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Exclusion Clauses Re-Examined

May 2008

What’s happened?

On 15 April 2008 the Court of Appeal handed down its ruling in the case of Regus (UK) Ltd v Epcot Solutions Ltd overturning a High Court decision that had previously caused suppliers considerable concern. The Court of Appeal decision set out some important factors that may be taken into account in determining whether an exclusion clause is enforceable.

The case concerned the reliance by a supplier of serviced office accommodation (Regus) on part of an exclusion clause in its standard terms of business. The part of the exclusion clause in question sought to exclude liability “in any circumstances” for “loss of business, loss of profits, loss of anticipated savings, loss of or damage to data, third party claims or any consequential losses” (the “Exclusion Clause”). A further clause limited Regus’ liability for other losses, damages or expenses to £50,000.

The customer (Epcot) complained to Regus about defective air conditioning in the office, and when this was not fixed by Regus, Epcot stopped paying Regus the service charges due under the agreement. Regus brought proceedings against Epcot for the amounts due to it, and in response, Epcot argued that the failure to provide air conditioning amounted to a breach of contract and counterclaimed for loss of profits, loss of opportunity to develop its business and distress, inconvenience and loss of amenity.

In order to defeat part of Epcot’s claim, Regus had to show that the Exclusion Clause was enforceable – in particular that it was reasonable under the Unfair Contract Terms Act 1977 (UCTA). In a High Court judgement of May 2007, the court had ruled that although in theory it was entirely reasonable for Regus to restrict damages for loss of profits and consequential loss, the clause was unreasonable as a whole as the exclusion was so wide that it effectively left Epcot without a remedy for a basic service such as defective air conditioning. It was therefore unenforceable, leaving Regus exposed.

Regus appealed on the grounds that the High Court judge had been wrong to say that the Exclusion Clause was unreasonable under UCTA and that it should be entitled to limit its liability in that way. The Court of Appeal agreed with Regus and reversed the High Court’s ruling.

What is the purpose and effect of UCTA?

The purpose of UCTA is to protect contracting parties (particularly consumers and business parties contracting on other business parties’ standard terms of business) from onerous contractual provisions such as exclusion and limitation of liability clauses. UCTA imposes limits on the extent to which liability for breach of contract, negligence or other breaches of duty can be avoided in a contract.

Where a clause is contrary to the mandatory restrictions set out in UCTA or is deemed by the court to be “unreasonable”, such a clause will be unenforceable, i.e. the relevant liability cannot be excluded or restricted.

Amongst other restrictions, Section 3 of UCTA is particularly important in the context of business to business contracts where the supplier is dealing on its 'standard terms of business'. This section provides that where a term seeks to exclude or restrict a supplier’s liability for breach of contract, such a term shall only be enforceable to the extent that it satisfies the reasonableness test.

What is the reasonableness test?

According to Section 11(1) of UCTA, in order to pass the reasonableness test, a contract term must have been:

".... a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made".

Schedule 2 to UCTA contains a non-exhaustive list of guidelines in assessing reasonableness, which in practice the courts apply when considering reasonableness in the context of Section 3 of UCTA. Such factors include the strength of the bargaining position of the parties relative to each other; whether the customer received an inducement to agree to a particular term; whether the customer had the opportunity of entering into a similar contract without the term; whether the customer knew or ought to have known of the existence and the extent of the term and whether it was reasonable at the time of the contract to expect that compliance with a term would be practicable.

In addition, under Section 11(4) of UCTA, where a party seeks by contract to restrict its liability to a specified sum of money, the courts will looks at the resources available to that party to meet the liability should it arise and the availability of insurance cover.

Why did the Court of Appeal reverse the High Court’s ruling?

Available Remedies

The Court of Appeal’s view was that, contrary to what the High Court judge had said, certain limited remedies were in fact available to Epcot and had not been excluded by virtue of the Exclusion Clause. In particular, Epcot could seek damages for the diminution in value of the services promised, i.e. the difference in value between the provision of air conditioned and non-air conditioned offices, which could be reflected in a percentage deduction of the fees paid by Epcot for Regus’ services. The cost of relocating to alternative offices or the cost of replacement air-conditioning were other possible remedies.

Assessment of Reasonableness

Rix LJ then went on to consider whether the Exclusion Clause was reasonable in light of the fact that it did not exclude all remedies. Rix LJ decided that the Exclusion Clause was reasonable on the following grounds:

as the High Court judge had said, in principle it was reasonable for Regus to restrict damages for loss of profits and consequential losses from the categories of loss for which it would become liable when in breach of contract;
Epcot’s managing director was an “intelligent and experienced businessman” who was aware of Regus’ standard terms when he had entered into the contract and had contracted before on identical terms;
Epcot had used a similar exclusion of liability for indirect or consequential losses in his own business;
Epcot had sought to re-negotiate terms of the contract frequently and energetically, although not the Exclusion Clause;
there was no inequality of bargaining power. Although Regus was the larger company, Epcot made use of and took advantage of the availability of local competitors of Regus in negotiations; and
the Exclusion Clause advised Regus’ customers to take out insurance for the losses excluded by the Exclusion Clause. Rix LJ felt that Regus’ customers were better placed to insure themselves against their business losses rather than Regus to insure its customers. This was particularly the case as Regus’ customers would frequently change and Regus was very unlikely to be in possession of the level of information relating to its customers which underwriters would require in order to provide insurance. In addition, leaving customers to obtain such insurance would enable them to choose whether, how and at what price they would wish to insure against business losses.

What is the effect of the Court of Appeal’s ruling?

The Court of Appeal ruling will give some comfort to suppliers who had become nervous about excluding all financial losses in their standard terms of business following the High Court’s ruling last year. The Court of Appeal has also provided some helpful guidance as to the sort of factors it will consider in assessing reasonableness. Although the facts will vary from case to case, as can be seen from the above, factors such as the parties’ bargaining strength, the sophistication of the buyer and the question of who is best placed to insure the loss will all be considered. Suppliers could also benefit from including wording in their exclusion clauses advising their customers to purchase insurance for those matters in relation to which the supplier excludes liability.

Julia Jones