If things go wrong on construction projects, the financial consequences can be significant. In some cases, the value sought to be recovered by the claimant is disproportionate to the value of the contract in place. All parties will carry insurance against certain liabilities, but with any insurance, this will have a limit of cover, whereas the costs in the case of a claim could exceed these limits.
Often there is a situation whereby the defendant is not the only party working on the project. Therefore from the client’s perspective, they would have to question if they need to have a similar level of liability with each party and if they stipulate a high level of insurance as a requirement across the supply chain. Some parties will not be able to take out such a level of cover, or perhaps this cost will be passed up the line. Therefore, is this a reasonable and efficient way to operate and could it be seen as unreasonable; can it even be effectively implemented?
For clients, the most straightforward way is to issue unlimited liability contracts. But from a supply chain perspective, and for many reasons, parties will seek to limit their liability to the level of insurance they provide or through the application or inclusion of clauses concerning specific exclusions or what they are exempt from in the event of a claim. What are the options, and how does each work?
Standard Forms of Contract and Limitation
Most of the mainstream contracts already contain the provision for limiting the overall liability for consequential losses, which is more prevalent where the contractor is undertaking design works. By way of example, in JCT Design and Build contracts, it states:
“The Contractor’s liability for loss of use, loss of profit or other consequential loss arising in respect of the liability of the Contractor referred to in clause 2.17.1 shall be limited to the amount, if any stated in the Contract Particulars; but such a limitation shall not apply to or be affected by any liability for liquidated damages under clause 2.19.”
Therefore, if the contract value is £250k and the contractor carries PI Insurance at £2m in the aggregate, then if the client states a limitation of £10m, this is not only five times the insured level carried but forty times the contract value. Therefore, whilst the provision remains, as the contractor, you would argue that it is disproportionate. But equally, from the client’s perspective, they may have assessed that if something were to go wrong based on the nature and risk of the work, they could reasonably be expected to incur such losses.
In NEC4 contracts, secondary option clause X18: Limitation of Liability states, “Each of the limits to the Contractor’s liability in this clause applies if a limit is stated in the Contract Data.”
This operates similarly to the JCT Contract, where the limit is included on a contract-by-contract basis. If X18 is not selected, then no limit is stated, and the contract is unlimited by its nature. X18 also excludes excluded matters which, if also selected are 1) delay damages, 2) low-performance damages, and c) the contractors share (of a target cost contract is chosen).
In terms of setting the limit, some are typically based on a flow down from the client’s calculated potential losses, whereas others can be expressed as a percentage of the contract value. Note that where the contract is subject to additional payment for variations, then as the client, you will want to tie in the limit of liability to the final contract value, not the starting one, so ensure you have words to that effect drafted to be included in the contract.
As well as the overarching limitation values stated in contract data for NEC or Contract Particulars in JCT, there are also time bars stated in some events. For example, in NEC contracts stated under clause 61.3:
“if the contractor does not notify a compensation event within 8 weeks of becoming aware that the event has happened the Prices, the Completion Date or a Key Date are not changed unless the event arises from the Project Manager or the Supervisor giving an instruction or notification, issuing a certificate or having an earlier decision.”
Therefore, the obligation lies with the contractor to notify a compensation event within this period or they face missing out on any potential entitlement. The critical element here is the ‘becoming aware’ part. The contractor may argue that, according to clause 15.1, either party may issue an early warning that could have ultimately led to the issuing of a compensation event. Therefore, if the contractor could prove the client was aware of an event but did not notify it, they could have a case to argue against being time-barred but equally, as the clauses are mutually exclusive the obligation of not being time-barred remains with the contractor.
Specific Liability Clauses or ‘Carve Outs’
Typically, these are usually requested by the supply chain when they are in a position of strength, i.e., market forces have dictated the client has a constricted set of suppliers of they are a specialist supplier. Therefore limited options are available for those to do the work. If market forces were the other way round, clients would be more robust in their calls for higher liability limits.
The clauses operate in a way that, instead of capping overall liability through a single clause such as X18, a new clause is drafted and agreed whereby only certain matters are limited and therefore certain matters are excluded from the limit, i.e., they are not liable for losses incurred for one of the stated reasons.
However, it would not be prudent to carve out all liability under such a clause which is why there is a general acceptance that certain events remain included regardless, e.g:
- Negligence or gross negligence
- Bribery, corruption, or fraud
- Deliberate misconduct or recklessness
- Damage to a third-party property
Historically, these clauses can be fraught with issues if they are invoked, usually because of interpretation; therefore, it is vital that the drafting is unambiguous.
For example, suppose a specific liability clause is drafted. In that case, it will need to deal with whether the liability is capped for consequential losses incurred through the contract and in tort, i.e., common law damages. Also, does it exclude or include delay damages or liquidated damages and what about defects? It’s good practice to think about all of the scenarios where losses could be recovered and be explicit about what the carve-out does and doesn’t cover. Also, could the client terminate the contract for a reason stated in the specific liability clause? If they do, will that have a material impact on their ability to recover losses, for example?
Notwithstanding the above, if the points above remain in the contract, i.e., negligence etc., then what is the definition of this, and as the client is the claimant, they would need to prove the contractor was negligent, which is no easy thing. For example, if this relates to design and the contractor demonstrates they have exercised reasonable skill and care in performing their duties. Still, the client believes they have been negligent, and then it may require such an event to be decided by a third party adjudicator.
This relates to in-direct costs incurred as a result of the direct costs of the event. For example, if you think a contractor causes damage to a client’s property as a result of construction activities, then from a loss perspective, they would need to undertake the repairs for which they can not charge the client and would presumably claim on their insurance (dependent on the amount of cost and their insurance excess). However, suppose the client’s premises were forced to close for a period to allow the repairs. In that case, that is a time where they are not taking any revenue and may have to undertake operations at other premises.
The client, in this instance, could be in a position of loss of profit through this period, which is due to the contractors’ actions, i.e., consequential losses. It is an adverse impact on the client’s business due to the fault of others. It should be noted that loss of profit claims is not always categorised as being in-direct or consequential as they are directly linked to the breach and can therefore also be categorised as a direct loss.
Another example may be where a long lead material is needed for a project, and there are known supply chain problems where demand consistently outstrips supply. Therefore, as a contractor, you could seek to add wording to the contract whereby in the event the materials are not delivered on time (and that you have an obligation to install such materials as per your contract) that you are not liable for the consequential losses to the overall programme and the direct losses either.
Consequential loss can be a ‘grey area’ with the parties arguing over what is a direct loss and a consequential loss and where the liability lies. To avoid this, another approach would be to draft a specific wording clause that states what the parties are liable for instead of what they are not. Still, if the list is not exhaustive and something gets missed, you could well find yourself in dispute territory again.
Net Contribution Clauses
As noted above, with most construction projects, there are numerous trades needed to build a project. If there is an issue, such as a defect, it is not uncommon for there to be multiple parties involved or deemed to be responsible for what is in effect a breach of contract.
In such instances, whilst the contract terms will deal with responsibility for correcting the defect, the recovery of losses can be more complicated. The contractor and designer will potentially be liable for costs. They could dispute the charges and blame the other or seek to dispute the apportionment of the costs between the parties. Therefore, net contribution clauses can be used whereby there is an apportionment between the main works contractors and the designers as stated in the contract. This is often a percentage split, typically 70:30, with the larger split against the contractor and the remainder against the design consultant.
However, as we have said above, if other clauses limit liability or do not ensure the elimination of ambiguity, the net contribution clause is paramount as in the event of a dispute, each clause should be read on its own merits, and if they conflict this will leave the intent open to interpretation.
Clients are less in favour of net contribution clauses because, rather than assert there is a case for damages to be recovered as a result of a breach and recover through the contract or in tort, they now have an added obligation to pick which party they believe is liable. Then as the claimant, the risk of proving they are the main party responsible now sits with you, which is unappealing for a client who is the innocent party in proceedings.
Photo by Markus Spiske on Unsplash
About Dean Suttling
A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.