Capping Your Liability

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Capping Your Liability

We can help you to understand liability caps.

Contract clauses that 'cap' your liability can help provide some important additional protection if you make an error and a claim for a significant financial loss is made against you.

This is important for any business charging for advice or a service and we can provide you with some basic guidance on the most effective ways of achieving this. We can help your understanding of liability caps, how they relate to your professional indemnity insurance and what issues you need to be aware of when you include these caps in a contract or terms of engagement. We also have access to specialist lawyers who can assist in designing the right words to use.

You may find our guidance note on this subject helpful, which explores the origins of capping liability and examples of how they work in practice.

Guide to Liability Caps and Professional Indemnity Insurance

In this guide we look at the subject of capping or limiting liability, it's relevance for professional indemnity insurance (PI) and what issues to be aware of when capping or limiting liability in a contract or terms of engagement.

What is a liability cap?

A liability cap is a contractual clause or agreement that limits the amount of damages a client can claim from a professional services firm, in the event of negligence or a breach of contract. It means that the client can only claim damages up to the amount specified by the cap, even if the law would otherwise award a greater sum in damages.

Clauses that limit liability are therefore, a very useful and successful risk management tool that professional firms are well-advised to use where possible.

Benkert UK Ltd v Paint Dispensing Ltd

The case of Benkert UK Ltd v Paint Dispensing Ltd considered a limitation of liability clause in a contract between two companies. In this case heard in the Scottish courts, a paint dispensing company was sued following a fire which broke out at a factory causing almost £30 million of damage. Benkert alleged that two paint dispensing machines supplied by Paint Dispensing Limited (PDL) were responsible for the fire breaking out and that the machines had not been properly maintained. PDL resisted the claim and, as part of their defence, relied on a term in their annual maintenance contract which stated that their liability was limited to their annual charge – in this case just £3,225!

This case helps shape the guidance on the ‘reasonableness’ of limitation clauses. You can read a detailed summary of the case on our website. Here’s a link to the relevant web page - Benkert UK Ltd v Paint Dispensing Ltd.

How did they originate?

Initially, the idea of a liability cap became popular with the large accounting firms who audited major public companies. Even a simple mistake could have huge repercussions and trigger claims for tens or even hundreds of millions of pounds.

Given the almost unlimited amounts of damages that could potentially be claimed, it made sense for such firms to ‘cap’ their liabilities.

Before long the usefulness of such clauses was recognised by professional services firms in other sectors, from construction and manufacturing to design and marketing. Now even relatively small companies tend to use them as a matter of course when negotiating contractual terms and conditions.

Do they work?

Yes, they often do work, provided they are used correctly. The courts will often uphold such clauses, especially where sophisticated commercial parties are involved, provided the clause passes the 'reasonable' test.

Types of liability cap

Parties can insert a capping clause into a contract to exclude or restrict their liability to one another in a number of ways.

Some clauses seek to exclude liability altogether. Others put a limit on liability, perhaps by capping the amount of damages payable or restricting the types of loss recoverable or maybe imposing a short time limit for claims.

Liability caps and professional indemnity – how one supports the other

In contract negotiations, clients will generally want to protect themselves by insisting that the other party has an adequate level of pofessional indemnity insurance in place before awarding them any work.

If the other party does not carry PI cover it increases the risk to the client, so in most contract negotiations adequate PI cover is usually a mandatory condition.

PI provides a degree of protection to both parties – it reassures the client that a claim can be met and it also reassures the policyholder that they are indemnified against such a claim. However, it’s possible that the amount of damages claimed could be in excess of the amount covered by the policy and so a liability cap is just an important way of providing a level of extra protection to the policyholder from aggressive claimants. If the cap helps the claim perhaps be imposing a limit below the level of cover, such protection will be looked on favourably by PI insurers and may be rewarded in better terms. So, caps are a good idea.

Setting the level of the liability cap – what is reasonable?

This is where things can get rather complicated. In theory, it is in the interests of a professional services company to exclude as many risks as possible and set a liability cap at a very low level. This gives them excellent protection and will make them very popular with their PI provider. However, there are issues to be aware of.

Firstly, the client is unlikely to accept such terms in a contract – they will almost certainly refuse to take on this amount of risk themselves and they will find a contractor that is more agreeable to sharing the burden equitably.

Secondly, the Unfair Contract Terms Act 1977 (UCTA) imposes limits on the extent to which liability for breach of contract, negligence or other breaches of duty can be avoided using contractual provisions. UCTA makes certain terms ineffective and states that others will only be enforceable to the extent that they are ‘reasonable’.

A detailed review of the UCTA ‘reasonableness test’ is outside the scope of this article. However, factors which a court take into account when considering whether a clause is reasonable include:

  • The parties’ relative negotiating positions when entering the contract
  • Information available when the contract was drawn up, was it clear or discussed
  • The sophistication and knowledge of the parties
  • Limit of the cap relative to the size of the loss

In practice, what this all means is that the lower the cap and the more exclusions, the less likely it will be enforceable.

Can you set the level of the cap lower than your PI cover?

You can set the level of the cap at a lower level than the PI insurance and it is certainly not unusual to do so.

However, you should be mindful of the points above in that if you set a cap too low, or less than the sum provided by the PI policy, it may fail the ‘reasonableness test’.

A good illustration of this is the case of Ampleforth (Claimants) v Turner & Townsend Project Management (Defendants). The court had to review the following limitation clause:

Liability for any negligent failure by TTPM to carry out Our duties under these Terms shall be limited to such liability as is covered by Our Professional Indemnity Insurance Policy terms…and in no event shall Our liability exceed the fees paid to Us or £1 million whichever is the less

Under the terms of their appointment, TTPM agreed to take out PI with a limit of indemnity of £10 million. The court considered whether the limit of liability was reasonable and was entitled to consider TTPM’s insurance cover. The judge ruled that the limit of liability was unreasonable.

If you set a cap that is significantly lower than the cover provided by your PI policy, and don’t make this clear to your client, you could find yourself in a similar situation and find your liability is set by the extent of your PI cover and not by the cap.

Does having PI insurance limit your liability?

As the case above demonstrates, there is a link between your PI insurance and liability caps – but it is a tenuous one. You need to understand that having insurance does not limit your liability to your clients. That’s because they are two entirely separate contracts.

Your contract with your insurer only limits the insurer’s liability, in the event of a claim, to the amount of your cover (subject to specific conditions and any excess).  Your contract with your clients or contractors will not limit your liability there unless there is an express clause to that effect. So, any limit on liability is independent of the level of your insurance cover.

You can have insurance without limiting your liability and you can limit your liability without having insurance. If you don’t have insurance, it is definitely in your interest to limit your liability and prevent a claim making your company insolvent. If you do have insurance, it does not limit your liability – insurance is an asset against which claims can be made, but it won’t prevent a claim from being greater than the amount of your cover.

How does a liability cap work in practice?

Here's an example we've made up to illustrate the difference a cap can make. Brunel & Palmerston (BP) is a surveying partnership with PI cover set at £500,000 each claim. They agree a project contract with Gladstone & Darwin Limited (GDL) to provide surveying advice. The fee charged by BP is £10,000. BP unfortunately makes an error in its advice. GDL suffers a loss and their claim against BP is for £1,250,000.

If there is no liability cap

The insurers agree to pay £500,000 (the full policy limit) leaving BP to find the remaining £750,000 themselves. BP has insufficient funds and the two partners have to sell their houses to fund the deficit.

Fee-based liability cap

BP add a liability cap clause to the contract, limited to three times the fee charged, in this case, £30,000. The reasonableness of the cap is challenged by GDL. The Court agrees that it is unreasonable and sets the cap aside. BP’s liability therefore is unlimited (as in the example above).

Liability cap of £250,000

BP negotiate with GDL and agree a liability cap of £250,000, which is then included in the contract. GDL subsequently challenge the cap. The Court, having considered all the relevant circumstances, upholds the liability cap. BP’s liability is therefore limited to £250,000 and their insurers pay that sum to GDL together with their costs.

Summary

Liability caps and PI insurance can be considered in unison. They can be combined to provide a firm with better protection against risks but must be carefully aligned and considered in the overall context of the contract.

Good legal advice should always be sought form a solicitor on the wording of capping clauses and their usage. Certain professional bodies also provide some very helpful guidance on this subject and if you are a regulated business or belong to a trade association, they may be able to offer advice or specimen documents.

This guidance note is intended for information purposes only. It is not and does not purport to be legal advice or specific insurance advice. Whilst all care was taken to ensure its accuracy at the time of writing it is not to be regarded as a substitute for specific advice. If you require specific advice, please contact your solicitor or insurance adviser. This guidance note shall not be reproduced in any form without our prior permission. © All copyright is owned by Professional Indemnity Insurance Brokers Ltd.