different contracts.

As a result, the court found that Pinewood Tech’s liability for loss of profit, whether direct or indirect, had been completely excluded. Pinewood Asia’s claim had no real prospect of success and so it was appropriate to grant summary judgment to Pinewood Tech.

What does this mean for me?

This was a decision on an application for summary judgment, so it does not create any new law.

However, the decision is worth noting because it helpfully sets out key principles of law in relation to exclusion and limitation clauses.

It also illustrates some important points when structuring and negotiating exclusion and limitation clauses.

First, it is important to structure exclusion and limitation clauses clearly. In this respect, there are some useful steps a party can take.

  • State clearly what kind of liability is limited. For example, clarify whether the limitation applies to liability in contract, for misrepresentation, for negligence, for any combination of these things, or for any other kind of liability.
  • State clearly what kinds of loss are excluded. For example, clarify whether only indirect loss is excluded, or whether certain types of direct loss are also excluded. (It is unusual to exclude all types of both direct and indirect loss, as this effectively neuters the contract.) State whether the party is excluding economic loss as well as physical loss.
  • Structure the exclusion clause clearly. For example, if excluding both indirect loss and economic loss, it is sensible to use separate sub-paragraphs and, if possible, to clarify that both direct and indirect economic loss are being excluded. This avoids the court potentially reading the phrase “economic loss” (or a particular type of economic loss) alongside with words “indirect loss”.
  • Consider setting out any exceptions. Recent case law tells us that, when interpreting an exclusion clause, the courts will assume that the parties do not intend to exclude any type of liability which it is unlawful to exclude. So, for example, the court will assume that parties do not mean to exclude liability for fraud, even if a clause attempts to limit liability without specifically carving out liability for fraud.

    However, it is nonetheless common to state that exclusions or limitations do not apply to fraud, and some insurers may demand this if they are underwriting liability for breaches of contract (such as under warranty and indemnity (W&I) insurance).

The case also provides useful guidance on when parties are dealing on one party’s written standard terms of business and so when UCTA will apply.

In theory, it may seem tempting for one party to “go along” with other’s standard terms of business so that it can later claim that exclusions or limitations in those terms are unreasonable.

In practice, this is not wise. The fact that UCTA applies to a contract does not automatically mean that any exclusion clauses in that contract are unenforceable. They may nonetheless be reasonable (although the burden of proving this will lie with the person seeking to rely on them).

The fact that a party has had a chance to read the standard terms, including any exclusion or limitation clause, digest them, comment on them and take legal advice on them may well make it difficult for that party to argue later that the clause was unreasonable.

It is far better to engage proactively on any contractual terms and enter into sensible negotiations to reach a position between the parties that is clear and reflects the commercial bargain.

Read the judgment in Pinewood Technologies Asia Pacific Ltd v Pinewood Technologies plc [2023] EWHC 2506 (TCC)