TCC upholds exclusion of liability for fraudulent breaches of contract

A recent TCC decision has decided that a generally worded exclusion clause was sufficient to exclude liability for fraudulent breaches of contract committed by a party’s employees or the party itself. The Court also concluded that the clause satisfied the reasonableness requirement under the Unfair Contract Terms Act 1977 which applies where commercial parties contract on standard terms. The Court’s findings have significant implications for the negotiation and drafting of exclusion and limitation clauses in commercial contracts generally.

Excluding liability for fraud or wilful misconduct

Generally speaking, the seriousness of a breach of contract does not prevent a clause which would otherwise exclude or limit liability for that breach from taking effect. In the well-known Suisse Atlantique and Photo Production cases, the House of Lords rejected the so-called “doctrine of fundamental breach” which would disable a party from relying on an exclusion clause where a contract had been brought to an end as a result of a fundamental breach of contract, such as by repudiation. Whether an exclusion clause was to be applied to any given breach of contract was held to be purely a matter of contractual interpretation. Although as Lord Wilberforce noted in Suisse Atlantique, the usual rules of contractual interpretation meant “the more radical the breach the clearer must the language be if it is to be covered”.

In the Photo Production case, an employee of a security firm was found to have deliberately lit a fire which caused the destruction of a factory that the firm had been engaged to patrol. The contract contained a clause which stated that “under no circumstances shall [the firm] be responsible for any injurious act or default by any employee of the [firm] unless such act or default could have been foreseen and avoided by the exercise of due diligence on the part of the [firm].” This clause was sufficient to exclude liability for the wilful misconduct of the firm’s employees.

In HIH Casualty and General Insurance Ltd v Chase Manhattan Bank, the House of Lords considered the more extreme case of alleged fraud by an insurance broker. The clause in that case stated that the insured would have “no liability of any nature” for any information provided by third parties, including the broker. As a matter of interpretation, the majority of the House found that this generally worded clause was insufficient to exclude the broker’s fraud and that such an exclusion would need to be expressed “in clear and unmistakeable terms on the face of the contract” (per Lord Bingham of Cornhill).

The House of Lords reserved the question as to whether, as a matter of public policy, a suitably worded clause could exclude liability for the fraud of an agent in procuring a contract. Lord Hoffman noted that there was “no doubt that a party cannot contract that he shall not be liable for his own fraud” but that “whether he can contract that he should not be liable for his agent's fraud is less clear”. Two of the Lords noted a potential distinction in this regard between the fraud of an agent inducing the making of the contract and fraud of an agent in the performance of a valid contract – for example, a clause in a contract of carriage excluding liability for theft of the goods in transit – with fraud in the performance of a contract being less objectionable on public policy grounds.

A recent TCC decision has now decided that a generally worded exclusion clause is capable of excluding liability for fraud by an agent and by a party itself in the performance of a contract (but not its inducement).

Innovate Pharmaceuticals Ltd v University of Portsmouth Higher Education Corporation

Innovate claimed damages from the University of Portsmouth (“UoP”) arising out of a Research Agreement between the parties. Innovate developed a liquid form of aspirin called IP1867B (the “Drug”) which it believed could be used as a brain tumour treatment. UoP were assisting with furthering the research and testing of the Drug.

The Research Agreement contained the following exclusion and limitation of liability clause:  

“11.4 Except as provided in clause 11.5 the University is not liable to the Funders because of any representation (unless fraudulent), or any warranty (express or implied), condition or other term, or any duty at common law, non-observance or non-performance of this Agreement, for … any loss of profits, business, contracts, opportunity, goodwill, revenues, anticipated savings, expenses, costs or other similar loss … and/or any indirect, special or consequential damages or losses (whether for loss of profits or otherwise).

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 lead researcher at UoP published an academic paper in a renowned medical journal, which was alleged by Innovate to have been “infected by errors”. It was Innovate’s case that these errors were deliberate (and dishonest) manipulations of raw data, such that the results were commercially useless to them, and re-testing would have to be carried out. The journal ultimately retracted the paper due to concerns about its content and Innovate brought a claim for damages in excess of £100m.  

In circumstances where the Court found that a large portion of the damages claimed by Innovate were for loss of profits, it had to determine whether the exclusion clause was applicable.  Innovate’s argument in relation to the exclusion clause was twofold:

(a)    the exclusion clause could not apply, because the breach had occurred due to acts of a dishonest or fraudulent nature; and

(b)    even if it were to extend to fraud, the clause would fail the reasonableness test set out by the Unfair Contract Terms Act 1977 (“UCTA”).

Liability for fraudulent breaches excluded

The TCC rejected Innovate’s arguments and found that both clause 11.4 and 11.5 applied to fraudulent breaches of contract. After reviewing a number of previous authorities, the Court formulated the following principles which it considered to be “well established”:

“(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.”

The Court applied the plain literal meaning of clause 11.4 to find that the exclusion of liability in respect of loss of profits was applicable to all claims (death and personal injury claims aside), except where the claim was based upon a fraudulent representation (i.e. a claim in the tort of deceit). This meant that “loss of profits caused by a breach of contract not involving a representation is excluded even if that breach was committed fraudulently.” As Innovate had not advanced a case for fraudulent misrepresentation, its very large loss of profit claim was excluded.  

The Court reached a similar conclusion in relation to clause 11.5 so that claims for breaches of contract (whether fraudulent or not), insofar as they were not excluded by clause 11.4, would be capped at £1m save only for cases of fraudulent misrepresentation or those involving death or personal injury.

Unfair Contract Terms Act

Innovate’s fallback position was that an exclusion of liability for fraudulent breaches of contract would fail to satisfy the reasonableness requirement in UCTA. This requirement applies to exclusion or limitation clauses in contracts based on a party’s standard terms and conditions and to any exclusion or limitation clause relating to liability for negligence.

The Court rejected this argument also, concluding that the exclusions and limitations of liability agreed were reasonable considering the parties had equal bargaining power, that UoP’s payment was very low in comparison to alternative testing agents, and that the Research Agreement had been actively negotiated by a qualified lawyer.

The Court disagreed that the fact the clauses extended to fraudulent breaches of contract made them unreasonable. The Court noted that this would result in the entirety of the clauses being struck down when the allegations of fraud made by Innovate were “highly unusual” and “very unlikely indeed to have been in the contemplation of the parties when the Agreement was concluded”. The Court would be “slow to apply [UCTA] to strike down these clauses because of the occurrence of events outside that contemplation.”

The Court’s findings on clauses 11.4 and 11.5 meant it was unnecessary for it to deal with Innovate’s allegations as to fraud (because those clauses would apply in any event), but the Court nonetheless found that no case of fraud against the UoP or its employees had been made out on the facts.

Conclusions and implications

This is a very significant decision as to the drafting of exclusion and limitation clauses in commercial contracts for a number of reasons:

• The Court’s finding that fraudulent breaches of contract by employees or agents were covered by the clauses in question finds precedent in other cases, but stronger wording was used in those cases. Clause 11.4 contained no words of expansion such as “howsoever arising” or “under no circumstances” which would be indicative of an intention to catch all breaches of contract regardless of the intention with which they were committed. The Court’s finding may therefore suggest that generally worded exclusion or limitation clauses will usually cover fraudulent breaches of contract by employees or agents.
   
• The Court’s finding that fraudulent breaches of contract by a contracting party itself may be excluded or limited would appear to be unprecedented. A number of previous cases have stopped short of a finding that personal fraud in the performance of a contract can be excluded and it is unclear how the Court’s finding is to be reconciled with judicial comments such as those in the HIH case that “a party cannot contract that he shall not be liable for his own fraud”.
   
• The Court’s finding in this regard is all the more prominent for the fact that the wording of clause 11.4, as noted above, is entirely general without any words of expansion. By contrast, one previous case (Regus (UK) Ltd v Epcot Solutions Ltd) involved a similar exclusion clause, but with stronger language, providing that a party would not “in any circumstances have any liability” for loss of profits, business and the like. The use of such language was still, in the Court of Appeal’s judgment, insufficient. Such generally worded clauses would not “naturally be construed as purporting to exclude liability for fraud or wilful damage”.
   
• The Court’s approach to the reasonableness requirement under UCTA also involves novel elements. The reasonableness requirement under UCTA requires the court to consider the circumstances which ought reasonably to have been in the contemplation of the parties at the time the contract was made. However, it is unclear why the Court considered its finding that the parties were very unlikely to have contemplated the types of fraud claims made by Innovate as supportive of the reasonableness requirement. On one view, an exclusion for fraud would be more reasonable where acts of fraud were within contemplation (i.e. if they have a known prevalence within a particular sector or industry).

This case would appear to continue a broad trend among first instance decisions giving effect to generally worded exclusion or limitation clauses even where the breaches of contract in question were alleged to be intentional, repudiatory or fraudulent. For a recent Law-Now on a case involving allegations of repudiatory breaches, please click here.

As noted in previous Law-Nows, the widespread use of generally worded limitation and exclusion clauses makes the outcome reached in these cases of considerable importance to commercial parties contracting under English law. Clauses which seek to specifically exclude liability for fraudulent breaches of contract are unlikely to be acceptable to most counter-parties. Yet without knowledge of the above case law, parties may assume that generally worded clauses will not be capable of extending to such breaches. Such an assumption is likely to be encouraged by the position taken in other well-known jurisdictions where liability for fraud is unable to be excluded on public policy grounds (see, for example, the statement of New York law in Kalisch-Jarcho Inc v New York).

Parties may now be best-advised in many circumstances to insist on carve-outs from exclusion and limitation clauses for intentional, repudiatory or fraudulent breaches of contract. Such carve-outs are commonly seen in sectors, such as the energy industry, where widely drafted exclusions of liability are used. The drafting of these provisions can reach high levels of sophistication, with specificity as to the precise degree of wilfulness required as well as the governance level at which the conduct must be present, and may provide a helpful starting point for parties in other sectors wishing to address the risks posed by the caselaw noted above.

References:

Suisse Atlantique Societe d'Armement Maritime SA v N V Rotterdamsche Kolen Centrale [1967] 1 AC 63

Photo Production Ltd v Securicor Transport Ltd [1980] AC 827

Kalisch-Jarcho Inc v New York, 448 N.E.2d 413, 416 (N.Y. 1983)

HIH Casualty and General Insurance Ltd v Chase Manhattan Bank [2003] UKHL 6

Regus (UK) Ltd v Epcot Solutions Ltd [2008] EWCA Civ 361

Innovate Pharmaceuticals Ltd v University of Portsmouth Higher Education Corporation [2024] EWHC 35