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Exclusion Clauses and Dishonesty

Can liability for fraud / dishonesty be contractually excluded?

A recent decision of the High Court has reflected the willingness of the courts to uphold exclusion and limitation clauses, even in what might, at first glance, be thought to be surprising circumstances.

The basic facts of the case in question – Innovation Pharmaceuticals Ltd v University of Portsmouth Higher Education Corporation – were that the university had entered into a research agreement with a pharmaceutical company, whereby it would carry out research on a new drug patented by the company and would produce an academic paper.

Once published, the paper was found to contain various errors and erroneous data – to such an extent that part of the court’s decision was to award £1m in damages to the company, on the basis that the university did not use all reasonable skill and care to ensure the accuracy of the work performed.

The judge was satisfied that the work carried out was, in fact, commercially valueless and that the company was, in principle, entitled to recover the costs of further testing up to a £1m limit.

This was, however, only a small fraction of the sums (exceeding £100m) that the company wanted to claim.

The obstacles that it faced could be found in clauses 11.4 and 11.5 of the research agreement.

By clause 11.4, the university was not to be liable because of any representation made to the company (unless fraudulent) or any warranty given or any condition or any other term or any duty at common law, or for non-observance or non-performance of the agreement, for any loss of profits, business, contracts, opportunity, goodwill, revenues, anticipated savings, expenses, costs or other similar loss. Indirect, special or consequential damages or losses (whether for loss of profits or otherwise) were similarly excluded.

Clause 11.5 went on to say that “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 £1m”

The company issued court proceedings alleging that the university had in fact acted in a dishonest manner in the production of the research. The university denied dishonesty and also defended the claim on the basis that in any event, clauses 11.4 and 11.5 effectively excluded liability for dishonest and fraudulent breaches of contract. The company argued that where fraud / dishonesty was present, the university was not entitled to rely on the exclusion clauses.

On the evidence, the judge accepted that fraud on the part of an agent or employee of the university could suffice in principle, but decided that, in fact, the errors made were not the result of dishonesty, but were simple failures to exercise reasonable skill and care. The judge further ruled that had there been any dishonesty in the performance of the contract, the result would have been the same. In the judge’s view, it was important to note that the carve out in Clause 11.4 in respect of what was fraudulent was limited to representation. As a matter of construction of the clause, the word “fraudulent” applied only to “representation”, not to the words which followed ( i.e“or any warranty (express or implied), condition or other term, or any duty at common law, or under the express terms of this Agreement”). Because the company was not basing its claim on any alleged fraudulent representation or on having acted to its detriment in reliance upon it – there was no such representation, merely alleged dishonest performance – clause 11.4 shielded the university from the company’s claim. The university was able to rely on the principle established in the earlier case of Frans Maas (UK) Limited v Samsung Electronics (UK) Limited that an exclusion clause could effectively exclude liability for losses for fraud in performance of the contract, whilst accepting that liability for a fraud that induces a party into a contract cannot be excluded.

The company’s argument that the exclusion clauses were unreasonable under the Unfair Contract Terms Act 1977 similarly failed. The judge concluded that for the purposes of that Act, the exclusions were reasonable. The contract had been negotiated by lawyers for the two parties (both of which were commercial entities). The company did not simply accept the terms presented to it but actively negotiated aspects of it and made a number of suggested changes to the terms. In terms of bargaining power, there was no inequality between the parties or none which was skewed against the company. The university had agreed to receive only a relatively small sum (£50,000) in payment for performance of the contract, while, on the company’s case, opening itself to potentially much larger liabilities of up to £100 million.

The decision emphasises the potential breadth of application of exclusion clauses, even for fraudulent or dishonest behaviour, and the need for specific rather than broad wording if the scope of exclusion clauses is to be limited.

Disclaimer: this article is not to be relied upon as legal advice. The circumstances of each case differ and legal advice specific to the individual case should always be sought.