Exclusion clauses in commercial contracts – how far can they go?

Exclusion clauses in commercial contracts

It is common in commercial contracts to apportion risk among the parties. One way this is achieved is through exclusion clauses.

Exclusion clauses might address liability for contractual breaches as well as other types of liability, such as negligence. There are three main types of exclusion clauses:

  • those that exclude the rights a party otherwise enjoys, through the terms of the contract or law;
  • those that restrict the rights of one party, while not necessarily excluding liability of the other; and
  • those that qualify rights by subjecting the rights to specified procedures or preconditions.

While the concept of freedom of contract generally means that exclusion clauses may be valid, there are rules that apply, developed in consideration of the best interests of the public – public policy. However, as with any contractual term, they are subject to classification and construction. Accordingly, care ought to be taken in negotiating and drafting exclusion clauses.

How exclusion clauses are interpreted

The approach of the courts when interpreting exclusion clauses is to construe the clause according to its natural and ordinary meaning in light of the contract as a whole. This requires consideration of the nature and purpose of the contract. The courts have also adopted a strict approach when construing exclusion clauses. This means that it is important that care is taken in drafting to ensure that a term operates as intended.

Where there is ambiguity in a clause, the contra preferentem rule applies so that the clause will be construed against the party seeking to rely on it. In other words, if a clause seeks to exclude a party’s liability entirely but is poorly drafted to make it unclear what types of liability are excluded, a court will interpret the clause in favour of the party that would not benefit from the clause. That is, if the clause is unclear, the court will not enforce it.

Effect of statutes

In addition to the principles of construction adopted by the courts, there are other limitations that apply to exclusion clauses that operate due to statute.

One well known example of a statutory limitation is the operation of section 64 of the Australian Consumer Law (the ACL). This section renders void any term of a contract that seeks to exclude, restrict, or modify a consumer’s rights subject to the consumer guarantee regime. That is, you cannot contract out of the consumer guarantee. However, subject to section 64A of the ACL, it is possible to limit the remedies available where the contract is not for goods or services ordinarily for personal, domestic, or household use.

The ACL also provides protection for consumers from unfair contract terms where that term is found in a standard form contract. This means that if you offer goods or services subject to a standard form contract, a court or tribunal can strike down a term in circumstances in which it is found to be unfair. A term will be unfair:

  • if it causes a significant imbalance in the parties’ rights and obligations;
  • it is not reasonably necessary to protect the legitimate interests of a party advantaged by the term; and
  • it would cause detriment to a party if it were relied upon.

Exclusion clauses that might allow a business to avoid meeting its obligations might be unfair, particularly if reasonable notice is not provided or where the term is not easily understood.

Similarly, an exclusion clause might be considered in light of the Contracts Review Act (1980). Under that legislation, a court might find a term or provision, including an exclusion clause, is unjust, and refuse to enforce such a term.

Excluding or limiting liability – how far can you go?

Although freedom of contract means that parties are, generally, at liberty to decide the terms on which they engage, there are some limitations when it comes to exclusion clauses.

Keeping in mind the approaches of the courts in interpreting exclusion clauses, while it might be tempting to draft a very broad clause excluding ‘all liability’, the courts have been quick to strike out such terms. Accordingly, it is important to take care when drafting your contracts to ensure that any term designed to exclude or limit liability can operate as desired.

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