Contracts are legally binding agreements that facilitate the exchange of promises between individuals and businesses. One aspect of contracts that sometimes needs to be considered is which party will pay for certain costs that may eventuate. For example, this might include the consequential financial losses arising from a breach of contract, or losses caused by an unforeseen event (fire, rogue employee etc). These situations can be covered by exclusion and indemnity clauses.

Provisions that cover these situations

There are several provisions that normally account for these types of commercial concerns, including:

  1. Liability provisions (Limitations and Exclusions); and
  2. Indemnity provisions.

The purpose of these provisions is to share or disburse the risk that can sometimes arise out of contractual relationships. These provisions can be very effective tools in reducing the liability and risk, although it is important to have contract lawyer closely review these clauses (if the contract is already drafted) or carefully draft them (if no contract exists yet). The provisions may be overly onerous or overly advantageous to one party or another and a contract review is always important.

It is important to note that there exist other limitations on the way in which these provisions can be drafted that are imposed by the Australian Consumer Law.

Indemnity Clauses

Indemnity clauses typically assure one party that the other party will cover any loss suffered (to an extent).

So, for example, if James buys 100 ovens from Ovens’R’Us Pty Ltd for his hotel, the contract may contain an indemnity clause that states that Oven’R’Us Pty Ltd will pay for any repairs or replacements needed if the ovens are faulty.

Exclusion Clauses (Obligation/Liability)

Exclusions clauses serve two important functions, including:

  1. Specify what duties (or obligations) one party will not need to perform or fulfil; or
  2. Express what expenses (or liabilities) one party will not have to pay.

What is ‘consequential loss’?

Consequential loss refers to losses that may arise indirectly. It is not uncommon for a party to want to avoid liability for these kinds of losses. However, consequential loss clauses are not always clearly defined, in that there is uncertainty surrounding what is direct or indirect loss.

For example, if Ovens’R’Us Pty Ltd is relying on an operative exclusion clause for any consequential loss that may arise if the ovens do not function properly, and James cannot cook food for a month as a result of these broken ovens, which party will pay for these losses? Are they direct or indirect? While one party might argue these losses are consequential, the Courts may disagree and conclude the opposite. The take away from this is that your contract lawyer should draft exclusion clauses with as much specificity as possible.

Limitation Clauses

Instead of avoiding liability entirely for any losses that may arise out of an unforeseeable event, parties will sometimes place a limit, or a cap, on the liability they will incur if a certain event occurs. This is referred to as a limitation of inability clause. This means that an indemnity clause can coexist with a limitation clause, the latter quantifying the former.

James would ideally want an indemnification from Ovens’R’Us Pty Ltd for any loss resulting from the faulty ovens. Ovens’R’Us Pty Ltd might want to give itself protection by having its lawyer insert a limitation clause into the contract. This limitation may be in reference to the amount Ovens’R’Us Pty Ltd may pay in terms of lost profits, which might be capped at the value of the contract.

Risks of Exclusion Clauses

Exclusion clauses need to be carefully drafted so as to be enforceable. Courts will generally adopt a commercial approach to construing contracts. However, in the case of an ambiguous exclusion clause it will be construed contra proferentum –that is to say against the party seeking to rely on the exclusion clause (Darlington Futures Ltd v Delco Aust Pty Ltd (1986) 161 CLR 500)

Conclusion

Both exclusion and indemnity clauses are contractual tools designed to allocate risk between parties. They function in many different ways, such as designating which party will pay for certain losses that may arise. The more ambiguous the exclusion clause, the more likely a Court will be to interpret the clause against the party relying on it. Don’t forget that the Australian Consumer Law cannot be excluded and any attempt to exclude the ACL may result in an unenforceable or void contract, not to mention criminal liability.

For legal advice on the construction of these clauses, contact LegalVision on 1300 544 755.

Lachlan McKnight

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