Freedom of contract is a concept that is often discussed in jurisdictions around the world, particularly in common law jurisdictions where contract law – at least as it applies in a commercial context – is still embodied primarily in case law rather than in statute, and adopts a relatively laissez-faire approach to regulating private commercial contracts (i.e. contracts between commercial parties as distinct from consumer contracts).
On occasion, however, the courts and legislatures in common law jurisdictions intervene to impose limitations on the concept of freedom of contract. An example of court intervention is the law governing restraint of trade or non-compete clauses, where the courts have imposed the requirement for such clauses to be reasonable. (For a discussion about non-compete clauses, see Non-compete clauses in China Business Law Journal, March 2015.)
An example of legislative intervention is the law governing exclusion clauses, where statutes impose the requirement for exclusion clauses to be reasonable in certain circumstances. This article examines the law governing exclusion clauses. It starts by defining exclusion clauses, how they work and the various contexts in which they appear. It then examines the legal treatment of exclusion clauses under English law and Chinese law.
What are exclusion clauses?
As their name suggests, exclusion clauses are designed to enable a party to exclude liability for certain consequences that arise in connection with a contract or activities that are governed by contract. Contractual liability may be triggered by a range of factors, including a breach of contract, the commission of a tortious act, such as negligence, or by a defect in the quality of services or goods that are supplied under the contract.
Sometimes the concern of the party who wishes to exclude liability is to limit the scope of the potential liability to which it is exposed. For example, the party may want to limit the scope of liability to direct loss arising out of a breach of contract and to exclude liability for indirect or consequential losses.
Sometimes the concern of the party is to limit the amount for which it is potentially liable and to impose a liability cap. (For a discussion about liability caps in the context of legal services, see Liability caps in China Business Law Journal, May 2014.)
Alternatively, a party may wish to exclude liability altogether.
Exclusion clauses appear in a wide range of contexts. These include sale agreements, where entire agreement clauses exclude liability for statements made before the contract was signed, and supply agreements where a supplier excludes or limits liability for goods and services supplied under the contract. (For a discussion about entire agreement clauses, seeWarranties and misrepresentations in China Business Law Journal, March 2010.)
Exclusion clauses are particularly common in consumer contracts for the sale of retail products, where manufacturers and suppliers exclude or limit their liability for loss arising out of the use or incorrect use of a product. They are also relevant in the context of insurance contracts.
Exclusion clauses are often referred to as exemption clauses and disclaimer clauses.
The legal treatment of exclusion clauses under English law
As in the case of non-compete clauses, the common law (i.e. judge-made law) has traditionally adopted an unfavourable attitude towards exclusion clauses. Although the courts in common law jurisdictions such as England and Australia now apply the normal rules of contractual interpretation when interpreting exclusion clauses, they still impose additional rules. For example, the courts will usually interpret exclusion clauses narrowly. In particular, if the clause is ambiguous, it will be interpreted against the interests of the party who is seeking to rely on the clause. (This concept is reflected in the Latin phrase contra proferentem, meaning “against the provider”.)
There are other rules that the common law applies in interpreting exclusion clauses, particularly in terms of the scope of liability that is excluded. Three examples are particularly important. Firstly, liability for negligence usually will only be excluded if there is an express reference to negligence in the exclusion clause. Secondly, a party cannot exclude or limit liability for its own fraud or for the fraud of its agent in the making of the contract; however, it may be possible to exclude or limit liability of agents or employees in the performance of the contract.
Thirdly, if a party intends to be liable for direct losses but to exclude liability for “indirect and consequential loss”, the courts will interpret the exclusion narrowly. It is therefore important to identify the specific type of loss that is excluded to avoid uncertainty about what type of loss is direct and what type of loss is indirect. Uncertainty may arise in relation to loss of profits, which may be interpreted as being either direct or indirect depending on the circumstances. (For a discussion about the remoteness test that is applied to determine liability for breach of contract generally, see Compensate or indemnity in China Business Law Journal, February 2013.)
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A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia.