An exclusion clause is a clause in a contract which limits or excludes the legal liability of one of its parties. Essentially, it defines the scope of the obligations, duties, rights or liabilities of parties to a contract. Often, a party may try to limit its liability for another party’s loss, such as when it arises out of negligence.
Exclusion clauses can be a powerful tool in legal contracts but they can also present a complex legal hurdle for those drafting them or seeking to rely upon them. At times, exclusion clauses have become void when they are too vague, inconsistent with law or inconsistent with the purpose of the contract. If you want to use these terms to define the limits of your legal responsibility to others, you will need to carefully and correctly draft them to enjoy their intended effects.
What Are Exclusion Clauses?
Exclusion clauses can limit or exclude the liability of a party in multiple ways. One way is by qualifying a legal right, such as by imposing a time limit on a party to exercise their right.
Another way is to restrict a legal right, such as by limiting the types of losses that are able to be recovered. For example, a contract term may state that a party is only liable for direct losses which are a natural result of the negligence but not indirect losses, such as loss of profits. Exclusion clauses can also exclude the rights of a party altogether.
Some common examples of exclusion clauses include:
- Capping the financial liability of a party who acts negligently.
- Excluding liability for certain types of losses arising out of negligence, such as harm to goodwill or reputation.
- Imposing a time limit on a party to bring a claim for negligence, such as by requiring that a claim be brought within 12 months of the negligent act.
- Indemnifying or ‘holding harmless’ another party for their liability in negligence.
- Excluding liability due to force majeure (an unforeseen event which makes it impossible to complete the contract).
How Have Courts Construed Exclusion Clauses?
If your contract ends up before a court in a dispute, your exclusion clauses could be carefully interpreted and scrutinised. Courts will decide whether they are valid or not and how they should be applied in a dispute, despite what you might have intended when you signed the contract. This makes drafting exclusion clauses a very important process.
Courts have generally interpreted exclusion clauses according to the natural and ordinary meaning of the words used in the contract. Exclusion clauses will also be read in light of the entire agreement to understand their wider context.
Generally, interpreting exclusion clauses may include considering the following questions:
- How serious are the rights which have been limited or excluded?
- How serious was the negligence?
- Does the exclusion clause conflict with the overall purpose of the agreement?
- Was the exclusion clause transparent and brought to the other party’s attention?
- What did the parties intend for the exclusion clause to mean when they entered the agreement?
For example, in an Australian court decision concerning an insurance policy, an exclusion clause did not apply because it was too vague. The insurance provider covered a construction company. Its policy contained an exclusion clause which excluded cover for loss or damage where the construction company had provided any professional services to a third party. This was called the ‘professional services exclusion’.
The insurance company argued that the construction company had given professional project management services and that the exclusion clause should apply. The Court had to decide what was considered a ‘professional service’. It found that because project management tasks were a routine activity in a construction company, they were not professional services.
By considering the wider context of the insurer’s business activities, the Court narrowed the application of the exclusion clause. The insurance company therefore was liable to pay. Greater specificity in the exclusion clause could have removed this ambiguity and prevented a court from narrowing the definition of an exclusion clause.
Contra Preferentem Rule
If an exclusion clause is especially ambiguous and it cannot be resolved by context, the clause can work against the party who seeks to rely upon it. This is a last-resort rule known as contra preferentem. Courts can narrow the effect of an exclusion clause and favour the party who is disadvantaged by the clause.
The contra preferentem rule reflects the idea that a disadvantaged party could have interpreted the exclusion clause in several ways. It also shows that courts will not lightly take parties to have carved out their legal duties and responsibilities. Strong and unequivocal language in exclusion clauses is therefore essential.
What Is The Law On Exclusion Clauses?
The Australian Consumer Law (‘ACL’) may also limit the use of exclusion clauses for certain rights and remedies. These rights include consumer guarantees, which are automatic guarantees to a customer that a good or service works and does what you expect it to.
There are many consumer guarantees, such as those which ensure fitness for any disclosed purpose, that goods are of acceptable quality and that services are carried out with due care and skill. If you do not comply with these consumer guarantees, you may have to offer a repair, replacement or refund.
Consumer guarantees are not able to be carved out by a party. The ACL voids any contract term which excludes, restricts or modifies any consumer guarantees for supply of goods or services. It also appears that you cannot contract out of liability from misleading and deceptive conduct in the ACL, although there is mixed opinion on this issue in Australian courts.
The ACL also protects businesses from unfair terms in contracts. Unfair contract terms include those which enable one party, but not another, to avoid or limit their obligations under a ‘standard form contract’. A standard form contract is one where one party may have little negotiating power and is presented with a ‘take it or leave it’ contract.
A term is likely to be unfair if:
- It causes a significant imbalance in the parties’ rights and obligations
- It is not reasonably necessary to protect a party’s interests
- It causes financial or other detriment to another party
- It is not transparent to the disadvantaged party
A court or tribunal may decide that unfair terms are void and will strike it out of a contract. The rest of the contract will continue to operate, insofar as it reasonably can when the unfair term is deleted.
A small business enters into a contract with a larger business which leases and installs office furniture. The contract contains a term which states the larger business is indemnified from all loss or damage arising out of the service, including as a result of the larger business’ negligence.
This term creates a significant imbalance between the two parties. It also does not appear to be reasonably necessary to protect the larger business’ interests. It is likely unfair and could be void.
How Do I Write An Exclusion Clause?
Will the exclusion clauses in your contracts stand up when put to the test? A strong exclusion clause will be specific, unambiguous, clearly explain who accepts liability in the case of negligence, and be consistent with the purpose of the agreement.
Getting these words rights requires careful consideration of any possible meanings that could benefit another party or cause doubt in the eyes of a court. If you need help drafting your exclusion clauses, we can help you! Reach out to us at firstname.lastname@example.org or contact us on 1800 730 617 for a free, no obligation chat.
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