The Rebirth of Limited Liability Clauses?

April 30, 2001

On 23 February 2001, the Court of Appeal handed down its judgment in the caseof Watford Electronics Limited v Sanderson CFL Limited [2001] EWCA Civ 317. Thiswas an appeal against part of an order made on 27 July 2000 by the judge belowwho had been hearing preliminary issues in the Technology and ConstructionCourt. Decisions in the area of IT systems supply are infrequent, and this caseis significant as it upholds the reasonableness of contractual limited liabilityclauses.

The Background Facts

The claimant, Watford Electronics Ltd, ran a business involving the sale ofcomputer products, principally by mail-order. In April 1992 it moved to newpremises, and required an integrated software system which would enable it toexercise greater control over its expanding business. In particular, it needed amore extensive computerised system for mail-order sales, and the handling ofwarehouse stock and accounts. It therefore entered into discussions with thedefendant Sanderson CFL Limited. Sanderson supplied software products, includingin particular a product known as ‘Mailbrain’. This product could be used inconjunction with other products to satisfy Watford’s requirements.Negotiations between the companies took place during 1992, and led to thesigning of three contractual documents. There was a sales contract for thesupply of equipment, a software licence, and a separate software modificationlicence.

All three documents were made subject to Terms and Conditions on the reverse.The Terms and Conditions contained an ‘entire agreement’ clause. This meantthat the parties agreed that the terms of the written agreements represented theentire agreement between the parties, and that no pre-contract statements orrepresentations had been relied upon before entering into the contract. TheTerms and Conditions also contained a ‘limited liability’ clause. This meantthat liability for indirect or consequential losses were excluded, andSanderson’s liability under the contract was limited to the price paid byWatford. The price amounted to £104,596, and included not only the initial costbut also continuing annual licence fees up to the end of 1996.

Unfortunately the system failed to perform satisfactorily despite efforts byboth parties to remedy the defects, and ultimately it was replaced by a newsystem from a different supplier.

The Claim

Watford sued for pre-contract misrepresentation, and breach of contract inrespect of the terms it said were implied into the contract. It said thatSanderson had warranted a level of performance that had not been reached. Thecombined claim was for loss of profits, increased cost of working, and the costof mitigation, amounting to a total of £5.5 million.

Sanderson’s defence relied upon the entire agreement and limited liabilityclauses explained above.

The Issue

The trial judge had found that there was a single contract between theparties, that that contract contained implied terms as pleaded, and that Watfordhad relied upon pre-contract representations. He also held that the UnfairContract Terms Act 1977 (UCTA) applied to the contract, and that the limitedliability clause was unreasonable in its entirety under UCTA – the entireagreement clause being irrelevant to the reasonableness issue. He thereforestruck down the limited liability clause. Sanderson appealed only in respect ofthe decision that the limited liability clause was unreasonable.

The Court of Appeal’s Decision

Precedent requires that an appellate court such as the Court of Appeal shouldnot interfere with a trial judge’s findings unless that judge had proceededupon an erroneous principle, or was plainly and obviously wrong. The Court ofAppeal therefore considered the judge’s approach; their lordships decided thathe had indeed erred in his construction of the contract, and that they couldinterfere. Furthermore they decided that the limited liability clause had twolimbs. The first limb (the exclusion in respect of the indirect or consequentiallosses) had a separate purpose from the second limb (the limitation of liabilityto the price paid). Consequently it could construe both separately within thecontext of the entire agreement clause.

After a long and careful analysis, the Court of Appeal held that thecontractual term excluding indirect and consequential loss was a fair andreasonable one under UCTA and, in that context, limiting liability to the pricepaid was also reasonable. The main factors influencing this conclusion were asfollows:

1. The parties were of equal bargaining power, and therefore should be takento be the best judge both of the commercial fairness of the agreement andwhether the terms of that agreement were reasonable. The court should notinterfere unless it was satisfied that despite this, one party had taken anunfair advantage of the other or that a term was so unreasonable that it couldnot have been properly understood or considered at the time.

2. The key terms of the contract including the entire agreement and limitedliability clauses were subject to negotiation. The parties negotiated as toprice, and Watford as the customer secured substantial reductions. The partiesalso negotiated as to which of them should bear the risk (or the cost ofinsurance against the risk) of making good the loss of profits and otherindirect or consequential loss which Watford might suffer if the product failedto perform as intended. Whilst Watford did not succeed in obtaining theconcessions it wanted, it did obtain an undertaking that Sanderson would use its‘best endeavours’ to allocate appropriate resources to ensuring that theproduct performed according to specification. There was no finding thatSanderson had not used its best endeavours, and in those circumstances Watfordsecured an advantage from that ‘best endeavours’ clause to the extent thatno unfair advantage or lack of understanding by Watford could be justified.

3. Watford’s own terms and conditions contained a similar exclusion clausefor indirect or consequential losses, and this was relevant to the court’sconsideration of whether Sanderson’s terms and conditions were unreasonable.

Case Comments

Whilst no doubt the judgment in Watford will require further examination,initial conclusions are that it represents a further movement away from thehigh-water mark against limited liability clauses reflected in the two casesinvolving International Computers Limited (ICL), namely St Albans DC v ICL[1996] 4 All ER 481 and South West Water v ICL [1999] BLR 420. This movement wasnudged forward by the case of Anglo v Winther Brown (2000) 72 Com LR 118 inMarch 2000, and we can now see from Watford that the court will uphold suchclauses, given the right circumstances.

In St Albans, the Court of Appeal found that the parties were of unequalbargaining power and that, as the defendant ICL had taken out insurance, it wasevident where the risk of loss should fall. In addition ICL’s standard termsof business remained effectively untouched during the negotiations. In SouthWest Water, there was a similar position with respect to ICL’s standard termsof business and, in addition, the ‘entire agreement’ clause purported toexclude liability for misrepresentation. In contrast this was not the case inthe Watford claim, and in addition there was negotiation on the standard termsof business.

In a further case, Peglar Limited v Wang (UK) Limited [2000] BLR 218 inFebruary 2000, the evidence showed the following. First the limitation ofliability clause had been non-negotiable. Secondly there had been no ‘entireagreement’ clause of the Watford type, so that pre-contract misrepresentationswere a factor leading to a finding that the limitation of liability clause wasunreasonable.

In Anglo, the court decided that a limitation of liability clause wasreasonable because the customer had not been obliged to contract on the standardterms and conditions. Furthermore it held that the parties had equal bargainingpower


1. Standard terms and conditions should clearly be made open to negotiation.The negotiations should reflect a clear link between the price at which theparties are prepared to contract, and the placing of risk exposure concerningany unquantifiable claims for indirect or consequential losses which might besuffered by the customer if things go wrong.

2. The inclusion in the contract of an ‘entire agreement’ clause helpsthe court to regard the liability for negligent performance as being contractualin nature, rather than tortious under the rules for recovery of loss fornegligent mistake or misrepresentation.

3. The standard terms and conditions of both parties are relevant in lookingat the factual matrix behind the decision as to the reasonableness of anyexclusion or limitation clause under UCTA. n

Margaret Harvey is a Partner and Nick Rudgard a Solicitor in the Technologyand Intellectual Property Group in Addleshaw Booth & Co.