Limitation of liability clauses: Protection even from dishonest or fraudulent breaches?

The case concerned a dispute between Innovate Pharmaceuticals Limited (Innovate), a pharmaceutical company engaged in research and development of medicines, and the University of Portsmouth Higher Education Corporation (UoP), which operates a "Brain Tumour Research Centre of Excellence".  

Innovate holds the patent for a liquid aspirin drug.  The parties entered into an agreement under which UoP would research the impact of the drug on brain tumour treatment (the Agreement).

The claim focussed on the publication of an academic research paper in a well-respected scientific journal, which Innovate alleged had been "infected by errors" which were "the product of dishonesty" on the part of one of UoP's employees.  Innovate claimed that, as a consequence of these errors and the resulting retraction of the paper from the journal (at the request of its editor-in-chief), it would be obliged to carry out a fresh research programme and delay the date from which it could exploit its patent.  The total amount of loss claimed was in excess of £100 million.    

The Agreement included the following exclusion and limitation clauses which were relevant to the claim:

"11.4     Except as provided in clause 11.5 the University is not liable to the Funders because of any representation (unless fraudulent)…for:

any loss of profits…" (the Exclusion Clause); and

"11.5     The liability of a Party to another howsoever arising (including negligence) in respect of or attributable to any breach, non-observance or non-performance of this Agreement or any error or omission (except in the case of death or personal injury or fraudulent misrepresentation) shall be limited to £1 million" (the Limitation Clause).  

The central issue before the Court was whether Innovate could claim more than £1 million and loss of profits on the basis of dishonest breach of contract or it was prevented from doing so by the Limitation Clause and the Exclusion Clause respectively.  

The Court was also asked to consider whether these clauses satisfied the reasonableness test under the Unfair Contract Terms Act 1977 (UCTA), which requires a clause to be:

"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" (the Reasonableness Test).    

Exclusion and limitation of liability

The Court held that Innovate could not claim more than £1 million and could not claim loss of profits for dishonest breach of contract on the basis that:

• the Exclusion Clause was applicable to all claims, except those based on a fraudulent representation;
• the Limitation Clause applied to any claims, other than where the cause of action was for death, personal injury or fraudulent misrepresentation;
• the correct construction was that both clauses preserved liability for fraudulent representation but not for fraudulent breach;
• Innovate's claim was not for losses caused by reliance upon the alleged misrepresentations but was instead a claim for fraudulent breach and, as such, subject to both the Exclusion Clause and the Limitation Clause.

In reaching this decision, the Court considered the authorities on the construction of exclusion and limitation clauses in the context of fraud, noting the following well-established principles:

"(1) Exclusion clauses mean what they say;
(2) It is a matter of construction rather than law as to whether liability for deliberate acts will be excluded;
(3) Limitation clauses are not regarded by the courts with the same hostility as exclusion and indemnity clauses;
(4) A contracting party cannot exclude liability for its own fraud in inducing a contract;
(5) As to whether a clause excludes liability for fraud in performance of a valid contract is a matter of construction of the commercial provisions and risk allocation;
(6) An exclusion or limitation clause is more likely to be construed as effective if it is excluding the liability for fraud of an agent or employee rather than the fraud of the contracting party itself;
(7) The words "howsoever arising" are capable of effecting an exclusion of liability for wilful default."

Points 4 and 5 were of particular note, namely the distinction between fraud in inducing a contract (for which a party cannot exclude liability) versus fraud in performance of the contract (which is a matter of construction of the commercial provisions and risk allocation).  The Court noted the rationale for this from Lord Hoffmann's judgment in Frans Maas (UK) Ltd vs Samsung Electronics (UK) Ltd [2004] EWHC 1502:

"In my respectful view, the reasoning for this difference in approach is at once apparent. Parties do not contemplate fraud in the making of a contract; as observed by Lord Bingham, there would be no deal. But it is another thing altogether to say that parties do not contemplate the risk of deliberate wrongdoing at some point in the performance of a valid contract. That is a matter for construction of the contractual provisions and risk allocation, whether by way of insurance or otherwise."

UCTA

The Court rejected Innovate's claim that the Exclusion Clause and the Limitation Clause did not satisfy the Reasonableness Test under UCTA on the basis that:

• there was no inequality of bargaining power between the parties (a point which was discussed in more detail in Last Bus Ltd (t/a Dublin Coach) v Dawson Group Bus and Coach Ltd, for which please see our summary here); and
• the amount of the claim in this case (over £100 million) versus the amount payable to UoP under the Agreement (£50,000) underlined the commercial reality (or even necessity) of the two clauses.

This decision is fact dependent and will not automatically extrapolate to other cases.  However, in light of the distinction drawn by the Court between fraud inducing a party to enter into a contract (cannot be excluded) and the fraudulent performance of a contract (can be excluded), it is worth parties giving express consideration to whether or not limitation or exclusion clauses will apply to fraudulent and wilful breach of contract.